Elephant in the Room
From the November 7, 2016 HRA Journal: Issue 260
I’ve always considered politics a little bit crazy. “Little bit” doesn’t begin to describe the gong show that passes for an election in the US. The good news is that it will soon be over. Good riddance.
The gold sector continues to tread water. Things look a little better on the base metal side though there are reasons to exercise a bit of caution with some of them as I detail in the editorial.
In better news, several HRA companies are now embarking on important drill programs or continuing discovery programs. The number of explorers that look like they have bona fide new discoveries is small but they are being treated well by the market. I consider that a positive sign for the health of the exploration sector going forward.
I still expect the sector to hold its own once the election turbulence has passed. Of course, that assumes The Donald is not the winner of the US election. That outcome could generate some serious headwinds for markets in general but would also generate a large bounce for the gold sector.
Note the Last Call for the Metals Investor Forum on page five. The room will be full but we will always make room for subscribers so don’t let that hold you back. It should be a great show with a strong company line up. See you there.
It’s been a strange period in the markets and you can chalk most of the strangeness up to the US election. Because of the candidates running the outcome is being viewed as binary and the market sees one candidate as being particularly risky. (in case you haven’t guessed the scary one is running for the party represented by an elephant—get it?)
I had a lot or travel time since the last issue. That held things up a bit, but so did spending way more time tracking a US election than I ever have in the past. That’s because this particular election presents more defined “risk on/ risk off” choice for markets and, indeed, markets have reacted quite differently to this election cycle than to other cycles in the past.
Historically, national elections have been good for Wall St. The idea of a new start generates some optimism and markets trend high going to election day. Not this time.
Because Trump is viewed as such a high risk candidate we’ve had the strange situation of risk-off assets moving in tandem with Trump’s poll results.
The gold chart below is the perfect example of this phenomena. Look at the two week chart below. Gold has had some wild swings lately an they relate directly to political events. You can see from the chart below that gold started a $40-50 move the instant the US FBI Director said he might reopen an investigation into Clinton’s email practices.
As this issue was being completed the FBI reversed its position and gold reversed its price move. As this is written gold is only $15 above where it started its “Comey” move. Optimists can hang onto that but we won’t know what the impact is until the election is over and the votes are counted.
Barring a recount situation (let’s hope not!) I expect most of the impact of the election result to have washed through the market by the end of the New York trading day on Wednesday. If this was any other year I’d say that we’ve seen most of the impacts already. We may have in the equities market. I’m not as confident that is true of the gold market. A lot of the recent buyers are hedging the possibility of a Trump victory. After the shock of the Brexit vote we have to assume there are plenty of traders who aren’t willing to take off hedges until they see a final count.
The one good thing about this election (the only good thing maybe) is that its almost over. The main market impacts will have washed through in 48-72 hours, assuming the polls are right and it’s a Clinton victory.
Should Trump win, gold has $100/ounce near term upside. It’s a pretty asymmetric bet at this stage. The Trump upside for gold is probably at least five times the potential Clinton downside, perhaps more. Even post-Brexit, I’m not willing to bet so many polls are that far off. I’ll be staying on the sidelines, watching the coverage and preparing to trade on whatever Wednesday's “new normal” is.
Meanwhile, back in the real world.
That brings us back to the post election real, wider world we have to live and trade in. There has been a lot of movement in the commodity markets and much has come on the base metal and bulk material side. I’d like to take all those price changes at face value but I find some of the price moves pretty surprising.
Take a look at the copper chart on the next page. Does the right side of that chart look like a normal move to you? Most of you know I haven’t been bullish about copper this year due to oncoming supply. I’m not a bear though and this isn’t sour grapes. I expect a small supply surplus next year. Nothing massive but, still, a surplus.
The chart at the top of this page shows a metal trading like there is an imminent supply crunch. The middle chart tells you there isn’t. Yes, there’s been a drawdown in LME inventories since early October, but the early October high was a two and a half year one.
