Gold’s 2015 performance in various currencies (chart)

The Brazilian Real was walloped and the dollar was clearly a standout winner. Gold’s relative underperformance shows against US dollars that the US dollar is still seen as a safe haven currency.

Until that changes gold will underperform as measured by US dollars. I think we’re closer a that point in time when we see positive price action then we were a year ago, but I can’t say for certain if the markets will agree until stocks move in to a bear market.

As seen in the start of 2016, when stocks were out of favor, gold caught a bid and moved higher each day stocks were sold off. Now that stocks are catching a bid, gold is selling off.

Whether or not 2016 is the year that stocks enter a bear market remains in question. I am inclined to think that we have only seen a prelude for the downside in stocks that could occur this year.

Gold may be closing in on a bear market bottom

As we approach extremes in bearish sentiment, the number of gold ounces promised per contract (on the Comex at least), relative strength and the dollar rallies on the promise of a tightening cycle — I think it’s important to take a moment and reflect.

Interest rates make a bad situation worse for debtors

The US government currently spends over 6% (about $250 billion per year) of its budget on interest alone.  If interest rates were to normalize this figure would swell significantly.  So the idea of a tightening cycle being a possibility without a significant (and deflationary) reduction in government spending is unlikely.  Even if spending were to be decreased, it would not be in time to reduce the deficit or debt burden.

Further, liabilities in the private sector are explodingStudent loans, car loans, credit card debt, mortgages and debt-driven share buybacks are all at unprecedented levels.  This is further evidence that the system at large is far too debt-dependent to move to a higher rate structure without a significant rise in insolvencies.

Leverage and volatility don’t mix well

Lest we forget the interest rate complex at large.  The biggest swath of derivatives in the world, hundreds of trillions of dollars of leveraged OTC instruments, are tied directly to it.  To give you an idea of its scale, the amount of interest derivative products alone dwarf the global GDP by nearly 7 fold.

Large moves in short periods of time render leveraged trades insolvent due to the trade turning against them.  If one is borrowing $9 for every $1 they put in to a trade, then if the trade goes against them by 10% they are wiped out.  More than 10% and they owe more than the $1 they put down.

This is precisely the risk present in the world of derivatives.  The only difference is the leverage is much, much higher than 10 to 1.

Another problem is that in a tightening environment that’s unilaterally led by the US central bank (when other central banks do not follow), deflationary shock waves may proliferate throughout the global financial system and wreak havoc on interest rate derivatives markets, emerging equity and bond markets, US corporate debt and ultimately global financial markets as a whole.

Sensitive markets showing stress

Corporate bonds are beginning to sell off. Emerging markets have been in a funk for some time as they were once the beneficiaries of QE.

Given the level of medicine applied, one would expect the patient (the global economy) to have either rebounded or died of an overdose. Neither has happened, but markets are essentially in the eye of the storm.  The troubles past are gathering speed again at a remarkable pace behind the scenes.

Consequences are continuing to climb

This time around it is not just the financial system at risk, it is many governments of the world and many of their respective central banks that risk insolvency.  We are witnessing the biggest bubble that has ever been blown in history.

No wonder there is so much effort in preserving such a bubble.  The result of its end is a mind blowing problem.  And that’s precisely why the rate normalization cannot happen.  We may see a push higher by 25-50 basis points.

Policy road fork ahead

Such a hike, however, will in all likelihood pale in comparison to how the Fed manages its maturing balance sheet of bonds.  A new round of QE-like activity will likely emerge as those funds that mature are put to use to purchase longer dated bonds to re-stimulate debt markets in a variant of operation twist.

As equity markets finalize what appears to be their ultimate topping formation, I assume that we will witness another sharp move downward.  The Federal Reserve appears to be more sensitive to the gyrations of financial markets than the economy at large.  As a result it will likely pause and possibly even reverse in to this new variant of operation twist.

Ultimately this is bullish for gold

I believe we will have already formed the bottom in precious metals and begin to see a resurgence in prices once the stock market has topped and the Federal Reserve is no longer willing to tighten.  Whether the gold price tests the $1,000 level is still on the table, but I don’t see much further downside from here based on these assumptions.

The Fed has zero credibility until it raises rates

A lot of hot air, but no substance. That’s what’s been emanating out of the mouths of Federal Reserve officials over the two years about the direction of interest rates — with no follow through of taking rates higher.

As a result the Fed has no more credibility left.  When Fed officials talked about moving rates in the past markets would move with their chatter.

Not so much recently.  Market participants are squelching out the talk and waiting for the Fed to walk the walk.

Don’t buy the dips. Sell the rallies.

