Hunting Season

From the September 6, 2016 HRA Journal: Issue 257

Ok, Happy now?

All you traders that were wringing your hands and calling tops for the sector since PDAC finally got a correction to call your own.  It wasn’t much of one.  I don’t think I’d get it framed or bronzed, but it’s yours.  You can all relax now in the knowledge that you won’t be the one buying the top. That top, at least.

With a correction (of sorts) and a clear interim bottom in the gold price the deck is cleared for the mountain of news releases headed our way.  Expect high volumes and high volatility.  We know traders want to own these companies as they prepare to report but we don’t know yet what sort of results will satisfy shareholders. That will be a company by company decision and management's ability to convey and explain their results will be a big factor.

We’re still early in this bull cycle and waiting for the first major new discovery.  They were thin on the ground last cycle. Maybe that happens again but with some companies working in new areas I’m hopeful we’ll see one soon.

I’m hoping a company already on the HRA list finds something big and new. That’s easier for both of us.  I’ll be watching news from everyone though, not just HRA list companies.  I should have a couple of new names for Journal readers soon, either ones I’m already looking at or something completely new that comes out of the drill reporting about to begin.

***

September.  This is when the rubber meets the road in the exploration game. We’re in a global market with companies reporting from projects on seven continents. Even so, the old school concept of saving the heavy exploration reporting for after Labour Day lives on.

Most traders focus on drill hole data almost exclusively.  Drill holes are considered the most “consistent” sampling method. (That’s an oversimplification but we’ll deal with that issue on another day). The market reacts and revalues early stage deals on a scary scale based on drill results from the first couple of programs.  There is a ton of that data hitting the markets in the next few weeks.

I’m well aware of that prejudice. That’s why, in addition to development level projects, I look for companies where the drill reporting is still to come. This is the higher risk end of the spectrum, make no mistake.  But its also the area with the biggest potential for gains.  As long as we find situations that others find later. Then we’re in a position to mitigate the risk by trading our costs down, positioning for the flood of drill results then crossing our fingers. We’re there now.

The chart of the TSXV index above tells the story.   We saw a pullback in the gold price during late August.  That move bottomed out almost exactly where the previous two did at $1310.  This time however, hawkish comments from Fed governors and continued drivel from Wall St. about an accelerating economy had traders on edge. 

There was heavy selling in the gold space, more so in seniors than Juniors. Some of the big name investors beloved by Wall St (think George Soros) dumped positions or took profits. That had hedgies who can’ think for themselves heading for the exit.

That led to a bit of a panic attack by weak longs, exacerbated by some heavy selling in the gold futures market. There were two or three instances of $1 billion plus in selling in a matter of minutes in the gold futures market.  Literally billions and literally minutes.  I have no idea who was behind that selling.  The impressive thing is how little long term impact those bouts of selling had.

The proximal cause of all this angst was a suddenly more hawkish US Federal Reserve.  Markets internationally had taken Brexit in stride and the US had posted great payroll numbers in June and July.   Wall St suddenly wasn't so sure the “lower for longer” narrative was in play.  It didn’t just impact gold.  The SPX was flat though most of August as traders worried that a supportive central bank no longer had their back.

Well, that was last week.  Things started to turn with the publication of a weak manufacturing sector ISM survey that actually shows the manufacturing sector in the US contracting in August. 

The August payroll report came next and that too was lighter than expected at 150k new jobs against a consensus estimate of 180k.  That isn’t a big miss but it may have reminded Wall St, which seems to have no institutional memory, that the US posted great payroll numbers last summer too, just to have things fall apart later.

I long ago gave up on the idea of the monthly non farm payroll report as a reliable growth barometer. It simply hasn’t been for some time now. I pay close attention to the report mainly because I know it will heavily influence markets, right or wrong.

The part of the payroll report I have been taking seriously is changes in average hourly earnings and average workweek.  Those two numbers determine aggregate compensation for non supervisory workers (most of the work force) which gives us a sense of what the broad population has to spend.

The US is the world’s most consumer driven economy. Americans can, and do, dip into savings or increase debt but at some point there has to be some balance between aggregate earnings and spending. 

Wall St and the FOMC have pushed the idea the US economy is about to accelerate for months.  I’ve been a skeptic because I haven’t seen aggregate compensation accelerate.  August brought more of the same with year over year hourly earnings and the average workweek decelerating for the second month in a row.   I still expect Q3 GDP to be better than the first half of the year but I just don’t see evidence it’s the start of a trend. Acceleration will have to wait. Again.

