Defensive assets are topping out, for now

The last 12 months have seen an aggressive rally on defensive assets, fuelled by geopolitical risks (trade wars, Iran, impeachment attempts in the US, Brexit, etc.) as well as a slowdown in global growth. We believe the risk/reward ratio is now stretched on defensive assets like US treasuries and gold, while cyclicity will likely make a comeback towards year-end to early 2020.

US 10-year Treasury ields (weekly graph and perspective for next 2 to 4 months)

It has been a year since Treasury yields topped out, in October 2018. The sell-off has been impressive and is now pointing to our I Impulsive targets towards the downside (right-hand scale) in the 1.3–0.7% range. Theoretically, these targets could be reached over the next 12 to 18 months. In the meantime, however, considering the speed and scope of the recent downward move, we believe that Treasury yields could be due for a counter-trend rebound. Indeed, both our oscillator series (top and bottom charts above) are pointing at an intermediate low between now and mid/late October. The bounce that could follow may last between 3 to 6 months, or into Q1 and perhaps spring next year. According to our daily graphs (not shown here), we would expect this rebound to travel back above 2% and possibly even inch towards 2.5% if the 2% mark is passed. US10Y yields may retrace down towards their recent lows over the next couple of weeks, although we don’t believe they will hit new lows.

 

Gold Spot (Weekly graph or perspective for the next 2 to 4 quarters)

Gold has also rallied strongly over the past 12 months. It recently reached the lower end of our I Impulsive targets to the upside (right-hand scale), achieving more than 25% performance year on year. Hence, although we expect further upside 12 to 18 months out (around the high 1,600s or even above that), the potential over the next few months may be limited. Indeed, here too, both our oscillator series (top and bottom charts) are pointing to a counter-trend move over the next 3 to 6 months. These intermediate tops may have been reached in early September on our long-term oscillators (bottom chart), yet could still see some upside retesting into October on our medium-term ones (top chart). Our view is that by mid/late October, gold should confirm its downward correction, probably towards Q1 2020 or by spring. The downside retracement potential we calculate is between 0.5 to 0.8 times our volatility measure “delta” (here at 308.9; middle chart, right-hand side), or back towards the 1,300–1,350 USD/oz range, a zone of previous upside resistance, which could now serve as support.

In both Treasuries and gold – and defensive assets more generally – we believe that an intermediate top is in the making. It may have been reached already in early September, but could still see some upside retests during October, which should then trigger a downside correction into Q1 and perhaps spring 2020. Hence, during October, we will be looking to take profit on some defensive positions and reallocate to more cyclical profiles.

 

Jean-Francois Owczarczak, CEO, Management Joint Trust SA on behalf of Hoving Partners