Free Samples

The following excerpts from TSI commentaries should give those who are unfamiliar with our service a taste of the sort of financial-world analysis provided on a twice-per-week basis to our paying subscribers. Note that during a typical week our subscribers receive two market reports, with each report generally containing 2500-3500 words and 7-12 charts.

This page will usually be updated every Tuesday with one or more excerpts from recent commentaries.

 



Date posted as sample Commentary Excerpt
21-Jul-14 From the 21st July 2014 Weekly Update:

Goldman's Gold Forecast

Last week, a Goldman Sachs analyst reiterated his forecast for the gold price to drop to $1050/oz by the end of this year.

The Goldman Sachs gold-market analysis is much better than the gold-market analysis of Eric Sprott and many other high-profile gold bulls, because at least Goldman is looking in the right direction for clues as to what the future holds in store for gold. Many gold bulls, on the other hand, haven't the foggiest idea about gold's fundamental drivers.

Goldman's gold forecast has little chance of being correct, though, because it is predicated on a strengthening US economy and because gold's true fundamentals are trending in a bullish direction. Of particular importance, we note that:

a) The BKX/SPX ratio, a measure of how the banking sector is performing relative to the broad US stock market, gradually began to turn gold-bullish (meaning: bank stocks gradually started to weaken relative to the overall market) in early-July of last year and turned decisively gold-bullish in April of this year. This influential ratio will remain supportive for gold as long as it is making lower highs and lower lows.

Here's a daily chart comparing gold and the BKX/SPX ratio over the past four years.



b) The HYG/TLT ratio, a measure of US credit spreads, began to move in gold's favour (meaning: credit spreads began to widen, causing the HYG/TLT ratio to decline) at the end of last year and made a new 52-week extreme last week. As is the case with the BKX/SPX ratio, the HYG/TLT ratio will remain supportive for gold as long as it is making lower highs and lower lows.

Here's a daily chart comparing gold and the HYG/TLT ratio over the past four years.



Our guess is that the gold price will end this year in the $1400-$1500 range.

 

14-Jul-14 From the 14th July 2014 Weekly Update:

Gold

Speculators versus Commercials

Speculators, not commercial traders, drive price trends in the gold market. The proof of this is the simple fact that the speculative net-long position in gold futures almost always trends in the same direction as the gold price (an increase in the speculative net-long position almost always accompanies an increase in price and a decrease in the speculative net-long position almost always accompanies a decrease in price). It is therefore fair to say that in the gold market, speculators are price makers and commercials are price takers.

An example is the 2-week period ended 1st July 2014. During this period a definitive upward reversal in the short-term price trend coincided with a large increase in the speculative net-long position. Specifically, the price quickly rose from $1272 to $1328 while the speculative net-long position in COMEX gold futures jumped by about 80K contracts.

As dictated by basic arithmetic, the 80K-contract increase in the speculative net-long position during the 2-week period ended 1st July went hand-in-hand with an 80K-contract increase in the commercial net-short position. These changes in the speculative and commercial positions are two sides of the same coin. One would not be possible without the other.

In general terms, speculators, as a group, could never increase their long exposure to gold futures unless commercial traders (primarily bullion banks), as a group, were prepared to take the other side of the trade and increase their short exposure to gold futures, and speculators could never reduce their net-long position (or become net-short) unless commercials were prepared to reduce their net-short position (or become net-long). This means that those commentators who rail against the short-selling of gold futures by bullion banks and other commercial traders are effectively railing against the buying of gold futures by speculators.

Moving on, a superficial comparison of the gold price and the commercial net-position in gold futures could lead to the conclusion that the commercials are always on the wrong side of the market, except at short-term price extremes. For example, 'the commercials' were relentlessly net-long during the final six years of gold's 1980-2001 secular bear market and have been relentlessly net-short since the beginning of gold's secular bull market. Looking only at futures positioning could therefore lead to the impression that the commercials have lost a fortune trading gold, but such an impression would be wrong. The reality is that the bullion banks (the biggest commercial traders) generally don't care which way the gold price trends, because they generally don't make their money by betting on price trends. Instead, their goal is to make money regardless of price direction by taking advantage of spreads (for example, spreads between the cash and futures prices and spreads between different futures contracts) and the charging of commissions.

Current Market Situation

Gold did enough last week to provide us with more evidence of a major reversal to the upside. Specifically and as illustrated by the following chart, it has just achieved a weekly close above its 65-week moving average (the blue line on the chart) and intermediate-term channel resistance.



We doubt that this obvious and belated confirmation of strength will lead to a significant immediate extension of the rally. The reason is that at this early stage of the new cyclical bull market, gold, silver and the silver/gold ratio will probably have to 'correct' their 'overbought' conditions before powering higher. That gold and silver are stretched to the upside on a short-term basis is indicated by the elevated levels of daily RSIs and the high level -- relative to where it has been over the past 12 months -- of the speculative net-long position in COMEX gold futures.

That being said, a substantial correction is unlikely at this time. The 65-week moving average should now provide strong support, which suggests that gold should remain above $1310 on a weekly closing basis. The shorter-term moving averages of importance (the 50-day, 150-day and 200-day moving averages) are now either into the $1290s or should move into the $1290s within the next three weeks, which suggests that the $1290s is probably now the worst case for an intra-day downward spike.

The bottom line is that some consolidation is likely over the coming 2 weeks, but there remains a good chance that gold will trade in the $1400s before the end of September. We therefore remain short-term bullish.

 

23-Jun-14 From the 23rd June 2014 Weekly Update:

Gold

Current Market Situation

The gold price broke out to the upside last Thursday, signaling an end to the correction that began in March. The upward reversal was not surprising, but its exact timing was unpredictable.

The gold market is likely to test resistance at $1400 within the next two months and could trade as high as $1500 before year-end, but we have no opinion on what it will do over the next two weeks. The RSI shown at the bottom of the following daily chart reveals that the market is now short-term 'overbought', but this only means that a 1-2 week consolidation would not be out of the ordinary. It doesn't mean that the price won't continue to move higher. For example, the gold price continued to move higher for about three weeks after the daily RSI reached a similar 'overbought' level in February.

What we can say is that the 50-day and 200-day moving averages, which are currently in the $1285-$1290 range, should act as a price floor if a pullback begins in the near future.



