Stocks have rallied into year-end in anticipation of a Fed pivot, with more follow-through after yesterday’s Fed meeting. A possible Santa rally is something we highlighted back in early-November.
Bonds and gold have also risen significantly, confirming our bullishness there. While further upside in stocks looks limited, what about for bonds and gold? We look at which one we prefer in this article.
We also look at how rising stablecoin dominance could be signaling a potential top in crypto, and update our views on Chinese Stocks (MCHI) and Turkish stocks (TUR).
Gold/TLT Ratio Big Reversal is a Key Signal
Gold has proven a better hedge than bonds in the post-pandemic years, outperforming by over 50 pp.
However, the Gold/TLT ratio saw a big reversal in November after hitting its highest level in 20+ years. That reversal is challenging gold’s leadership, and is something we’re paying attention to.
In this article we review how we’re looking at gold versus bonds as defensive assets going into what we expect to be a weakening economic environment next year.
Why We’ve Been Bullish on Gold
We’ve liked gold as part of our diversified bet on a recession materializing next year:
- It has a constructive long-term technical setup with strong momentum
- A recession would see bond yields and the dollar fall, benefiting the yellow metal
- Gold offers upside potential in an environment of higher inflation volatility
- It could also see significant gains if recent geopolitical risks escalate
- Structural issues with U.S. government debt make dollar devaluation increasingly likely, with gold benefiting in that environment
Our bullishness was reflected in an initial rating of 8 (Strong Buy) in early-November, ahead of a significant run-up in gold prices.
We then downgraded GLD to a 7 in early-December, as it was trading near key resistance, and ahead of GLD’s latest correction.
Today we’re downgrading GLD to a 6 and leaving TLT at an 8, given the aggressive reversal in the Gold/TLT ratio shown in the first chart. We believe there could be more follow-through as we show in the next section.
Managing Risks in Gold, Bonds Look Like a Better Bet
While we’re still positive on gold, we’re managing our risks in the event that we’re wrong. The big reversal in the Gold/TLT ratio as highlighted in the first chart has turned us a bit more cautious.
- Gold is priced significantly higher than implied by real yields
- That means there’s potential for gold to be overvalued relative to bonds
- If a recession fails to materialize, downside risks could be bigger for gold
As a result, gold’s time to shine may be over in the near-term. We believe it has more runway than gold as a bet on a Fed pause and eventual end of the economic cycle.
That said, we remain positive on GLD given its diversification potential (more on that in the next section). As long as GLD trades above $180 we believe the setup remains constructive.
Why is gold trading so strongly? We believe that a few factors are driving gold’s premium:
- Worries that the Fed will cause a policy mistake by tightening too much, driving a recession
- Concerns about a structural increase in inflation volatility (i.e., gold outperforms bonds in inflationary and deflationary environments)
- Geopolitical risks due to Russia/Ukraine and Israel/Hamas wars increase gold’s value as hedge
- Central banks have bought large amounts of gold in 2022/2023, the most in the last decade
Gold helps hedge economic risks like bonds, but with an additional return advantage if inflation and geopolitics become volatile.
These factors make gold a diversifier in portfolios and hence we remain constructive despite our preference for bonds.
Stablecoin Dominance as a Risk Sentiment Indicator in Crypto
Stablecoin dominance is the market capitalization of the Tether stablecoin relative to the total market capitalization of all cryptocurrencies:
- Rising dominance means risk-off as stablecoins are much less volatile than BTC or ETH
- As a result, we believe it’s an accurate risk sentiment indicator in the crypto space
- It’s historically helped time Bitcoin tops when it tests key trendline support
Stablecoin dominance is currently approaching key trendline support. If it gets tested it signals that Bitcoin may have more limited upside than we expect. If BTC corrects significantly, that would likely lead Ethereum lower as well.
We’re a lot more bullish on Ethereum than Bitcoin, and recently upgraded it to Strong Buy at an 8:
- We believe ETH has more runway to outperform stocks and BTC in a Fed pivot melt-up
- Price is close to key channel support, improving the risk-reward of the trade
- Momentum is bullish as reflected in a golden cross triggering in late-November
If stablecoin dominance tests uptrend support, that reduces the odds of ETH managing to clear the all-time highs. That may lead us to set relatively-tight stop-losses. Our current one is a weekly close below $2,100.
Chinese Stocks are at Long-Term Support
Throughout 2023 we’ve been expecting China to deploy big fiscal stimulus, but have been left disappointed. Hence, we’re holding MCHI at a neutral rating, waiting for a clear catalyst to buy.
China entered deflation in consumer prices in recent months, a dangerous development:
- Consumer spending remains weak as the country didn’t write stimulus checks like the U.S. did
- It could set in motion a negative feedback loop: falling prices → lower profits → rising unemployment → lower spending → falling prices and so on…
China has deployed significant stimulus in prior episodes when it’s seen deflation, helping it overcome the drag from economic crisis. We could be approaching a turning point here too.
China entering a deflationary environment looks like a logical time for the government to act forcefully:
- The Shanghai Composite (CSI 300) is at key long-term support, a potential inflection point
- However, the highly-anticipated 2023 Central Economic Work Conference this week disappointed by offering no hints that big stimulus is coming next year
A breakdown of key long-term trendline support would mark a significant bearish development for Chinese stocks and increase the probability of the stocks becoming value traps.
We’d downgrade MCHI to a Sell rating of 4 if it materialized.
After a Good Run, We’re Downgrading TUR to Sell
We downgraded TUR to a Sell rating of 4 this week given deterioration in the technical structure. We’d been constructive since August given the policy pivot and TUR’s diversification potential.
We’re not keen to holding on to a policy-driven trade if momentum starts to fall apart.
The key negative macro catalyst appears to have been the central bank hiking interest rates to 40% in November. That proved to be a more aggressive level than expected by the market.
Investors are getting worried that tight monetary policy could end up wrecking the economy. That could explain why the Turkish lira hasn’t yet appreciated despite the big hike in interest rates.
If the breakdown ends up proving false, and price moves to trade above support again, we’ll upgrade to neutral and monitor for signs that policy momentum is picking up again.
