Market Update: Year In Review

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Hello everybody and welcome back to Breaking The Dollar. I'm your host, Everett Millman, and this week's episode is going to be a little bit of a market update.

What's been going on with gold silver and in the financial markets recently. And also since we are right around the Thanksgiving holidays, we are in the last month of the year, I'm also going to kind of step back and take a look at the year in review.

So I'll start there with precious metals.

Without a doubt, there's been a pretty big pullback in gold and silver prices over the last, I'd say six weeks. We've seen that more so with silver than gold, and that's a pretty typical trend as silver is definitely the more volatile of the two metals. It tends to follow whatever trend or direction gold is moving, but it does it in kind of an amplified way.

So earlier this summer when the precious metals were at their highs, silver had rallied quite a bit more than gold in percentage terms, and so with this recent pullback, we've seen the same dynamic where silver has posted bigger losses than gold, and so obviously that begs the question, why are we seeing that?

Why are the metals prices going down?

There's a couple of pretty simple, straightforward reasons for that.

One is that prices were really high. In fact, earlier this summer, gold reached its highest point in six years and one of the side effects of that is that it tended to depress demand for gold in places like China and India where retail buyers, the general population, are pretty sensitive to price increases.

So because gold was at its highest level at any time in the past six years, that did put a damper on how much gold jewelry, especially was being bought in India and China during the late fall and early winter.

I saw some data that at one point, late this year, gold was selling at a $50 discount in India, which is a pretty big deal when you think about it. I mean that is a huge discount because people were unwilling to buy at the current prices. So partly the metals were losing momentum.

The other big reason is simply that more investors and traders were moving into the stock market and riskier assets at given time.

There's only so many investment dollars out there chasing different assets. And so if more people are piling into the stock market, that usually does mean you're going to see less money going into other sectors like gold or silver.

And I think that that's another interesting thing to review or take a look at is, what is the stock market been doing?

And in the United States, the U S markets have been rallying to all time highs recently. And for the most part, I think the reasons for that are equally straight forward.

First and foremost, one thing that always drives action in the stock market, are corporate earnings and the third quarter earning season was relatively good.

In most people's opinion, more than 70% of companies beat the expectations for the earnings they reported.

But that's really just the headline and headlines are mostly what people pay attention to. They don't dig a lot deeper.

One of the reasons that earnings beat expectations is that most companies lowered their expectations.

So by setting the bar lower, it was easier to exceed the forecasts. So that's one side of it.

And on the other end, most companies lowered their forward projections for the fourth quarter in 2020 so if you only looked at the top of the line of the reports or if you only looked at the headlines, yes, earning seasons seemed pretty strong and the stock market certainly rallied on that perception.

But upon closer inspection, it really was a mixed bag because most big companies were saying that they do not expect earnings to continue to grow at that pace going forward.

Another reason that the equity markets have rallied is that we've gotten a little bit of optimism when it comes to some of the big macro economic disputes that are going on.

So the two that everyone talks about are the trade war and Brexit. On the Brexit front, really it just became a matter of extending and pretending. They haven't resolved the situation.

The negotiations between the EU and Britain are still kind of stalled, but they at least have not collapsed earlier this summer. There didn't seem to be much hope.

And so I guess you could say that a stabilized situation in terms of Brexit is actually better than what most people had been expecting. So that's helped a little bit.

The trade war has more or less been a tug of war between positive and negative headlines. There have been some indications that the situation is deescalating so that China and the US may lower the tariffs that they've placed on one another, that maybe there will be kind of a step back from the brink and everyone will start to get along a little bit better.

But again, that perception really only comes from the headlines.

The dispute is far from being resolved and it probably is going to drag out for years, but at least at the moment optimism seems to be carrying the day and you do see that with all of the financial news almost every day. In the reporting there will be something about how we're getting close to a deal or the first phase, phase one of the trade deal is close to being finalized, but nothing is materially been done.

Nothing has actually materialized as far as an actual agreement.

It just seems like sort of similar to Brexit, as long as the situation isn't getting worse, everyone is pretty happy about that.

Besides that recent shift towards optimism and something else that I think is playing a very large role in supporting the stock market is the fact that central banks all around the world are continuing to ease monetary policy and what that means is that they are lowering interest rates, they're injecting stimulus into markets.

They're kind of doing everything they can to make sure that stock markets stay afloat.

Now the central bank that gets all the attention for this is the federal reserve and it is true that three times this year the federal reserve has cut interest rates and the fed has also intervened in the overnight lending markets.

Like we talked about on our episode about the repo market panic. But it is not only the fed or the European Central Bank and the People's Bank of China have both gone back into stimulus mode as has the Bank Of Japan.