By the way, while the historical record indicated that the so-called "Golden Cross" (the 50-day MA crossing from below to above the 200-day MA) that occurred in March would probably mark a short-term price high and that the so-called "Death Cross" (the 50-day MA crossing from above to below the 200-day MA) that occurred at the end of May would probably mark a short-term price low, the next Golden Cross -- which is likely to occur within the coming month -- will have no predictive value.

The reason for the gold reversal

Despite much press coverage putting last week's sharp rise in the gold price down to increasing Iraq-related tensions and/or the Fed's confirmation that official US interest rates would not be raised for a long time, neither explanation rings true. First, increasing tension in Iraq would affect the oil market more than the gold market and would also affect the equity and bond markets, but there were no signs of heightened concerns about Iraq in any of these markets. Second, the Fed's plan to keep its targeted interest rate near zero for the foreseeable future is not news. Everyone was already aware of this.

It could be argued that by emphasising her devotion to hopelessly flawed Keynesian ideas at a press conference last Wednesday, Janet Yellen gave a gentle downward push to confidence in the Fed. Given that gold's perceived value is the reciprocal of confidence in the Fed, this could have helped to 'get the gold ball rolling'. However, last Thursday's surge in the gold price had been telegraphed well in advance by the performance of the gold-mining sector, so we don't think it makes sense to attribute the rise to any particular piece of recent news.

We think the upward reversal can be adequately explained by the combination of fundamental drivers and a bullish mismatch between sentiment and price action (sentiment had become far more bearish than warranted by the price action). As stated in the 9th June Weekly Update: "It seems that almost every 'technical analyst' on the planet is calling for gold and the gold-mining indices to make new lows within the next few months. The long-term bulls expect a final decline to marginal new lows prior to the start of a multi-year upward trend, whereas the long-term bears expect a decline to well below last year's lows as part of a continuing bear market. Enough strength over the weeks ahead to confirm that the March-June decline was a correction to a new upward trend rather than the continuation of the 2011-2013 downward trend would therefore catch the maximum number of chart-huggers and price-followers off guard. This doesn't mean that gold is about to reverse course and prove the majority wrong, but it does mean that there is plenty of sentiment-related fuel to propel the price upward. As discussed in previous commentaries, there is also now plenty of fundamentals-related fuel for a gold rally..."

 

16-Jun-14 From the 16th June 2014 Weekly Update:

Gold

We've written that gold needs to get back above $1280 on a daily closing basis to confirm that the short-term trend has reversed from down to up, but $1292 is actually a more significant price level. A daily close above $1292 would break gold above its short-term channel top as well as its 50-day, 150-day and 200-day moving averages. This is a feat that has already been accomplished by GDXJ and has almost been accomplished by the HUI. We expect that it will be accomplished by gold bullion within the next three weeks, but hopefully not in response to news from Iraq.



When the gold price rose to around $1350 in late February we thought it was due for a correction that could take it down as far as the $1270s. The Ukraine drama then began, which quickly pushed the gold price up to almost $1400 in early March. We said at the time that as is always the case when gold is bid-up in reaction to international military conflict or the increasing threat of international military conflict, all the price gains achieved by gold on the back of the Ukraine news would be relinquished. This turned out to be so, but with the clarity that only hindsight can provide we now see that the upward price spike in reaction to the Ukraine drama had a much larger effect than originally anticipated. In a financial-market version of Newton's Third Law of Motion (for every action there is an equal and opposite reaction), the surge of uninformed gold-buying prompted by the Ukraine news set the stage for a deeper and longer correction than would otherwise have happened.

Due to the latest developments in Iraq, with Sunni jihadist militants have taken control of the country's second-largest city and a further escalation of violence seemingly on the cards, understanding how gold typically responds to increasing geopolitical instability could be of near-term importance. That's why we just revisited gold's reaction to the Ukraine drama.

The recent upturn in gold-related investments does not appear to be due to the latest developments in Iraq, but if gold spikes upward in the near future in response to a worsening situation in Iraq then the start of the next multi-month advance in the gold price would likely be postponed. This is because any Iraq-related gains would subsequently be given back and because the surge of uninformed buying would weaken the structure of the market.

Now, if the situation in Iraq were to worsen to the point where it provoked another large-scale US military intervention, then the backdrop would become increasingly gold-bullish. This would not be directly due to the military action itself, but due to the damage to the US economy inflicted by the government wasting a lot more resources on another counter-productive escapade. However, history teaches us that even in this case the initial price gains would likely be given back in full.

 

09-Jun-14 From the 9th June 2014 Weekly Update:

The Stock Market

...We are surprised that the stock market's upward trend has extended into June. This opens up the possibility that the overall topping process could continue into the final quarter of this year, with a significant decline during the next couple of months followed by a rally to test the high later in the year.

On a short-term basis, however, the recent price action has only increased the downside risk, in that the strength that has enabled the NASDAQ100 Index (NDX) to confirm the new highs in the S&P500 Index (SPX) has led to the senior stock indices becoming very 'overbought'. As an example, the Dow Jones World Stock Index (DJW) has risen on 10 of the past 12 trading days. The daily advances have all been small, but, as illustrated by the following daily chart, the result is that DJW is now at the top of its intermediate-term price channel and DJW's daily RSI(14) is now at a 2-year high.



Also worth noting is that a put/call sell signal was generated at the end of last week in the US stock market. We define a put/call sell signal as the 10-day moving average of the equity put/call ratio moving to the vicinity of its 3-year low concurrently with the 10-day MA of the OEX (S&P100 Index) put/call ratio moving to the vicinity of its 3-year high. Such signals usually occur no more than twice per year and are short-term bearish omens because they indicate a lack of concern about downside risk on the part of the 'dumb money' (the dominant influence on equity option volumes) combined with a heightened level of concern about downside risk on the part of the 'smart money' (the dominant influence on OEX option volumes).



Therefore, although the stock market has defied our expectations over the past few weeks, this is not a good time to become more short-term bullish.

 

02-Jun-14 From the 2nd June 2014 Weekly Update:

Gold

The "Golden Cross" and the "Death Cross"

There was a "Golden Cross" in the gold market during the second half of March. It worked the way that the historical record indicated it would work (it marked a high of at least short-term importance), which happens to be the opposite of the way that most commentators and analysts believe it is supposed to work. To further explain, here is an excerpt from our 19th March commentary:

"While on the subject of false beliefs, another one that will soon come into play in the gold market is the "Golden Cross". A Golden Cross is defined as a move -- in any market -- by the 50-day MA from below to above the 200-day MA. Its opposite (a move by the 50-day MA from above to below the 200-day MA) is often referred to as a Death Cross.

