Friday, September 14, 2012

Precious Metals Update - Part I

Market Notes
  • The Investor Intelligence survey tracking newsletter advisors, tends to be a good contrarian indicator. This week's readings came in at 51% bulls, 25% bears and 24% neutrals. We are witnessing a prolonged period of low bearish sentiment, that strikes high similarities leading up to the 2008 bear market, 2010 flash crash and 2011 stock market crash. Where are the bears?
  • Bill Gross of PIMCO, a well respected bond investor, last month cut his Treasury Bond holdings to 21 percent from 33 percent in expectation of further reflationary policies (QE) by the Federal Reserve. Mr Gross stated that “QEs lower real interest rates and raise nominal rates because their intent is to reflate.” Will Mr Gross be right in picking a Bond top?
  • Current Merrill Lynch Credit Spreads show remarkable calmness in the financial markets. However, it is important to note that spreads are at more elevated levels relative to the good old 2004 - 2007 days, when the global economy was in the midst of a credit boom. While many market pundits believe Europe has turned a corner, I believe it is the calm before the storm...
Big Picture
The last two weeks has seen central bank intervention promises pushing risk assets out of oversold levels. The Euro has experienced a 9 cent rally from its previous bottom around $1.20. Copper, which tends to be an industrial economic indicator, is attempting to break above its 200 MA. However, Copper is far away from confirming the S&P's new highs in 2012. The Emerging Markets, saviour of global growth in the post Lehman recovery, continue to lag other equity indices indicating that not all is well with the BRICs. Currencies and precious metals have technically broken out to the upside, but the real test will come as volatility returns to global risk assets and whether the US Dollar starts to rally again. Finally, the DAX is now moving almost vertically like a NASA rocket, which usually does not end well.

Leading Indicators
OECD's leading economic indicator data was released today. OCED press release writes that:
"...the loss of momentum is likely to persist in the coming quarters in most major OECD and non-OECD economies. In Italy, China, India and Russia the CLIs continue to point to a slowdown. For the Euro Area, France, and Germany the CLIs point to continued weak growth. The CLIs for Japan and the United States show signs of moderating growth above trend, while in Canada the CLI continues to point to growth moderating below trend. The CLIs for the United Kingdom and Brazil tentatively point to a pick-up in growth, but remain below trend. The OECD Development Centre's Asian Business Cycle Indicators (ABCIs) suggest that ASEAN economies show overall resilience, though some signs of weakening are observed."
Two out of the big three economies (EU and China) have already been in contraction mode and it seems to me that the US in now slowly being affected. Furthermore, the world's third largest economy, Japan, seems to be slowly rather rapidly, especially as its exports to China (largest export market) drop off rather aggressively. Germany is also another major worry, as the contraction accelerates. After looking at the recent OECD data, the million dollar question is - how long can the US economy de-couple for? Bulls say de-coupling is possible as long as the EU situation stays relatively calm, while bear say that de-coupling is wishful thinking, last heard in early 2008 prior to a global recession.
Moving along, Merrill Lynch's Global Wave indicator continues to contract, signalling that the global economy is headed for a contraction. For those not similar with the index, the components include Global Industrial Production, Global Consumer Confidence, Global Capacity Utilisation, Global Unemployment, Global Producer Prices, Global Credit Spreads and Global Earnings Revision Ratio (one of my favourite indicators). Merrill Lynch summarises the recent data by stating:
"The Global Wave fell again this month as macro data deteriorated globally. Six of the seven components are now weakening. The most significant moves were falls in the Global Earnings Revision Ratio and Global Industrial Confidence. It is an amalgamation of measures of output, demand, productivity, the labour market, manufacturing prices, credit spreads and earnings expectations."
Global Wave indicator tends to lead the unemployment picture by a few months, so the recent weakness in growth could eventually spill into corporate layoffs. If that was to occur in the coming quarters, consumer spending would diminish substantially and most likely send the global economy into a synchronised recession.
Finally, it has been awhile since we looked at the ECRI leading economic data (published last Friday). ECRI Growth Index has risen from -3.5% towards +1% over the last couple of months. 
While the short term trend still remains positive for now, the ECRI Weekly Index is failing to make new highs and rise above the 2 year moving average. Furthermore, the chart above speaks of a bearish divergence between new highs in stocks which has not yet been confirmed by the ECRI Growth Rate. This could signal trouble ahead.

