So Far, So Good

From the February 25, 2014 HRA Journal: Issue 210

We’re one issue into the cycle since I made the start of year predictions.  I don’t look stupid yet which might be some sort of record.   So far, so good.

If the trend of the past two weeks holds up the correction that started 2014 is already over.   If you use the Dow as the benchmark the dip was eight percent.   I’m not sure that is large enough to make me comfortable.

I was hoping for something in the 10% plus range.  That would have been large enough to kill off some optimism and bring some bears out of hibernation.  I’m not bearish myself—I’m looking for a correction, not a crash—but I continue to be uncomfortable about the levels of almost blind optimism in New York.  NASDAQ is particularly scary.

Nothing seems to faze traders on Wall St lately.   True, that is the mark of a bull market but it’s also the mark of a market that might still need a wakeup call.  If I see more negative slant on market coverage from people other than permabears then I’d say 8% did the job but I haven’t seen that yet.

Since the last issue went out there have been several major economic readings issued.  In the case of those out of the US the numbers were less mixed and more negative than readings through late 2013.

Market observers are blaming everything on the weather.   That could be true and certainly things have been ugly through the NE states for weeks now.  I’m sure weather is a big part of it but we won’t know that for sure for a couple of months.

I wasn’t that surprised by another below consensus non-farm payroll number out of the US (113k vs. 185k consensus) but it’s disconcerting that the much weaker December number (75k vs. 180k consensus) received only a nominal revision to 76k.  Not impressive, even with blizzards to lay most of it off on.

Consumer spending and industrial production were also way below estimates, especially the former. Again, maybe all weather related but we simply won’t know for a couple of months at least.

The poor consumer spending number will get plugged right into the GDP calculation.  It looks now like Q1 growth in the US could be under 2%.   If the US is to reach growth near 3% this year we’ll have to see a significant acceleration in activity later.

The bad news in the US and worse news in emerging markets spooked traders—for about three weeks.   The market bottomed as we exited January and hovers near all-time highs again.  The S&P is less than one percent off its all-time high.  So much for nervous traders.

Braver traders extend all the way down to the junior market as the graph above shows.  When I predicted a 30% plus year for the Venture index I noted that gold would have to clear resistance in the mid-$1280s and the Venture would need to turn around and get above its January high.  Both of those conditions have now been met.

The Venture index looks stronger than it has at any time since the gold crash last April.  Its put in a higher low and reached a 10 month high. The 200 day moving average now looks like support.  The 50 day average recently rose above the 200 day, a “golden cross” if you pay attention to that sort of thing. Trading since the start of the year has included more up days than we have seen in a long time, even if some of them were barely in the green.

As important are the higher trading volumes, particularly in the past few sessions.  There are still plenty of traders who want out.   In order for the market to generate the gains I expect higher volumes are a necessity.

The financing environment has also strengthened quite a bit in the past month but it’s a very top down affair as I expected.   There have been a number of bought deals announced, some of them quite large.  This will inflate the numbers for the whole sector even though they are only helping a handful of companies so far.

Most bought deals are being done at fairly big discounts and include high fee structures.  The fact they are happening at all is a positive but we’re certainly not in a “rising tide lifting all boats” scenario.

The better tone in the Junior market relates directly to stronger markets for gold and other metals since the start of the year.  Gold continued its climb after the last issue and, significantly I hope, was going up on both “bad news” and “good news” days.  Major markets lifting off their lows didn’t have much negative impact at all.

I’ve seen a number of comments about the Fed taper being slowed due to weak economic readings.  I don’t think that is likely yet and it seems strange that traders would be jumping back into equities with both feet and buying gold as an insurance trade.  I hope most of the buying isn’t taper related.  I suspect it isn’t and this is just lazy financial journalists looking for something to pin a trade on.

My reasons for predicting a $1400 high this year were simple supply demand.  The market was running out of sellers and physical buying in Asia was strong enough to lift prices.  That still seems the case. There is even sustained buying in the EFT space for the first time since 2012.

