Sentiment Anecdotes

On August 8, Deutsche Bank's Jim Reid penned a piece reminiscing about the past five years, in which he argues that it was in August 2007 when the financial world finally began to appreciate that something was about to go horribly wrong. Readers may recall that August 2007 was when the ECB provided its first emergency liquidity injections (back then a relatively tame €95 billion). Reid has therefore chosen this point in time as the starting point of the crisis, although we would argue that the real starting point was probably late February 2007, when the first sub-prime lenders went to the wall. One could even say that the BoJ's decision to lower Japan's  monetary base by about 25% in one fell swoop in the summer of 2006 was what triggered the crisis, as it rooughly coincided with the price peak of the US real estate bubble.


In any event, Reid included a chart listing an eclectic list of financial assets and commodities that compares how they have done over the past five years.



 








 

Jim Reid's chart of the total return performance of 'major financial assets' since the beginning of the crisis – click chart for better resolution.




We're not sure if we would call corn a 'major financial asset', but obviously, had corn not been included in the list, gold would inconveniently sit in the number one spot. What's interesting about all this is the title of an article that appeared in the Financial Times (FT) on August 9: “Corn and oil among top assets in crisis” the headline blares. A quick perusal of the above chart informs us that while Brent oil didn't do badly, gold and silver both rose more than twice as much. This headline therefore evokes what experts call a 'WTF?' moment.

As Bill Fleckenstein points out, not too many people can easily invest in corn or Brent oil directly (one would have to open a futures account at a minimum), while it is fairly easy to invest in gold and silver. Fleckenstein also asks  rhetorically: what if stocks as measured by the SPX, instead of being up by 10% had been up by 140%, similar to gold (which as our abacus confirms is 14 times as much)? Would people argue that one shouldn't buy or own them? It's a good bet that they wouldn't so argue. And yet, the mainstream opinion on gold can still be best described as lying somewhere between willful ignorance and outright disdain. Incidentally, the very same FT gave us an example of this attitude in an article published on August 7 entitled “Cash out of gold and send kids to college”, which is essentially a long list of reasons why one shouldn't invest in gold.

The article has a point that gold is no longer the bargain it once was – but we strongly doubt that the author was pounding the table recommending to buy it at any other point in the past. If memory serves, the FT's editorial stance regarding gold has basically always mirrored the Keynesian 'it's a barbaric relic' line of thought – in practice that means 'denigrate it at every opportunity'.

One argument the above linked article forwards deserves additional comment:


“Just like the non-barking dog in the Sherlock Holmes story, the gold price has become strangely insensitive to the usual stimuli.

The eurozone remains locked in an existential crisis. Growth is fading in the US and China, and policy makers appear conflicted or just plain clueless about how to respond. Meanwhile, losses and scandals at large banks are coming to light weekly.

Unsurprisingly, investors are running scared. The global flight to safety has seen capital flood into “core” sovereign bond markets, driving yields down almost to vanishing point. Yet, despite this perfect storm of financial instability, the gold price remains becalmed. In fact, over the past year gold bullion has behaved like a “risk on” asset, rising and falling in sync with stock markets.”


In short, the author is saying that gold should be rising in price, and the fact that it hasn't done so lately in spite of a plethora of seemingly supportive fundamentals leads him to the conclude that one should sell it. This can only have been written by someone who has no experience in how financial markets work. They always do what they 'should do' – but rarely when they're supposed to do it. It is actually quite hilarious to read this because the same idea has been forwarded during every gold price consolidation that has taken place since the year 2000 (the first iteration of the argument was encountered when gold briefly fell after Colin Powell's speech at the UN made clear that Iraq was likely to be attacked. Gold corrected from $380 to $320 in the weeks following the presentation).

Also notable in this context last week was a warning published in the WSJ:”Gold Bugs Watch Out: Morgan Stanley Slashes Gold Forecast 13%”. We should add here that a number of other banks and investment banks have done likewise. The same banks have raised their gold price forecasts in the month leading up to the peak in 2011, so we're not quite sure how this can be interpreted as bad news. It rather seems to us that the correction has done what it was supposed to do: it has sowed doubt and removed quite a bit of speculative froth. Although these are merely anecdotes, they confirm what other indicators of gold sentiment are saying at the moment – faith in a resumption of the rally has crumbled. This is something that should embolden rather than dishearten bulls – it would be far more worrisome if the correction were met with complacency, or worse, calls to back up the truck.

