Commodities & Energy Sector

Highlights Portfolio Strategy Depressed technicals, compelling valuations, macro tailwinds, improving operating fundamentals and the messages from our relative profit growth models and relative Cyclical Macro Indicators all signal that the time is ripe to initiate a long energy/short utilities pair trade. Pricey valuations, overbought technicals, the sell-off in the bond market and weak profit fundamentals, all warrant an underweight stance in the S&P utilities sector. Recent Changes Initiate a long S&P Energy/short S&P Utilities pair trade today. Table 1 Why The SPX Does Not Resemble The Late-Nineties Why The SPX Does Not Resemble The Late-Nineties Feature Equities propelled to uncharted territory, celebrating an easy Fed and the US/China détente with a hint of a tariff rollback, overcoming the seasonally difficult months of September and October. Historically, investors chase performance during the end of the year and seasonality will likely favor further flows into equities in the last two months of the year. On the economic front, while manufacturing remains in recession, a resilient labor market is providing a significant offset allaying fears of recession gripping the broad economy. Drilling deeper on the labor front is revealing. The unemployment rate ticked higher to 3.6% last month based on the household survey as the participation rate increased. However, according to the Sahm Rule Recession Indicator (SRRI), courtesy of Fed economist Claudia R. Sahm,1 were the unemployment rate to average 4% for three consecutive months by September 2020, the US economy will enter recession. In other words, based on empirical evidence the SRRI shows that when the three-month average unemployment rate has jumped by 50bps compared with previous twelve month low, the US has entered recession 100% of the time since the end of WWII (Chart 1). Chart 1Watch The Sahm Rule Recession Indicator Watch The Sahm Rule Recession Indicator Watch The Sahm Rule Recession Indicator Meanwhile, the parallels drawn with the mid-to-late 1990s and the current market backdrop have mushroomed, but our view is that the differences could not be wider. Since the history of our reconstructed SPX data going back to the late-1920s, there has never been a five-year period when the S&P 500 rose by at least 20% every year except for the 1995-1999 era. In that five-year period the SPX soared more than threefold, increasing annually by 34%, 20%, 31%, 27% and 20%, respectively. Investors forget that those were manic markets and despite a high and rising fed funds rate that peaked at 6.5% in early 2000 (real rates were over 4%), the forward P/E multiple went to the stratosphere ignoring theory and defying logic (Chart 2). Putting the late-1990s exuberance into perspective is instructive: if 1995 is similar to 2016 (and 1998 is similar to 2019) then the SPX should spike to over 6000 by the end of next year! Moving over to economic green shoots, we turn our attention to the signal the emerging markets are emitting. While both the EM and the Chinese manufacturing PMIs are expanding smartly, leading indicators suggest that the recovery may be running on empty. Chart 2One Of A Kind One Of A Kind One Of A Kind Chart 3Mixed Signals Mixed Signals Mixed Signals Chart 3 shows that the Chinese credit impulse is contracting, weighing on EM FX momentum and also signaling that the CAIXIN China manufacturing PMI, that has opened the widest gap with the official China NBS manufacturing PMI since the history of the data, will likely suffer a setback in the coming quarters. In the transportation sector, the Baltic Dry Index is down 33% since the early-September peak and is also losing steam on year-over-year basis, warning that a global trade recovery is skating on thin ice. Moreover, EM sentiment is downbeat. Investor flows into EM equities, according to the most liquid iShares MSCI EM ETF, have been drifting lower since the 2018 peak and have more recently gapped down (bottom panel, Chart 3). Thus, the recent green shoots may prove fleeting. This week we are initiating a new market-neutral pair trade and reiterate our negative view on a niche defensive sector. With regard to US liquidity, that we have been inundated with client requests recently, we highlight our simple liquidity indicator: industrial production (IP) growth versus M2 money supply growth. In other words, we gauge how fast a unit of currency is translated into IP. Chart 4 highlights that IP/M2 is contracting at an accelerating pace, heralding further earnings growth pain for the S&P 500. US dollar based liquidity is also contracting as we showed in last week’s US Equity Strategy Webcast slides. Chart 4Clogged Pipelines Weighing On Profit Growth Clogged Pipelines Weighing On Profit Growth Clogged Pipelines Weighing On Profit Growth Other SPX profit indicators we track continue to suggest that the earnings soft patch is not out of the woods yet (we use forward EBITDA estimates to gauge trend growth, which excludes the one time fiscal easing boost to net EPS). Net forward EBITDA revisions are below zero, the ISM manufacturing new orders-to-inventories ratio has fallen 40% from the 2018 peak and is hovering near parity, momentum in the key ISM manufacturing new orders subcomponent is contracting and BCA’s boom/bust indicator continues to deflate. All of this, suggests that a turnaround in profits remains elusive and is a first half of 2020 outcome, at the earliest (Chart 5). Already, Q4/2019 profit growth estimates have now sunk into negative territory according to the latest FactSet data.2 Finally, the Fed released the last Senior Loan Officer Survey of the year in the past week and demand for C&I loans collapsed. This data series has broken below the 2016 trough and warns that C&I credit origination will continue to contract. Chart 5No Pulse No Pulse No Pulse Chart 6Capex Contraction Dampens Need For Credit Capex Contraction Dampens Need For Credit Capex Contraction Dampens Need For Credit Such a souring backdrop makes intuitive sense as animal spirits have died down courtesy of the Sino-American trade war. CEO’s are still voting with their feet and are canceling/postponing capital outlays. Absent capex, C&I credit demand runs aground (Chart 6). It remains unclear if a US/China “phase one” trade deal including tariff rollbacks can reverse the ongoing global trade contraction, signaling that caution is still warranted on the prospects of the broad equity market for the next 9-12 months. This week we are initiating a new market-neutral pair trade and reiterate our negative view on a niche defensive sector. Long/Short Idea: Buy Energy/Sell Utilities There is an exploitable opportunity in going long the S&P energy sector/short the S&P utilities sector and we recommend initiating this market-neutral trade today. The top panel of Chart 7 shows that energy stocks have come full circle and are trading at levels last seen two decades ago when WTI oil was fetching less than half of today’s $55/bbl price. Encouragingly, there seems to be long-term support for relative share prices at the current overly depressed level. While utilities have been making headlines all year long given their outperformance, when put in proper perspective this niche defensive sector with a mere 3% weight in the SPX looks like a shipwreck (bottom panel, Chart 7). Taken together, this battle between two diminishing sectors presents a tradable opportunity by favoring energy stocks at the expense of utilities. In fact, this ratio trades at more than two standard deviations below the historical uptrend, and thus offers a lucrative risk/reward profile (Chart 8). Chart 7Buy Energy… Buy Energy… Buy Energy… Chart 8…At The Expense Of Utilities …At The Expense Of Utilities …At The Expense Of Utilities Beyond depressed technicals and compelling overall valuations with an alluring relative dividend yield (investors are paid an unprecedented 100bps in dividend yield carry to put on this trade, Chart 9), macro tailwinds, improving operating fundamentals, and the messages from our relative profit growth models and relative Cyclical Macro Indicators (CMI), all signal that the time is ripe to initiate a long energy/short utilities pair trade. On the macro front, inflation expectations have tentatively troughed and if oil rebounds further, as our Commodity & Energy Strategy service expects, then given their tight positive correlation with oil prices, rising inflation expectations should put a definitive floor under the relative share price ratio (Chart 10). Chart 9Unloved And Oversold Unloved And Oversold Unloved And Oversold Chart 10Return Of Inflation… Return Of Inflation… Return Of Inflation… However, the real interest rate component (i.e. growth) also explains roughly half of the selloff in the 10-year Treasury yield since early September, which also moves in lockstep with relative share price momentum (bottom panel, Chart 10). Were this budding global growth recovery to gain steam into the first half of 2020, then energy profits would outshine utility sector profits. As a reminder, oil is a global growth barometer and rises with increasing global growth while defensive utilities flourish when growth sputters (Chart 11). The US dollar’s recent appreciation has also dealt a blow to this trade and a grinding lower currency which is synonymous with a modest global growth recovery would also reverse this pair trade’s fortunes (top two panels, Chart 12). Chart 11…And Green Shoots Beneficiary …And Green Shoots Beneficiary …And Green Shoots Beneficiary Chart 12Operating Metrics Also… Operating Metrics Also… Operating Metrics Also… Zooming into the relative operating outlook, the bottom panel of Chart 12 shows that oil price inflation is outpacing natural gas selling prices. This relative underlying commodity backdrop is important as energy stocks move with the ebbs and flows of the oil market, whereas the marginal price setter for utility services is natural gas prices. The upshot is that heading into 2020, bombed out relative share prices should play catch up to the firming relative commodity backdrop. Capital spending outlays also favor energy shares over utilities stocks (top two panels, Chart 13). Surprisingly, the utilities sector net debt-to-EBITDA ratio is above 5x, waving a red flag, but energy indebtedness is coming down fast in the aftermath of the early 2016 oil price collapse and the energy sector’s net debt-to-EBITDA ratio is close to 2x (bottom panel, Chart 13). Our relative CMIs and relative profit growth models do an excellent job capturing all these moving parts and are unanimously sending a bullish message that an earnings-led recovery is in store for the relative share price ratio (Chart 14). Chart 13…Favor Energy Over Utilities …Favor Energy Over Utilities …Favor Energy Over Utilities Chart 14Green Light From US Equity Strategy Models Green Light From US Equity Strategy Models Green Light From US Equity Strategy Models Bottom Line: Initiate a long S&P energy/short S&P utilities pair trade today. Out Of Power Warning Utilities stocks have been all the rave this year, but given their small weighting in the SPX they only explain a very small part of the broad market’s run (in contrast, the heavyweight tech sector explains most of the S&P 500’s rise as we highlighted in recent research).3 We reiterate our underweight stance in this small defensive sector that has run way ahead of soft profit fundamentals. Worrisomely, utilities trade with a 20 forward P/E handle and command a 20% premium to the broad market, but their forecast EPS growth rate at 5% trails the SPX by 350bps (not shown). Chart 15 shows that our composite relative Valuation Indicator has surged to one standard deviation above the historical mean, a level typically associated with recession. Technicals are also extended (bottom panel, Chart 15), warning that this crowded trade is at risk of deflating, especially if the breakout in bond yields gains steam.   Chart 15Overbought And Overvalued Overbought And Overvalued Overbought And Overvalued   In sum, pricey valuations, overbought technicals, the selloff in the bond market and weak profit fundamentals, all warrant an underweight stance in the S&P utilities sector. The top panel of Chart 16 shows that relative share prices and the 10-year Treasury yield are closely inversely correlated. Now that the risk free asset is having a more competitive yield, investors will likely start to abandon this niche defensive sector. Similarly, the recent selloff in the total return bond-to-stock ratio also warns that buying up expensive utilities at the current juncture is fraught with danger (second panel, Chart 16). The jury is still out on the final outcome of the Sino-American trade war. However, there has been a decisive change of heart in US exporters and the ISM manufacturing survey’s new export orders subcomponent reflects an, at the margin, improvement in the US/China trade relationship. This bodes ill for safe haven utilities stocks (new export orders shown inverted, bottom panel, Chart 16). Chart 16Budding Recovery Weighing On Utilities Budding Recovery Weighing On Utilities Budding Recovery Weighing On Utilities Chart 17Sell The Strength Sell The Strength Sell The Strength Turning over to the sector’s operating metrics reveals that investors piling into utilities is unwarranted. Natural gas prices are contracting at the steepest pace of the past four years (middle panel, Chart 17) and signal that the path of least resistance is lower for relative share price momentum. Meanwhile, electricity capacity utilization is in a multi decade downtrend, warning that the relative profitability will remain under pressure in the coming quarters (bottom panel, Chart 17). In sum, pricey valuations, overbought technicals, the sell-off in the bond market and weak profit fundamentals, all warrant an underweight stance in the S&P utilities sector. Bottom Line: Shy away from the expensive S&P utilities sector. The ticker symbols for the stocks in this index are: BLBG – S5UTIL– PPL, PNW, ATO, PEG, FE, EIX, AEE, SO, SRE, AEP, XEL, DTE, EVRG, WEC, AES, CMS, LNT, ED, NRG, D, AWK, DUK, ETR, EXC, NEE, CNP, NI, ES.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com     Footnotes 1     https://www.federalreserve.gov/econres/claudia-r-sahm.htm 2       https://insight.factset.com/sp-500-now-projected-to-report-a-year-over-year-decline-in-earnings-in-q4-2019 3       Please see BCA US Equity Strategy Insight Report, “Deciphering Sector Returns” dated August 30, 2019, available at uses.bcaresearch.com.   Current Recommendations Current Trades Size And Style Views Stay neutral cyclicals over defensives (downgrade alert) Favor value over growth Favor large over small caps (Stop 10%)