Though prices have risen 10% from the bottom and there are more stories about gold in the financial press there is no danger of short term euphoria.  Most investment banks are steadfast in their calls for lower prices and business reporters never tire of starting stories with “after gold’s historic crash…” or suchlike.

Its impressive how little resistance met buyers to this point.  The mid 1290’s took a few attempts but the psychologically important $1300 level and the 200 day moving average were cleared with ease.  There has been short covering but overall the short position is still high.

We may need to see some consolidation here before the bulls try to move the price to and through $1350.  I expect a lot more resistance there.  That is where the price topped out in the fall and may be a line in the sand for the shorts. If gold does clear $1350 we could see a real short covering rally.

If gold buying is a fear trade we’re not seeing the other side of that trade yet.  The US Dollar index looks weak and there hasn’t been much of a move in US Treasury yields either way.  Some of the USD weakness is a pair trade against the Euro.  The EU is one of the few areas where economic readings have provided positive surprises.

While I focus on physical supply demand gold does get traded against the greenback.  I would be surprised to see the $USD index break 80 but if that happens the next leg up for gold could start.

There are a lot of moving parts on the currency side.  As this editorial was being written the Bank of Japan reiterated it would keep expanding the money supply and added new low interest loan facilities.  The Nikkei responded joyously but the reason for the continued dovishness by the BoJ is less comforting.  Japan grew at half the consensus rate in Q4 and all the money printing still hasn’t moved the needle on Japan’s disinflation.

At the same time, and at the opposite end of the spectrum, the Bank of China undertook repo trades to drain liquidity from the Chinese banking system and tighten credit.   I noted in the last issue that the PBoC is not out of ammunition and many of the recent interest rate spikes were probably intentional.  The current one certainly was.

The latest action came after reports showing credit expanded much faster than consensus in January.  The market took this as a positive sign for Chinese growth and it generated gains across the commodity space.  Beijing was clearly less thrilled about the reading.  They are struggling to clamp down on lending and the shadow banking sector.  I said in the last issue that this will be one of the biggest potential risks this year and that remains true.

The pie chart above shows the distribution of lending by “investment trusts” which are marketed to (hopefully) high net worth Chinese as savings vehicles with promised yields far above the miserly rates offered by banks.

The quickest year over year growth has been in products lending to infrastructure, industry and (go figure) mining.  Infrastructure loans are mainly to local and provincial governments—hopefully toll roads that can pay them back. Most of the industrial/mining loans go to companies that cannot attract traditional bank loans to over capacity industries like coal mining.

One trust was saved last month by parties unknown but another, also loans to a coal miner, is now in default.  The latest, “Songhua River #77 Shanxi Opulent Blessing Project” (and how could one resist a name like that?) was marketed by a regional bank that is promising to “find the money”.  Maybe it will but with a large number of these trusts maturing in the next few months a couple of defaults seem guaranteed.  The markets are ignoring this one and assuming an implicit government guarantee just as unit holders are. Let’s hope so.

After all these twists and turns it seems it all comes down to weather.  If weakness in the US is a statistical blip markets should remain calm.  If we see more weak readings once things warm up another correction is highly likely.   I do think weather accounts for most of the weakness.  I still expect the US economy to put in a decent performance.  That said, unbridled optimism may still generate another correction.

Metals have made a small comeback. We’ll see how much of that is due to assumed weakness in the US as more economic readings come in.  Growing strength in Europe could help counter a stronger $US even if the States gets back on track.

We want to see resistance levels just cleared become support levels.  If the retail crowd returns to gold at even a fraction of levels two years ago that could be enough to support and lift precious metals through the next major price point at $1350-60.

Resource stocks have been the best performing sector this year.   A bit more of that and fair weather traders may again decide they are “cheap”.  A lot of the time the market is just about momentum.  It’s been negative for most of the past three years but you can sense a turn now.  We’re in for a better year if we can get through the next few weeks holding support levels.

Next the Juniors need to survive the post-PDAC period.  The idea of the “PDAC Curse” is so ingrained that plenty of traders will be taking profits. We want a lasting uptrend so I am fine with no premature euphoria.  We need a wall of worry to climb.                           

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