Negative Interest Rates & Their Impact On Financial Asset Prices

In an unexpected move very early this past Friday morning (Jan 29th), the Bank of Japan announced that it will cut the rate on current accounts that commercial banks hold with the BoJ to minus 0.1%, adding that it will push this rate even lower if necessary. With this move to a negative interest rate policy (NIRP), the Bank of Japan now joins a half dozen central banks in major countries across Europe with interest rates also below zero. 

When I was a fresh young student at the University of Chicago Graduate School of Business 40 years ago, interest rates below zero were thought to be theoretically impossible. However, here we are in the real world and clearly the impossible is now becoming commonplace. In recent Q&A's following scripted speeches, Federal Reserve Chairman Yellen and influential NY Federal Reserve President William Dudley both said that a negative interest rate policy here in the United States was possible if financial conditions deteriorate enough to warrant such action.

San Francisco Federal Reserve Bank President John Williams told reporters this past Friday that he now sees slightly slower growth, slightly higher unemployment, and about a tenth of a percent lower inflation this year than he had expected in December, when the Fed raised rates for the first time in nearly a decade. The Federal Reserve probably needs to keep U.S. interest rates lower for longer given headwinds from weak global economic growth, a stronger dollar and an unexpectedly sustained drop in oil prices, according to Williams."Standard monetary policy strategy says a little less inflation, maybe a little less growth ... argue for just a smidgen slower process of normalizing rates," Williams said. "We got a little stronger dollar, some mixed data on the economy, some weakness in (fourth-quarter U.S. GDP growth), all of those coming together kind of tell me that we probably need a little bit more monetary accommodation this year than I was thinking in the middle of December." 

All the "ducks" are starting to quack now! The hawkish views that were so "unanimous" following the Fed's interest rate hike in December have quickly receded to the point where almost no one expects more than a single interest rate hike from the Fed for the remainder of 2016, and voices can already be heard around the water coolers on Wall Street that the Fed might actually have to cut rates before year-end. And a 4th round of QE may also be a possibility now!

What does this mean for investors?

For U.S. equity prices, probably flat to higher over the rest of this year. Corporate earnings disappointments coincident with an economy on the verge of (or already in) recession will negatively impact share prices which will tend to offset any potential easing of monetary policy by the Federal Reserve.

For U.S. bond prices, Treasuries will probably represent a reasonable flight-to-safety option, and Treasuries will have scarcity value if talk of another round of QE escalates. Corporate bonds will be plagued by the stigma of  potential bankruptcies in the energy sector, but overall the better credits should do well.

For foreign exchange traders, the U.S. Dollar has been "king of the hill" for almost five years now. After bottoming out in May 2011, the U.S. Dollar Index is up 37% since then. When the BoJ "shocked" the financial markets this past Friday with a negative interest rate policy, the U.S. Dollar Index jumped about 1%. My own feeling is that Fed governors and other Fed presidents like Williams this past Friday will join in a united chorus of dovish speeches over the very near term which will knock down the U.S. Dollar in foreign exchange dealings over the next several quarters. And if QE4 is actually announced by the Fed, then the U.S. Dollar could plunge! 

What's left?

Oh yes, GOLD, precious metals, and related mining shares. I believe that the 4 1/2-year bear market in gold, silver, and related investments is over! Gold prices are already up 5.48% in 2016 (despite a stronger U.S. Dollar!), which far eclipses almost every other investment in terms of performance. The S&P 500 Index is down 5.07% so far this year, and most other major U.S. stock indexes are down even more. Among sector indexes, the NYSE Biotech Index is actually down 24.00% and the KBW Bank Index is down 12.62% year-to-date so far in 2016!

In the interest of full disclosure, my current allocation to precious metals mining shares is approximately 40% in the accounts I manage. This relatively high sector allocation is up from zero % to start the year.

If a picture is worth a 1,000 words, please take a look at the latest monthly chart of the Philadelphia Gold/Silver Stock Index (symbol XAU) which shows a monthly chart buy signal just triggered by my computer trading system for the first time in 18 years (since January 1998). A monthly chart buy signal was also triggered in the Major Gold Miners ETF (symbol GDX) this month (among other buy signals in gold and silver related mining shares).

Philadelphia Gold/Silver Stock Index (XAU) Monthly Chart with Computer-generated Buy & Sell Signals

Major Gold Miners ETF (symbol GDX) Monthly Chart with Computer-generated Buy & Sell Signals

Will The Federal Reserve "Blink" At Its Next FOMC Meeting?

