When I went outside this morning to wrangle my goats to milk them, I noticed something had changed.  All of a sudden it was October.  It was chilly in a way that only fall in North Florida could be, slightly drier and more temperate.  While it was a cold, wet summer for the most part, the past few weeks have been the kind of hot we used to in these parts.

It’s been a strange year, normally my goats start going boy-crazy at the end of July, but this year it took until last night for it to finally occur.  I’m not the only one to note this odd behavior in our dairy animals.

It’s similar to the start of Q4 every year in the markets.  All of a sudden people wake up and realize the end of the year is on the horizon and it’s time to get serious about what our opinions are on the state of the markets.

After yesterday’s sell-off, yte U.S. Treasury markets are now the story.  They are dragging all other markets along for whatever ride we are going on.  For years we have been stuck in a binary trade of risk-on vs. risk-off with stocks and foreign currencies on one side and gold and Treasuries on the other.

As a secondary effect of this binary trade over the past eighteen months or so, gold has been tied at the hip to the euro.  Weak euro, weak gold.  Strong euro, strong gold.

This week, however, we’ve seen a significant move in the prices of Treasuries to the downside. And that should be a risk-off trade right?  Gold should be dropping alongside the euro.  But, it’s not this week.  The euro is dropping while gold rallied above $1200 and continues to hold above that level while Treasuries sell off immensely.

10 year monthly.png

And this is supposedly explained simply by tighter and tighter dollar liquidity circumstances because of the Fed raising rates.  But, it isn’t the Fed raising interest rates that’s the proximate cause of this.  Rather, as Jeff Snider at Alhambra Partners keeps reminding us, it is the eurodollar markets which are signaling where big monied interests are handicapping things are going and will go.

And he has many of the same questions I do in this post.

Here we are again. UST yields suddenly burst higher today. Today’s action [wednesday 10/3/2018], however, doesn’t suggest reflation so much as liquidation. A 10 bps move in the 10s is a volatile one. Are UST holders afraid of Jay Powell’s view, or did something else happen?

It is interesting that this takes place while China is closed. And EUR is getting hit, too. Like April, bond yields are up as is the dollar where it really counts. We don’t know what CNY would be at today, but there are pretty consistent indications that it wouldn’t be in the direction of reflation.

Has gold finally begun decoupling from bonds in the risk-off trade because China is closed this week.

Zerohedge noted yesterday that while China sleeps for a week each year, Gold is usually strong, freed from their suppression, and gold as Snider pointed out (see chart above) has been tied to the yuan for a while now against the backdrop of them preparing for a global slowdown.

Something else to consider in this is that with the birth of the petroyuan  futures contract that gold is finding another vector of selling by oil traders booking profits in Shanghai, converting to gold and pulling the money out of the country that way.

That was, after all, the point of the petroyuan futures in the first place.  And given the extreme pressure emerging markets are under given the slowly, but inexorably rising USD gold is caught in the backwash of that need for dollars and oil.

It isn’t like the contract hasn’t been successful because volumes have been brisk since it began trading in March.

It wouldn’t surprise me at all to find that this is one of the way in which “China” has been supporting its emerging market trading partners, listing Iranian and Russian oil on its futures exchange and allowing profit-taking to be converted into gold to get struggling emerging markets (Turkey) or thriving ones (Russia) access to gold to get ‘hard currency’ into their hands to alleviate the effects of Trump’s sanctions and tariffs on dollar liquidity.

The takeaway, however, is that the real market forces, absent this effect, want to see a higher gold prices, decoupled from sovereign debt, as retail investors begin to fear for the future of their political institutions.

Perth Mint recorded huge sales in recent months.

Sales of gold products by the Perth Mint surged in September to their highest since January 2017, while silver sales more than doubled from August to mark an over
two-year peak, boosted by lower bullion prices, the mint said on Wednesday.

Sales of gold coins and minted bars surged 61 percent from August to 62,552 ounces last month, the mint said in a blog post.  Gold sales in September rose about 35 percent from a year-ago period.

Boosted by lower prices or that gnawing feeling that things are beginning to spiral out of control.  The bond markets certainly seem to think there’s something wrong.

For the global sovereign debt crisis to unfold, there has to be a shift in market psychology from sovereign debt being considered a safe-haven asset which stands next to gold to tangible assets.

President Trump’s tariffs and sanctions are providing the public proximate cause of this run on dollars.  The longer the policy persists the more investors fear a liquidity problem.  And that’s when retail wakes up to the reality that gold is how they protect their assets.

Unfortunately, gold is not big enough to absorb those capital flows so at the same time the rotations out of bonds will come with a move into U.S. equities, which is what we are seeing right now, despite the impassioned cries of bears everywhere.

We haven’t seen a blow-off top in U.S. equities.  In fact, we’ve seen the opposite, a rather structured and steady bull market punctuated with brief corrective pauses.

DOW quarterly.png

This week’s new all-time high, from a quarterly perspective is simply a breakout from a weak correction.  Technically, the failure to close above the Q1 high in September puts a limit on the upside here as this could become a false move up before the crash, since three-bar ‘reversal’ signals are notoriously faulty.  But with everything else going on and Treasuries getting slaughtered, this move is real and will require a policy response by the central banks at some point.

But, what’s the Fed’s most likely response to a new high in the DOW?  Higher rates to keep from getting blamed for creating a bubble in equities.  And that fits their agenda of raising rates to assist domestic pension funds which are trillions in arrears.

This is the setup as to why gold is getting bid when the dollar is starting to rise again.  All it will take is for a bombshell political crisis of some form for things to get very ugly, very quick.

My bet’s on Italy.  Where it is obvious the ECB is done trying to scare the Italian government into submission over its budget by intervening today in their bond market after a week of ridiculous volatility.

Italy 5 year.png

Either way, we’ll know if this strength in gold is enough to overcome whatever’s happening in China next week.  If it is then that should set up a harrowing and volatile Q4.

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