Precious Metals

Highlights We remain bearish on the US dollar over the next 12 months. The best vehicle to express this view continues to be the Scandinavian currencies (NOK and SEK). Precious metals remain a buy so long as the dollar faces downside. However, we remain more bullish on silver than gold. Go short the gold/silver ratio (GSR) again at 75. At the crosses, our favorite trade is short NZD against other cyclical currency pairs. These include the CAD, AUD, and SEK. Sterling is selling off as we anticipated, but our timing was offside. That said, the pound is cheap. We will go long cable if it falls below 1.25. Short EUR/GBP at current levels. The Swiss franc will continue to appreciate versus the USD, but will lag behind the euro. EUR/CHF will touch 1.15. We prefer the JPY to the CHF as a currency portfolio hedge. We argued last week that Prime Minster Shinzo Abe’s resignation does not change the yen’s outlook. Feature Our trade basket this year has been centered on a dollar-bearish theme. Since the top in the DXY index on March 19th, we have been expressing this view via various vehicles, most of which have been very profitable. Our favorites have been the Scandinavian currencies, silver, and the AUD, either at the crosses or against the US dollar. So far, these are among the best-performing trades in the G10 currency world (Chart I-1). Chart I-1A Currency Report Card Revisiting Our High-Conviction Trades Revisiting Our High-Conviction Trades Going into the final leg of 2020, the key question is which currency pairs will provide the most upside. In this report, we revisit the rationale behind our high-conviction trades. The Case For Scandinavian Currencies A review of Q2 GDP across the G10 reveals which countries have been doing relatively better during the pandemic. Norway emerges as the economy that had the best quarter-on-quarter annualized growth (Chart I-2). Swedish growth held up very well in Q1 and even the drop in Q2 still puts it well ahead of the US, the euro area, and the UK. As small, open economies which are very sensitive to global growth conditions, this is a very impressive feat for Sweden and Norway. Part of the reason for this is that over the years, the drop in their currencies, both against the US dollar and euro, has made them very competitive. Chart I-2A Currency Report Card A Currency Report Card A Currency Report Card Norway benefited from a few things during the pandemic. First, as a major oil exporter, the sharp fall in the NOK helped cushion the domestic economy against the crash in crude prices. Second, the handling of the pandemic was swift and rigorous, and this has almost completely purged the number of new infections in Norway. Third, aggressive monetary and fiscal stimulus (zero rates, quantitative easing, and the first budget deficit in 40 years) has set the economy on a recovery path. As a result, consumption is rebounding smartly and the Norges Bank expects mainland GDP to touch pre-crisis levels by 2023. Already, real retail sales have exploded higher (Chart I-3). Should global growth continue to rebound, a reversal in pessimism towards energy stocks (and value stocks in general) could see investors reprice the Norwegian stock market (and krone) sharply higher (Chart I-4). Chart I-3Norwegian Consumption Has##br##Recovered Norwegian Consumption Has Recovered Norwegian Consumption Has Recovered Chart I-4A Bounce In Oil & Gas Stocks Will Help The Krone A Bounce In Oil & Gas Stocks Will Help The Krone A Bounce In Oil & Gas Stocks Will Help The Krone In the case of Sweden, the sharp rebound in the manufacturing PMI also suggests the industrial base is recovering. This will also coincide with a solid bounce in exports, cementing Sweden’s rise in relative competitiveness and its exit from the pandemic-induced recession (Chart I-5). The Riksbank’s resource utilization indicator has stabilized, suggesting deflationary pressures are abating. Meanwhile, home prices are on the cusp of a recovery, which should help boost consumer confidence and support consumption. With our models showing the Swedish krona as undervalued by 19% versus the USD, there is much room for currency appreciation before financial conditions tighten significantly. Should global growth continue to rebound, a reversal in pessimism towards energy stocks could see investors reprice the Norwegian stock market (and krone) sharply higher. The bottom line is that both Norway and Sweden are well poised to benefit from a global economic recovery, with much undervalued currencies that will bolster their basic balances. We expect both the SEK and NOK to be the best performers versus the USD in the coming year (Chart I-6).  Chart I-5The Swedish Economy Is On The Mend The Swedish Economy Is On The Mend The Swedish Economy Is On The Mend Chart I-6The Scandinavian Currencies Remain Cheap The Scandinavian Currencies Remain Cheap The Scandinavian Currencies Remain Cheap Stay Long Precious Metals, Especially Silver In a world of ample liquidity and a falling US dollar, gold and precious metals are bound to benefit. This is especially the case on the back of a central bank that is trying to asymmetrically generate inflation. Gold has a long-standing relationship with negative interest rates, though the correlation has shifted over time. The intuition behind falling real rates and rising gold prices is that low rates reduce the opportunity cost of holding non-income-generating assets such as gold. But more importantly, the correlation is between the rise in gold prices and the level of real interest