Highlights The correlation between oil and petrocurrencies has shifted in recent years. It no longer makes sense going long petrocurrencies versus the US dollar blindly. One of the reasons has been the impressive and prominent output from US shale. We are currently long a basket of petrocurrencies versus the euro, but intend to shift this trade towards a short USD position on more visible signs of a breakdown in the US dollar. Go short CAD/NOK for a trade. Feature Chart I-1Oil And Petrocurrencies Have Diverged Oil And Petrocurrencies Have Diverged Oil And Petrocurrencies Have Diverged Since the middle of the last decade, one of the most perplexing disconnects has been the divergence between the price of oil and the performance of petrocurrencies. From the 2016 bottom, oil prices more than doubled, but the petrocurrency basket has underperformed by a whopping 110% versus the US dollar. This has been a very perplexing result that has surprised many investors on what was traditionally a very sound correlation (Chart I-1).  In general, an increase in oil prices usually implies rising terms of trade, which should increase the fair value of a currency. Throughout our modeling exercises, terms of trade were uncovered as what mattered the most for commodity currencies in general, and petrocurrencies in particular. In theory, this makes sense, given the improvement in balance-of-payment dynamics (that tend to be observed with a lag) and the ability for increased government spending, allowing a resident central bank to tighten monetary policy. In the case of Canada and Norway, petroleum represents over 20% and 50% of total exports. For Saudi Arabia, Iran or Venezuela, this number is much higher. Therefore, it is easy to see why a big fluctuation in the price of oil can have deep repercussions for their external balances. Historically, getting the price of oil right was usually the most important step in any petrocurrency forecast, but it has now become a necessary but not sufficient condition. Oil Demand Should Recover We agree with our commodity strategists that the outlook for oil prices is to the upside. Oil demand tends to follow the ebb and flow of the business cycle, with demand having slowed sharply on the back of a manufacturing recession. Transport constitutes the largest share of global petroleum demand. Ergo the trade slowdown brought a lot of freighters, bulk ships, large crude carriers and heavy trucks to a halt (Chart I-2). Chart I-2Oil Demand Has Been Weak Oil Demand Has Been Weak Oil Demand Has Been Weak Part of the slowdown in global demand is being reflected through elevated inventories. However, part of the inventory building has also been a function of refinery maintenance (Chart I-3). Chinese oil imports continue to hold up well, and should easier financial conditions put a floor on the manufacturing cycle, overall consumption will follow suit (Chart I-4). Chart I-3Oil Inventories Are Elevated Oil Inventories Are Elevated Oil Inventories Are Elevated Chart I-4China Oil Imports Holding Up China Oil Imports Holding Up China Oil Imports Holding Up The increase in oil demand will be on the back of two positive supply-side developments. First, OPEC spare capacity is only at 2%. This means that any rebound in oil demand in the order of 1.5%-2% (our base case), will seriously begin to bump up against supply-side constraints – especially in the face of OPEC production discipline. Second, unplanned outages wiped out about 1.5% of supply in 2018, and should this occur again as oil demand recovers, it will nudge the oil market dangerously close to a negative supply shock (Chart I-5). Chart I-5Opec Spare Capacity Is Low Making Money With Petrocurrencies Making Money With Petrocurrencies Bottom Line: A recovery in the global manufacturing sector will help revive oil demand. This should be positive for oil prices in general. A Necessary But Not Sufficient Condition Rising oil prices are bullish for petrocurrencies, but being long versus the US dollar is no longer an appropriate strategy. This is because the landscape for oil production is rapidly shifting, with the US shale revolution grabbing market share from both OPEC and non-OPEC members. As the now-largest oil producer in the world, the US dollar is itself becoming a petrocurrency. In 2010, only about 6% of global crude output came from the US. Collectively, Canada, Norway and Mexico shared about 10% of the oil market. Meanwhile, OPEC’s market share sat just north of 40%. Fast forward to today and the US produces almost 15% of global crude, having grabbed market share from many other countries. In short, as the now-largest oil producer in the world, the US dollar is itself becoming a petrocurrency (Chart I-6). Chart I-6US Has Grabbed Oil Production Market Share US Has Grabbed Oil Production Market Share US Has Grabbed Oil Production Market Share This explains why the positive correlation between petrocurrencies and oil has been gradually eroded as the US economy has become less and less of an oil importer. Put another way, rising oil prices benefit the US industrial base much more than in the past, while the benefits for countries like Canada and Mexico are slowly fading. Meanwhile, falling production in Iran, Venezuela, and even Angola has been a net boon for US production and the dollar.  In statistical terms, petrocurrencies had a near-perfect positive correlation with oil around the time US production was about to take off (Chart I-7). Since then, that correlation has fallen from around 0.9 to around 0.2. At the same time, the DXY dollar index is on its way to becoming positively correlated with oil as the US becomes a net energy exporter. Chart I-7Falling Correlation Between Petrocurrencies And The US Dollar Falling Correlation Between Petrocurrencies And The US Dollar Falling Correlation Between Petrocurrencies And The US Dollar Bottom Line: Both the CAD and NOK remain positively correlated with oil. So do the Russian ruble and the Colombian peso. That said, a loss of global market share has hurt the oil sensitivity of many petrocurrencies. Oil Consumers Versus Producers Our strategy going forward will be twofold. First, buying a petrocurrency basket versus the dollar will require perfect timing in the dollar downleg. We are long an oil currency basket versus the euro, but intend to make the switch once our momentum indicators for the dollar decisively break lower. With bond yields having already made a powerful downward adjustment, the valve for financial conditions to get any looser could easily be via the US dollar (Chart I-8). A loss of global market share has hurt the oil sensitivity of many petrocurrencies. The second strategy is to be long a basket of oil producers versus oil consumers. Chart I-9 shows that a currency basket of oil producers versus consumers has both had a strong positive correlation with the oil price and has outperformed a traditional petrocurrency basket. Rising oil prices are a terms-of-trade boost for oil exporters but lead to demand destruction for oil importers. It is also notable that the correlation has strengthened as that between petrocurrencies and the US dollar has weakened. Chart I-8The Dollar As An Arbiter Of Growth The Dollar As An Arbiter Of Growth The Dollar As An Arbiter Of Growth Chart I-9Buy Oil Producers Versus Oil Consumers Buy Oil Producers Versus Oil Consumers Buy Oil Producers Versus Oil Consumers Sell CAD/NOK The Norges Bank has been quite hawkish in spite of the dovish tilt by most other central banks. As such, the underperformance of the Norwegian krone, especially versus the euro, has been quite perplexing in the face of diverging monetary policies (Chart I-10). Our bias is that speculators have been using the thinly traded krone to play USD upside, but that momentum is now fading. The Norwegian economy remains closely tied to oil, with the bottom in oil prices in 2016 having jumpstarted employment growth, business confidence, and wage growth. With inflation near the central bank’s target and our expectation for oil prices to grind higher, we agree with the central bank’s assessment that the future path of interest rates is likely higher. A weak exchange rate will also anchor inflation expectations (Chart I-11). Chart I-10Diverging Monetary ##br##Policies Diverging Monetary Policies Diverging Monetary Policies Chart I-11A Weak Exchange Rate Will Anchor Inflation Expectations Higher A Weak Exchange Rate Will Anchor Inflation Expectations Higher A Weak Exchange Rate Will Anchor Inflation Expectations Higher The underperformance of the Norwegian krone has mirrored that of global oil and gas stocks. Perhaps sentiment towards the environment and climate change has been pushing investor flows out of these markets, but given the central role oil plays in the global economy, we may have reached the point of capitulation (Chart I-12). Our recommendation is that NOK long positions should initially be played via selling the CAD, as an indirect way to express USD shorts. Our recommendation is that NOK long positions should initially be played via selling the CAD, as an indirect way to express USD shorts (Chart I-13). The CAD/NOK briefly punched through the 7.1 level in October but is now seeing a powerful reversal. Our intermediate-term indicators also suggest the next move is likely lower. The discount between Western Canadian Select crude oil and Brent has also widened, which has historically heralded a lower CAD/NOK exchange rate (Chart I-14) Chart I-12ESG And Global Divestments ESG And Global Divestments ESG And Global Divestments Chart I-13NOK Will Outperform CAD (I) NOK Will Outperform CAD (I) NOK Will Outperform CAD (I) Chart I-14NOK Will Outperform CAD (II) NOK Will Outperform CAD (II) NOK Will Outperform CAD (II) Bottom Line: Go short CAD/NOK for a trade, but more aggressive investors should begin accumulating long NOK positions versus the US dollar outright. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been strong:  The labor market remains tight: nonfarm payrolls increased by 128K in October, well above expectations of 89K. Average hourly earnings continue to grow by 3% year-on-year. Unit labor costs grew by 3.6% year-on-year in Q3. The ISM manufacturing PMI increased to 48.3 from 47.8 in October. The non-manufacturing PMI soared to 54.7 from 52.6 in October, well above expectations. The trade balance narrowed by $2.5 billion to $52.5 billion in September. The DXY index appreciated by 0.8% this week. ISM PMI data points to improvements in both manufacturing and services sectors, mainly supported by production, new orders, and the employment components. It will be interesting to monitor if this signals an improvement in the global manufacturing cycle, or is a US-centric issue. Report Links: Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Preserving Capital During Riot Points - September 6, 2019 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been positive: The Markit manufacturing PMI slightly increased to 45.9 from 45.7 in October. The services PMI also improved to 52.2 from 51.8. The Sentix confidence index increased to -4.5 from -16.8 in November.  