Gold

Dear client, In addition to this week’s abbreviated report, we are also sending you a Special Report on currency hedging, authored by my colleague Xiaoli Tang. Xiaoli’s previous work mapped out a dynamic hedging strategy for developed market equity investors in various home currencies. In this report, she extends the work to emerging market exposure. I hope you will find the report insightful. Next week, in lieu of our weekly report on Friday, we will be sending you a joint Special Report on the UK on Tuesday, together with our Global Fixed Income colleagues. Kind regards, Chester Highlights The DXY index is up for the year, but further gains will be capped at 2-3% from current levels. Long yen positions are offside amid the dollar rally. This should wash out stale longs, and underpin the bull case. Lower the limit-sell on the gold/silver ratio to 68. We were stopped out of our short AUD/MXN position amidst a broad-based selloff in EM currencies. We are reinitiating the trade this week. Feature Chart I-1The Dollar Has Been Strong In 2021 The DXY index has once again kissed off the 90 level and is gaining momentum in March. Year-to-date, the DXY index is up 1.1%. This performance has been particularly pronounced against other safe haven currencies, such as the Swiss franc and the Japanese yen. GBP and AUD have fared rather well in this environment (Chart I-1). As the “anti-dollar,” the euro has also suffered.  Our technical indicators continue to warn that the dollar still has upside. Net speculative positions are at very depressed levels, consistent with many sentiment indicators that are bearish USD. However, this time around, any dollar rally could be capped at 2-3%, in sharp contrast to the bounce we witnessed in March 2020.  The Message From Dollar Technical Indicators Our dollar capitulation index has bounced from very oversold levels, and is now sitting above neutral territory (Chart I-2). The index comprises a standardized measure of sentiment, net speculative positioning and momentum. It is very rare that a drop in this index below the -1.5 level does not trigger a rebound in the dollar. This time around, the bounce has been rather muted. Chart I-2BCA Dollar Capitulation Index Suggests Some Upside Part of the reason has been concentration around dollar short positions. Investors throughout most of the pandemic executed their bearish dollar bets through the euro, yen and the Swiss franc (countries that already had negative interest rates). Positioning on risk on currencies such as the Australian dollar and the Mexican peso were neutral. This also explains the underperformance of the yen, as the dollar rises. From a sizing standpoint, ever since the dollar peaked in March 2020, counter-trend moves have been in the order of 2-3%. We expect this time to be no different. What To Do About The Yen The yen has been one of our core holdings on three fundamental pillars: it is cheap, it tends to rise during dollar bear markets and the economy in Japan is more hostage to deflation than the US. This bodes well for real rates in Japan, relative to the US. Over the last month, our long yen position has been put offside. First, demand for safe havens has ebbed as US interest rates have gapped higher (Chart I-3, panel 1). King dollar has once again become the safe haven of choice. As Chart I-1 illustrates, low beta currencies such as the Swiss franc and yen, that tend to do relatively well when the dollar is rallying, have underperformed.  Yield curve control (YCC) in Japan is also negative for the yen as interest rates rise (panel 2). Economic momentum in Japan is also rolling over (panel 3). Prime Minister Yoshihide Suga’s mulling to extend the state of emergency in the Tokyo region could further cripple any Japanese economic recovery. Chart I-3A Healthy Reset In The Yen Chart I-4USD/JPY Support Should Hold For short-term investors, USD/JPY is very overbought and is approaching strong resistance (Chart I-4). In our view, a washing out of stale shorts would provide a healthy reset for the bear market to resume. Meanwhile, USD/JPY and the DXY change correlations during risk-off periods, where the yen appreciates versus the dollar.  Therefore, a market reset is also positive for the yen.     Housekeeping Chart I-5Remain Short AUD/MXN We were stopped out of our short AUD/MXN trade last week for a loss of 6.1%. We are reinitiating the trade this week. The case for the trade, made a month ago, remains intact. A short-term recovery in the US economy, relative to the rest of the world, argues for an AUD/MXN short. In fact, a divergence has occurred between the BRL/MXN and the AUD/MXN exchange rate (Chart I-5). Domestic factors have certainly tempered the Brazilian real, but the underperformance of metal prices relative to oil in recent months is also a factor. We expect some convergence to occur, with MXN appreciating much faster than the AUD.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have stepped up: Personal income rose by 10% in January, while personal spending rose by 2.4% month-on-month. The ISM report was stellar. The manufacturing PMI improved from 58.7 to 60.8 in February. Prices paid rose to 86. Factory orders were slightly above expectations at 2.6% month-on-month in January.   The DXY index rose by 165 bps this week.  The narrative of a counter-trend reversal in the DXY index isn playing out. As the story unfolds, it will be important to establish targets. Our bias is that the DXY stalls before 93-94 is reached.  Report Links: Are Rising Bond Yields Bullish For The Dollar? - February 19, 2021 Portfolio And Model Review - February 5, 2021 Sizing A Potential Dollar Bounce - January 15, 2021 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data from the euro area remain weak: Core CPI in the Eurozone came in at 1.1%, in line with expectations. The unemployment rate declined from 8.3% to 8.1% in January. January retail sales were weak at -6.4% year-on-year. The euro fell by 1.7%% against the US dollar this week. It will be almost impossible for the euro to rise in an environment where the dollar is in a broad-based decline. Given elevated sentiment on the euro, a healthy reset is necessary for the bull market to resume. Report Links: Portfolio And Model Review - February 5, 2021 On Japanese Inflation And The Yen - January 29, 2021 The Dollar Conundrum And Protection - November 6, 2020 The Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data from Japan has been marginally positive: The employment report was positive, with the unemployment rate dipping to 2.9% and an improvement in the jobs-to-applicants ratio in January. Consumer confidence in February is rebounding from very low levels. The Japanese yen fell by 1.5% against the US dollar this week. The recovery in the Japanese economy is fragile, and tentative signs of a renewed lockdown will knock down confidence. In this transition phase, yen long positions could be hostage to losses. Longer-term, the yen is cheap and will benefit from a broad-based dollar decline. Report Links: On Japanese Inflation And The Yen - January 29, 2021 The Dollar Conundrum And Protection - November 6, 2020 The Near-Term Bull Case For The Dollar - February 28, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data out of the UK have been in line: Mortgage approvals rose 99K in January, in line with expectations. The construction PMI rose from 49.2 to 53.3 in February. Nationwide house prices are soaring, rising 6.9% in February on a year-on-year basis. The pound fell by 0.8% against the dollar this week. It is however the best performing currency this year. Our short EUR/GBP trade has benefited from faster vaccination in the UK (that could give way to a faster reopening of the economy) and a nice valuation starting point. Report Links: Portfolio And Model Review - February 5, 2021 The Dollar Conundrum And Protection - November 6, 2020 Revisiting Our High-Conviction Trades - September 11, 2020 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia was robust: Home lending remained in an uptrend. Owner-occupied loans increased by 11% in January, while investor loans increased by 9.4%. Terms of trade are soaring, rising 24% year-on-year in February. The current account surplus came in near a record A$14.5 billion in Q4. GDP grew by 3.1% QoQ in Q4. The Aussie fell by 1.8% his week. Terms of trade will continue being a tailwind for the AUD/USD. We also like the AUD/NZD cross, as a valuation and terms-of-trade bet. However, we expect that any positive surprises in the US will hurt AUD relative to the Americas. One way to play this is by shorting AUD/MXN. Report Links: Portfolio And Model Review - February 5, 2021 Australia: Regime Change For Bond Yields & The Currency? - January 20, 2021 An Update On The Australian Dollar - September 18, 2020 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 There was scant data out of New Zealand this week: Terms of trade rose by 1.3% in Q4. CoreLogic home prices rose 14.5% in February. The New Zealand dollar fell by 2.4% against the US dollar this week. The kiwi ranks as the most unattractive currency in our FX framework. For one, it has catapulted itself to the most expensive currency in our PPP models. Report Links: Portfolio And Model Review - February 5, 2021 Currencies And The Value-Versus-Growth Debate - July 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data from Canada was positive: The Nanos confidence index rose from 58.2 to 59.4 in February. Annualized 4Q GDP came in at 9.6%, above expectations. Building permits rose 8.2% month-on-month in January. The Canadian dollar fell 0.4% against the US dollar this week. Oil prices remain very much in an uptrend, which is underpinning the loonie. Better US economic performance in the near term should also help the CAD. Report Links: Will The Canadian Recovery Lead Or Lag The Global Cycle? - February 12, 2021 Currencies And The Value-Versus-Growth Debate - July 10, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data out of Switzerland have been improving: Swiss GDP rose by 0.3%  quarter-on-quarter in 4Q. The KOF leading indicator rose from 96.5 to 102.7 in February. The February manufacturing PMI rose from 59.4 to 61.3. Switzerland remains in deflation, with the core CPI that came in at -0.3% year-on-year in February. The Swiss franc fell by 2.6% against the US dollar this week. Safe -haven currencies continue to be laggards, as rates rise and gold falls to the wayside. This is bullish on  procyclical currencies, and negative the Swiss franc. We are long EUR/CHF on this basis, but short USD/JPY purely as portfolio insurance. Report Links: Portfolio And Model Review - February 5, 2021 The Dollar Conundrum And Protection - November 6, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 The data out of Norway has been robust: The unemployment rate fell from 4.4% to 4.3% The manufacturing PMI increased from 51.8 to 56.1 in February. The current account balance was robust in Q4. It should increase significantly in Q1 this year given the large trade balance in January. Being long the Norwegian krone is one of our high-conviction bets in the FX portfolio. The Norwegian krone fell by 1% against the US dollar this week, but outperformed the euro, amongst other currencies. The NOK ticks all the boxes of an attractive currency – cheap valuations, a liquidity discount, and primed to benefit from a global growth rebound. Report Links: Portfolio And Model Review - February 5, 2021 Revisiting Our High-Conviction Trades - September 11, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Most Swedish data releases were in line with expectations: GDP came in at -0.2% quarter-on-quarter, below expectations. Retail sales rose 3.1% year-on-year, above expectations. The trade balance came in at a surplus of SEK 5.2 billion  in January. The manufacturing PMI remained elevated at 61.6 in February. The Swedish krona fell by 2.4% against the US dollar this week. Manufacturing data is improving in Sweden but the economy remains hostage to COVID-19, compared to Norway. That is weighing on the krona. That said, Sweden is a highly levered play on the global cycle. Therefore, once the pandemic is behind us, the SEK will outperform. Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Underweight Last December when we penned the 2021 high-conviction calls Strategy Report, we put global gold miners in the “also rans” section as we did not have the courage to go underweight despite our view of an economic reopening. But it is better late than never, and in this Monday’s Strategy Report we pulled the trigger and downgraded this niche materials sub-sector to a below benchmark allocation. The economic reopening theme remains healthy and still dominates the market as is evident in 5-year/5-year forward real yields that have been soaring year-to-date signaling that investors should shy away from gold miners (Chart 1). Not only is the real economy standing on its own two feet, but the financial economy is also being propelled higher thanks to the Fed, ECB, BoJ, and a plethora of other central banks (CBs) including EM ones. CBs are still embarking on QE, effectively engineering a “risk on” asset price inflation phase that melts away the global equity risk premium and reduces the allure of the safe haven global gold mining industry (Chart 2). Chart 1Avoid Gold Miners Chart 2Avoid Gold Miners   Bottom Line: Downgrade global gold miners to underweight. This move also pushes the S&P materials sector back to the neutral zone.  

