From the June 23, 2016 HRA Journal: Issue 253
Well, ok then. Unexpected.
You already know what the big story is this issue. I ripped out the old editorial and rewrote it in the wake of the Brexit vote. I hate sounding like I’m making too big a deal out of an issue that is only a few hours old but this is one of those cases where any number of long term effects are obvious.
Risk Off is back. With a vengeance. Unlike some recent episodes gold is very much benefiting from the change in tone. The foundation for that was laid when generalist money started entering the space. One of the most likely outcomes of Brexit is lower for longer interest rates and vast liquidity injections by central banks. All of that, for a change, is gold positive. I don’t think this is a market where gold will be punished or be one of the first assets jettisoned when things get scary.
All of that adds up to more gains for the sector. There are ten pages of updates and plenty to choose from. I think we can dispense with talk of summer doldrums, at least in this sector.
Choose your target companies and a risk level you’re comfortable with. Don’t ignore risk management and regular harvesting of profits but do go looking for those profits. There will be plenty to be had in the gold resource stock space during the remainder of 2016. Have at it.
I decided early yesterday I would wait for the Brexit vote result before getting this issue out. I won’t insult your intelligence by pretended I expected this result. But there were so many bets being placed across so many markets that it was clear there would be huge volatility no matter the outcome.
With the outcome we got, the vote by Britons to leave the EU, the market impacts are being hugely magnified. The markets are all over the map but the short and sweet version is that it’s going to be ugly for a while – unless you own gold stocks.
Before going any further I should reiterate a comment that I (and many others who follow the gold market) have made in the past. I hate gold moves for “political” reasons. Gold often does move for geopolitical reasons of course as part of its appeal is as a currency without a counterparty liability. That makes it a good hedge when things like Brexit happen, much the same as “risk free” investments like US Treasuries and Japanese Government Bonds.
That all makes for fun market watching but be careful. Politically driven gold moves can be treacherous indeed.
Brexit is a large rock dropped into a small pond. The ripples will be violent and there will be large ebbs and flows as the impacts reverberate across markets worldwide. That said, gold should benefit from both “risk off” and “currency” buying. Just be careful about things like high openings.
When things like this happen you can get large flows of outside money that think nothing of putting large market orders in on securities they think are liquid. That can make for locked trading at the opening and moves of 10-20% on gold stocks. Nice if you already own them but tricky if you don’t. Of course as HRA subscribers I’m safe in assuming you have a much heavier than average weighting in this sector. You should be feeling smarter than average because of it.
I’m throwing even more charts than normal in this editorial. This is one of those times where pictures really are worth a thousand words. Keep in mind these are being generated on the fly during a hugely volatile session. Many could be out of date by the time you see this in a few short hours.
The UK Pound chart on the first page is simply breathtaking. Note that those are weekly bars and the giant swing you see on the last bar mostly happened in the past few hours. If you don’t watch currencies, particularly major ones like the Pound on a regular basis it’s easy to shrug off a move like that. You shouldn’t.
Historic is the only description that fits an eight hour move like that.
The volatility won’t end today or next week or probably next month. It will take a while for things to settle out. The initial moves across all markets were overreactions. While you’ll see plenty of people taking credit for predicting a “Leave” win, few did. That much is obvious from the way financial markets and the gold market traded in the past few days.
Clearly, most participants were positioning themselves for a “Remain” win. The initial shock reactions, especially in futures markets, came from traders stampeding to unwind trades on the wrong side of the market and plenty more who were unwound involuntarily as margin levels were breached.
Once the initial shock reactions start to wear off markets should revert to the mean, at least a bit. You can see that already in the gold chart on the previous page. After a massive $100 move up in the space of a few minutes, gold prices have settled back closer to $1300, though they are on the high side of the thirteen handle now. I think gold is likely to stay on the high side of $1300 this time and that should bring yet another wave of outside money into the sector.
It’s simply too early to say where things will settle out but it’s very clear we’re back to a “risk off” market. I don’t think that general tone will change very quickly and that will continue to favor gold. The bottom chart on this page is the ever popular SPX VIX volatility indicator that traders use as a proxy for risk sentiment. VIX exploded the minute the trend towards a Brexit vote became clear. Traders everywhere are shaken.
