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3Q US GDP Is Not What It Appears: US Bond Yields, USD TWI May Yet Fall As Per The Liquidity Models, PMs And Miners Should Rally

Note to readers:

The charts have been updated. I will update the text once we see the actual inflection points, which I expect to see this coming week.




US GDP which came in at 2.9%, well above the expectations of the Atlanta Fed Nowcast, is not what it appears. Here is an analysis of the breakdown of the GDP report:

"After digging into Friday's report on third quarter gross domestic product, it turns out that a good part of the heady 2.9% growth comes from much larger than usual exports of soybeans last quarter."

"Soybeans were exported at a close to unbelievable pace," comments Mike Materasso, who co-chairs Franklin Templeton's fixed income policy committee. Roughly 1% of the 2.9% GDP growth came from soybean exports alone, he says."

"The reason is that there was a weak soybean crop in South America, so the U.S. exported a lot more, says Krishna Memani, chief investment officer at OppenheimerFunds."

"The GDP growth rebound is driven by things that are not sustainable," says Memani. Soybean exports and a ramp up in inventory, which had been depleted are both reasons."

"We are still talking sub 2% type growth," says Memani. "That's better than 1%, but definitely not a situation that requires the 10-year Treasury to be at 3%."

This explains the curious behavior of the market right after the data was published -- the US Dollar TWI actually fell sharply, and bond yields were weaker going into the market close for the week. Moreover, the stock markets fell.

SA Contributor Lawrence Fuller discussed the impact of the very large soybeans export on the 3Q GDP, and the likely development thereafter (see that here).

In so far as the models are concerned, we have not seen any indication that the high growth rate in Q3 made a lot of difference -- my read is that yields should still fall over the next week or so, then ratchet higher again, and may actually peak by the November 14-22 period. We read the forecast trajectory of the US Dollar pretty much in the same way, closely following the lead of the short-term rate. The other assets will probably take the cue from the short-term rate as well.

Bond Yields:

The Liquidity Models suggest that the peak in rates may have been seen last week. The models suggest a week or so of declines and them we could see another run-up in bond yields until the period of November 14-22. This could even be a higher high before yields weaken again. From that point on, a decline in rates should persist until the end of the year. Nonetheless, we have also some evidence (which still needs confirmation) that US yields would be rising later in the January 2017 month. So for now, we work on the assumption that US rates see a top in mid-November but could see a bottom by year-end.

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US Dollar:

We have linked the US Dollar with the US 3-year yield, which we know to have very large impact on the valuation of the US Dollar. The USD is a very "noisy" variable and difficult to model, but changes in USD do correlate well with changes in the US 3yr short-term rate. So we used the short term rate as proxy for the USD, the added attraction being the very good correlation between changes in liquidity and changes in short term rates.

The Liquidity Models suggest that we could have seen a peak in the USD TWI last week. The models also suggest that another peak in USD should be expected during the period November 14-22. This could even be a higher high. The subsequent USD decline should persist until the end of the year.

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Equity Markets:

Prospects of a higher high in the equity markets (optimal: November 1) has faded, as the equity markets followed the lead of the Fed and treasury models lower. We should see an intermediate low by circa November 16, followed by a sizeable rally. But a final low may be seen early December (optimal: December 6), followed by another rally which could last until very late in the year.

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Gold and PMs:

Gold and PM prices have been tracking the inverse of the changes in short term rates well in recent months. That relationship accentuates the negative correlation between Gold and the USD. Since the US Dollar from current levels, then gold and PM prices should benefit and could rally. Gold prices are expected to rise this week. However, they may also make a lower low during the November 14-22 period. Nonetheless, from that prospective trough, gold and PM prices should rise until the year-end.

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Silver and Miners:

Silver prices still mirror Gold's changes, and collectively, Silver and the Miners have a strong comovements with short-term interest rates, with Silver and Miners lagging behind by 3-5 trading days. That relationship seems to be holding true. Miners did fall until late in the October month, and are probably due for another rally. There may be another low in late November, however. The upside momentum thereafter could bring Silver and Miners higher until year-end.

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Crude Oil:

Liquidity, via the effect of the HY rate, also impacts oil prices to a large degree. The models suggested a peak last week (optimal: October 26), then a decline into early November, then finally sharp rally and subsequent top sometime by mid-December.

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Exploration & Production Companies:

Liquidity, via the effect of the HY rate, also impacts oil exploration and production companies to a large degree; the impact of HY on E&P names is certainly much larger than the impact of the equity markets in general. The models suggest that E&P names will fall further in early November. And up then down movement culminates in a peak sometime during the first week of December.

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Refiners also respond well to the HY rate, but they lag behind the oil price and E&P names by about 5-7 trading days. Hence, they are just starting to roll over, lagging the developments in Oil and E&P names. The Liquidity Models suggest that the Refiners may continue to fall further over the next two weeks, until early 2nd week of November. A top is expected by late third week of December (optimal: December 19).

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.