"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Tuesday, May 27, 2014

TIPS Spread

I have had some private emails discussing the TIPS spread as well as some posts recently dealing with inflation expectations so I thought it might be helpful to post a chart of the TIPS spread to portray what the market is currently expecting in that regards.

The TIPS spread is calculated ( I am using the 10 year ) by essentially subtracting the yield on the 10 year Treasury Inflation Indexed Constant Maturity Security by the yield on the 10 year Treasury Constant Maturity Security. The difference between the two is the market's expectation of the inflation rate over that period.

Here is the chart that I have created using that data.

As you can see, the expectations have risen and fallen since the start of this particular data series. As you look at this chart, you can practically see the shift in sentiment as the market looks for deflation, then looks for inflation, then shifts back to deflation, etc.

What is interesting is to observe this chart starting near the end of May 2013 - beginning of June 2013 and move forward to the present time. Note how the pattern on the chart constricts with the inflation expectation oscillating somewhere between 2.30 on the top and 1.93 on the bottom. Then the range tightens on the downside moving up from a low near 2.06 and rising towards lows near the 2.11% level.  The top has come down somewhat as well.

What this tells us is that the market is reaching an inflection point where this indecision will eventually be resolved. One would think that the resolution would be to the upside if the economy were to begin really improving. I maintain that it is slack in the labor markets that is keeping inflation low as wages remain relatively flat. Thus the Velocity of Money continues to either move lower or remain flat. As long as that is the case, it is difficult to see inflation pick up to any degree of noteworthiness. If however, wages begin to move higher, this would have significant impact on the Velocity of Money as many businesses might begin to feel more comfortable passing along any price increases at the wholesale level. So far, it seems that many are trying to absorb as much of those costs as possible to retain pricing competitiveness among very price-conscious consumers.

Along this line, a strengthening Dollar will generally tend to put pressure on commodity prices.

I do want to also point out that the constricting range in the spread above corresponds very closely to the range trade that we have been seeing in gold. In looking over the price chart for the metal, one can see that same sideways pattern going back to last spring and continuing to the present day.

I am going to fine tune this chart as time permits this week and will overlay the price of gold over it. I think you will find the results rather remarkable. One thing I can already tell you in advance from doing a cursory examination of the two, is that peaks in the price of gold have tended to correspond rather closely to peaks in the TIPS spread.

That would confirm that gold is moving based on inflation expectations or the lack thereof, something which I feel confirms the idea that gold is doing exactly what it ought to be doing during a period of uncertainty in regards to the future of inflation expectations. At the risk of again angering the gold manipulation crowd, if the gold price is moving in sync with the TIPS spread, then asserting that the price is being manipulated is a big stretch as one would have to make the serious case that the inflation expectation of the market place over the last several years has been completely misguided. Given the ( up until recently) rather mediocre at best payrolls numbers, stable to falling commodity prices in general, and a steady US Dollar, that would be a very difficult case to make except for all but the most imaginative.

GLD reports Big Jump in Gold Holdings

GLD, reported a very sizeable jump in reported gold holdings this afternoon, something which I felt has enough significance that it should be noted. Holdings were at 776.89 tons as of last Friday but jumped to 785.28 tons this afternoon. After all, an 8.39 ton increase is not a small matter.

Let's keep an eye on this, especially if gold continues to descend lower. It would indicate some buying from some larger players if this sort of buying is more than a one day wonder. Reported holdings are now back to the levels that they were back at the start of this month.

They were at 798.22 tons to start off the year so the holdings are down by some 1.6% so far this year.

I have had my share of dealings with those from the gold bug community who have continually dismissed my notice of falling gold ETF holdings as if it bore no connection whatsoever to the fall in the price of gold over at the Comex. I maintain it is a measure of Western-based investment demand and as long as it is falling, gold is not going to be able to mount any sort of sustained rally.

If GLD reports holdings that begin to increase REGULARLY, then the downside for gold from this point, will be limited. If however the reported holdings begin to drop again after today, and continue to do so for the remainder of the week, gold has more downside left in it.

Stay tuned.

I still am concerned about the number of speculators who remain on the net long side of this market. Maybe today flushed a goodly number of them out but as I stated in the earlier comments from today, I would feel much better about this market moving forward if I could see speculative sentiment become bearish over at the Comex. It is not there as the specs remain bullish at this point.

Gold Gives up Ukraine Premium as Bears Growl

This past weekend's election in Ukraine has come and gone and the long awaited outcome has sent gold bulls packing - apparently the beginning of WW III did not commence as a moderate businessman received the nod from the majority of those who voted. Russia seems to be taking more of a conciliatory tone for now.

Combine that with a stronger Durable Goods number ( 0.8% gain in April and an upward revision to the March gain) ,  and a jump in the Consumer Confidence reading ( from 81.7 in April to 83.0) , and you could hear the umpire calling, "Strike 2". When news about decreasing Chinese gold demand (based on Hong Kong data )  reached the ears and eyes of market players, that was all she wrote for the yellow metal. Bulls jumped ship, bears got aggressive ( something that they have not been doing while Ukraine simmered on the back burner ) and the downside stops were reached. Once $1275 was breached, those stops were activated and the snowball began its downhill roll.

Throw in an option expiration day and the selling was fairly intense.

 I mentioned in my Friday comments that the still fairly sizeable grouping of speculators on the net long side of the gold market had me concerned. With falling GLD reported holdings, a sinking HUI and GDXJ, and a Fed talking quite a bit about their concern for the lack of inflation, it is rather remarkable that many specs were still bullish towards gold. As long as the technical charts held up, they were hanging in there over at the Comex, but today's breach of that key technical downside level near $1280, has now become a market factor insofar as it flips the gold market out of the recent range trade and shifts it more towards the POTENTIAL for a fresh trending move lower. Those speculative long positions are now deeply underwater ( especially those who foolishly chased the price higher fearing global war from the Ukraine crisis) and they are exiting as new shorts also move in. Losing bulls should be very thankful for those recently lowered margin requirements for gold as it might give them a wee bit more ability to hold onto losing positions should they so desire.

The saving grace for gold is that it happens to be near the cost of production for some mining outfits ( not all of them ) and that might serve to slow the downside momentum somewhat.

I can see the metal in a grinding move lower rather than a sharp fall as it slowly bleeds out speculative interest off the long side while meeting some increased physical buying from India and perhaps China. But as far as Western-oriented investment demand goes, that is not going to be there until investors believe that the bull market in equities is over or some fresh geopolitical event arises. As far as the majority of investors are concerned, the lack of inflation in a low interest rate environment with improving economic data is the perfect recipe for continued money flows into that asset class ( stocks ). Money managers are going to put money to work where it can produce returns - it is really that simple.

I would like to make one more point in this regard - again and again we get the chorus from the gold perma bulls that gold sentiment is lousy and that is a great reason to expect a bottom. The problem with this goofy theory is that the Comex positioning indicates the opposite - as I mentioned last Friday, every major group of speculators, whether it be the large hedge funds, the other large reportables or the small traders ( general public ) are NET LONG gold. How in the world can someone say with a straight face that gold sentiment is horrible and that is a reason to buy? It would be better to say that bullish sentiment towards gold is falling but remains positive. That would be more accurate. This is why that talk of a "capitulation bottom" is premature. That is the last hook that gold  perma bulls are now trying to hang their hats onto after their wrong-headed theories on negative GOFO rates and backwardation have collapsed.

My own view on this is that it would be much better for gold if the speculative category of traders actually moved to the NET SHORT Side of the market on the Comex. Then we might start having an intelligent discussion about "capitulation". Anything prior to that is just wishful thinking dressing itself up as market analysis.

Looking at the gold chart ( daily) you can see the loss of initial support near the $1280 level. That was followed by an additional breach of the next downside support level that came in near $1266 or so. The next level extends from $1260 - $1250.

The ADX is just beginning to rise indicating that the market has not yet entered a trending move lower but the potential does exist for such a thing. I am of the view, at the moment, the more likely outcome for gold is a steady grinding move lower, rather than a sharp leg lower. We'll have to see. A breakout of a trading range market, especially the longer the duration of the previous range trade, tends to bring about some big moves. The issue here is the level at which gold is already trading. As mentioned above, it is down near the cost of production of some miners. The problem is that the speculative forces are still trapped on the net long side of this market; the wrong side I might add. They are going to be exiting barring some unexpected geopolitical event but as price descends from the current level, it should attract some decent physical demand from the East. I guess the question is are these speculators on the long side going to only grudgingly throw in the towel and gradually get out or are they going to say, " I am done with this crap" and abandon the metal rapidly. I am leaning towards the former view at this point but as always, will respect the price action. If it is the former, the market will grind lower; If it is the latter, the market will drop very sharply.

In the meantime, let's just watch the price charts and let that guide us. I am especially interested in seeing what now becomes of the HUI and the GDXJ. The shares led the metal lower and should lead it higher when the time comes for a true bottom in the metal. The GDXJ is down over 5% as I type these comments while the HUI is not faring much better, losing over 4% right now.

Here is a chart of the GDXJ:

Note that the market GAPPED DOWN below a key support level that has been in place since April 22 of this year and has extended losses to the point that it is now trading at its worst level since early January. In other words, it is at an over 4 month low.

Forebodingly, the ADX is now beginning to rise indicating that the potential for trending move exists. That trend is however down. Bears are firmly in control with the -DMI registering the highest reading in nearly two months.

The HUI has lost chart support at the bottom of its range as well. It reached a low today right on top of a support level that runs back to December of last year. If that does not hold it, it is probably going to drop below 200. That would essentially wipe out any gains in the index for the entire year.

Silver had best thank copper today that the red metal is bucking the trend towards lower prices. Silver remains caught between following copper and following gold. It is hanging around that $19 level which is becoming more and more technically significant. It is a lot like the $1280 level in gold. The more the price held near that level but failed to extend higher, the greater the damage inflicted if/when that support level fails. Until silver can scale the $20 barrier and REMAIN FIRMLY above that level, it is vulnerable.

Interest rates remain subdued as bonds actually ticked up some despite the new all time high in the equity markets and the improving economic data. What seems to be at work in the US Treasury market is that traders are becoming more and more convinced that some sort of monetary easing is going to be coming the way of the Eurozone with lower rates resulting over that way. This is causing those who want to own bonds to increase ownership of US Treasuries due to the higher yields in what they consider to be a tame inflationary environment. In other words, money is flowing to where it can capture the best yields and with many thinking that the US economy is improving at a better pace than the Eurozone, money is flowing to the US.

That is boosting the Dollar at the expense of the Euro, which initially moved higher after the election results there this past weekend. Those results should prove interesting to see how or if they are going to influence policy coming out of Brussels. Nationalism is on the rise as many Europeans from their respective countries are airing their discontent with being governed by a far-away group of unaccountable bureaucrats. I maintain that the experiment is eventually going to fail there simply because the idea of creating a melting pot of the various European nations modeled around the United States is not possible. Here in the US we share a common heritage, a common culture ( at least we did at one time ) and to a great extent a common Judeo-Christian set of shaped values. No such unifying factors exist in Europe. I would dare say that this weekend's election is a watershed moment for the Eurozone. Is it the high tide in a counter centralization movement or the start of something greater? Time and events will make it clear for us.

Given Europe's past history of warfare and conflict, along with the terrible loss of human life and suffering, it is easy to understand the desire to never again see the rise of nationalistic tendencies that are of such strength, that they foment war among some of the population there and among some political leaders. However, a shared set of traditions, religion, culture, language, etc., is necessary to bind people together. How that can ever be successfully implemented, except for the use of force and that only for a generation or two at best, escapes me.

The Russell 2000 is rebounding nicely today on that positive economic news moving up over 1.1% as I type this. Risk is back on today and that has investors upbeat as they chase equities higher. As you can see, it is quite a ways off of its best level this year but it has officially moved out of "correction" territory ( down 10% or more from a peak) and has actually generated a mild buy signal. I will be most interested in how this index closes not only today, but especially this week. A push through 1160 or so should be accompanied by another all time high in the S&P 500.

Here is the S&P 500 chart ( weekly )
This incredibly uptrend continues. The last time the trending move higher was interrupted was back in October 2011, two and a half years ago!

Switching gears to the grains - they were beaten with the proverbial ugly stick today, especially soybeans which have been on a tear higher of late. Today, beans came back down to earth. The bean market has been a classic example of traders moving prices depending on what factor that they want to focus upon on any given day. When the focus shifts to the tight supply of ending stocks, the market rallies. When the focus shifts to the upcoming new crop and the potential for a massive crop, the price falls. Back and forth; up and down, it has gone. Today, the focus is on the great planting progress that traders are expecting to see in this afternoon's crop progress report and the relatively beneficial weather the planted crops are experiencing.

I realize farmers want the highest price for their crops  - and who can blame them? - as those prices determine their economic welfare. But for the sake of the livestock industry, the poultry industry and the average consumer, I do hope that this year's crops are large ones. Rising food prices are tough on us all but they impact the poorest among us as those are the ones with the least amount of discretionary income to spend. A large harvest of corn and beans, along with wheat, and falling gasoline prices would be of immense help to the average consumer.

Corn is in a trending move lower as indicated by the daily price chart. Same goes for wheat. Beans, both old crop and new crop, had been trending higher. That might change however if we get some downside follow through in either the July or the Nov's. So far, retracements lower in price have been eagerly bought. Whether or not that pattern is going to continue is up in the air at this time.

By the way, the US Dollar is closing on a key overhead resistance near 80.80 basis the USDX. The Euro continues moving lower towards key support near 1.35. It could not maintain its footing at initial support near the 1.366 level. There is some mild support on the chart near 1.3590. If it fails there, it will more than likely test 1.35 - 1.348. That is a big level from a technical analysis perspective. The Euro might very well have seen its best level in a long time if it fails to hold there. All eyes on going to be on this upcoming ECB meeting in June.