In the current policy and media stoked market environment, anything is possible. It’s the wonderful, magical world of hands-on policy making. 5 years after the financial crisis, but still not enjoying a ramping economy like the good old (and long gone) days of the last great secular bull market (RIP 2000)? Just sit back, relax and let the man in charge control the image.
The media love to get a hold of buzz words and then give them a spin and a life all their own. Recent examples were the mainstream media’s presentation of ‘Operation Twist’ – which was simply an official yield curve manipulation designed to sanitize and dampen inflationary signals – as an inflationary operation, and the ‘Fiscal Cliff’ drama that sent herds of conventional investors to the sidelines* when they should have been contrarian (and bullish) back in Q4, 2012.
The world expects the FOMC to update its expectations regarding a tapering of Treasury bond asset purchases tomorrow. The world thinks that a tapering of these purchases would be bad for gold.
I think a decrease in T bond purchases would be anything from neutral to a potential positive (see post coming later today on the matter). Regardless, it is time to be looking out beyond FOMC with regard to the precious metals, a most sensitive sector to monetary policy.
So here is a check list of what we want to see in order to press the bull stance.
As noted, this week’s letter was a difficult one because it raised a lot of questions, many of which seem to have opposite implications. Going forward I will try to be very clear in focusing on individual aspects of the macro picture as opposed to throwing everything up against the wall the way I think #255 did.
The individual aspect nagging at me from #255 is the yield spread issue. Here is a chart of gold and various yield curves, with the 30-year (TYX) as the constant, being divided by various other durations.
It had been established through gold’s bull market that the price of gold tended to rise with a rising yield spread, until the relationship went off course last year during the Operation Twist phase, when the Fed sold short-term bonds while buying long-term bonds. During that phase, inflation expectations were ‘sanitized’ right out of the picture, even though they were inflating. It was almost by magic.
As noted in #255, somebody is now selling short-term T bonds more aggressively than long-term bonds and I have been in this racket just long enough now to at least have suspicions that this is not an arbitrary situation. My more paranoid self wonders about potential back room agreements as to the structure of large T bond sales by big macro economic partners.
To put it plainly, I wonder about the potential that US policy makers and Chinese Central planners are on the same page as to how the process of China’s disgorgement of bonds may play out. The Fed used up its supply of short-term bonds and terminated Twist. By then damage had been done in the precious metals and momentum, media PR and whatever manipulation employed by the ‘boyz’ (it’s no secret, there is manipulation of the gold market; it’s just a fact… but never an excuse) probably helped push them to the lows registered in June.
In late 2012 gold had been following the yield spreads down during a routine and what looked like a healthy post-Euro crisis correction/cyclical bear. Then the curves turned up (I assume this was due to the Fed’s exhaustion of short-term bonds to sell) but gold and silver disconnected and crashed I assume for the reasons noted above, but also because it was simply time for them to take a frightening decline, which had not yet happened in the secular bull.
The curves then tanked as well and I assume this is due to short-term durations being sold more heavily than long durations by China and/or Japan. Can I prove it? No, not with the data available currently that I know of.* In the last couple of weeks this condition has intensified even as the precious metals rallied.
* Please forward if you have additional data that looks into the structure of Chinese/Japanese bond sales beyond the raw TICs data, which simply notes “T-Bills, T Bonds and Notes” with no discrimination about durations.
The bottom panel of the chart happens to be rising fairly aggressively. That is because the Fed is holding ZIRP while free(er) interest rates rise. That is the ultimate yield spread as policy is absolutely loose while inflation expectations (at least as implied by rising yields) creep upward. If indeed there is strategy behind how US creditors are unloading T bonds, the 30-T bill spread is probably the only honest one in play. But will that matter?
In the past we likened Op/Twist to a macro parlor trick. Well, trick or not it played a roll in the precious metals cyclical bear market and it appears that sellers of Treasury bonds are Twisting once again.
I would be flat out guessing if I pretended I could tell you the why’s and what for’s with respect to how this could benefit China, but one thing is for sure; a similar dynamic benefited the US greatly over the last year. Parlor trick or not, people believed in its signals. And is this not a market and an economy that is all about confidence?
At the moment I don’t think this development as a panic issue, but speaking for myself I am not going to tolerate much additional downside in the gold stocks. As it is my personal speculative portfolio is 77% cash with the balance in precious metals stocks roughly per the model portfolio here at the site; quality only.
There is a reason I do this weird and I guess complicated work and it is because I hate losing and in this macro game we are playing the stakes are high and as the last year showed us, anything is possible. So please, if for fundamental reasons you are secure in your orientation understand that it is my job to disturb things and ask hard questions. Even maybe to make you feel uncomfortable at times. But it is never my intention to try to influence you beyond a reasonable and balanced approach.