Featured Article
It has been a while since a Precious Metals article appeared on the blog, so we are definitely overdue for an update on the current situation. There is plenty to write about from both the short and long term perspective, so it is appropriate to break the post into two parts. The second part will be posted sometime next week.
Precious Metal bulls believe that the recent break above the 200 day moving average for Gold could be a game changer, which technically might signal the resuming uptrend in price action. Silver, in particular has now moved above its 200 day MA for the first time in over a year, after being extremely oversold (almost a 50% decline from the peak 16 months ago). Personally, I am not 100% convinced die hard Gold Bugs have it right, as Gold is moving towards its 11th annual gain in a row. In other words, I would have preferred to see the PMs sector correct further, with Gold experiencing a proper bear market and an annual loss.
Regardless of what I think, it is much more important to follow the price action. In the chart above we can see that the overall Precious Metals sector, including Platinum and Palladium, has recently broken out on the upside. I have personally participated by purchasing a large amount of Silver at the July lows and a smaller trade position at the August technical break out.
From their perspective lows during the summer bottoming phases Gold has rallied 14%, Platinum has rallied 20%, Palladium has rallied 22% and Silver has rallied 30%. Precious Metals have now become overbought from the near term perspective and sentiment has risen towards extremes again. Elliot Wave shows that the Daily Sentiment Index, measuring the short term view of future traders, records 90% bulls on Gold and 92% bulls on the Silver Chart above. Therefore, I would pull back from purchasing any Precious Metals right now, until we see some kind of a consolidation or a correction.
Bullish sentiment is also evident in the GLD ETFs weekly rolling fund flows. The chart above shows that after suffering three panic selling events over the last 12 months, GLD ETF is now in process of posting its 6th consecutive weekly rolling inflow. Retail investors seem to be chasing the prices higher, so caution is advised as it is never wise to follow "dumb money".

Having said, we could have also witnessed a major low in the PMs sector, like die hard Gold bugs believe (they believe every sell off is a major low). Assuming this is true and the cyclical bear market has finally finished, similarities could be drawn back to October and November 2008 prior to the Central Bank reflation policies, where we saw consistent inflows for 19 out of 21 weeks. I do have to admit that Precious Metals find themselves in a seasonality positive period of the year and therefore could surprise further to the upside, after a near term consolation or correction.
Calling a major low or for that matter a major high, is always a favourite game of retail investors, so I am not going to participate in the guessing game. Gold in particular has me worried, because its corrections have been rather muted at best, over the last decade. I know die hard Gold bugs will argue various technical and fundamental points to have me join their allegiance, but regardless of what anyone says, it is very rare for any asset to be up 11 calendar years in a row. But, to stick with the theme of this article, I admit there is definitely a lot of evidence that we have seen a low in PMs, so let us make that assumption.
In that case scenario, the best Precious Metals play tends to be Silver, as it behaves like Gold on steroids (very high beta). Over the last decade or so, during the Precious Metals secular bull market, Silver has experienced five major rallies out of technical bottoms. Assuming we have seen another major low, as Ben and Mario begin reflating, Silver might follow the historically strong seasonality period over the Summer months towards next years Spring months. The chart above shows Silver's analogue taking into context those five periods, while tracking the recent rally breakout, which started in late June at $26. Using a basic mathematical averaging method, if the rally follows historical patterns, it could last up to 160 to 190 trading days and gain more than 80 to 90 precent. That would put Silver back towards testing its major resistance level at $50.

Precious Metals have come back into favour with investors recently, as market focus turns to the possibility of the Federal Reserve starting another round of Quantitate Easing or monetization of the US government debt. While no one can be one hundred percent certain Precious Metals have seen a major low, the technical evidence together with a potential fundamental trigger, do speak of positive price action ahead. In the second part, which will be posted sometime next week, I will focus towards a much longer term outlook on where the price of Gold and Silver could be heading. In the meantime, I leave you with a great interview with Ray Dalio, who advised that holding Gold is a must in a portfolio going forward. Enjoy!

Trading Diary (Last update 05th of September 12)
  • Long Positioning: Long focus is towards the secular commodity bull market, with positions in Precious Metals and Agriculture. The largest commodity position is held in Silver, due to central banks gearing to print money, as the global economic activity deteriorates. If a negative reversal occurs and global risk asset volatility rises, reducing positions will be appropriate. NAV long exposure is about 100%.
  • Short Positioning: Short focus is towards the secular equity bear market due to deteriorating global economic activity. Exposure is held short in Junk Bonds, Technology, Discretionary and Dow Transportation. Tech stocks like the Apple parabolic and Amazon have been shorted with long dated OTM puts. Put options have also been purchased on the Pound and the Loonie (long USD). NAV short exposure is about 70%.
  • Watch-list: A major short in due time will be US Treasury long bonds, as they are extremely overbought and in a mist of a huge bubble mania. While Grains have exploded up, Softs still present amazing value for long term investors, with Sugar being my second favourite commodity (after Silver). Japanese equities are down about 80% from its all time high over two decades ago and offer some great value.
What I Am Watching