The Prospects for 'QE3' Recede

We haven't really looked at the details of today's jobs report yet, but it seems that it was strong enough to significantly lower the probability of the Fed engaging in another round of 'QE' anytime soon.

As Reuters reports:

 

“The economy created jobs at the fastest pace in nine months in January and the unemployment rate dropped to a near three-year low of 8.3 percent, providing some measure of comfort for President Barack Obama who faces re-election in November.

Nonfarm payrolls jumped 243,000, the Labor Department said on Friday, as factory jobs grew by the most in a year. The gain in overall employment was the largest since April and outpaced economists' expectations for a rise of only 150,000.

The report pointed to underlying strength in the economy, despite expectations that growth will slow in the first quarter. Economists had expected the jobless rate to hold steady at 8.5 percent. The rate is the lowest since February 2009 and has dropped 0.8 percentage point since August. The decline last month reflected large gains in employment in the separate household survey from which the unemployment rate is derived.

"It's certainly supportive of the U.S. recovery and suggests that momentum is gathering pace," said Brian Dolan, chief market strategist at FOREX.com in Bedminster, New York. U.S. Treasury debt prices fell sharply on the report, while stock index futures surged. The dollar rose against the yen. The continued labor market improvement could be a relief for Obama who faces a tough re-election.

The report contrasted with a glummer assessment of the economy's prospects offered by the Federal Reserve last week and it could lessen chances of the central bank launching another round of asset purchases to spur a stronger recovery.”

 

(emphasis added)

The central bank won't go for more monetary pumping unless it has some cover. Cover would be provided by further weakness in the jobs market or a big decline in the stock market.

Alas, today's unemployment report was the best in a very long time. Even though unemployment is generally regarded as a lagging indicator, it is a major data point in terms of the central bank's policy deliberations given its dual mandate.

Interestingly, the gold market seems to have immediately grasped the implications, as gold has begun to sell off since the report was published. By contrast, the stock market seems more focused on the positive implications for the economy. However, monetary pumping and the prospect of more of the same was also a major prop for stocks heretofore.

A 'sell the good news' effect could therefore conceivably still develop, whether today or over coming days and weeks (this is being written about half an hour after the open of trading). As we have pointed out yesterday, the still operative bearish e-wave count of the stock market does not leave a lot of room for further advances to remain a contender. A retest of the high of last year would still leave it potentially intact, but any higher high would invalidate it.

 

Gold and Gold Stocks

Interestingly, Mark Hulbert reported yesterday that the HGNSI measure of gold timer sentiment has increased to a slightly worrisome looking 51% just as gold has become technically overbought and run into strong lateral resistance. Hulbert writes that based on his indicator, 'gold's rally will soon come to an end'.

However, we would note that the HGNSI has a major drawback that it shares with so many financial and economic statistics: it is a mere aggregation. It simply adds up the average recommended exposures to the gold sector by the gold timers publishing newsletters. It doesn't answer the question 'why exactly are gold timers bullish or bearish'. There have been a number of incidences in the past when the signal of the HGNSI proved quite valuable, but there have also been occasions when it didn't work at all.

The best example for the latter is the early 2003 low in the HUI. At the time, gold rallied only very reluctantly, however the gold stocks spurted higher from their March low with great vigor. The HGNSI stood at 65%, a full 14 percentage points above the current reading. Hulbert issued a warning: 'this gold rally can not last'. Over the next nine months, gold kept going higher and the HUI index rallied by about 100%. Shortly after the top, in early 2004, the HGNSI suddenly took a big dive as gold and gold stocks began to correct.

Mark Hulbert concluded that it was a good time to buy the dip. Only, it turned out it wasn't. Gold went nowhere for nearly two years, and gold stocks entered a grueling, 18 month long cyclical bear market. Once again, the gold timers had used the action in gold stocks relative to gold as their yardstick, a fact the aggregated bull/bear allocation ratio can not reveal.