rates, meaning as long as the latter stays negative, it is sufficient to sustain the gold bull market (Chart I-7). Gold tends to be a “Giffen good,” meaning demand increases as prices rise. This can be seen in the tight correlation between our financial demand indicator (proxied by open futures interest on the Comex and ETF holdings, Chart I-8) and gold prices. The conclusion is that, just like the US dollar, gold tends to be a momentum asset, where higher prices beget more demand – at least until the catalyst of easy money and negative rates vanishes Chart I-7Gold Prices And Real Yields Gold Prices And Real Yields Gold Prices And Real Yields Chart I-8Gold Is A Giffen Good Gold Is A Giffen Good Gold Is A Giffen Good There is reason to believe that the bull market in gold might be sustained for longer this time around. The reason is that central banks have become important (and price-insensitive) buyers. Foreign central banks have been amassing almost all of the gold annual output in recent years. It is remarkable that for most of the dollar bull market this past decade, the world’s major central banks (and biggest holders of US Treasurys) have seen rather stable exchange rates relative to the gold price (Chart I-9). This suggests that gold price risks could be asymmetric to the upside. A fall in prices encourages accumulation by EM central banks as a way to diversify out of their dollar reserves, while a rise in prices encourages financial demand and boosts the value of gold foreign exchange reserves. While we like gold, more value can be found in silver (and even platinum) prices, which have lagged the run up in gold. While we like gold, more value can be found in silver (and even platinum) prices, which have lagged the run up in gold. During precious metals bull markets, prices tend to move in sequence, starting with gold, then silver. Meanwhile, the gold/silver ratio (GSR) tends to track the US dollar (Chart I-10), since silver tends to rise and fall more explosively than gold. Part of the reason is that the silver market is thinner and more volatile. Silver’s rising industrial use has also led to competition with investment demand in recent years. Chart I-9Central Banks Will Put A Floor Under Gold Prices Central Banks Will Put A Floor Under Gold Prices Central Banks Will Put A Floor Under Gold Prices Chart I-10Silver Should Outperform Gold As The Dollar Falls Silver Should Outperform Gold As The Dollar Falls Silver Should Outperform Gold As The Dollar Falls The next important technical level for silver will be the 2012 highs near $35/oz. After this, silver could take out its 2011 highs that were close to $50/oz, just as gold did. Globally, the world produces much more gold than silver, with a supply ratio that is 7:1. Meanwhile, the price ratio between gold and silver is near 70:1. Back in the 1800s, Isaac Newton concluded that the appropriate ratio was 15.5:1. We initially shorted the GSR at 100 and eventually took 25% profits when our rolling stop was triggered. We recommend putting a limit sell at 75. More speculative investors can buy silver outright. Stay Short NZD At The Crosses, Especially Versus The CAD Chart I-11Stay Long CAD/NZD Stay Long CAD/NZD Stay Long CAD/NZD In our currency portfolio, trades at the crosses are equally important as versus the USD in terms of adding alpha. Over the past year, we have successfully been playing the short side of the kiwi trade. We closed our long SEK/NZD trade for a profit of 7.8% on March 20, and our long AUD/NZD trade for a profit of 5.2% on June 26. Today, we remain bullish on the CAD/NZD as an exploitable trading opportunity. First, the New Zealand stock market is the most defensive in the G10, while Canadian bourses are heavy in cyclical stocks. Should value start to outperform growth, this will favor the CAD/NZD cross. Second, immigration was an important source of labor for New Zealand, and COVID-19 has eaten into this dividend for the economy. As such, the neutral rate of interest is bound to head lower. And finally, in the commodity space, our bias is that energy will fare better than agriculture, boosting Canada’s relative terms of trade. At the Bank of Canada’s meeting this past Wednesday, the tone was slightly optimistic as it kept rates on hold. Recent data has been rather strong in Canada, especially in housing and goods consumption. This allows for the possibility of the BoC tapering asset purchases faster than the market expects, as argued by my colleague Mathieu Savary. This arbitrage is already being reflected in real interest rates, where they offer a premium of 180 basis points in Canada relative to New Zealand (Chart I-11). What To Do About Sterling? Trade negotiations between the UK and EU are once again hitting a brick wall. The key issue is around Northern Ireland. Ireland wants to remain bound to the EU’s customs and trade regime. The UK is seeking an amendment to be able to intervene, if there is “inconsistency or incompatibility with international or domestic law.” In short, it allows for UK discretion in the movement of goods to and from Northern Ireland, as well as state aid to Northern Ireland. The EU argues this is a clear breach of the treaty agreed to last year.    