There is widespread belief that Death Crosses are bearish and Golden Crosses are bullish, but nobody who has bothered to check the historical record could hold this belief. Here are the facts:

1) A sizeable majority of Death Crosses in major financial markets occur near lows of at least short-term importance. A Death Cross therefore tends to be a BULLISH signal.

2) On average, a Golden Cross has no predictive value. The historical record suggests that it is neither reliably bullish nor reliably bearish. However, in the gold market a particular type of Golden Cross has generally occurred near a high of at least short-term importance. We are referring to the situation where the cross occurs after the 50-day MA has risen from a long way below the 200-day MA. This is the situation we will be dealing with if -- as is very likely -- the gold market achieves a Golden Cross in the near future.
"

As illustrated by the following daily chart, the gold market's March-2014 Golden Cross occurred about one week after a multi-month price high. There has since been sufficient price weakness to pull the 50-day MA below the 200-day MA, creating a so-called Death Cross. The Death Cross occurred last week. Contrary to popular belief, the historical record indicates that this is a bullish signal.

 

19-May-14 From the 21st May 2014 Interim Update:

Gold Stocks

The HUI is staggering along near its lows of the past two months, frustrating the bulls by not showing any sign of strength and frustrating the bears by not accelerating downward. Beneath the surface, however, there is evidence that the downward correction of the past two months is about to end. We are referring to the fact that a bullish divergence has developed between the HUI and the GDXJ/GDX ratio (junior gold stocks relative to senior gold stocks).

The following chart shows the aforementioned bullish divergence as well as the bearish divergence that formed during February-March and the bullish divergence that formed in December. In this case, a bullish divergence involves lower lows in the HUI in parallel with higher lows in GDXJ/GDX, while a bearish divergence involves higher highs in the HUI in parallel with lower highs in GDXJ/GDX.



Even if the gold-mining sector is about to begin a new short-term upward trend (we think it is), a 'cleansing' spike down to 210 could precede a sustainable upturn.

 

19-May-14 From the 19th May 2014 Weekly Update:

Gold Stocks

Updated comparisons with the 1970s

Updated charts comparing the BGMI (Barrons Gold Mining Index) from its 1967 and 1974 peaks with the current HUI are displayed below. The current price action continues to be most similar to 1977 (the second of the following charts).

If the current price action continues to follow the 1977 path then an upward reversal will occur this week, perhaps following a spike to a new correction low.


 

19-May-14 From the 14th May 2014 Interim  Update:

Money Velocity, Supply and Demand

"Money Velocity" is NOT a useful concept in economics or financial-market speculation. The reasons have been discussed numerous times in TSI commentaries over the years, but in response to some emails received over the past few weeks it is time for a brief recap.

As is the case with the price of anything, the price of money is determined by supply and demand. Supply and demand are always equal, with the price adjusting to maintain the balance. A greater supply will often lead to a lower price, but it doesn't have to. Whether it does or not depends on demand. For example, if supply is rising and demand is attempting to rise even faster, then in order to maintain the supply-demand balance the price will rise despite the increase in supply.

When it comes to price, the main difference between money and everything else is that money doesn't have a single price. Due to the fact that money is on one side of almost every economic transaction, there will be many (perhaps millions of) prices for money at any given time. In one transaction the price of a unit of money could be one potato, whereas in another transaction happening at the same time the price of a unit of money could be 1/30,000th of a car. This, by the way, is why all attempts to come up with a single number -- such as a CPI or PPI -- to represent the price of money are misguided at best.

To summarise, in the real world there is money supply and there is money demand; there is no money "velocity". Why, then, do so many economists and commentators on the economy harp on about the "velocity of money"?

The answer is that the velocity of money is part of the very popular equation of exchange, which can be expressed as M*V = P*Q where M is the money supply, V is the velocity of money, Q is the total quantity of transactions in the economy and P is the average price per transaction. The equation is a tautology, in that it says nothing other than the total monetary value of all transactions in the economy equals the total monetary value of all transactions in the economy. In this ultra-simplistic tautological equation, V is whatever it needs to be to make the left hand side equal to the right hand side.

Another way to express the equation of exchange is M*V = nominal GDP, or V = GDP/M. Whenever you see a chart of V, all you are seeing is a chart of nominal GDP divided by money supply. That's why a large increase in the money supply will usually go hand-in-hand with a large decline in V.

In conclusion, V (money velocity) does not exist outside of a mathematical equation that, due to its simplistic and tautological nature, cannot explain real-world phenomena.

 

05-May-14 From the 5th May 2014 Weekly Update:

Gold fundamentals now bullish

The fundamental backdrop was unequivocally gold-bearish during the first half of last year. Around the middle of last year it began to shift in gold's favour with the upside breakout in the US yield-spread (the difference between 10-year Treasury yields and 2-year Treasury yields) and the rolling over of the BKX/SPX ratio, but at the beginning of this year it could best be described as mixed (neither definitively bullish nor definitively bearish). It remained 'mixed' throughout the first quarter, but due to two recent developments it is now bullish. One of these developments is the downside breakout in the BKX/SPX ratio discussed in last week's Interim Update. The other is the downside breakout in the HYG/TLT ratio, a credit-spread indicator. HYG/TLT rises when credit spreads are contracting (indicating rising economic confidence, which is bearish for gold) and falls when credit spreads are expanding (indicating declining economic confidence, which is bullish for gold).

Here is a chart comparing the gold price and the HYG/TLT ratio. The inverse relationship of the past 3.5 years is clear.



By the way, in addition to being a bullish omen for gold, last week's downside breakout in the HYG/TLT ratio is a bearish omen for the broad stock market.

 

21-Apr-14 From the 9th April 2014 Interim Update:

The Stock Market

Stock market strength doesn't indicate economic strength

The Zimbabwe stock market rose by millions of percent during 2005-2008. If stock market strength were an indicator of economic strength then Zimbabwe would have had the best economy in the world during this period, but it actually had the worst (or very close to it). Clearly, then, the astronomical gain in Zimbabwe's stock market was a sign of weakness rather than strength. However, we continue to see market analysts and commentators citing rises in broad-based stock indices as evidence of a strong economy. This prompts the question: how fast is too fast for a stock market to rise? That is, at what rate of ascent does a rising stock market become indicative of an economic problem rather than economic strength?