And those really are the biggest players when it comes to central bank policy.

What's interesting to me and that I will often reiterate is that these types of stimulus measures are becoming the new normal, but they are far from the historical norm. Usually central banks only step in like that when you are on the brink of a recession or already in a recession.

The argument now seems to be that they want to get ahead of the issue, but that still says to me that there are some major risks out there and that markets would not be hitting all time highs if not for those stimulus measures supporting them.

I think it's important that we keep in mind leverage in the global economy is still incredibly high and essentially what I mean by leverage, is the level of debt.

This is another one of those issues that is not just isolated to the United States. It is happening to basically every developed country in the world.

For instance, in China, they are starting to have some problems in their banking system with the high levels of debt and leverage. That type of leverage, in my view is the same reason that we've had some of these problems in the repo market.

I don't think that situation is sustainable, let's say.

At some point all of that debt is going to matter.

Now, the reason it doesn't matter right now is because as long as the world economy is growing, as long as countries are seeing their economies grow, they can continue to service that debt. They can pay the interest on that debt with no problem.

The problem arises if growth begins to slow or you enter a period of contraction where the economy is actually shrinking, then all of that debt does become a big problem.

So for now nobody is really worried about it.

But the most recent forecast for GDP in the U S for the fourth quarter is between 0.3% and 0.4%, that is not very big growth.

Over the past two or three years, GDP growth has been closer to 2% and at times as high as 3% and higher.

So although one quarter of very bad near zero growth like that is not going to cause the whole system to crumble, certainly not, but it's still kind of is a red flag.

It's a warning sign that if we get several quarters in a row of that type of slow growth, then all of that leverage is not going to be as easy to pay off and service.

Another factor that is certainly being taken into account by markets but has not had a major effect yet is the fact that there's a lot of political instability in the world.

I mean you don't have to look far to see it. We certainly have a lot of polarization in the US.

We have the whole impeachment circus going on, and then when you look globally, you have these protests in Hong Kong that are escalating.

There are also ongoing tensions in the middle East for instance, and a lot of normal alliances and relationships are starting to break up.

There's a lot of instability and that's another point that I come back to many times is that in general, political instability is bad for global trade.

It's bad for economic growth.

At some point it's going to be a major drag on the economy.

Aside from all of that, going on a global scale, something that is always interesting to me is a concept in statistics called mean regression, regressing to the mean.

I've brought it up before on the show, but basically it means that in any arena where there are statistics and data and numbers, if something has greatly overperformed or underperformed for a long time, the chances are good that in the near future it will move back toward the other direction.

It will come closer to its average rather than being way too high or way too low.

In some sense, that really is what we saw with the gold price after gold hit a six year high. The most logical place for it to go next was back closer to its average, to pull back toward the mean.

And so that's what I'm looking at with wall street and the stock market right now is not only that the US Stock Market is at an all time high, but that a measurement called the price to earnings ratio is close to historical highs.

And basically all the PE ratio means is that what are stock prices compared to the earnings that companies are reporting.

If the ratio is high like it is now, that means that the underlying earnings probably don't justify that high of a price.

And that ratio has been elevated for quite a long time.

So in terms of mean regression, I would expect that to correct backward and there's only two ways for it to do that.

One would be if earnings were much higher, which is not what companies are forecasting, or two would be that prices of stocks become much lower, which I think is the more likely scenario.

So those are the things that I think traders and investors should really be watching for as we go into 2020 and that dovetails kind of nicely on cue with this week's question from the listeners.

This one comes from LD in Bismarck. LD asks, what do you expect in 2020 for gold?

So for the most part, I think we will see some pretty similar patterns to what we saw this year in 2019.

In short, I think that gold prices will be higher over the next year.

They will probably test $1,600 an ounce because so many of those geopolitical issues that I brought up earlier are not going anywhere.

They're not getting any better and although supply and demand obviously matters for gold, gold is kind of unique in that it is very sensitive to the narrative and sentiment around what's going on in the world politically. What's going on with the global economy. Not just the economy of any one country.

And in that sense, if we do see global growth continue to slow down, if we continue to see tensions rise between trade partners, all of that is ultimately positive for gold because when investors are fearful that those types of things are happening, they usually buy gold.

That wraps it up for this week's episode. Really appreciate everybody tuning in. Thank you so much for listening.

Be sure to check out next week's episode where I will be jumping into what are platinum and palladium, the two forgotten precious metals. Nobody really talks about them, so you will want to check that out.

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The views and opinions expressed on the show are for informational purposes only and should not be used or construed as professional investment advice.