We remain bullish on the CAD/NZD as an exploitable trading opportunity. As negotiations go on, our base case is that a deal will eventually be reached. This is because neither side wants the worst-case scenario, namely, a no-deal Brexit. Should no deal be reached, the sharp rise in the trade-weighted euro will be exacerbated by a drop in the pound. This is deflationary for the euro area. And while the drop in the pound could be beneficial to the UK in the longer term, it will be very destabilizing since the UK is highly dependent on capital flows. Our roadmap for sterling is as follows: Historically, odds of a “hard” Brexit have usually been associated with cable near 1.20. This occurred after the UK referendum in 2016 and after Prime Minister Boris Johnson was elected with a mandate to take the UK out of the EU (Chart I-12). Intuitively, this suggests that maximum pessimism on the pound, driven by Brexit fears, pins cable at around 1.20. A “weak” deal cobbled together at the eleventh hour will still benefit cable. Depending on the details, 1.35-1.40 for cable will be within striking distance. In the case where both the UK and EU come to a “perfect” agreement, the pound could be 20%-25% higher. The real effective exchange rate for the pound is now lower than where it was after the UK exited the ERM in 1992, with a drawdown that has been similar in size. A good deal should cause the pound to overshoot the mid-point of its historical real effective exchange rate range (Chart I-13). Chart I-12GBP Has Historically Bottomed At 1.20 GBP Has Historically Bottomed At 1.20 GBP Has Historically Bottomed At 1.20 Chart I-13The Pound Is Cheap The Pound Is Cheap The Pound Is Cheap The pound is also cheap versus the euro, and we expect the EUR/GBP to start facing significant headwinds near 0.92. It is remarkable that UK data continues to outperform both the US and euro area (Chart I-14). As such, cable should be bought on weakness. Tactically, we would be buyers of the pound in the 1.24-1.25 zone, and our limit sell on EUR/GBP was triggered yesterday at 0.92.   Chart I-14The UK Economy Is Improving The UK Economy Is Improving The UK Economy Is Improving Thoughts On The ECB The main takeaways from the European Central Bank (ECB) conference were threefold. First, data in the euro area was better than the ECB expected. Second, the ECB did not give any hints on its policy review or extend forward guidance. Keeping policy easy until inflation is up to, but still below, 2% appears more hawkish than the Federal Reserve, which is now trying to asymmetrically generate inflation. And finally, the ECB said they are monitoring the exchange rate, but fell short of providing any hints that they will actively lean against the currency. The euro took off, both against the dollar and other European currencies. We outlined in last week’s report why we do not believe the euro can fall much from current levels. These include the common currency being cheap and having a large share of exports in the eurozone. A Few Words On The CHF Finally, a few clients have asked what happens to the Swiss franc in an environment where the euro is rising (and the dollar is falling). Our bias is that the Swiss National Bank lets a rising EUR/CHF ease financial conditions in Switzerland, and even leans into it. The Swiss National Bank has been stepping up its pace of intervention since EUR/CHF touched 1.05 this year and will continue to do so (Chart I-15). Unfortunately, there is not much it can do about a falling USD/CHF. This suggests the franc will fall against the euro, but not so much against the dollar. In a world where global yields eventually converge to zero, holding the Swiss franc is an attractive hedge. Chart I-15USD Weakness Will Be A Headache For The SNB USD Weakness Will Be A Headache For The SNB USD Weakness Will Be A Headache For The SNB   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data from the US have been positive: On the labor market front, nonfarm payrolls fell to 1371K from 1734K in August. The average hourly earnings increased by 4.7% year-on-year. The unemployment rate declined from 10.2% to 8.4%. Initial jobless claims increased by 884K for the week ending on September 4th.  Finally, the NFIB business optimism index increased from 98.8 to 100.2 in August. The DXY index initially rose to a 4-week high of 93.6 earlier this week with positive data releases, then fell back to 93. Our bias is that while the dollar has been rebounding since the beginning of the month, the rally could prove to be a healthy counter-trend move in the long-term dollar bear market. Report Links: Addressing Client Questions - September 4, 2020 A Simple Framework For Currencies - July 17, 2020 DXY: False Breakdown Or Cyclical Bear Market? - June 5, 2020 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data from the euro area have been mixed: The Sentix investor confidence increased from -13.4 to -8 in September. GDP plunged by 11.8% quarter-on-quarter in Q1, or 14.7% year-on-year.  The euro declined by 0.5% against the US dollar this week. The ECB decided to keep its interest rate and PEPP program unchanged on this Thursday. President Christine Lagarde sounded quite hawkish in the press conference, saying that incoming data since the last monetary policy meeting suggest “a strong rebound in activity broadly in line with previous expectations.” We continue to favor the euro against the US dollar. Report Links: Addressing Client Questions - September 4, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data from Japan have been mixed: The coincident index increased from 74.4 to 76.2 in July. The leading economic index also climbed up from 83.8 to 86.9 in July. The current account balance widened from ¥167 billion to ¥1,468 billion in July. GDP plunged by 7.9% quarter-on-quarter in Q2, or 28.1% on an annualized basis. Preliminary machine tool orders continued to fall by 23.3% year-on-year in August. Overall household spending contracted by 7.6% year-on-year in July. The Japanese yen appreciated by 0.2% against the US dollar this week. The expansion in Japan’s current account balance is mainly driven by the decline in domestic demand. Exports fell by 19.2% year-on-year in July while imports slumped at a faster pace by 22.3%. This suggests that deflationary forces are returning to Japan, which will boost real rates and buffet the yen. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data from the UK have been mostly positive: Retail sales continued to increase, rising by 4.7% year-on-year in August, following a 4.3% increase the previous month. Halifax house prices increased by 5.2% year-on-year for the 3 months to August. The Markit construction PMI declined from 58.1 to 54.6 in August. The British pound extended its sell-off this week, depreciating by 2.5% against the US dollar, making it the worst-performing G10 currency. Under ongoing trade negotiations, the possibility of a no-deal Brexit is now putting more downward pressure on the pound after the summer rally. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data from Australia have been mixed: The AiG services performance index fell from 44 to 42.5 in August. The NAB business confidence increased from -14 to -8 in August while the business conditions index fell from 0 to -6. The Australian dollar appreciated by 0.4% against the US dollar this week. Spending fell sharply during the pandemic, pushing Australia’s savings rate to 19.8% from 6%. Until consumer spending returns in earnest, the RBA is unlikely to raise rates, which puts a cap on how far the AUD can rise. The good news is that household balance sheets are being mended, which reduces macroeconomic risk. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data from New Zealand have been mixed: Manufacturing sales plunged by 12.2% quarter-on-quarter in Q2. The preliminary ANZ business confidence index increased from -41.8% to -26% in September. The ANZ activity outlook index also ticked up from -17.5% to -9.9%. The New Zealand dollar fell initially against the US dollar, then recovered, returning flat this week. The ANZ New Zealand Business Outlook shows that most activity indicators have increased to the highest levels since the beginning of the pandemic but are still well below pre-COVID-19 levels. We like the New Zealand dollar against the US dollar but believe that it will underperform against other pro-cyclical currencies including the Australian dollar and the Canadian dollar. Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data from Canada have been positive: On the labor market front, the unemployment rate declined from 10.9% to 10.2% in August. The participation rate increased from 64.3% to 64.6%. Average hourly wages surged by 6% year-on-year in August. Housing starts increased by 6.9% month-on-month to 262.4K in August, the highest reading since 2007. The Canadian dollar depreciated by 0.3% against the US dollar this week. The Bank of Canada maintained its target rate at 0.25% on Wednesday. It is also continuing large-scale asset purchases of at least C$5 billion per week of government bonds. Moreover, the Bank suggested that the bounce-back in activity in Q3 was better than expected, which bodes well for the loonie. Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data from Switzerland have been mixed: FX reserves continued to increase from CHF 847 billion to CHF 848 billion in August. The unemployment rate remained unchanged at 3.4% in August. The Swiss franc appreciated by 1% against the US dollar this week. The SNB Chairman Thomas Jordan said that “stronger currency market interventions relieve over-valuation pressure on the Swiss franc and protect the Swiss economy”. Recent dollar weakness could be another headache for the SNB, accelerating SNB’s currency intervention. While we like the franc as a safe-haven hedge with high real rates, the upside potential is likely to be more gradual as the SNB leans against it. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data from Norway have been positive: Manufacturing output increased by 1.8% month-on-month in July. Headline consumer price inflation ticked up from 1.3% to 1.7% year-on-year in August. Core inflation continued rising to 3.7% year-on-year from 3.5% the previous month. The Norwegian krone depreciated by 0.5% against the US dollar this week. The increase in headline inflation was mainly driven by furnishings and household equipment (10%), communications (4.9%) and food (3.7%). However, the Norwegian krone is still tremendously undervalued against the US dollar according to our models. Report Links: A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data from Sweden have been mostly positive: The current account surplus fell to SEK 63.2 billion in Q2 from SEK 75.5 billion in Q1. However, this compares favorably to a surplus of SEK 34.7 billion the same quarter last year. Manufacturing new orders continued to fall by 6.4% year-on-year in July. This is an improvement compared to the 13.1% contraction the previous month. Headline consumer prices inflation increased from 0.5% to 0.8% year-on-year in August. Core inflation also climbed up from 0.5% to 0.7% year-on-year. The Swedish krona appreciated by 0.5% against the US dollar this week. We continue to favor the Swedish krona amid global economy recovery. Moreover, our PPP model shows that the krona is still undervalued by 19% against the US dollar. