Ms. Congeniality

From the April 3, 2016 HRA Journal: Issue 249

So far so good.  We’re a month past PDAC and the world has not come to an end yet.  Well, there’s always tomorrow.

Markets, especially the NY variety, are happy and the rally that started there in February presses on.  I still don’t expect new highs near term but I admit I’m not far from being wrong on that one.  We’ll see if the fun continues once the next earnings parade starts and the share buybacks are blacked out for a few weeks.

Yellen was the star of the show.  I’m surprised one of the US political parties hasn't tried to draft her since she’s more popular than any of the likely candidates the Democrats or Republicans have on offer.

Gold is holding $1200 even in the face of all that Wall St optimism.  We’re just starting to see renewed financings farther down the food chain and we’re not seeing more company news yet but that will come.  More importantly we are seeing reactions to good news that aren’t fading in a matter of minutes or hours. 

If I’m not wrong about the SPX fading we should hold current levels in gold and even see some improvement.  The long USD trade, last year’s most popular, is quickly losing adherents.  That helps the whole commodity space though I’m still edgy about base metals. China showed a bit of improvement but so far it’s just one data point not a trend.


Did Janet Yellen just single-handedly save Wall St, the world and perhaps even the galaxy?  It certainly looks that way based on where the S&P is trading.  I went through potential impacts of central bank meetings in the last issue and there’s no doubt the Fed presented the most surprises.  

The Fed met just after the last issue was released and it didn’t disappoint.  While I could see the case for raising I didn’t think the FOMC would have the stomach for it.  As it turned out comments were even more dovish than I expected as were forward projections about how quickly interest rates might rise.  

Wall St was happy and the gold market was happy but that didn’t last, particularly for the latter.  The meeting and announcement was barely over before various Fed governors where crisscrossing the country making speeches and trying to “out Hawk” each other.   Several Fed governors – voting FOMC members and non-voting, have been wondering out loud about raising rates at the next meeting in late April.   That had predicable effects on the gold price.  Several of the larger moves down recently can be tied to hawkish Fed comments.

The fun didn’t stop there though.  Yellen had a chance to weigh in again when she gave a speech to the Economic Club of New York.  She doubled down on the dovishness, directly contradicting hawkish fellow members of the FOMC. She made multiple comments about offshore risks and how an expensive US dollar was weighing on the manufacturing sector, something HRA readers know all about already.

There is serious dissention in the FOMC.  I can’t recall ever seeing so many mixed messages.  As the name implies the FOMC is a committee; every voting member can and do have and vote based on their personal views. It’s not a dictatorship but Yellen might wish it was before this is over.  Perhaps she’s losing her grip on the board.  Things will get interesting if that is the case. If nothing else, this new bipolar Fed will create even more credibility issues for itself and confusion for traders.   

So far, Wall St has been the big winner in all this.  Yellen’s repeated dovish comments have driven bond yields down, driven down the VIX “fear” index and lifted the S&P index to the 2050 range.   Bullishness is alive and well again on Wall St and I’m seeing plenty of talk about new highs on the way.

Have I given up on my view that Wall St. is likely to have a 20% decline from last year’s highs before the year is over?  Not just yet, for reasons outlined below, but I’ll be the first to acknowledge I could end up looking foolish on that call.  I don’t expect a bullish SPX to be that much of a negative for gold or resource stocks so I won’t be losing any sleep over it.  A down move later – after the developers and explorers in the gold space have a chance to cash up – would be a better scenario for the companies I follow.  In any case, I still view this as a counter trend rally, however strong, and that the dominant trend for NY is still down.

My reasons for expecting more downward pressure in NY and, by extension, other major bourses hasn’t changed; earnings and economic deceleration.    A rising US currency was a danger for the US economy the Fed acknowledged several times.   The USD rolled over in December as I predicted it would.  “Fails” by other central banks and more recent economic readings that portend more weakness in the US have accelerated the down move in the greenback.  The trade deficit widened and the Personal Consumption Expenditures for March came in far weaker than (Wall St) expected and January was revised down. A lot. The next couple of non-farm payroll reports might help but as I have noted several times since last year its real earnings for consumers that matter.  Even if payroll numbers stay robust it won’t drive consumer spending the way Wall St hopes if workers aren’t getting raises and, so far, they aren’t. The just released payroll report shows an increase in YoY non-supervisory earnings of 2.3%. That’s a bit better but still nothing to cheer about.

