Still Not Really Loved

The so-called 'gold bugs' in the wider sense are usually a quite vocal bunch. This may at times give the erroneous impression that gold is a 'crowded trade', as in, widely participated in. However, that is not really the case if one considers the totality of investment assets and even less so if one compares the total amount of gold available for investment to the total amount of fiat money issued in the world.


Lately there has been quite a bit of negative sentiment expressed on an anecdotal basis, this is to say, it has been easier than usual to come across negative opinions in the press and mainstream banks and investment banks many of which began to love gold near its 2011 high have begun to cut back their target prices. Credit Suisse for instance calls it a “wounded bull” now.

Of course we must also stress again that gold isn't the bargain anymore it once  was. And yet, the fundamental backdrop has as of yet not become gold-unfriendly – we suspect rather on the contrary that it could become even more supportive for gold, although getting to that point may involve a few speed bumps. Since its 2011 high amid what has thus far been the peak of the euro area debt crisis, coinciding with a debt ceiling wrangle in the US, gold has been in a triangular consolidation. So far there has been neither a decisive breakout, nor a decisive breakdown, so from a technical perspective it remains in no-man's land for now. It is interesting though that while the consolidation has dragged on, sentiment has mostly turned more cautious, especially as triangles are usually continuation formations.




Gold in dollar terms, weekly. The triangle continues to put everyone to sleep – click for better resolution.



In non-dollar currencies we note that gold in euro terms has failed with its breakout attempt in the fall of 2012, but if anything now looks short term oversold. In fact, on the daily chart the RSI has fallen to its lowest level in many years, but even the weekly chart reflects that now.




On the weekly chart of gold in euro terms a small divergence has formed between price and RSI – click for better resolution.



Not surprisingly, in yen terms gold has recently returned to its 2011 high, as the yen has tanked. It often happens that when it does break out in terms of one major currency, the others tend to follow, but there can be no guarantee that this will happen every time. Moreover, it is probably a bit late in this particular move (mainly because the yen is abysmally oversold and due to bounce).




Gold in terms of the yen. We guess that there are probably fewer gold bears in Japan right now than in the US, given that sentiment to a great extent follows prices – click for better resolution.



On the daily chart one can see that gold remains mired in a fairly wide trading  range that sports  a number of support and resistance levels. Again, this is not really conclusive, but it is of course clear that there will be a breakout one way or the other at some point. The recent volume spike during an intra-day sell-off on 'news' (we use the term loosely) in the form of the release of the December Fed minutes could be signaling that a short term washout low is in place, as the price tested an important lateral support level in this fairly strong (and immediately reversed) selling squall.




Near term support and resistance levels in gold – click for better resolution.



We obviously don't know yet what effect this short term sell-off will have on the upcoming commitments of traders data, but recently there has finally been a bit of liquidation in the previously very large small trader net long position, which hasn't gone far enough yet to be conclusive either, but has at least removed some of the risk posed by this overhang of stale longs.

Presumably the sell-off on the release of the minutes has removed more of it, which can be ascertained on Friday afternoon. For some reason we still get these data with a  several days long lag even in an era when computerized trading attempts to close in on the speed of light. The latter, as readers probably know, is a universal speed limit, imposed by the guy who invented gravity as well as an often-quoted bon-mot about insanity that describes the apparent state of mind modern-day central bankers and politicians exceedingly well.



Gold CoT

Commitments of traders in gold futures – better, but not yet conclusive. The red line at the bottom shows the net position of small speculators. The ratio of small spec longs to shorts is at 2.65 to 1, not yet at the 2 to 1 which we would regard as the optimum prior to a renewed advance – click for better resolution.



However, one sentiment gauge we like to keep an eye on, the average gold newsletter positioning recommendation measured by Mark Hulbert, has recently entered territory that often coincides with lows (obviously, sentiment can still get more negative based on this indicator, but it has more or less made a complete round-trip):




The HGNSI (Hulbert Gold Newsletter Sentiment Index) has recently moved back into negative territory. This means that gold timers are on average recommending a 6.3% net short position at present – click for better resolution.



This brings us to gold stocks, because we have noticed in the past that moves in the HGNSI have a lot to do with how gold stocks act, and especially with how they act relative to gold.


Gold Stocks

Gold stocks have been quite disappointing over the past year, and depending on the sub-sector for an even longer time period. For instance, a great many juniors and explorers peaked back in April of 2011, along with the silver price. The HUI made a valiant rally attempt out of the low in May of last year, but obviously has given much of that back in the meantime. It is therefore in technical limbo as well. In fact, right now it doesn't look particularly bullish at first glance and it is a concern that the sector can't get off the mat relative to gold. This is not unusual in a long term gold bull market (the metal will tend to outperform the stocks of producers over time), but there should be occasional periods when the shares have their day in the sun. A rally in gold that sees no participation by the gold mining stocks is somewhat suspect.




A weekly chart of the HUI. The 375 level that was tested in May last year is actually support dating back to 2006/2007 – when gold was most of the time below $700 – click for better resolution.