So what explains the move in copper and even larger moves in things like iron ore and met coal that seem to be in even less danger of running short of supply? I think the lower chart on this page explains some of it. The Chinese Yuan dropped three percent during October (the chart is Yuan per Dollar; a higher number means a cheaper Yuan). Not massive but there are concerns China plans to keep devaluing. That has driven speculative funds into a variety of commodities. Trading volumes for many commodities in Shanghai have reached bubble levels. A lot of “hot money”, in Asia in particular, has been flowing into industrial metals.
Does that mean its all going to blow up? No. I think we need to be concerned or at least aware of speculative dumb money but there are legitimate reasons to be optimistic as well. The chart below is JP Morgan’s Global manufacturing PMI. I wouldn’t call it a world beater but the recent improvement is obvious.
Importantly, this is not a US story. Several other major economies have improving numbers and several, including Germany have better forward looking metrics like New Orders. China has also seen some recent improvement, though its coming out of a deep hole.
Demand for most industrial metals should be increasing with that sort of backdrop. Some metals, specifically zinc and nickel, do have supply issues and their price move look legitimate. Even copper doesn't look scary, just a bit ahead of itself. The recent price move has only taken the coper price back to where it was early this year.
My main point is that we have to recognize part of these moves are speculative, particularly for commodities like iron ore. If you’re interested in a base metal or bulk material with a well supplied market it may be worth waiting for a pullback. Even then, we should be pleased to see a broadening of the upward price trend to other metals. The more participation we get, the stronger a resource bull market is likely to be.
In any case, I don’t think this is an issue for earlier stage exploration stories. As long as exploration is succeeding, a move of ten or even twenty percent in the underlying commodity won’t make a big difference. Its more about discovery than metal prices. That certainly applies to the company featured in this issue. It has potential for large gains on continued discovery. Metal prices aren't like to factor into things any time soon.
And what about gold, which is the main underpinning of the new bull market so far? Traders will have to get used to the idea of a new administration in the US. Assuming the trend in global PMI isn’t just a head fake, traders will also need to get used to the idea that central bankers may become less accommodative. Less accommodative is a long way from hawkish however.
The chart at the below shows you that real long term rates in the US are as low as they have every been in the past 100 years! That is not the sort of trend that gets reversed by one or two rate increases. Do I think the Fed raises rates in December, assuming a Clinton win? I think its all but guaranteed. I also don’t think it changes the narrative.
The bond market is now pricing in over 80% odds of a December rate hike. Assuming a non-scary outcome to the US election the odds should go even higher. With odds that high priced in the move itself shouldn’t drive the US Dollar much higher.
If the US comes through election season with a burst of optimism, we may see upward pressure on the Dollar. Keep the global PMI chart in mind however. Other economies have seen improvement lately too.
Traders got excited when the US reported a Q3 GDP growth print of 2.9% It was a nice number alright, but over 1% of that growth came from inventory adjustments and a one-off surge in soybean exports. Still real but probably not repeatable. The US is doing better; I just don’t think the gap between the US and other advanced economies is as big as Americans would like to think.
Technical traders expect, indeed want, to see the gold and resource sector stay flat for a couple more months. They could get their wish if the markets come out of the election unscathed. Even so, the current situation is very similar to the one that prevailed a year ago. Traders were convinced the US Dollar was a one way ride because the US economy was accelerating and the Fed was about to start a series of rate hikes.
Things didn’t exactly work out that way. I think the economic underpinnings are a bit stronger than they were a year ago. That doesn’t change the thesis for higher gold prices down the road. The Fed isn’t even pretending its planning a series of rate hikes any more.
In a “normal” year we see tax loss selling trail off in the first week of December. I think we’ve seen some of that selling already, on top widespread profit taking. Even so, companies that look like they may have new discoveries are getting plenty of support. Just look at the first company in the update section.
Several of my favorite plays have announced drill starts in the past couple of weeks. Those will be the ones to watch. I don’t think gold is going much lower but discovery will trump (no pun intended) even a moderate additional price drop if it does happen.
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