The two charts below display the US Dollar Index and the Japanese Yen. Like gold, they are displaying classic risk off trading reactions. Also like gold the moves are massive; over three percent on the USD and five percent for the Yen. Gold’s move is that much more impressive given the spike in the $US.
One can only imagine how the Japanese government and Bank of Japan are reacting. The initial move took the Yen up to 100/dollar. This is a waking nightmare for the Japanese that depend so heavily on exports. I’m sure the BoJ was in the market selling Yen but even central bank machinations may prove fruitless until markets settle.
So where do we go from here? Once things start to settle we’ll see markets that are more removed from Britain and the EU normalize (relatively speaking) first. That will be aided and abetted by central bankers worldwide.
While I don’t expect QE program announcements the major central banks will be doing whatever they can to flood the markets with liquidity. Bond traders know that’s coming. Yields worldwide are plunging as traders seek refuge in government paper and anticipate another wave of central bank buying to hold rates down.
Plunging yields and the assurance of supportive central banks should have the bulls out in force on Wall St. You’ll be hearing plenty about how Brexit is either meaningless for the US economy or somehow an advantage. Wall St bulls haven’t given up easily during recent periods of market volatility and this time will be no different.
As the chart on the top of this page shows, traders have already engineered a pretty good bounce on the SPX and most New York traders are still asleep. Its also true that trading so far indicates yet another clear break in NYs uptrend. We’ve been here before several times since early 2015 and we’re here again. Maybe the overnight low of 2000 on the SPX is as bad as it gets. I doubt it. We’ll see.
The bigger question is whether the ultimate outcome is different as markets and companies adjust to the new reality. The reaction will be strongest in Britain obviously. What the real costs of Brexit are won’t be known for some time. The average estimate for the time required to engineer the exit is two years and that sounds optimistic to me. There are literally thousands of agreements, treaties, and multilateral commissions that will have to be rewritten or dismantled. Five to ten years sounds more realistic to me.
All those agreements at least leave room for the impact of Brexit to be lessened. If Britain can retain the trade advantages while regaining its sovereignty in other areas the potential impacts on the UK economy will be greatly reduced.
In immediate terms, companies in Britain that are there for access to the EU will be cutting back spending and probably hiring immediately. The City of London as a financial centre will take a big hit. Several of the world’s major investment banks already warned there could be mass layoffs in London. I don’t think that is an idle threat. If Britain can’t assure traders unfettered access to EU markets -and they can’t after today – plenty of finance jobs in London become redundant. The odds that Britain enters a recession almost immediately have just gone through the roof.
At a political level, we’re going to see national and regional movements that espouse turning inward soar in popularity. Britain could have an almost immediate, though opposite, problem with Scotland. The Scots almost voted to leave the UK recently but voted strongly in favor on remaining in the EU last night. Expect renewed calls for another referendum to separate from the UK to start almost immediately and this time the odds that Scots vote to leave will be even better.
The situation is similar in several of the EUs major continental economies. Recent polls in both France and Italy indicate that a majority of the population favors an EU referendum. Current estimates of the size of the “Leave” camp in France and Italy are much smaller than Britain’s, but then few thought the Brexit vote had much chance of passing at the start of the campaign either. I don’t think the pro EU contingent will be cocky anywhere after today.
The Brexit vote will embolden and strengthen the nationalistic and inward looking political parties that were already gaining traction. No doubt the champagne corks were popping in the headquarters of France’s National Front and Italy’s 5 Star parties.
France’s right wing fringe is nationalistic and jingoistic. The NF wants an end to immigration and, make no mistake, immigration was definitely the “elephant in the room” in the Brexit campaign. The massive influx of refugees into Europe in the past year was a major issue that swayed many British voters. The fear is understandable but still saddening. I can’t view a turn towards being inward looking and trying to lock out the world as a positive development in any way.
Italy’s 5 Star is more anti EU than anti-immigration. It would be amusing if it wasn’t potentially tragic. Given that Italy’s governments of all stripes have been serial screw ups when it comes to economic management the idea they would do better is laughable. No one’s laughing after today though.
