Last week was one of the most entertaining trading weeks in a long time for me. Not because of how my portfolio did, but purely based on the amount of economic information we got. We got a number of leading indicators like the ISM manufacturing and services reports, but also coincident indicators like unemployment numbers. Long story short, stocks celebrated the fact that unemployment came in less weak than expected. Fortunately for gold bulls, the selling did not start. On the contrary, the VanEck Gold Miners ETF (GDX) gained steam into the weekend and is building a strong fundamental and technical base for new highs.
Leading Indicators Have Entered Full-Blown Contraction
Last week was one of the most important weeks this year. We got the leading ISM manufacturing index, the services version called the ISM non-manufacturing index and unemployment data. The fact that these numbers are all reported in one week is nothing special as this happens pretty much every month. What is special however, is the situation we are currently in. The first released ISM manufacturing data confirmed what I had predicted for quite some time: economic growth slowing has turned into severe contraction as the index hit a 10-year low in August. The graph can be seen below and this link brings you to the full breakdown of the numbers which I highly recommend you to take a look at.
This basically implied that the economy is not as great as some thought and it increasingly will pressure the stock market until things improve. Anyhow, traders quickly focused on the ISM non-manufacturing (NYSE:NMI) numbers as strong services would had lifted a lot of pressure off the market. Well, that did not happen as the NMI index fell to 52.6 which is a multi-year low and just barely above the lows of the prior-cycle (51.4). We are clearly in a situation where manufacturing weakness has hit the core part of the economy which is services. The same happened in the prior cycle when it took a few months until services felt the pain.
Source: Twitter (@CharlieBilello)
The result was an S&P 500 decline of 4.5% from the highs of September 1st to the post-NMI lows on September 3rd. This was followed by an immediate short squeeze of roughly 2% on the very same day. After traders had focussed on leading NMI numbers, they were looking for a good jobs report on Friday.
Why The Jobs Report Matters
The result from last Friday were not that bad. The US economy created 136,000 jobs in September versus expectations of 145,000 jobs. Wage growth came also in slightly below expectations at 2.9% while the unemployment rate fell to 3.5% which is a 50-year low. The result was a market rally of another 1.3% which gives it a 3.4% performance since the lows reached on September 3rd.
Just to be clear, I am not here to predict the daily performance of the S&P 500. I am using the S&P 500 as an example of expectations. It was clear that traders were desperately looking for a reason to become bullish after both the ISM and NMI index were very weak. They did get a reason to buy after jobs indicated that things were not at all that bad. However, I think traders are making a major mistake and gold traders did not buy it.
See, gold is up 3.9% since September 1st without showing any weakness as a result of a 'strong' jobs report. The gold mining ETF GDX even had its best day of the month on Friday after the jobs report when the ETF rallied 2.3%. The 20+ government bonds ETF (TLT) gapped up and ended the day 0.7% higher.
So, we are currently seeing that 'the market' has had 2 very strong days while both bonds and gold miners are doing even better (relatively). It makes total sense that traders bought gold miners and bonds as it I think it does not make any sense at all to celebrate a jobs report like the one we got on Friday. Sure, the economy created more jobs, and that's always good. However, jobs are not leading. ISM and NMI numbers however are. And that means that jobs growth is expected to slow further. Last Friday's jobs report was not the result of ISM/NMI weakness in September bus from 2-3 months earlier. The fact that ISM/NMI numbers are now really starting to decline will mean that the pressure on jobs is just getting started. The graph below shows this quite well. The graph shows the year-on-year growth rate of total manufacturing jobs. Almost needless to say, the trend is clearly down.
Dollar Weakness Would Be A Blessing
That being said, another thing caught my attention. The USD index weakened as well. Since the start of the month, the index is down almost 1%. This is obviously not extreme weakness, but an interesting sigh as traders did not rush to buy the world's reserve currency. Instead, negative interest rate currencies like the EUR were able to gain almost one percent even though the Euro Zone economy is much more fragile than the US.
This has something or pretty much everything to do with the fact that the FED is expected to continue its easing cycle. After the most recent macro numbers, traders are once again pricing in more than 2 rate cuts according to my data. The graph below shows the difference between the FED Funds Rate and the 2-year government yield.
We have gone from 1 implied rate cut to more than 2 within days. That's how fast things go once it becomes clear that growth slowing is a reality. This includes the obvious fact that the FED is behind the curve and has to follow its way more dovish peers in Europe and other regions - hence traders did not rush to buy dollars.
Why GDX Will Continue To Deliver Alpha
GDX has a very pretty chart right now. Miners are bottoming thanks to a weaker dollar, declining economic growth and the fact that the jobs report was not that strong. I expect that miners are going to continue their uptrend to new 52-week highs over the next few weeks.
Note that I have switched to only discussing GDX a long time ago instead of covering single gold miners. GDX allows you to buy the 'whole industry' without having to do in-depth research and to buy volatile single stocks.
Moreover, the biggest risk to the current bull case is a situation where growth becomes so weak that traders rush back to the dollar and cause a huge deflationary pressure. However, as long as the FED is expected to accelerate its easing cycle, I think GDX continues to be a very good place to be.
I expect to see much weaker coincident indicators including industrial production, new orders and employment. On a side note, we are also about to enter a very busy Q3 earnings season which will reveal the true impact of growth slowing on corporate earnings. So, whether you decide to trade/invest in GDX or not, we are in for a few very interesting months.
Thank you very much for reading my article. Feel free to click on the "Like" button and don't forget to share your opinion in the comment section down below!
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GDX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.