At its December 2015 FOMC meeting, the U.S. Federal Reserve raised interest rates for the first time in almost a decade. While this first hike was only 25 basis points, post-meeting comments from FOMC voting members suggested that eight more 1/4-point hikes would be forthcoming over the next two years.

The U.S. stock market, as measured by the S&P 500 Index, fell sharply in the first three weeks of this new year. If we start with the closing year-end 2015 level of 2043.29 and then compare it to the January 20th intra-day low of 1812.29, the decline was 11.3%. And if we measure the January 20th intra-day low against the May 21st, 2015 all-time high in the S&P 500, then the decline was 15.1%. I don't think it's a stretch to conclude that at least some of investor concerns this year so far have been related to the actual and apparent expected tightening of monetary policy by the Federal Reserve. Don't fight the Fed? Isn't that the best investor advice ever written in the shortest possible words?!! Of course, maybe the collapse in crude oil prices had something to do with the collapse in U.S. stock prices, or lower economic growth in China, or the warm December weather, or the cold January weather. Pick your poison? Maybe it's Donald Trump's fault? You're fired!

I don't think it really matters why U.S. stock prices caved from January 4th through the morning of Wednesday,  January 20th. What matters is where do we go from here? My computer trading system indicates that U.S. stock prices are going higher from here. The rebound from Wednesday's intra-day lows has been meaningful, and I don't think this rebound is a "dead cat bounce". However, right now my own long positions only include energy, commodities, steel, and precious metals stocks. I recently read that over the last six years the best strategy has been to buy the general market (SPX) one week before each FOMC meeting and sell one week after each FOMC meeting. I was stunned by the results in this report. The "buy & hold" portfolio earned about 12% annually while the FOMC "two week" holding period strategy yielded more than double the buy & hold result. I think it's interesting that the U.S. stock market bottomed on Wednesday, January 20th, one week prior to the FOMC meeting this coming week. My best forecast here is that U.S. stock prices will be higher at least through the end of this month and maybe even for a couple of days in early February (consistent with the FOMC trading strategy of buying one week before each meeting and selling one week after each meeting)..

In my last blog dated Sunday, January 17th, I predicted that crude oil prices would bottom out early this past week and that prices would not stay below $30 a barrel for very long. For now, this looks like a pretty decent call. Of course, when prices were collapsing early Wednesday, my energy positions were testing my patience to the limit. However, the rebound in energy prices late Wednesday, Thursday, and Friday was nothing short of spectacular! One of my energy stocks, SM Energy (SM), actually rebounded 60% from Wednesday's intra-day low to Friday's intra-day high! My simple view here is that WTI Crude Oil prices will probably not trade significantly below $30/barrel for the remainder of 2016. $40/ barrel is a reasonable forecast for the current rebound over the near term (120 days), but I suspect prices will overshoot on the upside at one point in 2016. 

While Gold and Silver are among the few winning positions so far in 2016, with gains of 3.4% and 1.4% respectfully so far in January, most of the precious metals mining shares have been poor performers. While I am not sure why gold/silver mining shares have been weak (except ABX & AEM), It's not hard to imagine that the specter of four interest rate hikes this year from the U.S. Federal Reserve and the resulting positive impact of higher U.S. interest rates on the U.S. Dollar may have investors in the precious metals arena just a little bit nervous (understatement!). But what if the Fed backs down this coming Wednesday from its hawkish stance as signaled following its last meeting in December 2015? What will happen to gold and silver prices when investors realize that the U.S. Federal Reserve is NOT going to raise interest rates in 2016, and it may even lower them! And if U.S. economic results continue to disappoint, could the Federal Reserve actually initiate another round of "quantitative easing" (QE4)? For gold and silver prices to rally sharply, all that has to happen is for the FOMC to decide this coming week that maybe four rate hikes this year are off the table for now. While the Fed probably won't announce this action definitively, it probably will convey a much more dovish monetary stance, and gold, silver, and related investments will then surge sharply higher!

Bottom line:

1. The U.S. Dollar looks vulnerable to a major correction

2. Gold and Silver prices look ready to breakout on the upside

3. Gold and Silver mining shares look historically cheap right now

U.S. Dollar Index Daily Chart with Computer-generated Buy & Sell Signals

U.S. Dollar Index Weekly Chart with Computer-generated Buy & Sell Signals

Barrick Gold (ABX) Daily Chart with Computer-generated Buy & Sell Signals

Major Gold Miners Index (GDX) Daily Chart with Computer-generated Buy & Sell Signals

Russell 2000 Index Daily Chart (RUT) with Computer-generated Buy & Sell Signals

Russell 2000 Index Monthly Chart with Computer-generated Buy & Sell Signals

Where Is The Bottom In Crude Oil Prices?