The trade balance and personal expenditure numbers go right to the GDP calculation.  The latest GDPNow reading from the Atlanta Fed shows the impact of those and other recent weak readings. You can see the evolution of the latest reading (it changes constantly as new metrics come out) on the chart below. While Wall St was backslapping and high fiving the Q4 GDP reading being revised from 1% to 1.4% the Q1 2016 growth estimate dropped from 2.4% to 0.6%.  Sensing a pattern here?  Again, I don’t think we have readings in hand that say “recession” but the US economy is near stall speed again and we won’t see hard evidence of a recession until after it starts in any case.  Without some catalyst to reverse things this won’t be good news for Q1 earning which start coming out again in a couple of weeks.

The rally in NY has indeed been impressive but so was the last one and it didn’t manage to eclipse the May 2015 high.  I won’t assume this one does either until I see it happen.  A supportive Fed is a huge plus for equities.  I’m well aware of the “don’t fight the Fed” mantra so beloved by Wall St.  I agree with it to a point but only a point.  The problem is that the Fed has little manoeuvering room now, something Yellen herself has acknowledged in recent speeches.  A hugely and proactively accommodative Fed can overcome mundane issues like earnings trends, at least for a while.  The trouble is that the Fed never normalized and has little room now to be more accommodative.  QE-whatever going into a national election?  Not likely unless the market is collapsing, in which case my prediction will be right anyway.

It’s all good right now.  The Bulls are back, Wall St is promising the economy is about to accelerate and this time it really means it.  That’s pretty much the same story Wall St was telling at the end of December.  We know how that turned out.   The current rally got a lot of fuel (pun intended) from the oil rally.  The falling USD helped oil and most other commodities as well as gold.  Much of the oil rally was unwinding of a massive short position.  That is mostly done so it will take real buying to lift oil prices further. That will happen at some point but not quite yet I think.  I don’t expect oil to be a major drag on the SPX but I think it may have gotten most of the lift from that it’s going to until oil bases again.

Earnings are more problematic and, as I have noted ad nauseam it’s not just about oil.  The recent rally in oil and other commodities may help the energy and materials sector earnings, or at least arrest the fall, but several other sectors are expected to perform poorly.  Wall St almost always overestimates future earnings.  The current estimate for Q1 earnings growth is minus six percent.  Let’s hope Wall St is too pessimistic for once.  If earnings fall by that much or more we’ll have four consecutive quarters of falling earnings.  I know of no bull market that survived that for long. 

One last thought on earnings season.  Companies and their management generally enter a trading blackout a week or two before earnings are releases that extends for several weeks. As I have noted before, share buybacks have been a major source of buying lately. 

The chart below displays the SPX, blackout periods (earnings seasons, basically) and overall equities flows or the gross amount of money flowing into or out of the market.  While I wouldn’t go so far as to call this chart a “smoking gun” it does present clear evidence that money flows reverse during many recent blackout periods. Not the end of the world but something that, other things equal, will put downward pressure on equity prices.  With all the crosscurrents lately the period of bullish relative calm in the market may be drawing to a close.

The Gold Market: Janet Does us a Solid

After one of the best starts to the year for both gold and gold stocks in percentage terms, both are now experiencing a pullback.  That was expected, indeed hoped for, by many.  Strong bull markets climb a wall of worry and traders want to see support levels tested on the way up.  It hasn’t really been much of a pullback and like Wall St Traders we can at least partially thank Janet Yellen. Resource traders are fairly calm so far though that will change is gold drops a lot further.  We’ve had our hopes dashed many times in the past few years so some paranoia is healthy.

Gold would have to pull back substantially from current levels to negate the breakout we’ve seen.  It would take a move below $1150 to do that but resource traders would be freaking out long before that.  On the upside I think the target price we diehards would like to see is clear enough.  Long suffering gold traders want a 13 handle.  A move above $1300 would exceed 2015’s early year spike and give gold traders and more recent generalists that have entered the space a lot of comfort.

