2017 Yearly Forecast

 The US Stock Market

Of the 2016 forecasts we made roughly a year ago the only one that was a long way from the mark applied to the US stock market. Here's what we wrote last January:

"Monetary conditions remain very easy, so the sort of stock market collapse that occurred in 2008 is still not a realistic possibility. However, we think that the SPX will experience a peak-to-trough decline of more than 20% during the year. Just to be clear, if the 4th January intra-day high of 2038 turns out to be the high for the year, then our forecast is for the SPX to trade below 1630 at some point during the year. Also, we expect that the SPX will end the year with a loss of more than 10%, which means that we expect the SPX to end the year below 1840."

The only part of that forecast that wasn't wrong was the comment about a 2008-style stock market collapse being out of the question.

As to what 2017 holds in store for the US stock market, our views/expectations are a little vague. Here they are in point form:

1) The fact that monetary conditions remain very easy means that the sort of stock market collapse that occurred in 2008 is still not a realistic possibility.

2) The bull market won't end during the first half of this year UNLESS there is a strong price rise accompanied by a bearish divergence in market internals during the first few months of the year.

3) The market's performance during the year will be characterised by the word "volatility", with multiple declines of at least 8% followed by quick recoveries.

    The US Dollar

This was our 2016 forecast for the currency market:

"...we expect the Dollar Index to trade at least a few points above its March-2015 peak sometime this year. We don't have a firm opinion on whether this will happen during the first half or the second half of the year, but if forced to make a guess we'd say the second half.

The Dollar Index is effectively the reciprocal of the euro, so the above paragraph means that we expect the euro to trade at new bear-market lows before bottoming on a long-term basis. With regard to other currencies, as noted in the list of 2016 surprises presented early this month we expect the Yen to be this year's strongest major currency. Also, we expect that the A$ and the C$ will reach intermediate-term bottoms along with the commodity indices during the first quarter of the year."

This forecast was 'spot on'. We were right about the Dollar Index trading a few points above its March-2015 peak during the second half of the year, we were right about the euro making a new bear-market low, we were right about the Yen being the strongest major currency, and we were right about the A$ and the C$ making intermediate-term bottoms during the first quarter.

For this year we expect that the first quarter will contain a significant correction in the Dollar Index. The Q1 downward correction in the Dollar Index will naturally be accompanied by a significant rebound in the euro, but the Yen is expected to be the strongest currency during this 1-3 month corrective period. The Yen strength will be linked to strength in the gold and T-Bond markets.

Following the aforementioned Q1 correction, the US dollar's upward trend will resume.

We expect the US dollar's long-term upward trend and the associated downward trend in the euro to culminate during either the second or the third quarter of 2017, with the extreme being above 108 for the Dollar Index and below parity (100) for the euro. The timing of the US$ top and the associated euro bottom is based on the dollar's long-term cyclicality -- the dollar's record of repeatedly falling for 8-10 years and then rising for about 6 years. Also, the timing of the US$ top is linked to the likelihood that US equities will begin to weaken relative to global equities during 2017.

Our only other currency-market forecast for 2017 is that the British Pound will end up being the strongest major currency despite being buffeted by more Brexit-related uncertainty during the year's first half. This expectation is based on the Pound's relatively-attractive valuation and its strong tendency to make a major bottom every 8 years.

   T-Bonds

Here's what we wrote in our 2016 forecast:

"...we expect the prices of long-dated US Treasury Bonds -- as well as the long-dated bonds issued by the governments of Japan and Germany -- to top-out during the first quarter and to have a downward bias thereafter. Also, we expect that the price highs reached during the first quarter will be below last year's highs."

As it turned out, the T-Bond's upward trend was prolonged by the maniacal actions of the ECB and a sudden surge in fear due to the 'shocking' result of the Brexit vote in late-June. Consequently, the downward bias we were expecting didn't materialise until early-July. Once it did materialise, though, it was sufficient to more than fully retrace the preceding gains and leave the T-Bond with a net loss for the year.

Our expectations for the year ahead have been mentioned in previous commentaries and in the list of 2017 surprises included in last week's Interim Update, but the upshot is that we expect a strong first-quarter rebound in the T-Bond price and for the new (as of July-2016) long-term downward trend (down in price, up in yield) to then resume.

We expect that it will be another losing year for the T-Bond due primarily to rising fear of inflation during the second half of the year, but that a major T-Bond decline won't happen. Preventing a major decline will be price-support from central banks and periodic flights to safety, with the flights to safety being caused by stock market volatility in the US and political drama in Europe.

The current price for the T-Bond is 151. We expect the price to trade near 140 before year-end, but not below 130. This expectation is based on the strong tendency for intermediate-term declines in the T-Bond to bottom at or slightly below the 84-month moving average (the blue line on the following chart).



   Gold

Our 2016 forecast for gold bullion was:

"We expect that there will be a sustained turn to the upside from a Q1-2016 low, but that the upward trend over the remainder of the year will be choppy and that gold will end the year with a net gain of 'only' 10% (or thereabouts). This would be similar to what happened in 2000-2001, which appears to be the best analog to the present situation."

This expectation was close to the mark, as gold turned upward from a first-quarter low and ended the year with a gain of 8.7%.

Annual forecasts always involve more guesswork than analysis, but last year's gold forecast was relatively straightforward. This was because the speculative net-long position in Comex gold futures had recently fallen to its lowest level in more than 10 years and because the fundamental backdrop was neutral and seemingly set to turn bullish within the ensuing 1-2 months. This made it very likely that gold had either already bottomed or would soon do so, with an intermediate-term rally to follow. At the same time, the historical record suggested that a massive price gain was unlikely.

