Market Insights: Oil & Gold Rocketing into Orbit

Macroeconomic and Market Developments:

• North American markets were mixed again this week. In Canada, the S&P/TSX Composite Index was up 1.40% on the strength of energy and previous metals sectors. In the U.S., the Dow Jones Industrial Average was down 1.30% and the S&P 500 Index declined 1.27%.
• The Canadian dollar dropped slightly this week, closing at 78.55 cents vs 78.72 cents last Friday.
• Oil prices were dramatically higher this week. U.S. West Texas crude closed at $115.00 vs $91.98 USD last Friday, and the Western Canadian Select price closed at $102.57 vs $79.58 last Friday.
• The gold price was also much higher this week, closing at $1,969 vs $1,888 USD last Friday.
• Volatility continued this week as the markets’ attention was fixed on the continued invasion of Ukraine by Russia. Central bank policy was also in focus with the Bank of Canada raising its overnight lending rate from 0.25% to 0.50% on Wednesday. The widely expected move is the first increase since 2018 and is forecasted to be the start of an interest rate raising phase for the central bank.
• Canadian Real (after inflation) GDP grew 1.6% in the fourth quarter of 2021, following a 1.3% rise in the third quarter. On an annualized basis, Real GDP grew at a 6.7% pace in Q4. Specifically in the month of December, GDP was unchanged following six consecutive months of growth.
• Toronto-Dominion Bank (TD) announced that it has reached an agreement to acquire U.S. bank First Horizon (FHN) in an all-cash transaction valued at $13.4 billion, or $25.00/share. In another bank deal this week, Bank of Nova Scotia (BNS) announced that it has reached an agreement to acquire Grupo Said's remaining 16.8% stake in Scotiabank Chile, increasing its ownership in the Chilean entity to 99.8%.
• More bank earnings were released this week. On Tuesday, Bank of Montreal (BMO) reported better than expected quarterly earnings of $3.89/share vs $3.28/share expected, on revenue of $7.72 billion vs $6.61 billion expected. Also on Tuesday, Bank of Nova Scotia (BNS) reported better than expected earnings of $2.15/share vs $2.05/share expected, on revenue of $8.05 billion vs $7.88 billion expected. And on Thursday, Toronto-Dominion Bank (TD) reported better than expected earnings of $2.08/share vs $2.04/share expected, on revenue of $11.28 billion vs $10.47 billion expected.
• Canadian Natural Resources (CNQ) reported better than expected earnings of $2.21/share vs $2.05/share expected, and production of 1,313.9 Mboe/d vs 1,303.2 Mboe/d expected. And Crescent Point Energy (CPG) reported relatively inline cash flow of $2.57/share vs $2.56/share expected, however with lower than expected earnings of $4.11/share vs $4.23/share expected, with annual average production of 132,683 boe/d vs guidance of 133-137K.
• Pembina Pipeline (PPL) has entered into agreements with KKR to combine their respective western Canadian natural gas processing assets into a single, new joint venture entity, which will be owned 60% by Pembina and 40% by KKR's global infrastructure funds. The deals include ~$700 million of cash proceeds to Pembina expected upon closing, with ~$550 million expected to be deployed for debt repayment and ~$150M for additional common share repurchases.
• The U.S. ISM Manufacturing Index increased to 58.6 in February, beating the expected 58.0 (levels higher than 50 signal expansion; levels below 50 signal contraction). The major measures of activity were mostly higher in February, and all stand above 50, signaling growth. And the U.S. ISM Non-Manufacturing (Services) index declined to 56.5 in February, below the expected 61.1. The major measures of activity moved mostly lower in February, but nearly all stand above 50, signaling growth.
• U.S. employment numbers for February were released on Friday. Nonfarm payrolls rose by 678,000 vs the forecasted 440,000 and the unemployment rate fell to 3.8% vs the forecasted 3.9%.
• Here is a link to a short video from Canaccord’s chief U.S. Strategist Tony Dwyer entitled Identifying True Extremes: DWYER VLOG

Weekly Diversion:

Check out this video explaining the Nord Stream 2 natural gas pipeline, which has now taken on much more political significance.

Charts of the Week:

With both equities and fixed income having a difficult start to the year, it is noteworthy to show where there has been strength this year. This is clearly in physical commodities, specifically oil, which has been ripping up the charts of late as you can see below with the U.S. Oil Fund, which tracks the underlying commodity price. The other major commodity, gold, has also had a strong year so far as you can see from the SPDR Gold Shares Trust which also tracks the underlying commodity price. As of this afternoon, WTI Crude price is trading at more than 30% above its 50-day moving average, while the price of gold is about 7% above its 50-day moving average. These commodities are currently up 55% and 8% year-to-date respectively.

Source: Bespoke Investment Group

Why are we showing you both oil and gold? While it isn’t rare for one of these commodities to trade this overbought on their own, it is uncommon when both are this extended relative to their 50-day moving averages at the same time. Just how extended are we? If you look at the scatter plot below, of the more than 9,500 trading days since 1983, there have only been 33 occurrences where the prices of oil and gold were more than 20% and 5%, respectively, above their 50-day moving averages. That is just 0.34% of all trading days, and it would be even less if we looked at only those instances where oil was more than 30% above. We chose 20% above, as that is the price at which oil has traded at for the majority of this week.

Source: Bespoke Investment Group

If you look at the times when this has occurred, they have actually all been confined to five separate periods other than today going all the way back to 1983. There were a couple periods in the higher inflation times of 1986 and 1990, in the 2009 recovery after the 2008 Financial Crisis, and in 2016 after the 2014-15 commodity bear market. All these prior surges, except for 1990, came shortly after a large decline in prices. That is not the case today, which is more like August 1990 (when Iraq invaded Kuwait), when this is happening with crude oil prices hitting 52-week highs.

Source: Bespoke Investment Group

Lastly, let’s look at how the U.S. stock market has performed going forward after these prior occurrences. Here is the same chart for the S&P500 going back to 1983 showing the same red dots. For the most part, these instances happened toward the end rather than the beginning of equity market declines.

Source: Bespoke Investment Group

The following table summarizes the forward-looking returns for all three of these markets following the first day in each period where gold finished the day more than 5% above its 50-day moving average and WTI crude closed more than 20% above. There hasn’t been any clear trend for the price of gold, although shorter-term performance has been relatively weak. Turning to oil, even with it being more extended above its 50-day moving average than gold for each period, its forward-looking performance has been better. For the three, six and twelve months following, WTI has been higher 80% of the time with median gains in the 13-35% range. But what about equities which have been in a correction so far this year? Looking at the S&P 500 specifically, its past performance has been modest in the short-term, but improved significantly over six and twelve months, with positive results 80-100% of the time and median returns of 13% and 35% respectively which are exceptionally strong. It does make sense for the equity market to be accompanied by some short-term weakness as big moves higher in commodities often occur after a systemic shock that may cause some investors to sell risk assets. It often takes markets some time to settle down, but over time markets tend to find their footing and resume their general upward bias. Following the Russia invasion of Ukraine last week, there is no way to know if this time will play out in a similar pattern to these past occurrences, but at least the past evidence is encouraging for equity markets when looking at least six months out.

Source: Bespoke Investment Group

 

Sources: CNBC.com, Globe and Mail, Financial Post, Connected Wealth, BNN Bloomberg, Tony Dwyer, Canaccord Genuity, First Trust, Bespoke Investment Group