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

    - Interim Update 14th May 2014

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.

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.

The Stock Market

Russia

Due to the goings-on in the Ukraine and the associated biased media coverage, a good opportunity for speculators to accumulate long exposure to the Russian stock market is now presenting itself. This opportunity would have occurred anyway as a result of the Russian stock market's tendency to act like a leveraged play on the emerging-market and commodity themes, but the game being played on the international stage regarding political control of Ukraine is making the opportunity even better than it would otherwise have been.

The reason for our interest in obtaining some 'long' exposure to the Russian stock market -- via the Market Vectors Russia ETF (RSX) -- is illustrated by the following charts, the first of which shows that EEM, the iShares Emerging Markets Fund, has trended in the same direction as the Continuous Commodity Index (CCI) for many years. The relationship depicted on this chart suggests that EEM should perform well over the next couple of years if we are right to believe that commodities, as a group, are in the process of turning higher on a long-term basis. We are well aware that the economic fundamentals do not suggest that the recent relative strength in emerging-market equities will be sustained beyond the very short-term, but if the upward trend in commodity prices is set to continue then additional relative strength in emerging-market equities is a high-probability bet.

While the first chart makes the case that emerging-market equities (represented by EEM) tend to do well during cyclical commodity bull markets and poorly during cyclical commodity bear markets, the second chart makes the case that Russian equities tend to do the same, only more so. In other words, the second chart shows that the Russian stock market tends to rise by more than emerging-market equities in general during cyclical commodity bull markets and fall by more than emerging-market equities in general during cyclical commodity bear markets.



An implication of the above charts is that in the absence of Ukraine-related violence, political manipulation and biased media coverage, the commodity rally that began in January would probably have caused RSX to be strong relative to EEM over the past few months. Instead, the commodity rally went with a plunge in the RSX/EEM ratio as speculators and investors became distracted by the news of the day. This, we think, has enhanced the buying opportunity.

Due to the risk of substantial weakness in the US stock market and the potential for most other markets to be adversely affected, a position in RSX (or something similar) should be gradually averaged into. We suggest taking an initial position now and adding to the position on weakness over the next six months.

The US

The S&P500 and Dow Jones Industrials indices made new all-time highs during the first half of this week in parallel with more bearish divergences than we can poke a stick at. There's a high probability that a top of at least intermediate-term importance is being formed.


Gold and the Dollar

Gold

Gold re-tested support at $1280 at the beginning of this week and then rebounded to just below the resistance defined by its 50-day MA. This resistance is now at $1312.

This price action doesn't tell us much, although the fact that gold managed to hold above $1280 despite the S&P500 Index making a new high reduces the risk that the $1280 support level will be breached. In any case and as noted in the latest Weekly Update, we expect that the gold price will work its way up to around $1400 over the coming 6 weeks regardless of whether or not it first breaks below $1280.

The fundamental backdrop is becoming increasingly gold-bullish, sentiment is constructive (hardly anyone expects a meaningful gold rally to begin in the near future), and the historical record following cyclical bear markets points to strength over the next couple of months. Also worth noting is that over the past 14 years, 2013 was the only year in which gold trended lower into May and experienced significant additional downside over the ensuing 1-2 months. In the three other years in which the gold market trended lower into May (2004, 2005 and 2012), a multi-month rally commenced in May.



Silver

Silver has resistance at $20.00 defined by its 50-day MA and the top of the short-term channel drawn on the following daily chart. This resistance was tested on Wednesday 14th May.

Due to being 'oversold' in dollar terms and relative to gold, silver has the potential to spring upward in the near future. A daily close above $20.00 would signal that an upward 'spring' had begun.



Gold Stocks

The first three days of this week were uneventful for the gold-stock indices. The HUI managed to hold above support at 219 and move marginally above its 150-day MA, but the market was very quiet and essentially directionless. This is the proverbial "calm before the storm", as the narrowing price range of the past 7 weeks should soon give way to increased volatility.

We expect that the next move of consequence will be to the upside and that it will soon get underway, but we are prepared for the possibility of a quick decline by the HUI to the 205-210 range prior to the start of a strong rally.



There is now an interesting set-up for a trade in JNUG, a fund that is designed to have daily percentage moves that are three times the daily percentage moves of the Market Vectors Junior Gold Miners Index (GDXJ). For example, a 5% daily move by GDXJ will result in a 15% daily move in the same direction by JNUG.

The following chart shows the large swings in JNUG during its young life (it was introduced last October). If the gold-mining sector is about to turn higher, then a large percentage advance in JNUG is on the cards.

Adventurous speculators should consider buying JNUG near its current price and managing risk by either placing a stop just below the May intra-day low ($16.33) or planning to quickly exit the position if the HUI closes below 219.



The Currency Market

Last week's downside breakout in the Dollar Index turned out to be a 'fakeout'. It has since rebounded enough to breach minor resistance at 80, but the more important resistance defined by its 200-day MA lies just above this week's high at 80.5 and the most important nearby resistance lies a point higher at 81.5. Resistance at 80.5 could be tested and briefly exceeded in the near future, but we do not expect that resistance at 81.5 will be seriously challenged this year.

The incipient strength in most things commodity-related suggests that the next move of consequence in the Dollar Index will be to the downside.

Updates 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

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