The above work could be much ado about nothing, with the ZIRP spread being the key. But I trust that in these times many of you would rather have too much information (to sift through with your own b/s detectors) than too little.
I personally remain ready to gear further in to the precious metals or get the heck out (aside from real gold). Meanwhile in the regular personal portfolio I hold several equities (US and global) with charts and businesses I like, but also offsetting puts on the S&P 500. Part of what I’d like to flesh out going forward is the effect another Twist (instigated by foreign sellers this time) might have on US and global markets.
When you don’t fully understand something (as I do not with the current yield spread status) caution should be the default. My friend Mark at Inca Kola News quoted something in his newsletter* last week that I wrote a few months ago: “It is time to be right by not being wrong” or something along those lines. I had actually forgotten about that, so thank you for the reminder Mark. I think that given the situation in T bonds and the fact that the inflation case is not yet proven, it’s a good way to go until some things clear up.
* IKN Weekly continues to be what I consider the standard for ethical, grounded and hard working quality analysis of the mining sector.
Here is the chart we have been using in NFTRH, showing inflation protected T bond fund TIP vs. regular T bond fund TLT.
This ratio has been bottoming for months now and in the last few weeks had made some failed efforts to break out. Last week it closed above the bottom pattern neckline.
From NFTRH 252:
“TIP-TLT can be thought of as a barometer to ‘inflation expectations’. That could be what the precious metals, led by silver, are indicating in tandem with the above ratio. At the very least, it looks like a ‘deflationary expectations’ phase – which helped feed Goldilocks and croak precious metals – may be ending.”
Goldilocks lived by the deflationary pressures that Europe’s meltdown and China’s slow down exerted upon the world. Now, with the latest TICS report showing China and Japan selling T bonds we suddenly have the Fed’s Huey, Dooey and Louie jawboning a ‘taper’ of bond buying in the media. Ha ha ha… as if they have a decision to make.
The Treasury TIC data are only through June, which just happens to be the month we observed the breakout from bottoming patterns in 10 year and 30 year bond yields. But the play always (and I am talking nearly a decade since we began following this dynamic) been that America’s voracious consumption habits would be used to build out the Chinese economy on credit. They would not let us abuse our ability to inflate without consequence forever.
Do they perhaps feel built out enough for the time being? We’ll find out in future TICS reports. But I’ll just say that everybody thinks they know that there is no inflation and in this market what everybody thinks they know could well stand to be wrong. I have rarely seen so many of the right people on the wrong sides.
The destruction culminating in late June in the gold price brought out the usual suspects to school us ever since about why gold is all done as a worthy investment in an era of economic revival, compliments of heroic policy making by Ben Bernanke and Associates. Perceptions are now fully cemented toward policy maker control and a new global growth cycle.
These gold-negative voices included a pair of academics, the widely followed media star Nouriel Roubini and a lesser known writer named Robert Wagner, who has been riding the gold bear wave with a series of articles at SeekingAlpha, talking about how the main pillar supporting gold – the fear trade – is dead.
So we have a perma bear and new era bull coming at the barbarous, non-dividend paying relic from both sides! Excellent. Just as a tidal wave of knee jerking financial refugees piled into the ‘fear’ trade – as Wagner calls it – in 2011, the tide has spent two years slowly going out. But now the tide is starting coming in again on gold even as happy stock market and economic perceptions are being cemented; just as gold is doing this…
Our downside targets had allowed for just below 1000 up to the mid-1250′s. Gold poked down below 1200 amid fear, loathing, angst and all the other good stuff you need for bottom making. It did this while putting in a bullish divergence by the momentum indicators even as all the reasons to puke gold were chronicled by people who had waited a decade to do so. These reasons were also readily obvious to the public and the public puked gold, and the new found and cartoon-like gold bug ideologies they adopted in 2011.
Gold fanned upward from the positive momentum divergence and has now broached an important resistance level. This as the stock market appears to be cracking just as promoters there tout a new secular bull market for the public to suck on. Here’s the big picture chart from NFTRH 251.
In 2 years Ben Bernanke has gone from a goat (as Bond King Bill Gross poked him in the eye with a famous and ill-fated inflation inspired Treasury bond short position) to “hero” with his self-satisfied mug on the cover of a major magazine. We reviewed this dynamic here.
The point though, is that the S&P 500 is only doing the equal and opposite upside thing to its over done downside in 2009, which of course launched the cyclical stock bull amid epic suicidal sentiment.
Now we have people promoting a new bull market, players all-in on margin and the public moving in hard as well. The supporting data is beyond this post’s scope. Go look for it, you’ll find it. A “new secular bull market” is what people who think they are somehow being contarians 4.5 years into a rapidly maturing cycle think.
Here’s a closer look at the S&P 500.
