Gold update

It’s certainly making it’s way across the different newsletters that gold and silver at at multi-year or all-time highs, but I don’t see as much about it in the popular press…yet. I assume most readers are probably aware of the moves, but here’s a quick look through (as usual, we note the weekly):

Now check out the same chart, but denominated in euros:

Silver is really taking out each successive new high.

Lastly, both gold and silver are hitting highs in yen:

Now, why focus on the charts? Well, for starters, we’ve been discussing the new dominance of currencies in the investing equation. Without understanding the relationships and money flows, I think investors and traders may be missing a key component of drivers of performance. The other reason is to highlight that of the 3, the yen looks the most vulnerable. Now, it may be confirmation bias, since I’m short the yen, but the peaks in gold and silver are at least confirming it, and while they are not predictive (necessarily), it still points to being the right view.

I’m not a precious metals perma-bull, by the way, but at the same time, I’m sticking with my precious metals portfolio (GLD, SLV, GDX, PALL, PPLT).

Relevante ETFs: GLD, SLV, GDX, PALL, PPLT

Currencies dominate

For those with long enough memories, the current currency wagging the markets is reminscent of 1987. There, I said it. Portugal gets downgraded. Ireland is gonna haircut every debt holder. Etc. And the euro…rallies? Meantime, all the repatriation in the world can’t help the yen rally? Expected, but still brutal in its swings. And gold, after touching all time highs is selling off. Hmmm. Curioser and curioser.

It feels like the carry trade is back in vogue: sell the yen buy anything else. Now, I’m all for selling the yen. Those who bought EWJ as opposed to DXJ (as I recommended) will come to understand that it’s not your daddy’s markets any longer. You cannot invest in an asset class without understanding the currency implications.

On the other side, you have Bill Gross out with a new piece on America’s $65 trillion unfunded liabilities and the inevitability of higher rates. So the equity markets are going up by default, but I don’t think of their own volition and certainly not on the basis of their fundamentals. To which, I’ll remind readers that without the fundamental backdrop, this will not end well. I don’t mean to be a downer and I know I’ve been saying the equity markets are vulnerable for a long time.

For the record, our concentration in energy has led us to significant outperformance. Our positions in precious metals continue to make new highs every couple of weeks. Etc. I don’t need to go there.

Regardless, I anticipate that an event will come after a close, or over a weekend, or from a different field, that will shake the foundations of this equity rally. After the fact, it will be called a black swan and be credited with the gravity to bring equity prices down. In reality, it will be a grain of sand that randomly fell on a system fraught with fingers of instability, and as in every power law distributed system, the implications will be far larger due to the foundations rather than the immediate cause. And again, currencies will be the markets that lead.

Relevant ETFs: GLD, SLV, EUO, YCS, EWJ, DXJ, UUP, FXE, FXY

I don’t want to write about gold

I don’t want to write about gold and silver, but I just can’t help myself. Gold is at all-time highs and silver is at all-time ex-Hunt brothers highs. I don’t want to write about them, first because I already have exposure, second, because I’ve had exposure, increased exposure, and am not changing exposure. Lastly, I write about precious metals often enough that it feels as if there is nothing new to say. And there isn’t. In the grand scheme, gold and silver have been the longest consistently-used currencies in the world and all that there is to say about them has probably been said already at some point in the past. So I will only add a little tidbit here: what is the message implied by the rise in precious metals? Is inflation getting worse? Is this the end of fiat currencies? Are other commodities going to follow and reach new highs? If so, why haven’t they done so until now?

There is nothing new in these questions. The Roman Empire faced hyperinflation as the bureaucratic machine to manage far flung regions buckled under its own weight and successive emperors had to devalue the currency, leading to massive food inflation. On the flip side, the Great Depression led to such widespread fear that cash AND gold kept their value, while the price of almost everything else went down. Of course there were differences, so it’s not a one-to-one comparison, but rather just an acknowledgment that the questions we face now are not new.

I have written before that gold will peak on fear, not greed. The next step is to try to figure out fear of what. Is it fear of the end of fiat currencies or fear of the destruction of value in other asset classes? Certainly, at some point, even gold bugs will have to admit that the S&P priced in gold can become cheap:

I’m not saying we’re there (I’m long gold, short equities), but that the day will come at some point. This entry is only to serve as a thinking point for what will the peak in gold look like. Will equities bottom out as gold peak? Or will gold and equities move in tandem against the USD? I’m not sure and a lot of the traditional analytical tools we have at our disposal are limited in their capacities to anticipate the unimagined. So we’re left with sentiment and gut. For now, my bias is that equity markets are the overpriced assets, even against fiat currencies. However, I’m not so confident that I’m adding to my short exposure. Limiting position size can be just as important as the position itself in these environments.