After falling 35% in 2015, crude oil prices are down another 20% so far in 2016. Price action in the futures market this past Friday (01/15) could be described as a selling climax, but the rebound from intra-day lows was probably less than bulls may have hoped for. My own view is that crude oil prices will not trade significantly below $30/barrel for any extended period and that a meaningful rally will begin very early this coming week. I further believe that prices will soon rise above $30/barrel to begin a sustained advance to at least the $40/barrel area.

Much has been made in the financial press of the "flood gates" now open for Iran to add to current global surplus of oil production relative to demand, following the official lifting of sanctions yesterday. There is a widely held view that Iran will immediately add 500,000 barrels per day to global production on the open market, and within 12 months this number will be close to 1,000,000 barrels per day. While I am skeptical of these forecasts, few would argue the fact that this is the widely held consensus view right now.

"Buy the rumor, sell the news!" is a well known trading strategy often used by successful traders. I see the lifting of sanctions on Iran as the exact reverse in terms of timing the bottom in crude oil prices. In other words, we all should have been shorting crude oil on the expectation of the lifting of sanctions against Iran. However, now that sanctions have actually been lifted, shorts need to be covered and new longs established. I am not an oil trader, but this makes sense to me.

Here are a few noteworthy items from the last couple of days relating to crude oil prices:

(1) Jeff Currie, Head of Commodities Research at Goldman Sachs, has been among the most vocal bears on crude oil prices over the last year. Despite skepticism from me in a column several months ago, his incredible forecast of a $20 handle for oil has clearly been met, and his views relating to this particular commodity market must be respected. On Friday, Mr. Currie indicated that crude oil prices may be close to a bottom and that the expected rebound would take prices back to the $40/barrel area by June 2016. 

2. Russia, the world's largest producer of oil and the world's second largest exports at 7.3 million barrels per day in recent months, appears ready to curb production (for a number of different reasons). The Russian "state-owned" oil-pipeline monopoly Transneft said on Friday that Russian companies are likely to cut crude shipments by more than 6% over the course of 2016. This translates into a cut of almost 500,000 barrels per day which represents about 1/3 of the daily excess supply on the global market right now. Since Saudi Arabia has been consistent in its policy statements over the past year that it will NOT reign in production without cooperation from other major Non-OPEC producers to do the same, does Russia's announcement on Friday qualify? In other words, will Saudi Arabia finally curb production (or at least change its bearish rhetoric) in response to the latest Russian comments from Transneft?

3. Today, Bloomberg news reported that Saudi Oil Minister Ali al-Naimi said that crude oil prices will rise and he now foresees that market forces and cooperation among producing nations will lead to renewed stability. "I am optimistic about the future, the return of stability to the global oil markets, the improvement of prices and the cooperation among the major producing countries," al-Naimi said. Saudi Arabia currently produces 10.25 million barrels per day, up 750,000 barrels per day over the past year. Could these comments by Saudi Oil Minister Ali al-Naimi be an immediate "game changer" in the oil markets?

4. In the latest PIMCO "Economic and Market Commentary" blog, dated January 15th, Greg Sharenow makes a solid case for the end of the current downturn in crude oil prices, and perhaps even a compelling case for a decent rebound immediately ahead. Mr. Sharenow says that refinery margins remain robust given incredibly strong demand for gasoline and jet fuel. He also points out that spreads between short-term and long-term crude futures contracts are narrowing, which is apparently bullish. When there is demand weakness or an oversupplied market, usually the nearby contract declines more than the longer term contracts (a widening in spread prices). And most interesting to me from Mr. Sharenow's blog is the fact that WTI crude is now priced higher than Brent crude which has NOT been the case, on balance, since 2010. The reason for this is related to the fact that domestic U.S. onshore production has declined by at least 600,000 barrels per day in the 7 months ending October 2015. And since the data here is available only through October 2015, this production decline is probably significantly higher if we include results from November, December, and January (which have yet to be published).

In the interest of full disclosure, I currently have a 30% portfolio allocation to energy stocks. And if one of my stocks is any indication (SM Energy with a 22% short interest), there may be extreme levels of bearish sentiment by often-wrong investors in this space. Also in the interest of full disclosure, I now have a 40% allocation to a diversified portfolio of gold and silver mining shares. As you can see from one of the charts below, the benchmark Philadelphia Gold/Silver Stock Index (symbol XAU) is now at its lowest level since the year 2000 when gold was priced at $250/oz as compared to its current price near $1,090/oz. Is there value in the mining space right now? I believe that current share prices in the precious metals mining sector now represent what may very well be a "generational" buying opportunity! Unfortunately, for me to be right here, the U.S. Dollar needs to retreat significantly in foreign exchange dealings against most major currencies. Fortunately, my research now indicates that the Greenback is ready for a major downside correction as foreign exchange traders soon begin to realize that the U.S. Federal Reserve will NOT raise interest rates in 2016, and it may even CUT RATES in response to rapidly deteriorating U.S. and global economic data.