Highlights Portfolio Strategy The selloff in the long end of the Treasury bond market and related yield curve steepening, rising loan growth and a turnaround in bank net interest margins, all signal that a durable re-rating phase is in the offing in the beaten down financials sector. Soaring real and nominal yields on the back of a US economic reopening, sinking policy uncertainty, and the specter of a countertrend USD rally, all undermine global gold mining stocks. Downgrade to underweight. We deem there is an exploitable opportunity within the reopening theme and we reiterate our recent pair trade recommendation: long USES “Laggards” basket/short USES “Overshooters” basket (excluding the GICS1 sectors). Recent Changes Downgrade the global gold mining index to underweight, today. This move also pushes the S&P materials sector to a neutral allocation. Last week our rolling 2.5% stop was triggered and we booked gains of 17% in the deep cyclicals/defensives portfolio bent that is now on even keel. On February 10, we closed the S&P consumer staples and the S&P homebuilding high-conviction underweights for 8% and -11% returns, respectively, since the December 7 inception. On February 11, we rolled over the synthetic long SPY options structure from March expiry (long $390/$410 call spread/short $340 put) to June expiry (long $400/$420 call spread/short $340 put) netting gains of $5.41/contract or 676% since the January 12 inception. Feature While stocks swiftly gyrated last week and the selloff in Treasury bonds dominated the news flow, the corporate bond market remained as placid as ever. This eerie calmness is slightly unnerving as junk spreads, all the way out to the CCC poor-quality spectrum, have been steadily sinking. But, resurging commodities likely confirm that there is no real reason to panic as global growth remains on an upward trajectory courtesy of pent-up demand that will get unleashed in the back half of the year as the global economy reopens (Chart 1). We recently reinitiated the long “Back-To-Work” basket as the expense of our “COVID-19 Winners” basket and this trade is already up another 21.3% since the second inception on Feb 3, 2021. With regard to monetary policy that remains a key pillar of equity euphoria, the Fed has vociferously signaled that they will not be backing down from QE and their ZIRP policy. The FOMC is not even thinking about thinking about tapering asset purchases, despite a looming inflation spike in the coming months due to base effects and bottlenecks that they vehemently deem transitory. Chart 1Eerie Calm? Importantly, Charts 2 & 3 show that both the ISM’s manufacturing prices paid index and a sideways move in retail gasoline prices predict a surge in headline CPI in the April/May time frame as we first showed in a recent Special Report. Chart 2The Bond Market Is Already… Chart 3…Testing The Fed Tack on a plethora of anecdotes regarding shortages and price hikes in a slew of industries and an inflationary spurt is already here. In more detail, an inflationary impulse is not only evident in chip and car shortages and in container freight shipping rates, but also in dry bulk transport rates. Drilling beneath the surface of the Baltic Dry Index, and looking beyond Capesize carriers, reveals that Panamax and Handysize vessel freight rates are on a tear, probing 11-year highs and more than quadrupling since the March lows (Chart 4). These smaller ships are more nimble and rarely take voyage empty as recent container ships have been when returning to China to reload. Thus, the sizable increase in Handysize and Panamax shipping rates suggests that commodity demand is robust, especially industrial commodities. Returning to US shores, the most recent retail sales report also caused a jump in the Atlanta Fed’s GDPNow and the NY Fed’s Nowcast forecasts for Q1 near double digit real GDP growth. For calendar 2021, according to daily data from Bloomberg, economists expect US real GDP growth north of 4.9% (Chart 5). More blow out quarters are in the offing courtesy of the inoculation of the population, the reopening of the economy and persistent government largesse. Chart 4Look Beneath The Surface… Chart 5…And The Economic Recovery Is Gaining Steam… Crudely put, while consumers will not buy 10 coffees or eat 10 meals at a restaurant all at once when the economy fully reopens, they may choose to fly business on their next vacation and indulge on a more lavish hotel. Add on that the hospitality industry specifically has aggressively shut down capacity and an inflationary impulse is likely as consumer purse strings will loosen very quickly. Thus, trust in the Fed’s ultra-dovishness represents the biggest equity market risk in the coming months as the FOMC allows the economy to run hot and there are high odds that the bond market will continue to test the Fed’s resolve. Our sense is that the Fed will initially ignore the spike in inflation, at least until the summer, thus refraining from removing the proverbial “punch bowl”. However, if the market detects any signs of a “less dovish” Fed, especially if high inflation prints persist for whatever reason, risk premia will get repriced a lot higher (Chart 6). Chart 6…But A Lot Of Good News Is Baked In Staying on the topic of interest rates, we have a long-held rule of thumb that stocks cannot stomach more than 100-125bps tightening via a selloff in the 10-year US Treasury bond in a less than a year time frame basis. In other words, were the 10-year US Treasury yield to surpass and stay over 1.55% by March, 2.05% by June, and 1.75% by August, then the equity market will likely suffer a pullback, especially given the absence of a valuation cushion. In fact, last Thursday the 10-year US Treasury yield cleared the 1.6% hurdle and stocks sold off violently. In more detail, we examined data from 2009 onward, therefore only covering the QE era, which would increase the applicability of our analysis. Importantly, the 2009-2011 iterations provide the closest parallels as to what will likely take root this cycle as those instances occurred in a post recessionary environment, which is similar to today. The 2009-2011 period also best aligns with the main reason for having this rule of thumb in the first place: to gauge the risk of interest rates undermining the market by weighing on forward multiples and/or via an economic slowdown because of tightening in monetary conditions. Our analysis shows that while the exact timing and size of the stock market drawdown varies from episode to episode, it is generally consistent with a roughly 10% pullback in the S&P 500 albeit with a 1-2 month lag following the trigger in our rule1 (Chart 7). Chart 7Monitoring Our 100-125bps Rule Of Thumb Keep in mind that such a pullback is consistent with historical precedents when the Fed is actively engaged in QE, with the most recent example being last September’s/October’s 10% drawdown. Our sense is that the ongoing bond market selloff will serve as a catalyst for a continuation/acceleration of the reopening/rotation/reflation trade out of highly valued tech stocks and into more compellingly valued deep and early cyclicals. Such a transition typically proves tumultuous. This week, we update our sanguine view on an early-cyclical sector, and act on the downgrade alert to a deep cyclical sector via downgrading a safe haven commodity index to a below benchmark allocation. Financials Are On Fire Within the GICS1 universe, the most levered sector to interest rates is the S&P financials sector. Given that the bond selloff has staying power, we reiterate our overweight stance on this early-cyclical sector that we fist boosted to an above benchmark allocation on November 16, 2020. Following up from the 100-125bps bond market tightening rule of thumb, adding another layer of complexity via bringing in the yield curve (YC) is instructive. This analysis corroborates our rule of thumb and suggests that not only do 10-year US Treasury yields have more room to rise, but also so does the S&P financials sector, especially given that it is hovering at an extremely depressed level relative to the S&P 500 (Chart 8). Chart 8V-Shaped Recovery? Historically the yield curve peaks at a range of 150 to 250 bps. In the past 7 cycles, this range was in place with only one exception: the first leg of the double dip recession in the early 80s. This represents a stellar track record of where the YC peters out based on empirical evidence. Even in the post GFC world, the YC steepened north of 250bp (thrice) and during the early stages of that recovery. The implication is that if history at least rhymes, then the yield curve can steepen a lot more. Were it to revisit the 250bps level, the YC could nearly double from current levels (Chart 9A). Practically, given that the Fed will pin the 2-year US Treasury yield near zero with a near-term max value of roughly 50bps, this equates to a tentative early-cycle peak 10-year Treasury yield range of 2% to 3%.   Chart 9AYield Curve Can Steepen A Lot More Putting this in perspective, at current levels, the 10-year US Treasury yield is roughly where it stood right after Brexit in mid-2016, which was last cycle’s trough, and still deeply in overvalued territory according to BCA bond valuation model (Chart 9B). Importantly, back then, as now, yields have been late comers to the equity rally. As a reminder, during the manufacturing recession the SPX troughed on Feb 15, 2016 – the day the Royal Dutch Shell / BG Group merger closed – while interest rates bottomed in the first week of July 2016. One key driver of the positive impact of rising interest rates on relative financials share prices will be the end to the banking sector’s hemorrhaging net interest margins (Chart 10). Chart 9BBonds Remain Extremely Overvalued Chart 10NIM Turnaround Looms   Financial services companies represent the nervous system of every economy and a vibrant economy is synonymous with firming loan growth (bottom panel, Chart 11). Beyond the recovery in the broad non-financial corporate sector, the overheating residential housing market in particular is another vital area that is propping up the financials sector (top panel, Chart 11).  All of this suggests that relative profitability will pick up steam this year, a message that our macro-driven relative EPS models also corroborate (second panel, Chart 12). This stands in marked contrast to sell-side analysts’ profit expectations and represents an exploitable trading opportunity: the earnings hurdle is so low for financials that even a modest beat of suppressed EPS growth expectations will go a long way in breathing fresh life into this neglected early-cyclical sector (third & bottom panels, Chart 12). Tack on pent up financials sector buyback demand and a 40bps dividend yield carry versus the SPX and the profit outlook brightens further for this interest rate-sensitive sector. Chart 11Financials Rising Alongside The Economy Finally, relative valuations are bombed out on any metric used (middle, fourth & bottom panels, Chart 13). Granted, relative technicals are not as alluring as last November, however our Technical Indicator is still below overbought levels that have marked prior relative performance peaks (second panel, Chart 13). Chart 12Green Light On Earnings Chart 13Financials Are Cheap No Matter How You Cut It Adding it all up, the selloff in the long end of the Treasury bond market and the associated yield curve steepening, rising loan growth and a turnaround in bank net interest margins signal that a durable re-rating phase looms for the beaten down financials sector. Bottom Line: Continue to overweight the S&P financials sector. Are Gold Miners Losing Their Luster? Last December when we penned the 2021 high-conviction calls Strategy Report, we put global gold miners in the “also rans” section as we did not have the courage to go underweight despite our view of an economic reopening and selloff in the bond market. It is never too late. Today, we use the downgrade alert we issued on the S&P materials sector to trim the sector to neutral via downgrading the global gold mining index to a below benchmark