Of course we must add that none of the evidence from these indicators conclusively proves that the price will immediately rise or that the correction won't continue for a while longer. From a technical perspective, gold remains in no-man's land for now. However, as the charts below will show, there are a number of encouraging signs that the precious metals may be close to coming back to life.

First though a few charts that present objective statistical measures of sentiment. One of those deserves special attention.




The 'public opinion' measure published by sentimentrader, an amalgamation of several sentiment surveys: this shows that gold sentiment remains subdued, after numerous tests of the lowest level recorded since the 2008 correction low – click chart for better resolution.

 




 

 

Mark Hulbert's HGNSI (gold newsletter sentiment indicator). This indicator has also spent most of 2012 in 'extreme bearishness' territory. The level of the index indicates the average percentage of one's portfolio that according to gold timers should be allocated to gold. A negative figure means that a net short position is recommended – click chart for better resolution.



 

A chart of the Rydex precious metals sector fund with its total assets and cumulative net cash flows. This chart is the one we believe deserves some attention. As we have pointed out previously, it is not enough  when cumulative cash flows into the fund are very low – by itself this does not indicate that a turning point is near. Rather, what is required is a brief burst of cash inflows in spite of an ongoing decline. We have observed this on several occasions. Very likely a small percentage of Rydex fund traders actually represent 'smart money' that moves into the fund in advance of an anticipated rally. Conversely, important price highs are often accompanied by divergent lower highs in cumulative cash flows (denoting progressively diminishing net cash inflows) – click chart for better resolution.




Technical Conditions

We want to look specifically at weekly charts and a few ratio charts this time, in order to assess the bigger picture. There are a number of encouraging signs, such as price/RSI divergences and tentative MACD buy signals on the the weekly gold and gold stock index charts, but they are not yet conclusive.

What they do tell us is that the probability that the correction is nearing its end has  increased further. This evidence remains quite tenuous however, so it should be taken with a grain of salt. It is more of a heads-up that things may be on the verge of becoming interesting, but the caveat is that these small positive signs could quite easily be reversed again. As noted above, the gold price itself remains stuck in 'no-man's land' – as long as it trades approximately between $1530 and $1640/oz, a measure of caution remains advisable.




A weekly chart of gold in euro terms. The symmetrical triangle is usually a continuation formation, and there are both RSI/price divergences and an MACD buy signal in evidence now – click chart for better resolution.




The weekly chart of gold in US dollar terms looks slightly less convincing, but sports similar RSI and MACD signals, if less pronounced ones. Uncertainty has greatly  increased of late as the contraction in trading volume indicates. This is a slight positive as well, as prices have spent several weeks going essentially nowhere – click chart for better resolution.

 


 

A chart of the gold-silver ratio, showing its advance since the blow-off peak in silver in  late April of 2011. This ratio usually doesn't tends to rise in bullish phases (there are exceptions, e.g. when economic confidence crumbles rapidly such as in the summer of last year when the euro area crisis was heating up). In recent weeks it has gone sideways, putting in RSI divergences and and MACD sell signal in the process. Of course here we must stress as well that no breakout has taken place yet – click chart for better resolution.




The HUI-gold ratio appears to have put in a retest low and is once again approaching the downtrend resistance line that has held it in check since April of 2011. A break of this downtrend would likely be a significant development. Note though that the chart also demonstrates the pitfalls of jumping the gun – similar looking formations have previously failed to lead to a durable rally in the ratio – click chart for better resolution.



 

The weekly chart of the HUI also sports an RSI/price divergence and a tentative MACD buy signal – click chart for better resolution.



 

A 15 minute chart of the past ten trading days in the HUI. The low point on this chart occurred on the first trading day of August and essentially retested the HUI's first meaningful higher low since the May low (which was put in a little over one week earlier). Since then an impulsive looking advance appears to be underway – click chart for better resolution.



 

Silver has probably put just about everyone to sleep by now. And yet, there are also a few small positive signs visible at the moment. Whenever the silver market becomes as 'dull' as it has lately been, it is usually a good time to begin paying attention to it, as a big move is  likely coming soon – click chart for better resolution.



