Dollar Strength Threatens Our Precious Metals Ratings

Precious metals are an important part of our asset allocation:

• We currently have Buy ratings of 7 on GLD, SLV and GDX
• Our bullishness on precious metals was rewarded late last year given the Fed pivot

However, precious metals are down 2.5% in 2024. The weakness has mainly been due to the strengthening of the dollar:

• The dollar has been closely tracking Fed rate expectations
• Excitement around a Fed pivot led to a selloff in the dollar, making it oversold
• Recent Fed comments referencing inflation falling without hurting the labor market weakened the case for big Fed cuts in ‘24
• That led to a snap-back higher in the dollar, impacting precious metals

As a result, GLD and SLV are trading close to our stop-losses, with GDX having broken through it.

From a technical standpoint, the dollar is bouncing off support and could have a bit more runway to strengthen before it hits key resistance (i.e., anywhere between 1.8% to 3.6% appreciation).

That will depend on how the economic data progresses from here. If inflation keeps falling without a downturn, the Fed may be less aggressive in cutting rates than the market is expecting.

That said, the dollar has already risen back to a level more consistent with Fed rate expectations. As a result, we believe downside risk should be smaller for precious metals in the near-term.

We expect the dollar to weaken materially as a recession becomes more evident, benefiting precious metals. We’ll keep you updated on developments in the dollar in coming weeks.

A couple of important development took place since our last ratings post:

• Upgrading TLT to a Strong Buy rating of 9 from an 8, capitalizing on recent price weakness
• Downgrading XLU to Neutral from 7 due to price breaking below our stop-loss
• Upgrading XLK to Neutral from 4 as it broke out through channel resistance

Ratings:

Assets:

Gold Miners (GDX ETF)

Rating = Buy (7)

• GDX broke through our stop-loss of $29.37 driven by weakness in gold and narrowing market breadth. While the S&P 500 is up in 2024, the share of stocks trading above their 200-DMA has dropped from 80% to 70%. GDX is a function of both gold prices and market breadth.

• While our stop-loss was triggered, we want to be a bit more patient given the favorable macro backdrop for gold prices and our expectation that equities will continue their technical breakout in the first-half, following some weakness in January and February.
• As a result, we’re not yet downgrading it given that the GDX/S&P 500 ratio has fallen to key support, a development we mentioned was possible in our asset ratings report last week. With the ratio at support, we don’t think it’s an objective time to get out of the trade.
• We’ll be monitoring how GDX reacts at this critical level of support. If it breaks down, we’ll downgrade to a Neutral stance and wait for a more opportunistic entry.

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Utilities Stocks (XLU ETF)

Rating = Neutral (5)

• We’re downgrading XLU to a Neutral stance from a 7. Significant price weakness in recent trading sessions saw XLU break below our stop-loss of $63.
• Rising interest rates on the back of hawkish Fed speak and strong economic data played a role given that Utilities are anticorrelated with interest rates.

• The recent weakness in XLU relative to the S&P 500 has seen the monthly XLU/S&P 500 ratio break through multi-year support. It’s possible that price reverts to trade above support before the monthly close. That’d be a buying opportunity for investors looking to add a cheap hedge.
• If the XLU/S&P 500 ratio holds support by month-end, we’d likely re-enter the trade given Utilities’ very attractive valuations and much more favorable risk-reward.

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Equally-Weighted Tech Stocks (RSPT ETF)

Rating = Neutral (5)

• We’re monitoring RSPT as a tentative bet on U.S. equities. While we believe that U.S. stocks are expensive, RSPT offers growth at a more reasonable price than XLK for example.
• RSPT offers a way to bet on the secular tailwinds powering Tech but without the vulnerability that comes with expensive P/E ratios. We see it as a more calculated bet on U.S. equities.
• It could prove a successful buy following a short-term tactical pullback on the S&P 500 as we expect. We remain at a Neutral rating in RSPT until we find a more opportunistic entry.

• One way of gauging the attractiveness of an entry on RSPT is to look at the RSPT/SPX ratio. It currently stands near resistance, making an objective entry on RSPT difficult to justify.
• We’d be more willing to upgrade RSPT on a re-test of channel support, particularly if it coincides with multi-year uptrend support.

