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"Grexit" fears cause euro-zone (EZ) bond yields to diverge

Over the past two weeks there was a notable divergence between the yields on the 10-year government bonds issued by the 'peripheral' EZ countries and the 10-year government bonds issued by the 'core' EZ countries. In particular, the following charts shows that a) the yield on Germany's 10-year government bond continued along its inexorable path towards negative territory, b) the yield on France's 10-year government bond also continued to decline and is only marginally above the equivalent German yield, and c) the yields on the 10-year bonds issued by the governments of Spain, Portugal and Italy have clearly turned upward.

The most plausible explanation for the recent divergence is the small but increasing risk of Greece leaving the EZ. If "Grexit" were to be transformed from a remote possibility to a fact it would prove that entering the EZ was not irreversible and would prompt the question: Who's next? With the 'G' gone, the most likely answer would be one of the remaining PIGS.

We expect that a deal will be done within the next three weeks that keeps Greece in the EZ. This is also what the market expects, as the rise in the yields on Portugal-Italy-Spain (PIS) government bonds has not been substantial and the recent divergence closed a little on Wednesday. Furthermore, if Greece does make its feared exit in the near future we expect that the resultant sell-off in PIS government bonds will be mitigated by aggressive ECB intervention. However, the current situation is certainly interesting.

Quick note on uranium

Despite the lack of significant movement in the uranium price, the uranium-mining sector of the stock market is starting to show signs of life. This is most apparent in the recent stock-market performance of Cameco (CCJ), the world's most important publicly-traded uranium producer. Thanks to a 6% rise on Wednesday 22nd April it is also now apparent in the stock-market performance of the Global X Uranium Mining Fund (URA). The relevant charts are displayed below.

This could finally be the long-awaited major turning point for the uranium sector, but some words of caution are warranted. First, CCJ has just risen to resistance defined by its 200-day MA, which is where a strong rebound ended last November. Second, URA has just risen to lateral resistance and is within 5% of its 200-day MA. Third, the uranium-mining rebound is no doubt related in part to the recovery in the oil price, but our guess is that oil will make a short-term peak within the next couple of weeks.

The Stock Market

China's policy-makers send conflicting signals

Stricter rules on margin lending were implemented in China after the close of trading last Friday. We assume that this was done in an effort to reduce the amount of speculative froth in the stock market and, in doing so, reduce the risk of a 2007-2008-style collapse. However, just two days later (on Sunday) China's policy-makers cut the banking system's Required Reserves Ratio (RRR) by 1%, which, according to what we've read, would likely have the effect of releasing at least a trillion Yuan of 'liquidity'. So, within the space of two days while the stock market was closed the apparatchiks in China first made a move that would have the effect of quelling speculation and then completely negated it by making a move that would have the effect of boosting speculation. Why the sudden change of mind?

We can only guess, but Sunday's policy move was probably a knee-jerk reaction to the futures market, which showed that China's stock market would open 6% lower when trading resumed on Monday due to Friday's rule changes. It seems that China's policy-makers want to slow the speed of the stock market's advance, but they don't want it to fall. Like their Keynesian counterparts in the West, having caused economy-wide mal-investment via earlier bouts of monetary inflation and market manipulation they now perceive the need to inflate new investment bubbles to offset the fallout from the bursting of previous bubbles.



China's stock market is dominated by the public's perception of what senior policy-makers want the stock market to do. Valuation means nothing. The public's belief that policy-makers want higher stock prices was reinforced by last weekend's policy flip-flop.

All of this prompts the question: With China's economy still growing at 7% according to the latest GDP report, why are policy-makers so worried about bursting the stock market bubble?

The answer is that China's economy is almost certainly not growing at 7%/year. The official target is 7%, so regardless of what is actually happening on the ground a growth rate of around 7% will be reported. China's entire economy could collapse in a heap of mal-investment rubble and the country's government would still report on-plan GDP growth.

Currently, China's economy is probably not growing at anywhere near the 7% reported rate. The following chart of the year-over-year change in rail-freight indicates that it might even be shrinking. Nobody knows. What we do know is that China's apparatchiks are sufficiently concerned about the economy's performance that, in true Keynesian fashion, they see the urgent need to prop-up "aggregate demand" by whatever means available. At the moment this involves taking a leaf out of the US Federal Reserve's playbook and pumping-up the stock market.


                                Chart source: zerohedge.com via Stockman's blog

Japan

Like China's stock market, Japan's stock market, as represented on the following chart by EWJ (an ETF that tracks the performance of the Japanese market in US$ terms), is in the midst of an upward surge. The difference is that the Japanese stock market's surge is currently of far more modest proportions. In particular, at this time the Japanese market is well short of 'bubble territory'. In addition to the price action, a similarity is that both markets are being deliberately pushed upward by the government and the central bank.

The $14-$15 range (about 10% above the current price) is the target we have in mind for EWJ and is where we plan to take profits. If US and European equity markets hold together for another month or so, which, admittedly, is a big if, then EWJ could reach the aforementioned target by the end of next month.



