What Is Gold Telling Us?
Gold has done quite well since we last wrote about it. In late December we posted a comprehensive update on the technical and sentiment picture and so far gold's trajectory has largely played out according to the bullish wave count alternate we presented at the time. Not in terms of every wiggle of course, but the projection has so far more or less worked in terms of its rough outline. For an interim update of the wave counts and the sentiment picture check also our update in January following the unemployment report, where we argued that we didn't think that the report was a 'game changer' for gold.
This is what gold looks like at the moment:
Gold – so far not much different from the bullish alternate count we showed in late December. There is a slight momentum divergence between price and RSI in evidence at the moment and it is near a resistance level, so a pullback should not come as a surprise. On the other hand, if resistance at $1,800 should be bested, then a retest of last year's high would be almost a slam dunk – click chart for better resolution.
You'll notice that we have refrained from adding anything to the 'A-B-C' count above. There is a good reason for that – we're not quite sure if the current move up is part of a larger corrective structure or a beginning impulse wave. It is possible that the 'A-B-C' is itself only wave A of one higher degree, which would make the current advance a wave B of an ongoing correction. One argument that speaks against the idea that the recent advance is part of a corrective wave is that on smaller time scales, impulse waves have been evident. Below is a 5 minute chart showing the past ten days in the gold ETF GLD. The chart has gaps, as contrary to gold itself, GLD doesn't trade around the clock, but as the 30 min. chart of spot gold further below shows, the most recent wave up does look like an impulse (a 5 wave structure), with the lower degree up waves also looking impulsive.
GLD, a 5 minute chart showing the past 10 days of trading - click chart for better resolution.
A 30 minute chart of spot gold - click chart for better resolution.
All in all, this actually looks quite good, even though a short term correction may soon be at hand.
Unfortunately, it is not quite clear at the moment what gold is trading off. The market has seemingly treated it as a 'risk asset' that is pushed up by the oodles of central bank generated liquidity smothering the financial system - similar to what is happening with stocks and commodities.
On the other hand, gold continues to hold its own against industrial commodities, which would argue for the opposite view, namely that it is bought due to its 'safe haven' qualities. Gold tends to outperform commodities whenever economic confidence is waning. The rising stock market seems to say that economic confidence is actually increasing, but neither the yield on treasury bonds nor the gold-commodities ratio confirm this rosy interpretation.
The Gold-CCI ratio has gold nearly at a new all time high against commodities - click chart for better resolution.
It is no different against the more energy-heavy CRB index – gold is holding near an all time high against it - click chart for better resolution.
So, we don't quite know at this stage what gold will do should the stock market decline. Looking at interest rates, below are several charts showing the current gold-relevant backdrop:
The 10 year note yield minus the annualized CPI rate of change and the TIPS yield – both are negative - click chart for better resolution.
The TIP:TLT ratio as a proxy of 'inflation expectations' (this is to say, expectations regarding future CPI). According to this ratio, inflation expectations remain very low, but have begun to slightly rise of late - click chart for better resolution.
The TLT-JNK ratio as a proxy for credit spreads – after widening considerably late last year, spreads are coming in again – but this looks like a bullish chart to us (which is to say, credit spreads should rise further once the current correction is done). It is also noteworthy that this ratio likewise does not confirm the recent rally in stocks - click chart for better resolution.
We hasten to add here that the Fed's 'Operation Twist' is falsifying interest rate signals to some extent. We can not say by how much, but it seems likely that the degree of falsification is less than is generally believed – otherwise the gold-CCI ratio would probably be declining right now.
Similarly, silver has found it difficult to rise against gold, although the silver-gold ratio chart has begun to look a tad more bullish lately (i.e., it appears to be bottoming):
The silver-gold ratio is also not yet really confirming the rally in the stock market, although it has begun to improve somewhat recently - click chart for better resolution.
Silver itself has just wormed its way above its 200-day moving average, which has stopped a previous rally attempt. Alas, the break is not yet significant enough to be hailed as definitive. Moreover, it is slightly overbought now (but could of course become more so). What is encouraging is that the recent rally looks impulsive as well.
Silver's first peek above the 200 day ma since the September debacle. Whether it will re-establish itself above this demarcation remains to be seen. Alas, we like the shape of this move from the late 2011 low: it seems to be an impulse wave. Compare this wave up with the overlapping waves produced in the July-September rally. The difference is palpable - click chart for better resolution.
