American Tsunami

From the October 3rd, 2014 HRA Journal: Issue 221

Things went from bad to worse for commodities and resource stocks as we moved through the end of September.  The US Dollar went from strength to strength and simply mowed down everything in its path.   Traders on Wall St are gleeful now but a super strong currency has its own costs and those haven’t been felt yet.   I’ll go into that subject a bit more in the next issue.

For now we’re stuck in a market going in reverse.   It won’t last forever though it’s going to feel like forever while it’s happening.  The US Dollar is parabolic and that definitely won’t last forever.  Like the gold market the currency market is full of short term traders.  That sort of trader doesn’t like parabolic moves.   As I note in the editorial there is evidence that physical buying is picking up strongly in Asia.  That will have some influence eventually though commodities will have to unshackle themselves from the greenback first.  

I’m happy the US is doing well.  The other major economic blocks aren’t and the world economy needs all the help it can get.  I’m hearing plenty of people say it will be 2 or 3 or ….years before anyone buys resource stocks again.  Maybe, but the same people said the same thing in 2008 and the turn came faster than any of them expected.

I look forward to seeing some of you at the Subscriber Summit on October 9th in Vancouver. 

***

Well this month has sucked.  Things continued to fall after the last issue and both the gold price and the venture Index are at their lows for the year.   The gold and USD charts on the next page present the sorry picture.

Keep in mind that this is not just a gold or venture index issue.  Commodities, emerging market equities, small caps in the US, non-US currencies and lower grade debt are ALL getting hit.  Market divergences are growing and traders have been fleeing anything with even a hint of risk.

Is there any hope out there at all? It seems like there is very little and maybe, and ironically, that is a good thing.  I'm not being flippant when I say that.  While I thought we had seen the bulk of the capitulation selling when it came to metals and mining stocks there are others that felt it was still to come.   Some worried that traders were getting too positive too fast.   Most of the indicators I look at for the sector haven’t been wildly bullish so I was less concerned.

That looks like a mistake now.  I’ve had email exchanges with many “friends in the business” in the past week or two that have centered on the concept of capitulation.  Most of these guys were not believers when it came to earlier bottoms.  They were hopeful before but not hearing about pros throwing in the towel. Those pros are usually the last ones out.

All of us have been hearing of just that sort of trader exiting during this move.   That by itself won’t put in a bottom.  There will have to be some sign that the tsunami of buying in the US Dollar market and selling just about everywhere else is finally trailing off.  We’re not seeing that yet though there are some near term catalysts to watch for.

We are entering the quarter that is the kindest to gold and junior stocks in most years.  October is the second best month of the year on average for gold as pre festival and post-harvest buying in China and India kicks in.

The next three months could at least put a brighter face on things as long as the major markets don’t tank and take everything in sight with them.  The markets in New York are certainly heavily bought enough to be concerning.  While it doesn’t feel to me like we are far enough along in the US economic expansion to be worried about an immanent rollover the divergences we’re seeing are concerning in themselves.  There is no reason New York and a handful of other markets can’t gain while everything else withers. It’s happened before, but not often.  That sort of one-sided trading and money flow scenario is inherently unstable and things can go bad quickly.

If something stronger than a correction arrives in New York it’s more likely to be due to geopolitics than macroeconomics, at least US macroeconomics.  If we do get a near term correction in the S&P that is likely to be a positive rather than a negative for the gold price.

The gold and US Dollar charts clearly display the strong inverse correlation.   That inverse correlation isn’t always in force as both the currency and metal have plenty of different drivers but, right now, the gold market is all about the Dollar.

The USD is very overbought but that has been the case for a couple of months.   I don’t find relative strength indicators very reliable unless it really gets to extremes.   It’s getting close now but a reversal may still require some sort of catalyst.

Notwithstanding its recent dive gold is just barely in oversold territory. This could be a short term fluke. It still sure seems a lot of traders are targeting the $1180 low of late 2013.   It may not literally get there but I think the phase “close enough for horseshoes and had grenades” applies to charts too. There certainly hasn’t been much news coming out of Europe or Asia that would lead one to sell the Greenback and pile into Euros or Yen.  The dollar has gone parabolic though and is quite close to major resistance.  We might get some relief as traders take profits.

Weaker offshore economic readings won’t change overnight.  The divergence will continue but it may become self-healing to some extent.  A falling Euro might help generate a little bit of price inflation and even dollar bulls will decide its time to start taking profits soon if it keeps rising.

