Gold and Gold Stocks – Technically Still Convincing

by Pater Tenebrarum

Dips Are Bought, Pennants Indicate Trend Continuation

We recently came across the information that the DSI (daily sentiment index), a short term futures traders sentiment survey, clocked in at about 80% bulls. This is as high as at the interim peak in gold in late August 2013, so we want to caution that in the very short term, gold looks a bit stretched from a sentiment perspective. However, it must be pointed out that it is only this very short term indicator that shows a high level of bullishness. Similar enthusiasm is simply not reflected in any other sentiment data we watch. One point that needs to be made about the DSI is that it can sometimes remain stretched for long periods of time, and is moreover quite volatile, so that often a brief correction is all it takes to bring it back to a more balanced reading. Meanwhile, gold continues to look technically convincing and the same is true of gold stocks:

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Gold, April contract, 30 minute chart. The payrolls report dip was bought, with the low successfully retested earlier this week – click to enlarge.

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The daily chart of the April contract has developed a bullish-looking pennant formation – click to enlarge.

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Gold, public opinion – sentimentrader's amalgam of the most important sentiment surveys. Contrary to the DSI, we see no sign of froth here as of yet. In fact, sentiment is at best lukewarm – click to enlarge.

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Gold Stocks – Same Story, Only More So

Gold stocks have likewise built a pennant on the daily chart. A few things are worth noting: the 50-day moving average is now rising at the steepest clip since the rally of autumn 2012, while the 200-day ma is trying to flatten out for the first time since turning down in late 2011. Prices are now above both moving averages, and we suspect will manage to remain above at least one or perhaps even both of them in the near to medium term in the event of a pullback. Note also that RSI remains stubbornly above the 50 mark so far this year, which is a positive sign as well. Here is the daily chart of the HUI illustrating this:

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Resistance awaits between about 265 and 280 points, but so far the action continues to look bullish to us – click to enlarge.

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The 'more so' reference above has to do with sentiment on gold stocks as reflected in the Rydex precious metals fund. This fund is an excellent proxy of sentiment on the sector, and it has so far barely shown any signs of life in terms of inflows, never mind signs of froth. On the contrary, it reflects enduring and widespread skepticism about the recent rally. This is of course inherently bullish:

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Rydex precious metals assets and the percentage the fund represents of all Rydex assets. Both remain at levels that reflect a great deal of skepticism about the recent rally – click to enlarge.

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We should add an anecdotal observation here as well: many 'old hands' who are well known experts on the sector are also skeptical about its near term prospects. This is quite a change from the far more hopeful tone that still prevailed at similar index levels last year. Mind, this is not something we can really put numbers to – no statistical analysis of 'expert sentiment' is at our fingertips. We can only come to a qualitative judgment based on what we are reading and hearing, so you will have to take our word for it and keep in mind that we don't have the time to read everything (just as an example, Rick Rule, Sprott's junior mining expert, recently called the gold market 'frothy', a characterization we think is not applicable at this juncture. We are not picking on Mr. Rule by the way, who really does deserve the designation 'expert'. We merely note that he and other experts are quite cautious at the moment – and that is actually not a bad sign this early in a rally that has started from a very depressed level).

Addendum: Gold-Silver Ratio

Along the lines of what we discussed in recent updates on commodities, we want to point to the gold-silver ratio, which serves as an indicator of waxing and/or waning economic confidence. As Bob Hoye likes to say, it acts like a proxy for  credit spreads, even though it isn't one. In fact, it can at times give us early warning signals that the credit markets only confirm later. The idea is that silver tends to outperform gold when economic confidence is rising due to its significant industrial demand component, and vice versa when economic confidence is waning. Currently, gold is outperforming silver and the ratio chart suggests that this could continue for a while yet. If so, then it would indicate that more pronounced economic weakness must be expected in the not-too-distant future.

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Gold-silver ratio: still in an uptrend, and forming a pennant as well, which indicates it could well go higher from here – click to enlarge.

