The Market's Focus May Be Shifting After All
We decided to post an addendum to yesterday's gold related comments, in which we lamented that the market decided to ignore generally better earnings reports of gold miners last week in the wake of the revelation that ABX would issue a bunch of shares. Before we proceed, it should be noted that what happens on a single trading day is often just noise, but we always keep an eye out for behavior that is markedly different from what tends to happen normally.
Below is a 5 minute chart of the December gold contract with an overlaid bar chart (inside the red rectangle) that shows the intra-day action in the HUI index on Monday:
December gold contract (5 minute candles) vs. the HUI index on Monday (bar chart inside red rectangle) – a rare positive divergence – click to enlarge.
This is the second time a positive divergence between gold and gold stocks could be observed recently (the first time was on the day of the FOMC announcement last week). If this is not just noise, then there are several possibilities as to what it could portend.
One is that investors who plan to buy a large position in gold futures are buying gold stocks ahead of placing their trade in the futures market. This was quite common in the early days of the gold bull market (gold stocks would fairly regularly signal ahead of time whether gold was about to rally or decline in the short term), but has become less common in recent years, possibly due to the greater degree of investor participation in the sector.
Another possibility is that the sector is simply 'sold out' by now and that some investors are beginning to assess the earnings reports posted over the past two quarters in a more positive light and have concluded that the efforts to contain costs are beginning to pay off (which seems indeed to be the case).
Gold vs. Crude Oil – Is There a Message?
Also, the trend reversal in the gold-crude oil ratio we have recently discussed persists. In fact, the chart of the ratio continues to suggest that gold should be favored over oil (from a technical perspective):
Gold-crude oil (WTI) ratio: this chart continues to look bullish, even in the short term – click to enlarge.
Obviously, the crude oil market is driven by perceptions about its own fundamentals, and the short term trend in this market has turned down fairly sharply recently. The backwardation in WTI futures has given way to contango, a sign that supply issues that were previously on the mind of market participants are no longer regarded as supportive in the near term (the changing situation in Libya and Iran may be responsible for this reassessment). There is probably a limit to how low crude oil can go before it finds a floor, which is given by the profitability of marginal operations such as shale oil production in the US and also the price sensitivity of several OPEC member countries. Global oil demand growth is no great shakes at present, but demand is still growing.
However, the recent rise of the gold-oil ratio may actually be a subtle hint that the global economic recovery is not as strong as is widely hoped. Lakshman Achuthan of ECRI actually believes the US economy is already in a recession that will only be officially recognized with a delay. We think he is overstating the case for recession (at least as it is officially defined), but the idea that a downturn may be close is possibly not too far-fetched.
We say this because the ratio of capital vs. consumer goods production has reached new highs, while money supply growth has begun to slow down over recent months. With the economy becoming used to very high money supply growth rates over recent years, it may not take much of a slowdown to trigger a bust. Note that we are in uncharted territory with the Fed's 'QE' policy, so there are no historical precedents that we can really compare the current situation to. We can't be sure that the economy's sensitivity to slowing money supply growth rates is greater than previously, but it cannot be ruled out. As Frank Shostak points out here, the growth momentum of his narrow (and more volatile) money supply gauge money AMS (equivalent to TMS-1) has been slowing down quite a bit over recent months, and he expects that economic activity will follow suit.
What we do know is that if Mr. Achuthan is even half right, then there will not only be no 'tapering' of 'QE', but it will quite possibly eventually be increased. After all, money printing is the only 'medicine' central bankers routinely prescribe to 'treat' a weakening in economic activity. It is misguided and bound to harm true wealth generation even more, but it is what they are going to do. Anyway, if economic activity were to weaken, gold would definitely continue to rise against oil for a while.
The HUI Index and Silver
Below we show the daily chart of the HUI index with its Bollinger bands again. As we have mentioned yesterday, it would be a noteworthy change in character from a technical perspective if the index were not to travel toward to lower band before reversing. Maybe it changes direction from the mid-band this time around. Our friend B.A. incidentally pointed out to us that the trading volume in ABX on Friday was the highest since at least 1994 (very likely it was a record high), which is quite remarkable. Almost all the historical record spikes in single day trading volume in the stock since 1994 have occurred in the vicinity of intermediate to long term lows (there was a sole exception in late 2009, when a large volume spike marked a short term peak).