That's actually a trick question, because a rising stock market is NEVER a sign of genuine economic strength. It is, instead, a sign of monetary inflation. In a healthy economy with no monetary inflation an index representing the overall stock market would tend to oscillate around a horizontal line over the long term. In such an economy, long-term investors in a broad-based stock index would achieve no nominal capital gain. These investors would, however, achieve a significant real return due to dividends and the rise in the purchasing power of money.

In general terms it is therefore fair to say that the faster the rise in the stock market the greater the amount of monetary inflation. Furthermore, good economic theory tells us that the greater the amount of monetary inflation the more severe the coming economic downturn (since monetary inflation causes mal-investment). That's why the biggest economic busts have often followed the most spectacular stock-market advances. In such cases it wasn't the eventual stock market collapse that caused the severe economic downturn; the economic downturn was caused by the inflation-fueled boom, a symptom of which was a spectacular rise in the stock market.

It doesn't always work, but when trying to identify the countries that are going to have the weakest economies over the next 5 years a good place to start is to identify the countries that had the strongest stock markets over the preceding 5 years.

Current Market Situation

From the latest TSI Weekly Update: "In the US market, last week's downside breakout by the RUT/SPX ratio is evidence of an intermediate-term trend reversal from up to down, but this evidence has come with prices stretched to the downside. Furthermore, the NASDAQ100 Index (NDX), the senior stock index that has led to the downside, is now close to important lateral support at 3400. This makes it likely that a 1-3 week rebound will begin within the next two trading days."

The following daily chart shows that the NDX tested important lateral support at 3400 early this week and then reversed upward. It looks like a 1-3 week rebound has begun.



We are now entering the short time-window when the Presidential Cycle Model predicts a seasonal peak for the US stock market. The same model predicts a September-October seasonal bottom at a much lower level. Moreover, the fact that the market is entering the aforementioned topping window with high valuations, complacent sentiment, price extended to the upside and significant bearish divergences increases the probability that 'seasonality' will work this year.

Consequently, the next three weeks should be a good time for speculators to average into bearish US equity positions. At this stage we aren't going to make any formal recommendations, but for our own account we will consider put options on QQQ (the NASDAQ100 ETF), IWM (the Russell2000 ETF), and SSO (the ProShares UltraS&P500 ETF).

While the US stock market appears to be dangerously extended to the upside, the same cannot be said for many other stock markets around the world. For example, the following chart shows that Hong Kong's stock market has essentially moved sideways over the past four years. The Hong Kong market could still be dragged downward over the coming 6 months by substantial weakness in US equities, but it doesn't merit a bearish speculation.

 

14-Apr-14 From the 9th April 2014 Interim Update:

The Stock Market

The US

Major stock-market tops are a process, not an event, and the process involves some divergences/non-confirmations during the lead-up to the ultimate price high. In the current US situation, the recent relative weakness in the NASDAQ100 Index (NDX) opens up the possibility that if the SPX achieves a new high in the near future then the high won't be confirmed by the NDX.

Here are two other noteworthy and potentially-important divergences that have been developing:

1) The RUT/SPX ratio (small cap stocks relative to large-cap stocks) made a marginal new high at the beginning of March and in doing so confirmed the new high made by the SPX a few days earlier. However, the RUT/SPX ratio not only failed to confirm the new high made by the SPX in early-April, it also plunged to a new low for the year shortly after the SPX made a new high.

The RUT/SPX ratio will almost certainly fail to confirm any new high made by the SPX over the coming two weeks and is also in danger of breaking below the triple bottom that formed over the past 9 months.



2) The HYG/TLT ratio, a credit-spread indicator, generally trends in the same direction as the stock market. However, the following chart shows that HYG/TLT peaked at the end of last year and therefore failed to confirm any of this year's new SPX highs.

If HYG/TLT takes out its early-February low it will be a definitively bearish omen for the stock market (and a bullish omen for gold).



China

The asset-price-related effects of China's gargantuan credit bubble are almost totally focused on the real estate market. There is no evidence of this bubble in China's stock market, which probably means that a large decline in the Shanghai Stock Exchange Composite Index (SSEC) won't be a knock-on effect if the credit bubble bursts in the near future. In fact, it currently looks more like the SSEC is completing a major base than a major top.

We aren't interested in 'going long' China's stock market, but 'going short' this market is not the way to bet on the bursting of the world's greatest credit bubble. Furthermore, the evidence of important upward reversals in commodities and commodity-related investments that has emerged over the past three months suggests that China's much-anticipated bubble-bursting will be postponed for another year.

 

31-Mar-14 From the 31st March 2014 Weekly Update:

Monetary Inflation Update

The ECB got around to publishing its money-supply data for February late last week, enabling us to update our euro and G2 (US plus euro-zone) True Money Supply (TMS) charts.

Our first chart shows the year-over-year (YOY) percentage change in euro TMS. The ECB is coming under pressure to do more on the monetary inflation front, but recently it hasn't done much. Over the past two months the YOY rate of change in euro TMS flatlined at around 6%.

Note that while we have no opinion about the euro's likely performance on the foreign exchange market over the weeks immediately ahead, we are intermediate-term bullish on this currency (relative to the US$). The primary reason is our expectation that the low valuations of European equities relative to US equities will lead to outperformance by the former, boosting the investment/speculative demand for the euro. A secondary reason is that despite the Fed's "tapering" and the apparent intention of the ECB to do more on the monetary inflation front, the ECB could end up doing less than needed, in the face of substantial natural deflationary pressures, to create the sort of "price inflation" that bad economists and central bankers believe to be beneficial.



Our second chart shows the YOY percentage change in G2 TMS -- in our opinion the most useful leading indicator of the global boom-bust economic cycle. The last two economic busts commenced about 6 months after the annual growth rate of G2 TMS dropped to 5%. At around 7% the current growth rate is only slightly above its low of the past 4 years, but still comfortably above the level that ushered-in the previous two busts.



The UK's YOY rate of money-supply growth has been stable at 5.5%-6.5% for almost 18 months. This is inflationary, but not as inflationary as the money-supply growth rates in many other countries. Also, the average rate of increase in the supply of British Pounds was relatively low during 2009-2012. This goes part of the way towards explaining the strength in the Pound's exchange rate over the past 12 months and should continue to create a tail-wind for the Pound over the coming 12 months.