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'US is running out of soybeans' - Goldman

by Agrimoney.com

Goldman Sachs hiked its forecasts for soybean prices, and nudged higher expectations for corn and wheat prices, reflecting the impact of higher-than-expected exports in eroding US supplies.

"The US is running out of soybeans," the investment bank said, highlighting China's reluctance, so far, to cancel import orders from the US, as had been expected with a strong Brazilian harvest now in progress, and prices there cheaper.

"Shipments and export sales to China remain elevated despite a record large start to Brazil's soybean exports in February, and against our prior expectation for a slowdown," Goldman analyst Damien Courvalin said.

"The window for these [Chinese import order cancellations] to occur is shrinking quickly, given the continued strong pace of shipments in recent weeks.

"The fact that current strong US shipments are occurring despite lower South American than US cash prices, and sharply collapsing Chinese soybean crush margins, introduces a risk that the US over-exports soybeans, bringing domestic inventories to critically low levels."

Year of two halves

The bank forecast US soybean inventories ending 2013-14 at 139m bushels - 6m bushels below a forecast issued by the US Department of Agriculture on Monday, itself a downgrade of 5m bushels.

The estimate, which reflects ideas of US soybean exports hitting 1.565bn bushels, more than the USDA foresees, would leave stocks, as a proportion of use, at a historically low 4.2%, implying buyers will need to compete heavily for supplies and raise offers.

However, even upgraded by $1.50 to $14.00 a bushel on a three-month timescale, and by $1.00 to $10.50 a bushel in a year's time, the bank's forecasts for Chicago soybean futures prices remain below the levels the market is expecting.

The bank highlighted the potential for "record high" US soybean imports from Brazil this summer, more than the USDA is counting on, plus flagged the threat of porcine epidemic diahorrea virus (PEDv) to domestic demand, in stemming growth in the hog herd.

Further ahead, it cautioned that the "very strong Chinese soybean restocking" currently underway may be followed by slower purchases in 2014-15, when the US will face early-season competition from Brazilian soybeans left over from their record current harvest.

"We continue to expect that soybean prices will decline strongly in the second half of 2014," Mr Courvalin said.

Corn, wheat upgrades

For corn, Goldman raised its forecast for prices in the three-month horizon by $0.25 a bushel to $4.50 a bushel, prompting a "mechanical" upgrade to the estimate for Chicago wheat futures of $0.40 a bushel to $5.85 a bushel.

Prices of corn and wheat, as rivals for uses such as feed, typically show a good correlation.

Again, the bank cited better-than-expected exports in corn - plus a forecast of a "strong ramp up" in ethanol production next month as low inventories of the biofuel and healthy export demand underpin margins.

However, with the prospect of a strong harvest this year, pencilled in at 13.988bn bushels, a fraction above the USDA expectation, Goldman remained cautious over corn prices for next season.

"Our yield model based on trend yield growth and summer weather suggests that the US corn yield should reach 165 bushels an acre under average conditions this summer, bringing corn prices below $4.00 a bushel," Mr Courvalin said.

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Great Graphic: Emerging Markets' External Hard Currency Debt

by Marc Chandler

This Great Graphic was posted on Business Insider by Matthew Boesler. He got it from Nomura, who drew BIS and IMF data.  It looks the mix of foreign currency bonds. issued offshore, (red)) local currency bonds, issued on shore (gray) and cross-border loans (blue). 

Off-shore bonds are not picked up in the country-level balance of payments and capital account figures. The traditional national accounts are more interested in residency of the issuance not the nationality of the issuer.  Nomura estimates that since 2010, corporations, based in emerging markets, have issues about $400 bln in offshore debt, or about 40% of its total issuance.  The bulk is thought to be denominated in dollars. 

