$XLV Archives - LXV Research

“If history repeats itself, and the unexpected always happens, how incapable must Man be of learning from experience.” ― George Bernard Shaw

Goldbugs are gloating. Dollar bulls are hurting. Ellioticians are cursing. This, we hope, is not one of those pieces.

Trading in the Thin Zone

Actions speak louder than words. Well, except for the Federal Reserve. They talked a big game, did very little yet markets popped. None more so than precious metals.

Rather than discussing the what and why of the latest Fed meeting, we discuss our thoughts about trading strategies for the US dollar, gold and silver.

Before we explain, the summary:

The critical level for US dollar bears is around 92 on the $DXY or US dollars 24 for the Invesco DB US Dollar Index Bullish Fund $UUP;

Above US dollars 1,375 per ounce for gold; and

Around US dollars 17.50 per ounce for silver.

In the price charts below, we overlay the volume around each price level to identify what may be called “thin zones” ― areas where prices can move quickly and where positioning should be biased in favour of the shorter-term trend. The investment instruments we chart are ones we deem suitable proxies for the US dollar, gold and silver.

Thin zones are price levels where there has been relatively little buying or selling. Making them areas where there should be little to no support or resistance and so prices can move quickly through them.

These thin zones are typically preceded by, from above or below, price levels where there has been a lot of volume both on the way up and on the way down. These price levels are likely where institutional buying or selling has been heaviest in the past and where there are been a lot of push and pull between bulls and bears. And therefore the breach of such price levels can cause one set of market participants immense amount of pain while reap handsome rewards for the other set of participants.

Winners are unlikely to suppress a favourable move and instead may add fuel to the fire by increasing their positions and heaping yet more pain on those on the other side. The losers, except the most stubborn, are likely to cover adding yet more fuel to the move. With demand being almost unidirectional, prices can spike on very little volume ― making it profitable to position at the edges of thin zones.

Using $GLD as a proxy, gold given the recent sharp move higher is right at the very edge of the thin zone and any continuation of the move higher should be used to add to longs.

Based on $UUP, the US dollar is still someway from getting to the thin zone on the downside but is close to one on the upside. It is still too early to have a full short position in the US dollar and if the current move down is a head fake, shorts should close out positions and even look to go long.

We suspect, 92 on the $DXY is close to the pain threshold for foreign pools of capital holding US Treasury securities without hedging foreign currency risk. If the US dollar breaks 92, it will be time to put on a full short position in the greenback.

UUP

Silver has a lot of work to do before it too can get closer to the thin zone. Gold is probably the better instrument to trade if you want to be long precious metals at present. If, however, silver moves through US dollars 17.50 per ounce, all bets are off and gold longs should be rotated into silver.

slv

Another proxy for silver is to watch for a sustained move above its 48 month moving average.

XAG Curncy (Silver Spot $_Oz) 4 2019-06-20 12-54-14.png

Healthcare Follow Through

A few weeks ago we highlighted the sharp recovery in healthcare stocks and started thinking about the sector as hunting ground for new long ideas. Since then we have witnessed a follow through with the SPDR Health Care Select Sector ETF $XLV continuing to push higher, particularly on the back of mergers and acquisitions activity in the biotechnology space.

The sector has been a laggard year-to-date but a leader in the last month. If the current iteration of the US bull market still has legs, we expect healthcare to continue going from strength-to-strength.

XLV US Equity (Health Care Selec 2019-06-20 11-27-42.png

We remain long Repligen Corp $RGEN and Novocure $NVCR and identify two additional names as long ideas in the healthcare sector. (A long in $AbbVie has still not been triggered.)

RGEN US Equity (Repligen Corp) H 2019-06-20 12-07-54.png

Medtronic $MEDT

Medtronic is the world’s largest medical devices company that infamously acquired Ireland-based Covidien to enable Medtronic to shift its legal headquarters from the US to Ireland to benefit from the favourable tax-regime in Ireland.

We will look to enter a long position should the stock close above US dollars 100.

MDT US Equity (Medtronic PLC) He 2019-06-20 12-10-26

Edwards Lifesciences Corp $EW

Edwards Lifesciences is another medical equipment company. It specialises in artificial heart valves and hemodynamic monitoring.

We are long here.

EW US Equity (Edwards Lifescienc 2019-06-20 13-12-18.png

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This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

“There is nothing more deceptive than an obvious fact.” ― The Boscombe Valley Mystery by Arthur Conan Doyle

Gold vs. US 10 Year Treasury Real Yield

Source: Bloomberg

The above chart compares the year-over-year change in the US dollar price of gold versus the year-over-year change (inverted) in the real yield on US 10-year Treasury Securities. (The deflator used to calculate real yields is core inflation.)