allocation. As a reminder, in mid-January we had put the materials sector on our downgrade watch list as a way to express the move of the cyclicals/defensives portfolio bent back down to even keel. The stock-to-bond (S/B) ratio has broken out to at least a three decade high because stocks are near all-time highs and bonds are selling off violently. This represents an explosive cocktail for gold stocks and is warning that there is ample downside for relative share prices (S/B ratio shown inverted, Chart 14). Chart 14Sell Gold Miners… This is largely due to the definitive reopening of the US economy in the coming quarters (bottom panel, Chart 15). It is also evident in 5-year/5-year forward real yields that have been soaring year-to-date signaling that investors should shy away from gold miners (real yields shown inverted, middle panel, Chart 15). Even nominal yields underscore that the path of least resistance for global gold mining equities points lower, especially given that the recent bond market selloff is driven by the real (i.e. growth) not inflation component. As a reminder, gold bullion and gold miners yield next to nothing thus when real rates rise, the opportunity cost to hold gold and gold miners skyrockets and investors abandon gold miners for higher yielding assets (top panel, Chart 16). The recent fall in the share of global negative yielding bonds by over $4tn also weighs on the prospects of gold miners (bottom panel, Chart 16). Importantly, while we are not calling for the Fed to raise rates any time soon, the 12-month forward fed funds rate discounter (as backed out of the OIS curve) has jumped back to the zero line, opening a wide gap with relative share prices. This is unsustainable and our sense is that this gulf will narrow via a drop in the latter in the coming months (fed funds rate discounter shown inverted and advanced, middle panel, Chart 16). Chart 15…When The Economy Is Roaring Another source of worry for gold stocks is the USD. Historically, a rising greenback pushes gold bullion and gold equities lower and vice versa. If the US economy will rebound at a faster clip than the euro area as the Fed is explicitly taking inflation risk and is allowing the economy to run hot, then at some point the US dollar may start to flex its muscles. Granted, this will likely be a countertrend rally in the context of a USD bear market that commenced last spring, especially given the still lopsided US dollar positioning (Chart 17). Chart 16Rising Rates Are bearish Bullion Chart 17Mighty USA = Countertrend Rally In The USD In addition, US and global policy uncertainties are melting as the US/Sino trade war has been in hibernation, the US elections are behind us and a “Blue Wave” sweep is certain to deliver mega fiscal easing packages, thus exerting downward pressure on the safe haven status of gold bullion and gold mining equities (Chart 18). Finally, the global equity risk premium is in freefall as not only the Fed, but also the ECB, the BoJ, and a plethora of other CB including EM ones are doing QE effectively engineering a “risk on” asset price inflation phase (Chart 18). Nevertheless, our bearish gold mining equity thesis has to contend with oversold conditions and bombed out relative valuations. We will be closely monitoring these two risks and stand ready to act and cut losses in case value oriented buyers come out of left field (Chart 19). Chart 18Mind The Catch Down Phase Chart 19Two Risks To Monitor Netting it all out, soaring real and nominal yields on the back of a US economic reopening, sinking policy uncertainty, and the specter of a countertrend USD rally, all undermine global gold mining stocks. Bottom Line: Downgrade the global gold mining index to underweight today. This move also pushes the S&P materials sector back to the neutral zone. A Few Words On The “Back-To-Work” Trade Last year we created two baskets of stocks to capture the economic reopening theme by constructing a long/short pair trade. This year, we crystallized 21.5% in gains from that pair trade and subsequently reopened it and it is already up another 21.3% since the second inception on February 3, 2021. Two weeks ago, we took a fresh look at the economic reopening theme and pitted “Back-To-Work” laggards against leaders. First, we filtered for well-behaved cyclical industries among all the sectors and sub-sectors we cover. We define a well-behaved cyclical industry as one that trailed the SPX from February 19, 2020 to March 23, 2020; and then outpaced the broad market from March 23, 2020 to today (all computations are in relative to SPX terms). Such filtering excluded all of the defensive & cyclical industries that outperformed the market during the recession, and it also excluded those industries that were too damaged by the pandemic and could not recover above the March 23 trough level (for example, airlines) always in relative terms. Chart 20 is a stylized depiction of our analysis. In total 27 industries survived the filtering. We then computed what is the minimum percentage increase required in order for each group to recover to its February 19 level, and then calculated the difference between that required increase and the one that actually materialized. A positive value signifies that the sector climbed above its February 19 level, whereas a negative value means that the sector still has not recovered. Chart 20Stylized Depiction Of “Back-To-Work” Sectors To Buy And To Avoid… Chart 21 displays the results. Our rationale is as follows: should the economic recovery and normalization themes continue unabated as we expect, then the risk/reward trade-off of owning the “laggards” is greater than the “overshooters”: the former have ample upside potential left, whereas the latter are already discounting a lot of good news. Chart 22 plots the ratio of the two baskets against the ISM manufacturing prices paid sub-component and the 10-year US Treasury yield and supports our rationale that the “laggards” have a long runway ahead versus the “overshooters”. Chart 21…Buy The Laggards / Sell The Overshooters Chart 22Inflation Impulse Beneficiaries Bottom Line: We deem there is an exploitable opportunity within the reopening theme and we reiterate our recent pair trade recommendation: long USES “Laggards” basket/short USES “Overshooters” basket (excluding the GICS1 sectors). As a proxy for this trade we include tickers for the largest stock in each sub-sector (excluding GICS1). Laggards: V, BLK, HCA, MCD, HON, AXP, JPM, COP, PSX, MAR, SLB. Overshooters: EMR, BLL, LIN, NUE, UNP, HD, DHI, CAT, MS, J, TSLA, AMAT. We are aware of some minor conflicts between the “Overshooters” and the “Back-To-Work” basket and also versus our current recommendations table, but we still recommend investors stick with this pair trade.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com     Footnotes 1     A quick note on the taper tantrum and the 2016 iterations. During those periods the S&P 500 actually fell at the same time as yields rose (not after the rule was triggered), so technically we should not have counted that as a valid iteration on our chart.     Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Size And Style Views February 24, 2021 Stay neutral cyclicals over defensives January 12, 2021  Stay neutral small over large caps June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, ABNB, V). January 22, 2018 Favor value over growth

Highlights The price of Bitcoin has surged this year as the digital currency has gained increasing acceptance. Just as was the case with gold, a global financial system built around Bitcoin would be precariously unstable. Bitcoin transactions are expensive to make and slow to execute, making the currency unsuitable as a medium of exchange. Bitcoin miners consume more energy than many countries. ESG funds are likely to shun companies that associate themselves with the currency. Governments, which stand to lose billions of dollars in seigniorage revenue, will put up more obstacles to Bitcoin. As a result, Bitcoin will lose most of its value over time. Bitcoin And Bullion: Back To The Future? Modern banks grew out of the activity of goldsmith guilds during the Middle Ages. Not only did goldsmiths craft beautiful items from precious metals, but because they had to maintain adequate security, they also tended to offer safekeeping services. Chart 1An Inelastic Money Supply Historically Led To More Banking Crises A wealthy merchant who deposited some gold coins with a goldsmith would receive a receipt validating his claim on the coins. Rather than rushing back to the goldsmith to withdraw some coins in order to make a purchase, it became common practice to offer the receipt instead. To facilitate commerce, goldsmiths began to offer receipts for specific values, marking the creation of the first proto-banknotes. On a typical day, only a small fraction of the gold held on deposit would be withdrawn. As long as goldsmiths always had enough gold on hand to meet demand, they could issue notes in excess of the amount of gold that they held in their vaults. Sometimes the goldsmiths would use those additional notes to purchase goods for themselves. Other times, they would lend out the notes, with interest charged to the borrower. The fractional reserve banking system was born. As the fledgling banking system evolved, it became more sophisticated. Nevertheless, it continued to suffer from a fundamental flaw: It was highly vulnerable to self-fulfilling crises. If people began to fear that a bank would run out of gold reserves, they would rush to the bank to be the first to withdraw their funds. Chart 1 shows that bank runs were very common during the 19th century. What Is Bitcoin Good For? Not Much When Bitcoin enthusiasts talk about a world in which global finance is centred on cryptocurrencies, they see the future. Personally, I see the past. John Maynard Keynes famously called the gold standard a barbarous relic. He had a point. A world based on the “Bitcoin standard” would be just as chaotic as the one that was built on the gold standard. Bitcoin’s defenders would argue that the digital currency has advantages that gold, and more importantly, fiat money do not have. But what exactly are those advantages? It certainly is not ease of use. Whereas the Visa network processes nearly 25,000 transactions per second, the Bitcoin mempool, the pool of unconfirmed transactions, has trouble handling five (Chart 2). Bitcoin transactions take 10 minutes to an hour to complete compared to just a few seconds for most debit or credit cards. The average fee for a Bitcoin transaction is around $30 – a number that has been rising over the past year (Chart 3). Chart 2Bitcoin: The Speed Of Transactions, Or Lack Of It Chart 3Bitcoin: The Cost Per Transaction Is Rising Crypto-optimists insist that these impediments will recede over time. However, this is far from certain. Efforts to expedite Bitcoin transactions have run into “fundamental issues.” Markus Brunnermeier and Joseph Abadi have argued that no cryptocurrency can fully satisfy the three desirable properties of decentralization, correctness, and cost-efficiency. Unlike centralized institutions such as banks, blockchain technology works by generating a sort-of consensus among its participants about what constitutes a legitimate transaction. By its nature, the process tends to be very resource-intensive. Bitcoin’s Big Environmental Footprint Chart 4Bitcoin Is Not Your Eco-Currency (I) This raises another problem with Bitcoin: Its environmental impact. A single Bitcoin transaction consumes more than four times as much energy as 100,000 Visa transactions (Chart 4). Bitcoin’s annual electricity consumption now exceeds that of Pakistan and its 217 million inhabitants (Chart 5). The Bitcoin algorithm requires that “miners” solve computationally intensive problems to earn new coins. It should be stressed that the solutions to these problems have no social value. Miners are not solving protein-folding algorithms that are useful for the discovery of new drugs. They are basically wasting CPU cycles by competing with one another to guess extremely large numbers