It’s not uncommon for bull market opportunities to be exploited by buying dips in prices.  This is not one of them.

The bull market in equities is at least on pause, but in all likelihood over.  The latest series of down days is further confirmation of a lack of conviction.

There simply aren’t buyers.

Prices will go down farther if buyers don’t step up and buy dips.  This has already been evidenced on a day-to-day basis.  Whether it happens in the weekly charts remains to be seen — but price action seems to be confirming that as of late.

Commodity contagion

Weakness in the prices of energy, metals and other products continues to be a persistent theme.  And equities have finally noticed.

Stocks used to shrug off the losses in commodities as some sort of disinflationary tailwind.  No longer is that the case.  Now investors in stocks have become jittery on days when commodities are plunging.

The next leg down

Ultimately, the equity market is at much greater risk of a price decline than a rally.  The run up over the last 6 and a half years has been overextended.  Price to earning ratios, when share buybacks are discounted, are at higher than normal levels.

Corporations have amassed enormous amounts of debt and traders are speculating with more margin than in 2007 (the last stock market peak).  China has seen its managed economy unravel, while Japan’s attempt to start managing its economy is falling apart.

The Euro zone is in serious trouble.  There’s no amount of new debt that can cure the budget problems within many of its countries.

And the United States, which is starting to feel the pain of the rest of the world, is preparing for its own economic slowdown.  The Fed, panicked with uncertainty as its credibility fades away, decided once again to abstain from raising interest rates.

What does it all mean?

We’re closing in on the peak of this business cycle, if it isn’t already behind us.  This means that opportunities will be few and far between to find equities that are worth buying at these values.  Cheaper prices are quite likely in the future.

If I were still long a traditional portfolio of US equities I would take every rally as an opportunity to reduce exposure and raise cash.

Gold continues tumble without outside catalyst

Producer prices were flat as was the US dollar index, but that didn’t stop a determined seller from pushing gold prices down this morning.

What is driving the selling pressure?

Most traders are paid to execute orders to maximize value.  That is to say, if you are selling a commodity you want to sell it for the highest price (or short it at the highest price) to maximize your profits.

What we’ve seen within the last several years is the opposite of that.  Regular dumping of gold (and silver) futures contracts with heavy volume at the lowest prices.  Huge lots executed at once — rather than distributed over the course of a day to achieve a volume average weighted price.

Are prices being fixed?

This leads the gold investing community to believe that there is malicious manipulation underway in these markets.  And with just about every other market in the world having been proven to be manipulated, such as LIBOR, foreign exchange, bonds, equities and other commodities — perhaps, just perhaps it’s not too paranoid of a theory after all.

A reason to sell so many contracts in to the market at once would be to push price down through sell stop orders.  

This action forces prices even lower and pushes many out of long positions.

Only the people pushing the sell button truly know their own intentions (or that of the institution they are employed by).  An outside observer of these markets is forced to draw their own conclusions.

How can so many claim to own the same gold?

The ratio of futures contracts to ounces of physical gold at the COMEX has risen to the highest levels on record.  Last checked, it was closing in on 250 gold futures claims per ounce of physical gold actually available.  This means that should there be a large demand for COMEX gold delivery, there may not be the gold available to fulfill the order — necessitating a cash settlement.

If one was seeking delivery to obtain physical metal for storage, this would force that party to seek gold elsewhere as soon as possible with that settled cash.  And given that so many parties seem to have claims on the same ounces of gold, that could prove to be an interesting setup for a phenomenal short squeeze that drives prices much, much higher.

Potential scenarios for the continued decline.

How this particular situation resolves remains a mystery, but I am inclined to speculate that we have two possible scenarios that could play out:

1: We are witnessing the beginning of the one of the greatest deflationary collapses the world has ever seen, as evidenced by commodity prices imploding, China’s economy in serious decline and recent volatility in equity markets.  If this is the case then it will be difficult to find a safe home for one’s money almost anywhere.

2: The precious metals markets’ prices are being guided lower in order to reduce the bid for what were once considered safe haven assets by many.  Eventually, if such a scheme is underway, it will unravel with prices going much higher.

Which of these scenarios is playing out remains to be realized.  

The former means the global markets are coming unglued at the seams and the global economy is crushed.  The latter would indicate that certain parties are concerned that a higher gold price could reduce confidence in other markets such as stocks and bonds.

US stock rally ends with a whimper

Stocks traded higher earlier today, only to give back half of those gains in the afternoon, when institutional traders tend to move markets.

Crude oil surged higher on what appeared to be short covering.  The US dollar gave up ground.  Precious metals were modestly higher as a result.