 

The SIL (silver miners ETF) to silver ratio. Leaving aside the low in the ratio made on occasion of the April 2011 blow-off peak in silver, we appear to have a successful retest of the ratio's August 2011 low in place, and since then a higher low and an MACD buy signal – click chart for better resolution.



 

Assuming that all the small positive signals shown above result in an upside breakout in the metals and a break of the HUI-gold and SIL-silver ratio above their downtrends, we should see a sizable advance, with gold and silver stocks likely to outperform the metals for a while. There are very good reasons to doubt that they will outperform them in the  long term, but short to medium term the chances look actually quite good.

The reason why it is doubtful that the precious metals stocks will outperform the metals – especially gold –  in the long run has to do with the most likely driver of the final phase of the gold bull market: namely an accelerating breakdown of confidence in the current monetary system and with it the financial system more generally (we have briefly discussed this before and a reader recently reminded us of this line of reasoning). In such a scenario, all 'paper claims' will decline against the 'real thing', as the main motive for buying gold will be fear. This effect could be observed in the late 1970's as well: when gold rose by about 200% in the final year of the bull market, gold stocks kept losing ground relative to it (i.e., they rose far more slowly). By contrast, in the first rebound following gold's initial decline from its early 1980 high, gold stocks vastly outperformed the metal, as fear of a systemic breakdown had receded. 

Finally, a question that immediately suggests itself is of course whether gold and especially gold stocks can be expected to rise in the event that the broader stock market declines. The stock market is currently standing on a very weak foundation, something that can be quickly illustrated with a single chart, the ratio of the NYA (New York Stock Exchange Index) to the SPX. This ratio has been declining since late 2009, a decline that has accelerated with the end of 'QE2' in late June 2011:



 

The NYA-SPX ratio: declining since 2009, and the decline has clearly accelerated since mid 2011 – click chart for better resolution.




What this tells us is essentially that the 'generals' have been rising without the 'soldiers'. The 'safe haven' big caps (think WMT, DIS, PG, IBM, JNJ, MRK and AAPL, to name a few) have risen quite strongly while the broad mass of mid cap and small cap stocks has languished. As previously discussed, there are also many glaring intra- and inter-market divergences. For instance, cyclical stocks and sectors have vastly underperformed non-cyclicals. The stock market seems to be in a very tenuous position. Sooner or later something has to give.

However, looking at gold stocks relative to the broader market, they have apparently also decoupled (albeit so far mainly to the chagrin of investors in the sector):

 


 

The HUI-SPX ratio: when it goes sideways, the SPX and gold stocks are positively correlated. When it rises or falls, negative correlation predominates. Note the divergences that are in evidence here as well – click chart for better resolution.

 



Our guess at this point is that it should indeed be possible for the gold sector to rise even if the broader market falters, just as has e.g. happened in 2000-2003. However, it would be of concern if another liquidity crisis were to strike, with the stock market falling sharply in a very short period of time. In that event, gold stocks would likely sell off as well.

One must always keep in mind though that this is the only market sector that clearly sports a long term negative correlation with the rest of the stock market. This means that there must be short to medium term periods during which the correlation turns negative as well. The recent evidence that the correlation has turned negative again so far only incorporates a very brief burst  during which gold stocks were firm in spite of a faltering stock market (in the summer of 2011). Whether a genuine 'decoupling' has occurred and will stay in place remains to be seen, but at least one can have a little more confidence regarding this point today than was possible from 2009 to mid 2011.


Addendum: Gold's Competition

 


 

A chart from Doug Short showing the decline in the US dollar's purchasing power since  1870, with annotations. Since this relies on CPI it is an imperfect method of capturing the extent of the decline, but then again, there is no perfect method (one way of doing it would be to deflate the dollar by the true money supply growth rate minus estimated productivity growth, but the latter is difficult to ascertain). The final few percent until the currency's value reaches the 'zero bound' unfortunately promise to incorporate very interesting times, in the Chinese curse sense – click chart for better resolution.