As always, the monthly US payroll report was a market mover.   The number exceeded expectations and the unemployment rate dropped to 5.9%. That was enough to knock gold below $1200.  Its good news but I note again that we’re not seeing wage increases. Consumer spending in the US won’t keep increasing at recent rates much longer unless we do.  People can only borrow so much.

The ECB also met this week.   The bank confirmed it will start asset backed debt purchases but still managed to disappoint the market. The ECB wouldn’t disclose a purchase figure when it should really have been disclosing a huge one to impress the market.  Plus ca change.

That weak performance did lend a bit of support to the Euro but it will be short lived unless the market see follow through and aggressive bond purchases.

Whenever the markets looks this bad traders look for signs of either capitulation or support.  The charts on this page shows some evidence of both.

The upper chart is borrowed from Mark Hulbert who has a long standing publication that tracks newsletter editor picks and sentiment.  The chart shows gold newsletter editor (I don’t know the composition of the group) sentiment plotted against the gold price.  It’s a contrary indicator—the more bullish those closest to the market are the more cautious you should be.

Right now sentiment is stunningly negative.  The index currently stands at minus 50%.  Basically that means the average gold newsletter editor is recommending readers sell or go short.  The last time this index was this negative was when the gold price bottomed last year.  Hulbert considers the current reading a buy signal though  it doesn’t help you much on timing.  Things could stay negative for a few weeks though the reading implies a bottom is immanent.

In terms of support the GDXJ chart is constructive if not inspiring.  This index is above its 2013 low, though the gold price is nearly identical.  A glance at the chart shows you how much stronger the trading volumes are recently.   Last year’s bottom was put in on relatively light trading volume.  Trading has been far heavier through all of Q3.  If this is another bottom this one could be a bit more lasting then the previous two.

One final piece of positive evidence is worth your attention.  The chart at the top of this page is developed by Koos Jansen for his website www.ingoldwetrust.ch.  Jansen has been compiling and tracking Chinese gold demand for years using withdrawals from the Shanghai gold market as a guide.   I find his arguments for using this measure compelling. I think his figures are more reliable than others that depend on incomplete data like those released by the World Gold council.

The chart above starts in 2009.  You can see a very large lift in Chinese demand starting after the gold price collapsed in 2013.   Demand fell off some earlier this year though it stayed well above pre-2013 levels.   When gold prices start falling in August Chinese buying started to ramp up again.  You can see the rapid increase in volume over the past few weeks.

Chinese buyers are price sensitive and tend to step in most aggressively when prices have had a big drop.  If demand stays at its current level it should be increasingly supportive of higher prices.

There is at least antidotal evidence that demand is climbing in India too.  Demand there is more heavily dependent on farm income.  We won’t know the true picture until harvests are in but it looks like it will be at least decent year for demand.

In this market background it doesn’t make a lot of sense to chase stocks.  Companies that look extremely undervalued or those building on discoveries are the only ones I’d go near until the markets come to some sort of resolution.  I know there are many calling for traders to jump on marginal resources.   There is some logic to that as a call on the gold price.  I get that but I think in the long run it makes more sense to focus on companies that have resources that could be lowest cost quartile mining operations.   It will be a long time before money is easy again in the development space—if it ever is; deals that are financeable are the way to go.

Aside from that, companies with recent discoveries that may grow to be high margin deposits are still favored.  Strong discovery stories continue to trade better than their peers though even these companies have trouble making headway right now.  Chasing offers is not required and placing bids should be more than sufficient.

The way things have traded recently if we’re not in capitulation mode for the juniors we soon will be.  We may actually see the ranks of junior exploration companies finally get thinned. That would not be a bad thing.

The HRA–Journal and HRA-Special Delivery are independent publications produced and distributed by Stockwork Consulting Ltd, which is committed to providing timely and factual analysis of junior mining, resource, and other venture capital companies.  Companies are chosen on the basis of a speculative potential for significant upside gains resulting from asset-based expansion.  These are generally high-risk securities, and opinions contained herein are time and market sensitive.  No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer, solicitation or recommendation to buy or sell any securities mentioned.  While we believe all sources of information to be factual and reliable we in no way represent or guarantee the accuracy thereof, nor of the statements made herein.  We do not receive or request compensation in any form in order to feature companies in these publications.  We may, or may not, own securities and/or options to acquire securities of the companies mentioned herein. This document is protected by the copyright laws of Canada and the U.S. and may not be reproduced in any form for other than for personal use without the prior written consent of the publisher.  This document may be quoted, in context, provided proper credit is given.

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