Weekly Gold Market Outlook
A Gold & Currency Digest
And The Shifting Pendulum Of Courage
Gold closed off nearly US$36 Tuesday to US$575 in a general metals sell off that has seen 25-35 percent lopped off metals like silver, copper and palladium since May. Not surprisingly it is holding up better than the other metals in recent days and weeks; and the gold shares, though among the worst performing equities in recent weeks, also demonstrated some visible fresh resilience in the face of steep commodity declines (perhaps because they were weaker during May?).
Technically, as the HUI flirts with the 280 handle and gold prices with the US$560 range, the market is at an inflection point where it is threatening to breach the maximum downside parameters of the 12 month old intermediate sequences, and even reverse (as opposed to merely halt) those trends. The other gold stock averages similarly breached their last highest intermediate lows which were made in March. The number corresponding to intermediate trend support for gold is actually US$535 because that is the last highest low in the intermediate sequence (for the record these sequences are technical concepts defined and identified in terms of "specific," concrete and visible highs and lows).
It is now wholly arguable whether the previous intermediate trends in the gold stocks are good. In fact, even if gold were to make it to new highs, I am now inclined to think that the top for gold stocks in the primary (five year) sequence is in.
In other words, even if gold surged to US$900 by September, the gold stocks would on average lag and in all probability not confirm those highs in gold. In fact, some of the blue chip gold stocks already failed to confirm April's new highs.
It is tougher to make a case for significant intermediate term (1-2 year) gains in gold stocks now, and especially from our original selling points (Jan/Apr) unless one is prepared to accept the hypothesis that the five/six year sequence in gold is going to extend to the very high extremity of our present valuation range (US$1700) before it completes once and for all.
But even then, I would argue, the gold equities are likely to underperform gold.
In any case, if my intermediate gold, currency and stock market outlook proves correct then the odds are we are near or at the low end of what could turn out to be an intermediate trading range, implying that at least in the short term they are oversold. So far the short term behavior of those macro variables has not been supportive. The stock market is down 10%; but so what, gold stocks are down 30%. The US dollar has brushed it off, and the Fed is not backing down. In fact, Wall Street is talking about strong second quarter earnings. No crisis surfacing here yet, except in the gold, housing and commodity related sectors. Housing… now that could be a bad thing to be hawkish about, politically?
Anyway, while I could not argue with anyone that an intermediate correction is underway in the gold stock averages, I would still argue that the same cannot be said of gold itself yet - at least not technically.
The last highest low in gold's intermediate trend is US$535, also made in March, and the bears are only now threatening to push the "normal" boundary of this particular trend.
Of course, if this number is breached also, my short term call - that the bullish intermediate sequence (in gold) will hold - is going to be wrong, and my call for higher highs this year, before the onset of a (primary) liquidation of the six year sequence, should be reassessed. In a liquidation of this kind, should it get underway, gold could easily revisit the low US$400's by yearend. But for now, it is important to note that while my short term call is a little offside, the downside parameters of the intermediate sequence are still good - thus the trend as well as the fundamentals is still our friend.
I'm talking about gold alone - my intermediate outlook on the non-precious metals turned prematurely bearish ever since copper advanced through US$3 and silver through US$13. In fact, that outlook is still the wrench in my bullish gold outlook, but I continue to prefer the view that gold is both relatively and fundamentally cheap, for which the chief premise is that the markets have generally over priced growth and under priced inflation if you will. Indeed, there is a gold lining to all the current hawkish rhetoric, which is that the Fed is limited in how hawkish it can be without confessing too much of an inflation problem, or risk retribution in the bond markets where inflation expectations have been most contained.
In terms of commodities, in other words, the Fed may have pricked a momentum bubble; but in terms of gold it cannot be more than a healthy cleansing because 1) it is still undervalued, and 2) the inflation trade was far from most popular.