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Technology Stocks (XLK ETF)

Rating = Neutral (5)

• We’re upgrading XLK to a Neutral stance as it broke out through channel resistance on Friday. This had been a level we’d been monitoring for several weeks, and our expectation was that XLK would be rejected at this level given how overextended it looked.
• It’s possible that momentum gets exhausted and that this ultimately proves to be a false breakout. When XLK breaks back below channel resistance, which we expect will occur when the S&P 500 pulls back, we’d likely re-initiate our short position.
• As we mentioned in our most recent S&P 500 Memo, we believe the odds favor a tactical pullback in the S&P 500 in the January-February period, and will likely be downgrading the S&P 500 soon.

• A melt-up in Tech stocks is something we considered was possible in a Fed pivot. The gains in Tech are being driven by euphoria around AI again. Last week, Taiwan Semiconductor Manufacturing (TSMC) provided a very bullish outlook for semiconductors on the back of a boom in demand for generative AI.
• The stocks may have a bit more of outperformance left in the tank based on the XLK/S&P 500 ratio approaching a key level of resistance, as we’ve commented in recent asset ratings posts. We expect a reversal in XLK after the ratio re-tests that key level.

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Treasury Bonds (TLT ETF)

Rating = Strong Buy (9)

• We’re upgrading TLT to a Strong Buy rating of 9 from an 8, capitalizing on the recent weakness that’s brought it to key support.
• Strong economic data and hawkish Fed commentary have driven Treasury yields higher recently, negatively impacting TLT and creating a buying opportunity in our view.
• TLT represents our highest conviction bet and we expect it to significantly outperform the S&P 500 as the economy enters a recession in the second-half of 2024.
• A breakdown of support would indicate a false breakout in recent weeks, putting into question that the Fed has pivoted and increasing the risk of further downside. Our stop-loss is set at $92.

• The S&P 500/TLT ratio has been in a channel structure throughout the entirety of the Fed tightening episode. It’s been a well-respected pattern, although a false breakout occurred in October 2023 as concerns around a potential U.S. fiscal crisis erupted.
• The ratio is now back at resistance, creating an objective buying opportunity for TLT relative to stocks. A breakout in this ratio would invalidate the S&P 500/TLT price channel’s usefulness.

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Copper

Rating = Buy (7)

• Price momentum in copper has weakened recently, breaking through trendline support. Like the case with precious metals, the strengthening in the dollar has been a headwind.
• We’ve been bullish on copper as a bet on China deploying fiscal stimulus, making it an uncorrelated bet with U.S. equities. That outcome would see the dollar weaken significantly.
• We remain constructive on copper as long as it trades above $3.67. A breakdown from that level would see us turn Neutral.

• Our bet on copper is highly sensitive to the dollar. In fact, copper is now as negatively-correlated to the dollar as silver is. That’s because tight Fed policy has become a major headwind for global manufacturing, impacting the demand for copper.
• In the post-Covid years, copper has become increasingly more anti-correlated with the moves in the dollar. Oil, on the other hand, has become much less correlated (zero correlation today).

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Oil

Rating = Sell (4)

• Oil prices are now re-testing downtrend resistance. A break above it would weaken the bearish technical picture (at least in the short-term), and hence we’d likely revert our Sell rating of 4 back to Neutral until a more favorable shorting opportunity appears.
• Price momentum remains weak, with oil continuing to trade below various moving averages. However, an escalation in geopolitical risks, that have expanded to include cross-border confrontations between Iran and Pakistan, could see oil prices shoot up quickly.

• We expect significant downside in oil prices given our view of a recession materializing this year. As oil becomes more volatile around recessions, the fall in prices could happen quickly and aggressively. We’re trying to position ourselves to capture the bulk of this move.
• A Fed pivot represents a risk to our bearish oil thesis as it could lead to a rebound in manufacturing rebound. But rising U.S. oil production helps offset that risk.
• One technical structure we’re watching is a head-and-shoulders that’s yet to trigger. When it does, it’d send a very bearish signal for oil. We’d likely increase our bearish conviction by downgrading to a rating of 3 or lower.