STOXX EUROPE 600 STOCK INDEX REACHES HIGHEST LEVEL IN A YEAR -- EUROPEAN BOND YIELDS ARE ALSO RISING -- A WEAK EURO MAKES EURO COMMODITY INFLATION EVEN HIGHER -- DOLLAR IS TRYING TO BOUNCE OFF CHART SUPPORT -- GOLD STRUGGLES WITH RESISTANCE
STOXX EUROPE 600 HITS 52-WEEK HIGH... My last message focused on the idea that foreign stocks were also turning up which has strengthened the global rally. My main focus was on Europe which I'm returning to today. First, the rally the stocks. Chart 1 shows the STOXX Europe 600 Index (plotted through Thursday) rising to the highest level since the end of 2015. [The index includes stocks from 17 European countries including the UK]. The pattern looks bullish. After declining from spring 2015 to the start of 2016, the index traded sideways throughout 2016 in a bottoming formation. It broke its falling trendine last August turning its trend from down to sideways. It broke out to the upside during December and is now in an uptrend. And like the US, the rally is being led by financial, resource, and economically-sensitive stocks. It's not too much of a stretch to suggest that Europe is also benefiting from the postelection optimism. In fact, Europe has risen faster since the election. Since November 8, the Europe 600 Index gained 10% through Thursday, versus a 7.5% gain in the S&P 500. And, like here, money moving out of bonds is going into stocks.
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Chart 1
EUROPEAN BOND YIELDS ARE ALSO RISING... A headline in today's Wall Street Journal reads: "European Investors Bet On Economic Revival". The most obvious example of that is the upturn in stock prices (which usually precedes an economic upturn). The Journal article, however, focused more on the upturn in European bond yields. Just like in the U.S., the upturn in European stocks has been accompanied by an upturn in European yields. In other words, investors have been selling European bonds. That's because bond yields rise (and prices fall) when a rising stock market signals economic growth with rising inflation (more on that shortly). The blue line in Chart 3 shows the 10-Year German Yield trading at the highest level in a year. [At the same time, yields in Italy and France have reached 18 and 16 month highs respectively. UK yields are at a nine-month high]. The bund is considered to be the main benchmark for eurozone yields. The bottom in yields during the second half of last year occurred at the same time that U.S. Treasury yields turned up. That's also not surprising because (like stocks) global bond yields usually trend in the same direction. Money coming out of European bonds has been used to buy European stocks. That shows that market trends in the U.S. are being mirrored by trends in Europe. The same is true with inflation.
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Chart 2
INFLATION IS ALSO RISING IN EUROPE... Another factor pushing European bond yields higher is rising inflation in that region. German inflation is nearing 2%. Inflation in the rest of the eurozone in only 1.1%, but both measures are at the highest levels in three years. Mario Draghi stated in his last news conference that the ECB saw no evidence of rising inflation. Unlike the Fed, the ECB includes food and energy in their inflation gauges. Apparently, the ECB hasn't noticed that those commodities are rising. Chart 3 shows two different version of the Reuters/Jefferies CRB Index (of 19 commodities). The lower line is the traditional version of commodity prices priced in dollars. It bottomed last February and has since risen nearly 16%. The upper line plots the CRB Index in Euros ($CRB:$XEU). That stronger line gained 18% over the past year. Over the last six months, however, commodities quoted in Euros rose 12% versus a smaller 7% gain quoted in dollars. That discrepancy is due to the fact that the Euro plunged to a 14-year low in December against the dollar and has still down more than 4% since last August. That makes the commodity inflation threat even worse in Europe because it takes more euros to buy food and energy. Rising inflation is one of the factors pushing European bond yields higher. There are already calls for the ECB to reign in its buying of bonds to stimulate growth and inflation. How soon it decides to do that may depend on how soon it looks at some charts. For U.S. investors, the moral of this message is that bond yields are bottoming all over the globe as it shifts away from deflation into a more inflationary climate. And the rotation out of bonds into stocks is global in scope. And that trend may be just beginning.
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Chart 3
DOLLAR IS BOUNCING OFF SUPPORT ... With U.S. stocks resuming their uptrend this week, and Treasury yields rebounding, it's the dollar's turn to show some strength. The daily bars in Chart 4 show the PowerShares Dollar Index Fund (UUP) starting to bounce off chart support along its early December low. The UUP is also finding support near a rising trendline drawn under its September/November lows. The 14-day Slow Stochastic Oscillator (top of chart) may also be turning up from oversold territory below 20. [Stochastics are more sensitive than the RSI line and spot oversold conditions more quickly]. Postelection optimism pushed bond yields, the dollar, and stocks higher. All three pulled back during January until the past week. It may not be long before all three are back in sync on the upside again. That would make the going even tougher for gold.
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Chart 4
GOLD HAS A BAD WEEK... My message from the previous Thursday showed the Gold Shares (SPDR) meeting resistance along its spring 2016 lows. Chart 1 shows GLD backing off from that resistance line. Gold has two things going against it. First, this week's rally in stocks reduced the need for safe havens like gold. Second, a rebound in Treasury yields is normally bad for gold (which is a non-yielding asset). The third, and possibly more serious threat, would be an upturn in the dollar. At the same time, base metals like copper had another strong week.
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Chart 5
COPPER/GOLD RATIO MEANS HIGHER RATES... Since the November 8 election, the price of copper has risen 21% versus a -6% loss in gold. There's a message in that. The brown line in Chart 6 plots a ratio of copper divided by gold over the last two years. The ratio bottomed last September, but really took off during November. That was driven by the rise in copper to an 18-month high (along with other base metals like aluminum and steel). Industrial metals were driven higher by expectations for more infrastructure spending and a stronger global economy (along with stocks tied to them). The green line in Chart 6 shows the 10-year Treasury yield tracking the copper/gold ratio very closely. That same correlation goes back several years. Strong industrial metals are pulling bond yields higher around the world. Higher bond yields, however, are usually bad for gold. Hence, the rising copper/gold ratio. The next time someone on TV suggests buying gold as an hedge against inflation, change the channel. In the current environment, copper is a much better inflation hedge. Chart 6 also shows that there's economic power behind rising global bond yields.
