<% 'pass = Request.Form("pass") IF ((Request.Form("pass") = 1) OR (Session("pass") = "pass")) THEN %> Speculative-Investor.com

    - Interim Update 4th December 2013

Copyright Reminder

The commentaries that appear at TSI may not be distributed, in full or in part, without our written permission. In particular, please note that the posting of extracts from TSI commentaries at other web sites or providing links to TSI commentaries at other web sites (for example, at discussion boards) without our written permission is prohibited.

We reserve the right to immediately terminate the subscription of any TSI subscriber who distributes the TSI commentaries without our written permission.

The most over-valued and under-valued property markets

We took the following chart from an article posted at businessinsider.com. The chart shows the current house rental yield (house-price-to-rent ratio) relative to the long-term average rental yield for 28 different countries. Based on this valuation measure, the five countries with the most expensive residential real estate are Canada, New Zealand, Norway, Belgium and Australia, while the five countries with the cheapest residential real estate are Japan, Greece, Germany, Portugal and Slovenia.

Canada has the dubious distinction of having the most over-valued residential property, with house prices that are presently 85% above their long-term average relative to rents. Note, though, that some locations with very expensive residential real estate were not included in the comparison. Hong Kong, for example. Canadian real estate is certainly in bubble territory, but house prices in Canada could still look cheap to an investor in Hong Kong.



Due to the comparative expensiveness of real estate in Canada and Australia, there's a good chance that relative weakness in the residential property markets of these two countries will be part of the fundamental justification for relative weakness in the associated currencies over the next two years. The reason is that bearish trends in house prices will result in relatively easy monetary policy.

The illusion of strength

The latest monthly ISM numbers show that US manufacturing is still going strong. Especially noteworthy is the 2.5-year high in the ISM New Orders Index in November-2013. Refer to the following chart for details.



The strength in the US manufacturing sector is undoubtedly a monetary illusion. What we mean is that the strength is primarily due to activities that have sprung up on the back of rapid monetary inflation and are not self-sustaining. These activities waste resources and pave the way for severe future economic weakness and unemployment, but, as the man who jumped off the Empire State Building was heard to say as he plummeted past the 50th floor, so far so good.

Additional rapid monetary inflation will be needed to maintain the illusion. As evidence we cite the fact that the ISM New Orders Index fell below 50 in June of 2012 and remained below 50 during July and August of 2012, signaling that the manufacturing sector had begun to contract and that the US economy was slipping into recession. In response, "QE3" was introduced in September of 2012. This arrested the decline in manufacturing, but in December of 2012 the New Orders Index again dipped below 50. "QE3" therefore didn't appear to be sufficient to maintain the illusion, so the 'money pumps' were ramped up a few more notches via "QE4". The latest QE program ("QE4") got underway during the first quarter of this year and has met with short-term success, but the long-term cost will be very high.

One reason that inflating the money supply is a popular policy is that in real time it will usually be impossible to tell the difference between artificial strength derived from money pumping and genuine strength derived from increasing productivity. For example, the US economy seemed to be doing fine in May-2007, even though it was only six months from commencing its most severe recession since the 1930s. The 2007-2009 recession was so severe because the superficial strength of 2003-2007 was largely an artefact of 'monetary accommodation'.

On a related matter, when reading the article "Revolutionary France's Road to Hyperinflation" we were struck by the similarities between France's experience with inflation -- and, eventually, hyperinflation -- in the 1790s, and what the US is currently going through. What's now happening in the US is like a slow-motion version of what happened in France in the 1790s. In France during the 1790s it took 7 years to go from the first round of money-pumping to complete destruction of the currency. In the present-day US it is taking much longer.

The Stock Market

Cracks are beginning to appear in the global stock market rally and the most significant of these cracks are appearing in Europe. For example, the top section of the following daily chart shows that the EURO STOXX 50 Index (STOX5E), a proxy for large-cap European stocks, has broken below short-term lateral support defined by the lows of the past two months. This suggests that a decline to intermediate-term support defined by the May and August highs is on the cards.

The bottom section of the following chart shows that large-cap European stocks have been weakening relative to large-cap US stocks since mid-October. This has implications for the currency market as mentioned later in today's report.