in the hopes of acquiring a shrinking volume of new coins (the total number of Bitcoins that can ever be produced is limited to 21 million). Chart 5Bitcoin Is Not Your Eco-Currency (II) To make matters worse, more than two-thirds of Bitcoin mining takes place in China, where electricity is primarily generated using coal. Companies that claim to be environmentally conscious have no business trafficking in Bitcoin. What Explains The Bitcoin Bubble? Given the seemingly intractable existential problems that Bitcoin faces, why has its price gone through the roof? To some extent, the euphoria over Bitcoin is part of a broader speculative mania that has swept over everything from shares of electric vehicle companies to dubious SPACs and highly shorted “meme stocks.” No commentary about Bitcoin on the internet is complete with an obligatory prediction that it is “going to da moon.” Chart 6Lower Spending And Higher Income Led To Mounting Excess Savings Occasionally funny late-night talk show host John Oliver has joked that Bitcoin is “everything you don’t understand about money combined with everything you don’t understand about computers.” When people don’t have a good basis for determining what something is worth, they can let their imaginations run wild, causing prices to become unhinged from reality. Bitcoin and other cryptocurrencies are especially susceptible to feedback loops because they rely on network effects: The more people that use Bitcoin, the more appealing it is for others to use it. PayPal’s decision to let its customers trade Bitcoin on its platform, as well as Tesla’s announcement that it will accept it as payment, have stoked hopes that the digital currency is about to go mainstream. A surfeit of savings has also helped propel Bitcoin. US households accumulated $1.5 trillion in excess savings in 2020, two-thirds of which came from spending less than they normally would (Chart 6). The counterpart to the savings glut is a dearth of high-yielding assets. Bitcoin does not generate any cash flow, but with real rates still in negative territory, the prospect of capital appreciation has been more than enough to compensate investors for that deficiency. Bitcoin: Risks Tilted To The Downside Of course, if the price of Bitcoin were to start trending lower, speculators could flee the currency en masse. And therein lies the problem: If people decide that Bitcoin is not worth much, then it will not be worth much. Chart 7The Uses Of Gold: A Breakdown One could argue that the same risk plagues gold. There is some truth to this argument, but it should be noted that gold does have alternative uses, most notably jewelry. According to the World Gold Council, jewelry comprised 46% of the above-ground stock of gold at the end of 2020. Private investors held 22% of the gold stock, while central banks held 17% (Chart 7). Bitcoin has absolutely no alternative use to fall back on. Whereas central banks have been willing to hold gold as part of their external reserves, the same courtesy is unlikely to be extended to Bitcoin. The existence of fiat currencies gives central banks the power to set interest rates and provide liquidity backstops to the financial sector. Bitcoin would deprive them of that power. Governments derive significant benefits from the ability of their central banks to create money out of thin air and use it to purchase goods and services. In the US, this “seigniorage revenue” amounts to over $100 billion per year. Bitcoin threatens this stream of revenue. Speaking to The New York Times DealBook conference on Monday, Treasury Secretary Janet Yellen panned Bitcoin: “To the extent it is used I fear it’s often for illicit finance” she said, adding “It’s an extremely inefficient way of conducting transactions, and the amount of energy that’s consumed in processing those transactions is staggering.” Many companies have cozied up to Bitcoin in order to associate themselves with the digital currency’s technological mystique. As ESG funds start to flee Bitcoin, its price will begin a downward spiral. Stay away.   Peter Berezin Chief Global Strategist pberezin@bcaresearch.com    

Highlights For the month of February, our trading model recommends shorting the US dollar versus the euro and Swiss franc. While we agree a barbell strategy makes sense, we would rather hold the yen and the Scandinavian currencies. In the near term, we recommend trades at the crosses, given the potential for the dollar rally to run further. An opportunity has opened up to short the AUD/MXN cross. We are tightening the stop on our short EUR/GBP position to protect profits. We believe EUR/CHF still has upside. While the US has been labelling Switzerland  a currency manipulator, the real culprit is Europe. Precious metals remain a buy. We are placing a limit sell on the gold/silver ratio at 70, after our initial target of 65 was touched. Platinum should also outperform in 2021. Remain long AUD/NZD, as the key drivers (relative terms of trade and cheap valuation) remain intact. Feature Currency markets are at a crossroads. On the one hand, news on the vaccine front continues to progress, raising the specter that we might return to normalcy sometime in the second half of this year. On the other hand, the current lockdowns are slowing down economic activity across the developed world, which is bullish for the dollar. With the DXY index up 1.4% this year, it appears near-term economic weakness is dominating the currency market narrative. Our long-term trade basket is centered on a dollar-bearish theme, but we have been shifting much focus in the near term to non-US dollar opportunities. Central to this has been our conviction that the dollar is due for a countertrend bounce, in an order of magnitude of 2%-4%.1 It appears we are already halfway there (Chart I-1). For the month of January, our trade recommendations outperformed the model allocation. Notable trades were being short gold versus silver and being short EUR/GBP. Silver in particular was a big winner in January (Chart I-2). Most emerging market currencies saw weakness, especially the Korean won, Russian ruble, and Brazilian real Chart I-1The Dollar Has Been Strong In 2021 Chart I-2Our FX Portfolio Did Well In January For the month of February, our trading model recommends shorting the US dollar, mostly versus the euro and Swiss franc (Chart I-3 and Chart I-4). The model gets its signal from three variables: Relative interest rates (both levels and rates of change), valuation, and sentiment.2 While some of these variables have moved in favor the dollar, the magnitude of these moves has not been sufficient to trigger a model shift. We agree a barbell strategy makes sense. That said, we would rather hold the yen (as the safe haven, compared to the CHF) and the Scandinavian currencies (compared to the EUR). These are our two strategic positions, and we made the case for yen long positions last week. Chart I-3Our FX Model Remains ##br##Short USD... Chart I-4...Especially Versus The Euro And Swiss Franc Circling back to our trades at the crosses, we maintain that they should continue to perform well in February and beyond. We revisit the rationale behind these trades, as well as introduce a new idea: Short the AUD/MXN cross. Go Short AUD/MXN A tactical opportunity has opened up to go short the AUD/MXN cross. Central to this thesis are three catalysts: relative economic activity, valuation, and sentiment. The Australian PMI has rebounded quite strongly relative to that in Mexico, driven by the performance of the Chinese economy, versus that of the US economy. Australia exports mostly to China, while Mexico is heavily tied to the US economy. With the Chinese credit impulse rolling over, the US economy has been outperforming of late. If past is prologue, this will herald a lower AUD/MXN exchange rate (Chart I-5). Correspondingly, oil prices are outperforming metals prices. China is the biggest consumer of metals, while the US is the biggest consumer of oil. A higher oil-to-metal ratio is negative for AUD/MXN. Terms of trade between Australia and Mexico have been an important driver of the exchange rate (Chart I-5). China had a massive restocking of metals last year, much more than oil and natural gas. This implies that the destocking phase (should it occur) will be most acute among metal inventories (Chart I-6), suggesting oil imports into China could fare better than metals. On a real effective exchange rate basis, the Aussie is expensive relative to the Mexican peso. Historically, this has heralded a lower exchange rate (Chart I-7). Chart I-5AUD/MXN And Terms Of Trade   Chart I-6Chinese Destocking: From Crude Oil To Metals? Chart I-7AUD/MXN Is ##br##Expensive Back in 2020, when everyone was short the Aussie and long the MXN, being a contrarian paid off handsomely. Now, speculators are roughly neutral both crosses. Should the trends we are highlighting carry on into the next few months, this will be a powerful catalyst for speculators to jump on the bandwagon. We recommend opening a short AUD/MXN trade today, with a stop loss at 16.50 and an initial target of 13. Stay Short EUR/GBP Chart I-8An Asymmetry In Pricing Our short EUR/GBP position is performing well, amidst a more hawkish Bank of England this week. Technically, there remains room for much downside on the cross. Real interest rates in the UK are rising relative to those in the euro area. The Brexit discount has not been fully priced out of the EUR/GBP cross, whereas broad US dollar weakness has eroded the discount in cable (Chart I-8). From a technical perspective, speculators are still very long the EUR/GBP, even though our intermediate-term indicator is nearing bombed-out levels (Chart I-9). Chart I-9EUR/GBP Still Has Downside Finally, short EUR/GBP tends to benefit from an outperformance of oil prices. We will be revisiting the fair value of the pound in upcoming reports given the fundamental shifts that are happening in the post-EU relationship. For now, we are tightening stops on our short EUR/GBP position to 0.89, in order to protect profits. Remain Long NOK And SEK Chart I-10NOK Follows Oil Prices The Scandinavian currencies are  extremely cheap and an attractive bet for 2021. As such, we believe the recent relapse in their performance provides an opportunity for fresh long positions. For the NOK, a rising oil price is bullish, both against the EUR and USD (Chart I-10). Meanwhile, superior handling of the pandemic has buoyed domestic economic data in Norway. Both retail sales and domestic inflation have been perking up, pushing the Norges Bank to dial forward expectations of a rate lift-off. Sweden is also holding up relatively well this year. Part of the reason for this is that over the years, the drop in the Swedish krona, both against the US dollar and euro, has made Sweden very competitive. With our models showing the Swedish krona as undervalued by 13% versus the USD, there is much room for currency appreciation before financial conditions tighten significantly. The bottom line is that both Norway and Sweden are well positioned  to benefit from a global economic recovery, with much undervalued currencies that will bolster their basic balances. We expect both the SEK and NOK to remain the best performers versus the USD in the coming year.  