Relevant ETFs: GLD, SH, SPY, UUP, SLV

Euro holding up, all considering

Considering the fact that Portugal just lost it’s government after its Parliament rejected a deficit-cutting plan. What happens next? Well, some combo of Germany, IMF, US, and China comes to the rescue. My bet is that the Chinese have the biggest vested interest in holding the euro up, since they are trying to stimulate without stimulating and the need Europe as their biggest trading partner to continue purchasing their overcapacity. I’m not optimistic about the euro. Then again, I haven’t been optimistic about its prospects for a long time (yeah, I prefer looking at the weekly chart):

And here’s gold in euro:

I have been short euro since November 2009 and have not added/subtracted to/from the position in that time. I’m now analyzing whether this is a good opportunity to add to either a short euro/USD or short euro/gold. I’ll keep you posted.

Relevant ETFs: FXE, EUO, GLD, UUP

MacroView

A bit later than usual…

As always, MacroView is produced in collaboration with MacroMan. To show the extent of our need to SEEK conflicting data, today’s MacroView has a number of charts showing support/resistance for inflation triggers. I’m not in the inflation camp for the time being. I see no wage pressures, a consumer slowdown, increased savings rate, lower velocity, lower housing, excess capacity, etc. That being said, one must always let the data lead, and I’m open to re-interpretation…

macroviewmarch17

MacroView

A quick tour around some key markets: signals from gold, the next leg for AG, and what is the euro thinking(!) – all part of today’s MacroView charts. We have mentioned it before, but it’s worth pointing out that the averages are hiding some massive rotations. It’s not so much whether your long or short these days, but rather WHAT you’re long or short.

macroview_9Mar11

Term of the day: Safe Haven

It seems that every other article I’m reading this morning has some mention of the idea of safe haven, as in “the Swiss Franc is getting a safe haven bid”. I just have to pause for a moment to contemplate the idea of safe haven.

Safe haven used to mean an asset class that investors could rely on to guard their wealth, and in return, they would willingly give up potential upside returns. So, if there was political turmoil in some far off place, investors would collectively decide to forgo the upside of equities and move their funds into US treasuries.

All good so far. As unknown unknowns become known unknowns investors feel like certain investments are riskier and choose to go to the safe haven. So what are today’s safe havens? Let’s look at a few.

Silver: I like silver. I own silver. But is it really a safe haven? It’s up almost 100% in 12 months and has outperformed gold over that time 3 to 1.

If anything was going to get the safe haven bid, shouldn’t gold get it more than silver? In reality, maybe it’s not a safe haven bid at all, as the articles suggest, but rather, pure old-fashioned momentum and speculation. Nothing wrong with that as long as you know it, but at least let’s back away from calling silver at these levels the safe haven.

Euro: Seriously? This is the safe haven? Every morning I wake up not knowing who’s going to get a fresh downgrade in the eurozone. Greek 8 month yield is over 12%, along with the rest of the usual suspects. Merkel is facing increasing domestic resistance to bailouts, while Iceland has become the posterchild for the no-austerity/no-bank-bailout crowd. It’s a lethal combination; and yet, investors are content. If ever there was a case where central banks should try to use a devalued currency to stimulate growth, Europe is it. Instead, Trichet talks the euro up and crushes any hope that Spain has to increase their exports and stimulate the economy. If I was Spanish, I’d be pretty upset that my central bank doesn’t care about my job. Oh wait, “my central bank” doesn’t care about my job – they don’t answer to me at all.

Lastly, US equities. Since when did equities become the safe haven? Let me rephrase that…since when did equities at the current valuations, with the current macroeconomic backdrop, etc. become the safe haven? They didn’t and they’re not. People are under the mistaken impression that stocks will provide an inflationary hedge. That’s a big maybe, especially starting with these valuations. For point of reference, from 1971 to 1982 the S&P 500 was up about 10% TOTAL. Inflation was rampant, but valuations got squeezed as the P/E headed towards single digits. In a best case scenario, if S&P 500 earnings are roughly $90 and we assume a P/E of 15, then the S&P is fairly valued. That’s in a BEST CASE SCENARIO. Any deviation or hiccup would leave equities vulnerable to significant downside, with little upside potential. (I happen to believe earnings will face margin contraction and stall or even go down AND P/E valuations will go down.)

So what we see is not a true flight to safety and quality. What we see is speculation and hope, momentum and greed – not great investing strategies. This will not end well for those getting in too late.