The bonds issued abroad potential currency-mismatch and need to be assessed on a company-by-company basis, but a relatively large amount of foreign currency borrowings is potential risk that is often not appreciated when looking at national accounts.   Russia has the highest amount of hard currency debt at about 12% of GDP.  In Russia's case this may sound more threatening than it actually is.  Consider a company that exports oil, gas, or industrial metals.  Its revenue is likely to be large in dollars.  Dollar income could be matched with a dollar-denominated bond. 

Other companies may not have achieved such a natural offset, but borrowed in dollars because it is cheaper. Such companies may be more exposed to adverse local currency movement.  As the local currency falls, such as the Russian rouble, the foreign debt increases, lifting overall debt as a percentage of assets. 

This lower chart was tweeted by  Niall  O'Connor, which he got from UBS.   It shows that in  several emerging markets, the external debt as a percentage of GDP is lower than 1996.   However, the take away might not be so benign as suggesting there is less risk of widespread currency mismatches.
First, only half of the eight countries selected show improvement (Thailand, Indonesia, Philippines and Mexico) and there are some considerations that suggest more than meets the eye. For example, 1996 was the eve of the 1997-1998 Asian financial crisis.  External debt in Asia was near a peak.  Mexico, for its part, was just getting out of its Tequila crisis.
Second, some countries have actually more external debt than previously.  The chart shows this is true for South Africa and, to a less extent, Turkey.   Third, even with small improvement, 20% external debt to GDP can still be problematic.  It is also important to understand the mix between public and private sector foreign debt.  It depends on the provisions, including whether hedging instruments are used and central currency reserves.   Risk is also a function of how much of the external debt is short-term and how much is long-term. 

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Seeing Through Emerging-Market Volatility

By AllianceBernstein

Stock markets in emerging markets (EMs) have gotten off to a rough start this year after a challenging 2013. Valuations have fallen and volatility remains high. So should investors add exposure to emerging markets—or is it better to steer clear?

In our view, it’s probably too early for a large tactical shift towards emerging markets. But we do think the time is right for investors who are underweight EMs—or who lack exposure altogether—to start rebalancing towards their strategic targets in developing-world stocks. While short-term caution is appropriate, we think EM stocks continue to provide a good long-term opportunity—especially for active managers.

New and Old Problems

EM stocks’ underperformance started with the Fed’s tapering talk, but now the spotlight is on endogenous problems. These include some that have traditionally plagued emerging markets, notably the troubles in the “fragile five”—Brazil, India, Indonesia, South Africa and Turkey—which depend on foreign investment flows to fund domestic deficits and are more at risk from currency depreciation. And as Russian stocks plunged this week in response to the Ukraine crisis, investors received a stark reminder that political instability is a fact of life in key emerging markets.

Newer threats are also worrying investors. These include China’s slowdown and the need for structural reforms in several large EMs, including the BRICs (Brazil, Russia, India and China), which could suppress growth. Fears of a credit crunch are also rife after a rapid credit expansion in many EMs; several banking systems—and large EM companies with heavy benchmark weights—could be vulnerable.

Reasons for Resilience

However, we think these concerns have also obscured some key reasons why most developing countries are likely to be more resilient than in past crises:

• External independence—with the exception of the fragile five, most larger developing countries today have strong public finances and large foreign currency reserves
• Low inflation—monetary policy should remain accommodative, except in countries with external deficits that are raising interest rates to defend their currencies
• Company resilience—balance sheets of companies are typically strong and there is often more scope for margin improvement than in developed-market counterparts (Display, left chart)

We also think worries about China are overdone. Although the days of double-digit growth are over, we expect growth to stabilize at about 7.5% a year. This still would represent a huge engine for demand from the world’s most populous country.

Why Maintain Exposure?

We believe that there’s still a compelling longer-term case for significant EM equity exposure within a diversified portfolio. Emerging-market equities can provide better long-term earnings growth from access to the rapid economic growth that is typically fueled by stronger productivity growth. In some countries, working age populations are growing much faster than in developed markets. And valuations today are once again significantly lower than in developed markets.

