Gold and Silver Roaring Back

August 26, 2013

After a couple of weeks of declines, the S&P500 managed to eke out a small gain last week, rising less than 0.5%. Volume was very light. In fact, August volume is coming in at some of the lowest levels in the last decade. For all the talk of investors ‘rotating into stocks’ it seems that it’s just that—talk, The dismal volume figures suggest that people are not rushing back into stocks, when they sell their bond holdings. Instead, they’re just hiding out in cash. Volatility also barely changed, but at historically very low levels, levels still associated with a great degree of complacency.

The technicals are still painting a topping picture on the weekly charts. Upward momentum is stalling and lots of the internal indicators (eg. breadth signals) are still weakening. This means that increases in prices are being led by fewer and fewer stocks, while at the same time many other stocks are falling, often to new 52 week lows.

The daily charts, on the other hand, are pointing to the possibility of a short-term bounce. The modest price increases towards the end of last week may carry over into this week.

The big story for the markets continues to revolve around the Fed and its planned taper of perpetual QE. So the US economic data are influencing the markets in a perverse way. Any improvements in data are greeted with fear because economic improvements give the Fed more reason to go ahead and taper QE. This leads markets to sell off. On the other hand, any deterioration in data is greeted with cheers; bad data means more QE, and more QE means higher stock prices.

And last week’s macro data was mixed, which meshes well with the mixed results in the stock market—the S&P rose slightly but the Dow fell slightly. The Chicago Fed National Activity Index fell. This is a leading indicator and it continues to paint a picture of a slowing economy. Existing home sales beat expectations, but new home sales missed—-badly. Initial jobless claims rose more than expected. But both leading indicators and the Kansas City Fed Manufacturing Index beat consensus estimates.

After hitting a low of $1,182 in late June, gold has roared back to hit $1,400 last Friday. This is an 18% jump in less than two months. Silver’s snap back has been even more impressive. After touching $18.15 in June, silver climbed to well over $24 on Friday. This is a 32% spike.

What happened?

Despite all the pronouncements that the secular bull market in gold and silver has ended, it looks like this call may not be accurate. More and more evidence is supporting the argument that the paper price of gold was taken down (and silver follows) to allow entities that are ‘short’ the metal to get their hands on it to satisfy delivery requirements. But while the GLD did disgorge physical gold, the gambit appears to have failed as almost all other natural investors in gold actually accumulated the metal on the price drop. Strong evidence supporting the argument that the price was manipulated down rests with the major US metals exchanges which saw their inventories fall to dangerously low levels. If the price were truly market-driven, inventory would not evaporate……but it did.

So now, while some major ‘owners’ of gold, such as Germany (which is forced to wait seven years to regain possession of only a small portion its gold), are still missing their gold, the challenge to satisfy every gold owner who wants to take delivery just became that much greater. Instead of scaring owners of gold into selling their physical gold, the entities that engineered the recent price drop only served to create more demand for the metal.

The bottom line is that the price of gold is starting to return to levels more in sync with the actual physical supply of the metal. Since supply is tight, the price must rise.

And sure enough, the price is rising.

US Treasury Rates Soaring—Not a Good Sign

August 19, 2013

The S&P500 slumped over 2% last week, recording one of its largest weekly losses of 2013. The volatility index, or VIX, increased only slightly. And volume was not very strong. Both of these points suggest that the sell-off, while meaningful from a percentage standpoint, was not rooted by panic selling where investors were rushing to get out of the stock market.

Technically, especially beneath the surface as expressed by breadth signals, things are looking more bearish. Momentum to the upside has clearly ebbed, on the daily charts. But upward momentum has not turned down on the weekly charts. In terms of breadth, new lows are now greater than new highs, and this indicator looks like it’s going to get even worse over the next several weeks. Also, the percent of stocks above the 50 day moving average has turned down decisively. This is also a bad sign.

On the surface, the stock market has not sold off all that much. Despite the recent price weakness, prices are still not that far away from their all-time highs. But beneath the surface, the breadth indicators are turning bearish, and this is often a precursor to a much more severe price sell-off, one that would turn the more important weekly price and momentum indicators down also into bearish mode.