 

24-Mar-14 From the 19th March 2014 Interim Update:

Gold

Unfounded Beliefs

In the latest Weekly Update we warned that the Ukraine situation created near-term downside risk rather than near-term upside potential for gold. Based on the historical record it was almost inevitable that gold would fully retrace any gains made in reaction to the heightened threat of military conflict in Ukraine, with $30/oz being our guess as to the amount of Ukraine premium in the price as at the end of last week.

When it became apparent at the beginning of this week that the Ukraine conflict was not going to immediately escalate, the gold price quickly dropped $30.

The Ukraine-related conflict between Russia and the "West" could escalate in the future, causing the gold price to surge. If it does, the same will apply: any price gain made by gold on the back of such news would almost certainly be retraced in full.

The upshot is that contrary to popular belief, international military conflict or increasing risk of such conflict never creates a short-term buying opportunity in the gold market. However, it sometimes creates a short-term selling opportunity.

While on the subject of false beliefs, another one that will soon come into play in the gold market is the "Golden Cross". A Golden Cross is defined as a move -- in any market -- by the 50-day MA from below to above the 200-day MA. Its opposite (a move by the 50-day MA from above to below the 200-day MA) is often referred to as a Death Cross.

There is widespread belief that Death Crosses are bearish and Golden Crosses are bullish, but nobody who has bothered to check the historical record could hold this belief. Here are the facts:

1) A sizeable majority of Death Crosses in major financial markets occur near lows of at least short-term importance. A Death Cross therefore tends to be a BULLISH signal.

2) On average, a Golden Cross has no predictive value. The historical record suggests that it is neither reliably bullish nor reliably bearish. However, in the gold market a particular type of Golden Cross has generally occurred near a high of at least short-term importance. We are referring to the situation where the cross occurs after the 50-day MA has risen from a long way below the 200-day MA. This is the situation we will be dealing with if -- as is very likely -- the gold market achieves a Golden Cross in the near future.

The 20-year gold-market history of the type of Golden Cross mentioned above (the type where the cross occurs after the 50-day MA has risen from a long way below the 200-day MA) contains only five examples. Here they are:

1) In April of 1995, a Golden Cross occurred about one week after an intermediate-term price high. An intermediate-term price low was then marked by a Death Cross in October of the same year.



2) In October of 1999, a Golden Cross coincided with an intermediate-term price peak.



3) In June of 2001, a Golden Cross coincided with a short-term price peak. If Golden Crosses are supposed to be bullish signals then the June-2001 cross was the least wrong of our examples.



4) In February of 2009, a Golden Cross occurred about one week prior to a price high that held for 6 months.



5) In September of 2012, a Golden Cross occurred just prior to an intermediate-term price high. If Golden Crosses are supposed to be bullish signals then the September-2012 cross was the biggest failure of the past 20 years due to the fact that it occurred near the beginning of a large 9-month price decline.

 

17-Mar-14 From the 12th March 2014 Interim Update:

The Gold Fix

In mid-2012 there was a proverbial storm in a teacup over the attempts by some private banks to manipulate LIBOR (London Inter-Bank Offered Rate), the interest rate that banks use when making short-term loans to each other and the reference rate for many other loans. As we explained at the time, that such a big deal was made of this alleged manipulation was so absurd it was laughable. This was partly because the manipulation clearly hadn't changed any significant interest-rate trends and had, at most, resulted in miniscule short-lived deviations, but it was mostly because interest rate manipulation is openly practised on a vastly greater scale every day by government-sponsored entities known as central banks. We are dredging up the old "LIBOR scandal" because there is now a similar, albeit even more absurd, "storm in a teacup" brewing over the possibility that the five private banks responsible for arranging the twice-per-day London Gold Fix have used the 'fixing' process to manipulate the gold market.

The article linked HERE explains why it's extremely unlikely that the London Gold Fix has been used to manipulate the gold price. However, this article misses the point that the Gold Fix is a snapshot taken within a global market that trades 24 hours per day and is trading in other parts of the world at the time of the Fix. A consequence is that any attempt to move the price out of line with genuine supply/demand via the Gold Fix would, at most, cause some intra-day volatility, and would not create a significant advantage for the banks involved. It could not possibly affect multi-week price trends, let alone the longer-term price trends that most investors care about.

Actually, even the fact that London's daily gold-fixing process could not have been used to significantly alter price trends misses the most important points. The concern, apparently, is that the process is "open to manipulation", but everyone involved in the financial markets should know that all major financial markets have always been manipulated and always will be manipulated. If you cannot handle this fact of life then you should stay out of the markets. The absolute last thing we need is for the government to become more involved in a supposed effort to ensure a "level playing field", because the manipulation that really matters is perpetrated by governments and central banks.

Which brings us to the main point: While 'public-spirited' activists rail against the market manipulation that may or may not have been done by private banks, central banks continue to MASSIVELY distort ALL interest rates, leading to wild swings in the economy and generally wreaking havoc. All other market manipulation is trivial in comparison. But nary a word is said by the outraged fighters for market justice against this destructive fudging of the market's most important price signals. In fact, these self-appointed fighters for market justice usually want the government to do something. Their hearts may well be in the right place, but they are misguided (to put it politely).

If anti-market-manipulation organisations such as GATA didn't exist, the Fed would have to create them in order to distract the public from the market manipulation that really matters: the manipulation of interest rates, money supply and economic statistics by central banks and governments.

 

11-Mar-14 From the 10th March 2014 Weekly Update:

The Currency Market

The US dollar's "reserve" status

The US$ is not the most popular reserve currency because governments choose to hold it in reserve. Governments around the world favour US dollars for their currency reserves because the US$ is by far the most popular currency in the global marketplace. The fact is that in terms of use in international financial dealings, no other currency comes remotely close to the US$. That's not going to change within the next several years, so political threats to abandon the dollar can be ignored. These threats are just hot air.

Also, it's worth reiterating a point we've made in the past, which is that foreign currency reserves aren't reserves in the true meaning of the word. A nation's currency is not backed by the foreign currency reserves held by its central bank. Instead, the volume of a nation's foreign currency reserves is usually a reflection of the exchange-rate manipulation carried out by its central bank. When a central bank other than the Fed wants to weaken its currency it will sell newly created units of its own currency for the most popular currency for international dealings, which, as noted above, is presently the US$ by a wide margin. And when a central bank other than the Fed wants to strengthen its currency it will do the opposite.