This year's forecast is anything but straightforward. Prior to year-end we wrote that a strong Q1 rebound was likely (an expectation that is in the process of being met), but the set-up for a longer-term rally is not YET in place. In particular, the fundamental backdrop is currently bearish -- albeit not as bearish as it was a month ago -- and the sentiment situation is nowhere near as constructive as it was at this time last year.

We therefore expect that the December-2016 low ($1125) will be breached during the second or third quarter of 2017. Beyond that, our only expectation is that a very important bottom will be put in place for the US$ gold price before year-end in parallel with a major top for the Dollar Index.

   The Gold Mining Sector

Our 2016 forecast for the gold-mining sector (as measured by the HUI) was:

"After the US$ gold price turns upward, the gains achieved by the gold-mining indices are likely to greatly outstrip the gains achieved by gold. This is consistent with what happened in the past and with the dramatic relative weakness of the gold-mining indices over the past few years.

We expect that the HUI will gain at least 50% within two months of a major Q1-2016 bottom and end the year at least 100% above whatever low it makes during the first quarter."

As it turned out, the HUI bottomed in Q1 (19th January, to be precise), gained a lot more than 50% within two months of the bottom and ended the year 83% above the low it made during the first quarter (it ended the year at 182 and the first quarter low was 99). Our expectation for the year-ending level was therefore slightly too optimistic, although we revised our outlook in the 4th May Interim Update when the HUI was at 210. At that time we wrote: "...our guess is that the HUI will end this year within 15% of its current level." This guess (that's all it was) turned out to be correct.

Turning to the forecast for 2017, prior to the start of this year we wrote that a strong rebound was in store for the gold-mining sector during the first quarter of 2017. The rebound is expected to take the HUI to at least 220 and possibly as high as 250.

The gold-mining sector should again outperform gold, although this year's outperformance will not be as pronounced as last year's and will have a different driver. Whereas last year's strength in the gold-mining sector relative to gold bullion was primarily driven by the enormous declines in gold-mining stocks relative to gold over the preceding few years (it was largely a catch-up), the main reason for this year's outperformance will be general strength in commodity-related equities. That is, we expect the gold-mining sector to be supported by a broad-based rise in the demand for commodity plays.

Performing better than gold bullion probably won't, however, lead to substantial 12-month returns for the gold-mining indices. A reasonable expectation is that the Q1 rebound will be followed by a choppy market over the remainder of the year.

By "choppy" we mean that there will be no major trends, although we expect that there will be tradable swings in both directions. One of these tradable swings is likely to result in the December-2016 low (160) being tested or perhaps even undercut during the second or third quarter of the year, but we do not expect the January-2016 low (99) to be tested.

Our guess is that the HUI will end 2017 at 200 +/- 10%. This is obviously not an exciting forecast, but our goal is to be realistic rather than exciting.

Aside from the trading opportunities presented by the sector-wide swings from 'overbought' to 'oversold' and back again, we expect that 2017 will generate excellent opportunities to profit from large rises in the prices of individual gold-mining juniors. But unlike the first three quarters of last year when a lot of 'turkeys' flew to great heights, this year the gold-mining sector will be more of a stock-picker's market.

   Industrial Commodities

Here's how our 2016 annual forecast for industrial commodities (oil and the industrial metals) was summarised:

"For this year there is no reason to make separate forecasts for different industrial commodities, because they are in synch. They are all massively 'oversold' and poised for at least intermediate-term and possibly long-term upward reversals from whatever lows are made during the first quarter."

The forecast 'panned out', although there is an as-yet-unanswerable question as to whether the Q1-2016 upward reversals were the intermediate-term or the long-term kind.

In one respect, this year's forecast for industrial commodities is the opposite of last year's. Whereas last year we were expecting an intermediate-term bottom during the first quarter, this year we are expecting an intermediate-term top during the first quarter. This is partly because speculators have built up unusually-large long positions in some commodities, most notably copper and oil. It is also because the forces that have caused the recent strength in the prices of industrial commodities are likely to soon disappear, at least temporarily. These forces are the US$ correction and the Trump-related enthusiasm for any perceived beneficiary of "fiscal stimulus".

To further explain, the Dollar Index will probably make a new multi-year high during the second quarter of this year and the Trump-related enthusiasm is misplaced. It is misplaced because a) the additional US infrastructure spending will be less than anticipated (due to budget constraints) and will have no meaningful effect on global commodity consumption, and b) the planned tax cuts will take longer to implement and will bring about less additional spending than currently believed.

We expect that the Q1-2017 top will be followed by a multi-month correction and an important bottom around mid-year in parallel with an important top for the US$. With the US$ no longer a headwind and speculative long positions having been greatly reduced in response to price weakness, the stage will then be set for general commodity-price strength during the second half of the year.

Overall, we expect that 2017 will be an up-year for commodity prices.

Also, as part of last year's annual forecast we wrote:

"In the commodity markets, measures of negativity and downside momentum have reached rare and in some cases unprecedented extremes. Also, the bottom section of the following chart shows that the Goldman Sachs Spot Commodity Index (GNX) has fallen to near its 2001 low relative to the S&P500 Index (SPX)."

Here is an updated version of the same chart. Note that although there was a significant rebound in commodity prices (as represented by GNX) from the early-2016 bottom, the GNX/SPX ratio is still near its 2001 low. Regardless of how the commodity markets fare in nominal dollar terms, this suggests that the risk/reward favours commodities over equities.