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Gold continues to realign with commodities

The realignment of gold with other commodity prices is one of the more significant events occurring in global financial markets today, so I have updated the chart (above) I introduced last April.

Last April I also noted the strong gains that equities were starting to register against gold, so the above charts are worth repeating, along with these excerpts from that post:

Over the time period of the second chart above, there have been only two episodes in which stocks strongly outperformed gold over a sustained period: the first, from around 1950 to around 1965, and the second, from late 1982 through 2000. In the first period, real GDP grew at an annualized rate of 4.5%, which is substantially more than the the 3.1% long-term average growth rate of the U.S. economy. In the second period, real GDP grew at an annualized rate of 3.7%, well above average. Real GDP growth was below average in the periods during which stocks fell relative to gold, the worst being from 2000 through 2012, when real GDP growth was an annualized 1.6%.
The upturn in stocks is thus a preliminary indicator that the economic fundamentals may be shifting in favor of equities, and that, in turn, would suggest that the long-term outlook for the economy is improving. Probably not immediately, but some time in the next few years we could see some genuine improvement in the economic fundamentals. Markets are always forward looking, and this indicator (the ratio of stocks to gold) could be one of the most forward-looking of all. Let's hope so.

More signs of strength in the housing market

The news keeps getting better for the U.S. housing market. Prices are up, construction is up, and new home sales are up. These are significant changes on the margin that are likely to have positive ripple effects throughout the economy.

Both measures of housing prices show a 12% gain over the past year. Higher mortgage rates are likely to temper—but not derail—further price increases. Higher mortgage interest rates are a logical response to stronger demand for housing.

On an inflation-adjusted basis, prices have bounced off their lows of early 2012. This marks almost four years of price consolidation after three years of catastrophic declines. There is every reason to believe that we have seen the worst, and that the future for housing looks bright.

The supply of homes for sales is at very low levels, after being very high for most of the past seven years. There is no longer a glut of homes for sale; the market is now faced with a relative shortage of homes for sale, although there are signs that the inventory of homes for sale is rising. Rising prices are restoring equity to millions of homeowners that had been "underwater."

May new home sales beat expectations (476K vs. 460K), and are up 75% from their lows. That's in line with the 90% increase in housing starts since the 2009 lows. It's reasonable to expect further gains, since construction is still very low from an historical perspective. 

Putting higher interest rates in perspective

As I detailed last week, the dramatic rise in nominal and real yields since the end of April marks a big change in the market's expectations for the future of the U.S. economy. Two months ago, the market believed the economy would be so weak that the Fed would be unable to raise short-term interest rates for the next two years. Today, the market expects the economy to be doing well enough to allow the Fed to raise short-term rates to about 1% two years from now. As a result, interest rates all across the yield curve have jumped, and it's all because the market has gained confidence in the economy's ability to grow. It's hard to see how this can be interpreted as a negative for the equity market, or for the housing market, since even after the expected rate increases occur—if indeed they do—interest rates would still be relatively low from an historical perspective.


The chart above shows the Treasury yield curve as it stood at the end of last April, as it stands today, and as the market expects it to be in two years. 5-yr Treasury yields were 0.7% two months ago, and are now expected to climb to 2.7% over the next two years. 10-yr Treasury yields were 1.7% and are now expected to be 3.3% in two years. These are significant changes, but they are hardly life-threatening from the economy's perspective.

As the chart above shows, a 3.3% yield on 10-yr Treasuries would still qualify as an extraordinarily low yield from an historical perspective. 

As the chart above suggests, the current -0.2% real yield on 5-yr TIPS is only now approaching levels that might be consistent with the economy growing by a tepid 2% per year for the next several years—at about the same rate that it has grown over the past several years. What stands out in this chart is just how low real yields had fallen two months ago. The bond market was exceptionally bearish on the economy's prospects last April, and now it is much less pessimistic. But it is still far from being optimistic.

Today's interest rates, which embody expectations of higher interest rates to come, are not likely to pose a threat to the U.S. economy. They have presented a problem, however, for investors who thought that interest rates would remain close to zero for a very long time. 

The jump in Treasury yields has boosted mortgage rates by almost a full point, as seen in the chart above. Does this threaten the housing market? I doubt it. In the entire history of the U.S. mortgage market, rates have only been lower than they are today for the preceding year. Prior to 2012, rates have never been lower than they are today. 

Today's release of the Conference Board's measure of consumer confidence marked a new high for the current recovery. This is consistent with the action in the bond market: people are feeling a bit more comfortable now about the future prospects for the U.S. economy. 

UPDATE: According to ICI, taxable bond funds this month have experienced their biggest net outflow in over four years. Big things are indeed happening; the bearish case for the economy—which calls for very low interest rates for as far as the eye can see—has been dealt a serious blow.