Complacency at Huge Highs despite US $ Weaker
Victor HugoMarkets are mechanisms that have evolved to convince people to buy when they should be selling - and vice versa. When confidence is high, it is seductively "rational" to climb aboard the trend and to expect to go for a profitable ride. Yet every good trend ends.
One of the best ways to recognize that the end of an up-trend is close is to look at various measures of confidence and complacency, such as volatility, the ratio of calls and put options being bought and sold -- and the net sentiment of buyers and sellers.
For some time I've been warning that the US, still the leader of the financial markets, cannot sustain a combination of increasing fiscal and personal debt and trade deficits in a stock market environment, globally driven more by liquidity factors than by established earnings.
Rational factors say that this must be right, yet markets go higher, despite the warnings from the US$. What is becoming clear is that not only in the US, but globally, there has been a massive attempt to stimulate growth with increasing liquidity from lower interest rates, in order to avoid stagnancy, recession -- or even worse, depression.
Liquidity driven positive earnings expectations have been important in fuelling confidence, but the problem is that earnings expectations are fickle. They can go, quicker than they came.
John Bollinger points out and like us is concerned about high confidence and complacency shown by the various indexes that measure this, such as the VIX in the US. Low volatilities are comfortable and reassuring to would- be buyers at first blink. Yet at current very high levels of confidence and after having come so far since March 2003, markets could be near a major correction or reversal.
Next thought most of us have when reading this is that these worries have been around for months now - and those who have stayed on the sidelines have missed some good opportunities -- and don't want to miss the next phase of what is perhaps an incipient bull market, despite the dire warnings.
Well, hindsight is perfect and it is easy but useless to regret over-caution. The factors that preceded the strong markets since March don't apply now. Does one want to be a buyer after a strong 9 month push at technically over-bought levels, or does one want to be a buyer after the next dip or dump? Surely a 10% or 20% or 40% dip/pullback/dump must offer better buying opportunities in 2004 –better than trying to chase trend at current levels, after hardly a breather since March?
Perhaps most important is what the US$ has been warning since July 2001 and particularly since April 2002. In US$ Index terms, the US$ has fallen roughly 25% and the trend to weaker on technical factors is intact and arguably accelerating. Market veterans such as Mr. John Templeton warned already a month ago that the US$ has 40% downside potential in the next few years. This while the US adjusts to the reality of having to reduce borrowings and watches investment flow focussing elsewhere. If Mr. Templeton is right and I think he is -- there are huge implications for the global financial environment.
Firstly, China and much of Asia is already convinced that the next 2000 years belongs to Asia, at least financially -- if not militarily and technologically. China's growth rates and aspirations are startling. The "First World " just cannot compete against labour costs running at e.g. 1/10 of first world wage demands. Asia is steadily acquiring technology, copying and sometimes improving it -- and selling goods and services at much lower prices than the West can manage.
Secondly, resource producers like South Africa, Australia, Canada and Russia are going to do well. The hyper-stimulation of the global economy during the last two years if successful -- will lead to inflation. If unsuccessful, will lead to stagnancy or deflation and currency questions. Again resources as “hard assets” are beneficiaries.
Either way, resources/commodities are the name of the game for the next few years. Investment patterns will shift accordingly, with some of the money that was sitting in US Treasury Bonds and property and in Wall Street, moving to resource producers and to responsible developing markets. A period of massive adjustment and formation of new investment expectations and beliefs. What worked from 1981 to 2000 will not be repeated now.
China and the Middle East additionally have their own geopolitical priorities persuading them to disinvest from the U.S. if they can do so without hurting themselves financially.
Next, implications for South Africa are positive. The country has an established infrastructure, tourism potential (even with a strong Rand!), a problematic but growing new democracy -- and is a useful gateway for a regional development and then for development deep into Africa.
China and the Muslim world and the West are all jockeying for influence in the region. Meanwhile South Africa collects from all of them and reaps the benefits of still tentative long-term investment inflow and higher property prices and prospects for still lower interest rates – despite the inevitable shocks that will come along the way.