There wasn’t much of a change today from yesterday in terms of prices or my overall outlook on equities.  I still feel that the path of least resistance in the short to medium term is downward.  Valuations cannot be justified, volatility is on the rise and complacency of investors seems to be a consistent theme.

It takes a greater fool to set a higher price by buying an asset for more than the last time it traded.  Just how many are left to buy US stocks at these levels?

Bernanke’s Bubble in Stocks and Bonds

Summary

Six years after the height of the financial crisis, we may be living in one of the most prolific financial bubbles in recent history.  Under Dr. Bernanke’s guidance the US Federal Reserve system expanded its balance sheet to about 4.3 trillion dollars, with asset purchases creating a disproportionate wealth effect in equities and debt-based financial instruments.

Despite this massive injection of liquidity, by and large the US economy has not significantly recovered. Yet the US stock market (with the exception of the NASDAQ) is at all time highs. This disconnection in equity prices vs. measurable economic recovery is the primary reason that I believe a bubble exists. In addition, the artificially low interest rate environment (see: ZIRP and QE) has also created an enormous bond market bubble as reflected in US treasury bond yields.

LFP Participation

The US workforce is languishing 

A quick glance at the US Department of Labor’s recent U3 unemployment data would have us believe that almost as many Americans are employed as had been before the Great Recession.  Unfortunately the Department of Labor’s U3 unemployment rate is based on the amount of Americans currently on unemployment benefits — not the number of Americans out of work.

The US Labor Participation Rate is at its lowest levels since 1978, indicating that US job creation is not sufficient to support widespread employment. In addition, the quality of new jobs being created is equally deficient, with lower pay being a prevailing theme.  One of the Federal Reserve’s mandates is maximum employment.  A mandate they seem to be failing to uphold when utilizing more objective measures of employment.

cci

Raw materials are rolling over

While equity markets re-test all time highs, commodities are sinking fast.  Traditionally weakness in industrial commodities and energy prices signal global economic weakness.  Since July we have seen that weakness accelerate as the sell-off in commodities prices took the CCI (a broad measure of commodities prices) to multi-year lows.  This is a powerful sentiment indicator.

Optimism about global growth would be expressed in higher commodities prices — as more orders for raw materials would increase demand.  Another mandate of the Federal Reserve is stable prices.  A cursory glance at the above chart shows we certainly don’t have stable prices.

usd

Stronger dollar, weaker world?

Part of the recent decline in commodities prices has been attributed to recent strength in the US dollar index, which is in its most basic form, a measure of the dollar’s spot value vs. the Euro, Yen and GBP.  There are other currencies in the basket, but none are quite as influential.  In essence, the US dollar currently signals that it is more favored than the Euro, Yen and GBP through its ascent towards 87.

As commodities are priced in dollars, it is expected that some weakness will occur if the US dollar strengthens, especially under the back drop of softening global demand.  But one must also question the utility of the current US dollar index structure — and whether or not such an index is relevant in a world that seems to be increasingly moving away from the dollar as the primary trade currency.

spx

Stocks surged on stimulus. Now what?

With the S&P 500 back above 2,000 and optimism among fund managers back to similarly lofty levels, it may be time to examine the US stock market with a degree of skepticism. There exists a very high probability that we are in a bond and equity bubble that was fomented by the US Federal Reserve system. And traditionally these bubbles deflate when policy makers begin to head for the exits.

With QE3 over, and no immediate sign of further stimulus in sight, as well as the Fed signaling that rates are going higher in 2015, perhaps we are closer to seeing this bull market mature.  After all, it’s been largely driven by liquidity injections and those have since ended.

sp-500-vs-federal-reserve-balance-sheet1

A direct connection: Fed assets and stock prices

The correlation here is uncanny. QE’s various incarnations have an incredibly potent effect on boosting US equity prices to all time highs.  Just about every dollar the Federal Reserve has injected in to the US bond and mortgage market has found its way in to US equity markets directly or indirectly.

Now that QE3 has ended, what policies will be utilized next?  Is the Japanese QE-to-infinity program going to be enough to generate a new carry trade that pops US equities higher?  Or are we finally witnessing the tail end of one of the biggest financialized bubbles in US history?  One that has brought bond yields to the lowest levels in decades whilst simultaneously inflating mortgage-backed securities (lowering interest rates) and equity prices.

treasury

Is this bond bubble ready to bust or is it signaling something worse?