From a technical perspective, the recent rally in gold looks quite constructive. As can be seen on the chart below, a false breakdown in December has been followed by a vigorous advance that has overcome a major downtrend line. However, corrections of this magnitude often take more time to conclude. Following the 2006 blow-off move, gold took a long time to consolidate in a very similar triangle formation. It took 14 months before a sustainable advance to new highs got going.

 


 

Technically, gold looks good. However, it has run into lateral resistance, is overbought and sentiment has perhaps turned a tad too enthusiastic in the short term – click chart for better resolution.

 


 

However, looking at Sentimentrader's 'public opinion' chart, we see that this amalgamation of various gold related sentiment indicators remains far from overbought:

 


 

Gold, public opinion, via sentimentrader.com. This measure is not in overbought territory yet – in fact it remains closer to its recent lows than its recent highs - click chart for better resolution.

 


 

While the unemployment report was certainly a strongly positive surprise, the overall trend of economic data compared to economists' expectations has recently turned down. To wit, Nomura's version of the 'economic surprise index' has clearly reversed late last year:

 


 

Nomura's US economic surprise index: after rising strongly from its August 2011 lows, it has begun to reverse in December 2011 - click chart for better resolution.

 


 

On this occasion, we want to briefly revisit our December 22 update on gold and gold stocks to see where we stand relative to that. We published a 'bullish alternate wave count' as well as a bearish alternate for gold at the time, with projections. So far, the market has by and large followed the bullish alternative's projection (of course there is a certain fuzziness to such projected paths – one can not possibly predict every wiggle of the market. The projections must be viewed as a general outline rather than a precise forecast). Below is a reproduction of this chart:

 


 

The bullish alternate wave count we posted on December 22. The market has by and large followed the path outlined, although the actual rise was faster and stronger than we thought it would be in the beginning - click chart for better resolution.

 


 

Considering this wave count, it is possible that a new impulsive rally in gold has begun – but one can not yet be certain of this, because the rally is still too young. The possibility that it is part of a more complex, longer lasting correction roughly analogous to the 2006-2007 one remains open.

In this light let us also reconsider the possible HUI wave count we posted on December 22.

If gold has begun a new impulse advance, it stands to reason that the HUI has begun one as well. Below is the updated version of our wave count. It assumes that the correction that began in December of 2010 was a so-called 'double three' – two 'a-b-c' three wave structures interrupted by an 'x' wave.

If so, then the recent advance could be a beginning impulse wave to the upside. However, similar to gold, one can not yet be certain if it is not merely a continuation of the correction and that the correction will become even more complex. We have annotated the putative beginning impulse wave in blue:

 


 

The bullish wave count interpretation of the HUI. A double-three correction has ended, and a new impulse wave has begun - click chart for better resolution.

 


 

There is one obvious problem with this interpretation: a lack of symmetry. The first 'A-B-C' structure took about twice as long to form as the second one. So a possible alternative would be that the second 'A-B-C' is only part of a bigger, higher degree wave 'A' and that the current advance is part of the higher degree wave 'B'. Below we show this alternative count that implies that the corrective process is not yet over and that the putative 'double-three' correction is not yet finished:

 


 

HUI, alternate wave count. Here we assume that the the move to the December low was only wave 'A' of a larger 'A-B-C' structure and that the next impulse move only begins after a one more 'up-down' sequence has been put in place for waves 'B' and 'C' - click chart for better resolution.

 


 

Of course there is no way for us to know with any degree of certainty which of these alternatives will turn out to be correct, or whether an entirely different structure is about to evolve. We can only discuss probabilities here. The fact that the structure since December 2010 looks corrective makes it highly probable that it will be followed by another impulsive rally to new highs. The main question is the precise timing and the road map.

Of the two HUI counts discussed above, we would currently rather lean toward the second one than the first one. The reason is that the fractal shapes the market produces often take such symmetrical forms, in both price and time. We can not say why this is the case: we can only state that it is an empirical fact. The explanation is probably psychological – in fact, technical analysis is basically behavioral analysis. It tries to discern the 'herding effects' in financial markets by considering the structure of prices.