South Africa's mining industry is squealing in pain about the stronger Rand - after years of wage and cost increases, some stemming from a weakening currency. But we have to remember a positive outcome of all this is that for the first time in three decades, it is becoming attractive for the global resource industry to develop existing and new mines.
The land of platinum, gold, diamonds, rare earths and base metals -- has not sparkled so nicely since the Gold price rocketed to $850 in the 1970s. Although there will be some job losses and painful adjustment, South Africa will make a plan. This problem is a pleasant one after the problems already overcome.
And that is what the Rand is saying. Memories are so short. Investors already forget how pleased the tourism and mining industries were when the Rand moved from the ZAR$ 4.00's to the 5.00's in 1998. In the 6.00's we need to get lean and more efficient and we have a window of opportunity to do so in the changing global investment climate sketched above, with record low local interest rates helping.
As uncertainty about the US$ and other paper assets increases, perhaps the Rand is telling us another very important bit of information. That South Africa has one of the best reserve profiles in the world. First, its people - yes, even with all the social problems to be overcome.
But don't forget another huge resource -- the biggest known gold and platinum reserves in the world. In the ground. A good place to be -- where profligate politicians and others can't get their hands on it quickly.
So where to the Rand next year? ZAR$6.083 was a huge resistance, but momentum and fundamentals of interest rate and positive relative macro-economic trends can still fuel more Rand strength. Technical ranges and long-term cycles persuade me that next year's range will be ZAR$5.40 to 6.60 unless the US$ dumps dramatically.
The Rand is already in a reaction weaker since yesterday's 6.075, now at 6.218 -- but I will not be surprised at another probe stronger to the next major resistance at ZAR$5.93 before the end of 2003 – but would be surprised at stronger than that soon. Cyclical factors favour the Rand to take a breather weaker for a couple of months any time -- starting now or just before Christmas -- support at ZAR$6.60. To give some idea of the strength of this trend, the 50 day average is at 6.83 -- and there would have to be a lot of swinging work to change the direction of that trend direction.
However that comment itself also implies that a rubber band effect -- back to usual trend averages for a few weeks would not be surprising either -- especially if geopolitical and global economic intensity strikes as in September 2001.
No smooth rides.
Recommended market strategy for the JSE and most global stock markets remains defensive, looking to buy the dips in good value sectors -- when the dips or dumps come.
I think golds are a buy at current levels for those who are patient and believe in the macro picture discussed above.
For much of this year we have been forecasting the Gold price to $413 to the $445 range by end 2003. It looks like this forecast is on track and SA gold shares may at last start feeling the benefits if the Rand reacts a few % weaker or stabilises -- while the $Gold price does well. Let's not get negative about South African gold shares because of the Rand.
Many out there are amazingly now starting to say that the Rand can go to the ZAR$ 4.00's. It can, if the US$ weakens another 25% + and politicians continue to make the right noises. But the Rand going to the 4.00's may take a year or two or three. Not likely right away!
Meanwhile SA gold shares offer some of the best value out there, with price earnings ratios typically less than the life of the gold mines -- as Mr. David Shapiro points out.
US gold shares have already done well -- but as soon as the US$ or $Gold price takes a breather next -- profit taking could be intense. My recommendation on SA gold shares remains, buy the dips -- such as the current one.
The cycle and technical set-up still support scope for the $Gold price and Gold price in Euro and SF and JYen to rocket. Behavioural price and cycle counts indicating scope for two year scenarios – highlight the target resistance e.g. at $520 and $612.
Perhaps the most interesting aspect is that in non-US$ major currencies, the Gold price is only now breaking out or is near to long-term range breakout levels. Demand for the yellow metal itself is increasing -- whereas supply is limited. Have you noticed how quiet central bankers are about selling any significant gold reserves lately?
When the average global portfolio manager decides he has to up his portfolio weighting in gold mining shares from the current typical 3.8% to 7% -- he will look for value – and will find it in SA Gold shares.
More on share selection, levels, targets and strategy in our Turning Point, Traders Call and GOLDSIGNAL newsletters -- see www.HugoCapital.com and www.GoldSignals.com
4 December 2003
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