All in all this is a bunch of mixed signals that don't allow one to come to a firm conclusion regarding what the market regards as gold's major driver at the moment. We will obviously learn more as the coming weeks unfold. A correction in the stock market would provide valuable information in this context.
As to gold's correlation with the US dollar, lately it has been negative, but over the medium term there hasn't been much of a correlation one way or the other over the past few years – this is to say it flips back and forth between being positive and negative in the short term.
The dollar index and gold. The correlation swings back and forth between positive, negative and no correlation at all. Currently the dollar is rising against the yen and falling against the euro, a combination that gold seems to find agreeable - click chart for better resolution.
We should also point out that the euro's recent rally has so far largely failed to dent the determination of speculators both large and small to bet against it.
Commitments of traders in euro futures: speculators of all stripes remain close to record net short the beleaguered common currency. Ave Ceasar, morituri te salutant, but it's not quite clear yet who's going to play the 'morituri' role – the euro or those betting it will go down - click chart for better resolution.
The opposite picture is by the way evident in DXY futures, where small speculators continue to stubbornly hang on to a record net long position. This is tantamount to a bet that the Fed will not succeed in devaluing the dollar further, or at least prove less adept at the task than the ECB and the BoJ.
In this interesting race to currency oblivion, gold still seems like the natural winner.
This Time, It'll Work…Or Not
The biggest fly in the ointment is no doubt the sluggish action in gold stocks. We've heard all year last year that they were poised to do better than the metal and have been occasionally guilty of stating so ourselves.
Unfortunately the market doesn't care what anyone thinks and keeps cheapening the gold stocks relative to the metal. In our last update we noted that the HUI chart was difficult to interpret on account of being in a corrective formation (which seems to become more complex and drawn out as time goes on). We weren't quite sure whether to go with interpretation one or two.
You will possibly be relieved to hear that we still have no idea (just in case anyone erroneously thought we had more of a clue than others).
Here is the still messy HUI chart:
The HUI – this recent jumble of overlapping waves hasn't been terribly informative. The most bullish interpretation is probably that it's a series of 1's and 2's – if so, we'll know real soon - click chart for better resolution.
Most investors in gold stocks are either thoroughly frustrated, or they're no longer investors in gold stocks. These corrective periods can wear people's resolve down, especially when they occur against the backdrop of a very strong gold price. Note that the HUI is consolidating just above the 2008 high – which coincided with gold surpassing the $1,000 level for the first time. Here we are, with gold 70% higher and the gold stocks have largely gone nowhere.
In terms of the HUI-gold ratio, the downtrend that began last year has still not been broken:
The HUI-gold ratio: gold stocks haven't been this cheap against gold very often - click chart for better resolution.
The problem is that no-one really knows what this means, if anything. In the 1970's gold bull market, gold stocks also continuously underperformed the metal, with the exception of brief periods. However, nothing could be inferred from this fact about the future of the gold price itself. Moreover, the period of under-performance came on the heels of a period of strong outperformance during the 1960's – which made sense, as the market evidently surmised that the Bretton-Woods gold-dollar peg would fall.
Curiously, gold stocks then proceeded to outperform gold right after it had peaked in January of 1980, which goes to show that financial markets are not always very logical or very prescient.
At the moment the market seems to expect absolute perfection from gold miners regarding their earnings and their development costs, in spite of the fact that both gross and net margins are at a record high. The favorite Wall Street game of 'earnings expectation' beats or misses should have no bearing on the stocks of mining operations, given their inherent unpredictability in the short term. Alas, the stocks of gold companies that 'miss' tend to get beaten mercilessly, while the 'beats' don't really count for much.
pointed us to a recent example, following GFI's earnings report. A post-earnings report by a Citigroup analyst stated:
“FY11 was good, but came at a price: HEPS increased 89% to 1,003c (USc139),
mainly due to a higher gold price, good cost control and stable production.
The result was, however, assisted by the R7.0bn minority buy-outs during the year, which positively impacted second half production and costs.”
OK, so the result was very good (earnings per share up 89%), even if 'assisted' by the buyout of minorities. As far as we can tell this 'assistance' is permanent as long as the minorities stay bought out, which they will.
What to conclude? Should one buy the stock?
“Given the above, we expect that gold equities’ currently high ROIC margins will be short lived. This is as significant increases in capex budgets are yet to work their way into the “IC” part of the equation, while the “RO” part is currently inflated by high gold prices.”
Maintain Sell, TP reduced to R110 on a higher than expected capex outlook.”
