Overdone Treasuries and Metals

Last week we were bullish towards gold, silver, and Treasuries, and this week we are reversing our views towards those markets in the wake of their recent, excessive gains. The perceived Fed pivot combined with similar pivots by other central banks does create a bullish environment, and with the shift in policy after one of the most aggressive rate hike cycles in history, the markets likely need more than just a few sessions to price in the new regime.

However, many markets have overestimated the potential weakness in the US economy. US economic activity has shown significant resiliency throughout the post pandemic era. Inflation is easing, and Fed policy is likely to become a tailwind instead of a headwind. One could argue that recent US scheduled data has been more mixed than weak, with inflation readings consistently moderate. We are not arguing against gold and silver entering an uptrend pattern, but we see action in the dollar and Treasuries becoming less supportive to the metals and possibly undermining them.

Precious Metals

Much of the gains in gold and silver off the October lows were directly tied to hopes for significant losses in the dollar, with the surprisingly large decline in US Treasury rates an added bonus. However, recent economic data suggests the US economy is not as weak as the European economy. And if the US economy continues to exhibit a softening pattern, we would expect to see a wave of recession forecasts for the euro zone. We also think that the slide in the dollar has run its course and that the trade is wrong to think the US Fed will cut rates before other central banks do.

Technical conditions in gold and silver are also flashing red, with both markets maintaining relatively large spec and fund net long positions. Today’s Commitments of Traders report showed these traders were net long 214,838 contracts of gold as of December 12, which is not too far from the 2023 high of 251,980. These traders were also net long 45,530 contracts of silver versus the 2023 high of 55,847.

Another potential problem for the bull camp is the mismatch of timing for a US rate cut. Daily trade sentiment seems to be embracing a US cut in the first quarter, but that was not backed up by Fed dialogue or the CME FedWatch Tool. The FedWatch Tool gives only a 62% chance for the US Fed to cut rates at the end of March.

We suggest traders take a contrarian approach to gold and silver, looking to position for a technical and fundamental correction. Because of the magnitude of recent gains, we suggest traders limit risk by entering bear put spreads as opposed to selling futures outright.

Treasuries

The Treasury markets have also overplayed the paradigm shift by the Fed, with Bond prices up 17 points and 10-Year Notes up 7 points since October. However, both markets have held significant spec and fund net short positions going back to August 2021, and at times the combined net short has been more than 1 million contracts. This suggests that a portion of the recent gains have likely been stop loss buying, and this action has likely resulted in implied Treasury yields falling too far. The US economy continues to show resiliency, and the sharp declines in interest rates and fuel prices and the weakening dollar should take away some growth headwinds.

The bull camp should be concerned about the lack of effort in Washington towards addressing the continuing resolution on the debt ceiling, which is slated to end on January 19. Given recent history, we do not expect them to take up the subject until the last minute, which could produce new threats to credit rating for US debt and pressure US Treasury prices.

Treasury prices are expensive, the bullish euphoria from rate-cut hopes was premature, and the US economy can show resiliency. Given the potential volatility, we suggest would-be shorts use at-the-money bear put spreads to quantify risk in the face of what has been a tectonic shift in fundamentals.

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Originally Published December 15, 2023