European Natural Resources Fund: Expectations for Fed rate cuts weaken, rate cut pace is becoming more cautious

According to the Zhitong Finance and Economics APP, Li Gangfeng, an analyst at the European natural resources fund Commodity Discovery, stated in a post last week that Powell mentioned that the Federal Reserve is not in a hurry to cut interest rates. He believes that if the U.S. economy develops as they predict, the U.S. will cut interest rates twice more this year, totaling 50 basis points (1% for the year). After the speech, both the stock market and gold showed signs of deflation. In addition, the announcement last Friday that the U.S. added more jobs in September than expected by the market, led to a change in market expectations for a 50 basis point rate cut in November to 25 basis points, reducing the popularity of gold.

The previously provided official data on new job positions in the U.S. has been confirmed to be a farce (the number of new job positions in the past year has been revised down by nearly 1 million). It seems that the market is still trading purely based on the data provided by the government. In other words, the trend of the investment market is completely controlled by the government's preferences rather than the fundamentals, which is a dangerous situation. He mentioned that even though there is a trend of deterioration in the technical aspects of gold, the support provided by the situation in the Middle East should not be ignored.

Data source: CFTC/LSEG Workspace

*For comparison purposes, the metal equivalent of COMEX gold is divided by 10, and the metal equivalent of COMEX silver is divided by 100.

As of last Tuesday, only platinum and copper in the U.S. metal futures saw a continued increase in net long positions, while other metals saw a decrease in net long positions.

The net long positions of gold futures in the U.S. fell by nearly 6% on a weekly basis last week, ending three consecutive weeks of increase; at the same time, short positions in funds plummeted by 35%, resulting in fund holdings falling from a net long position of 793 tons to 775 tons, marking the 51st consecutive week of net long positions (previously 46 weeks net long), also the historical high of 908 tons in September 2019 by 85% (close to the highest level in recent years). As of October 1st, the price of gold in U.S. dollars has risen by 28.9% this year (up 28.7% the previous week), while net long positions in funds have risen by 49.7% during the same period (up 58.3% the previous week).

Silver, which is highly correlated with gold prices, has always had stronger fluctuations than its cousin, platinum. The net long positions of silver futures in the U.S. fell by 9% on a weekly basis last week; short positions in funds rose by 18%, resulting in fund holdings falling from a net long position of 7167 tons to 5969 tons, marking the 30th consecutive week of net long positions and reaching 39% of its peak period. As of October 1st this year, the price of silver in U.S. dollars has risen by 32.2% this year, with net long positions in silver funds accumulating by 44.6% (59.4% the previous week) and net short positions falling by 25.3% (36.9% the previous week).

The net long positions of platinum funds in the U.S. rose by 7% on a weekly basis last week; short positions fell by 10%, resulting in an increase from a net long position of 24 tons to 30 tons, the highest level in the past 18 weeks. Historically, the net short positions of platinum funds in the U.S. have been maintained for 31 consecutive weeks (from April 2018 to October 2018) The net short position of the US Palladium Fund has fallen back to 24 tons. The author believes that even though the bull market in palladium may have ended, if palladium continues to maintain a significant net short position, it may still be quite difficult for other precious metals to completely reverse the trend. The US Palladium Fund has been in a net short position for 97 consecutive weeks, marking the longest net short position in history.

The fund's net long position in US futures gold has risen by 84% since the beginning of the year (accumulated increase of 101% in 2023).

Data Source: CFTC/LSEG Workspace

The fund's net long position in US futures silver has risen by 125% since the beginning of the year (accumulated decrease of 44% in 2023).

Data Source: CFTC/LSEG Workspace

The fund's net long position in US futures platinum has risen by 13.2% since the beginning of the year (accumulated decrease of 7% in 2023).

Data Source: CFTC/LSEG Workspace

The fund's net long position in US futures copper has risen by 175% since the beginning of the year (accumulated decrease of 0.3% in 2023).

Data Source: CFTC/LSEG Workspace

Basically, from the above charts, it is clear that despite the global inflation heating up in recent years, prices of various metals have experienced varying degrees of decline, mainly because the futures market lacks funds to drive leverage for long positions. If someone had a crystal ball years ago and knew about the sudden global inflation surge, conflicts, and uncertainties this year, and went long on precious metals in the futures market, they would most likely lose money. Since the global spread of the pandemic in 2020, the net long positions in US futures for precious metals have been continuously declining, reflecting a deliberate effort by funds to prevent precious metals from rising.

The CFTC weekly reports on US copper have been available since 2007. Due to the bear market in copper from 2008 to 2016, it is not surprising that copper has mostly been in a net short position historically. However, starting from 2020, due to the impact of the global pandemic on the supply side and mining operations, coupled with market expectations for strong demand for copper in electric vehicles, copper prices have risen, even reaching new historical highs However, the current global investment concept is that the world is entering an economic recession, leading to a decrease in commodity demand.

As the US presidential election approaches (in October) or by 2025, one should be cautious about the decline in copper prices. Copper prices are closely related to the US stock market. On the other hand, China's increased capital investment in the stock market should help support copper prices from a confidence perspective.