You might not want to be 'long', but it isn't advisable to be bearish on a market that a buyer with infinitely-deep pockets is trying to elevate.

The US

Most US stock indices have been range-bound since the beginning of March. They almost broke out to the downside about three weeks ago and have since rebounded. In the case of the S&P500 Index (SPX), the rebound has taken the price back to near the top of its 8-week range. In the case of the Dow Transportation Average (TRAN), which is the index that came closest to breaking out to the downside and signaling a top of at least intermediate-term significance, the rebound has taken the price back to near the 50-day MA (see chart below).



The recent back-and-forth price action in the US stock market provides us with no clues as to what lies ahead, but it goes part of the way towards explaining the recent indecisive price action in gold bullion and gold-mining stocks. The reason is that although it doesn't always work this way, the extent to which the fundamental backdrop is bullish for gold tends to move in the opposite direction to the US stock market. For example, Wednesday's small up-move in the SPX was accompanied by a small up-move in the real US interest rate and a small narrowing of credit spreads, both of which are bearish for gold.

Gold and the Dollar

Gold and Gold Stocks

Overview

We posted some charts at the TSI Blog following Monday's trading session to make the point that the price action was hinting at some near-term upside in gold and the gold-mining sector. There was one day of upside (Tuesday), but on Wednesday there was enough weakness to eliminate the near-term bullish signs. This continues the pattern of the past few weeks, with the market for gold-related investments hinting at a move in one direction and then being unable to follow through.

Most of the bullish-leaning investors who weren't already bludgeoned into submission by the large declines of 2013-2014 have probably either given up or are now close to giving up due to this year's superficially boring performance by gold bullion and the gold-stock indices. From our perspective, however, the recent price action has been fascinating. The main reason is that although we haven't been expecting gold bullion and the HUI to do much more in the near future than rise to the $1230s and the 190s, by the close of trading on Tuesday the gold-mining sector had worked itself into the position where it was not far from generating price signals that were bullish on an intermediate-term basis. And an intermediate-term bullish signal for gold mining would imply an intermediate-term bullish signal for gold bullion. For example, at the end of Tuesday's session GDXJ was near the top of its intermediate-term downward-sloping channel.



The problem is the fundamental backdrop. Many gold-bullish commentators claim that gold's fundamentals are bullish and, therefore, that the lacklustre performance of the US$ gold price is anomalous. We expect that gold's true fundamentals will turn bullish before this year is out, but the current fundamental backdrop is actually no better than neutral for gold. Furthermore, a neutral/mixed fundamental backdrop for the US$ gold price has prevailed since around July of last year (the fundamentals momentarily turned bullish during the first half of last year).

Current Market Situation

On Monday, gold closed below its 20-day MA and held at its 50-day MA. On Tuesday it closed above both of these MAs, but on Wednesday it closed below both of these MAs and achieved its lowest daily close in more than three weeks.

There is lateral support at $1180. If this support is breached then the obvious conclusion will be that gold is on its way back to the November low (around $1140), but the obvious conclusion is often not the right conclusion. For example, gold's breach of obvious support in the low-$1180s in December was almost immediately followed by a strong multi-week rally.

While we continue to suspect that gold will re-test its November low within the next three months, we will be surprised if it happens within the next three weeks.



The HUI re-tested resistance at 180 on Tuesday and then pulled back in sympathy with gold bullion on Wednesday. It has fallen below its 50-day MA and lateral support/resistance at 175, but remains above its 20-day MA.

Wednesday's price action reduced the probability of the HUI making it to the 190s in the near future. However, there have been a number of deceptive price moves over the past six weeks, so we are reticent to base any conclusions on the conflicting signals that occurred over the past three days. The only clear message is that resistance at 180 is important.



The Currency Market

We mentioned earlier in today's report that the recent back-and-forth price action in the US stock market goes part of the way towards explaining the recent indecisive price action in gold bullion and gold-mining stocks. The US Dollar's recent back-and-forth movement also goes part of the way towards explaining the indecisiveness of gold-related investments.

The mid-March bottoms in gold and the gold-mining indices coincided with a peak in the US$. As illustrated by the chart displayed below, the Dollar Index quickly lost a few percent during the days immediately following its peak and then began range-trading. With the Dollar Index leaving open the question as to whether it has peaked on a multi-month basis or only a multi-week basis, there are no clear currency-market signals for gold to key-off.

We expect the Dollar Index to drop back to near its 200-day MA, even if its longer-term upward trend is intact. A daily close below the 50-day MA would be a preliminary sign that the market was in the process of meeting this expectation, while a daily close below 96 would be a more definitive sign and a daily close below 94 would eliminate all doubt. However, as things currently stand there is still a realistic chance of the Dollar Index making a marginal new high prior to the start of the anticipated decline to the 200-day MA.

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
http://bigcharts.marketwatch.com/