From a tactical perspective, both wave counts indicate that there will be more short term upside in the gold stocks over the next several weeks. However, once the lateral resistance of the consolidation period comes into view, one will need to carefully assess the state of sentiment and the shape of the wave forms on smaller scales in order to determine whether another wave C down is probable or not.

It would probably make sense to play defense if the market indeed reaches these levels (approximately the 580-610 range on the HUI).

Meanwhile, to answer the question posed in the title to this post: the jobs report is probably not yet a 'game changer'. While it makes 'QE3' less likely over the next few months, it is a lagging indicator and as such tells us nothing about the future. Leading economic indicators continue to indicate that the economy will weaken again and 'economic surprises' aside from this jobs report have lately embarked on a downward trend.

However, one should not dismiss its significance out of hand. If the recent positive trend in employment data persists, interest rates will begin to head noticeably higher. In fact, the US treasury bond market has taken a significant hit today upon the release of the jobs data. Treasuries were of course already overbought and overloved and have lately become too much of a 'sure thing' due to 'Operation Twist'. A correction seemed increasingly likely regardless of upcoming economic data releases. Nevertheless, there is a danger that the Fed will even have to abandon 'ZIRP' much earlier than is currently thought if the labor market continues to exhibit strength. This would create a significant headwind for gold, the price of which is strongly supported by the current negative real interest rate environment.

 

 

Charts by: StockCharts.com


 

 

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13 Responses to “The January Unemployment Report and Gold – A Game Changer?”

  • Andyc:

    Pater

    Most commentary that Ive read on that employment report from the smarter end of the financial media have been calling this report totally bogus.

    Denninger called it a fraud, zero hedge was screaming bloody murder about it, I have not seen Mish’s analysis but I doubt he will like it either…..

    The participation rate hit a 30 year low and between that and seasonal adjustments there was like an over 3 million swing between the negative number and the printed one.

    http://market-ticker.org/akcs-www?post=201459

    http://www.zerohedge.com/news/trimtabs-explains-why-todays-very-very-suspicious-nfp-number-really-down-29-million-past-2-mont

    http://www.zerohedge.com/news/final-nail-todays-nfp-tragicomedy-record-surge-part-time-workers

    http://www.zerohedge.com/news/record-12-million-people-fall-out-labor-force-one-month-labor-force-participation-rate-tumbles-

    I gave up trusting any government numbers a long time ago and assume the real numbers are worse than even the critics are claiming…if you can believe that.

    : )

    • James T in MA:

      Yeah, it’s quite possible that they’re screwing around with the numbers as usual (Guess in which direction the results of this report will be revised by the next one. Yeah, that’s my guess, too. It’s everyone’s.).

      But there are some factors which could even be somewhat innocently making the adjustments to this report risible. I mean, you’ve got an actual loss of 2.7 million jobs that they massage into a . . -presto!- gain of 243,000. The supposed gain is dwarfed by the adjustment. It’s an order of magnitude bigger. Try to imagine doing that in whatever your vocation is. But a lot of the U.S. has had better than usual January weather this year. The BLS loves to cite unusually bad weather as a cause of negative news. They don’t seem so quick to do the opposite.

      And historical habits of hiring and re-hiring in a new year are unlikely to be holding in a long, grinding recession like this. If the BLS assumes that these old habits will hold and applies adjustments based on historical patterns set more in good times or mildly bad times those assumptions will misrepresent what happens in a long, grinding recession like this.

      • worldend666:

        Hi James/Andy

        I agree the system is rigged to not show the participation rate and that U6 gives a much better picture of the true woes of the economy. However what would be the motivation for rigging the report right now?

        A strong employment report puts upward pressure on bond yields and makes it more expensive for the Fed to finance the deficit.

        Surely a poor unemployment report would be welcome at the Fed as they would have a public reason to embark on QE3.

        Or do I have the wrong end of the stick here? Perhaps it’s not the Fed pulling the strings at the BLS?

        • James T in MA:

          I suspect you’re getting at the right answer with your last line. The Bureau of Labor Statistics is part of the labor department. They’re not immediately under the supervision of the Fed but rather the Obama administration. This is an election year. Of course, I have no smoking gun information.