Diversification is another benefit. Although correlations between emerging and developed markets have increased in recent years, last year reminded us that they often still behave very differently. And within emerging markets, investors can diversify further by including smaller markets; stocks in the United Arab Emirates, Qatar and Vietnam markets have done very well this year.

Good Conditions for Active Management

In today’s volatile conditions, we think stock picking is the best way to go. Spreads are unusually wide between higher-beta, more cyclically exposed stocks, and “safer” low-beta stocks (Display). While some of these stocks, for example in basic commodity sectors, may deserve low valuations, our research suggests that others look more promising, such as Indian cyclicals. There are also many high quality companies with solid fundamentals and high return on equity to be found.

We’re wary of taking a passive approach and just buying an index. Since last year’s sell-off was not uniform, it has accentuated some already large pricing discrepancies that are creating rich pickings for bottom-up stock pickers. And the stocks that win in the years to come are likely to be very different from the winners in the last five, as the sources of growth in emerging markets shift. Meanwhile, macro risks vary widely by country and are not always fully reflected in pricing differentials; so, in our view, it’s especially important to discriminate in country exposure within a portfolio.

Emerging markets have always been volatile—but that’s one of the reasons why they have also delivered higher returns than developed markets over time. We think it’s no different today. In our view, investors with a long-term horizon should maintain their allocation to emerging-market stocks.

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The Fed Has Failed (and Will Continue to Fail), Part 1

by Charles Hugh Smith

The Fed's policies have been an unqualified success for financiers and an abject failure for the bottom 99.5% who have to work for a living.

After five long years of politicos and the financial media glorifying the Federal Reserve's policies as god-like in their power and efficacy, let's take a quick look at the results of these vaunted policies: ZIRP (zero interest rates), (QE) quantitative easing, both of which are ways of shoving nearly limitless, nearly-free money ( a.k.a. liquidity) into the banking sector, where all this free money is supposed to filter into the global economy, working miracles of prosperity.
Let's start with a chart of the Fed's balance sheet, which reflects just how much money the Fed has created and pumped into the financial system. $4 trillion is larger than the entire GDP of Germany, and roughly 25% of U.S. GDP.


Next, let's look at the effect of the much-glorified Fed policies on full-time employment: If you call a return to the levels of 2005 (despite a 7.5% increase in population) a success, then what would you consider a failure?
Let's recall that the Fed's policies are unprecedented. Keeping interest rates near-zero for five years and pumping $4 trillion into the system are both completely off the scale of central bank policy in the U.S.


Next, let's look at the participation rate--how many people of working age who are actively in the workforce. The trend is ugly; the percentage of the civilian population who are working or actively seeking work is plummeting.


Next: real median household income: this is household income adjusted for inflation.Another ugly chart, as real median household income is back to the levels of 1990. Once again: if you reckon this a success, then what would you consider a failure?


How about the annual change in disposable income? we can assume that "prosperity" and "recovery" mean disposable income are rising at a healthy clip, right? Alas, the rate of disposable income growth is sinking toward zero. The Fed's policies of bailing out "too big to fail" banks and QE/ZIRP have correlated to the most stunning drop in disposable income growth in decades.


How about financial sector profits? Hey, now we're finally getting somewhere-- these are through the roof. We finally found something with a positive correlation to Fed policies--financial profits are hitting all-time highs. Yee-haw, we have a winner.


Last but not least, how about the stock market? Here is a chart of the Fed balance sheet and the S&P 500 since 2009. Ding-ding, we have another winner--stocks are also hitting all-time highs.