A chart of the HUI-gold ratio illustrates the problem, but as depressing as it looks, it also contains a ray of hope – the momentum of the relative decline has clearly decreased and the ratio has at least begun trying to find a low. We never expected it to go that low to be sure (at least not prior to a bow-off rally in gold), but it is what it is. As it were, rally attempts that end up going nowhere are not really helpful, as a rally requires an unwinding of the negative sentiment that has informed this decline. It will apparently require some time before investors begin to appreciate the recent efforts by mine managements to improve returns by cutting costs, raising dividends and becoming more picky about growth (these days it is far more difficult for a new mining project to get the development nod, as mine development costs have gone up even more than production costs).



HUI-gold ratio

The HUI – gold ratio, a.k.a. the nightmare of gold stock investors – click for better resolution.



However, there are a few additional potentially encouraging signs. The daily chart of the HUI shows that a support level has been reached recently amid divergences with momentum oscillators:




The trendline from the two preceding lows has been reached, there is a divergence between price and RSI and the most recent lows were made with small inverted hammer candles – click for better resolution.



This has happened concurrently with gold stocks becoming the by far most hated sector of the entire stock market:




sector sentiment

Sentiment on different market sectors. Pessimism on gold stocks has reached an extreme – just as people have become extremely bullish on a great many other sectors (chart via sentimentrader).


Assets in and cumulative cash flows into the Rydex precious metals fund have declined, but luckily not by too much. It is important that the initial inflow not be given back, because experience has shown that when this happens, it can take much longer for a durable low to form (often there will be some kind of divergence near both lows and highs as 'smart money' either moves in or out of the fund in a timely fashion).



Rydex-precious metals

Rydex precious metals fund, total assets and cumulative cash flows. Not a lot of enthusiasm here, but at least some of the funds that have flowed since the price lows have remained invested thus far (chart via decisionpoint) – click for better resolution.


Another slight positive signal is given by the junior and exploration sectors in which  the decline originally began. Here is the ratio of GDXJ (gold juniors ETF) to GDX (senior gold producers ETF):




Gold juniors are showing some life relative to senior producers – click for better resolution.



Looking at the price charts of GDXJ and the exploration stock ETF GLDX we can see that the 'double divergence' in the former, while the latter actually has retested its May 2012 lows twice already:




GDXJ revisited its May low in August while GDX made a higher low and is now outperforming – click for better resolution.




GLDX has done the same, but has recently revisited the same low again, concurrently with an RSI/price divergence and MACD giving a buy signal – click for better resolution.



Yet another positive divergence has just occurred in the price of silver relative to silver stocks:




Silver has made a lower low, while the silver stock ETF SIL (the line at the bottom of the chart) has not – click for better resolution.



An interesting aside to all of this is that futures traders have recently become quite bearish on the US dollar, so much so that one should probably expect it to rally relatively soon. It is too early to say how this will affect gold, which has at times risen in parallel with the dollar and at times been pressured when the dollar's external value has increased in recent years, but it is a noteworthy piece of the 'risk-on/risk-off' puzzle.

We have a nagging suspicion that gold may be more likely to rise when the next 'risk-off' phase begins, although this is more of a hunch than anything based on concrete evidence. However,  there is a fundamental justification as well: if a 'risk off' period begins because of weakening economic growth, then both gold and especially gold mining stocks should be expected to do well (the latter because their input costs will decline, raising their margins).



Dollar CoT

Commitments of traders in the dollar index: speculators have turned quite bearish. This mirrors their bearishness on the yen, another currency closely tied to risk perceptions – click for better resolution.



Over the past year there were by the way a number of exceptions in the gold sector of the market, a sub-group of stocks that has done very well: gold royalty stocks and those of other gold producers that are not really 'miners'. The stock of a company we have previously profiled in detail, DRDgold, has been among those exceptions (DRD 'mines' slime dams, which is not really mining at all – there is very little sustaining capital expenditure once the initial investments have been undertaken). This shows that the troubles of many South African gold mining stocks to properly reflect the very high Rand gold price are not really tied to 'political risk' (even though they will of course always sport a permanent political risk discount). Rather, they are held back by problems very similar to those of other producers.




A daily chart of DRD-Gold. Shedding all underground mining risk is beginning to pay off – click for better resolution.



The Putative Fed 'Exit'

We must also briefly comment on the release of the December Fed minutes and the market reaction to them. There has been a split within the Fed ever since the 'QE' programs began. A handful of the district Fed chiefs (Richard Fisher, Charles Plosser and Jeffrey Lacker most prominently, and Thomas Hoenig as well while he was still with the Kansas Fed) have always been wary of these money printing exercises and have often dissented with the majority. A few others can be said to have occasionally been on the fence, and we don't know yet how Esther George (Hoenig's successor) will vote, but we suspect she will turn out to be a 'hawk' as well.

Whenever these dissenters do have a vote at the FOMC, they are regularly outvoted, so the fact that they want the programs to end as fast as possible does not represent 'change'. It represent business as usual. Note that even those Fed district chiefs that do not vote take part in the committee's deliberations, so their misgivings will always find their way into the minutes.