Stay Long EUR/CHF While the US has been labelling Switzerland  a currency manipulator, the real culprit is the euro area. To be clear, the SNB has been actively intervening in the currency markets. However, when one looks at relative monetary policy, the expansion in the ECB’s balance sheet far outpaces that of the SNB (Chart I-11). With the correlation between balance sheet policy and the exchange rate shifting, it may embolden Switzerland to intervene even more strongly in currency markets. Historically, the Swiss franc was buffeted by the global environment (improving global trade) and rising productivity in Switzerland. As a result, the SNB had no alternative but to try to recycle those excess savings abroad by lifting its FX reserves, or see even stronger appreciation of its currency. With global trade much more muted, intervention in the FX market could be a more potent headwind for the franc. Chart I-11The SNB Is More Hawkish Than The ECB Chart I-12EUR/CHF And The Global Cycle In the near-term, the risk to this trade is that safe-haven flows  reaccelerate, as investors re-price risk. However, this will be a short-term hiccup. EUR/CHF is a procyclical cross and will benefit from improvement in the Eurozone economy relative to the rest of the world (Chart I-12). Meanwhile, by many measures, the Swiss franc remains expensive versus the euro. Stay Long AUD/NZD Chart I-13RBA QE Will Hurt AUD/NZD The rally in the kiwi has provided an exploitable opportunity to lean against it. We remain long the AUD/NZD cross, despite the RBA stepping up the pace of QE at its latest meeting. The rationale is as follows: The balance sheet of the RBA was already lagging that of the RBNZ, so the latest move is simply  catch up (Chart I-13). It has no doubt been negative for the cross, as Australia-New Zealand rates have compressed. However, when the program expires, the AUD will be subject to external forces once again.  The Australian bourse is heavy in cyclical stocks, notably banks and commodity plays, while the New Zealand stock market is the most defensive in the G10. Should value outperform growth, this will favor the AUD/NZD cross. The kiwi has benefited from rising terms of trade, as agricultural prices have catapulted higher. Should a correction ensue, as we expect, this will favor NZD short positions. Our conviction on long AUD/NZD has clearly been hit with the RBA’s latest move. As such, we are tightening stops to 1.05 for risk management purposes. Stay Long Precious Metals, Especially Silver And Platinum We are placing a limit sell on the gold/silver ratio at 70, after our initial 65 target was hit. The rationale for the trade remains intact: In a world of ample liquidity and a falling US dollar, gold and precious metals are bound to benefit. However, silver has underperformed the rise in gold. The long-term mean for the gold/silver ratio is 50, providing ample alpha for this trade (Chart I-14). Chart I-14The Case For Short Gold Versus Silver Silver is heavily used in the electronics and renewable energy industries, which are capturing the new manufacturing landscape. Silver faced resistance near $30/oz. However, this will be a temporary hiccup. The next important level for silver will be the 2012 highs near $35/oz. After this, silver could take out its 2011 highs that were close to $50/oz, just as gold did.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see our Foreign Exchange Strategy report, "Sizing A Potential Dollar Bounce," dated January 15, 2021. 2 Please see our Foreign Exchange Strategy report, "Introducing An FX Trading Model," dated April 24, 2020. Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights US inflation expectations will continue to grind higher as commodity markets tighten, and financial markets price to an ultra-accommodative Fed over the next 2-3 years. The US stock-market rally is reducing equity yields and squeezing equity risk premiums, which acts as a drag on gold prices.  Higher earnings, lower stock prices or both are needed to reduce this effect. Pandemic uncertainty continues to fuel safe-haven demand for the USD, which remains a headwind for gold and silver.  Vaccination availability needs to reach a level that convinces markets global contagion risk has been minimized.  Until then, this remains the dominant downside risk to gold and commodities. The balance of risks continues to favor gold: US real rates will remain weak as the Fed remains behind the inflation-vs-rates curve, and the USD will be pushed lower (Chart of the Week).  We continue to expect gold prices to push to $2,000/oz. We remain bullish silver, and view the recent retail-spec price blip as transitory.  Fundamentally, silver supply growth is weakening, and demand is strengthening as the renewable-energy buildout accelerates and consumer spending revives.  We expect silver's price to trade back to $30/oz.  Feature US inflation expectations will continue to grind higher, as tightening markets for industrial commodities push oil and base metals prices higher (Chart 2).1 As is apparent in Chart 2, these real-economy factors feed directly into five-year inflation expectations, which are important to policy makers and portfolio managers managing risk in trading markets.2 Continued Fed accommodation of massively expansive US fiscal policy also will stoke inflation expectations, and keep real rates negative or weak at low positive levels as realized inflation and inflation expectations increase. These real and financial effects will be positive for gold prices, as the Chart of the Week illustrates. Chart of the WeekRising Inflation Expectations vs. Falling Risk Premiums Restrain Gold Chart 2Tightening Commodity Markets Push Inflation Expectations Higher Battling against this tailwind is the historic US equity rally, which has crushed stock yields and the equity risk premium vs bond yields.3 Gold prices are positively correlated with equity risk premiums – the positive economic forces that push dividend yields higher also tend to push gold and commodity prices higher – which means the falling risk premiums are acting as a headwind to gold prices (Chart 3).4 If, as the global economy recovers, the rate of growth in earnings is greater than that of equity prices, stock yields will expand, which will be supportive of gold prices. That said, we do not expect the contraction of the equity risk premium to dominate the evolution of gold prices. Tightening fundamentals in the real economy and continued monetary accommodation at the Fed will dominate gold- and silver-pricing dynamics. Chart 3Falling Stock Yields Pressure Equity Risk Premiums Balance of Risks Favors Gold Fed policy pronouncements point to continued accommodation of massive fiscal stimulus in the US, with the central bank strongly indicating it will, as a matter of policy, remain behind the inflation-vs-rate-hikes curve for at least another 2-3 years. Taking the Fed at its word, this means US real rates will remain weak, and the USD will be pushed lower as the central bank continues to accommodate higher US budget deficits at the federal level. However, as we have repeatedly noted, the broad trade-weighted USD has found strong support at current levels following a precipitous fall from its COVID-19-induced highs in 1Q20: As pandemic uncertainty feeds into global policy uncertainty, USD safe-haven demand remains elevated (Chart 4).5 While we concentrate on five-year inflation expectations in our modeling, indications of price pressures are showing up in the manufacturing sector in the US (Chart 5), as our colleagues in BCA Research’s US Bond Strategy note in their report this week.6 This confirms that the price strength seen in commodity markets for raw materials used in manufacturing are showing up in the economy as a whole. Chart 4Lower USD, Stronger GDP Bullish For Copper Prices Chart 5Inflation Indicators Hook Up Our price target for gold remains $2,000/oz. The sooner vaccines are deployed globally – so that markets can reasonably assign lower odds to a resurgence of COVID-19 and its more insidious variants forcing new lockdowns – the sooner the pandemic uncertainty keeping the USD well bid will dissipate as a fundamental factor restraining a continuation of gold’s rally. Silver Is Not GameStop The Reddit-powered surge in retail silver trading this past week, which lifted silver prices some ~ 11% on Monday to $30/oz, is all but a memory now that the white metal is again pricing in line with fundamentals. We turned bullish silver in July of last year, arguing fundamentals suggested silver could outperform gold in 2H20, which it did.7 Supportive fundamentals remain in place, with total supply (mine output and recycling) falling, demand rising and balances tightening (Chart 6). We expect the supply side of the market to remain under pressure this year and the next, given the physical deficits we are forecasting for the copper market over the next two year: The supply side of silver is a function of copper, zinc and lead mine output (i.e., silver largely is a byproduct). On the demand side, continued recovery of consumer spending and the decade-long buildout of renewable-energy generation – which is heavily reliant on copper and silver to a lesser degree – will force prices higher. We remain bullish silver. However, given our expectation its price will trade again to $30/oz, we do not expect any dramatic tightening of the gold/silver ratio this year (Chart 7). Chart 6Silver Market Tightens, Along With Other Commodities Chart 7Expect Gold/Silver Ratio To Continue To Narrow Bottom Line: Tightening commodity fundamentals and continued monetary accommodation at the Fed will dominate gold- and silver-pricing dynamics this year and the next. The contraction of the equity risk premium will not dominate the evolution of gold prices. At the margin, if earnings growth exceeds  equity-price increases, equity yields will expand, which will support gold prices. We expect gold and silver to trade to $2,000/oz and $30/oz this year – i.e., close to ~ 10% gains for both. Therefore, we do not expect much movement in the gold/silver ratio this year   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Commodities Round-Up Energy: Bullish OPEC 2.0’s Joint Technical Committee (JTC) lowered its estimated demand growth for 2021 to 5.6mm b/d from its 5.9mm b/d estimate last month, at its Tuesday meeting. The JTC also is expecting the oil market to be in a deficit this year, which will, by the Committee’s estimate, peak at 2mm b/d in May 2021, according to reuters.com. This is in line with our maintained hypothesis that the producer coalition led by Saudi Arabia and Russia will continue to calibrate production in line with demand to keep global storage levels drawing. The JTC was not expected to recommend any change in production policy to oil ministers on Wednesday when they met. We expect OECD oil inventories to hit their rolling five-year average in 1H21, largely because of OPEC 2.0’s production discipline and production losses outside the coalition (Chart 8). Base Metals: Bullish Battery-grade lithium carbonate soared 40% y/y in January in China to $9,450/MT, according to mining.com. The reporting service noted strong demand for lithium iron phosphate (LFP) batteries used to power subsidized short-range autos, public transport infrastructure electrification, and power generation. Precious Metals: Bullish COVID-19-induced demand destruction pushed gold demand down 14% y/y in 2020, to just under 3,760 tons, according to the World Gold Council’s 2020 supply-demand tallies.  At 4,633 tons, gold supply lost 4% y/y, the most since 2013, according to the WGC.  Supplies were disrupted by COVID-19 as well.   (Chart 9). Ags/Softs: Neutral Despite poor weather conditions in South America, US farmers are beginning to worry about record or near-record crops in the current growing season, according to farmprogress.com. grains are trading lower following recent rallies on concerns the upcoming harvest could be better than expected. Tomorrow’s USDA WASDE report will be eagerly awaited for the Department’s latest assessments. Chart 8OPEC 2.0 Keeps Supply Growth Below Demand Growth Chart 9Gold Below 200 Day Moving Average     Footnotes 1     Our most recent reports on copper and oil prices – Copper's Supply Challenges and Brent Forecast: $63 This Year, $71 Next Year published 10 December 2020 and 21 January 2021 – highlight the tightening of industrial-commodity markets globally. 2     While we do find strong relationships between gold prices and 5- and 10-year US real rates, we do not find any relationship with the slope of the US rates forward curve. 3    For a discussion of equity risk premiums, please see Asness, Clifford S. (2000) “Stocks versus Bonds: Explaining the Equity Risk Premium.” Financial Analysts Journal. March/April 2000: pp. 96-113. 4    In the post-GFC period 2010-2020, the S&P 500 equity risk premium is borderline insignificant in a cointegrating regression that includes other real and financial variables (i.e., copper prices, US Fed Funds, and global economic policy uncertainty). We therefore to not treat it as determinant to the evolution of gold prices in the same way as the real and financial variables we use as regressors. 5    We expect this pandemic uncertainty to break, but not until markets are convinced sufficient supplies of vaccines will be available globally to control COVID-19 infections, hospitalizations and deaths. Please see Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals, which we published last week, for further discussion. It is available at ces.bcaresearch.com. 6    For the first time 2011, the Prices Paid component in last month’s ISM Manufacturing PMI came in above 80, signaling for the first time since 2011. Please see No Tightening In 2021, published by BCA’s US Bond Strategy 2 February 2021. It is available at usbs.bcaresearch.com. 7     Please see Silver Likely Outperforms Gold In 2H20, which we published 2 July 2020. It is available at ces.bcaresearch.com. We recommended a long silver position then at $18.51/oz and closed it 23 September 2020 at $26/oz. Investment Views and Themes Recommendations Strategic Recommendations Commodity Prices and Plays Reference Table Summary of Closed Trades