Anyway, we will soon know if the HUI is not merely closing a gap before resuming its downtrend (the 'noise' possibility) and whether the usual trek to the lower Bollinger band can be avoided this time. RSI closed just below the water-line of the 50 level, and no MACD sell signal has been given yet. The probability that all these short term deliberations will turn out to be moot is of course quite high, but since we are in the time window during which major trend changes often occur, one must keep an open mind.
Lastly, silver is currently hugging the uptrend line that has been established since the low in late June. So far it has bounced strongly every time it has touched this line – and if it does so again, it would obviously likely coincide with strength in gold and silver stocks. Conversely, a sustained break of this trend line would be a negative for the sector.
HUI daily, with Bollinger Bands - click to enlarge.
December silver, daily. The shallow uptrend line in red has so far held and may do so again – click to enlarge.
Gold Supply and Demand
One reason why we posted this update was that Mr. Armstrong recently opined that 'people won't return to gold unless there is a crisis'. We're not sure what his definition of 'crisis' is, but we don't think this is correct. Usually prices begin to move long before the 'reasons' for the move become obvious to all. Moreover, he propagates the idea that markets move according to 'fixed' time cycles and that is in our opinion not correct. Human action is subject to future states of knowledge which we cannot forecast with certainty. There are therefore no such deterministic cycles of fixed length (there exists no empirical evidence for such determinism either). What we do however agree with is that gold buying by investors in China is not particularly relevant, in the sense that big buying by Chinese investors does not have to necessarily result in rising prices. Many of the deliberations regarding the gold supply and demand situation in this context are misguided. See e.g. this recent missive by David Franklin at Sprott, which begins by noting:
“2013 has been the year that China has lit the physical gold market on fire; however you would never know from the metal’s price performance. While the price of gold has fallen more than 20%, bullion flow to the East has been nothing short of spectacular.”
Why should gold flowing from A to B result in a rising price? It doesn't matter how big these flows are, since what was bought by investors in China was sold by someone else, ounce for ounce. If one wants to know whether gold is in a bull or a bear market, then one needs to look at the price action. One may disagree with the urgency demonstrated by the sellers due to having a different opinion of the fundamentals, but their greater urgency relative to that of the buyers is reflected in the price decline. How the gold price is formed has been best described in an article by Robert Blumen we posted a while ago: “What Determines the Price of Gold?”
Gold isn't an industrial commodity and all the gold ever mined still exists above ground. As an investment or monetary asset, it needs to be analyzed differently from industrial commodities. Eric Sprott also posted an 'Open Letter to the WGC' recently, in which he took issue with the WGC's admittedly extremely flawed supply-demand analysis – only to offer a similarly flawed supply-demand analysis in its stead (h/t to Steve Saville, who recently discussed this topic as well). That does not mean that one cannot analyze the gold market's fundamentals or form an opinion about how they are likely to change in the future, but these fundamentals are all of the 'indirect' sort and are independent of such things as trends in mine production, jewelry demand or how much gold is flowing from West to East (a comprehensive list of the fundamental drivers can be found here). At any given time, not all of the fundamentals will necessarily be bullish or bearish concurrently, and what the market will focus on in the short term is unknowable. However, it is a good bet that the market will recognize a coming change in the fundamental backdrop before it becomes blindingly obvious. If that were not so it wouldn't be such a struggle to determine whether a trend change is underway or not. We could all simply follow the Armstrong method and only buy when the newspaper headlines blare 'crisis'!
Conclusion:
It could well be that the short term trend is about to reverse again in an upward direction. Soon the next payrolls report will be released, and that occasion often marks short term trend changes. Whether the divergence between gold and gold stocks on Monday was only noise or something more meaningful should be clear relatively soon. Given that the market has been in technical no-man's land for a long time now, we should also soon know the direction of the next medium term move. What is certain is that at current gold and silver prices, the shares of mining companies remain historically very cheap.
Charts by: BarCharts, StockCharts