Relevant ETFs: FXE, EUO, IWM, RWM, SPY, SH, GLD, PHYS, SLV, PSLV

Gold-Silver

I’m long both gold and silver, but I can’t help wondering if this trend will continue…

Relevant ETFs: GLD, PHYS, SLV, PSLV

Spain’s banks need to be recapitalized

Reuters is reporting that Spanish banks need an injection of roughly $27 billion in the next seven months or risk at least partial nationalization.

Concerns that Spain’s savings banks, which account for 50 percent of the financial system, will require an expensive bailout have weighed on the country’s sovereign debt and fueled fears it will need an EU/IMF-backed bailout like Ireland.

“The government considers it necessary to take a number of measures to dispel any doubt over the solvency of our credit entities and their ability to withstand shocks even under the most adverse scenarios, and so ease their access to capital markets,” Salgado said during a news conference.

In a move to restore market confidence, Salgado announced a regulatory overhaul of the banking sector, obliging all banks to boost core capital ratios to a new minimum of 8 percent by September.

Read the full article at http://www.reuters.com/article/idUSLDE70N1M020110124.

Remind me again why the euro is rising? Is the Fed printing so much relative to Europe that the USD is getting weaker? Is it anticipation of QE3? Quite honestly, I don’t get it, and I can’t help think that this is a suckers rally, because the structural issues remain, the bad debt overhang remains, and the social unrest remain. I expect the euro to resume its downward drift shortly. Maybe it will head to 1.40 range first, but I don’t think it will approach the highs at 1.50. Which means it has about 5-10% upside, but at least 20% downside risk. Working out the probability of each and I come out to a negative (significantly negative in my eyes) expected return from any long exposure to the euro at these levels.

In another view, gold, priced in euro has pulled back recently, and with talk of a general pullback in gold that position faces some downside risk. Heavy traders can take position to play the swings, but for investors and core positions, I’m still long gold:euro and think it represents a safe haven trade as euro investors will soon look for preservation against their internal wealth destruction.

Relevant positions/ETFs: EUO, FXE, GLD

Quick note on the euro

Brazil and Chile are both intervening to buy USD (weaken their currencies), but who cares…the important news is in the euro. Portuguese, Spanish, Greek, etc. spreads are all shooting higher, and Europeans should (rightfully) be scared. In the meantime, I read somewhere (I wish I had the source) that 41% of Germans no longer want to be part of the euro. Not surprising, and I anticipate that it will only get worse.

Some might argue that the USD is not the best alternative. Perhaps. Euro-Gold has come in off its highs; maybe that’s the right trade. I have exposure to both (USD and GLD against short euro):

A new year, but not much has changed…

Sure, it will take a couple of weeks to get used to the “idea” of 2011, if not the reality. The main changes with any new year, in terms of investments, are structural. Tax losses have been taken, performance numbers have been set, bonuses have been calculated, etc. It is also a time of prediction, which is always a fun game.

For me, though, it’s also a time for reflecting. I spent most of 2010 getting increasingly concerned about valuation and inter-market relationships, most important of those is the impact that currency relationships will impact other asset classes. As I turned the annual leaf, I thought I would reexamine that posture, from both a numbers perspective, but also a bigger, more conceptual perspective.

It ain’t pretty. From a valuation perspective, the equity markets are as overvalued now as they were at multiple other peak, except 2000:

• The relationship of the S&P 500 to a regression trendline (more)
• The cyclical P/E ratio using the trailing 10-year earnings as the divisor (more)
• The Q Ratio – the total price of the market divided by its replacement cost (more)

“To facilitate comparisons, I’ve adjusted the Q Ratio and P/E10 to their arithmetic mean, which I represent as zero. Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which I’m using as a surrogate for fair value,” said Doug.

According to this methodology, the Index is overvalued by 63%, 43% or 38%, depending on which of the three metrics you choose.

Source: dshort.com

These fundamental indicators are really bad timing mechanisms, because each of them could continue extending, but they all point to the same thing: equities are in a danger-zone.

What about treasuries? When Bill Gross, who in 2008 supported a trillion dollar deficit, now writes:

• American politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion-dollar annual deficit.
• Policy stimulus is focused on maintaining current consumption as opposed to making the United States more competitive in the global marketplace.
• Dollar depreciation will sap the purchasing power of U.S. consumers, as well as the global valuation of dollar denominated assets.

Read the full article here.

Separating the noise from the louder noise

There’s obviously been a lot of news since last night and I’ve been trying to wrap my head around it, but for starters let’s mention some of the big items:

Belgium and Spain are only the latest, but not the only(!), reasons for the euro to fall…and fall it did. We’re back to a 1.32 handle. Why do I say that they’re not the only reasons? Well, for starters, I thought the euro was structurally flawed before any downgrade, and continue to think so. The euro is now trading by default since there’s no alternative in Europe. Imagine for a moment if Germany came out tomorrow and said that it would start issuing Marks. The euro would be DOA.

