Although gold and the gold miners started 2014 with a big rally, ever since the end of February they have sagged badly.
Gold chart</a> </div>
The gold mining stocks have fared no differently.
GDX Gold Miner ETF</a> </div>
Although I was lucky enough to have jettisoned my long nicely into the rally, I was too eager to replace it on the subsequent pullback. I have been lugging around a GDX position since the high 24s.
I am still bullish, but I am aware that so far, the market is not agreeing with my position.
But yesterday for the first time in a long while, I saw some action that really piqued my interest.
The junior gold miner ETF GDXJ had a strangely big rally. Have a look at how it performed versus the more senior GDX.
GDX (yellow line) vs. GDXJ (white bar)</a> </div>
I am not sure if I am reading too much into this outperformance, but it certainly felt for the first time in a while that the path of least of resistance for the GDX and GDXJ was higher, not lower.
I am going to add to my gold stock position by adding a little GDXJ to the mix.
Fed taper schedule
A week from today the Fed will meet for the fourth time this year. The overwhelming consensus is that they will continue with their telegraphed tapering schedule and reduce their asset purchases by $10 billion.
If they continue with the $10 billion per meeting, that means that the December 17th meeting will be the final sign off for the QE3 program.
|FOMC Meeting||Taper Amount||QE for period|
|June 18th||$10 billion||$35 billion|
|July 30th||$10 billion||$25 billion|
|September 17th||$10 billion||$15 billion|
|October 29th||$10 billion||$5 billion|
|December 17th||$5 billion||zero|
There is some debate about whether the Fed will reduce the QE purchases by $15 billion on the October 29th meeting, or whether they will wait to December for the last $5 billion.
My guess is that the they will do $15 billion in October. The Fed is looking for excuses to get policy on a more normal trajectory and they will take any opportunity they can to quickly wind down the QE program.
In fact, I think there is a decently large contingent within the Fed that want to start raising rates sooner rather than later.
If that is the case, then the timing of the last $10 or $15 billion taper is important. Assuming the Fed wants to wind down QE before raising rates, then their choice for that extra $5 billion odd lot affects whether we get rate hikes in 2014 or not.
Right now the market is no where near ready for the Fed raising rates anytime soon.
When the Fed first introduced the tapering, the market went into a tizzy extrapolating an aggressive rate rising campaign. The Fed then needed to convince the market that “tapering wasn’t tightening.” Since then the Fed has been successful at squeezing out the shorts that had been aggressively pushing rates higher.
Now we are back to square one. Rates are too low and the Fed needs to eventually start weaning the economy off the ZIRP policy.
But the moment the Fed starts to talk about raising rates, the market will once again extrapolate much higher rates.
According to the Taylor rule, the Fed should have already raised rates to 1.84%.
Fed policy is too loose, and as the economy improves, it will only get looser the longer it stays stuck to zero.
By this fall, I expect that the continuing recovery will be gathering steam and the Fed will be playing catch up as the curve backs up ahead of them.
The recent bond market short squeeze is only going to make the eventual adjustment all the more difficult. There will be less bids in the market as the bond bear rears its head.
I was perplexed at the severity of the recent bond market rally, but I think it was simply a case of too many hedge funds trying to front run the Fed. Once the Fed convinced them that rate hikes were not going to come as soon as they feared, they forced the hedge funds to cover.
I think that once again, the hedgies will prove to be zigging when they should have been zagging.
There are more and more signs that the bond market rally has been a head fake.
The Sep 2016 Eurodollar contract that I like to watch has already given back 30 basis points from the short squeeze highs:
Sep 2016 Eurodollar contract</a> </div>
Have a look at this chart of the ratio of the Dow Jones transports versus the utilities. Traditionally this ratio has tracked US yields very closely.
Dow Jones Transportation/Utilities Ratio vs US 10 Year yields</a> </div>
For the past month this ratio has been screaming higher. It was only recently that yields have reluctantly finally decided to follow.
Yesterday I saw the first market pundit call for an increase in the tapering pace at this next FOMC meeting. Although I think this is a little premature, I do think that the bond market will be on offer for some time to come.
Last month’s bond market rally has likely been the last gasp of the multi-decade long bond bull market.
The Fed has boxed themselves into quite a conundrum. This recent bond market short squeeze has only made that difficult situation all the worse.
I am short bonds and will press in the coming months if the market agrees with my assessment.