 


 



Charts by: Deutsche Bank, bigcharts, StockCharts.com, Decisionpoint, Sentimentrader, Doug short


 
 

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9 Responses to “Gold, Silver and Gold Stocks”

  • jimmyjames:

    Since this relies on CPI it is an imperfect method of capturing the extent of the decline, but then again, there is no perfect method

    *****************
    There is another fairly reliable method to prove the dilution of dollar buying power and that is to simply look at a silver 25 cent piece from that era and what it could buy then and now-

    $5.0257 is the rounded silver value for the 1916-1930 silver quarter on August 14, 2012. This is usually the value used by coin dealers when selling these coins at melt value.

    http://www.coinflation.com/coins/1916-1930-Silver-Standing-Liberty-Quarter-Value.html

    *************

    The price of a gallon of gas back then was about 17-19 cents-

    http://bit.ly/MxeS4p

    (source)

    http://bit.ly/zZhbVS

    *******************
    So back then a silver quarter would buy a bit over 1 gallon of gas and today that same silver quarter will still buy a bit over 1 gallon of gas-

    17-19 cents in today’s money wont even buy you free tire air at the service station…oh i forgot–most places even charge for air now-

  • jimmyjames:

    “Corn and oil among top assets in crisis” the headline blares. A quick perusal of the above chart informs us that while Brent oil didn’t do badly, gold and silver both rose more than twice as much. This headline therefore evokes what experts call a ‘WTF?’ moment.

    ****************

    Yes it is bloody amazing-almost surreal how invisible and hated gold is to even to the so called gold experts-

    Kitco’s Nadler and Dennis Gartman come to mind-

    “I hate gold and i hate goldbugs- every time I’m in the same room as one i feel like i need a shower-
    i even hate myself when i buy gold”

    Dennis Gartman on BNN-

  • RedQueenRace:

    A bit OT as it is not gold-related but I thought I would point out that today the VIX closed at 13.70. The day’s low was 13.67.

    On March 16th of this year the VIX bottomed at 13.66. Prior to that one has to go back to 2007 to find lower VIX levels.

  • JasonEmery:

    The gold chart is very bullish, in my view. We had a monster move up in late 2010/early 2011, and it has been consolidating nicely since.

    We are coming up on a very seasonally bullish time of year for gold, which is October to January, more or less. I will be very surprised if gold doesn’t take out $2200/oz before the end of January 2013.

  • Silvermoneyfuture.com:

    Great article.

    Whilst I admit I read the FT to get the headlines, their total commitment to blindness where Gold is concerned is impressive.

    It is important to remind ourselves that the key reason to buy Gold is to protect oneself from a collapse of the fractional reserve banking and fiat monetary system. Other than jewelry, Gold is fairly useless as anything but Money.

    Stocks and other paper claims must be realized through the banking system. Ask yourself:

    1) Once the bank (through which I am hoping to sell for a fortune) no longer exists, how will I get my paper money back?

    2) Even if I did achieve the above, what would those paper dollars be worth? (Simply follow the line on the ‘Decline of the purchasing power of the Dollar’ forwards a couple of years for a clue.)

    3) Would I not sleep better at night, knowing that my wealth was safe and that I had voted against the system by withdrawing my wealth?

    Just a thought.

    JC.

    • worldend666:

      Referring to your point 2) above silvermonyfuture, it is quite likely that in the event of a collapse of the counter parties in futures markets – read banks which are short – following a fast rise in gold prices, gold will cease to trade and there will be a government mandated delivery price which will not reflect the underlying metal. This is the biggest risk for investors in paper gold.

      And regarding your point 3), yes it is such a relief to get away from the leverage and put your savings in a box where it cannot be traded. Since I did this my sleep has literally improved.

      • Silvermoneyfuture.com:

        Dear worldend666

        Agreed. We cannot expect the authorities to play fair when the game has changed. It does strike images of the rich kid of the neighborhood deciding that if he wasn’t allowed to win, he would simply take his act and ball home.

        JC.

      • Silvermoneyfuture.com:

        Dear Worldend666

        Indeed, I am sure the Hunt Brothers would happily explain what happens when the monetary metals hit the ‘highest acceptable’ price on the futures market.

        JC.

  • tociph:

    I find it very funny that Bernanke used to say that house prices will stabilize, they never did but gold prices have stabilize something Bernanke is completely clueless about in the public’s eyes.

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