We've heard this refrain for years. Wall Street tells us every year that 'higher gold prices are not sustainable', and yet, when the year is out, the gold price seems to be higher than it was a year earlier every time. Why should high gold prices not be sustainable? While we cannot know the future for certain, does anyone really believe the central banks will stop printing money all of a sudden?
Below are is a chart showing the results of another major South African gold miner, Harmony (HMY):
HMY's results: margins have roughly doubled in a year, with cash operating profit soaring - click chart for better resolution.
Note that in the last quarter, the company's earnings per share of 242 cents exceeded the 'average analyst expectation' of 159 cents per share by a huge margin. Citigroup's estimate of 133 cents per share was exceeded by a cool 82%. The conclusion by the analyst? You have one guess. We quote from Citi's post-earnings report:
“Strong result: HAR reported 2Q12 HEPS of 242c, 82% above our 133c expectations (Bloomberg consensus 159c). Encouragingly, this result was driven by a 13% increase
in yield, which resulted in a 5% increase in production and 6% decrease in costs.”
“On the back of this encouraging result, we upgrade our FY12 earnings expectations 33% to 627c; minor changes to FY13 and 14. Our valuation and TP remains unchanged at R85. Maintain Sell.”
Apparently, that 82% earnings beat wasn't 'perfect enough' just yet. Admittedly HMY has a history of disappointing expectations, so this 'beat' came as a bit of a surprise. On the other hand, we wonder why apparently no-one bothered to consult the chart of the Rand gold price beforehand:
The gold price in Rand terms – might it conceivably have been possible to conclude from this chart that the earnings of RSA based gold miners were going to improve? - click chart for better resolution.
When we last posted the above chart we said:
“South African producers continue to enjoy a near record high gold price when measured in their local currency. The recent correction also looks like a fairly routine pullback in an uptrend”
This wasn't exactly an earth-shattering conclusion to arrive at, but we wonder why the mainstream analysts that are paid big bucks so woefully underestimated the coming earnings results? Apparently looking at a gold price chart is not something they do very often.
The point we wish to make is mainly this however: we don't know the future for certain, but we do know that so far, high margins continue to be in evidence for gold miners. We also know that mainstream analysts remain deeply skeptical. To maintain a 'sell' rating on a stock after it has just blown away your earnings estimate by 82% probably does take a certain degree of stubbornness.
The faith that 'this time the gold price will come down' remains strong, in spite of a distinct lack of evidence. If one expects a lower gold price, one should at least be able to say why. No such explanation has been forwarded in any of the recent analyst reports we have seen.
Meanwhile, the public remains fairly skeptical as well, as evidenced by sentimentrader's 'public opinion' chart, an amalgam of various gold sentiment data:
Pubic opinion on gold: the recent rally has so far failed to significantly increase bullish sentiment - click chart for better resolution.
So the case for a positive rerating of gold stocks remains strong, in spite of the disappointments on this score over the past 18 months – if mainly because expectations are now so thoroughly subdued that it the market may be set to confound said expectations once again.
Is the US Economy About to Strengthen Further?
Recently US economic data have been quite encouraging, so we were already beginning to wonder whether the ECRI (Economic Cycle Research Institute) would stick with its recession call.
As we have pointed out previously, from our own point of view the imbalance between the amount of spending on capital goods production versus that on consumer goods production represents a significant red flag, as it suggests that a production structure has emerged that ties up more final goods than it releases. Or putting it differently: entrepreneurs have invested in a production structure that is too lengthy and can not be supported by the amount of real savings available. It is an attempt to go beyond the 'production possibilities frontier', which must necessarily fail (although we can obviously not say when exactly this will become evident).
For US interest rates, the US dollar and the gold price it seems important whether or not this interpretation is correct. As it has turned out, ECRI continues to stick with its recession call.
In a recent CNBC interview, Lakshman Achuthan insists that the economy is in far worse shape than it appears on the surface, see 'US growth at a 21 month low'. A more extensive presentation is available here.
According to Achuthan, the fact that people 'feel better' about recent data releases is not as relevant as the data ECRI is looking at, which continue to suggest that the economy will dip into recession. As Achuthan remarks, 'all the money printing makes us feel better', but it actually doesn't make things better, a view with which we would certainly agree.
Although Achuthan doesn't mention it, both the ever wider yawning gap between the 10-year note yield and the S&P 500 index and the gold-CCI ratio seem to confirm what he is saying – the economy's bout of strength is likely only superficial.
Charts by: Bigcharts, Barcharts, StockCharts, SentimenTrader, Federal Reserve of saint Louis Research
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