The US economy, meanwhile, is limping along as usual. The headline retail sales report missed expectations. So did business inventories. Producer prices came in lower than projected; consumer prices met expectations. The Empire State manufacturing survey also missed expectations. And the Philly Fed survey badly missed. Industrial production, at 0.0% was well below estimates. Housing starts missed. But the biggest miss of the week was consumer sentiment—instead of rising slightly as expected, it collapsed, notching its biggest miss on record….going back to 1999 when it was first introduced. Clearly, the US economy, now over four years after beginning it’s so-called ‘recovery’ is nowhere near to truly recovering.

Several months ago, we noted the burgeoning development in the US Treasury markets—namely that interest rates were beginning to rise—and that this could be the precursor to other negative market movements. Well now, over two months later, US Treasuries have sold off even more. The 10 year rate is now approaching 3%, when about a year ago it was under 1.5%.

As mentioned in the earlier post, rising rates—when inflation is largely steady—means that REAL interest rates are rising. This leads to several negative consequences. Corporations will reduce investment in capital expenditures, which will lead to lower growth and lower profits. Corporations will have to pay more to borrow on their existing debts, which will lead to lower profits. Consumers will have to pay more to borrow ¬†for everything—homes, cars, credit purchases—which will also lead to lower corporate sales and profits. Finally, investors will be more enticed to pull money out of stocks, ¬†because they will be able to earn fatter returns, at lower risk, by buying US Treasuries; this leads to a greater risk of a severe correction in the stock market.

US Treasuries are not, by any means, rising for the typical good reason—the economy is booming and rates must rise to reflect the good times.

So while the warning a few months ago was tentative, the warning today is becoming louder and more serious. Not only have rates risen substantially recently, they look like they could rise even more.

If so, be prepared for a major risk-off moment, or two, when ironically, if stocks were to sell-off, money could flow out of stocks and back into Treasuries driving the yields back down.

Larry Summers for Fed Chairman?

August 12, 2013

The S&P500 lost a little over 1% last week on abysmally low summer trading volumes. Volatility crept up over 10%, as measured by the VIX, but it’s still near multi-year lows. There was certainly no panic in the selling activity last week.

In a light week for data releases, the ISM services index beat expectations. And so did international trade; in other words, the trade deficit improved more than expected. Consumer credit rose less than economists predicted. Initial jobless claims were slightly better than the consensus forecast. And finally, wholesale trade missed.

So the US economy, while not falling apart, is limping along at near stall-speed in terms of growth. Meanwhile, the US stock markets, near all-time highs, are priced for perfection, not only in terms of corporate earnings growth, but also in terms of strong US economic growth expectations.

Technically, the S&P500 has turned down on a shorter term basis, specifically on the daily charts. This suggests that there might be some more near term selling ahead. But on the longer-term weekly and monthly charts, the S&P is still pushing clearly into overbought levels. And longer-term momentum still favors some continuation to the upside. On the other hand, market internals are turning bearish. It seems as though fewer and fewer market leaders are responsible for the overall market advance, while many other firms are lagging behind in appreciation or even starting to drop in price. This is often a sign that the stock market is poised for a more meaningful pullback.

Talks of the ‘taper’ in the Fed’s QE policy is quickly shifting to heated discussions about the successor to the Fed’s leadership role, now occupied by Ben Bernanke, who has announced that he will not be seeking another term when his current term expires in January. So Barack Obama will soon need to announce a candidate, subject to approval by the Senate, to become the next chairman.

For the last year or so, the current vice-chair, Janet Yellen, has been the odds on favorite to succeed Bernanke, and the risk markets (especially stocks) loved this because if anything, Yellen has expressed an inclination to print even more money than Bernanke. And as we all know, in the short-term, this QE printing program has helped prop up equity prices, especially since the printing is currently open-ended, the taper notwithstanding.

But in the last two weeks, former Treasury Secretary and while house economic advisor and close friend of Barack Obama, Larry Summers has emerged as the new front-runner to replace Bernanke.

Why could this be important to stocks?

Simple—Mr. Summers, over the course of numerous discussions and presentations in the last year, has openly questioned the effectiveness of QE. So, if nominated and confirmed, there would be a greater risk that QE gets shut down instead of just cut back slightly (the taper).