It's way too early to conclude that a reversal of more than short-term significance has occurred. If we are, in fact, witnessing the reversal of a long-term trend, the most likely path over the next two months would entail additional weakness over the next several days followed by a 2-4 week rebound and then a decline that takes out the December low.


Gold and the Dollar

Gold

As a result of this week's price action, gold's short-term price channel is now well defined. With reference to the following daily chart, notice that gold traded slightly below its channel bottom on Wednesday before reversing upward. It then ran into resistance in the low-$1250s before settling back to around $1240.

Although the channel top is presently around $1310, we would still interpret a daily close above $1280 as a clear warning that the trend had reversed from down to up.



It will be interesting to see how the gold market reacts to the monthly US employment report on Friday, especially if the report reveals enough improvement to prompt more predictions of imminent "Fed tapering". A failure of gold to react negatively to the same old "tapering" talk would be a sign that the bear market had run its course.

As we've noted many times in the past, a major trend change in the gold market will not require additional money-pumping. The money-pumping is currently propping-up the stock market, not the gold market.

A major trend change in the gold market actually won't, in all likelihood, be marked by anything specific in real time apart from better price action. Like all such reversals in the financial markets, it will be driven by a subtle sentiment swing that does not appear to be supported by the news of the day.

Gold Stocks

The XAU fell into line with the HUI during the first half of this week by dropping to a new bear-market low. The new low was only marginal (see chart below), but it eliminated the potential top-bottom symmetry discussed in the latest Weekly Update.



The cyclical decline in the gold-mining sector is now unprecedented, in that it has lasted three months longer than the longest decline of the 1960s-1970s secular gold bull market and has lasted about seven months longer than the first cyclical decline of the 1980s-1990s secular gold bear market*. That being said, we are dealing with a very small sample size and we are also dealing with unprecedented monetary machinations and debt levels. Consequently, while new multi-year lows for the gold-stock indices in December of 2013 is not something we would have ever predicted, we are not shocked by this outcome. It's likely that many financial-market records will be broken on the downside and the upside in the years ahead.

We won't be certain that the XAU's cyclical bear market is over until intermediate-term resistance at around 112 is decisively breached, but as a result of the price action of the past few days we would now view a daily close above the 50-day MA as clear-cut evidence of a trend reversal.

    *There isn't a realistic possibility that gold commenced a secular bear market in 2011, but it is still worth pointing out that the gold sector's decline since its 2011 peak is not similar to the decline that followed the 1980 peak. Despite this week's new lows, the current episode still looks most similar to the declines of 1968-1970 and 1974-1976.

Currency Market Update

The Dollar Index continues to test short-term support at 80.5. Breaching this short-term support on a daily closing basis would suggest that major support at 79 was going to be re-tested.



The Dollar Index's momentum, sentiment and price action are neutral and are therefore give us nothing to go on. However, the recent strength in large-cap US equities relative to large-cap European equities is an important factor in the Dollar's favour. As a result of the US stock market's relative strength, the Dollar Index is probably not going to do any worse over the next few weeks than fall back to 79.

The Australian Dollar (A$) is immersed in a cyclical bear market that probably has a long way to go. On a purchasing power parity basis, fair value for the A$ is around 0.75.

It is reasonable to expect that the A$ will drop to fair value or lower before its bear market comes to an end. It is also reasonable to expect that it will take up to two more years for the A$ to get where it is going. The reason is that with all G7 central banks implementing ultra-easy monetary policy, the sort of financial-market liquidity event that happened in 2008 and caused a very rapid decline in the A$ is currently not a realistic intermediate-term possibility. The A$'s downward path is therefore likely to be interrupted by numerous corrections in the forms of counter-trend rebounds or periods of horizontal range-trading.

The following daily chart shows that:

1. The A$ completed a major topping pattern during the second quarter of this year when it broke below long-term support at 95-97.

2. Former support at 95-97 acted as resistance and capped the rebound from the August low.

3. The A$ is now short-term 'oversold' and within a point of its August low. This sets the stage for another counter-trend rebound.

Update on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://research.stlouisfed.org/

 
Copyright speculative-investor.com
<% Session("pass") = "pass" Session.Timeout = 480 ELSE Response.Redirect "market_logon.asp" END IF %>