On our side of the pond, we have treasury yields continuing to move up. 10 year yield is now above 3.5%! We’ve discussed the phenomenon before where we can have deflation AND rising yields at the same time. Locking in 3.5% for 10 years isn’t that attractive afterall. We’ve been calling it biflation, but I’ve been researching some underlying elements to help explain the phenomenon. Each time I come to the same issue: What cause yields to rise?

• If yields are REACTING to inflation and inflation expectations, then they are lagging commodities, but still part of the same message we’re getting from other asset classes. This could be bullish for equities and real estate, as well as supporting the runup of commodities in general (such as copper, industrial commodities, etc).
• If they are LEADING and are a result of fear over solvency, or frontrunning the pack (e.g. fear China will sell their holdings), then the recent run-up could be part of a debt-deflation cycle which is very negative and could be a harbinger of increased real costs of borrowing, economic slowdown, deflation across asset classes, etc. This would be very bearish for industrial commodities such as copper, but still supportive of precious metals as stores of value.

This dichotomy is the debate being had across the street. The first case is easier to deal with – we have the fiscal and monetary tools to stop inflation, and while painful down the road, we know it. The second case is similar to what happened during the Great Depression (and I don’t use that comparison lightly). It’s a world where fiscal and monetary policies are powerless, and it’s the scenario Bernanke fears most. Unfortunately, increased government spending does not and will not stop scenario two from occurring, so it just leaves us more vulnerable. We are maintaining our short treasury exposure.

Gold down. Oil up. Noise for me, since these are long term positions.

Muni bonds have gotten hit recently (as we predicted a few months ago). Noise for me at this point since we cut all exposure. At some point, yields will become attractive enough to take long term positions, but for me, not yet.

Tax bills, healthcare constitutionality, and WikiLeaks – all noise.

David Rosenberg (Rosie) discussing the rise of inputs versus no retail pricing power causing the mother of all margin squeezes?

The U.S. PPI, at +0.8% MoM in November and the core (which removes the effects of food and energy) at +0.3%, were both above expected but skewed by a seasonal rebound in auto pricing. Outside of that, core would have been as expected at +0.2%.

What is striking, however, is how cost trends are accelerating at the early stages of production in lagged response to the recent leg of the commodity boom. The “core crude” PPI jumped 3.1% MoM and is now up 30.2% on a year-over-year basis. This is the very early pipeline stage.

At the same time, core intermediate PPI leapt 0.7% and is up 4.7% from a year ago. When we get to final core goods PPI, the YoY trend is running at a mere 1.2% (and -0.7% on a three-month annualized basis).

In other words, the closer you are to the commodity complex, businesses have greater pricing power. And, the closer you are to the consumer at the final stages of production, the less pricing power you have. (emphasis mine)

That’s not noise. It’s just further confirmation that equity valuations are too high.

Update

Here are the things I’m watching:

Obviously equity is getting hit. Let’s call it down 1.5% so far today, but I expect the S&P to take out 1165 before not to long.

Everyone is talking about seasonal strength and consumers shopping more than expected. Maybe. Valuations are already pricing that in, and they are NOT pricing in geo-political risk, downside surprises, etc.

Gold:

We didn’t sell, and have long discussed the idea of gold peaking on fear, not greed. As expected, it’s holding up well. More importantly, gold in euro terms is manifesting the problems on the continent.

Dollar Index:

I like it when everyone tell me I’m wrong – it means they are all positioned on one side of the trade. That’s what happened with the dollar index. Even Bernanke can’t overcome the structural problems of the euro and yen.

Quick update: gold/euro chart

One of our subscribers rightfully pointed out that yesterday I mentioned gold in euros but did not provide a chart, so here it is:

It’s just under the highs, but with Ireland, Greece, and (soon) Spain undermining the stability of the entire eurozone, I anticipate it to go higher.

All about the dollar

The euro and the yen are both weaker, sending the USD index higher – everything else is just being priced off the currency markets now:

Sure, gold:euro is going to break out to new heights. Yes, the asian currencies ex-Japan, will benefit against the yen and the euro. For me, the story is still in the G3 and hard assets, and then the resulting implications for the financial assets. I don’t see equities rallying in any sustainable fashion alongside the dollar. At least the curve is coming in a little, which eventually should help stimulate some lending, instead of just generating NIM.

Of course, it’s happening because 10-year yields are rising faster, which means that in the short term, borrowing costs will rise. Talk about unintended (but completely predictable) consequences: dollar is getting stronger, alongside higher interest rates – exactly the opposite of what Obama, Bernanke & Co. wanted.