Bug Killer

Gold bugs are quickly becoming an endangered species. When the monetary authorities around the globe leapt into action last spring the yellow metal responded by tacking on a quick $600 from the panic lows of March. It now looks like the spectacular success of vaccine developers has provided an effective spray for these pessimistic financial pests.

For bearish investors, precious metals tend to be an easy default choice, although Bitcoin players have lately had an even better run of luck. The pandemic and its associated policy responses greased the skids for the precious metal trade. That phase seems to be fading, judging by the market's response to the twin positives of political renewal and prospects for an effective vaccine.

By offering the world hope for a Covid-free world within the next two years, AstraZeneca, Pfizer and Moderna are proving formidable pest-control specialists. The message of gold's current sell-off is unambiguously bullish for risk assets. Now you know why I obsess about the Copper/Gold ratio. It's working perfectly!

Last week's two-day pause in the rally seems like a head fake now. The "All on Board" rally continues this week and I find myself at odds with an ever-improving tape, having taken profits last week. It reminds me of past episodes in market history that followed from the initial stage rally off a major low. My first experience managing money in this type of market was in 1982. When Paul Volker, the architect of the 20% prime rate that cratered inflation, finally took his foot off the brakes in August of that year, nobody believed the rally that ensued. Bearish investors were left in the dust. Calls for a retest ultimately went unheeded. The dramatic change in policy was both surprising and decisive, just as it has been this year. All major turning points in monetary policy have had similar doubting Thomases in their initial phase.

Fast-forwarding to this rally, I see some parallels to that long-forgotten trade, but also some differences. Although the mechanics of the system are vastly more complex than those days, the behavioural response is eerily similar. When greed replaces fear so quickly, there is always a temptation to second guess. But such is the nature of risk-markets when animal spirits are aroused. This time, it's not just a FED shift but a cure for COVID that is providing the fuel for risk-taking.

It's a bit of a random walk from here to year-end now. The positives promised by a COVID-free future are tantalizingly close now. Visions of a military scale roll-out of billions of vaccine jabs to an eagerly awaiting population next year have supplanted all concern about a COVID racked economic double-dip. And a Biden presidency, with his initial moves to a more cogent and centrist policy set, looks to provide even more certainty for the few remaining fearful investors.

But can the market completely ignore the devastation currently unfolding in the economy? Apparently so. It did so in the fall of 1982, and it's looking more and more like that now.

Shut-downs and travel restrictions are back with a vengeance. Whatever happened to 'once bitten, twice shy'? I'm guessing the massive work-from-home stock rally from March to August is fresh in people's minds. It looks like the same people who missed the Growth rally are now determined not to miss the Value trade, no matter what.

It looks like the rally has legs till year-end. What self-respecting portfolio manager wants to be seen sitting out the best-credentialed market in years? Volume confirmation (OBV Indicator) of the move in XLF and XLE, the left behind Financials and Energy stocks that lagged the work-from-home stock craze lends credence to the shift to the "reopening" trade ( see charts). The catch-up mentality is a now powerful motivator.

Financial ETF

Energy ETF

Will this end badly? It depends on when the bond market starts to wake up and smell the coffee. Yields are currently being held back by the threat of a new round of quantitative easing - meaning a FED purchase of long-dated securities. How long would that fantasy last if a successful reflation was to occur? Emerging markets, led by China, are already leading the economic recovery, pushing up commodity prices in the process. Won't the Biden-led fiscal package include inflation-inducing infrastructure spending? And come this spring, how will bonds deal with the statistical inflation generated by the simple lapping of the sudden-stop global economy of earlier this year?

I don't even want to talk about issuance. It has always been said that 'the bond market crop never fails'. How can the debt-fuelled recovery possibly be self-financed when the real economy starts to absorb the available liquidity? I believe it is now impossible to diversify risk-assets properly as all asset prices have such an enormous sensitivity to rising rates. Yields that just two years ago would have seemed low, now present a major threat to asset prices, should they rise meaningfully.

The melt-up in financial assets continues. The financial euphoria unfolding as I write should continue until the adults in the room put a stop to the party. Bondies... I'm looking at you!

Risk Model: 3/5 - Risk On

Well, at least the model is still bullish even if I'm a bit reluctant. The decline in the 3mo VXV to a new post-COVID low has brought it below the range. This is very constructive, but it looks a bit stretched.

3 Mo VXV

As the explosion in the Copper/Gold ratio (below) continues, and with AAII Sentiment decidedly positive, there is ample appetite for the rally to continue unopposed.

Copper/Gold

The positioning of the market itself is overbought to the extreme, hence my caution. The RSI is elevated, rising to above the 70 line. More dangerous, the XIU is now more than 10% above its 200 DMA - a level associated with an elevated risk of sudden setbacks as we saw earlier this year.