Postscript written Monday, January 18th at 11:00 AM CT:

In the latest data released by the U.S. Commodity Futures Trading Commission, for the week ended January 12th, speculator short positions in WTI Crude Oil futures surged 15% to the highest in records dating back to 2006. Net long positions fell to the lowest in more than five years. I view this massive one sided bet as the single best technical indicator that crude oil prices are about to rebound sharply.

Oman is now the first major non-OPEC oil producer to say it would slash its output in coordination with other countries. This morning, Oman's Oil Minister Mohammad bin Hamad al-Rumhy announced that Oman is ready to cut its total crude oil production by 5% to 10% in order to help stabilize prices.

Other OPEC and Non-OPEC producers are soon likely to follow the lead of Russia and now Oman in announcing planned cutbacks in crude production! Can a major rebound in crude oil prices be far behind?

U.S. Dollar Index (symbol DXY) Daily Chart with Computer-generated Buy & Sell Signals

U.S. Dollar Index (symbol DXY) Weekly Chart with Computer-generated Buy & Sell Signals

 

Oil Services ETF (symbol OIH) Daily Chart with Computer-generated Buy & Sell Signals

Oil Services Index (symbol OSX) Monthly Chart with Computer-generating Buy & Sell Signals

Philadelphia Gold/Silver Stock Index (symbol XAU) Monthly Chart with Computer-generated Buy & Sell Signals

Was There A Selling Climax In The Mining Stocks Today?

While most major U.S. stock market averages posted solid gains today, the mining sector saw devastating selling which pushed many equities down 10% or more at their lowest prices intra-day.

Among the more interesting stocks was Freeport McMoran (FCX), a diversified mining stock with exploration activity in copper, gold, natural gas, and crude oil, among other natural resources. This company is heavily leveraged with debt to equity now at 1.89 to 1. With commodity prices sharply lower over the last two years (at least), Freeport McMoran has been a disastrous holding for investors. The company's stock peaked in May 2008 at 127.25. Amazingly, it traded as low as 3.65 today. Yes, that's a 97% loss in equity over the last 8 years. Heck, FCX traded at 39.32 less than 18 months ago! FCX has been involved in three of the worst natural resource areas you can possibly imagine over the last 18 months: Copper, Gold, and Energy!

Wall Street analysts have been tripping all over themselves in recent days to downgrade this hated stock. Jefferies was the latest today, downgrading FCX from Buy to Hold. While it's probably an understatement, I think these downgrades maybe just a little late! In fact, I think a major selling climax was witnessed today in Freeport McMoran and this stock is now a strong buy. At one point today, FCX was down over 15%. However, it rebounded late in the day to close 12.6% above it's intra-day low and only down 4.6% on the day. In the interest of full disclosure, I bought a fairly significant position in FCX today.

A week ago, I had no stocks in any of my managed accounts. I was 90% in cash and 10% in mid-term blue chip bonds. However, over the last three days I have reallocated 2/3's of my cash to mining shares with exploration interests in energy, copper, gold, and silver. Most of this cash was put to work today.

With commodity prices in an apparent free fall on a global basis, what's going to change? Where is the light at the end of the tunnel for shareholders in mining shares? The answer may be as simple as one dovish speech from a single Federal Reserve official. I think it's pretty safe to say that the Fed's plan to hike interest rates four times this year is off the table now. In fact, I wouldn't be at all surprised if the Federal Reserve doesn't hike rates even one time in 2016! 

U.S. Recession In 2016? News Flash: It's Already Begun!

On December 16th, 2015, the Federal Reserve raised interest rates for the first time in almost a decade. While still extremely low by historical standards, the Fed Funds rate was effectively doubled from the old target of a 0.25% cap to the new target cap of 0.50%. Voting members at the Federal Reserve were unanimous despite recent divisions among these policymakers, some of whom preferred to wait until next year to raise rates. While Fed Chair Janet Yellen claims the Federal Reserve will remain "accommodative" in its monetary policy immediately ahead, the "small print" within the Fed's post-December meeting statement suggests otherwise. The median estimate for the targeted Fed Funds rate by current voting members of the Federal Reserve at year-end 2016 is 1.4%; and then to 2.4% by the end of 2017. This implies four separate 1/4-point hikes this coming year and an additional four separate 1/4-point hikes next year.

