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Novum Alpha - Weekend Edition 20-21 February 2021 (10-Minute Read)

The re-flation trade, a term repeated so many times its got its own built-in "re" is back in force again as investors dumped long-dated government securities on Friday and rotated into economically-sensitive sectors of the stock market, betting on a swift recovery in the coming months. 

Welcome to your weekend! 
In brief (TL:DR)
  • U.S. stocks traded flat going into the weekend with the S&P 500 (-0.19%), tech-centric Nasdaq Composite (+0.07%) and blue-chip Dow Jones Industrial Average (+0.00%) more or less unchanged as investors sat on the sidelines awaiting clearer assessments over inflation. 
  • Asian stocks ended the week a mixed bag and drifted rudderless for most of Friday's trading session. 
  • The benchmark U.S. 10-year Treasury yield surged to 1.340% reflecting a broad sell-off in longer-dated U.S. Treasuries as short-term debt becomes increasingly scarce (yields rise when bond prices fall). 
  • The dollar slipped heading into Friday. 
  • Oil was flat with March 2021 contracts for WTI Crude Oil (Nymex) (-2.12%) at US$59.24 as energy infrastructure was being repaired in Texas after a devastating winter knocked out power lines and crippled energy production capabilities. 
  • Gold was firmer with April 2021 contracts for Gold (Comex) (+0.14%) at US$1,777.40, mainly on the back of a weaker dollar. 
  • Bitcoin (+8.91%) soared to US$56,000 on the back of a successful Canadian Bitcoin ETF launch and with outflows from exchanges leading inflows (outflows typically suggest that traders are looking to hold Bitcoin in anticipation of higher prices). 
In today's issue...
  1. Gold's Year to Shine Has Been Eclipsed
  2. Marching Into Market Mayhem
  3. Build a Bitcoin ETF and They Will Come