What parties like NF and 5 Star probably would do if the shackles of EU monetary policy were removed is bring back their old currencies and immediately devalue them. After all, devaluation is the last bastion of an incompetent finance minister. If some of the shakier EU members do manage to get their own referendums going there is real potential for the EU to fracture and the race to the bottom for currencies will enter a whole new phase.
All of this adds up to uncertainty piled on uncertainty. That is not a climate that is conducive to investment in long term assets or new projects by major corporations. Investment was already the Achilles heel of this expansion in many economies, particularly the US.
The current political situation isn’t likely to make corporate decision makers braver when it comes to new investments. The lack of investment is one of the reasons this cycle has displayed such lacklustre productivity growth. That may have actually helped hiring, at least in low wage jobs, but its not increasing value per worker or promoting the idea of increasing wages. That too has been a constant problem during this expansion.
Brexit led me to toss most of the editorial out the window and start fresh. One point I do want to touch on is displayed in the chart on page 5 which I had in a recent SD Alert. The chart displays the changes in the Labor Market Conditions Index. The US Federal Reserve’s Labor Market Conditions Index. The Index is calculated by integrating 19 different labour market indicators in different regions of the US.
This is a pretty horrible chart and it was certainly available to FOMC members before the general public. Given that, how do you make any sense out of the hawkish stance of so many FOMC members before the last Fed meeting?
The short answer is, you don’t. I think this chart proves that the Fed wants to raise rates this year for the same reason I thought they should have done it two years ago. Not because the US economy is strong but because they need ammunition if the US falters. Right now there is almost nothing the Fed can do if conditions weaken other than variations on the QE theme.
The chart also brings home the point that the lousy May payroll report may not have been a one-off. I didn’t think it was even before I saw the chart. For some time, I’ve been concerned the US could see the start of a mild recession this year. If the trends that began in the last few hours are extended the odds of that just went way up. Scary headlines could be enough to weaken consumer spending. Its all but certain to reduce corporate investment. That is doubly true if the USD keeps surging. That is going to hurt corporate profits. The surging dollar and fear of weakening economies has lopped $3 off the oil price in the past few hours. If that continues we could see renewed problems in the high yield debt markets in the US.
I’m not trying to scaremonger here. I’m just calling it the way I see it. Recessions never get called in advance by Wall St or mainstream economists. I’m giving you fair warning that that outcome is now a very real possibility in the US this year.
That brings us, finally, to our little corner of the market. It’s likely to be the one of the happier parts of it for the foreseeable future. Beware of high opens in the near term but that doesn’t mean avoid the sector. Far from it. I expect precious metals stocks at all levels to be one of the few winners in this scenario.
The move won’t be smooth or even. Brexit injects a huge amount of uncertainty into the markets and there will be many who chose to bow out. Companies that didn’t have the projects or management to get the market’s attention before will have even more trouble getting it now. The bifurcation of the juniors into “haves” and “have nots” will broaden and deepen. Make sure the company you’re interested in can make the grade as the margins for error will be smaller.
Notwithstanding the wild swings in the past few hours I’m not expecting any sort of crash in the near term. If I was I would be lot more concerned for the whole sector. While I still believe NY may have seen its highs I actually agree with Wall St bulls that we shouldn’t overestimate the impact of Brexit on the US and many other economies. It will weaken demand though so I’m leerier of base metals and energy. I’d also be a lot more cautious when it comes to bubble sectors like Lithium. Areas like that are the first ones traders flee when their risk tolerance vaporizes.
Those caveats aside, Brexit will be a boon to the gold stocks, junior and senior. Odds of gold seeing $1400 plus just went way up. As you know, I never expected much of a summer pullback this year. I certainly don’t now. If you’ve been waiting for that mythical pullback to step up any buy gold explorers, developers or producers – stop waiting.
Ten pages of updates follow this editorial. There are plenty of choices within those pages at different risk levels. Volatility will be higher for some time to come but the way the world is unfolding there is room for a lot more gains. Go get ’em.
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