The author has updated the important indicator of the short-term direction of gold prices with respect to gold mining stocks. Last week, the USD gold price/North American gold mining stock ratio rose:

Data Source: LSEG Workspace

As of Friday (the 4th), the gold price/North American gold mining stock ratio was 16.78X, up 2.6% from the 27th, marking the third consecutive week of increase. The ratio reached a new high for the year of 19.22X (closing price basis) 33 weeks ago. It has accumulated a 2.1% increase for the year. In 2023, it increased by 13.2% for the full year (6.4% in 2022), with the highest ratio in 2023 at 17.95 and the lowest in January at 13.99X and 11.24X in 2023 and 2022, respectively.

The author believes that tracking overseas gold mining stock prices is a more reliable forward-looking tool. If the gold price continues to rise but gold mining stocks experience a sharp decline, caution is advised.

Gold-Silver Ratio

The gold-silver ratio is an indicator of market sentiment. Historically, the gold-silver ratio has operated at levels between approximately 16 and 125 times:

Data Source: LSEG Workspace

Generally, the more fearful the market, the higher the gold-silver ratio. For example, in 2020, due to the spread of the new crown globally, the gold-silver ratio once reached a historical high of over 120 times.

Last Friday, the gold-silver ratio index was 82.37, down 1.8% from the previous period, with a cumulative decline of 5.0% this year. It rose by 14.0% in 2023, with the highest and lowest points in 2023 being 91.08 and 75.93, respectively. It fell by 3.1% in 2022.

It is important to note that both the USD gold price/North American gold mining stock ratio and the gold-silver ratio are clearly showing a trend of bottoming out and rebounding. The financial markets have clearly entered into recession trading.

Market Expects a Major Reversal in the Probability of US Rate Cuts in November

At the time of writing, the market believes that the probability of the Fed cutting rates on November 7th, and the probability of another 50 basis point cut, has dropped from 53.3% two weeks ago to 0% last Friday. Currently, the market believes that the probability of a 25 basis point cut in November is as high as 97.4%:

Source of images: CME Group

This is a yield probability distribution chart for the US in December 2024 in the futures market when writing:

Source of images: CME Group

As of last Friday, the mainstream view in the market is that the US will cut rates by 50 basis points for the rest of this year.

A week ago, the market believed there was a 49.7% chance that the US would cut rates to 4.00%-4.25% by the end of the year, but by last Friday, this probability had plummeted to 17.7%; on the other hand, the probability of a rate cut to 4.25-4.50% had surged from 21.3% a week ago to 80.2% last Friday, indicating that the market believes the pace of rate cuts in the US has become more cautious. In just one week, the market has made such a significant adjustment to its rate expectations, once again confirming the author's words: after a long period of verification, the futures market's predictions of US interest rate trends, especially forward expectations, are generally wrong. For example, the market had originally expected the Fed to cut rates by only 25 basis points in September, but in the week before the meeting, the market suddenly bet on a 50 basis point cut, which I believe was due to some people in the market receiving information.

The author originally believed that when the Fed cut rates by 25 basis points in September, it was the peak for US stocks; therefore, the 50 basis point cut was a bit unexpected (it should be noted that the economic data released by the US a week before the meeting in September was not that bad). The result of the 50 basis point cut is to temporarily shift from recession trading back to optimistic trading.

Last week, Powell stated that the Fed is not in a hurry to cut rates. He believes that if the US economy develops as they predict, the US will cut rates twice more this year, totaling 50 basis points (a total of 1% for this year). After the speech, both the stock market and gold showed signs of deflation. In addition, the announcement last Friday that the US added more jobs in September than expected by the market changed the market's expectation for a rate cut in November from 50 basis points to 25 basis points, reducing the popularity of gold.

The job creation data provided by US official institutions has been proven to be a farce (the number of new jobs added in the past year has been revised down by nearly 1 million), indicating that the market is still trading purely based on the government's data. In other words, the trend of the investment market is completely controlled by the government's preferences and is detached from the fundamentals, which is a dangerous situation.

The current market situation is clear: if there is no significant drop in US stocks (if there is a major drop, safe-haven assets will benefit), then risk assets (the most popular companies in US stocks, digital currencies, silver, copper, and other commodities) and safe-haven assets (including bonds and gold) will rise to varying degrees However, it is important to note that the Federal Reserve will discuss interest rates in November. In other words, the focus of the U.S. stock market in October may shift from rate cuts to the U.S. presidential election. As it currently stands, the two candidates seem evenly matched, so it is estimated that due to uncertain factors, the U.S. stock market in October may become more volatile.

On the other hand, according to the World Gold Council, before the National Day holiday in China and India, local gold prices were discounted compared to international prices, indicating that gold prices may be overbought in the physical market:

Image Source: World Gold Council

Whether Chinese gold prices can shift from a discount to a premium after the National Day holiday may be a short-term key for gold prices.

The biggest challenge in the next 12 to 24 months will be if the U.S. starts cutting interest rates again, but inflationary pressures start to rise. Where will the Federal Reserve go from there?

Despite the technical trend showing a downturn in gold, do not overlook the support provided by the situation in the Middle East for gold prices.

Although local currencies have appreciated recently, I believe it is just a transitional reversal after the strong U.S. dollar crowded out trades. Especially, even though environmental stocks rebounded last week, I tend to believe that this rebound is just a flash in the pan, enticing more funds to enter the market. Therefore, I personally recommend gradually reducing holdings of risky assets during this rebound (but it is uncertain how long it will last) to secure profits