Oops, well maybe it is just another ‘buy the dip’ or maybe it is the final ‘oops’, coming with a new fairy story fully told and all the right players positioned as they should be, with people who buy promotions all in and people who don’t prepared for big changes on the macro.
Regardless, the right people are lining up on the wrong sides, just as changes are set to come about. This is signaled by the impulsive moves in the precious metals (led by silver) and yesterday it manifested in a break upward through resistance by the Gold-SPX ratio.
A little history; we used a monthly chart of the SPX-Gold ratio like the one below to remain aware of just how bad things could get for gold and/or how good they could get for the stock market. When the 1.23 (+/-) target area off of a clear bottoming pattern was satisfied, gold no longer had this technical need hanging over its head in relation to US stocks. Now we have the break above resistance and the 50 day moving averages by the Gold-SPX daily chart above.
So with perceptions fully cemented in an equal and opposite way to March, 2009, 4.5 years into a very mature cycle we are ready for change.
But the the precious metals have been led by the impulsive and excitable little brother, silver. Going forward the stodgy old man, gold, could play some catch up. But first, this chart of the Silver-Gold ratio shows a panic to get in that is not sustainable.
Silver-Gold became over sold in the spring, put in bullish divergence by RSI and MACD (not shown) through July and simply exploded. It is getting over baked right now. There are several other cautionary data points that we are covering in NFTRH that will guide traders about what to anticipate on the near term, but the bigger macro theme is change.
This change was led by silver, it favors the precious metals sector and it could have some legs to it. The last two years were worse for the precious metals than I thought it would be in 2011, when we became guarded about the over loved status of gold and silver. Through an emphasis on risk management we remained intact first and ready to capitalize second (per NFTRH’s oft-stated mission).
We are now capitalizing and this could run for some time to come. But the precious metals promoters are licking their chops now as they know full well it is time to suck in the herds. There will be corrections and volatility going forward but as I have done from day one when I began writing, I’ll just ask readers to tune their b/s detectors and go about things in a rational way. The initial panic burst is getting a little over done.
Don’t get played over bullish on the rallies or over bearish on the corrections. It should be a long ride because the bottom is coming from epic negative sentiment and the initial statement, made so well by silver, was a strong and impulsive one. This implies change. Stock market bulls might also consider the implications of change.
Last week the Silver-Gold ratio (SGR) failed to get with the bear memo as the sector got a hard shakeout, and look what happened. This week through the ups and the downs silver has continued to lead.
If it gets through the red dotted line we might say bye bye to the precious metals complex, leaving the smart guys schooling people about why to avoid gold and silver like the plague rationalizing all the way up. Silver’s leadership, along with what is going on with China also says to me that an ‘inflation (effects) trade’ may not be dead after all.
Here is TIP-TLT, a spread between inflation protected and unprotected T bond funds, trying to break out yet again this week.
Separately, did you see Jim Cramer jumping around last night talking about how global stocks are now starting to carry the US market, doing the heavy lifting, instead of the other way around? Why not just state that the risk vs. reward globally is better than it is in the US, Jim? Here’s FXI-SPY, maybe a little too peppy of late and at resistance, but definitely having turned the corner.
Speaking of global stocks, here is an interesting comparison showing the TIPs fund correlating pretty well with the emerging market ETF of late.
TIP got hit yesterday in the T bond rout, but has been in a similar pattern to EEM since May. Is EEM saying that TIP will soon turn up as well, along with an inflationary phase? Regardless, TIP’s relationship to TLT should continue to guide.
The chart above is the main reason I own Europe for a trade and a trade only. It spent months testing support at 2500 and targets 3000+.
Here is housing in the US, continuing to degrade and I continue to hold put options on it.
Although I continue to wonder how I would be allowed to profit from such an obviously bearish chart. That measly support at the June low is holding so far. If it breaks down and considering the interest rate backdrop, a long banks/short homies spread would have worked very well. I sold pig positions KRE and IAT, so I have done that spread, just not concurrently.
The post started as a big picture look at the SGR but ambled along through other areas too. That makes sense because silver’s relationship to gold is a macro credit spread of sorts and it is bullish. As substance abusers and casino patrons look for a new hot play, they may find it in silver.
This may signal that the macro markets – while changing to emphasize global stocks – will not ultimately top out until sometime in 2014, which is our current plan. If gold had continued leading silver (either up through greater gains or more likely down through lesser price destruction) things could have gotten dicey on the global macro.
I have a group of quality precious metals positions and a long standing view of real gold as value. I have a group of what I think are good US stock positions along with ETFs covering the global picture in the event that the inflation, pumped so hard by US and other developed nations’ authorities, finally begins to take root and kick off some effects.
It is not early in the inflation cycle. It is late. But the effects have thus far only rooted in US stocks. I think it may now fan out before it flames out. All subject to tweaks, revisions and the improved focus that events yet to unfold add to the picture. The market is getting fun again.