Retail sales grew by 3.1% year-on-year in September, an improvement from the 2.7% yearly growth rate in the previous month. EUR/USD fell by 0.8% this week. On Monday, Christine Lagarde, the former managing director of the IMF, gave her first speech as the new ECB president where she urged Europe to overcome self-doubt, aiming to boost investor and business confidence in the euro area. However, no comments were given regarding ECB monetary policy. Report Links: On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Battle Of The Central Banks - June 21, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been negative: Vehicle sales shrank by 26.4% year-on-year in October. The monetary base grew by 3.1% year-on-year in October. The services PMI plunged to 49.7 from 52.8 in October. The Japanese yen depreciated by 1% against the US dollar this week. We remain short USD/JPY given global economic uncertainties and domestic deflationary tailwinds. Should the global economy pick up early next year, the yen could still remain bid against the USD, allowing investors time to rotate their short USD/JPY bets. Report Links: Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 A Few Trade Ideas - Sept. 27, 2019 Has The Currency Landscape Shifted? - August 16, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been positive: The Markit manufacturing PMI increased to 49.6 from 48.3 in October. Services PMI increased to 50 from 49.5 in October. Retail sales increased by 0.1% year-on-year in October, compared to a contraction of 1.7% in the previous month. Halifax house prices grew by 0.9% year-on-year in October. GBP/USD depreciated by 1% this week. On Thursday, the BoE decided to leave its interest rate unchanged at the current level of 0.75%. However, unlike a unanimous decision as in previous policy meetings this year, two BoE officials unexpectedly voted to lower interest rates amid signs of deeper economic slowdown and entrenched Brexit chaos. Report Links: A Few Trade Ideas - Sept. 27, 2019 United Kingdon: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Battle Of The Central Banks - June 21, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mostly positive: Retail sales grew modestly by 0.2% month-on-month in September. The Commonwealth composite PMI fell slightly to 50 from 50.7 in October. The services PMI also fell to 50.1 from 50.8. The trade balance increased by A$1.3 billion to A$7.2 billion in September. Both exports and imports grew by 3% month-on-month in September. The Australian dollar has been volatile against the US dollar, but returned flat this week. The RBA has left its interest rate unchanged this Monday, as widely expected. We remain positive on the Australian dollar and went long AUD/CAD last week, which is currently 0.3% in the money. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mostly negative: The participation rate increased marginally to 70.4% from a downward-revised 70.3% in Q3. The labor cost index increased by 2.3% year-on-year in Q3. The unemployment rate however, climbed to 4.2% from 3.9%, higher than expectations of a rise to 4.1%. The kiwi fell by 1.4% against the US dollar, making it the worst performing G-10 currency this week. Despite the rise of the unemployment rate in Q3, the under-utilization rate, a broad measure of labor market spare capacity has fallen to the lowest level in over 11 years, as suggested by the manager of Statistics New Zealand, Paul Pascoe. That said, we remain underweight the kiwi given it will likely lag other commodity currencies in a global growth upswing. We will change this view if New Zealand terms of trade start to inflect meaningfully higher. Stay with our long AUD/NZD and SEK/NZD positions. Report Links: USD/CNY And Market Turbulence - August 9, 2019 Where To Next For The US Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been negative: The Markit manufacturing PMI was little changed at 51.2 in October. The trade deficit narrowed marginally from C$1.24 billion to C$0.98 billion in September. Exports and imports both fell in September. Ivey PMI fell to 48.2 from 48.7 in October. USD/CAD increased by 0.3% this week. The recent uptick in oil prices support the Canadian dollar, but the loonie will likely underperform other petrocurrencies. We remain bullish on the oil prices, however, spreads will likely continue to move against the Western Canadian Select blend. Report Links: Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 Preserving Capital During Riot Points - September 6, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been mostly negative: Headline CPI fell below 0 at -0.3% year-on-year for the first time over the past 3 years in October. On a month-on-month basis, it contracted by 0.2%. Real retail sales grew by 0.9% year-on-year in September. PMI improved to 49.4 from 44.6 in October. FX reserves were little changed at CHF 779 billion in October. The Swiss franc fell by 0.9% against the US dollar this week. Faced with deflationary pressures, the SNB will likely to use its currency as a weapon to stimulate the economy and exit deflation. This will favor long EUR/CHF positions. Report Links: Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been mixed: Industrial production contracted by 8.1% year-on-year in September, mainly caused by the slowdown in extraction and related services. On the positive side, manufacturing output grew by 2.9% year-on-year. The manufacturing output of ships, boats, and oil platforms in particular, grew by 26.2% year-on-year in September. The Norwegian krone appreciated by 0.3% against the US dollar this week, despite the broad dollar strength. The WTI crude oil price increased by nearly 6% this week, which is a tailwind for petrocurrencies. We maintain a pro-cyclical stance and expect oil prices to increase further. The global growth recovery and a weaker US dollar should all boost the oil demand, and lift the Norwegian krone. Please refer to our front section this week for more detailed analysis on the NOK. Report Links: A Few Trade Ideas - Sept. 27, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been negative: The manufacturing PMI fell marginally to 46 from 46.3 in October. Industrial production growth slowed to 0.9% from 2.1% year-on-year in September. Manufacturing new orders contracted by 1.5% year-on-year in September. The Swedish krona has been flat against the USD this week. The PMI components of new orders, industrial production, and employment all continued to fall. On the positive side, the export component increased marginally. We expect the cheap krona to help improve the trade dynamics in Sweden and put a floor under the krona. Report Links: Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Lebanon and Iraq – the two countries most entrenched in Iran’s sphere of influence – are experiencing mass unrest. Protesters in both states are calling for the dismantling of sectarian based political systems, economic reforms, and reduced foreign interference. The unrest in Iraq is of greater consequence due to its role as a major global oil supplier. The widening rift between the rival Iraqi Shia blocs implies that any détente will be temporary.  We remain tactically long spot crude oil on the back of the geopolitical risks to supply amid an expected revival in global demand. Feature A wave of popular uprisings has swept over Lebanon and Iraq. While the riots are to a large extent a product of long-standing economic and governance failures, the timing is consequential. The Middle East is experiencing a paradigm shift. With the US reducing its strategic commitment to the region, most recently evidenced by the withdrawal of its troops from northeast Syria, a power vacuum has emerged. This opens up the necessity for foreign actors – Russia – as well as regional powers – Saudi Arabia, Iran, and Turkey – to fill the void. The evolution of power could be unsettling given that it will likely generate greater instability in a region that is fertile ground for unrest. Iran has so far emerged a winner in this dynamic. It has expanded its influence in Iraq since the US pullout, it has played a critical role in saving the Assad regime, and it has seen Saudi initiatives fail in Syria, Yemen, Lebanon, and Qatar. It is making progress toward building its ‘land bridge’ to the Mediterranean (Map 1).1 Map 1Iran’s Aspirational ‘Land Bridge’ To The Mediterranean Iraq's Challenge To Iran Is Underrated Iraq's Challenge To Iran Is Underrated The tensions brought about by the US withdrawal from the JCPOA further illustrate Iran’s growing regional sway. It has hardened its stance. Meanwhile the US and its allies have been vacillating. The Saudi coalition – mired in a war in Yemen and confronting domestic risks – is reluctant to engage in a full-scale confrontation.  Even though Iran has a higher pain threshold, it stands on shaky ground. Just last year it was rocked by domestic protests demanding less foreign adventurism. Lebanon and Iraq are the two countries most entrenched in Iran’s sphere of influence. Protesters in both countries are calling for greater national unity – demanding an overhaul of the political system, and arguing that the sectarian set-up has failed to meet their most basic needs. What occurs in Beirut and Baghdad will be of great consequence for Tehran. Deadlock In Iraq “Out, out, Iran! Baghdad will stay free!” - Chants by Iraqi protesters While both the grievances and demands of the protesters in Lebanon and Iraq are similar, the unrest in Iraq is of much greater consequence from a global investor’s perspective. The trigger was the removal of the highly revered Lieutenant General Abdul-Wahab al-Saadi from his position in the Iraqi army by Prime Minister Adel Abdul-Mahdi.2 The popular general was unceremoniously transferred to an administrative role in the Ministry of Defense. The sacking of al-Saadi – considered a neutral figure – was interpreted as evidence of Iranian influence and the greater sway of the Iran-backed Popular Mobilization Forces (PMF), an umbrella organization of various paramilitary groups. Iraqis all over the country responded by attacking the Iranian consulate in Karbala and offices linked to Iranian-backed militias. Chart 1AFertile Ground For Unrest In Iraq Fertile Ground For Unrest In Iraq Fertile Ground For Unrest In Iraq The protesters are also united in their economic grievances, frustrated at a political and economic system that is unwilling to translate economic gains to improved livelihoods for its people. The May 2018 parliamentary elections, which ushered in Prime Minster Abdul-Mahdi, failed to generate much improvement. The country continues to be plagued by high unemployment, corruption, and an utter lack of basic services (Charts 1A & 1B). This has ultimately resulted in a lack of confidence in Iraqi leadership who are being increasingly perceived as benefiting from the status quo at the expense of the populace. Chart 1BFertile Ground For Unrest In Iraq Iraq's Challenge To Iran Is Underrated Iraq's Challenge To Iran Is Underrated Most importantly, the ruling elite has failed to respond to key trends that emerged in last year’s parliamentary elections. The extremely low voter turnout reveals that Iraqis are disenchanted with the government's ability to meet their needs. Meanwhile the success of Shia cleric Moqtada al-Sadr’s Sairoon coalition – running on a platform stressing non-sectarianism and national unity – in securing the largest number of seats highlights the desire for a reduction of foreign interference (both Iranian as well as US/Saudi) in domestic politics. Where the election results failed to translate into real change for Iraq is in the appointment of the Prime Minister. Abdul-Mahdi – a technocrat – was a compromise candidate that surfaced as a result of a five-month long political standstill between the two rival Shia blocs, each claiming to have gained a majority of seats in parliament. On one end is the Iran-backed bloc led by Hadi al-Amiri head of both the Fatah Alliance and the PMF, and Nouri al-Maliki leader of the State of Law Coalition. On the other end is al-Sadr’s Sairoon coalition, which joined forces with Ammar al-Hakim of the Wisdom Movement, and champions greater unity and less foreign interference. The result has been a weak prime minister who is perceived to be incapable of pushing back against Iraq’s ruling elites and ushering in structural reforms. Instead the Prime Minister is seen as benefiting from a corrupt system. The rift between Iraq’s rival Shia blocks is deepening. Thus, the ongoing protests are to a great extent the result of the new government’s failure to heed the warnings brought about by the 2018 election and protests. They have served to deepen the rift between the rival Shia blocs. Last week Abdul–Mahdi responded to calls by al-Sadr and former Prime Minister Haider al-Abadi to resign by arguing that it is up to the main political leaders to agree to put forward a vote of no confidence in the Iraqi parliament. He agreed to resign, on condition that political parties jointly approve of a replacement. For now, that appears improbable. In a move that has been interpreted as a display of Iranian interference, al-Amiri changed heart after a reported meeting with Iranian Quds Force leader Qassem Suleimani last week in Baghdad. He backed down on his agreement to support al-Sadr to bring down Abdul-Mahdi, and has instead stated Abdul-Mahdi’s resignation will only bring about more chaos. This interference on the part of Iran was likely induced by fears that a crisis-stricken Iraq would weaken its hegemony over the region. Iraq is in a state of deadlock. A vote of no confidence would require a majority of 165 in parliament and would require the support of various Sunni and Kurdish parties (Chart 2). Al-Sadr is likely calculating that a new election is in his best interest. He would be able to capitalize on the movement given that he has aligned himself with the protesters, and will gain seats in parliament. Chart 2A Shia Schism In Iraq’s Parliament Iraq's Challenge To Iran Is Underrated Iraq's Challenge To Iran Is Underrated This would allow the nationalist bloc to gain a majority and appoint a government that is acceptable to the protesters. However, this scenario would also entail greater meddling from Iran, as it is unlikely to stand by idly as its influence wanes. As a result, we are likely to witness greater unrest as the rift between the two Shia blocs intensifies. Neither the US nor Saudi Arabia have an appetite to step in and provide the support necessary to counteract Iran. Moreover, Iran and its proxies in Iraq will not back down easily. At the