Dear client, In lieu of our regular report next Friday, we will be sending you a special report on Australia next Tuesday, co-authored with our Global Fixed Income colleagues. We hope you will find the report insightful. Kind regards, Chester   Highlights Any tactical bounce in the dollar should be limited to 2-4%. A barbell strategy is the most attractive positioning in the next one to three months: a basket of the cheapest currencies and some safe havens. Remain short the gold/silver ratio. Feature Chart I-1Dollar Downside Hits Q1 Forecasts The market narrative towards the dollar is turning more bullish. Fundamental analysts point to the recent rise in US interest rates, relative to countries like Germany or the United Kingdom, as a serious cause for concern. A rules-based technical approach certainly warned that the dollar was getting much oversold last year, and the recent bounce is reinvigorating the possibility of a more powerful countertrend move. Being in the dollar-bearish camp, the key question is: how large could a potential dollar bounce be, and for how long can it last? According to Bloomberg forecasters, the dollar has already exhausted any potential decline penciled in for the first quarter of this year. Q1 consensus forecasts for the DXY index sit at 90, exactly where the index level rests today (Chart I-1). Bloomberg has consistently lowballed the level of the dollar since 2018, making the current forecast unduly bullish. This dovetails with recent market commentary that the decline in the dollar is largely done, and powerful catalysts for a countertrend move could take hold. Risks From The Reflation Trade Chart I-2A Stock Market Rout Could Derail The Dollar An equity market correction could be one of the potential catalysts that pushes the dollar higher. We showed last week that the dollar and the S&P 500 have had a near-perfect inverse correlation (Chart I-2). When a stock market and its currency exhibit an inverse correlation, it means that foreign investors have been hedging their equity purchases by selling the currency forward. This is not usually the norm (equity relative performance and currencies tend to move together), but was especially the case last year as inflows into US equities surged, but the dollar declined. Should any profit taking ensue, this will trigger a knee-jerk rally in the dollar, as forward shorts are closed. A few equity indicators warn that we could be at the cusp of such a counter-trend move:  The put/call ratio in the US is extremely depressed. This warns that positioning is lopsided and could easily topple the equity market rally. A rising put / call ratio has been synonymous with a higher dollar over the past few years (Chart I-3). This will be consistent with foreign investors unwinding their dollar hedges (as they take profits on equities) and/or safe-haven inflows into the dollar. Chart I-3Both Puts And The Dollar Offer Protection Cyclical stocks continue to outperform defensive ones of late, but the cracks are beginning to emerge, specifically in the industrials space. Industrials share prices have been relapsing of late (Chart I-4). The dollar tends to weaken when cyclical stocks are outperforming defensive ones, and vice versa. This is because non-US equity markets have a much higher concentration of cyclical stocks in their bourses. The huge correction in the relative performance of the global tech sector also warns that the tech-heavy US bourse might benefit from any bounce in tech equities. Global earnings revisions are heading higher, but the momentum of US earnings has regained the upper hand, especially relative to the euro area. Bottom-up analysts are usually too optimistic about the level of earnings, but are generally spot on about their direction. Relative earnings revisions between the US and other markets have led the dollar by about nine to 12 months (Chart I-5). Should cyclical earnings hit a soft patch as the pandemic engulfs much of the developing world, the more defensive US market might prove resilient. Chart I-4A Red Flag From Global Industrials Chart I-5Earnings Revisions And The Dollar In a nutshell, corrections in equity markets are usually a healthy reset for the bull market to resume. In similar fashion, a washing out of stale US dollar short positions will ensure the bear market for 2021 unfolds with higher conviction. A garden-variety 5-10% cyclical correction in the S&P 500 has usually coincided with a 2-4% bounce in the DXY, as can be seen from Chart I-2. This could be the story over the next one to three months. The Signal From Currency Markets Our dollar capitulation index hit a nadir in July last year and has since been rebounding from very oversold levels. It has been very rare that a drop in this index below the 1.5 level did not trigger a rebound in the dollar (Chart I-6). Part of the reason this did not happen this time around has been concentration. Dollar short positions since 2020 have mostly been against the euro, yen and Swiss franc, with positioning in currencies such as the Australian dollar and Mexican peso more neutral. This will limit the extent to which the broad dollar index could rise from a flushing out of stale shorts. Chart I-6BCA Dollar Capitulation Index Suggests Some Upside For example, the exchange rate that best signals whether we are in a reflationary/deflationary environment is the AUD/JPY rate. Since the Great Recession, the yen has been the best performer during equity drawdowns, while the Aussie has been the worst. As a result, the AUD/JPY cross has consistently tracked the drawdown of the broad equity market (Chart I-7). As the bottom panel shows, exuberance in the AUD/JPY cross has also coincided with equity market peaks.  That exuberance hardly exists today. The AUD/JPY cross has consistently tracked the drawdown of the broad equity market. That said, speculators are very short the dollar, even if the currencies used to implement these views are very concentrated. Sentiment towards the dollar is the lowest in over a decade and our intermediate-term indicator is at bombed-out levels (Chart I-8). Chart I-7AUD/JPY As A Risk On Gauge Chart I-8The Dollar Is Oversold In a nutshell, the message from technical indicators is that a bounce in the dollar is to be expected. However, the magnitude will be smaller than prior episodes. Ever since the dollar peaked in March 2020, counter-trend moves have been in the order of 2-3%. We expect this time to be no different.  The Dollar And Commodities Commodity prices across the board have been on a tear. This has usually been an environment where the dollar is in a broad-based decline. Commodity prices hold a special place as FX market indicators, since they are both driven by final demand and financial speculation. More importantly, rising commodity demand can signal an improving FX trend between commodity producing (Australia, Canada, Mexico, Colombia, Russia) and importing (Euro area, India, Turkey, or even China) countries. We will buy the currencies of commodity producers on weakness as the bull market continues. Metals prices have exploded higher on strong demand, especially from China (Chart I-9). Not surprisingly, speculative positioning in copper options and futures is also extremely elevated. If investors have been betting on higher copper prices, based on the expectation of a lower dollar, then a relapse in the red metal will be synonymous with a higher greenback. That said, commodity bull markets have tended to last over a decade, with the recent rise in prices also driven by deficient supply. As such, we will buy the currencies of commodity producers on weakness, rather than sell on strength, as the bull market continues. This also argues for a fleeting technical bounce in the dollar. Chart I-9A Bull Market In Metals Chart I-10The Gold/Silver Ratio is Rebounding Within the commodity space, watching the gold/silver ratio (GSR) is instructive. The GSR tends to track the US dollar (Chart I-10). This is because it has usually rallied on safe-haven demand and relapsed once there is a pickup in economic (or manufacturing) activity. Gold benefits from plentiful liquidity and very low real rates, while silver benefits from rising industrial demand. It is possible the surge in global infections dampens economic activity and lifts demand for safe havens. This will be good for the dollar. However, as vaccinations take hold and the economy reopens, silver will surge. Relative Interest Rates Interest rates are moving in favor of the dollar, and there has been a long-standing relationship between relative real rates and the US currency. The question is whether the rise in US interest rates has been sufficient to compensate investors for the higher budget deficits they will need to finance. To answer this, it is always instructive to look at the relationship between gold and US Treasuries. Remarkably, the ratio of the total return in US government bonds-to-gold prices has tracked the dollar pretty well since the end of the Bretton Woods system in the early 1970s.  The bond-to-gold ratio is an important signal for the dollar, since both US Treasuries and gold are safe-haven assets and thus, by definition, are competing assets (Chart I-11). The ratio of the US bond ETF (TLT)-to-gold (GLD) is an important proxy for investor sentiment on the dollar (Chart I-12). Ultimately, investors are driven by real rates. Positive real returns will favor Treasuries, while negative real returns will favor gold. The latter appears to have the upper hand for now. Remarkably, the ratio of the total return in US government bonds-to-gold prices has tracked the dollar pretty well since the end of the Bretton Woods system in the early 1970s. Chart I-11Gold and Treasurys Are Competing Assets Chart I-12Watch The Bond-To-Gold Ratio The implication is that the rise in US interest rates has not yet convinced investors that a significant margin of safety exists for possible runaway inflation. This augurs badly for the dollar, beyond the near term. Investment Implications Our investment strategy is simple: hold a basket of the cheapest currencies and, some safe havens that will benefit if the dollar bounces. Opportunities at the crosses also make sense. On safe-haven currencies, our preferred vehicle is the Japanese yen, which sports an attractive real rate relative to the US. Relative value is particularly attractive on short CAD/NOK, long AUD/NZD, short EUR/GBP and long EUR/CHF. Stick with them. Stay short USD/JPY and long the Scandinavian currencies as a core holding. Remain short the gold/silver ratio.