Source: Zero Hedge

The most charitable assessment we can make of Fed policy is that the "prosperity" it created is at best, ahem, grossly concentrated in the most parasitic and politically powerful sector: finance. Why should we be surprised that the Fed, itself a servant of the banking sector, should devise policies that enrich the bankers and financiers?
Let's be clear about one thing (to quote the president): the Fed's policies have been an unqualified success for financiers and an abject failure for everyone who has to work for a living. The Fed has not just failed to rectify the nation's obscene inequality in wealth and income; it has actively widened it by handing guaranteed returns to the banks and financiers while stripmining what's left of the middle and working classes' non-labor income, i.e. interest on savings.
Just as a refresher:

Tomorrow: how the Fed rewards imprudent parasites and punishes the prudently productive.

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10 Warnings Signs Of Stock Market Exuberance

by Lance Roberts

Imagine that you are speeding down one of those long and lonesome stretches of highway that seems to fall off the edge of the horizon.  As the painted white lines become a blur, you notice a sign that says "Warning."  You look ahead for what seems to be miles of endless highway, but see nothing.  You assume the sign must be old therefore you disregard it, slipping back into complacency.

A few miles down the road you see another sign that reads "Warning: Danger Ahead."  Yet, you see nothing in distance.  Again, a few miles later you see another sign that reads "No, Really, There IS Danger Ahead."  Still, it is clear for miles ahead as the road disappears over the next hill. 

You ponder whether you should slow down a bit just in case.  However, you know that if you do it will make you late for your appointment.  The road remains completely clear ahead, and there are no imminent sings of danger.  So, you press ahead.  As you crest the next hill there is a large pothole directly in your path.  Given your current speed there is simply nothing that can be done to change the following course of events.  With your car now totalled, you tell yourself that there was simply "no way to have seen that coming."

It is interesting that, as humans, we fail to pay attention to the warnings signs as long as we see no immediate danger.  Yet, when the inevitable occurs, we refuse to accept responsibility for the consequences. 

I was recently discussing the market, current sentiment and other investing related issues with a money manager friend of mine in California. (Normally, I would include a credit for the following work but since he works for a major firm he asked me not to identify him directly.)  However, in one of our many email exchanges he sent me the following note detailing the 10 typical warning signs of stock market exuberance.

(1) Expected strong OR acceleration of GDP and EPS  (40% of 2013's EPS increase occurred in the 4th quarter)

(2) Large number of IPOs of unprofitable AND speculative companies

(3) Parabolic move up in stock prices of hot industries (not just individual stocks)

(4) High valuations (many metrics are at near-record highs, a few at record highs)

(5) Fantastic high valuation of some large mergers (e.g., Facebook & WhatsApp)

(6) High NYSE margin debt

Margin debt/gdp (March 2000: 2.7%, July 2007: 2.6%, Jan 2014: 2.6%)

Margin debt/market cap (March 2000: 1.8%, July 2007: 2.3%, Jan 2014: 2.0%)

(7) Household direct holdings of equities as % of total financial assets at 24%, second-highest level (data back to 1953, highest was 1998-2000)

(8) Highly bullish sentiment (down slightly from year-end peaks; still high or near record high, depending on the source)

(9) Unusually high ratio of selling to buying by corporate senior managers (the buy/sell ratio of senior corporate officers is now at the record post-1990 lows seen in Summer 2007 and Spring 2011)

(10) Stock prices rise following speculative press releases (e.g., Tesla will dominate battery business after they get partner who knows how to build batteries and they build a big factory.  This also assumes that NO ONE else will enter into that business such as GM, Ford or GE.)

All are true today, and it is the third time in the last 15 years these factors have occurred simultaneously which is the most remarkable aspect of the situation.

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The following evidence is presented to support the above claim.

Exhibit #1: Parabolic Price Movements

Exhibit #2: Valuation

Excerpt from a recent report by David J. Kostin, Chief US Equity Strategist for Goldman Sachs, 11 January 2014

"The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock:

(1) The P/E ratio;

(2) the current P/E expansion cycle;

(3) EV/Sales;

(4) EV/EBITDA;

(5) Free Cash Flow yield;

(6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of inflation; nominal 10-year Treasury yields; and real interest rates.

Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of Operating EPS and about 45% overvalued using As Reported earnings.

Reflecting on our recent client visits and conversations, the biggest surprise is how many investors expect the forward P/E multiple to expand to 17x or 18x. For some reason, many market participants believe the P/E multiple has a long-term average of 15x and therefore expansion to 17-18x seems reasonable. But the common perception is wrong. The forward P/E ratio for the S&P 500 during the past 5-year, 10-year, and 35- year periods has averaged 13.2x, 14.1x, and 13.0x, respectively. At 15.9x, the current aggregate forward P/E multiple is high by historical standards.

Most investors are surprised to learn that since 1976 the S&P 500 P/E multiple has only exceeded 17x during the 1997-2000 Tech Bubble and a brief four-month period in 2003-04. Other than those two episodes, the US stock market has never traded at a P/E of 17x or above.

A graph of the historical distribution of P/E ratios clearly highlights that outside of the Tech Bubble, the market has only rarely (5% of the time) traded at the current forward multiple of 16x.

The elevated market multiple is even more apparent when viewed on a median basis. At 16.8x, the current multiple is at the high end of its historical distribution.

The multiple expansion cycle provides another lens through which we view equity valuation. There have been nine multiple expansion cycles during the past 30 years. The P/E troughed at a median value of 10.5x and peaked at a median value of 15.0x, an increase of roughly 50%. The current expansion cycle began in September 2011 when the market traded at 10.6x forward EPS and it currently trades at 15.9x, an expansion of 50%. However, during most (7 of the 9) of the cycles the backdrop included falling bond yields and declining inflation. In contrast, bond yields are now increasing and inflation is low but expected to rise.

Incorporating inflation into our valuation analysis suggests S&P 500 is slightly overvalued. When real interest rates have been in the 1%-2% band, the P/E has averaged 15.0x. Nominal rates of 3%-4% have been associated with P/E multiples averaging 14.2x, nearly two points below today. As noted earlier, S&P 500 is overvalued on both an aggregate and median basis on many classic metrics, including EV/EBITDA, FCF, and P/B."

Exhibit #3: Selling Of Company Stock By Senior Managers

Excerpt from a recent article by Mark Hulbert

"Prof. Seyhun - who is one of the leading experts on interpreting the behavior of corporate insiders - has found that when the transactions of the largest shareholders are stripped out, insiders do have impressive forecasting abilities. In the summer of 2007, for example, his adjusted insider sell-to-buy ratio was more bearish than at any time since 1990, which is how far back his analyses extended.

Ominously, that degree of bearish sentiment is where the insider ratio stands today, Prof. Seyhun said in an interview.

Note carefully that even if the insiders turn out to be right and the bull market is coming to an end, this doesn't have to mean that the U.S. market averages are about to fall as much as they did in 2008 and early 2009. The one other time since that bear market when Prof. Seyhun's adjusted sell-buy ratio sunk as low as it was in 2007 and is today, the market subsequently fell by 'just' 20%.

That other occasion was in early 2011. Stocks' drop at that time did satisfy the unofficial definition of a bear market, and the insiders' pessimism was vindicated."

Exhibit #4: Investor's Confidence

Exhibit #5: Ownership Of Stocks As % Total Financial Assets

The point my money managing friend wishes to make is simply that the ""warning signs" are all there. However, since the road ahead seems clear, it is human nature that we keep our foot pressed on the accelerator.   

As the Federal Reserve extracts liquidity from the markets, the "Bernanke Put" is being removed which leaves the markets vulnerable to a "mean reverting event" at some point in the future.  The mistake that many investors are currently making is believing that since it hasn't happened yet, it won't.   This time is only "different" from the perspective of the "why" and "when" the next major event occurs.

Of course, despite the repeated warning signs, the next correction will leave investors devastated looking to point blame at everyone other than themselves.  The question will simply be "why no one saw it coming?"

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