I’m all for that and I think it will happen –at some point.   It’s worth remembering that this year’s move off the bottom is already larger than last year’s in both percentage and absolute dollar terms.  It’s also already a more sustained move.  The steepness of the lift off was scary but the current sideways action is helping to work off the former overbought condition.  We can thank Yellen for the sideways trend; it looked like gold would go back below $1200 before the last Fed meeting.  A dovish meeting gave it a bounce before hawkish FOMC member comments drove it down.  Yellen came to the rescue again with her dovish speech in New York.

So far gold stocks, both junior and senior, have moved farther and held better than the gold price itself.  I have heard plenty of anecdotal evidence that buying by generalists that avoided the gold sector for four years are strengthening the bid.  This might be more fickle money but there is a lot of it.  Market generalists “discovering” the gold space can drive a lot of upward revaluation even if gold itself isn’t rising strongly.   The GSX and GDXJ did suffer 10% drops in a couple of trading sessions before the Fed meeting. That could easily recur if gold looks like it will break below $1200 again and the down move could be doubled if the price moved below $1180.  So far though, gold has found strong support every time it neared the $1200 mark and buying came on strong in gold equities too.

I don’t think gold has to go below $1200 or $1180 or whatever again but the possibility can’t be discounted especially in the slow summer months.  I’ve already noted that bull markets trade differently than bears and I’m less worried about things like futures market positioning.  I agree that the large short position by Commercial traders looks bearish but they are hedgers.  If we get an extended bullish run in the gold price Commercials will always have a big short position.  They’re hedgers by definition. That is what they do and it’s a reaction to the market trend as much, or more, than it’s a prediction of future prices. We shouldn’t ignore it but we also shouldn’t ascribe motives to their trades that probably don’t exist.

Whether it makes sense to play swings like that depends on how nimble you are and your personal trading philosophy. I’m more interested in finding good socks cheap than trying to trade every swing.  If you don’t trust the gold rally yet you could always lay in stink bids 10-20% below current levels on stocks you want to own or own more of and exercise some patience.  You might get filled, you might not. 

If we look back at the last bull market for gold from 1001-2009 (or 2012 if you prefer) late spring rallies from early April to mid-May were common but they were the weakest seasonal rally of the year. Three or four percent wouldn’t be an impressive upward move after what we just witnessed but it would be enough to reinforce the bullish trend.   If it happens it will put an end to a pullback in gold stocks at least for a while.

For the time being the important trend that supports gold (and other metals/commodities for that matter) is widespread negative rates internationally and comments by Yellen in the US.  For me the most important part of Yellen’s recent narrative was the acknowledgement that the Fed has painted itself into a corner.  She is clearly concerned that the next time a recession looms the Fed will have few weapons to fight it.  Ironically, that seems to be making it less likely the Fed will raise rates. I don’t find that position very logical but it’s working in the favor of the resource sector.  Yellen as much as said in her recent speech that she intends to be “behind the curve” on inflation.  As I noted late last year I expect a mild increase in inflation due mainly to a lower starting base after last year’s materials price collapses.  There is also cost push in a couple of areas like rental/housing and medical costs.  Not exactly “frills” that can be substituted. 

I don’t expect a major move on the inflation side but that isn’t the point.  It’s that central banks now seem determined (or are cornered, take your pick) into letting interest rates trail inflation and just taking their chances that things don’t overheat someday.  As most of you undoubtedly know, this is the classic recipe for stronger commodity prices and precious metals prices in particular. 

Long runs of negative real interest rates have marked several long cyclical and/or secular bull markets in gold.  My colleague Jordan Roy-Byrne who publishes which focuses on technical analysis of the gold market and a portfolio of gold stocks, was nice enough to lend me a very long term chart he recently created that speaks to this subject.  This 50 year chart compares gold prices, the real (inflation adjusted) Fed Funds rate and the real 5 year yield.  It conveniently displays some of the trends I’ve been discussing this past year.

Careful inspection will show that it’s not just absolute levels of positive or negative yields that matter.  Changes in trend are particularly important and often accompany the largest swings in gold prices. 

Jordan highlighted four areas of the chart, including the bear run that is now ending.  In all cases these periods were marked by increasing real rates – often from negative to positive and the belief rates were going higher still. A close look at the right side of the chart will reveal that real rates have turned negative again in the US.  More importantly, jawboning by the Fed and others is reinforcing the belief that negative rates could be here to stay for a long while.  This is an extremely constructive environment for gold and gold equities.  About time!

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