Market Overview
The re-flation trade, a term repeated so many times its got its own built-in "re" is back in force again as investors dumped long-dated government securities on Friday and rotated into economically-sensitive sectors of the stock market, betting on a swift recovery in the coming months. 
Fresh data out on Friday showed that business activity in the U.S. private sector is holding up, boosted by accelerating service activity and manufacturing output, hot on the heels of a report that showed American consumers used stimulus checks to boost retail spending last month. 
In Asia, markets were more muted on Friday's session closing a mixed bag with Tokyo's Nikkei 225 (-0.72%) and Sydney’s ASX 200 (-1.34%), down, while Seoul's Kospi Index (+0.68%) and Hong Kong's Hang Seng Index (+0.16%) were higher. 
1. Gold's Year to Shine Has Been Eclipsed
  • High expectations for a rally in gold were not met this year as the precious metal had its worst start in three decades 
  • Gold prices are coming under increasing pressure from both a resilient dollar, increasing Treasury yields and tepid inflation
Right up to the fourth quarter of 2020, analysts from both Goldman Sachs (+1.85%) and Citigroup (+3.62%) were both predicting a rally for gold right through to 2023 on the back of prolonged low interest rates and the prospect of inflation because of greater fiscal stimulus.
Gold hit a record high in 2020 on the back of fiscal stimulus and loose monetary policy and expectations were high that it would continue to do well this year, yet the precious metal is off to its worst start in three decades.
Spot prices for bullion touched a 7-month low on Friday before erasing losses as the dollar moved lower, but gold is still down a full 6% this year alone, even as other asset classes have risen.
Gold, which surged last year on pandemic panic-induced haven buying, low interest rates and stimulus spending, is now 2021’s worst performer compared with other commodities and facing a host of unexpected stumbling blocks to any further rally.
A resilient dollar and a rally in U.S. Treasury yields has made the holding costs of gold higher – because gold has no yield, higher yields in “safe” U.S. government debt makes the cost of holding gold, a non-yielding asset, higher.
And even though inflation expectations have climbed, with U.S. 10-year Treasury Bill break even levels (after accounting for inflation) reaching their highest this week since 2014, gold has not responded as the inflation hedge that many investors may have been expecting.
Nonetheless, there are still some who see gold as being a good investment, and possibly hitting even US$2,000 before the end of the year, betting that the inability of governments and central banks to normalize stimulus policy will ultimately support the previous metal. 
2. Marching Into Market Mayhem
  • U.S. short-term Treasury Bills are increasingly in short supply, despite their necessity to act as collateral in a wide range of other trades and transactions 
  • Shortage of short-term Treasury Bills could see momentary market shocks towards the end of March, especially if the U.S. Federal Reserve is slow to respond or does not anticipate the problem
“Beware the Ides of March.”
- William Shakespeare, Julius Caesar, Act One, Scene Two
Markets have an uncanny habit of turning south in the months of March and September and there are signs, albeit tenuous ones, that suggest next month may be the same, because the last two weeks of March look like a set-up for potential panic in the U.S. Treasuries and mortgage-backed securities markets.
While not likely to be cataclysmic, the market shocks could leave some investors, well, shocked.
Since the beginning of this year, the yield on short-term U.S. Treasury Bills has fallen by over 66%, while the yield for a 2-year U.S. Treasury Note slid by over 21% - dramatic moves in what are some of the most broadly traded securities.
Treasury Bills are a form of short-term U.S. government debt that can be readily lent, and re-lent, or otherwise pledged as collateral to secure other, unrelated transactions – think of them as similar to traveler’s checks for governments that are as good as cash.
But when trust is sorely wanting in the financial system, investors or institutions, demand more collateral, for instance by way of asking for more Treasury Bills to secure commitments.
Disconcertingly, distrust appears to be rising, and fast – which can be noticed not only at the outcome of official Treasury Bill auctions, but at the range of bids at those auctions.
How an auction works is that dealers will bid on the rate (or yield) that they are willing to accept on a Treasury Bill – the lower the rate, the more likely they will win the bid, because the U.S. government will get to borrow more cheaply.  
Low bids typically suggest that dealers are willing to accept very low rates, just to make sure they get some of that collateral and historically, that’s happened at systemic stress points or as a precursor to market crises. 
And that’s why conversely, the yields on longer dated U.S. Treasuries such as the 10-year and 30-year, have surged in recent weeks to record highs.
Short-term Treasury Bill liquidity is drying up, just as the U.S. Treasury Department is seeking to rebalance its issuance, by redeeming Treasury Bills and selling more long-dated bonds.
All of which is building up to a perfect storm in March, similar to the one experienced last March when the coronavirus pandemic led to an overnight shortage in Treasury Bills as investors clamored for safe and liquid securities.  
Treasury Bills are very actively traded in the secondary market, with an average of US$600 billion in daily transactions, and most of that activity is for short-term U.S. Treasury Bills, which are the easiest for investors to value and which are also those in the most short supply at the moment.
And last March, in the midst of the coronavirus pandemic, the usually deep and highly liquid secondary markets in U.S. Treasury Bills dried up almost overnight.
Because these securities are also used as collateral in many other markets, the ability of traders to trade in those other markets was also gummed up – the financial system lurched.
Fortunately, the U.S. Federal Reserve intervened at the time to stabilize the Treasury markets and restore normalcy, it remains to be seen if they’ll be able to do the same this March.   
3. Build a Bitcoin ETF and They Will Come
  • First North American Bitcoin ETF launches with a bang as US$165 million worth of shares traded on the first day 
  • Physically-settled Bitcoin ETF removes Bitcoin out of the tradeable supply and puts upward pressure on prices so long as demand remains constant
Hot on the heels of North America’s first ever Bitcoin ETF, Galaxy Digital Holdings, is positioning itself to ride on a surge of interest in the world’s largest cryptocurrency by market cap.
As one of several trading desks that is providing Bitcoin for Canada’s Purpose Bitcoin ETF, Galaxy Digital Holdings is also acting as the Bitcoin sub-advisor, executing trades on behalf of another Canadian Bitcoin ETF being filed, CI Galaxy Bitcoin ETF.
Galaxy Digital Holdings appears to be betting that by being at the nexus of supporting a Bitcoin ETF, it will position itself nicely, if or when the U.S. approves its first Bitcoin ETF.
The remarkable debut of the Purpose Bitcoin ETF on the Toronto Stock Exchange, where some US$165 million worth of shares were traded, sent Bitcoin higher into the weekend, clearing US$56,000 at one stage and giving it a market cap of US$1 trillion for the first time ever.
ETFs have long been seen by many Bitcoin stalwarts as a path forward to greater mainstream adoption of cryptocurrencies.
And while there are already a number of ETF-like Bitcoin products in Europe, as well as exchange-traded trusts such as the Grayscale Bitcoin Trust in the U.S., a full-fledged Bitcoin ETF out of the U.S. remains the Holy Grail.
The U.S. Securities and Exchange Commission (“SEC”) has repeatedly denied applications to offer cryptocurrency ETFs in the U.S., citing concerns over market concentration and manipulation, but the approval by Canadian authorities of a Bitcoin ETF may change things up.
While several Bitcoin ETFs already sit on the desk of the SEC, the prospective appointment of crypto-savvy Gary Gensler to helm the SEC might be just what the industry needs to finally see a Bitcoin ETF on a U.S. exchange approved and regulated.  
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Feb 20, 2021

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