same time, the geographical spread of the protest movement demonstrates that Iraqis are fed up with the current system.3 Despite the death of over 260 Iraqis, the protesters have yet to be deterred by the violence. This points to greater instability in Iraq as no side is backing down and the only foreign power willing and able to interfere is Iran. The impasse could be resolved if the main actors – the rival Shia blocs – agree to compromise. However, that is precisely what transpired last year and resulted in Abdul-Mahdi’s appointment. It ultimately led to only a temporary resolution of the unrest: a one-year deferral. If a similar compromise is reached in the current environment, it too will result in only a temporary détente. The grievances afflicting Iraqis cannot be resolved easily or swiftly. Iraq is in for an extended period of instability. Bottom Line: Iraqi protesters and authorities are in stalemate. The rift in the Shia bloc is deepening. There does not appear to be a clear path to bridge the demands and desires of the protesters and the leadership. Any détente will be temporary. Even if under a new election the protests translate to greater seats for the nationalist bloc, it will not translate to a de-escalation of domestic tensions. It may resolve the protests, but Iran-backed groups will retaliate. Iraq is in for an extended period of instability. Deadlock In Lebanon “All of them means all of them” “No to Iran – No to Saudi” - Chants by Lebanese protesters Just as Iraqi protesters are expressing national unity in calling for an end to sectarian politics and foreign interference, Lebanon’s protests stand out for crossing religious and regional divides. They have swept across the country, and include the Shia-dominated southern region where anger is even being directed at Hezbollah. Among the protesters’ demands is the removal of all three heads of the pillars of government – the Maronite Christian President Michel Aoun, the Sunni Prime Minister Saad Hariri, and the Shia Speaker of Parliament Nabih Berri. Rather than being a source of division, the unrest is a demonstration of unity among Lebanese of all ideologies against the entire political system. Since Prime Minister Saad Hariri’s resignation on October 29, the movement rages on. Protesters are claiming that they are unwilling to back down until all their demands are met, including a complete overhaul of the sectarian power-sharing system, which has defined the country’s politics since the end of the 1975-1990 civil war.4 Chart 3Economic Deterioration In Lebanon Economic Deterioration In Lebanon Economic Deterioration In Lebanon The movement and the protesters’ complaints are not surprising. The government has failed to prevent the economy from moving toward collapse. It has long been in decline, with Lebanese feeling the pinch of corruption, economic stagnation, high unemployment, and the effects of the massive influx of Syrian refugees (Chart 3).The trigger of the uprising, a tax on WhatsApp calls amid clear signs of a domestic liquidity shortage, is a delayed response to what citizens have already known and felt for some time: a deteriorating economic situation. While the protests were caused by these economic grievances, they persist due to a crisis of confidence between the political class and the masses. Neither concessions on the part of the government in the form of a list of reforms nor the prime minister’s resignation convinced protesters to halt the movement. The uprising appears set to remain steadfast so long as the current politicians remain in power. The challenge for Lebanon’s protesters – and political elite all the same – is that while the protesters are united in their demands, they have so far been headless. The protesters have refused to present a list of acceptable replacement leaders, insisting that it is the government’s role to propose potential alternatives to the people. This has led to deadlock and will be a hurdle for the government in negotiating with demonstrators. On the other side of the conflict, the current political class, including Hezbollah leader Hassan Nasrallah, has expressed warnings about the chaos that would ensue with a government resignation. According to the Lebanese constitution, following Hariri’s resignation President Aoun is now tasked with consulting Lebanon’s fractured parliament to determine the next prime minister – a role reserved for a Sunni Muslim. However, if history is any guide, this process could take months and protesters are not that patient. Given that Hariri has sidelined himself and – unlike Parliament Speaker Nabih Berri or Foreign Minister Gebran Bassil – he is not the core target of protesters’ ire, there is a possibility that he may once again be appointed to the post of prime minister. While the outgoing government will take on a caretaker role until a new one is formed, demonstrators are standing their ground. ​​This has generated a political standoff causing Lebanese assets to bear the brunt (Chart 4). The emergence of competing rallies – in the form of support for President Michel Aoun – only complicates and possibly prolongs the situation. For now, the army is staying on the sidelines, allowing the protests to be – for the most part – a peaceful one. However, with Hezbollah also subject to the protesters’ wrath, odds of greater regional tensions have increased. Hezbollah may attempt to regain lost support by provoking Israel. The instability could also prompt Hezbollah to reassert its willingness to use force against domestic enemies, namely any new government that attempts to disarm it. In the meantime, Lebanon’s economy and financial markets will remain under pressure. The economy depends on capital inflows from citizens living abroad to finance the large twin deficit and maintain the dollar peg. Thus, the decline in sentiment will weigh on the economy (Chart 5). While the government has not implemented official capital controls, banks have independently tightened restrictions and raised transaction fees to reduce capital outflow. Chart 4Further Unrest Ahead Further Unrest Ahead Further Unrest Ahead Chart 5Weak Sentiment Weighs On Lebanon's Economy Weak Sentiment Weighs On Lebanon's Economy Weak Sentiment Weighs On Lebanon's Economy Bottom Line: Lebanese protesters and the political class are in deadlock. The prime minister’s resignation has done little to ease the tension, and demonstrators are refusing to back down until a new non-sectarian, technocratic government is formed. The domestic economy will remain frail. Earlier this week the central bank asked local lenders to boost their liquidity by raising their capital by 20% or $4 billion in 2020 in anticipation of potential downgrades. A stabilization of the political situation is a necessary precondition to boost confidence and once again shore up capital inflows. Nevertheless, with the protest movement being largely headless, the path toward compromise with the government will be challenging, raising the odds of prolonged tensions. What Of Iran’s Sphere Of Influence? “Not Gaza, Not Lebanon, I Give My Life For Iran” - Chants by Iranian protesters, January 2018 Iran has a strong incentive to preserve the established systems in both Lebanon and Iraq. The protesters’ demands risk weakening its grip on power in the region. In both movements, pro-Iranian forces have taken a stance against the protests with Hezbollah in Lebanon advising against the resignation of Prime Minister Hariri while the Iran-backed bloc in Iraq voiced concern over the chaos that will ensue with the prime minister’s resignation. Meanwhile, Tehran’s position is hardening. Iran is taking further steps away from the nuclear deal, injecting uranium gas into centrifuges at its underground Fordow nuclear complex, making the facility an active nuclear site rather than a permitted research plant. Chart 6Popular Support For Iran’s Hardening Stance Iraq's Challenge To Iran Is Underrated Iraq's Challenge To Iran Is Underrated Chart 7US-Iran Détente Unlikely Iraq's Challenge To Iran Is Underrated Iraq's Challenge To Iran Is Underrated This reflects the loss of public support for the JCPOA and the loss of confidence that other countries will honor their obligations toward the nuclear agreement (Chart 6). In a speech on November 3 marking the fortieth anniversary of the 1979 US Embassy takeover, Supreme Leader Ayatollah Ali Khamenei renewed his ban on negotiations with the US. His stance mirrors public opinion, which is moving toward an increasingly unfavorable view of the US (Chart 7). However, this does not mean that President Hassan Rouhani’s administration is immune to popular discontent. Rather, with Iranians living through a continued economic deterioration and assigning the most blame to domestic mismanagement and corruption, there could be cracks forming in Iran as well (Chart 8). Chart 8A Case For Unrest In Iran? Iraq's Challenge To Iran Is Underrated Iraq's Challenge To Iran Is Underrated Bottom Line: The ongoing US withdrawal from the Middle East opens opportunities for Iran to increase its regional influence. It has been capitalizing on such opportunities by lending support to its proxies in Syria, Yemen, Iraq, and Gaza. However, the escalation of unrest in Lebanon and Iraq pose a risk to Iran’s grip on power in the region. On the one hand, if the movements there result in new governments, Iran will witness its wings clipped. This could incentivize retaliation and violence in Iraq, and provocations by Hezbollah along Lebanon’s southern border in an attempt to regain lost support. On the other hand, a prolonged standstill between protesters and the governments could result in greater Iranian influence over the long term. Other foreign powers are unwilling to wholeheartedly intervene to fill an emergent power vacuum. Investment Implications The risk of a decline in Iran’s control over its sphere of influence and the still unstable state of Iraqi domestic politics suggest that the geopolitical risk premium in oil prices should remain elevated. For now, President Trump is still enforcing sanctions and Iran’s oil exports have largely collapsed (Chart 9). The White House is continuing to add pressure by warning Chinese shipping companies – the largest remaining buyer of Iranian oil – against turning off their ships’ transponders. Chart 9The US Maintains Pressure On Iran Iraq's Challenge To Iran Is Underrated Iraq's Challenge To Iran Is Underrated News reports indicate that oil workers in Iraq’s southern region have started to join the government demonstrations. Moreover, reports on Wednesday indicate that the 30k b/d of production from the Qayarah oil field has been shut down due to road blockades in Basra that are preventing trucks from transporting crude to the Khor al-Zubair port. The geopolitical risk premium in oil prices should remain elevated. While the impact on the country’s oil production and exports have so far been minimal, a prolonged standoff between protesters and the government could result in supply outages. Today’s environment is notably different than that of the ISIS invasion of Iraq in 2014. Tensions then did not create a geopolitical risk premium in oil as they occurred amid an oil market share war, which kept supply abundant. Similarly, the September attack on Saudi Arabian oil facilities did not result in a lasting price spike as it occurred at a time of weak global demand. Moreover, Saudi Arabia possesses the technology and spare capacity that permitted it to swiftly restore output and maintain export commitments. The same cannot be said today about Iraq. A disruption there would be of greater consequence to oil markets, as illustrated by the 2008 Battle of Basra. Especially given Saudi Arabia's need to maintain high prices and amid the Aramco IPO and the tailwind created by a rebound in global growth. The fall in global economic policy uncertainty as the US and China move toward a trade ceasefire will weaken the dollar and support global demand for oil, which is overall bullish for oil prices. Moreover, US-Iran tensions remain unresolved which pose risks to production and shipping infrastructure in the region. We remain tactically long spot crude oil on the back of the geopolitical risks to supply as well as an expected revival in global demand. We are booking a 4.6% gain on our GBP-USD trade but remain long sterling versus the yen. Roukaya Ibrahim, Editor/Strategist Geopolitical Strategy RoukayaI@bcaresearch.com   Footnotes 1    The ‘land bridge’ is an aspirational route by which Iran would create a strategic corridor to the Mediterranean, stretching through friendly territory. 2   Lt. Gen. Abdul-Wahab al-Saadi was recognized and respected among Iraqis for fighting terrorism and his role in ridding the country of the Islamic State. The Iran-backed Popular Mobilization Forces were uneasy with Saadi’s close relationship with the US military. His abrupt removal was likely a result of the Iraqi government’s growing concern over al-Saadi’s popularity and rumors of a potential military coup. 3   Protests are occurring in all regions in Iraq. They are supported by Grand Ayatollah Ali al-Sistani. This is a significant development from the 2018 protests which were mainly concentrated in Iraq’s southern region. 4   Under the current system, Lebanon’s president has to be a Maronite Christian, the parliament speaker a Shiite Muslim and the prime minister a Sunni. Cabinet and parliament seats are equally split between the two Muslims groups and Christians.