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights While difficult to forecast, the trajectory of global auto sales likely will follow that of GDP growth (Chart of the Week). As a result, palladium’s supply constraints will re-emerge, but its “epic rally” likely unfolds at a slower pace as global economic conditions normalize at an uneven rate.1   We expect the COVID-19 pandemic will be contained – likely via a vaccine later this year or early next year, if public-health officials are correct in their assessments, and populations become habituated to observing social-distancing and face-mask measures.2   There is evidence to suggest that in the post-pandemic world consumers will avoid public transportation in favor of their own vehicles.  This would lift palladium demand at the margin – assuming environmental regulations are not relaxed dramatically. South Africa’s derelict power grid will continue to limit palladium supply growth, despite new investment in Russia.  We expect palladium prices to remain close to current levels at ~ $2,300/oz to year-end. Chart of The WeekGlobal Auto Production Will Follow GDP’s Trajectory Global Auto Production Will Follow GDP's Trajectory Global Auto Production Will Follow GDP's Trajectory Feature COVID-19 clobbered palladium, just as it has commodities generally – taking prices from close to $2,900/oz in February to just under $1,600/oz in mid-March (Chart 2). Since then, prices rallied to more than $2,350/oz and are now languishing just above $2,200/oz. As dramatic as the metal’s price action has been, the pandemic's demand destruction only provided a respite from what remains a fraught supply backdrop. Chart 2Palladium’s Rollercoaster Ride Will Not Encourage New Output Expect Backwardation To Persist Palladium's Rollercoaster Ride ill Not Encourage New Output Expect Backwardation To Persist Palladium's Rollercoaster Ride ill Not Encourage New Output South African palladium output, which represents 36% of global supply, is once again threatened by rolling electricity blackouts, which have plagued the economy for years.3 Russia accounts for 42% of global palladium supply, and its top producer, Nornickel is maintaining production guidance of ~2.7mm ounces of palladium output this year. Even so, Nornickel expects global palladium output will total ~ 6.3mm ounces this year, down 1.3 mm ounces from 2019 levels (Chart 3).4 Inventories remain tight, and, with any recovery, can be expected to contract further (Chart 4). Chart 3Palladium's Physical Deficit Will Persist Palladium's Physical Deficit Will Persist Palladium's Physical Deficit Will Persist Chart 4Any Increase In Automobile Demand Will Further Strain Inventories Any Increase In Automobile Demand Will Further Strain Inventories Any Increase In Automobile Demand Will Further Strain Inventories This will continue a decade-long contraction in supply relative to demand, which spurred prices from $407.3/oz in 2010 to current levels but failed to energize supply growth or capex, which, from 2015 to 2019, grew by 7% and 15.2%, respectively. Auto Production Drives Palladium Demand Forecasting a recovery in palladium demand is extremely difficult, so much so even the most in-the-know market participants have suspended their usual balances assessments.5 All the same, there is a strong relationship between GDP and automobile production, as the Chart of the Week shows.6 This production drives the demand for palladium, as it is critical to the functioning of anti-pollution technology in gasoline-powered cars, which predominate in the global automobile market. Monthly car production in our sample peaked in November 2017 at 5.6mm units. In our modeling, we expected production will come in at ~ 4.3mm units in December of this year, and 4.6mm units in December 2021. This translates into a downturn of close to 6% in auto production this year versus 2019, and a recovery of ~ 9% for next year. If realized, this year’s downturn in auto production would only amount to a brief respite from the chronic supply-side weakness that has plagued the palladium market for a decade. In its May 2020 assessment, Johnson Matthey (JM) projects South African platinum-group metals (PGM) mining output will fall “at least 20%” this year. This suggests to us the physical deficits in palladium will widen and continue to do so over the medium term, which, all else equal – i.e., the global economic recovery we anticipate remains on track – will force prices higher if for no other reason than to attract capex to the PGM space. Upside Price Risk For Palladium Palladium prices will be prone to upside risk if the massive fiscal and monetary stimulus deployed globally is effective in reviving consumer demand for automobiles as household budgets are restored (Chart 5). Chart 5Rising Incomes Will Boost Auto Demand Rising Incomes Will Boost Auto Demand Rising Incomes Will Boost Auto Demand We find GDP (income) growth is an important explanatory variable for price, and would expect rising incomes in DM and EM markets would restore global employment growth and consumer confidence, leading to higher demand for new autos (Chart 6). In addition, anti-pollution regulations continue to be enforced, although states could relax these to help auto manufacturers reduce unsold inventories and to reduce the overall contribution palladium makes to a vehicle’s cost (Chart 7). Chart 6Fiscal And Monetary Stimulus Will Revive Consumer Demand Fiscal And Monetary Stimulus Will Revive Consumer Demand Fiscal And Monetary Stimulus Will Revive Consumer Demand These regulations pushed palladium loadings in internal-combustion engines