But I know we should have sold more than we did. I wrote even then that I would think exactly this when the correction came. They always fall more than expected, particularly if those expectations are made while one's psychology is still bullish. But in this business it is usually right to sell when it's toughest, psychologically, to pull the trigger.
Conversely, it is often lucrative to be a buyer at just the moment that you typically would shy away. Until now the correction in gold has been steep but within the range of previously bullish expectations. But today's move knocked at those boundaries, and as such it is certainly testing bullish conviction. So now is the time for the bulls to step up, and show potential buyers what they think about this; not when the market has been rising 10-20 bucks a day for months!
Let us now hear the bullish conviction that fired up the Internet - with talk of Gold US$2000 this year or next or that gold prices would NEVER see US$500 again - at the very height of gold's best bull market move in almost three decades!
Bah-ha-ha-ha… bull market food.
Well, I'll step up now. For gold, and maybe even silver, as well as the PM equities, I believe the worst of it is behind us in the short term outlook, and this extends to the intermediate outlook for gold specifically. I'm usually a little early.
Indeed, it is the bears that are the courageous ones today.
Several Federal Reserve officials have joined their chairman in recent days in pulling their heads out of the sand to acknowledge the risks of letting inflation expectations get too far out of hand, adding impetus to the newly emerging bearish argument positing higher REAL interest rates and threatening a genuine monetary policy tightening.
Even Mr. George Soros jumped on the bandwagon, saying "Commodities probably are in for a period of correction... We are in a situation where all asset classes are under pressure because of a reduction in liquidity." Interestingly, he also called for a weak "dollar", and didn't say anything about gold itself (at least as far as I saw). See link below:
In the backdrop, moreover, and notwithstanding, the beaten down US dollar has been getting some mileage out of the hawkish central bank rhetoric and the potential appointment of Goldman's former CEO to the Secretary of Treasury, which has stirred the ghost of Rubin's strong dollar policy. Evidently, policymakers mean business, for now.
This is the message the markets appear to be taking. And so far the Fed is not relenting on its newfound hawkish resolve despite the nearly 1000 point drop in the DJIA and the 90 point drop in the S&P 500 over the past six weeks.
But this does not refute my general hypothesis on the depth of the Fed's current resolve. I would not expect to see cracks in it at least until the 20% rule kicks in - i.e. until the DJIA falls through 9750 (or 1150 for the S&P 500), which is another 1000 point decline from today's levels. They are probably willing to wait until the effects of this new determination to wring out 'some' of the inflation risks become apparent as an erosion in unemployment or any of the growth statistics, or until one of the enterprises that have grown dependent on easy money conditions and did not expect a real "tightening" blow up, or until the US President decides he needs to finance another military expedition, etc.
You pick it, but this new hawkish stance (it is not yet a policy) does seem to have 'some' if limited legs.
The next FOMC is June 29th. One empirical fact that gained momentum throughout the 2005/06 advance in gold prices is that they tended to rally in the run up to each FOMC. I'm not sure if they will this time but I would hypothesize that if they do, the intermediate bull trend is still good. If they don't then it could suggest that the Fed's recent hawkish comments effectively broke the bullish momentum of this advance and so long as it doesn't abandon this resolve, a top could be forming in the gold sector. Still, I am skeptical. The central bank has a record of talking tougher than it acts, especially just before a potential action. It would only be a further deviation from its stated goal to increase transparency if it suddenly acted tougher than it talked. Perhaps I am underestimating the resilience of the economic 'boom' but I do not yet believe that the central bank can afford too much of this check on inflation. For now maybe the risks of inflation seem to outweigh the risks of an economic slowdown; but if stock prices continue to plummet, at some point that is soon enough, the risks of a slowdown will inflate and the monetary policy pendulum will swing the other way again.
It is anyone's guess what the exact trigger might be but equity traders everywhere have already voted with their feet, abandoning the easing/pause trade that has fueled the advance in almost every equity sector for more than a year.