Highlights The slowdown in global industrial activity appears to have bottomed. This, along with an apparent shared desire for a ceasefire in the Sino-US trade war, points toward a measured recovery in manufacturing and global trade, which will contribute to higher iron-ore and steel demand beginning in 1H20. A trade-war ceasefire, should it endure, will reduce global economic uncertainty. Along with continued monetary accommodation from systematically important central banks, reduced economic uncertainty will boost global growth and industrial-commodity demand generally by allowing the USD to weaken. We expect Beijing policymakers to remain focused on keeping GDP growth above 6.0% p.a. To that end, we believe a boost in infrastructure spending next year is likely, which also will be bullish for steel demand. Given China’s growing share of global steel production, we expect price differentials for high-grade iron ore – most of which comes from Brazil – to widen as steel demand increases next year. Given this view, we are initiating a strategic iron-ore spread trade at tonight’s close: Getting long December 2020 high-grade (65% Fe) futures traded on the Singapore Exchange vs. short the benchmark-grade (62% Fe) December 2020 futures traded on the CME. We recommend a 20% stop-loss on this recommendation. Feature Iron ore and steel demand will get a lift from the rebound our proprietary Global Industrial Activity (GIA) index has been forecasting for the past few months (Chart of the Week). The GIA index is designed to pick up changes in Chinese industrial activity, given its outsized influence on world industrial output, and also makes use of trade data, FX rates, and global manufacturing data. The rebound we are expecting will get a fillip from an apparent shared desire for a ceasefire in the Sino-US trade war, which, based on media reports, is close to being agreed. Should this ceasefire prove to be durable, it would contribute to a lowering of global economic policy uncertainty (GEPU), which, as we have shown recently, has kept the USD well bid to the detriment of industrial-commodity demand.1 Chart of the WeekBCA GIA Index Pick-Up Points To Higher Global Steel Demand BCA GIA Index Pick-Up Points To Higher Global Steel Demand BCA GIA Index Pick-Up Points To Higher Global Steel Demand While we do expect economic uncertainty to decline next year, it will remain elevated due to continued Sino-US trade tensions – even if a “phase-one” deal is agreed – ongoing hostilities in the Persian Gulf, and popular discontent with the political status quo globally. As global economic uncertainty fades, the USD broad trade-weighted index for goods (TWIBG) will fall, which will bolster EM GDP growth, and a recovery in global trade next year (Chart 2). If, as media reports suggest, this so-called “phase-one” agreement includes a relaxation – or complete removal – of tariffs by the US on Chinese imports, we would expect manufacturing activity to pick up as Chinese manufacturers spin-up capacity to meet demand. A reduction in tariffs also will lessen the deadweight loss they imposed on US households, which will support higher consumption.2 Chart 2Reduced Global Economic Uncertainty Bolsters Global Trade Volumes, EM GDP Iron Ore, Steel Prices Set To Lift Iron Ore, Steel Prices Set To Lift That said, economic uncertainty still remains high. This uncertainty is destructive of demand and will remain a key risk factor in 2020. While we do expect economic uncertainty to decline next year, it will remain elevated due to continued Sino-US trade tensions – even if a “phase-one” deal is agreed – ongoing hostilities in the Persian Gulf, and popular discontent with the political status quo globally. China’s Steel Demand Holds Up In Trade War China accounts for more than half of global steel production and consumption, and the lion’s share of seaborne iron-ore consumption (Chart 3). This makes its steel industry critically important to the global economy, and a key barometer of industrial activity worldwide. With global industrial activity bottoming and moving higher, and the USD expected to weaken, we expect iron ore demand and steel production in China to move higher next year as domestic and global demand for steel rises. China’s apparent steel demand held up fairly well during the slowdown observed in manufacturing and in commodity demand growth globally, averaging 8% y/y growth ytd (Chart of the Week, bottom panel). It now appears to be stalling in the wake of the global manufacturing slowdown. In addition, Chinese credit stimulus remains weak, contrary to expectations. However, with global industrial activity bottoming and moving higher, and the USD expected to weaken, we expect iron ore demand and steel production in China to move higher next year as domestic and global demand for steel rises.3 Chart 3China Dominates Global Steel Production and Consumption China Dominates Global Steel Production and Consumption China Dominates Global Steel Production and Consumption Chart 4Construction, Real Estate Strength Offset Lower Chinese Auto Production Construction, Real Estate Strength Offset Lower Chinese Auto Production Construction, Real Estate Strength Offset Lower Chinese Auto Production Greater demand for steel by the construction and real estate sectors offset lower consumption by the automobile industry in China this year, as manufacturing and trade slowed globally (Chart 4). Overall, apparent demand is still growing (Chart 5), which will continue to support iron ore imports, even though domestic production of low-grade ore picked up as steelmakers’ margins tightened earlier in the year (Chart 6). Chart 5China"s Apparent Steel Demand Growth Holds Up During Industrial Slowdown China"s Apparent Steel Demand Growth Holds Up During Industrial Slowdown China"s Apparent Steel Demand Growth Holds Up During Industrial Slowdown Chart 6China Iron Ore Imports Remain Stout China Iron Ore Imports Remain Stout China Iron Ore Imports Remain Stout Chinese imports from Brazil have rebounded following the Brumadinho tailings dam collapse in January at Vale’s Córrego do Feijão iron ore mine, which killed close to 300 people. The collapse in margins from steel mills combined with outages to Brazil and Australia high-grade ore exports led to a rise in imports and domestic production of low-grade iron ore. High-Grade Iron Ore Favored; Policy Uncertainty Persists Our overall view for industrial commodities – iron ore, steel, base metals and crude oil – is constructive but not wildly bullish going into next year. Our oil view, for example, calls for a rally in the average price of crude oil next year of ~ 10% from current levels for Brent crude oil, the world benchmark. While we expect global monetary stimulus to offset much of the tightening of financial conditions brought on by the Fed’s rate hikes last year, and China’s de-leveraging campaign of 2017-18, elevated economic uncertainty will keep the USD better bid that it otherwise would be absent the Sino-US trade war and global economic policy uncertainty. This translates into weaker commodity demand, generally, as a strong USD raises local-currency costs for consumers and lowers local-currency production costs for producers. At the margin, both push commodity prices lower. On a relative basis, we expect the more efficient, less-polluting technology likely will be called on to meet higher steel demand – in China and globally – next year, which means higher-grade iron ore will be favored by Chinese steel mills as profitability improves. For iron ore and steel in particular, environmental considerations also are important, given the Chinese government's “Blue Skies Policy” aimed at reducing the country’s high levels of air pollution.4 This policy has led to the forced retirement of older, highly polluting steelmaking capacity, which has been replaced with newer, less-polluting technology that favors high-grade iron ore. However, the application of regulations designed to reduce pollution has been uneven, and still relies on local compliance, which has been spotty. We expect demand for high-grade ore will increase as global manufacturing and trade also recovers. On a relative basis, we expect the more efficient, less-polluting technology likely will be called on to meet higher steel demand – in China and globally – next year, which means higher-grade iron ore will be favored by Chinese steel mills as profitability improves. The restoration of high-grade exports from Brazil means this ore will be available. It is worthwhile noting that these steelmakers account for an increasing share of global capacity. For this reason, we expect demand for high-grade ore will increase as global manufacturing and trade also recovers (Chart 7). Given our view, at tonight’s close we will get long December 2020 high-grade iron-ore futures (65% Fe) traded on the Singapore Exchange vs. short benchmark-grade iron-ore futures (62% Fe) traded on the CME. Both are quoted in USD/MT and settle basis Chinese port-delivery (CFR) indexes in cash. Given the uncertain nature of the durability and depth of the ceasefire currently being negotiated by the US and China, we will keep a stop-loss on this position of 20%. Bottom Line: China’s steel demand has held up relatively well despite the global slowdown in manufacturing and trade. Given our expectation for a pick-up in global growth – in response to global monetary and fiscal stimulus and lower economic uncertainty in the wake of a ceasefire in the Sino-US trade war – we expect Chinese steel demand to resume growing. This will support iron ore prices, particularly for high-grade ores. On the back of this expectation, we are recommending an iron-ore spread trade, going long high-grade futures vs. short benchmark-grade iron ore futures. Chart 7High-Grade Iron Ore Should Outperform Strategically High-Grade Iron Ore Should Outperform Strategically High-Grade Iron Ore Should Outperform Strategically   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com   Market Round-Up Energy: Overweight. Bloomberg reported China is looking to invest between $5-$10 billion in the Saudi Aramco IPO through various vehicles. Such an investment would give China a deeper stake in the Kingdom’s oil industry, and a hedge to price shocks. In addition, it could open the way for deeper investment in the Saudi oil and petchems industries. For KSA, as we have argued in the past, a deepening of China’s investment and involvement in the Kingdom’s economy would diversify the states that have a vested interest in ensuring its safety.5 We will be updating our analysis of China’s pivot to the Middle East, and KSA’s pivot to Asia next week. Separately, we the last of our Brent backwardation trades – i.e., long December 2019 Brent vs. short December 2020 Brent – was closed last week with a gain of 110.8%. Base Metals: Neutral. Copper prices are up 6% vs. last month, supported by supply-side worries in Chile and, more recently, easing trade tensions. Cyclically, we believe copper prices are turning up – spurred by easy monetary conditions and fiscal stimulus directed at infrastructure and construction spending. Most of our key commodity-demand indicators have bottomed and are suggesting EM demand growth will move up. This supports a year-end base metal rally. Precious Metals: Neutral. A risk-on sentiment fueled by expectation the U.S. and China will sign a trade deal weighs on gold’s safe-haven demand. Prices fell 2% since last week. Additionally, U.S. 10-year bond yields shot higher – pushing gold prices lower – on Tuesday following a stronger-than-expect ISM services PMI data release. Gold-backed ETF holdings reached a new record in September at 2,855 MT (up 377 MT ytd), surpassing the December 2012 peak. A reversal in investors’ sentiment towards gold could send prices down. Ags/Softs: Underweight. The USDA reported that 52% of the U.S. corn has been harvested, a 13 percentage point increase relative to last week, yet the figure came shy of analysts’ expectation and far below the 2014-2018 average of 75%. On a weekly basis, corn prices are still down 2% due to drier weather forecast. Soybean harvest did better reaching 75%, and meeting expectations. Soybean price is almost unchanged on a weekly basis, despite having edged higher earlier in the week on the back of rising expectations the US and China will agree on a ceasefire in the ongoing trade war.   Footnotes 1     We measure this uncertainty using the Baker-Bloom-Davis Global Economic Policy Uncertainty (GEPU) index. This is a GDP-weighted index of newspaper headlines containing a list of words related economic uncertainty. Newspapers from 20 countries representing almost 80% of global GDP are scoured for reports reflecting economic uncertainty. Please see our October 17 and October 31, 2019, reports Policy Uncertainty Lifts USD, Stifles Global Oil Demand Growth and Global Financial Conditions Support Higher Commodity Demand for the original research on this topic. Both are available at ces.bcaresearch.com. 2    We discuss deadweight losses to US households arising from the tariffs in Waiting To Get Long Copper, In China’s Steel Slipstream, published August 29, 2019. It is available at ces.bcaresearch.com. 3    BCA Research’s China Investment Strategy expects China’s business cycle likely will bottom in 1Q20 of next year, rather than in 4Q19. This aligns with our expectation. Please see China Macro And Market Review, published November 6, 2019. It is available at cis.bcaresearch.com. 4    We examined the implications of China’s “Blue Skies” policy in China's Anti-Pollution Resolve Critical To Iron Ore Markets, published April 4, 2019. It is available at ces.bcaresearch.com. 5    We discuss these issues in our Special Report entitled ضد الواسطة published November 16, 2018. The Arabic title of the report translates as "Against Wasta." Wasta means reciprocity in formal and informal dealings. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q3 Iron Ore, Steel Prices Set To Lift Iron Ore, Steel Prices Set To Lift Commodity Prices and Plays Reference Table Trades Closed in 2019 Summary of Closed Trades Iron Ore, Steel Prices Set To Lift Iron Ore, Steel Prices Set To Lift