globally up 14% last year, led by stout increases in Europe and China, according to JM. At 9.6mm ounces of the total gross demand for palladium, autocatalysts accounted for ~ 84% of global consumption last year (Chart 8). Chart 7Environmental Regulations Drive Palladium Demand Environmental Regulations Drive Palladium Demand Environmental Regulations Drive Palladium Demand Chart 8Autocatalysts Dominate Palladium Demand Palladium’s Recovery To Follow Auto Sales Palladium’s Recovery To Follow Auto Sales Bottom Line: The COVID-19 pandemic provided a respite for the palladium market’s relentless drive to take prices high enough to encourage new capex to bring no new supply. However, with the massive stimulus now deployed globally, we expect global GDP growth to revive in line with the World Bank’s estimates, which drive our modeling of GDP growth. This will cause demand for automobiles to revive next year, pushing demand for palladium higher as supplies are contracting – assuming, of course, governments do not relax environmental regulations pushing demand for the metal higher.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Fernando Crupi Research Associate Commodity & Energy Strategy FernandoC@bcaresearch.com   Commodities Round-Up Energy: Overweight  Brent crude oil trade through $46/bbl, or ~ 3.7% in early trading Wednesday, on the back of sharp inventory drawdowns for the week ended reported by the US EIA Wednesday. We continue to forecast a physical deficit for the balance of the year and expect to see continued draws as a result. Our price forecast for the 2H20 remains at $44/bbl and $65/bbl next year for Brent, with WTI expected to trade ~ $3/bbl below that this year and next (Chart 9). Base Metals: Neutral Copper production in Peru, the second-largest producer in the world, fell 20.4% y/y in 1H20, according to mining.com. Production appears to have recovered by June, with output increasing almost 41% m/m to 180,792 MT. The government began relaxing its quarantine restrictions, imposed in March, in May. Precious Metals: Neutral We are moving our rolling stop on gold to $1,950/oz at tonight’s close, up from our previous stop of $1,850/oz. Gold was trading close to $2,050/oz early Wednesday. We also are moving our silver stop-loss to $26/oz at tonight’s close, up from $23.50/oz, and making this a strategic position. We remain bullish these precious metals, expecting central banks globally, led by the Fed, to continue to flood markets with liquidity, particularly USD liquidity. This will keep real rates low, and will, in our view, continue to support a weakening of the USD, both of which are bullish for gold and silver (Chart 10). The Fed has made it clear they are not considering any rate increases in the foreseeable future, which will lead markets to expect continued weakness in real rates. Ags/Softs:  Underweight The USDA reported 72% of the US corn crop was in good-to-excellent condition for the week ended August 2, compared to 57% for the same period last year in the 18 states accounting for 91% of the crop. 73% of the soybean crop was in good-to-excellent condition vs. 54% last year at this time. Chart 9 Oil Price Rally Remains Intact Oil Price Rally Remains Intact Chart 10 USD Weakening Bullish For Precious Metals USD Weakening Bullish For Precious Metals Footnotes 1 Please see Epic Palladium Rally Likely Continues, which we published February 27, 2020.  2 Please see Anthony Fauci Explains Why the US Still Hasn’t Beaten Covid published by wired.com July 29, 2020. 3 Eskom, the South African electricity monopoly supplying ~ 90% of the country’s power, resumed rolling blackouts last month as COVID-19-induced lockdowns were relaxed.  The lockdowns provided a brief respite to the overloaded grid.  Please see Eskom: SA on the brink of load shedding again, as six units ‘trip-out’ published by thesouthafrican.com news service July 27, 2020.  We discuss this in our earlier publication cited in fn 1. 4 Please see Pandemic helps Russia tighten its grip on a key strategic metal published by miningweekly.com July 2, 2020.   5 See, e.g., Johnson Matthey’s Pgm Market Report: May 2020 published May 18, 2020, which notes, “At the time of writing, it was not possible to quantify these changes to supply and demand and we have elected not to publish forecasts for 2020. Our autocatalyst pgm demand models incorporate external industry estimates of vehicle production; at the time of preparing our report, these industry forecasts for 2020 were undergoing regular downgrades as the pandemic progressed across Asia and then to Europe and North America. It is also unclear to what extent primary and secondary supplies will be disrupted.” 6 Automobile demand also could get a boost at the margin from more people choosing to use their own cars and light vehicles instead of public transportation in the post-COVID-19 world. The IBM Institute for Business Value surveyed 25k US consumers in April, and found COVID-19 prompted almost 20% of their sample to say they intended to use their personal vehicles more frequently. Please see https://newsroom.ibm.com/2020-05-01-IBM-Study-COVID-19-Is-Significantly-Altering-U-S-Consumer-Behavior-and-Plans-Post-Crisis. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Trade Recommendation Performance In 2020 Q2 Palladium’s Recovery To Follow Auto Sales Palladium’s Recovery To Follow Auto Sales Commodity Prices and Plays Reference Table Trades Closed In Summary of Trades Closed In Palladium’s Recovery To Follow Auto Sales Palladium’s Recovery To Follow Auto Sales

