February 1, 2022

Gold Responds to a Tighter Fed
It was fun while it lasted, but it didn’t last long…

That statement certainly describes gold’s recent flight-to-safety rally (and subsequent sell-off). But it could also be considered a worthy refrain for gold’s three prior lift-off attempts since last August, each of which proved to be a false breakout.

The latest failed breakout attempt came two weeks ago when the U.S. stock market nosedived on fears that the Fed’s money policy is becoming too restrictive in view of growth concerns (including omicron and the Russia/Ukraine crisis). The metal rallied $40 in just two days as investors fled risk and ran to the safety of bullion.

But just as quickly as the rally began it faltered, and by last Friday gold had settled back at $1,787 an ounce, surrendering all its gains. The culprit in this case was the sudden strength in the U.S. dollar index last week, which responded to the latest wave of stock liquidation by jumping to a one-year high. On top of that, a corresponding surge in Treasury yields was simply too much for gold to bear and the metal slumped.

Now that gold has returned to earth (and below its 40-week moving average), it’s hard to get excited about its near-term prospects—even in the face of rising inflation pressures. On that score, the respected Wall Street economist Scott Grannis recently opined that what gold is likely responding to right now isn’t rising inflation, but the likelihood that inflation conditions will be changing in the next several months.

Specifically, Grannis points to tighter Fed policy (and rising interest rates) as reasons why gold can’t seem to get anything going on the upside. And while it’s not a perfect relationship, he notes further that there’s a historical inverse correlation between the real yield for the 5-year Treasury Inflation Protected Security (TIPS) and gold. That is, when real yields are falling (due to an accommodative Fed), gold tends to outperform. But when real yields are rising (due to a tighter Fed), gold underperforms.

The following graph illustrates this relationship between the TIPS yield (which is inverted) and the gold price. The implication here is that the recent tendency for the higher TIPS yield is pointing to a more restrictive Fed that will (in Grannis’ words) “deliver lower inflation in the future.” Hence, gold’s inability to gain any significant traction in recent months.

Thankfully, the major industrial metals have been much more responsive to near-term inflationary pressures than gold. Saxo Bank anticipates a bullish longer-term performance for copper due partly to the global transition to copper-intensive alternate energy sources, while UBS expects industrial metals generally to rise between 10% and 15% in 2022, due mainly to undersupply.

Meanwhile, in aluminum, the white metal is expected to post a 2.2 million-ton deficit this year and analysts are predicting even higher prices than last year. Strong industrial demand and supply-squeezing plant closures in China and Europe due to rising energy costs, plus recent tensions between Russia (a top producer) and Ukraine, are the main fundamental factors underpinning the bullish outlook.

So while we continue to wait (and wait and wait) for gold to finally commence another sustained uptrend, there still look to be some intermediate-term opportunities ahead in the other metals.

Note: In the portfolio, we have one new addition (a commodity ETF) to add this week.

Updates
Among the most actively U.S.-traded aluminum stocks, Alcoa (AA) has been an outperformer and a relative strength leader versus both the broad equity market as reflected in the benchmark S&P 500 Index as well as the broader base metals group. I recommended on December 16 that participants purchase a conservative position in AA, using a level slightly under 45 as an initial protective stop. On December 22, I recommended taking half profits in AA after the latest 17% rally. I further suggested raising the stop-loss on the remaining position to slightly under 55 (intraday). Unfortunately, this level was violated during last week’s financial market correction, kicking us out of the remainder of our position in AA. SOLD

We were stopped out of our conservative trading position in the GraniteShares Gold Trust (BAR) late last week after our stop-loss at 17.75 was violated. As previously discussed, I recommended using this admittedly tight stop since a violation of this level would imply a total reversal in buying interest (hence a “head fake” situation). Unfortunately this was the case, for reasons discussed above. SOLD

Traders recently purchased a half position in Freeport-McMoRan Copper & Gold (FCX) using a level slightly under 37 (closing basis) as the initial stop-loss. I recommend raising the stop to slightly under 40 (closing basis) after its latest rally, and we were stopped out when this level was violated in last week’s broad market sell-off. SOLD

I recently placed the iPath Series B Bloomberg Tin Subindex Total Return ETN (JJT) on a buy thanks to improvement in the tin price after a brief stumble in December. Keep in mind this is an exchange-traded note (ETN), not a traditional ETF, which is an unsecured debt note that trades more like a bond than a stock. Earlier last month, I recommended buying a conservative position in this tin-tracking vehicle. I suggested using an initial stop-loss slightly under the 115 level on an intraday basis for this trading position. I also recently recommended taking a 50% profit in this position after January’s big rally. I further suggest raising the stop-loss on the remaining position to slightly under 120 (the current location of the 50-day moving average) after the recent rally. HOLD A HALF