In lieu of our regular weekly report, we are sending you a special report by our colleagues Bob Ryan, Chief Commodity and Energy Strategist, and Hugo Bélanger, Senior Analyst, from BCA Research Commodity & Energy Strategy. The report highlights how global economic policy uncertainty over the past year has enabled gold and the USD unusually to rise together. In the near term, the combination of global economic stimulus and a US-China trade ceasefire should reduce policy uncertainty and encourage global demand for commodities. On a cyclical basis this should allow the dollar to fall back, inflation expectations to revive, and gold to appreciate. We trust you will find this research useful and insightful. All very best, Matt Gertken Geopolitical Strategy Feature The once-reliable negative correlation between gold and the USD was indefinitely suspended beginning in 4Q18 by the pervasive economic uncertainty we identified last week as the culprit holding back global oil demand growth via a super-charged dollar.1 This uncertainty is most pronounced in the US and Europe vis-à-vis gold, and partly explains the performance of safe havens, particularly the USD, which has soared to new heights on a trade-weighted goods basis, and gold (Chart of the Week). So far, gold has held its ground after breaking above $1,500/oz from the low $1,200s in mid-2018, indicating investors are much more concerned about economic risks arising from economic policy uncertainty than inflation and other diversifiable risks gold typically hedges (Chart 2). Cyclically we remain positive on gold prices on the back of a lower dollar and rising inflation pressure in the US. Chart of the WeekDemand For Safe Havens Soars As Economic Policy Uncertainty Rises Demand For Safe Havens Soars As Economic Policy Uncertainty Rises Demand For Safe Havens Soars As Economic Policy Uncertainty Rises Economic policy uncertainty in Europe and the US supports gold prices. Chart 2AUS, Euro Economic Uncertainty Correlated With Gold Prices US, Euro Economic Uncertainty Correlated With Gold Prices US, Euro Economic Uncertainty Correlated With Gold Prices Chart 2BUS, Euro Economic Uncertainty Correlated With Gold Prices US, Euro Economic Uncertainty Correlated With Gold Prices US, Euro Economic Uncertainty Correlated With Gold Prices Even so, we are putting a $1,450/oz stop-loss on our long gold portfolio hedge to cover tactical risks showing up in our technical indicators. In addition, as is the case with oil demand, if the ceasefire we are expecting in the Sino-US trade war materializes in 1H20 and limited trade – mostly in ags and energy – is forthcoming, demand for safe-haven assets could weaken gold prices at the margin. Fiscal and monetary stimulus globally also could revive economic growth and commodity demand, pushing global yields higher, which would put negative pressure on gold at the margin, as well, given the high correlation between real rates and gold prices. Feature The once-reliable negative correlation between gold and the USD will remain muted over the short-term tactical horizon – 3 to 6 months – as economic policy uncertainty continues to stoke global demand for safe havens.2 This can be seen in the elevated correlations between the USD’s broad trade-weighted goods index with the Baker-Bloom-Davis (BBD) Economic Policy Uncertainty (EPU) indexes for the US and Europe (Chart 3).3 Rising economic uncertainty – particularly since 4Q18 – has created a rare environment in which both the USD and gold trended up simultaneously and continue to move in the same direction. The implication of this is that gold’s correlation with both the USD and EPU is weaker than before because economic policy uncertainty now is positively correlated with the dollar. Chart 3Strong USD, EPU Correlation Strong USD, EPU Correlation Strong USD, EPU Correlation Chart 4Correlation of Daily Gold, USD Returns Also Moving Sharply Higher Correlation of Daily Gold, USD Returns Also Moving Sharply Higher Correlation of Daily Gold, USD Returns Also Moving Sharply Higher   There is a possibility global policy uncertainty could be reduced later this year if the US and China can agree on a trade ceasefire... The typically negative correlation between daily returns of gold and the USD also is weakening, moving toward positive territory (Chart 4), as both the USD and gold trend higher simultaneously (Chart 5). Chart 5Gold and USD Levels Trending Higher Gold and USD Levels Trending Higher Gold and USD Levels Trending Higher ...If this occurs, the risk premium supporting gold will ease, and markets will once again turn their attention to possible inflationary consequences of the global stimulus. Our short-term technical indicator is signaling an overbought gold market (Chart 6), and our fair-value model indicates gold should be trading ~ $1,450/oz (Chart 7). The latter signal off our fair-value model is less concerning, given the demand for safe-haven assets like the USD and gold now dominates gold’s typical drivers. Chart 6Gold Technical Indicators Signal Overbought Market Gold Technical Indicators Signal Overbought Market Gold Technical Indicators Signal Overbought Market Chart 7High USD Correlation Throws Off Fair-Value Model High USD Correlation Throws Off Fair-Value Model High USD Correlation Throws Off Fair-Value Model However, to be on the safe side, we are placing a $1,450/oz stop-loss on our long-term gold position, which as of Tuesday’s close was up 21% since inception on May 14, 2017. This is a precautionary measure, which recognizes the possibility global policy uncertainty could be reduced later this year if the US and China can agree on a trade ceasefire, and global fiscal and monetary policy are successful in reviving EM income growth, which would revive commodity demand generally, pushing up global bond yields. If this occurs, the risk premium supporting gold will ease, and markets will once again turn their attention to possible inflationary consequences of the global stimulus. During that period, the monetary and fiscal aggregates we track as explanatory variables for gold prices will reassert themselves as the dominant drivers of gold prices (see below). This could produce tension between a falling USD and rising real rates as growth picks up, which would send us to a risk-neutral setting re gold, given the current high correlation between gold and real rates, which should remain strong until the Fed starts hiking rates again, most likely in 2020 (Chart 8). This is part of the reason we are including the stop-loss at $1,450/oz for our existing gold position: During this risky period going into 1H20 economic uncertainty could dissipate, and real rates could rise. Although the USD depreciation would mute these effects, rising real rates would be a risk to gold prices. Chart 8Rising Real Rates Could Weaken Gold Prices Rising Real Rates Could Weaken Gold Prices Rising Real Rates Could Weaken Gold Prices Economic Uncertainty Dominates Gold’s Fundamentals At present, economic policy uncertainty overwhelms the other factors we typically use as explanatory variables when modeling gold prices. In Table 1, we collect the variables we consider when assessing gold’s fair value. At present, economic policy uncertainty overwhelms the other factors we typically use as explanatory variables when modeling gold prices. This variable broadly falls in the geopolitical risk we regularly account for in our analysis of gold markets. Table 1Fundamental And Technical Gold-Price Drivers Global Economic Policy Uncertainty Lifts Gold And USD Together Global Economic Policy Uncertainty Lifts Gold And USD Together If the uncertainty captured by the EPU indexes is resolved, we would expect the dollar to fall and the negative gold-USD correlation to reassert itself and strengthen. Checking off each of these groups, we see: · Demand for inflation hedges remaining muted over the short-term, as inflationary pressures remain weak. In line with our House view, however, we do expect inflation could move higher toward the end of next year and overshoot the Fed’s 2% target for the US. This would support gold prices. · Monetary and financial aggregates are working less well as explanatory variables for gold prices in a market dominated by economic policy uncertainty. The USD-gold correlation continues to be disrupted by strong demand for safe-haven assets. As inflation picks up next year, we expect nominal bond yields to rise. Real rates, however, could remain subdued, as long as the Fed is not aggressively raising rates to get out ahead of a possible revival of inflation (Chart 9). Later in 2020, the correlation between rates and gold should be supportive for gold prices – the correlation fades when the Fed tightens, which creates a demand for safe-haven assets like gold. All the same, an increase in real rates would be a risk to gold prices in 1H20. · At present, demand for portfolio-diversification assets via safe-haven assets is a powerful force in gold’s price evolution. It is worthwhile pointing out, however, that if global economic uncertainty is resolved and global growth does rebound, recession fears will diminish, thus reducing the marginal impact of geopolitical shocks. On the other hand, if the uncertainty captured by the EPU indexes is resolved, we would expect the dollar to fall and the negative gold-USD correlation to reassert itself and strengthen. Should that happen, short-term volatility in gold will rise (Chart 10). Chart 9Bond Yields Should Rise As Inflation Revives In 2H20 Bond Yields Should Rise As Inflation Revives In 2H20 Bond Yields Should Rise As Inflation Revives In 2H20 Chart 10Investors Expect Large Positive Moves In Gold And Silver Prices Investors Expect Large Positive Moves In Gold And Silver Prices Investors Expect Large Positive Moves In Gold And Silver Prices Investment Implications Over a tactical horizon – i.e., 3 to 6 months – we expect global economic policy uncertainty to remain elevated. Going into 2020 – and particularly in 2H20 – we expect the USD to weaken on the back of global monetary accommodation policies and increased fiscal stimulus. We also are expecting a ceasefire in the Sino-US trade war, which will revive trade somewhat and support EM income growth and commodity demand. These assumptions, which we’ve laid out in previous research, will be bullish cyclical factors supporting commodities generally. Bottom Line: A ceasefire in the Sino-US trade war, coupled with global fiscal and monetary stimulus, will reduce some of the economic uncertainty dogging aggregate demand. This should be apparent in the data in 1H20. As a result, we continue to expect rising EM income growth to be cyclically bullish for commodities generally. This will allow inflation to revive – again, assuming the Fed does not become aggressive in raising rates. Net, this will be bullish for gold: As India’s and China’s economic growth picks up, we expect income to grow, which would support physical gold demand in EM countries (Chart 11) Chart 11EM Income Growth Will Support Demand For Gold EM Income Growth Will Support Demand For Gold EM Income Growth Will Support Demand For Gold   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com     Footnotes 1               Please see “Policy Uncertainty Lifts USD, Stifles Global Oil Demand Growth,” published October 17, 2019, available at ces.bcaresearch.com. 2              We expect a ceasefire in the Sino-US trade war to be announced in 1H20, which will defuse – but not eliminate – an important risk for global growth in our analytical framework.  We expect this will allow the relationship between the USD and gold to move back to its previous equilibrium in 1Q20 or 2Q20. 3              For more info on the Baker-Bloom-Davis index, please see policyuncertainty.com

Highlights An expansion in the Federal Reserve’s balance sheet will increase dollar liquidity. This should be negative for the greenback, barring a recession over the next six to 12 months. Interest rate differentials have largely moved against the dollar. The biggest divergences are versus the more export-dependent NOK, SEK and GBP. A weak dollar will supercharge the gold uptrend. Gold will also benefit from abundant liquidity, and persistently low/negative real rates. Remain short USD/JPY. The path to a lower yen is via an overshoot, as the BoJ will need a shock to act more aggressively. The Bank of Canada left rates on hold, but may be hard-pressed to continue meeting its inflation mandate amid a widening output gap. Go long AUD/CAD for a trade. Feature Chart I-1A Well-Defined Channel Signposts For A Reversal In The Dollar Bull Market Signposts For A Reversal In The Dollar Bull Market The DXY index has been trading within a very narrow band this year, defined by the upward-sloped channel drawn from the February lows (Chart I-1). At 97, the DXY index is just a few ticks away from the lower bound of this channel, which could be tested in the coming weeks. A decisive break below will represent an important fundamental shift, since it will declare the winner in the ongoing battle between deteriorating global growth and easing financial conditions. Global Growth And The Dollar One of the defining features of the currency landscape last year was that U.S. interest rates became too tight relative to underlying conditions. This tightened dollar liquidity both domestically and abroad. Chart I-2 plots the neutral rate of interest in the U.S. relative to the fed funds target rate. A widening gap suggests underlying financing conditions are low relative to the potential growth rate of the economy. Not surprisingly, this also tends to track the yield curve pretty closely, assuming long-term rates are a proxy for the economy’s structural growth rate, while short-term rates reflect borrowing costs. For economic agents, a narrowing spread suggests a rising risk of capital misallocation, as the gap between the cost of capital and return on capital closes. This is most evident for banks through their net interest margins. At the epicenter of this shrinking spread are the Fed’s macroeconomic policies. These include raising interest rates (especially in the face of a trade slowdown) and/or shrinking its balance sheet. These are the very policies that also tend to strengthen the greenback. The result is a rise in the velocity of international U.S. dollars, pushing up offshore rates and lifting the cost of capital for borrowing countries. A widening gap between U.S. neutral rate of interest and fed funds target rate suggests underlying financing conditions are low relative to the potential growth rate of the economy.  