The occasional 'fence sitters' however are surely swayed to some extent by the changing social mood. The Fed must tread carefully, as the ranks of its critics keep swelling. Lately even many mainstream economists have begun to doubt whether the 'QE' programs make any sense. The calls for ending the money printing are getting louder.

That however doesn't mean it will actually end. First of all, the board of governors in Washington is to a man and woman lined up behind the chairman and his Great Depression inspired experiment. Or let's rather say, the experiment based on his woeful misinterpretation of that historic period, a misinterpretation that is the result of him (and most of his colleagues) believing in economic theories that are misguided, to put it as politely as possible.

Moreover, a number of district chiefs often sound even more dovish than the chairman and at times the FOMC voting bloc can become very one-sided, such as it was in 2012 and will be again this year. These people are very eager to prove to us that their theories will work. Some of the less eager participants in the meantime console themselves with the 'well, we don't really like it, but we have no other choice' excuse. It is simply not conceivable to them that a central planning agency like the Fed could do nothing. Unfortunately the only thing a central bank ever does is debase the money it issues, at varying speeds. Currently the speed is quite phenomenal, as we have demonstrated here.

There is a good reason why the Fed might even like to do things like deciding to increase its 'QE' program by $45 billion per month to a total of $85 billion per month in the very same meeting in which many participants voice their misgivings which then find their way into the minutes. It helps with the one thing that is the most important condition for being able to inflate at breakneck speed, namely the management of inflation expectations. It is the signal to the rest of the world that “one of these days, honest injun, the inflation will stop”.

However, one would do well to remember that we have heard 'exit talk' with unwavering regularity for the past four years. During the entire time, the Fed has in reality moved ever further away from said 'exit' in the exact opposite direction. Of course this is not necessarily an immutable condition.

However, consider what happens when an inflation-inspired echo boom is confronted with an end to the inflation policy. Normally this will in fairly short order bring on another round of liquidation of malinvested capital. An excuse to resume the inflationary policy will therefore very quickly present itself. 

In fact, it is quite conceivable that another excuse to simply continue with the policy or even intensify it will present itself before the current round of 'QE' is ended.

Moreover, extremely loose monetary policy has become a global phenomenon. There is now a certain danger that the BoJ will join the party with far greater force than before. 'Beggar thy neighbor' is apparently getting ever more popular these days.  Ambrose Evans-Pritchard recently mused that even Britain and Switzerland are now engaged in a 'currency war'. The man is pretty confused, as can be seen from this combination of statements, all in the same article. He says for instance:


“[…] we have a very odd situation. Much of the world needs a lower currency and a higher interest rate structure to right the ship. But they can’t all have lower currencies.”


To the sentence we highlighted above, what can we say but “well spotted, AEP”.

However, in the same article – after enumerating the many things the Swiss are buying with Francs created from thin air and bemoaning that the Japanese are about to do the same, he writes:


“This blog is not intended to be an attack on the Swiss, valiant defenders of the democratic nation state. What they are doing is entirely understandable. Such intervention creates net global stimulus and does more good than harm in a deflationary world.”

How confused can one get about these issues? Apparently very. And if only it were a 'deflationary world' – however, it is anything but. True, in a free market setting without central banks and deposit insurance backstopping the deposit liabilities of fractionally reserved banks, a great cleansing event would indeed have occurred and a mountain of money substitutes would have gone to money heaven. As we have often done in the past, we ask again: so what? All the physical assets in this world, every factory, every mine, every pipeline, every piece of infrastructure would have been left standing. Only the ownership of a great many assets – and especially that of the banks – would have changed hands.

Malinvested  capital would have been purged very thoroughly, no doubt a salutary event.  Please note our qualification 'free market setting' – this implies no government interference with wages and prices, which is the sine qua non for such a purging to be thorough, effective and mercifully brief.

However, everybody is doing what the Swiss are doing, to varying degrees and in slightly different technical ways (and yet, it all amounts to money printing in the end). We do not see even the remotest chance of that changing materially anytime soon. Hence it is not possible to be anything but long term bullish on gold. 

Does this mean it will rise for a 13th year in a row? Not necessarily – perceptions can sometimes trump reality for certain periods of time, and we cannot apodictically state that there won't be a bigger correction and that it cannot happen this year. On the other hand, it also would not surprise us greatly if gold did indeed rise again this year. The technical parameters that will help us spot what is likely to happen are all laid out quite clearly – and should it come to a larger degree correction, then it will probably represent an outstanding buying opportunity.

At some point we expect that the market will lose faith in the central planners in rather spectacular fashion. It is the very last bastion of investor confidence now that even developed nation governments are seen to be no longer entirely immune from bankruptcy (as long as they are small enough, they get bailed out as well of course, but Greece sure did default). When that time comes, then it will be exactly like a friend of ours from Hong Kong often says when he is asked about how to properly value gold. He answers the question with a counter-question:

What's the value of the last parachute on a crashing airplane?



Charts by: stockcharts, sentimentrader, decisionpoint




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