If this continues and the market falls through the aforementioned support levels, the first real test of this resolve will have arrived; but until then or the next FOMC the Fed's newfound resolve must be considered to be untested.
A genuinely tightening Fed might be bearish for commodity prices eventually, but if the current bear raid is but a bluff, well, V-shaped baby. In other words, the gold sector is increasingly attractive from the long side again as the bears push the DJIA closer to 9750, which happens to be the final support point for the three year bull trend. At that point we would expect cracks in this resolve to surface, and easing speculations to recover. Or, maybe instead of a return in the easing plays, we'll face a dollar crisis arising from an asset crunch where the Fed may be forced to continue hiking nominal interest rates, but before then I would expect to see signs of a confirmed bottom in gold and the gold shares.
What to Do With the Cash?
Our allocation is geared towards capitalizing on the intermediate trends which we did between January and April by reducing the gold stock position by 25 percent and cutting back our gold bullion long by 10 percent for cash… yes dollars. We do not have a foreign currency position and have not been short the US dollar since early in 2005 in the anticipation of generally reduced volatility in the currency markets, especially relative to the commodities markets.
However, after turning bullish then neutral on the short term outlook during the first half of 2005 I became bearish on the foreign exchange value of the US dollar again in the summer of 2005, but not bearish enough to warrant a position in this asset class in light of the opportunity costs in other asset classes. A trading range has become apparent on the charts, meanwhile, and just as the crowd gets used to it, the next great call is going to be which way it's going to break out.
The outline of a weak two year head and shoulders bottom is evident, but it is unconfirmed and must remain a mere potentiality. There are lots of reasons to be bearish on the real value of all the currencies, but on a relative basis there are lots of reasons to be bullish on the greenback (relative to other 'currencies' - not gold) also, superficial or not.
So for the moment I have no strong conviction or insight on the short term direction of the FOREX markets, but I think the burden of proof is to dollar bulls and thus it is probably wise to stay generally bearish until the market breaches the resistance level that controls the neckline of the potential bottom (or trading range) at 92 on the NYBOT USd index.
Our allocation, after April's reductions, is still concentrated (60%) in the gold sector, which on a relative basis within the commodity spectrum I believe is still absolutely the best place to be. The cash component makes up about 15% of the total allocation (for the first time since inception), and the remaining 25 percent represents a short against the financials (Tnote, S&P 500, and XLF SPDR). Thus, we are adequately hedged for a crunch in debt / equity values as they would affect the remaining gold stock long (30%), and the allocation generally already reflects a more cautious outlook for the gold sector in the intermediate outlook (we don't trade the short term trends). The gold stocks may make a good short term trade but the greatest scope for an intermediate move, I believe, will occur in either gold itself or the stock market.
I'm speaking in terms of the various asset classes.
In light of this particular allocation I believe the best action to take is to increase the short position against the S&P, thereby elevating it from a hedge (8% of the allocation) to "bet" status (20%) in our portfolio - no fundamental leverage.
Those figures are approximate, and I will update them precisely in the next issue.
Going with the hypothesis that the FOMC is going to run with this "tightening" ball until something blows up, and that the growth trade is the most over priced (i.e. the economy is really not growing as fast and strong as the pundits say it is), we are committing our total cash reverses to an increased short position against the benchmark US equity average.
Although in practice this position would be finessed, for reporting purposes we will merely record the average value of the S&P in tomorrow's session. Moreover, there are probably better sectors or averages in the global equity realm to short than the US average but implicit in this move is: 1) a vestigial bearish bet against the US dollar; and 2) an unwillingness to initiate any meaningful new positions on account that I am winding down the report in its current format. Lastly, the actions I take in this allocation should never be construed as personal advice because they are always relative to the specific allocation that we have managed which does not take into account the individual reader's own financial position and goals. This action is only meant to convey the general proposition that the environment is now bearish for stocks.
Editor - The GoldenBar Report
June 14, 2006
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