In other words, the accumulation of international currency reserves is usually part of a process designed to devalue a currency. The efforts to devalue generally run for several years, at which point it becomes obvious that the manipulation has gone too far and caused an inflation problem. In desperation, the opposite process is then initiated.

The Commodity Currencies

We think that the Australian Dollar (A$), one of the two most important commodity currencies, is in the early phase of a multi-month, or possibly even a multi-quarter, rally. Assuming it occurs, the rally will probably turn out to be the bear-market variety, in that the A$ remains very over-valued on a purchasing-power-parity basis, but an advance within the context of a long-term bear market yields just as much profit as the same percentage increase within the context of a long-term bull market.

The A$'s recent performance has generated some evidence to support the aforementioned opinion of ours. We are referring to the fact that it broke above its 50-day MA, pulled back to test its breakout and then made a new high for the move.

There is substantial resistance at around 92 defined by the 200-day MA and the top of a channel. This resistance could limit the upside over the next few weeks.



Our outlook for the Canadian Dollar (C$), the other major commodity currency, is the same, but unlike the A$ the C$ hasn't yet generated any evidence that a bottom is in place. At this time, all we have is a rebound to the 50-day MA. Consequently, it is distinctly possible that the C$ will make a new multi-year low before a meaningful rally gets underway.

A daily close above 91.5 would be initial price-related evidence that a sustainable up-turn has occurred. In the meantime, we view the C$ as suitable for accumulation below 90.



The Yen

Despite everything, the Yen still trades like a safe-haven currency. In particular, it tends to weaken in response to stock market strength and strengthen in response to stock market weakness. This pattern should continue over the next few quarters.

A 10%+ Yen rally will probably coincide with the next 10%+ stock market decline, but if -- as now seems likely -- the stock market retains an upward bias until at least late-April, it's possible that the Yen will test or even breach its January-2014 bottom before a meaningful rally gets underway.

 

03-Mar-14 From the 26th February 2014 Interim Update:

Gold

Confusing Cause and Effect

As we explained in multiple TSI commentaries last year, the large 2013 decline in the Comex gold inventory was an effect of the large decline in the gold price, not a cause of it. Furthermore, based on the historical record it was a predictable effect, in that over the past 35 years major trends in Comex gold inventories have followed major trends in the gold price. In other words, there was nothing untoward, suspicious or even the slightest bit strange about last year's Comex inventory decline.

It's a similar story with the physical gold inventory of bullion ETFs such as GLD. There's a nuance here in that changes in the quantity of gold held by GLD are not directly driven by changes in the gold price, they are driven by arbitrage. More specifically, if the price of a GLD share rises relative to the gold price then arbitrage activity will cause physical gold to be added to GLD's inventory, and if the price of a GLD share falls relative to the gold price then arbitrage activity will cause physical gold to be removed from GLD's inventory. (It's this arbitrage activity that prevents the GLD price from ever wandering far from its net asset value.) This means that a rising gold price won't necessarily result in gold flowing into GLD's inventory and a falling gold price won't necessarily result in gold flowing out of GLD's inventory. However, because trend-followers and other short-term traders exert a greater influence on the price of GLD shares than on the price of gold bullion, GLD's price will tend to rise faster than the gold price during a strong upward trend and fall faster than the gold price during a strong downward trend. This creates a tendency for the arbitrage activity mentioned above to add gold to GLD's inventory during strong gold markets and remove gold from GLD's inventory during weak gold markets.

The main point we want to make is that a likely EFFECT of an upward trend in the gold price over the months/years ahead will be the addition of gold to the Comex and GLD inventories, but going by past performance many analysts will confuse cause and effect and wrongly interpret the inventory change as the cause and the price change as the effect. There is a self-reinforcing element in that as physical gold is added to the GLD inventory there will be marginally less gold to satisfy demand elsewhere, but the process begins with a change in the price trend.

 

27-Jan-14 From the 27th January 2014 Weekly Update:

Gold

If we use a magnifying glass we see that gold broke out to the upside last Friday, but if you have to use a magnifying glass to see a breakout then a breakout hasn't really happened. The US$ gold price is clearly very close to providing us with preliminary evidence of an upward trend reversal by breaking above its channel top and its December-2013 rebound peak, but some additional strength is required.

A weekly close above $1300 would be conclusive evidence of an upward trend reversal.



In A$ terms, gold bottomed last April and has since made a sequence of higher lows. This price action should lead to relatively good results for gold producers with operations in Australia.



In the 6th January Weekly Update, we wrote:

"Gold's fundamentals turned more bullish in mid-2013 and in our opinion will become increasingly so over the next 6 months, but right now the fundamental backdrop for gold can best be described as mixed. The reason, in a nutshell, is that there is still a lot of economic optimism and confidence in both the Fed and the ECB. That's why credit spreads have been relentlessly narrowing since June of 2012 and are now almost as narrow as they ever get.

The narrowing of credit spreads is indicated on the first of the following charts by the upward trend in the HYG/TLT ratio (high-yield bonds relative to Treasury bonds), because HYG outperforms TLT when investors become less risk averse and bid-up high-yield (junk) bonds relative to US government bonds. The HYG/TLT ratio probably can't go much higher, but it needs to start trending lower to become 'gold bullish'. A break below 0.85 would confirm a downward trend reversal.
"

The HYG/TLT ratio hasn't yet become 'gold bullish' by confirming a downward trend reversal, but the following chart shows that it is now heading in the right direction.

 

20-Jan-14 From the 20th January 2014 Weekly Update:

Probably the most important fundamental [gold] driver right now

Given that gold is widely viewed as a hedge against problems in the financial system it makes sense that the relative strength of the banking sector tends to have a significant effect on the gold market. Over the past few years this effect has been much stronger than usual. In fact, we noted in a recent commentary that the banking sector's relative strength, as indicated by the BKX/SPX ratio, currently appears to be the most influential of gold's fundamental price drivers.

The strong inverse relationship between the US$ gold price and the BKX/SPX ratio is illustrated below. Notice that the major 2011 high for the gold price roughly coincided with a major low for the BKX/SPX ratio and that the late-June bottom for the gold price roughly coincided with a peak for BKX/SPX. The jury is still out as to whether the June-July 2013 extremes for the gold price and the BKX/SPX ratio were the major variety.