Ever since the gold-bubble popped in 2011, the year-over-year change in its price has been negatively correlated with real 10-year yields. Intuitively, this makes sense given gold is a non-yielding asset and the lower the real yield on bonds the more attractive a non-yielding asset becomes on a relative basis.

Real yields can, of course, decline either due to nominal yields in bonds declining or by inflation picking up. In either case, if the relationship between gold prices and real yields holds, gold prices should move higher. With little seeming desire on the part of the Federal Reserve to jawbone rates higher — especially with a Twitter-happy president and global trade uncertainties rising — precious metals, other than their customary volatility, could be primed to move much higher. Our conviction will be increased if see gold take out its 2016 highs of around US dollars 1375 per troy ounce.

Thinking About the Euro

Try and go back to the start of the year and imagine:

(1) the trade dispute between the US and China escalating;

(2) global risk aversion — measured using the BNP Paribas Global Risk Premium Index — reaching levels last witnessed at the start of 2016;

(3) Italian bond yields blowing out;

(4) economic data coming out of Germany deteriorating;

(5) systemically important European banks, such as Deutsche Bank, crashing to new lows; and

(6) the positive carry (higher interest rate) for the US dollar over the euro sustaining.

Given the above scenario, most investors would want to be long the US dollar and short the Euro. And, indeed, positioning in futures markets suggests that investors are indeed long the greenback and short the euro. Yet, the US dollar is not moving higher. What gives?

EURUSD Curncy (EUR-USD X-RATE) 2019-06-07 18-06-14.jpg

The above is a monthly chart of the Euro US dollar cross. If we get follow through in the recent move higher in the euro by the end of this month, the probability is the euro strengthens from here at least to 1.20 and possibly higher. If, however, the recent move fails and the US dollar strengthens, then we may well get the doomer scenario of a US dollar that is too strong for the rest of the world to handle.

Our base case view is that a weakening greenback finally gets us the blow-off top or ‘market melt-up’ in US equity markets that many have been waiting for.

Watch the euro-US dollar cross and position yourself in stocks accordingly.

The ECB: Not Doing Enough to Prevent the Worst

At this week’s governing council meeting, the European Central Bank (ECB) left the deposit rate at -0.4 per cent and extended forward guidance into 2020, with rates expected “to remain at their present levels at least through the first half of 2020”.

The ECB also confirmed that the proceeds from maturing bonds in its portfolio will be reinvested to keep the stock of assets steady. Details of a third Targeted Longer-Term Refinancing Operation were also revealed: it will be held quarterly from September at interest rates as high as main refinancing operation rate (currently at 0 per cent) + 10 basis points and as low as the deposit rate + 10 basis points. The precise rate will depend on banks hitting their lending targets.

The ECB’s measures should support the European economy and potentially slow down the upward pressure on the euro from an increasingly dovish Fed. However, we do not think the ECB has gone far enough to address the challenges faced by its banks and a further deterioration in global trade activity. It might be that Mr Mario Draghi is passing the buck onto his yet to be named successor but we think the ECB may have at least one trick left up its sleeve: Open Monetary Transactions.

The Open Monetary Transactions (OMT) facility, established during the European crisis, has never been utilised. Currently, the ECB can only buy government bonds according to member states share of its capital. Under an OMT program, however, it would have the power to buy bonds of a specific member state if said member’s government accepts conditionality along the lines demanded by the International Monetary Fund for countries in its funding programs.

If the ECB eventually, albeit reluctantly, comes through with an OMT like programme or another measure to reduce the burden of negative interest rates on European banks, that too could push global stocks much higher.

Sharp Recovery in Healthcare Stocks

Take a look at the relative chart of the SPDR Health Care Select Sector ETF $XLV to the S&P 500 in the second panel below. After a more than four-moth period of drastic under performance by the healthcare sector, we have witnessed a sharp recovery in recent weeks.

We think healthcare stocks might be ripe ground for stock pickers.

XLV US Equity (Health Care Selec 2019-06-07 18-21-02

Some of the names we are tracking closely in the space are highlighted below.

Novocure $NCVR

Research and development company focused on developing cancer treatments with a market capitalisation of US dollars 5.3 billion. We recommend a small position here with a view of adding if it breaks to new highs, above US dollars 56.67.

NVCR US Equity (Novocure Ltd) VE 2019-06-07 18-44-57.jpg

AbbVie Inc $ABBV

Pharmaceutical behemoth $ABBV is starting to looking interesting to us at current levels. A move up US dollars 81.50 and we would be buyers. We recommend buy stops at the level.

ABBV US Equity (AbbVie Inc) VEEV 2019-06-07 18-50-15.jpg

Repligen Corp $RGEN

Massachusetts based $RGEN is engaged in the development and production of materials used in the manufacture of biological drugs ― substances made from a living organisms or its products and used in the prevention, diagnosis, or treatment of cancer and other diseases.