And if this were to occur, then the stock markets in the US, and likely around the developed world, could throw a temper tantrum by selling off very hard.

So stay tuned. Obama must make his decision very soon. Maybe this could be the straw that breaks the camel’s back in terms of the artificial manipulation of stock markets.

Dismal Prospective Returns

August 5, 2013

The S&P500 crawled up about 1% last week on abysmally low summer volume. At the same time, volatility dropped back down to near record-low levels as investors once again seem to have dismissed the risks that stock market, near its all-time highs, could possible decline—meaningfully—from here. Corporate sales are falling. Corporate profits are weakening. And the US economy is stalling. Yet the US stock markets keep on chugging along, as though nothing could possibly stop corporate profits—still near record high levels when compared to sales or GDP—from growing even more.

Yet in other markets, the picture was not so optimistic. Treasuries sold off again for the week. So did investment grade corporate bonds, as well as high yield, or junk, bonds. These markets, combined with their derivatives markets, are far larger than the combined US stock markets. And these markets are expressing a bearish message. One of these two camps is wrong—either the stock market is too high and will come down to meet the larger credit markets, or the credit markets are wrong and will go back up to meet the exuberant stock market. History shows, over and over again, that the credit markets are almost always right.

The US economy is still limping along, struggling to gain traction fully four years after entering its so-called ‘recovery’ in mid-2009. Last week, pending home sales missed. The Dallas Fed manufacturing survey missed. Consumer confidence missed. Chicago PMI missed. And construction spending missed. The first estimate for Q2 GDP growth beat expectations, but only after the first quarter GDP growth was slashed almost in half. And still, even with the Q2 beat, growth is anemic. Initial jobless claims beat expectations as did ISM manufacturing. However, the big number of the week, payrolls, was a big miss, on several fronts. First the headline jobs number, at 162K, came in lower than the expected 175K. Then the workweek fell below consensus estimates. Next, average hourly earnings plunged; instead of rising 0.2%, the fell 0.1%. Finally, the labor force participation rate dropped, which means that even more would-be workers are so discouraged by hiring prospects that they’re simply leaving the workforce and are no longer even counted as being unemployed by the Bureau of Labor Statistics.

Technically, the S&P500 is extremely stretched. On multiple technical measures, the stock market is grinding along at highly overbought levels. which means that millions of investors are comfortable riding this wave all believing that they’ll have no problems exiting the party, or the market, at the first sign of trouble.

John Hussman, long time money manager, in his weekly comments points out that as the stock market grinds ever higher, returns in the future will by definition continue to creep lower. And today, the US stock market is priced to return only 2.8% per year for the next ten years, with severe price volatility to be expected in the interim. This is the lowest 10 year prospective return since the tech bubble highs in 2000.

He measures this prospective return several ways. He first notes valuation using the Shiller PE, and today at 24, the stock market is far over his 18 threshold for being over-valued. He also judges whether the market is over-bought, which is primarily dome by looking at Bollinger bands at the daily, weekly and monthly resolutions; and yes the stock markets are over-bought. He then looks at bullish sentiment by comparing the bullish vs. bearish sentiment of investment advisors, and yes, the stock market is overly bullish. Finally, he assesses whether the US 10 year Treasury yield is rising when compared to its yield from six months earlier; and yes, this too is happening.

But the worst part is not the measly 2.8% prospective yield over ten years (which by the way, Hussman has been estimating with 90% accuracy for several decades). The worst part is the intervening price volatility, which means that even though the 2.8% annual yield may be achieved, the market conditions—as outlined above—are almost always associated with intervening price drops over 40% or more.

So the question is, if you’re buying into the stock market now (or just deciding to hold on to what you have), are you really prepared—emotionally—for the strong possibility of massive, yet temporary, price drops along the way, over the next ten years?

What we learned in 2000-2002 and again in 2007-2009 is that while most investors say they are ‘buy and hold investors’, very few actually have the stomach not to sell out near the lows, much less put new money to work at the lows. Instead, most people—professionals and retail alike—tend to sell near the lows, locking in losses, and therefore never actually realizing their former paper gains.

This challenge is once again facing investors in the US stock market today. And once again, good luck with the ‘holding’ part of the investment strategy.