Bond yields are an inverse indicator of the underlying asset price. That is to say, the lower the bond yield, the higher the paper price to buy that bond.  This chart illustrates US Treasury bond bubble in no uncertain terms.  With US government debt exceeding GDP, whilst simultaneously at all time low yields, there is something wrong with this picture.

Typically the higher the debt level, especially as it exceeds the GDP of a country, the worse its debt outlook becomes.  The only exception we’ve seen to this rule has been Japan, which has ‘enjoyed’ a 25 year economic malaise that was culminated by their very own real estate bubble.  The deflationary forces at work there have been keeping bond yields and economic activity pinned down for a quarter century.

Reading the tea leaves of macroeconomic data

Signs seem to be pointing to an intermediate term deflationary bias.  It’s likely that this situation will be greeted by more quantitative easing from central banks of developed countries around the world. Signals include a rocketing dollar, collapsing commodities, the Bank of Japan already engaging in record QE and the weaker EU countries slipping back in to recession or worse.  In addition, China’s miracle growth story seems to be concluding with a not so happy ending.

m2

Velocity of money sinks to lowest level on record

Worse yet, with all of the Fed’s easing and stimulus, the velocity of US money has been collapsing.  This is an indication of economic activity insofar as how fast money is changing hands. Generally during periods of strength the velocity of money will increase.  What we’ve seen since about 2002 has been just the opposite.  A marked decrease in the velocity of money across all measures to the lowest levels ever recorded.

NYSE-margin-debt-SPX-since-1995

Leverage and levitating stock prices

Margin debt on the NYSE (see above chart) is at record highs, and similar leverage is being employed across many equity and bond markets around the world.  That means that the level of debt-based risk taking now exceeds what we saw during previous bull market peaks and as such a reversal in psychology would be even more dangerous to stock prices.

A replay of 2008’s volatile panic selling of various asset classes is quite possible.  The level of complacency and leverage in financial markets is similar to where we were in the fall of 2007 before the financial system began to collapse.

Conclusion

Watch these trends carefully.  Further deterioration of M2 stock velocity, commodity prices and increased dollar strength will signal the increased potential for a renewed deflationary global recession.  If such a situation unwinds, and if equity prices are dragged down in sympathy, then I do believe the Federal Reserve will begin to reinvigorate its stimulus programs and we could see the pendulum swing back towards a more inflationary bias.

What remains a mystery is how the Fed will do so when it already possesses the biggest balance sheet in its history — and has largely failed across many metrics to remedy the economic problems that face the US.  Alternatively, if Bernanke’s Bubble is allowed to burst, the consequences will be catastrophic, not the least of which for the Federal Reserve and its balance sheet.

 

News recap for Monday, Oct 3rd

Today was an exciting day for global markets.  Below you’ll find a recap of today’s most important news.  We are not anywhere near out of the woods, yet.  In fact I think equity markets are bound to get much worse.

Global equity markets are tumbling:

http://www.bloomberg.com/news/2011-10-03/asia-stocks-drop-as-euro-weakens-before-meeting.html

Banks are getting hit the hardest:

http://www.zerohedge.com/news/final-countdown\

Many EU banks have serious liquidity problems:

http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2011/09/Euro%20Bank%20Liquidity.png

The yield curve is flattening, which usually happens before it inverts, signaling a potentially deep recession:

http://www.zerohedge.com/news/curve-flattening-credit-never-good-sign

Protests in NYC are spreading:

http://online.wsj.com/article/SB10001424052970204612504576608730855935832.html?mod=WSJ_hp_MIDDLENexttoWhatsNewsSecond

And more protests are being planned:

http://www.theglobeandmail.com/news/world/americas/activists-throughout-canada-set-to-show-solidarity-with-wall-street-protesters/article2188341/

I’ll have more posted as I digest and research the events that are transpiring in global markets.

Silver’s scary sell-off

Silver and silver-related assets were smashed across the board on Friday as the World Bank and IMF met in Washington, DC to discuss the worsening global crisis.  Other commodities saw sharp declines as well.  More silver was traded that day in any given hour than silver is available on the market for an entire year.  It was an electronic sell-off.  Physical prices now command a 10-20% premium to spot paper prices, the highest in years.  Gold to silver ratio is now over 1:50, the highest in a very long time.

Predictably news comes out after the trading day (but we must assume the large insiders knew the whole time) that COMEX was raising margins by 15.6% on silver. 

http://www.gold-prices.biz/comex-raises-gold-margins-by-215-silver-margins-by-156/

The problem is the COMEX does not have the silver to deliver, so forced liquidation is the strongest tool they have to bring prices down and take parties who would seek delivery out of the equation.