By the way, gold has tended to lead the BKX/SPX ratio by 1-3 months at significant turning points over the past three years. We are referring to the fact that gold turned lower about 3 months before BKX/SPX turned higher in late-2011, that gold turned higher about 1 month before BKX/SPX turned lower in mid-2013, and that gold turned lower about 2 months before BKX/SPX turned higher in Aug-Oct of 2013. At this time we have a late-December upward reversal in the gold price that should, if it is genuine, be confirmed by a downward reversal in BKX/SPX by the end of March.

Always one of the least important fundamental [gold] drivers

As explained in many TSI commentaries over the years, changes in annual gold production are so unimportant that they can safely be ignored when considering bullish and bearish influences on the gold price.

The gold market can be likened to a company that increases its share count by about 1.7% every year. In this analogy, the amount of new supply added by the mining industry to the aboveground gold inventory each year is equivalent to our hypothetical company's small annual addition to its share count. Some years the increase in the share count could be as high as 1.9% and some years it could be as low as 1.5%, but in terms of effect on the share price these variations in the number of new shares will be dwarfed by changes in sentiment, the performance of the broad stock market, company-specific fundamentals such as earnings, and economy-wide fundamentals such as monetary policy.

In the gold market, the small annual change in the total aboveground supply will always be trivial compared to influences such as central bank monetary machinations and changes in economic confidence. So, anyone who is currently basing a bullish gold view on the possibility that gold production will decline is probably going to be right for the wrong reason.

 

16-Dec-13 From the 11th December 2013 Interim Update:

The Bitcoin Speculation

Unless you've just regained consciousness after being in a coma for at least two months, you are probably aware of the extraordinary performance of the Bitcoin price. Since the beginning of last month the price of a Bitcoin has gone from $200 up to $1200 down to $650 and back up to $900+ (see chart below). What's the story?



As far as we can tell, the latest round of speculation in this "digital currency" had two main drivers.

First, the US financial establishment gave Bitcoin an implicit stamp of approval, thus contradicting the idea that holding Bitcoins is an effective way to keep purchasing power away from the prying eyes and hands of central banks and governments. That the financial establishment would utter soothing words about Bitcoin should not be a big surprise, though. This is because a long-term goal of the government-bank partnership is for all regularly-used currencies to be electronic, leading to a digital record of all payments and thus theoretically making it possible for every financial transaction to be either monitored in real time or traced after the event.

Second, gamblers in China discovered Bitcoin. Members of the same group that completely ignored valuation while bidding the Shanghai Stock Exchange Composite Index up from 1000 to 6000 within the space of two years (Q3-2005 to Q3-2007) and completely ignored valuation while bidding permanently-vacant apartments up to absurd prices, have recently turned their attention to Bitcoin.

Some gold bulls are against Bitcoin because they believe that, like a US dollar and unlike an ounce of gold, a Bitcoin has no intrinsic value. This line of thinking is wrong, because value is always subjective. A US$, a Bitcoin and an ounce of gold have exactly the same intrinsic value: zero. By way of further explanation, gold will have a different value to different people and could have a different value to any single person depending on that person's circumstances. For example, in our present situation we think gold is very valuable, but if we were stranded alone on an island with no hope of being rescued we would value a fresh coconut or a fish more highly than an ounce of gold. Under such circumstances gold would most likely have no value to us, but something with "intrinsic" value would, by definition, have value under all circumstances.

From our perspective, one important difference between gold and Bitcoins is that gold is a physical quantity that has been highly valued by humans for its physical properties for thousands of years and will probably be highly valued for the same physical properties for a very long time to come. A Bitcoin, in contrast, doesn't exist outside the memory of a computer. It's not about intrinsic value, it's about physical presence. Related to this difference is that gold has subjective value outside of its role as a currency or an investment or a speculative plaything, whereas Bitcoin's current subjective value is almost totally based on its role as a speculative plaything.

A second important difference is that whereas there are strict limitations on the supplies of both gold and Bitcoins, there is an infinite supply of things that are identical to Bitcoins in every way except name. The Bitcoin network can be duplicated ad infinitum, which means that maintaining a high value for a Bitcoin involves maintaining the belief that there is a significant difference between a Bitcoin and the other digital currencies that are created using the same coding, when in reality no such difference exists.

Due to the points outlined in the above two paragraphs, we are confident that gold will be worth a lot more in real terms five years from now whereas we have no idea if a Bitcoin will be worth a lot more or a lot less. Moreover, gold will still have substantial value under any future scenario we can imagine, but we perceive a high probability that Bitcoin's value will eventually drop to zero.

We haven't speculated in Bitcoins yet and probably won't, because, due to its extreme volatility and our belief that its ultimate price will be zero, we know we wouldn't be able to hold through the corrections. To hold through the corrections you need to be a true believer.

 

02-Dec-13 From the 2nd December 2013 Weekly Update:

Gold

Although the gold price did very little last week, the price action helped to define the two price channels indicated on the following daily chart. Notice, in particular, that last week's intra-day low coincided with the bottom of a channel dating back to the late-August rebound high and the bottom of a narrower and more steeply-sloped channel dating back to the October rebound high.

Friday's close coincided with the top of the steeply-sloped channel dating back to the October high, so any additional price gain from here would create a minor upside breakout. However, more important resistance lies in the $1270s. A counter-trend rebound shouldn't do more than test this resistance, which is why we would interpret consecutive daily closes above $1280 as confirmation that an important bottom was in place.



Over the past 5 years, one of the most important gold-market 'fundamentals' has been the relative performance of the US banking sector as indicated by the BKX/SPX ratio. Gold tends to do well when the banking sector is weakening relative to the broad stock market and gold tends to do poorly when the banking sector is strengthening relative to the broad stock market. The following chart shows the performance of the BKX/SPX ratio.

There is preliminary evidence in the market action that the BKX/SPX ratio made a trend reversal of at least intermediate-term significance at the end of June-2013. Taking out the early-November low would provide conclusive evidence of such a development and would substantiate the view that the gold market commenced a major bottoming process in June.

 

04-Nov-13 From the 4th November 2013 Weekly Update:

Eric Sprott's Flawed Analysis

Great success in business or investing does not imply great understanding of macroeconomics or how the gold price is formed. This has been proved many times in the past by Warren Buffett. Recently, it has also been proved by Eric Sprott in an open letter to the World Gold Council (WGC). Sprott criticises the hopelessly-flawed supply-demand analysis of both the WGC and Gold Fields Mineral Services (GFMS), but not for the right reasons. He actually uses the same hopelessly-flawed methodology, the only differences being in some of the figures that are plugged into the analysis.