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been resilient: The headline 140K job loss last Friday was not as dire, looking into the details. There was a net two-month revision of +135K jobs. Core CPI came in line at 1.6% year-on-year, while average weekly earnings surged by 4.9%. MBA mortgage applications came in at a blockbuster 16.7% week-on-week, for the week ending on January 8. The DXY rose by 0.3% this week. There was some element of consolidation in markets earlier this week, with a few equity bourses softening and the dollar catching a bid. However, that has been overwhelmed by the reflation trade as we go to press. We expect any dollar bounce to be technical in nature, and in order of magnitude of around 2-4%.  Report Links: The Dollar In A Blue Wave - January 8, 2021 The Dollar Conundrum And Protection - November 6, 2020 The Dollar In A Market Reset - October 30, 2020 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data from the euro area have help up: The unemployment rate in the euro area fell from 8.4% to 8.3% in November. Sentix investor confidence remains resilient at 1.3 in January, versus -2.7 the previous month. Industrial production in the euro area is recovering, as signaled by the PMI releases. The euro fell by 0.5% against the US dollar this week. The unfolding political crisis in Italy warns that the euro might be due for a setback, as European peripheral bond spreads rise. We remain bullish the euro longer-term, but short-term trades are at risk from lopsided positioning.  Report Links: The Dollar Conundrum And Protection - November 6, 2020 Addressing Client Questions - September 4, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 The Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data from Japan has been better than expected: The expectations component of the Eco Watchers Survey rose from 36.5 to 37.1, versus expectations of 30.5 in December. Machine tool orders continued to inflect higher in December, to the tune of 8.7% year-on-year. Bank lending remained around a robust 6% in December. The Japanese yen was flat against the US dollar this week. Japanese fixed income investors are in a quagmire, since nominal rates are better in the US, but real rates are more favorable in Japan. The yen could remain caught in a tug of war between these forces, with a slight advantage to Japanese rates. We remain long the yen as a portfolio hedge.   Report Links: The Dollar Conundrum And Protection - November 6, 2020 The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 There was scant data out of the UK this week: BRC like-for-like sales rose by 4.8% year-on-year in December. The British pound rose by 0.8% against the US dollar this week. Vaccinations continue to progress smoothly in the UK, but cracks are already starting to emerge in the post Brexit UK-EU relationship. There are mounting food shortages in Northern Ireland and a hiccup in fish exports from the UK, as the necessary paperwork adds a layer of bureaucracy. As investors digest the potential impact to the pound, it will add to volatility. Ultimately, a cheap pound should outperform both the dollar and euro. Report Links: The Dollar Conundrum And Protection - November 6, 2020 Revisiting Our High-Conviction Trades - September 11, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 There was little data out of Australia this week: The final retail sales print was 7.1% month-on-month in November. The Australian dollar appreciated by 0.4% against the US dollar this week. Base metals, especially copper and iron ore have been on a tear this year. This is boosting Australian terms of trade. More importantly, a shortage of ships has catapulted Asian LNG prices to all-time highs as a cold spell hits countries like Japan and Korea. This should be beneficial for Australian energy producers. We are currently long AUD/NZD. Report Links: An Update On The Australian Dollar - September 18, 2020 On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 There was scant data out of New Zealand this week: REINZ house sales rose by 36.6% year-on-year in December. Building permits rose 1.2% month-on-month in November. The New Zealand dollar fell by 0.3% against the US dollar this week. The release of the US WASDE report confirmed a looming agricultural shortage, as production forecasts were slashed on weather worries. This is NZD bullish. That said, technically, agricultural prices are stretched, and so some consolidation will deflate air off the high-flying kiwi. In a commodity basket, we prefer the Aussie that is underpinned by more structural factors. Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data from Canada have been disappointing: Employment fell by 62.6K jobs in December. However, this was driven by 99K part-time job losses, with full-time job gains of 36.5K. The sales outlook in the BoC survey improved from 39 to 48 in 4Q 2020. The Canadian dollar appreciated by 0.5% against the US dollar this week. Oil prices are dominating commodity gains this year, given the shift from Saudi Arabia and the prospect of higher transport demand. This bodes well for the loonie. Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data from Switzerland have been mixed: The unemployment rate was flat at 3.4% in December. FX reserves increased from CHF 876 billion to CHF 891 billion. The Swiss franc fell by 0.2% against the US dollar this week. The biggest risk to Switzerland and the SNB authorities is a potential correction in the euro, which encourages safe-haven flows into the franc. This will also be a risk to our long EUR/CHF position. Our bias is that the valuation cushion on the cross provides an ample margin of safety. Report Links: The Dollar Conundrum And Protection - November 6, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 The data out of Norway has been robust: Headline CPI came in at 1.4% year-on-year, while underlying CPI was a whopping 3%. House prices rose 2.9% quarter-on-quarter in Q4. Industrial production came in at -0.9% in November, an improvement from -2.7% the previous month. The Norwegian krone is the best performing currency this year at +1.5%. Good management of the COVID-19 situation as well as rising oil prices have been positive catalysts. We expect the krone to keep outperforming for the rest of the year. Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data from Sweden has been rather disappointing: Private sector production fell by 1% year-on-year in November. We would expect this to reverse with the improvement in the December PMIs. Industrial orders rose 5.7% year-on-year in November. Household consumption fell 5% year-on-year in November. The Swedish krona has been the worst performing currency this year, falling by 0.7% against the US dollar this week. That said, it might be a case of profit taking. The Swedish krona remains cheap and should benefit from an upshot in the global manufacturing cycle. Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Markets largely ignored the uproar at the US Capitol on January 6 because the transfer of power was not in question. Democratic control over the Senate, after two upsets in the Georgia runoff, is the bigger signal. US fiscal policy will become more expansive yet the Federal Reserve will not start hiking rates anytime soon. This is a powerful tailwind for risk assets over the short and medium run. Politics and geopolitics affect markets through the policy setting, rather than through discrete events, which tend to have fleeting market impacts. The current setting, in the US and abroad, is negative for the US dollar. The implication is positive for emerging market stocks and value plays. Go long global stocks ex-US, long emerging markets over developed markets, and long value over growth. Cut losses on short CNY-USD. Feature Chart 1Market's Muted Response To US Turmoil Scenes of mayhem unfolded in the US Capitol on January 6 as protesters and rioters flooded the building and temporarily interrupted the joint session of Congress convened to count the Electoral College votes. Congress reconvened later and finished the tally. President-elect Joe Biden will take office at noon on January 20. Financial markets were unperturbed, with stocks up and volatility down, though safe havens did perk up a bit (Chart 1). The incident supports our thesis that the US election cycle of 2020 was a sort of “Civil War Lite” and that the country is witnessing “Peak Polarization,” with polarization likely to fall over the coming five years. The incident was the culmination of the past year of pandemic-fueled unrest and President Trump’s refusal to concede to the Electoral College verdict. Trump made a show of force by rallying his supporters, and apparently refrained from cracking down on those that overran Congress, but then he backed down and promised an orderly transfer of power. The immediate political result was to isolate him. Fewer Republicans than expected contested the electoral votes in the ensuing joint session; one Republican is openly calling for Trump to be forced into resignation via the 25th amendment procedure for those unfit to serve. The electoral votes were promptly certified. Vice President Mike Pence and other actors performed their constitutional duties. Pence reportedly gave the order to bring out the National Guard to restore order – hence it is possible that Pence and Trump’s cabinet could activate the 25th amendment, but that is unlikely unless Trump foments rebellion going forward. Vandals and criminals will be prosecuted and there could also be legal ramifications for Trump and some government officials. Do Politics And Geopolitics Affect Markets? The market’s lack of concern raises the question of whether investors need trouble themselves with politics at all. Philosopher and market guru Nassim Nicholas Taleb tweeted the following: If someone, a year ago, described January 6, 2021 (and events attending it) & asked you to guess the stock market behavior, admit you would have gotten it wrong. Just so you understand that news do not help you understand markets.1 This is a valid point. Investors should not (and do not) invest based on the daily news. Of course, many observers foresaw social unrest surrounding the 2020 election, including Professor Peter Turchin.2 Social instability was rising in the data, as we have long shown. When you combined this likelihood with the Fed’s pause on rate hikes, and a measurable rise in geopolitical tensions between the US and other countries, the implication was that gold would appreciate. So if someone had told you a year ago that the US would have a pandemic, that governments would unleash a 10.2% of global GDP fiscal stimulus, that the Fed would start average inflation targeting, that a vaccine would be produced, and that the US would have a contested election on top of it all, would you have expected gold to rise? Absolutely – and it has done so, both in keeping with the fall in real interest rates plus some safe-haven bonus, which is observable (Chart 2). Chart 2Gold Price In Excess Of Fall In Real Rates Implies Geopolitical Risk The takeaway is that policy matters for markets while politics may only matter briefly at best. Which brings us back to the implications of the Trump rebellion. What Will Be The Impact Of The Trump Rebellion? We have highlighted that this election was a controversial rather than contested election – meaning that the outcome was not in question after late November when the court cases, vote counts, and recounts were certified. This was doubly true after the Electoral College voted on December 14. The protests and riots yesterday never seriously called this result into question. Whatever Trump’s intentions, there was no military coup or imposition of martial law, as some observers feared. In fact the scandal arose from the President’s hesitation to call out the National Guard rather than his use of security forces to prevent the transfer of power, as occurs during a coup. This partially explains why the market traded on the contested election in December 2000 but not in 2020 – the result was largely settled. The Biden administration now has more political capital than otherwise, which is market-positive because it implies more proactive fiscal policy to support the economic recovery. Trump’s refusal to concede gave Democrats both seats in the Georgia Senate runoffs, yielding control of Congress. Household and business sentiment will revive with the vaccine