Silver is still up 46.31% on the year and has strong support in the $30.00 area.  I think we need to see what the price action is when buyers step in and shorts cover.  It could very well move up as fast as it did down (and higher) if we see ECB rate cuts, a Greek bail out, good earnings in the US, emergency Fed easing or other central bank policy movements as well as any geopolitical or event risk scenarios playing out.

Given that even though silver fell to $30.00, but physical silver commands a price of $33-35.00, there is evidence of a growing paper vs. physical price discovery bifurcation. 

http://www.apmex.com/Category/160/Silver_Eagles___Uncirculated_2011__Prior.aspx

As far as my strategy goes, I don’t see any change in the situation for the dollar long term.  The recent strength has been more of a liquidation panic in Europe and foreigners buying dollars because it’s the least bad currency for the moment.  There’s even some rumor of weaker central banks liquidating gold and silver holdings to raise liquidity.

I saw the same pattern of behavior in 2008 and 2009, yet gold and silver are much, much higher now despite the occasional (and sometimes violent) correction.

Over the last 11 years silver and gold have outperformed all sectors of the S&P 500 by many multiples.  There is no paper asset class quite as trusted during times of crisis, either. 

http://finance.yahoo.com/q/ta?t=my&s=SLV&l=on&z=l&q=l&c=SPY (three year chart)

Now, given the potential for further easing by the Fed, ECB, BOJ, BOE, SNB and others, the need to monetize debt in the US to keep the government open (i.e. the necessity for QE3) — without debt monetization the government will go in to a crisis mode where their ability to spend will be limited as interest rates rise because treasuries are sold more than bought.  But we’re not the only country that has to monetize debt.  Keep in mind the US government has over $75 trillion in unfunded liabilities and there’s no ‘economic growth’ scenario that allows these debts to be funded from revenues.

QE3 from the Fed at this point seems like a foregone conclusion once we see a sovereign debt or large bank collapse.  The ECB is also monetizing debt in the Euro zone for a few of the larger PIIGS, the BOE has QE’d in England and there’s a good chance the BOJ and SNB will continue to print money to artificially devalue their currency.

http://www.reuters.com/article/2011/09/24/us-imf-ecb-stark-idUSTRE78N1Y220110924

These actions will create a short to intermediate term burst in global money supply — and hot money seeking a high return.  These types of inflationary pressures lead to booms for precious metals.  

http://www.businessweek.com/ap/financialnews/D9PU96280.htm

Greece’s default is all but inevitable, and that is going to rock the world and create the need for much, much more liquidity.  This situation will spread throughout Europe and spread here and to Asia.  Lower rates and more stimulus will follow.

http://www.zerohedge.com/news/lehman-weekend-redux

Many shops sold out of their silver bars and coins on Friday because the appetite for physical silver was so strong at $30.00 (even though customers gladly paid the $5.00+ premium making purchases $35.00+ per ounce).  In fact I still saw online stores selling silver for $45.00 to $50.00 per ounce.

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2011/9/23_Sprott_Money_Temporarily_Runs_Out_of_Physical_Silver.html

I believe that the bifurcation in physical and paper prices is important to note because it indicates that there are two markets.  A real market and a phony market.  The phony market is being manipulated downward to an artificially depressed price.

This happened in 2008, too.  But from that low price of $8.00 silver quickly rose to $48.00 in the course of three years, a 600% increase or averaged to 200% per year.

http://www.kitco.com/charts/popup/ag3650nyb.html

Gerald Celente, one of the best trend forecasters of our era is now buying physical silver.  He made the announcement on Friday, so I believe that will mean something to the many that follow his advice and watch his investments closely.

http://kingworldnews.com/kingworldnews/Broadcast/Entries/2011/9/24_Gerald_Celente.html

One year silver chart

Tonight silver is testing the 350 day moving average.  Some continuation selling was to be expected after Friday’s drop, but we’re looking for some consolidation or even a short term reversal due to the very, very oversold condition, combined with the support of the 350 day moving average at 29.57 as well as the appetite that should be present in Asia during this season.

We’re also dealing with price move that is over a four standard deviation event — i.e. something that is extraordinarily rare and it’s punctured the bottom bollinger band, leaving a reversion to the moving average around $37.00-40.00 quite possible if technical buyers come in.

24 hour silver chart Right now silver is trading at $29.83, having found some support at the $29.57 area.

Volume is light as to be expected, but once Sydney and Hong Kong open we’ll get a better idea of what the Asian appetites for metals are after last week’s discount.

Personally, I am tempted to buy silver and silver-related assets given these discounts.  Even if prices are weak short term, I know they will be much, much higher in the intermediate and longer term.