Gold's Next Leg Higher, Commodity Complex Moving Up

 | Aug 10, 2014 10:20PM ET

With geopolitical tensions continuing to escalate, there's a tendency by participants and pundits alike to fit the headlines to the tape.

U.S., Europe Stocks Decline, Treasuries Rally on Ukraine   

Don't. 

While these events have certainly not hurt demand, the respective trends in both Treasuries and gold have been in place all year and under what we believe are more endogenous and cyclical motivations - than event driven reflexes at the whim of Putin, Hamas or Israel. From our perspective, the same holds true with the recent cracks in the US equity markets, which we view as an obvious - but latent reaction, to the Fed slowly ending their policy support this fall.

Generally speaking, we've approached the broader macro picture in the US equity markets from the top down bearings of the long-term 10-year yield cycle and the proportional trends of Shiller's P/E ratio - which we have described in previous notes (see here ) as sharing close parallels with the cyclical peak in equities in 1946. Although the trend in equities did extend further than we anticipated at the start of the year, similar market and policy conditions still exist that hold strong congruencies with this historic time period. This perspective remains supported by:
  • The long-term yield backdrop - which we would argue primarily drives the boat from a valuation and asset cycle point of view and is similar to the range in yields witnessed in the mid 1940's. Yields currently reside on the mirrored return of the 80 year cycle - which would extends the range (~1.5-3.0%) of this extremely low yield environment further out than is currently considered.  
  • The current disposition of Shiller's P/E - which our trend analysis would indicate has a low probability of exceeding the proximate and previous cyclical peak in 2007.
  • Similarities in extraordinary measures in monetary policy between today and the 1940s - which saw the Fed purchase and hold all available short-term U.S. Treasuries and virtually all long-term U.S. Treasuries. We expect a similar outcome in the markets to the normalization of current monetary policy, which from our perspective would likely push an actual rate tightening cycle further out than is currently considered.
  • Similarities in equity market performance since the Fed started visibly supporting the markets at the previous cycle lows in 1942 and 2009. Although the composite duration in policy support extended from the Fed has been longer today, it was intermittently halted on two occasions over the past five years. Taking into account these pauses between QE salvos, comparisons between the two equity market cycles are commensurate.   
  • The pivot higher in the commodity markets this year, which was also dramatically evident when the Fed pivoted from its outright purchase of securities in the market at the end of 45' and extended the commodity cycle to its cyclical high in 51'. Generally speaking, we view the bid in the precious metals sector this year as the leading edge for the broader commodity space and find efficacy in the Fed's policy pivot - which signaled to the markets a trend change in inflation expectations.
Just as the policy shifts by the Fed in the mid 1940s sparked the unique conditions in which long-term yields declined with a rejuvenation in commodities and inflation (see