Please note that we will be on our summer holidays next week. Our next report will come out on August 20. Highlights The 30-year bond yield is the puppet master pulling the strings of all other investments. Where 30-year bond yields are still far from the lower bound, they will ultimately get a lot closer. Continue to overweight 30-year bonds in the US and periphery Europe versus 30-year bonds in core Europe. Continue to overweight the US stock market versus the European stock market. An expected near-term setback to stocks versus bonds will briefly pause the European currency rally. The gold rally is also due a pause, given that it is overstretched relative to the decline in the real bond yield. Fractal trade: Long USD/PLN. Feature Chart I-1AThe Collapsed 30-Year Bond Yield Explains The Collapse Of Banks... The Collapsed 30-Year Bond Yield Explains The Collapse Of Banks... The Collapsed 30-Year Bond Yield Explains The Collapse Of Banks... Chart I-1B...And The Collapsed Earnings Yield (Surging Valuation) Of Tech And Healthcare ...And The Collapsed Earnings Yield (Surging Valuation) Of Tech And Healthcare ...And The Collapsed Earnings Yield (Surging Valuation) Of Tech And Healthcare   The abiding mantra of this publication is that investment is complex, but it is not complicated. By complex, we mean that the financial markets are not fully predictable or analysable. By not complicated, we mean that the relative prices of everything are inextricably connected, rather like the movements of a puppet. All you need to do is find the puppet master pulling the strings. Right now, the puppet master is the 30-year bond. The Real Action Is In 30-Year Bonds While most people are focussing on the 10-year bond yield, the real action has been at the ultra-long 30-year maturity. In the US and periphery Europe, 30-year yields are within a whisker of all-time lows. Yet these ultra-long bond yields are still well above those in core Europe which are much closer to the lower bound. The upshot is that while all yields have equal scope to rise, yields have more scope to fall further in the US and periphery Europe than in core Europe (Chart I-2 and Chart I-3). Chart I-230-Year Yields In The US And Periphery Europe... 30-Year Yields In The US And Periphery Europe... 30-Year Yields In The US And Periphery Europe... Chart I-3...Are Still Well Above Those In ##br##Core Europe ...Are Still Well Above Those In Core Europe ...Are Still Well Above Those In Core Europe This simple asymmetry has created a winning relative value strategy that will keep on winning. Overweight 30-year bonds in the US and periphery Europe versus 30-year bonds in core Europe. Our preferred expression is to overweight 30-year bonds in the US and Spain versus Germany and France. Bond yields have more scope to fall further in the US and periphery Europe than in core Europe. Remarkably, in the US, the 10-year real yield is also tightly tracking the 30-year nominal yield (minus a constant 2.2 percent) (Chart I-4). Using a little algebra, this means that the market’s 10-year inflation expectation is just a steady-state value of 2.2 percent minus a shortfall equalling the shortfall in the 10-year nominal yield versus the 30-year nominal yield (Chart I-5). Chart I-4The 10-Year Real Yield Is Just ##br##Tracking The 30-Year Nominal ##br##Yield The 10-Year Real Yield Is Just Tracking The 30-Year Nominal Yield The 10-Year Real Yield Is Just Tracking The 30-Year Nominal Yield Chart I-5The 10-Year Inflation Expectation Can Be Derived From The 30-Year And 10-Year Nominal Yields The 10-Year Inflation Expectation Can Be Derived From The 30-Year And 10-Year Nominal Yields The 10-Year Inflation Expectation Can Be Derived From The 30-Year And 10-Year Nominal Yields 10-year inflation expectation = 2.2 – (30-year nominal yield – 10-year nominal yield) The reason that this is remarkable is we can explain the trend in inflation expectations from just the 30-year and 10-year nominal yields, and nothing more. In turn, gold is tightly tracking the inverted real yield, as it theoretically should. Gold, which generates no yield, becomes relatively more valuable as the real yield on other assets diminishes (Chart I-6). Having said that, the most recent surge in the gold price is stretched relative to its relationship with the real bond yield, suggesting that the strong rally in gold is due a pause (Chart I-7). Chart I-6Gold Is Just Tracking The (Inverted) Real Yield... Gold Is Just Tracking The (Inverted) Real Yield... Gold Is Just Tracking The (Inverted) Real Yield... Chart I-7...But Gold's Most Recent Surge Is ##br##Stretched ...But Gold's Most Recent Surge Is Stretched ...But Gold's Most Recent Surge Is Stretched The 30-Year Bond Is Driving Stock Markets Moving to the stock market, bank relative performance has closely tracked the collapse in the 30-year yield, because the collapsed bond yield signals both weaker bank credit growth and a likely increase in banks’ non-performing loans (Chart of the Week, left panel). Banks and other ‘value cyclicals’ whose cashflows are in terminal decline are highly sensitive to the prospects for near-term cashflows, which are under severe pressure in the pandemic era. At the same time, as the distant cashflows are small, the banks’ share prices are less sensitive to the uplifted net present values of these distant cashflows that come from lower bond yields. In contrast, technology, healthcare and other ‘growth defensives’ generate a growing stream of cashflows. Making their net present values highly sensitive to a change in the bond yield used to