Gold and Oil Prices: Ready to Go Up Again?

Key Concepts

• Economic Policy Uncertainty (EPU): A measure of uncertainty surrounding government economic policies, impacting investment and trade.
• PMI (Purchasing Managers' Index): An indicator of economic health, with values above 50 indicating expansion and below 50 indicating contraction.
• Quantitative Easing (QE): A monetary policy where a central bank purchases government bonds or other assets to increase the money supply and lower interest rates.
• Shadow Fleet: A network of tankers used to transport oil, often bypassing sanctions.
• Deglobalization: The process of diminishing interdependence and integration between national economies.
• NFP (Non-Farm Payroll): A measure of the number of jobs added or lost in the US economy, excluding farm employment.
• Fed Chair Kevin Walsh Nomination: The potential appointment of Kevin Walsh as the next Fed Chair, impacting market expectations regarding monetary policy.

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Market Performance & Economic Data Review (Last Week)

Last week saw relatively muted stock market performance, with the S&P 500 gaining 0.3% (following a 0.4% decline the prior week) and the NASDAQ declining 0.3% (after a 0.2% gain). The 10-year Treasury yield increased slightly by 0.2%, while yields at the front end remained “soggy.” Despite evidence of economic improvement, the Federal Reserve maintains a bias towards potential rate cuts, with Fed Chair Powell stating “nobody on the committee expects that this is the time to be hiking rates” and the “base case is still that uh there's some amount of easing that's on the menu for this year.”

Crude Oil Price Surge

A significant trend is developing in crude oil prices, with a 6.8% increase last week following a 2.9% rise the week before. This is attributed to disruptions in illicit oil supplies to China, specifically sanctions-busting oil from Iran, Russia, and Venezuela. Factors contributing to this disruption include:

• Internal unrest in Iran: A popular uprising since December 28th is impacting Iranian crude supply reliability. Iran is seeking dialogue with the US.
• US & French enforcement against shadow fleets: The US has seized six tankers, and France one, targeting vessels circumventing sanctions.
• Venezuela’s pricing: China is potentially being forced to purchase Venezuelan crude at market prices, rather than discounted rates.

Approximately one-fifth of global oil supply is estimated to be from these shadow fleets, with China as the primary buyer. If China needs to replace this supply with purchases from Saudi Arabia, the Gulf states, Iraq, Brazil, or Ghana, it will face higher prices and potentially contribute to an oil glut scenario not currently reflected in market behavior.

Gold Market Volatility & Fed Chair Nomination

Gold experienced a pullback last week, declining 4.7% after a prior week’s surge of 8.4%. This decline coincided with the announcement of Donald Trump’s intention to nominate Kevin Walsh, a former Fed Governor, as the next Fed Chair. The market reaction suggests investors are focusing on Walsh’s long-standing hawkish stance on monetary policy, despite his recent dovish rhetoric.

Walsh has historically advocated for shrinking the Fed’s balance sheet and reducing QE, potentially leading to liquidity contraction, a stronger dollar, and weaker precious metals. However, the long-term narrative for gold remains tied to its role as a non-sovereign wealth transfer mechanism in a deglobalizing world with increasing currency policy competition.

Currency Movements & Bitcoin Performance

The US dollar weakened slightly last week, with the euro up 0.5% and the yen up 0.8%, though the dollar partially recovered following the Walsh nomination news. Bitcoin continued its decline, falling 6.4% and demonstrating it is neither a risk asset nor a safe haven.

Upcoming Economic Events & Central Bank Policy

The coming week features significant event risk, including:

• Reserve Bank of Australia (RBA): Expected to raise rates from 3.6% to 3.85% due to strong economic performance and building inflationary pressure, with further tightening anticipated.
• Bank of England & ECB: Markets anticipate 37 basis points of rate cuts from the Bank of England this year, while the ECB is not expected to change rates.
• US Economic Data:
  • ISM Manufacturing PMI: Surged to 59, the strongest reading since mid-2022, indicating a robust manufacturing sector. Prices component rose to 59, but inflation remains relatively contained.
  • ISM Services PMI: Expected to cool slightly.
  • US Jobs Report (BLS): Forecasts a 70k increase in non-farm payrolls, with the unemployment rate holding steady at 4.4%.

Fed Policy & Market Expectations

The strong economic data, particularly the manufacturing PMI, may weaken the case for near-term rate cuts by the Fed. However, markets remain positioned for 48 basis points of cuts this year, anticipating the first cut in June and a second in October, while the Fed forecasts only one cut. This divergence is attributed to high levels of economic policy uncertainty.

Economic Policy Uncertainty & Deglobalization

The Economic Policy Uncertainty (EPU) index is at its highest level since the COVID-19 pandemic and 1985, driven by trade policy uncertainty and broader geopolitical tensions. This uncertainty is cooling economic activity and challenging the AI-driven narrative in stock markets, which relies on frictionless global trade.

The global supply chain is distributed as follows: 38% in North America, 24% in Europe, and 26% in APAC, with key dependencies on countries like Taiwan, Korea, Japan, and China. Disruptions to this supply chain due to trade tensions threaten the AI narrative.

Trading Strategy & Outlook

The speaker maintains short positions in the US dollar against the pound, euro, and Canadian dollar, anticipating dollar weakness. They have initiated short positions in gold puts (expecting volatility to decrease with a bullish bias), short Bitcoin via put verticals, short bonds via put verticals (expecting yields to rise), and short positions in the NASDAQ and S&P 500. They are long oil, based on the expectation of continued inflationary pressure and fewer rate cuts.

The speaker concludes that if economic data remains stable, the markets may react negatively to the lack of justification for rate cuts, despite their desire for them.

Quote: “nobody on the committee expects that this is the time to be hiking rates and that the base case is still that uh there's some amount of easing that's on the menu for this year.” - Fed Chair Powell.