 In some ways it’s like déjà vu all over again.  This time last year markets were bracing themselves for an interest rate increase in the US.  There had been a string of good economic metrics released through the summer, though some were pointing to trends rolling over. Fed governors were crisscrossing the country warning traders not to doubt their resolve to tighten monetary policy.

A market crash in China last August put paid to the idea of a September rate increase last year.  Hawkish Fed governors kept insisting the meeting was live but bond traders effectively flipped them the bird. Traders bought yields down in the bond market as equity traders freaked out at the thought of a measly 25 basis points.  The Fed finally pulled the trigger in December.

Any of this sounding familiar?  This time around it’s US numbers fading fast.  Much like last year we have Fed governors insisting September is still “live”.  The market started tuning that out after the August payroll number.  There was worse to come. 

The top chart on this page shows the non-manufacturing PMI from the Institute of Supply Management.  The service PMI as it’s otherwise known captures the bulk of the US economy.  The August reading was a major miss, the lowest service PMI reading in six years.  Could it be a fluke?  Perhaps, but the ISM has a pretty good reputation for data integrity and the drop actually fits into a longer term downtrend in the reading that started early last year.

You can see the impact that had on the US Dollar in the lower chart.  Things have come full circle in the space of only two weeks.  The Jackson Hole bounce in the USD and Treasury yields has evaporated.

I’m sure there will be other scares in the gold and USD markets.  The FOMC is very serious about wanting to raise rates.  While it seems the Fed will now have to set its sights on December I wouldn’t doubt their resolve.  I don’t think it’s a smart idea at all but some of Fed governors seem more worried about the Fed’s credibility than the potential impact of rate increases. 

What I don’t know is how much control Yellen has over the FOMC.  If she can bend them to her will then I think we see no increase before December and even a December increase isn’t likely.  The hawks on the FOMC are worried about looking like they follow the market (which they do) rather than lead it.  Hopefully they don’t win the arguments and hike rates out of some sort of misplaced “macroeconomist machismo”.  No one will be impressed by them keeping their nerve if they blow up the market in the process.

The Venture chart on page one and GDXJ chart on page three are the summaries of the recent drama that matter to us.  The Venture had a very quick correction, just deep enough to even deserve the name. There were plenty of “I told you so’s” from traders who missed the rally and probably didn’t buy the dip either.  They will be chasing the next leg up.  It was ever thus during bull markets. 

Take particular note of the volume on both charts, which I.  Volume hit a two month high as soon as we passed Labour Day.  I think there are higher volume days ahead as the real flood of drill reporting begins.

The volume increase on the GDXJ is even more pronounced (note that this chart is weekly and the last bar only represents today).  Last week was the highest volume week in over a year. That action backs up anecdotal comments that there is still a lot of outside money that wants in. There are plenty of funds that backed off as the spring and summer rally continued and decided to wait for a pullback.  Based on last week’s volume those funds were worried about being left behind again.  They bought hard at the first sign of a bottom.

The juniors still have some hurdles to overcome, like large amounts of placement stock coming free trading.  That worried many as the market dipped last month.  If the renewed volume keeps up however it placement selling volume should be absorbed.  At the end of the day its all about exploration results. If they are good enough the selling volume won’t matter.

And what of the senior markets?  Clearly, traders are still bullish and the recent drop in both yields and the USD will help.  Those can only do so much however.   If the recent ISM readings present an accurate picture than we may be in for yet another quarter of falling earnings on the big board.  

Traders have shrugged off falling earnings for several quarters now but they won’t do it forever.  Companies have made up for lower earnings by increasing share buybacks and dividend payouts.  Indeed, according to S&P, buybacks plus dividends actually exceeded operating income for S&P 500 companies for the first time since 2008.  That is not a sustainable trend.

As long as bond yields stay low the major indices will have some built in protection.  Don’t get too complacent however.  Maybe everything goes back to “normal” again but we need to be on the lookout for further deterioration.  With the stretched valuations it will be hard for NY markets to make much more headway.  While the US economy does seem to have stabilized I still maintain the position that there is a decent chance of a recession or something that feels like one starting before the end of 2016.  We may dodge that bullet, as long as we don’t see Fed policy errors.  Just one more reason we should all be cheering for the doves on the FOMC.

With gold now back at $1350 the stage is set for the fall rally we’ve expected since early this year.   We’re still waiting for the market to deliver a real new discovery story the sector can get behind.  That may come out of this season’s drill reporting.  I’ll be watching everyone’s news closely—not just current HRA companies—hoping for something new and exciting I can send your way.  Stay tuned. 

 

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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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