discount those large distant cashflows. The profits of the tech and healthcare sectors are proving to be highly resilient in the pandemic era. Through 2018, the 30-year yield went up by 1 percent, so the forward earnings yield of growth defensives went up by 1 percent (their valuations fell). Subsequently, the 30-year yield has collapsed by 2 percent, so unsurprisingly the forward earnings yield of growth defensives has also collapsed by 2 percent (their valuations have surged). To repeat, financial markets are not complicated (Chart of the Week, right panel). Moreover, the profits of the growth defensives are proving to be highly resilient in the pandemic era, holding up well in the worst shock to demand since the Great Depression. The combination of resilient profits with higher valuations explains why the technology and healthcare sectors are reaching new highs, while the rest of the stock market is going nowhere (Chart I-8). Chart I-8Tech And Healthcare At New Highs While The Rest Of The Market Languishes Tech And Healthcare At New Highs While The Rest Of The Market Languishes Tech And Healthcare At New Highs While The Rest Of The Market Languishes Meanwhile, the relative performance of stock markets is also uncomplicated. It just stems from the relative exposure to the high-flying growth defensive sectors. Compared with Europe, the US has a 20 percent larger exposure to technology and healthcare (Chart I-9). Which is all you need to explain the consistent outperformance of the US versus Europe (Chart I-10). Chart I-9The US Is 20 Percent Over-Exposed To Tech And Healthcare... The US Is 20 Percent Over-Exposed To Tech And Healthcare... The US Is 20 Percent Over-Exposed To Tech And Healthcare... Chart I-10...Which Explains Its Consistent Outperformance Versus Europe ...Which Explains Its Consistent Outperformance Versus Europe ...Which Explains Its Consistent Outperformance Versus Europe A Quick Comment On European Currencies And The Dollar Turning to the foreign exchange market, the recent rally in European currencies can at least partly be explained as a sell-off in the dollar. Begging the question, what is behind the dollar’s recent weakness? The dollar has moved as a mirror-image of the global stock market. For the broad dollar index, the explanation is quite straightforward. True to its traditional role as a haven currency, the dollar has moved as a mirror-image of the global stock market, measured by the MSCI All Country World Index (in local currencies). Simply put, as the stock market has shaken off its year-to-date losses, the dollar has shaken off its year-to-date gains (Chart I-11). Chart I-11The Dollar Has Just Tracked The (Inverted) Stock Market The Dollar Has Just Tracked The (Inverted) Stock Market The Dollar Has Just Tracked The (Inverted) Stock Market Looking ahead, we can link the prospects of currencies to the outlook for 30-year bond yields. A further compression in yields will weaken the dollar, and help European currencies, in two ways. First, as already mentioned, yields have more scope to decline in the US than in core Europe, and a fading US yield premium will weigh on the dollar. Second, to the extent that the lower yields can prevent a protracted bear market in stocks and other risk-assets, non-haven currencies can perform well versus the haven dollar.  Having said that, an expected near-term setback to stocks versus bonds will briefly pause the European currency rally. Concluding Remarks The charts in this report should leave you in no doubt that the 30-year bond yield – particularly in the US – is the puppet master pulling the strings of all investments: bond market relative performance, real bond yields, gold, banks, growth defensives, equity market relative performance, and major currencies. Which raises the crucial question, can the downtrend in 30-year bond yields continue? Yes, absent an imminent vaccine or treatment for Covid-19, the downtrend in yields can continue. As we explained last week in An Economy Without Mouths And Noses Will Lose 10 Percent Of Jobs, the spectre of mass unemployment is looming large. Specifically, the major threat to the jobs market lies in the coming months when government lifelines to employers – such as state-subsidised furlough schemes – are cut or weakened. Where 30-year bond yields are still far from the lower bound, they will ultimately get a lot closer. Hence, it is inevitable that those central banks that can become more dovish will become more dovish. Given the political difficulties of using fiscal policy bullets, the lessons from Japan and Europe are that the monetary policy bullets get fully expended first. In practical terms, this means that where 30-year bond yields are still far from the lower bound, they will ultimately get a lot closer. The upshot is that core European bonds will continue to underperform US bonds, and that the European stock market will continue to underperform the US stock market. European currencies will trend higher versus the dollar, albeit a setback to stocks versus bonds is a near-term risk to the European currency uptrend. Fractal Trading System* This week’s recommended trade is to play a potential countertrend move in the dollar via long USD/PLN. The profit target and symmetrical stop-loss is set at 4 percent. The rolling 1-year win ratio now stands at 57 percent. Chart I-12USD/PLN USD/PLN USD/PLN When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated  December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System   Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations