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Monday, August 29, 2011

Gold's Prophets Of Doom

Investing today is hard enough and just when you find a sector that you think will help your portfolio recover from the battering it has received over the past few years it falls apart. Investing in any sector of the market makes one feel a bit like the guy who drives the caged Jeep at the driving range collecting golf balls, while they know full well that people are teeing up with the full intent of being able to hit the moving vehicle with their drive, whether they admit it or not.  One of the arguments that is commonly used to justify why all of us sheeple should not be investing in the “metal of Kings” is that it is an emotional investment and requires a “greater fool” to drive it higher, as opposed to mainstream stocks that have earnings and cash flow to justify their valuations and when that is not enough we are to rely on tried and true valuation methods like eyeballs, hit counts or some other bogus metric.  The greater fool theory lives in stocks as much as in metals, where people delude themselves that the price they pay for a stock today will be worth more based upon assumptions of future cash flow that may or may not materialize.

If you are following my blogs or Twitter posts you have pretty good idea of where my thinking lies regarding the general economy and the stock market. I am by no means a gold or silver bug, although I do hold a percentage of assets in the metals via allocated closed end funds, along with other precious metal and regular equities.  I do understand and respect the value the metals bring to a portfolio, maybe because of my parents European background.

The lack of understanding and use of the metals in finances is really more of an American cultural bias partially driven by the FED, Wall Street, Government and misguided Keynesians. In many other areas of the world the metals are not only part of the culture but also have a place in finance.  People around the world view the metals as a store of value, something that can’t be printed up or debased at will by a government. To people around the world the metals provide the foundation of their savings and has for generations.  People in the US always use that tired statement that you can’t eat it and it doesn’t pay interest along with other Wall Street logic. You can’t eat stocks either and many of them don’t pay interest ie.. dividends.

Enough digression into my philosophy regarding the metals instead I want to focus on what is going on with them. As gold was making its run to $1,917.10 I could see the mood was becoming euphoric and began tweeting that one could contemplate putting on a hedge for safety’s sake. I am not pointing that out to gloat but instead to show that you need to keep a cool head while everyone else has stars or Dollar signs in their eyes. Of course we all know what happened gold hit is high and was trumpeted from the roof tops by CNBC and alike and then promptly began to decline. Yes things were getting a bit frothy but once the decline began I fail to see why the CRIMEX had to raise margins to exacerbate the decline. I find their excuse about curbing volatility (I know they have a formula) pathetic as they only seek to curb it on the upside but their requirements never seem to be concerned with the shorts and downside volatility doesn’t bother them, but that is a different story for a different day.

Let’s take a look at the situation since the drop. Gold has declined and out of the woodwork as usual came the bears or bearish minded people not that I mind them as it confirms for me that there still is another side to the trade and not everyone is onboard. After all you will need suckers to sell to at the actual top. Everywhere you turn now all you hear is that the “Gold Bubble” has burst and everyday there are calls by so called experts for lower and lower correction prices.  One must remember that these are the same guys that missed the run up and continually called the top for years.  As a gold investor one should welcome these corrections to be able to acquire more metal at a better price even though it is human nature not to want to see lower prices and profits temporarily eroded. The reality is that the Gold market was beginning to go parabolic and had this correction not occurred gold truly could have become a bubble and fallen below its intrinsic value. If gold did put in a exhaustion top then ask yourself where would you be safe to park your wealth and ride out the reorganization of the world monetary system?

Gold started this leg of it historic run on July 5th when it hit bottom at $1486.20 and peaked out almost 1.5 months later at $1,917.90 a move of $431.70. When trying to project where prices of various securities or assets are likely to go I have found that using Fibonacci retracements are a pretty accurate method.  

Fibonacci retracement is a method of technical analysis for determining support and resistance levels. They are named after their use of the Fibonacci sequence as discovered by Leonardo Fibonacci one of the greatest mathematicians of the dark ages. He noticed that certain sequences of numbers occur in nature and subsequently people who study markets have found use of his discovery.. The idea behind Fibonacci retracement is that markets or a security will retrace a predictable portion of a move, after which they will continue to move in the original direction

In the markets the Fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8% and 100%. Using Fibonacci levels helps one stay more focused on reality and tune out the doomsayers who are making outrageous calls. I am convinced that all these people that come out with these highly negative predictions are not only bearish on whatever they are making the call (for any number of reasons) but I believe that they are hoping to place a bet on an outlier. What I mean is they are trying to make a name for themselves and because they either don’t have enough knowledge to make accurate calls or they are gambling that they might achieve notoriety by having the outrageous miraculously materialize. No matter whether you have invested in Gold, Stocks, Bonds or whatever these guys and gals are always out there doing this sort of “bashing”.

Back to Fibonacci in terms of this gold run. The move was $431.70 from bottom to top. Below I have placed a chart showing the Fibonacci levels and the corresponding dollar value of the drop and the price at the specific level.

On this current correction the gold price retraced almost exactly 50% of its move which is a very common retrace for a large move. I had been expecting a retracement of 50% with an outside possibility of the 61.8% retracement since there was a breakaway gap at about $1,673 where the price had jumped higher. If you follow charts there is a saying that gaps get filled, and while they usually do there is not iron clad law that they must be filled. Regardless I thought there would be a possibility that a test of the 61.8% retracement in order for that gap to get closed. Instead what we saw was a pull back to the 50% level not once but three separate times in the same day before Gold bounced and put in what technicians would call a “hammer” indicating a trend reversal or bottom on Thursday accompanied by strong volume. The bounce on Friday was very healthy and also on excellent volume but in my opinion in typical gold fashion it overshot too much to the upside. I personally would have been happier if it would have had the same volume and closed around $1,785 and that would have set us up better for today, but as the Rolling Stones say “you can’t always get what you want”.

Today Gold dropped down in to the $1,780s which is over a 3% move to the downside, however, volume declined appreciably on the day indicating less selling. I know those who own the yellow metal would like to see it jump to the upside everyday but that is just as unrealistic as the calls for a drop to $1,250. Nothing goes up in a straight line not stocks, not planes not even gold can defy the laws of physics, for if they do go straight up they tend to fall back to earth with terminal velocity.   

Since Gold hit its current high on 8/23 I have seen a ratio of 13:2 bearish vs bullish articles regarding gold. The current situation reminds me more of the battle of gold $1,500 where back in January of this year the Barbarous Relic bottomed out at $1,309.10 on the 28th and then proceeded in a spectacular run to a high of $1,571.40 (5/2) a move of $262.30. Then like today Gold peaked out and there were any number of bearish articles and the metal retraced just under 50% of its move testing down to $1,462.50 on May 5th or a move of $108.90. At the May price level that $108 was about a 7% price swing. In the current correction the numbers are larger so the swing while roughly 3% greater in size the amount of dollars in the swing has doubled. I point that out because as gold continues to march to its ultimate peak the dollar value of the corrections will be larger and more dramatically reported  which will also serve to keep people out of the market as they will be feed a constant diet of why the metal is risky and they should fear it. Of course the swings in the purchasing power of their currency will be as extreme if not more to the downside and they like many throughout history will not understand why it is happening.

At the moment I do not see any meaningful changes in the world that would change the long term trajectory of gold or silver for that matter. All the fundamentals are still in place and those of you who follow this market or have read my many missives know the reasons that gold and silver are rising. The plain truth is that the metal just plain got ahead of itself and needs a rest before going into its seasonally strong period. After the drop in May it took gold a second retest at the beginning of July for Gold to kiss the $1.500 level good bye and get us to where we are today, and this took placeat the beginning of the summer traditionally the weakest period for the metals. It is my contention that the gold doomsayers are wrong and that the metal is going to consolidate around this area and possibly (although I think it is a low probability event) retest the $1,702 level before ramping up again. It would be healthy for gold to back and fill here for a couple weeks and build a base from which to recapture $1,900 and take out $2,000 in the fall seasonally a gold friendly time of year.

We have heard all the gold naysayers and their tired arguments and they sound like a broken gold record. At the moment the problem child EU is finishing off their vacation month and soon enough it will be back to business and I believe that is when the fireworks will restart, since the cracks are already showing and there like here things are only band aided or smoke and mirrors. The governments of the West are running out of road to kick the can down, but they will try. All of this is gold positive which is why I believe that much more support exists for the yellow metal than the naysayers believe.

Let’s look at the charts below :

This first chart is of the US Dollar. The Dollar is contained within this descending triangle and looks like it is biding time before it continues on its downward path. The Dollar is not in an oversold situation and while it has not broken down it really has not had the ability to rally with any significance. There are many that argue the Dollar is about to enter a multi month rally, but the chart does not say that to me.

The next chart is one of gold that has been circulating showing a head and shoulders top forming. I don’t buy this for a couple reasons. First, this formation only really shows on a line chart with end of day prices and it is short in duration. Second, head and shoulder tops especially when they are this small have a tendency to not get validated as they may not complete or may complete but still not be of significance. Moreover, look at the chart immediately following from 2009 when the gold market was arguably under a lot more downward pressure and you can see the same formation that the naysayers were touting then and they were wrong. Instead I would submit this is too easy and instead it is a bear trap.

Lastly let’s look at today’s gold chart in candlestick form where things look clearer to me. Gold opened today with the excess left from Friday’s continuation of the snap back rally and proceeded to drop. Notice the volume on the chart declined and the overbought condition is relieved on the RSI at the top of the chart.  Additionally the entire correction has still essentially occurred within the confines of the uptrend line and the supposed neckline from the head and shoulders intersects with the uptrend support at about $1.750.  My hope is that gold grinds sideways here and works off some of the remaining exuberance before continuing higher, but gold has a mind of its own and will do what it wants. If we do get a retest in price I believe it will be an opportunity to add or load more. To paraphrase Ronald Reagan, Ask yourself is the economy and the underlying situation that has brought gold to these levels any better now than when the bull market started? The answer to that question will determine if you will buy more on a dip or sell in to any panic.

Wednesday, August 3, 2011

Operation Twisted: Gold, the Swissie, Financial Repression and Annaly

The markets rebounded today and prevented the earning of the dubious distinction of longest down day streak set back in 1978 at 9. All three major indices finished up less than 1% but up none the less. Today Gold hit new highs today closing at $1666.30 after reaching as high as $1,675.90. Gold’s rise today was spurred by the economic situation and Switzerland’s decision to lower interest rates to try and weaken their currency.

There are few safe haven assets today besides the metals but the “Swissie” is one of them. The problem is that the amount of money flowing out of the Euro zone as well as other money from around the world seeking safe haven related to a growing distrust of FIAT currencies has been driving the “Swissie” to records. Yes, the Swiss Franc is a FIAT currency but the Swiss are known for their stewardship of the currency as well as being a monetary haven. Dear reader, if you think of Switzerland who still has a AAA credit rating along with a positive outlook but a GDP of about 550 Billion Swiss Francs and then think of the oceans of cash looking for a port in a storm and one can see why the “Swissie”  has appreciated.

The problem for the Swiss is that their currency has gotten so strong that it has caused a feedback loop of money seeking safe haven which continues to reinforce that strength. Ironically, just about a week ago I saw an article that described a proposal to have two Swiss Francs one of them backed by gold. Could you imagine how strong that currency would be versus how weak the regular “Swissie” would become.

Switzerland has a population of about 8 Million which is not large enough to have internal markets to support their industries, to do that a country needs around 30+ Million inhabitants. The Swiss economy is heavily export dependent and the strong currency is impacting their ability to compete for business. Remember that the manufacture of fine watches and great chocolates is only part of their economy and they have a very large and strong industrial sector as well.

As an aside before I went in to finance I ran a small manufacturing company that used to import machinery from a Swiss company. The machines that we imported were of very high precision and quality but the pricing was shall we say less than competitive with machines of the same size but lesser quality coming from Asia. The high price structure was due to the strength of the “Swissie” even at that time and the high cost of skilled labor there versus the same labor elsewhere in the world. The Swiss company ultimately went out of business and we acquired the rights and assets so we could continue to manufacture the machinery but here in the US. Even with the weaker dollar the labor costs of American machinists ate heavily in to our margins and while we were more competitive than our Swiss counterparts we were less competitive than manufacturers from the far East.

As a result of all the capital rushing in to the Swiss banking system and driving the value up action had to be taken. The Swiss have long been known as a business savvy and practical people so it did not surprise me to learn that that counter measure they took did not have to do with intervening in the markets like Japan regularly does.  The Swiss central bank instead decided to lower interest rates which made the “Swissie” slightly less appealing as a safe haven as some of the hot money may pull out seeking better yields elsewhere. This seems like a good strategy to me as not to undercut your currency but stem the flow with longer lasting results than direct intervention. The  problem for the Swiss is that their interest rate  is now basically at zero so they can’t pull that rabbit out of their hat again. This action by the Swiss National Bank is part of the reason for the strength in Gold and Silver today as another perceived safe haven takes it on the chin.

In addition to the Swiss actions today the rumor mill was fired up as there were rumblings of QE3 being discussed by various FED officials. The QE3 boogey did not cause but certainly aided the bounce off the lows today. As the markets were tanking out I decide to tune in CNBC again today to get a pulse of the mood. The prevailing mood was again a mixture of fear and despair as the stocks descended in to their lows and everyone from the hosts to the guests were bearish and expect further large declines.  I am not sure about you dear reader but after 8 days of declines it felt to me more like an exhaustion day and interestingly the volume increased as we came off the lows today. The consensus was that no one believes that this was a bottom of any kind, where as I get the feeling that the decline was manufactured since the markets got everything the wanted: no debt default, no tax raises, and no credit downgrade. The other fear over the past couple days was Italy’s debt status as they are considered “to big to bail” so fears of a contagion gripped the markets even though nothing really transpired there.

It would be my contention that what we have witnessed is the markets throwing a temper tantrum to cajole “B52 Ben” to fire up the QE3 bombers and give the order from HQ in Jackson Hole later this month. Now dear reader I have made my position pretty clear in the past that QE is a giant waste and serves no purpose other than to foster bubbles and bail out fat cats, but who is it that comprises the market? The QE programs have been a failure on so many levels but they did goose the markets didn’t they? I have also said that the next QE may not take the same form and most certainly will not be called QE. A new old euphemism has been circulating in place of QE called “Operation Twist” which is a rehash of the same ploy used 40 years ago in 1961. Essentially it is QE targeting certain duration of the yield curve to flatten it out. The net effect of Operation Twist, QE or Financial Repression is the same, to suppress interest rates and allow inflation to increase thereby reducing the size of deficits over time.

In this kind of environment safe havens like Gold and Silver (anti-debt assets) work well since you are dealing with negative real interest rates, cheap FIAT money and lots of debt. As I have stated in other missives companies that can grow their earnings and have a record of increasing dividends are also good candidates for this environment as I believe that for many investments dividends will be a major component of total return.

One stock that I have featured in the past is Anally Capital (NYSE : NLY) a stock that is commonly referred to  as an MReit or Mortgage Reit. Given that the FED has stated they intend to keep rates suppressed for an extended period a stock that pays a 14% yield is attractive and trades close to book value. Annaly is not the only MReit but in my opinion their management is top notch and has proven itself capable of navigating today’s tricky waters. I wrote an article recommending Annaly a while ago but I feel that the same rationale applies today, and you can read the article by clicking here. Others of interest in the Mreit space are Hatteras Financial (NYSE : HTS), Chimera (NYSE :CIM) (which Anally owns a big chunk of) and American Capital Agency Corp (NASDAQ : AGNC) . Each of the Mreits pays a high dividend but you should do your own due diligence as there are differences in how they get to those dividend numbers by the kinds of securities they deal in.

If you do buy in to the MReits you need to be aware that they can be somewhat volatile at times for a variety of reasons.  I have owned Annlay for well over a year and in that time the stock has trended higher over time and paid dividends but also there have been several price drops.  The most common reason for the drops in price that happened while I have owned the stock have come as a result of secondary offerings. The perception is that the secondary offerings are diluting the current share holders but that has not been the case. Instead of dilution  the capital raised by the offering is used to acquire more securities after all this is the method by which Annaly maintains market share and grows their own fees since they want to continue to make increasing sums of money just like you enjoy a salary increase.  A real risk to the Mreit is one of rising rates, since they do use leverage to achieve the high dividends they pay out, but in the current environment where the FED has telegraphed that its intention is to keep rates low the MReit should perform very well. The key will be not to overstay your welcome with an MReit. If one feels that rates are to rise then a new home should be found for your capital, until then you can enjoy the income.

The MReits have pulled back and are working their way back to equilibrium from a precipitous but extremely short lived crash. You see dear reader the Debt Ceiling debate, possible default,  potential US credit downgrade  and algorithmic machine trading all conspired one day last week to takedown the MReits. At the height of the Debt Ceiling Kabuki theater ,with the media publicizing every move of the legislative sausage making process the notion that Congress would not come to an agreement and actually default ran wild through the credit markets. MReits are interest rate and credit market sensitive instruments so the idea of a default caused a “no bid” scenario in the repo market and the next reaction was for the algorithms to kick in and sell off the MReits plunging some of them in excess of 15% in seconds. Fortunately, sanity returned to the market as the media flipped back to a story that no default would take place and the Mreits recovered much of their losses and today are almost back to the level they were at prior to the selloff. The other threat to Annaly or the other MReits would have been a credit down grade as that would have affected interest rates, but Fitch and Moodys both affirmed the US’s AAA status so that is not a problem at the moment.

I tell you this story because I want to highlight the potential scenarios you could face if you decide to invest in an MReit like Annaly. Armed with knowledge you will not panic when these situations play out and you can make clear decisions ahead of time and evaluate what is going on in the heat of battle.