This has been the backdrop for the dollar for much of the past two years. The good news is that more recently, the Fed has been quick to rectify the situation. The funding crisis among U.S. domestic banks will be resolved through repurchase agreements and a resumption of the Fed's bond purchases. Chart I-3 shows that the interest rate the Fed pays on excess reserves may soon exceed the effective fed funds rate, meaning the liquidity crisis among U.S. banks may soon be over. Correspondingly, banks’ excess reserves should start rising anew. The drop in rates and the easing in funding conditions have been partly sniffed out by a steepening yield curve (Chart I-3, bottom panel). This will incentivize banks to lend, which in turn, will boost U.S. money supply. As the economy recovers and demand for imports (machinery, commodities, consumer goods) rises, this will widen the current account deficit and increase the international supply of dollars. This should further calm dollar offshore rates, helping short-circuit any negative feedback loops that might have hampered growth in the past. Chart I-2The Fed Has Pivoted The Fed Has Pivoted The Fed Has Pivoted Chart I-3Easing Liquidity Strains Easing Liquidity Strains Easing Liquidity Strains The message from both global fixed-income markets and international stocks is that we may have reached a tipping point, where easing in financial conditions is sufficient to end the manufacturing recession. This is especially the case given this week’s breakout in the S&P 500, the Swedish OMX, and the Swiss Market Index (Chart I-4) – indices with large international exposure and very much tied to the global cycle. Such market cycles also tend to correspond with a weaker dollar, especially when the return on capital appears marginally higher outside the U.S. (Chart I-5). Chart I-4A Few Equity Breakouts A Few Equity Breakouts A Few Equity Breakouts Chart I-5Europe And EM Leading The Rally Europe And EM Leading The Rally Europe And EM Leading The Rally Chart I-6Less Stress In Offshore USD Funding Less Stress In Offshore USD Funding Less Stress In Offshore USD Funding Bottom Line: Rising dollar liquidity appears to have started greasing the international financial supply chain. One way to track if dollar funding is becoming more abundant is through the convenience yield, or cross-currency basis swap.1 This measures the difference in yield between an actual Treasury bond and a synthetic one trading in the offshore market. On this basis, we are well below the panic levels observed over the past decade (Chart I-6). Interest Rate Differentials And International Flows If the rise in global bond yields reflects a nascent pickup in growth, then the message from interest rate differentials has been clear: This growth pickup will be led by non-U.S. markets, similar to the message from international equities. Should the nascent pickup in global growth morph into a synchronized recovery, this will go a long way in further eroding the U.S.’ yield advantage. More specifically, the currencies that have borne the brunt of the manufacturing slowdown should also experience the quickest reversals. This is already being manifested in a very steep rise in their bond yields vis-à-vis those in the U.S. (Chart I-7A and Chart I-7B). For example, yields in Norway, Sweden, Switzerland and Japan have risen by an average of 75 basis points versus those in the U.S. since the bottom. Should the nascent pickup in global growth morph into a synchronized recovery, this will go a long way in further eroding the U.S.’ yield advantage. Chart I-7AInterest Differentials And Exchange Rates Interest Differentials And Exchange Rates Interest Differentials And Exchange Rates Chart I-7BInterest Differentials And Exchange Rates Interest Differentials And Exchange Rates Interest Differentials And Exchange Rates International investors might still find U.S. bond markets attractive in an absolute sense, but the currency risk is just too big a potential blindside at the current juncture. Markets with the potential for currency appreciation such as Australia, Canada, Norway or even the European periphery within Europe might be better bets. Flow data highlights just how precarious being long U.S. dollars is. As of last August, overall flows into the U.S. Treasury market have been negative, which may have contributed to the bottom in bond yields. Net foreign purchases by private investors are still positive at an annualized US$166 billion, but the momentum of these flows is clearly rolling over. This is more than offset by official net outflows that are running at $314 billion (Chart I-8). As interest rate differentials have started moving against the U.S., so has foreign investor appetite for Treasury bonds. More importantly, private purchases have not been driven on a net basis by foreign entities, but by U.S. domestic concerns repatriating capital on the back of the 2017 Trump tax cuts. On a rolling 12-month basis, the U.S. was repatriating back close to net $US400 billion in assets, or about 2% of GDP. Given that the tax break was a one-off, flows have since started to ease, contributing to the ebb in Treasury purchases (Chart I-9). Chart I-8A Growing Dearth Of Treasury Buyers A Growing Dearth Of Treasury Buyers A Growing Dearth Of Treasury Buyers Chart I-9Repatriation Flows Are Ebbing Repatriation Flows Are Ebbing Repatriation Flows Are Ebbing Meanwhile, while U.S. residents have been repatriating capital domestically, foreign investors have been fleeing U.S. equity markets at among the fastest pace in recent years. On a rolling 12-month total basis, the U.S. saw an exodus of about US$200 billion in equity from foreigners earlier this year, the largest on record. Foreigners are still net buyers of about $265 billion in U.S. securities (mostly agency bonds), but the downtrend in purchases in recent years is evident. Bottom Line: Flows into U.S. assets are rapidly dwindling. This may be partly because as the S&P 500 makes new highs amid lofty valuations, long-term investors are slowly realizing that future expected returns will pale in comparison to history. Given that being long Treasurys and the dollar remains a consensus trade (Chart I-10), international investors run the risk of a potential blindside from a sharp drop in the dollar. Chart I-10Unfavorable Dollar Technicals Unfavorable Dollar Technicals Unfavorable Dollar Technicals Dollar Reserve Status And Gold The decline in the dollar may not mark the ultimate peak in the bull market that began in 2011, but at least it will unveil some of the underlying forces that have been chipping away at the dollar’s reserve status over the past few years. China has risen within the ranks to become the number one contributor to the U.S. trade deficit over the past few years. At the same time, Beijing has been destocking its holding of Treasurys, if only as retaliation against past U.S. policies, or perhaps to make room for the internationalization of the RMB. In a broader sense, there has been an underlying shift in the global economy away from dollars and towards a more diversified basket of currencies. This makes sense, given that a growing proportion of trading – be it in crude, natural gas, bulk commodities or even softs – is being done outside U.S. exchanges. Gold continues to outperform Treasurys, which has historically been an ominous sign for the U.S. dollar. Ever since the end of the gold/dollar link in the early ‘70s, bullion has stood as a viable threat to dollar liabilities. With the Fed about to embark on a renewed expansion of its balance sheet, we may have just triggered one of the necessary catalysts for a selloff in the U.S. dollar. This means that holding gold in dollars may become more profitable compared to other currencies (Chart I-11). Given that being long Treasurys and the dollar remains a consensus trade, international investors run the risk of a potential blindside from a sharp drop in the dollar.  The one tectonic shift that has happened over the past decade is that central banks have become net gold buyers, holding 20% of all gold that has ever been mined. If that number were to rise to say 25% or even 30%, it could have the potential to propel the gold price up towards $2800/oz (Chart I-12). If you think such an idea is far-fetched, just ask the Swiss, who a few years ago called a referendum to increase their gold holdings from 7% of total reserves to 20%, or Russia that has seen its gold holdings rise from 2% to over 20% of total reserves. Chart I-11Watch Gold In ##br##USD Terms Watch Gold In USD Terms Watch Gold In USD Terms Chart I-12What If Central Banks Bought Gold More Aggressively? What If Central Banks Bought Gold More Aggressively? What If Central Banks Bought Gold More Aggressively?   Bottom Line: Reserve diversification out of U.S. dollars is a trend that has been underway for a while now, and unlikely to change anytime soon. Gold will be a big beneficiary of this tectonic shift. A Few Trade Ideas If the dollar eventually weakens, the more export-dependent economies should benefit the most from a rebound in global growth, and by extension their currencies should be the outperformers. Within the G-10 universe, there would notably be the European currencies led by the Swedish krona, the Norwegian krone and the pound. The countries currently experiencing the steepest rise in interest rate differentials vis-à-vis the U.S. could be a prelude to which currencies will outperform (previously mentioned Chart I-7A). We expect commodity currencies to also hold firm, but this awaits further confirmation of more pronounced Chinese stimulus, which so far has not yet materialized. The Canadian dollar should also be a beneficiary from dollar weakness, with a technical formation that looks categorically bearish USD/CAD (Chart I-13). Should the 1.30 level be breached, the next level of support is around the 2017 lows of 1.20. The BoC left rates unchanged this week, but the dovish tone from Governor Stephen Poloz was a big reminder that no central bank wants to tolerate a more expensive currency for now. Looser fiscal policy and rising oil prices will eventually become growth tailwinds. Chart I-13A USD/CAD Breakout Or Breakdown? A USD/CAD Breakout Or Breakdown? A USD/CAD Breakout Or Breakdown? Chart I-14Canadian House Prices Canadian House Prices Canadian House Prices However, we will favor the Aussie over the loonie since the downturn in the Australian housing market appears much further advanced compared to Canada. And with macro-prudential measures already implemented in Vancouver and Toronto, there is a rising risk that Montreal could follow suit (Chart I-14). Historically, policy divergences between the Reserve Bank of Australia and the BoC have followed the relative growth profiles of their biggest export markets, and the message so far is that the RBA is well ahead of the curve in its dovish bias (Chart I-15). Go long AUD/CAD for a trade. Chart I-15Buy AUD/CAD Buy AUD/CAD Buy AUD/CAD Finally, the Bank Of Japan left interest rates unchanged but signaled it was willing to ease should the path towards their 2% inflation target be in question. As the central bank that has been pursuing the most aggressive monetary stimulus over the last few years, it is fair to say this week’s policy meeting was a non-event. The yen will continue to be buffeted by powerful deflationary tailwinds that are holding the Japanese economy hostage, as well as global economic uncertainty. In the event that global growth picks up, the yen will depreciate at the crosses, but can still rise versus the dollar. This puts long yen bets in a “heads I win, tails I don’t lose much” scenario. Bottom Line: Go long AUD/CAD and stay short USD/JPY. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Arvind Krishnamurthy and Hanno Lustig, “Mind the Gap in Sovereign Debt Markets: The U.S. Treasury basis and the Dollar Risk Factor,” Stanford University, August 29, 2019. Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the U.S. have been mixed: Preliminary GDP growth slowed to 1.9% quarter-on-quarter from 2% in Q3. PCE slowed to 1.5% quarter-on-quarter in Q3. Core PCE, on the other hand, increased to 2.2%. New home sales contracted by 0.7% month-on-month in September, while pending home sales grew by 1.5% month-on-month. The trade deficit narrowed marginally by $2.7 billion to $70.4 billion in September. Initial jobless claims increased by 5K to 218K for the week ended October 25th. The DXY index fell sharply after the Fed's press conference, ending with a loss of 0.6% this week. On Wednesday, the Fed cut interest rate by 25 bps for the third time this year to 1.75%, as widely expected. The fading interest rate differential will continue to be a headwind for the U.S. dollar. Report Links: On Money Velocity, EUR/USD And Silver - October 11, 2019 Preserving Capital During Riot Points - September 6, 2019 Has The Currency Landscape Shifted? - August 16, 2019 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been firm: GDP growth in the euro area slowed marginally to 1.1% year-on-year in Q3, down from 1.2% in the previous quarter. On a quarter-on-quarter basis, the growth was unchanged at 0.2%. Headline inflation in the euro area slowed slightly to 0.7% year-on-year in October. Core inflation however, increased to 1.1% year-on-year. Retail sales in Germany grew by 3.4% year-on-year in September, up from 3.1% in the previous month. EUR/USD increased by 0.5% this week amid broad dollar weakness. The current debate among central bankers in the Eurozone is whether ultra accommodative monetary policy is still warranted. This espouses the view that at least, to some members of the ECB, the neutral rate of interest in the Eurozone is higher than perceived. Report Links: On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Battle Of The Central Banks - June 21, 2019 Japanese Yen Chart II-6JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been mostly positive: Headline inflation was unchanged at 0.4% year-on-year in October. Core inflation however, increased marginally to 0.7% year-on-year in October. Retail sales soared by 9.1% year-on-year in September in anticipation of the consumption tax hike. Industrial production grew by 1.1% year-on-year in September, compared to a contraction of 4.7% year-on-year the previous month. Consumer confidence increased marginally to 36.2 from 35.5 in October. The yen appreciated by 0.5% this week against the U.S. dollar. The BoJ left its policy rate unchanged this Thursday, while reassuring markets that more stimulus could be added if needed in the future. Report Links: A Few Trade Ideas - Sept. 27, 2019 Has The Currency Landscape Shifted? - August 16, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the U.K. have been mixed: On the housing front, nationwide house prices increased by 0.4% year-on-year in October. Mortgage approvals increased marginally to 65.9K in September. Money supply (M4) grew by 4% year-on-year in September, up from 3.3% in the previous month. GfK consumer confidence fell further to -14 in October. The pound appreciated by almost 1% against the U.S. dollar this week. The E.U. has agreed on yet another Brexit extension until January 31st. An earlier exit is also possible if the U.K. so chooses. Meanwhile, the U.K. economy is holding up quite well despite the cloud of uncertainty. We remain tactically long GBP/JPY. Report Links: A Few Trade Ideas - Sept. 27, 2019 United Kingdon: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Battle Of The Central Banks - June 21, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mostly positive: Headline inflation increased to 1.7% year-on-year in Q3, up from 1.6% in the previous quarter. HIA new home sales grew by 5.7% month-on-month in September. Building permits contracted by 19% year-on-year in September. However on a monthly basis, it grew by 7.6% in September. AUD/USD surged by 1.2% this week. During a speech this Monday, RBA Governor Philip Lowe ruled out the possibility of negative interest rates in Australia, and urged businesses to start investing given historically low interest rates. Going forward, we expect the Aussie dollar to rebound amid a global growth recovery.  New Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mixed: Building permits increased by 7.2% month-on-month in September. Business confidence came in at -42.4 in October. This was an improvement from -53.5 in the previous month. The activity outlook fell further to -3.5 from -1.8 in October. The New Zealand dollar soared by 0.9% against the USD this week. While we expect the kiwi to outperform the USD amid global growth recovery, it will likely underperform its pro-cyclical peers. Report Links: USD/CNY And Market Turbulence - August 9, 2019 Where To Next For The U.S. Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in the Canada have been firm: GDP grew by 0.1% month-on-month in August. Bloomberg Nanos confidence index fell marginally to 57.4 for the week ended October 25th. The Canadian dollar has depreciated by 0.7% against the U.S. dollar, making it the worst performing G-10 currency this week. The BoC decided to keep interest rates on hold this Wednesday, with relatively strong domestic growth and inflation on target. While growth in Canada has surprised to the upside, it might not prove sustainable. We are shorting the Canadian dollar this week against the Australian dollar. Report Links: Preserving Capital During Riot Points - September 6, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Swiss Franc Chart II-15HF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been mixed: KOF leading indicator increased to 94.7 in October, up from 93.9 in the previous month. ZEW expectations fell further to -30.5 in October. The Swiss franc has increased by 0.7% against the U.S. dollar this week. Domestic fundamentals remain strong in Switzerland, but are at risk from the global growth slowdown. As a safe-haven currency, a rising gold-to-oil ratio points to a higher franc. Report Links: Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway has been positive: Retail sales increased by 0.8% year-on-year in September. USD/NOK is flat this week amid broad dollar weakness. The Norwegian krone has diverged from the ebb and flow of energy prices, and is currently trading around two standard deviations below its fair value. While energy prices have recently been soft, the selloff in the Norwegian krone is exaggerated. We are looking to short CAD/NOK. Report Links: A Few Trade Ideas - Sept. 27, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been positive: Consumer confidence rebounded to 92.7 in October. Retail sales increased by 2.6% year-on-year in September. Trade balance of goods shifted back to a surplus of SEK 2 billion in September, following the deficit of SEK 5.5 billion in August. Both imports and exports increased by SEK 6.6 billion and SEK 14.1 billion month-on-month, respectively. USD/SEK fell by 0.6% this week. The Swedish krona is much undervalued. A cheap krona should help to improve the balance of payments dynamics in Sweden. We expect the krona to bounce back sharply once global growth shows more signs of recovery amid a U.S.-China trade war détente. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

  The key question for asset allocators over coming months will be when (or, perhaps, whether) the global manufacturing cycle will turn up. This would trigger a move into more cyclically sensitive markets, for example euro zone equities and Emerging Market assets. It would push up commodity prices and government bond yields, and lead to a weakening of the U.S. dollar. Recommended Allocation Monthly Portfolio Update: Looking For The Turning-Point Monthly Portfolio Update: Looking For The Turning-Point Chart 1First Inklings Of A Pick-Up? First Inklings Of A Pick-Up? First Inklings Of A Pick-Up?   For now, the evidence of this turning-point remains ambiguous, and so we hesitate to pull the trigger. BCA Research's calculation of the global OECD Leading Economic Indicator bottomed earlier this year and should lead to a pick-up in manufacturing activity soon (Chart 1). However, only in EM have the manufacturing PMIs bottomed (Chart 1, panel 2) and this was due mainly to a questionably strong September PMI in China which might be reversed when the latest data-point is published on October 1. In the euro zone, the best that one can say is that the PMIs have stopped falling but they remain at a low level (41.9 in Germany, for instance). Some market-based indicators also signal a pick-up – but not yet convincingly (Chart 2). Defensive currencies such as the U.S. dollar and yen have fallen a little against cyclical currencies like the Korean won and Australian dollar. Euro zone equities have shown some strength, especially in the beaten-down auto sector. The global stock-to-bond ratio looks to be about to break out of its recent range. And copper has bounced off its lows. But these moves could turn out to be just noise rather than the beginning of a trend. Chart 2Are Markets Sniffing Out A Turn? Are Markets Sniffing Out A Turn? Are Markets Sniffing Out A Turn? Easier financial conditions are the most likely cause of a rebound. BCA Research's Financial Liquidity Index tends to lead both manufacturing activity and the relative performance of global stocks by around 12-18 months (Chart 3). With the dovish turn of central banks this year, the decline in long-term interest rates (the 10-year U.S. Treasury yield, even after its recent rebound, is only at 1.7% compared to 3.2% a year ago), the contraction in credit spreads, and a pick-up in money supply growth especially in the U.S. (where M2 is now growing 6.5% year-on-year), it would be surprising if these looser monetary conditions do not feed through into stronger activity over coming quarters. Chart 3Financial Liquidity Propels Growth Financial Liquidity Propels Growth Financial Liquidity Propels Growth Chart 4Could Inflation Now Slow? Could Inflation Now Slow? Could Inflation Now Slow? Indeed, one can easily imagine a scenario next year where growth rebounds but inflation slows (due to the lagged effect of this year’s weaker growth, Chart 4), allowing central banks to remain dovish for some time. This non-inflationary accelerating growth would be highly positive for risk assets and negative for the U.S. dollar. Chart 5 shows how various asset classes behaved in such an environment in the past. Chart 5How Assets Behaved Under Rising Growth/Falling Inflation Monthly Portfolio Update: Looking For The Turning-Point Monthly Portfolio Update: Looking For The Turning-Point Easier financial conditions are the most likely cause of a rebound. There are some risks to this optimistic scenario, however. Chinese growth remains sluggish with, for example, imports – the most important factor as far as the rest of the world is concerned – falling by 8.5% year-on-year in September and showing no signs of recovery (Chart 6). The acceleration of Chinese credit growth in early 2019 has petered out since the summer and points to a much flatter recovery of activity than was the case in 2016 (Chart 7). A politburo meeting in late October could lead to monetary stimulus being ramped up but, for now, investors should not assume a big reflationary impulse from China. In the developed world, the biggest risk is that the slowdown in manufacturing spills over into employment, consumption, and services. There are some signs in the U.S. that companies are delaying hiring decisions: job openings have fallen, and the employment component of both the manufacturing and non-manufacturing ISMs points to a deterioration in the labor market (Chart 8). Growing CEO pessimism, presumably because of anemic earnings and the trade war, points to continuing weakness in capex and a further decline in activity indicators (Chart 9). Chart 6Chinese Growth Still Sluggish... Chinese Growth Still Sluggish... Chinese Growth Still Sluggish... Chart 7...As Credit Growth Peters Out ...As Credit Growth Peters Out ...As Credit Growth Peters Out   Chart 8Are Firms Starting To Delay Hiring? Are Firms Starting To Delay Hiring? Are Firms Starting To Delay Hiring? Chart 9CEOs Are Not Happy CEOs Are Not Happy CEOs Are Not Happy Chart 10Stocks Should Outperform Cyclically Stocks Should Outperform Cyclically Stocks Should Outperform Cyclically On balance, we still expect global growth to accelerate next year, and therefore global equities to outperform bonds over the next 12 months (Chart 10). But we want to have greater conviction for that view before we recommend more aggressive pro-cyclical tilts. We remain overweight equities versus bonds, but hedge the downside risk through an overweight in cash, and through tilts towards U.S. equities, and DM over EM equities. We continue to recommend hedging against the upside risk of greater Chinese stimulus and a strong rally in cyclical assets through an overweight in global Financials, Industrials, and Energy, and also through a neutral stance on Australian equities, which are a clean play on a Chinese rebound. We continue to look for the right timing to turn more positive on pure cyclical assets such as euro zone equities, and Emerging Markets. Fixed Income: A cyclical pick-up would imply that global government bond yields have further to rise (Chart 11). Our global fixed-income strategists have a short-term target for the 10-year U.S. Treasury yield of 2.1% (versus 1.7% now) and -0.2% for Bunds (-0.4% now), which would take yields back to their 200-day moving averages (Chart 12).1 We continue to recommend a moderate underweight on duration, and prefer TIPS to nominal bonds, since inflation breakevens imply that the Fed will miss its inflation target by 80 basis points a year on average over the next 10 years. In an environment of accelerating economic growth, credit (both investment grade and high-yield)should outperform in both the U.S. and Europe. The most attractive points on the credit curve are BBB-rated bonds in IG, and the riskiest bonds in HY. For more risk-averse investors, agency MBS currently offer an attractive yield pickup over quality corporate credits. Chart 11Growth Will Push Up Yields Further... Growth Will Push Up Yields Further... Growth Will Push Up Yields Further... Chart 12...Initially To Their 200-Day Average ...Initially To Their 200-Day Average ...Initially To Their 200-Day Average     Equities: Any upside for U.S. equities must come from improved earnings performance. Throughout 2019, earnings have been beating overly pessimistic analysts’ forecasts and Q3 looks to be no exception, with EPS growth on track to be much stronger than the -5% year-on-year that analysts forecast going into the results season (Chart 13). Next year, nominal GDP growth of 4% and a weaker U.S. dollar should produce 7-8% EPS growth. But, with a forward PE of 17x and the Fed unlikely to boost the multiple by further rate cuts, upside is limited. In the right economic environment (as described above), euro zone and EM stocks should do much better. We are currently neutral on euro zone equities, but the recent stronger performance by European banks gives us more confidence that we may be able to move to overweight soon (Chart 14). Similarly, our EM strategists have instituted a buy stop on the MSCI EM index and say they will go overweight EM equities if the index in USD terms rises 3% from its current level.2 Chart 13Analysts Are Too Pessimistic On Earnings Monthly Portfolio Update: Looking For The Turning-Point Monthly Portfolio Update: Looking For The Turning-Point Currencies: The first inklings of U.S. dollar weakness over the past month suggest that it may, too, be sniffing out the start of a cyclical rebound, since it tends to be a very counter-cyclical currency (Chart 15). Going forward, relative interest rates are also unlikely to be as bullish a force for the U.S. dollar as they have been in the past few years. For now, we are neutral on the U.S. dollar on a trade-weighted basis, but do see it depreciating against the Australian dollar and the euro over the next 12 months. The British pound has already risen to take into account the lesser probability of a no-deal Brexit, and we would not expect it to move much either way until the General Election result is clear. There are some risks to the optimistic scenario: Chinese growth remains sluggish, and there are signs that U.S. companies are delaying hiring decisions. Chart 14First Signs Of Euro Banks Recovering? First Signs Of Euro Banks Recovering? First Signs Of Euro Banks Recovering? Chart 15Recovery Would Be Dollar Bearish Recovery Would Be Dollar Bearish Recovery Would Be Dollar Bearish Commodities: Industrial metals prices have bottomed out in recent months, in line with Chinese leading indicators (Chart 16). But we will need to see greater Chinese stimulus before we become more positive. Crude oil has moved largely in a range for the past six months, with tightness in supply offset by some weakness in demand, especially from developed economies (Chart 17). With demand likely to pick up in line with the global economy, and supply still constrained by the Saudi/Russia production pact and geopolitical disturbances, our energy strategists see Brent crude averaging $66 a barrel in Q4 and $70 in 2020, versus $60 now. Chart 16Not Enough China Stimulus For Metals To Bounce Not Enough China Stimulus For Metals To Bounce Not Enough China Stimulus For Metals To Bounce Chart 17Oil Kept Down By Weak Demand Oil Kept Down By Weak Demand Oil Kept Down By Weak Demand As last year, the Global Asset Allocation service will not publish a Q1 Quarterly in mid-December. Instead, we will send clients on November 22 our annual report of the conversation between Mr and Ms X and BCA Research’s managing editors. This report will detail BCA's house views on the outlook for the macro environment and investment markets in 2020. We will publish GAA Monthly Portfolio Outlooks on the first business days of December and January.   Garry Evans Senior Vice President Chief Global Asset Allocation Strategist garry@bcaresearch.com   Footnotes 1Please see Global Fixed Income Strategy Weekly Report “Big Mo(mentum) Is Turning Positive,” dated 29 October 2019, available at gfis.bcaresearch.com. 2For an explanation, please see the Emerging Markets Strategy Weekly Report " EM Local Bonds: A New Normal?" dated 24 October 2019, available at ems.bcaresearch.com.   Recommended Asset Allocation Model Portfolio (USD Terms)