Quite frankly, I see almost no chance for these kind of rate hikes in 2016 or 2017. In fact, I see at least an even 50-50 probability that the Federal Reserve will actually reverse its latest 1/4-point hike in 2016, and I would not be at all surprised to see negative interest rates at some point over the next two years (in response to deteriorating economic conditions and actual recessionary forces).

Yesterday, the Institute for Supply Management (ISM) released its latest monthly Chicago Purchasing Managers report. The December Chicago PMI plunged to a reading of just 42.9, down 5.8 points from the previous month. This latest reading represented a new 6-1/2 year low and was the seventh contraction this year. It also was far below expectations of a break-even reading of 50. Readings above 50 represent economic growth and readings below 50 represent economic contraction.

The biggest contributor to the decline was a 17.2 point collapse in order backlogs, to 29.4, marking their eleventh consecutive month in contraction. December's reading was the lowest since May 2009. The index also was depressed by ongoing weakness in new orders, which contracted at a faster pace, down 5.3 points to 38.8, the lowest level since May 2009. Both production and employment also fell into contraction (below 50).

While regional indicators like the monthly Chicago PMI don't always reflect the direction of the National economy, this latest completely unexpected negative Chicago report bears more than the usual scrutiny for its implications nationwide.

I see myself as a decent market technician and better than most at reading the "tea leaves" of U.S. and global economic activity, but I can't begin to match Wall Street experts at corporate earnings estimates or supply-chain data flow. I have no "pulse" when it comes to merger and acquisition activity, and the new issue market is a complete blank to me. It was reported today that famed hedge fund manager David Einhorn posted a 20% loss in his flagship fund for all of 2015. I can say with complete certainty that Mr. Einhorn and his expert staff know more than me on almost every valuation measure and metric you can imagine. However, being the smartest person in the room doesn't always guarantee success on Wall Street. In fact, quite simply, I had a better year than Mr. Einhorn and also a better year than the average hedge fund manager who lost approximately 3% in 2015. My rate of return for 2015 on taxable funds under management was +42.58%; for non-taxable funds it was +2.23%; and the blended rate of return on combined funds was +17.54%. However, that was "yesterday", and the keys to the kingdom in this business can be elusive. 2016 is a new year, and what have you done for me lately?

Here are the annual rates of return for the major averages in 2015:

DJIA                                        - 2.23%
DJTA                                      -17.85%
S&P 500                                  - 0.73%
NY Composite                         - 6.42%
Russell 2000                           - 5.71%
Gold/Silver Index (XAU)           -34.14%
Oil Index (XOI)                         -25.20%    
Nasdaq Composite               +  5.73%

While forecasting is always a dangerous game, here are some of my predictions for 2016:

1. With the U.S. economy already in recession (in my view). GDP will actually contract in Q-1 and Q-2 to begin this new year.

2. There will be no interest rate hikes from the Federal Reserve in 2016.

3. Most major U.S. stock market averages will post at least a 15% correction in the first half of 2016.

4. The housing and auto sectors will lead the downturn in the U.S. economy.

5. The U.S. Dollar is vulnerable to a major correction in foreign exchange dealings in 2016. I think the closely watched Dollar Index (DXY) topped out at 100.60 on December 3rd, 2015 and will trade at least 10% lower at one point in 2016.

6. I believe that commodity prices have bottomed, but the expected recovery will be U-shaped and often marked by fits and starts. Copper and steel share prices look interesting to me at current depressed levels, and I am now looking to dip my toes into the energy sector despite the obvious negatives in the supply/demand picture for this arena.

7. Gold and Silver prices will be sharply higher at year-end 2016 as speculators begin to discount lower U.S. interest rates, a weaker U.S. Dollar, and even the possibility of QE4 from the Fed, but I am not ready to bet the ranch on the ultimate bottom just yet. While bearish sentiment is "off the charts" (and therefore bullish if you are a contrarian), the trader in me sees one last short-lived selling spree in these two closely watched precious metals markets.

8. Hillary Clinton will be the next president of the United States. Her victory next November will be viewed as a landslide over her Republican opponent. The perceived mandate from this landslide victory will have dramatic consequences for Wall Street. And the Health Care industry will be shaken to its roots!

Here are three very interesting charts for your review (please note the Red Dot sell signals):

Housing Sector Index (HGX) Weekly Chart with Computer-generated Buy & Sell Signals

Housing Sector Index (HGX) Monthly Chart with Computer-generated Buy & Sell Signals

NY Composite Index Monthly Chart with Computer-generated Buy & Sell Signals