As previously discussed, prices for steel making coal are on the rise, which is partly attributable to the improved outlook for steel production and consumption globally. A beneficiary of higher coal prices is Natural Resource Partners (NRP), which is a master limited partnership engaged in owning and managing a diversified portfolio of mineral reserve properties, including coal and other natural resources (mainly gas and timber). Approximately 65% of the firm’s coal royalty revenues and around 45% of coal royalty sales volumes were derived from metallurgical coal in the latest quarter, making the stock a good proxy for steel demand. In the third quarter, the company reported revenues of $57 million that were 90% higher from a year ago. Per-share earnings of $1.10, meanwhile, beat consensus expectations by 28 cents. Management said it sees steel demand “remaining strong” going forward, as global economic recovery is “more than offsetting” Covid-related challenges. The company also said it remains committed to finding alternative revenue sources across its large portfolio of land, mineral and timber assets. Participants last week purchased a conservative position in NRP using a level slightly under 31 as the initial stop-loss on a closing basis. After the recent 10% rally, I recommended selling a half and raising the stop on the remaining position to slightly under 32.50 (closing basis). Let’s maintain this stop for now. HOLD A HALF

Sigma Lithium Resources (SGML) is a Canada-based, exploration-stage lithium developer that we purchased in mid-December using a level slightly under 8.75 (intraday) as the initial stop-loss. After its initial 10% rally, I recommended selling half this position and raising the stop-loss to slightly under 9.50 (intraday) near the 50-day line. This stop was activated during last week’s broad selling wave, kicking us out the remainder of our position. SOLD

Vale S.A. (VALE) is one of the world’s largest iron ore and nickel miners, as well as a diversified producer of other industrial and precious metals. Earlier this year, the company garnered attention when management announced an ambitious plan to reach 400 million tons of iron ore production by 2022, which, if realized, would be a 33% increase from 2020’s total production. More recently, though, Vale has shifted its focus on so-called “green” metals in an effort to diversify and generate higher shareholder returns. Vale recently guided for copper production to increase to a midpoint of around 345,000 tons per year, led by the firm’s Salobo 3 expansion copper project, while nickel production is expected to reach around 185,000 tons per year. Additionally, Vale’s outlook received a boost from the recently passed $1 trillion infrastructure spending bill, which would dramatically expand fiscal spending for roads, water pipes, EV charging stations and other infrastructure, in turn necessitating higher industrial metal production volumes. Analysts, meanwhile, expect Vale’s revenue for full-year 2021 to increase 34% while per-share earnings improve 85%. From a technical standpoint, VALE is coming off a 1-year low near 12 but appears to be bottoming out. Any improvement in iron ore, copper and nickel prices from here should provide a boost to the stock. Traders who didn’t mind the China-related volatility risk did some recent nibbling around 14, using a level slightly under 12 as the initial stop-loss on a closing basis. After the recent 14% rally, I suggested taking 50% profits and raising the stop to slightly under 13 (closing basis). I now recommend raising the stop to slightly under 14.00 (closing basis), where the 50-day line comes into play. HOLD A HALF

New Positions
With inflation likely to persist at least through the first half of 2022, not only industrial metals but commodities in general should generally outperform. One way of playing the bullish trend in natural resources is the Invesco DB Commodity Index Tracking Fund (DBC), an actively traded index ETF which is based on several major commodity futures contracts ranging from metals (including gold, silver and copper) to grains (including corn, wheat and soybeans) to energy products (including oil and natural gas). A combination of strong global demand for farm commodities, exceptionally volatile weather in many food growing regions around the globe and rising input costs (i.e. fuel and fertilizer) should contribute to rising hard asset prices in the months ahead. Additionally, crude oil prices are expected to remain elevated in the coming year, and for that reason, I expect DBC—which is heavily skewed toward the energy sector—to continue to show relative strength. Traders can purchase a conservative position in DBC using a level slightly under 21 as the initial stop-loss on a closing basis. BUY A HALF

Portfolio

Buy means purchase a position at or around current prices.
Buy a Quarter/Half means allocate less of your portfolio to a position than you normally would (due to risk factors).
Hold means maintain existing position; don’t add to it by buying more, but don’t sell.
Sell means to liquidate the entire (or remaining) position.
Sell a Quarter/Half means take partial profits, either 25% or 50%.