Sprott, the WGC and GFMS tally the amounts of gold bought by some parts of the gold market and call this quantity "demand", and tally the amounts of gold sold by other parts of the gold market and call this quantity "supply". They then compare the two tallies to determine whether the gold price should be rising or falling.

In this method of analysis, the gold-mining industry is by far the biggest seller. In fact, in this method of analysis the supply side of the equation is always represented by the 2400-2800 tonnes per year of gold produced by the mining industry plus the amounts of gold sold by a few relatively minor players. Over the past year the gold ETFs have collectively been one of these minor players on the supply side (physical gold has left the ETFs).

In the real world, however, the supply side of the equation is the total aboveground gold inventory, which is about 150,000 tonnes. Since all the gold is always held by someone, demand is also equal to the total aboveground inventory of (very roughly) 150,000 tonnes. In other words, at any given time supply equals demand equals 150,000 tonnes.

In the real world, the gold sold by the mining industry is no different to the gold sold by any of the current holders of gold. For example, if the gold price reaches a level at which Trader A wants to buy 1,000 ounces of gold, then Trader A's demand can be satisfied by a sale of gold on the part of any of the current holders of gold, including the mining industry.

Price is the quantity that changes to keep supply and demand in balance. If demand increases relative to supply at a certain price, the price will immediately adjust upward by as much as it takes to re-establish the balance. By the same token, if demand falls relative to supply at a certain price then the price will immediately adjust downward by as much as it takes to re-establish the balance. Price, therefore, is the only measure of whether the urgency to sell is rising or falling relative to the urgency to buy.

Here's another way to look at the situation: For every purchase there must be a sale. That is, the amount of gold sold must always be equal to the amount of gold bought (another reason, by the way, that it makes no sense to separately tally sales and purchases as if one could ever be larger than the other). What causes the price to change, therefore, isn't a greater volume of selling or buying, it's the relative eagerness of buyers and sellers. For example, if a large number of eager get-me-out-at-any-price sellers enter the market then the volume of trading will increase, meaning that the amount of gold sold and the amount of gold bought will increase by the same amount, and the price will fall. Some analysts will look at the increase in buying that accompanied the price decline and will be nonplussed, because they don't seem to understand that an increase in buying MUST go hand in hand with an increase in selling, and that the price decline tells you with 100% certainty that the sellers were more eager than the buyers.

Over the past six months we've probably devoted too much space in TSI commentaries to debunking the nonsensical gold supply-demand analysis that gets put out by GFMS, the WGC, and now Eric Sprott. However, it's an important issue, because gold bulls (including us) can't learn from past mistakes unless they understand why they were wrong. If you were bullish over the past year and you still believe that you were right to be bullish, then you haven't learned anything and you will almost certainly make the same mistake again.

 

21-Oct-13 From the 16th October 2013 Interim Update:

The China-Gold Myth

Rather than cast doubt on the wrongheaded idea that China's buying is a cornerstone of the gold bull market, the fact that a major 2-year correction in gold's bull market has coincided with a large increase in the amount of gold flowing into China has only served to fuel conspiracy theories. After all, how could the gold price trend downward in parallel with a large increase in Chinese demand unless powerful, unnatural forces were at work?

The gold price is capable of trending downward in parallel with a large increase in Chinese demand because the change in China's demand for gold explains very little about past movements in the gold price and says very little about likely future movements in the gold price. In more general terms, the amount of gold flowing from one geographic region to another or from one set of holders to a different set of holders tells us nothing useful about gold's major price trend. The reason is that the flow of gold is an indicator of trading volume, which can increase or decrease in parallel with a rising or a falling price. The market-wide urgency to buy relative to the market-wide urgency to sell is what determines the price, and the only reliable indicator of whether buyers or sellers have greater urgency is the change in the price itself.

By way of further explanation, consider a model of the global gold market in which there are only two traders: China and the World Excluding China. We'll refer to China as Trader A and the World Excluding China as Trader B. Clearly, in order for Trader A to increase its gold exposure, Trader B must decrease its gold exposure, and vice versa. To put it another way, for A to be a net-buyer B must be a net seller, and for B to be a net-buyer A must be a net seller. Price is the force that keeps the change in A's demand in balance with the change in B's demand. This means that if B is not prepared to part with enough gold to satisfy an increase in A's demand at a gold price of X, then the price will rise to (X+Y) where Y is whatever it needs to be to bring the market into balance.

Those making the "China's buying is bound to drive the gold price to new highs" claim are, in effect, only looking at one side of the equation. They are looking at A's buying and forgetting about B's selling. They seem to be making the assumption that A is increasing its buying while B does nothing, but this assumption is patently wrong because A cannot possibly increase its buying unless B increases its selling. The change in price is the only valid indicator of which is the more important, A's buying or B's selling. Moreover, a net flow of gold from A to B or from B to A could be accompanied by either a rising or a falling gold price. In fact, not only is a net flow of gold from B (the World ex-China) to A (China) not inherently bullish, a net flow in the opposite direction would not be inherently bearish.

Another relevant point is that Trader B (World ex-China) is the proverbial gorilla in the gold market. To understand why, consider that in very rough terms there are probably at least 150,000 tonnes of aboveground gold in the world and probably no more than 10,000 tonnes of gold in China. This means that when total gold supply is taken into account, China is probably no more than 6.7% of the global market. This, in turn, means that it would take a 30% increase in China's gold demand to offset a 2% decrease in gold demand across the rest of the world. It is therefore fair to say that if the overall demand for gold outside China rises by at least a few percent then the gold price is going to rise, regardless of what's happening in China, and if the overall demand for gold outside China falls by at least a few percent then the gold price is going to fall, regardless of what's happening in China.

To sum up, we aren't saying that an increase or a decrease in China's gold demand is completely irrelevant. We are saying that a) China can only increase its gold ownership if the World Excluding China decreases its gold ownership, b) price is the only reliable indicator of the importance of China's gold demand relative to the gold demand of the World Excluding China, and c) China's gold demand is dwarfed -- in terms of effect on the gold price -- by the overall change in gold demand outside China.

As explained in many previous TSI commentaries, the overall change in gold demand outside China is largely determined by confidence in the senior central banks and the stock market's valuation trend.