    • Yes, some people call it the ‘Bureau of Lies and Statistics’, and I have of course seen the criticism; in fact, I have major trouble believing in the current ‘birth/death’ data, as other data show that more businesses are in fact ‘dying’ than are born – in fact, the number of US business establishments is in decline since 2005.
      The idea that the labor force is declining at such speed is also difficult to fathom, although we probably must consider the fact that long-range demographic effects are also beginning to take their toll: US society is ‘graying’ as more and more baby boomers retire.

    • As an aside, I would say that Mish usually offers the most detailed and nuanced updates on the jobs data, which is why I don’t delve into the subject in more detail myself – you can get it all from Mish, and there is no point in duplicating this kind of work here.
      He has really made an effort to understand the ins and outs, although there remain BLS ‘black boxes’ no-one can fully penetrate.
      One thing is clear though, the jobs market remains a disaster – one only needs to look at data like ‘persons out of work 27 weeks or longer’. They look like what one would expect to see in a depression.
      Also worth mentioning is Charles Biderman of TrimTabs, who tracks payrolls tax payments in order to interpret the jobs data. This has the advantage of offering a real time snapshot of the true situation. Needless to say, Biderman also has his doubts about the recent improvements in the data.

  • ab initio:

    As Pater notes employment is a lagging indicator. Additionally this report continues with the trend of generating lower headline unemployment through taking folks out of the labor pool.

    A speculative scenario that I think has a decent probability is that US growth will start declining sometime in the next 2 quarters. By that time it is very likely that Europe including the core is in full blown recession and even emerging markets are around “stall” growth rate. Couple that with increasing probabilities that even with “infinitely” growing central bank balance sheets, there will be a funding squeeze at some of the weaker TBTF banks; and an increasing probability that as the global economy slows Japanese trade deficits grow leading to repatriation of funds strengthening the yen and making their exports even less competitive, leading to the first signs of a breakout in yield spreads in Japanese debt. The response to this scenario would be central banks going even more nuclear on a coordinated basis. However, bond markets will start showing the first signs that they care more about debasement risk than risk of nominal principal return. The fat tail probability that the secular bear market in bonds that some have been predicting for some time gets going in the middle of recessionary times when it is least likely.

  • worldend666:

    I just couldn’t resist asking why you put any stock in Mark Hulbert’s predictions. At best he is right 50% of the time, but then so is a coin toss.

  • rodney:

    Nevertheless, there is a danger that the Fed will even have to abandon ‘ZIRP’ much earlier than is currently thought if the labor market continues to exhibit strength. This would create a significant headwind for gold, the price of which is strongly supported by the current negative real interest rate environment.

    Not if they are behind the curve once again. The first rate hikes in 2004 had very little impact on gold, with the increasing ‘inflation expectations’ well ahead of the rate hikes. Judging from Fed policy since Greenspan, they are more likely to increase interest rates only when it is obvious to everyone that they should have done it already.

    • That is certainly true, but we would probably get a knee-jerk correction at that point anyway – depending of course on the precise circumstances. I certainly agree that we can expect them to be ‘behind the curve’ when inflation expectations really do increase (this may have begun actually).

  • I, for one believe the QE’s and LTRO’s have very little to do with the economy and a lot to do with how much problem the TBTF banks have in raising cash. Otherwise, the money wouldn’t be piling up at the CB’s around the world. Being it is my feeling the TBTF banks are using the cash to pay off their debts and speculate, poor market performance always keeps that hammer in the background, which is the ultimate moral hazard. The cash markets are like the oil markets, in that you must cover every dime of liability to make the books balance. It is already clear the banks have too much cash, but the question is which ones have too much and which don’t. As you know, they owe many times more cash than they have.

    • worldend666:

      Hi mannfm

      I agree with you and I am sure Mr Tenebrarum would too. QE is all about preventing a financial crisis and little to do with stimulus.

      However the Fed does its best to create the impression that its actions are geared toward the economy and not toward bank charity, so they will likely wait for some economic upheaval before acting.

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