distribution and economic recovery, while the passage of larger fiscal stimulus is highly probable. US fiscal policy will almost certainly avoid the mistake of tightening fiscal policy too soon. Taken with the Fed’s aversion to raising rates, greater fiscal stimulus will create a powerful tailwind for risk assets over the next 12 months. The primary consequence of combined fiscal and monetary dovishness is a falling dollar. The greenback is a counter-cyclical and momentum-driven currency that broadly responds inversely to global growth trends. But policy decisions are clearly legible in the global growth path and the dollar’s path over the past two decades. Japanese and European QE, Chinese devaluation, the global oil crash, Trump’s tax cuts, the US-China trade war, and COVID-19 lockdowns all drove the dollar to fresh highs – all policy decisions (Chart 3). Policy decisions also ensured the euro’s survival, marking the dollar’s bottom against the euro in 2011, and ensuring that the euro could take over from the dollar once the dollar became overbought. Today, the US’s stimulus response to COVID-19 – combined with the Fed’s strategic review and the Democratic sweep of government – marked the peak and continued drop-off in the dollar. Chart 3Euro Survival, US Peak Polarization, Set Stage For Rotation From USD To EUR Chart 4China's Yuan Says Geopolitics Matters The Chinese renminbi is heavily manipulated by the People’s Bank and is not freely exchangeable. The massive stimulus cycle that began in 2015, in reaction to financial turmoil, combined with the central bank’s decision to defend the currency marked a bottom in the yuan’s path. China’s draconian response to the pandemic this year, and massive stimulus, made China the only major country to contribute positively to global growth in 2020 and ensured a surge in the currency. The combination of US and Chinese policy decisions has clearly favored the renminbi more than would be the case from the general economic backdrop (Chart 4). Getting the policy setting right is necessary for investors. This is true even though discrete political events – including major political and geopolitical crises – have fleeting impacts on markets. What About Biden’s Trade Policy? Trump was never going to control monetary or fiscal policy – that was up to the Fed and Congress. His impact lay mostly in trade and foreign policy. Specifically his defeat reduces the risk of sweeping unilateral tariffs. It makes sense that global economic policy uncertainty has plummeted, especially relative to the United States (Chart 5). If US policy facilitates a global economic and trade recovery, then it also makes sense that global equities would rise faster than American equities, which benefited from the previous period of a strong dollar and erratic or aggressive US fiscal and trade policy. Trump’s last 14 days could see a few executive orders that rattle stocks. There is a very near-term downside risk to European and especially Chinese stocks from punitive measures, or to Emirati stocks in the event of another military exchange with Iran (Chart 6). But Trump will be disobeyed if he orders any highly disruptive actions, especially if they contravene national interests. Beyond Trump’s term we are constructive on all these bourses, though we expect politics and geopolitics to remain a headwind for Chinese equities. Chart 5Big Drop In Global Policy Uncertainty US tensions with China will escalate again soon – and in a way that negatively impacts US and Chinese companies exposed to each other. Chart 6Geopolitical Implications Of Biden's Election The cold war between these two is an unavoidable geopolitical trend as China threatens to surpass the US in economic size and improves its technological prowess. Presidents Xi and Trump were merely catalysts. But there are two policy trends that will override this rivalry for at least the first half of the year. First, global trade is recovering– as shown here by the Shanghai freight index and South Korean exports and equity prices (Chart 7). The global recovery will boost Korean stocks but geopolitical tensions will continue to brood over more expensive Taiwanese stocks due to the US-China conflict. This has motivated our longstanding long Korea / short Taiwan recommendation. Chart 7Global Economy Speaks Louder Than North Korea Chart 8China Wary Of Over-Tightening Policy Chart 9Global Stock-Bond Ratio Registers Good News Second, China’s 2020 stimulus will have lingering effects and it is wary of over-tightening monetary and fiscal policy, lest it undo its domestic economic recovery. The tenor of China’s Central Economic Work Conference in December has reinforced this view. Chart 8 illustrates the expectations of our China Investment Strategy regarding China’s credit growth and local government bond issuance. They suggest that there will not be a sharp withdrawal of fiscal or quasi-fiscal support in 2021. Stability is especially important in the lead up to the critical leadership rotation in 2022.3 This policy backdrop will be positive for global/EM equities despite the political crackdown on General Secretary Xi Jinping’s opponents will occur despite this supportive policy backdrop. The global stock-to-bond ratio has surged in clear recognition of these positive policy trends (Chart 9). Government bonds were deeply overbought and it will take several years before central banks begin tightening policy. What About Biden’s Foreign Policy? Chart 10OPEC 2.0 Cartel Continues (For Now) Iran poses a genuine geopolitical risk this year – first in the form of an oil supply risk, should conflict emerge in the Persian Gulf, Iraq, or elsewhere in the region. This would inject a risk premium into the oil price. Later the risk is the opposite as a deal with the Biden administration would create the prospect for Iran to attract foreign investment and begin pumping oil, while putting pressure on the OPEC 2.0 coalition to abandon its current, tentative, production discipline in pursuit of market share (Chart 10). Biden has the executive authority to restore the 2015 nuclear deal (Joint Comprehensive Plan of Action). He is in favor of doing so in order to (1) prevent the Middle East from generating a crisis that consumes his foreign policy; (2) execute an American grand strategy of reviving its Asia Pacific influence; (3) cement the Obama administration’s legacy. The Iranian President Hassan Rouhani also has a clear interest in returning to the deal before the country’s presidential election in June. This would salvage his legacy and support his “reformist” faction. The Supreme Leader also has a chance to pin the negative aspects of the deal on a lame duck president while benefiting from it economically as he prepares for his all-important succession. The problem is that extreme levels of distrust will require some brinkmanship early in Biden’s term. Iran is building up leverage ahead of negotiations, which will mean higher levels of uranium enrichment and demonstrating the range of its regional capabilities, including the Strait of Hormuz, and its ability to impose economic pain via oil prices. Biden will need to establish a credible threat if Iran misbehaves. Hence the geopolitical setting is positive for oil prices at the moment. Beyond Iran, there is a clear basis for policy uncertainty to decline for Europe and the UK while it remains elevated for China and Russia (Chart 11). Chart 11Relative Policy Uncertainty Favors Europe and UK Over Russia And China The US international image has suffered from the Trump era and the Biden administration’s main priorities will lie in solidifying alliances and partnerships and stabilizing the US role in the world, rather than pursuing showdown and confrontation. However, it will not be long before scrutiny returns to the authoritarian states, which have been able to focus on domestic recovery and expanding their spheres of influence amid the US’s tumultuous election year. Chart 12GeoRisk Indicators Say Risks Underrated For These Bourses The US will not seek a “diplomatic reset” with Russia, aside from renegotiating the New START treaty. The Democrats will seek to retaliate for Russia’s extensive cyberattack in 2021 as well as for election interference and psychological warfare in the United States. And while there probably will be a reset with China, it will be short-lived, as outlined above. This situation contrasts with that of the Atlantic sphere. The Biden administration is a crystal clear positive, relative to a second Trump term, for the European Union. The EU and the UK have just agreed to a trade deal, as expected, to conclude the Brexit process, which means that the US-UK “special relationship” will not be marred by disagreements over Ireland. European solidarity has also strengthened as a result of the pandemic, which highlighted the need for collective policy responses, including fiscal. Thus the geopolitical risks of the new administration are most relevant for China/Taiwan and Russia. Comparing our GeoRisk Indicators, which are market-based, with the relative equity performance of these bourses, Taiwanese stocks are the most vulnerable because markets are increasingly pricing the geopolitical risk yet the relative stock performance is toppy (Chart 12). The limited recovery in Russian equities is also at risk for the same reason. Only in China’s case has the market priced lower geopolitical risk, not least because of the positive change in US administration. We expect Biden and Xi Jinping to be friendly at first but for strategic distrust to reemerge by the second half of the year. This will be a rude awakening for Chinese stocks – or China-exposed US stocks, especially in the tech sector. Investment Takeaways Chart 13Global Policy Shifts Drive Big Investment Reversals The US is politically divided. Civil unrest and aftershocks of the controversial election will persist but markets will ignore it unless it has a systemic impact. The policy consequence is a more proactive fiscal policy, resulting in virtual fiscal-monetary coordination that is positive both for global demand and risk assets, while negative for the US dollar. The Biden administration will succeed in partially repealing the Trump tax cuts, but the impact on corporate profit margins will be discounted fairly mechanically and quickly by market participants, while the impact on economic growth will be more than offset by huge new spending. Sentiment will improve after the pandemic – and Biden has not yet shown an inclination to take an anti-business tone. The past decade has been marked by a dollar bull market and the outperformance of developed markets over emerging markets and growth stocks like technology over value stocks like financials. Cyclical sectors have traded in a range. Going forward, a secular rise in geopolitical Great Power competition is likely to persist but the macro backdrop has shifted with the decline of the dollar. Cyclical sectors are now poised to outperform while a bottom is forming in value stocks and emerging markets (Chart 13). We recommend investors go strategically long emerging markets relative to developed. We are also going long global value over growth stocks. We are not yet ready to close our gold trade given that the two supports, populist fiscal turn and great power struggle, will continue to be priced by markets in the near term. We are throwing in the towel on our short CNY-USD trade after the latest upleg in the renminbi, though our view continues to be that geopolitical fundamentals will catch yuan investors by surprise when they reassert themselves. We also recommend preferring global equities to US equities, given the above-mentioned global trends plus looming tax hikes.   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com   Footnotes 1 January 6, 2020, twitter.com. 2 See Turchin and Andrey Korotayev, "The 2010 Structural-Demographic Forecast for the 2010-2020 Decade: A Retrospective Assessment," PLoS ONE 15:8 (2020), journals.plos.org. 3 Not to mention that 2021 is the Communist Party’s 100th anniversary – not a time to make an unforced policy error with an already wobbly economy.