Thursday, January 22, 2015

Global QE and the gold price

After months of waiting, the European Central Bank (ECB) finally carried through with its stated promise of unlimited monetary support to its ailing economy.  The ECB announced its own version of quantitative easing (QE) on Thursday, a move which lifted the dark clouds that have recently hung over financial markets.  

In March the ECB will begin purchasing 60 billion euros’ worth of government and corporate bonds through September 2016.  In response to the announcement the equity markets of several major countries rallied while the price of gold and silver also rose. 

Gold also received a boost after the Danish central bank reduced its key interest rate for a second time this week, underscoring the concerted nature of the monetary policy response.  Central banks the world over are finally waking up to the threat of deflation and have responded in lock step this week.  On Wednesday, the Bank of Japan lowered its inflation outlook to 1% from 1.7%, which boosted the yen.  Meanwhile the Bank of England held off on a previously announced intention to increase interest rates, which resulted in a 1.63% rally in the FTSE stock index.   

The great danger facing the global economy in recent months has been the threat of deflation.  The U.S. has been the lone standout as its economy has proven resilient and has been largely immune to deflationary pressures (with the gasoline price being a conspicuous exception).  The great debate raging among economists has been whether and for how much longer the U.S. can hold out against the global economic slowdown.  That question may now be moot thanks to the latest European central bank announcements.  Indeed, equity markets have discounted this and investors are clearly eager to embrace loose money. 

Yet investors haven’t completely cast off their fears as evidenced by Thursday’s rally in the U.S. dollar index to yet another multi-year high.  By contrast, oil, copper and other economically-sensitive commodities were down on Thursday despite the ECB announcement.  Could it be that investors aren’t quite ready to believe the seriousness of central banks’ commitment to monetary stimulus? 

Investors certainly can’t be blamed for being skeptical given how long it took European banks to respond to the deflationary threat. Foot-dragging is a universal policy among central banks, even when faced with a major economic crisis (witness the slowness of the Federal Reserve’s response to the 2007-2008 credit crisis).  When central bankers finally decide to act, however, the policy response tends to be both emphatic and sustained and nearly always has the desired effect of countering deflation. 

Critics maintain that QE “doesn’t work” but there’s no denying the efficacy of the Fed’s QE program in staving off deflationary pressures in the wake of the 2008 credit collapse.  Without it the U.S. almost certainly would have suffered another Great Depression.  Indeed, the one ingredient missing that has prevented a re-inflation of global economies in the wake of 60-year cycle bottom last October has been the austerity (or semi-austerity) policies in many European and Asian countries.  But now that policy makers are finally realizing the folly of such policies, deflation’s days are numbered in the euro zone.  Other countries may soon follow the ECB’s lead, thus fostering the re-inflation of the global economy. 

Now that the promise of coordinated global monetary stimulus may soon become a reality, what are the intermediate-term implications for gold and silver?  The precious metals should continue to benefit from the uncertainty that still surrounds the global economic outlook.  Investors aren’t likely to shake off their fears of deflation overnight and as long as even the slightest apprehension remains, gold is likely to benefit.  But what happens when the promise of global QE becomes an established reality?  At that point there may be an adjustment phase where gold and silver prices enter lateral trading ranges.  In the overall scheme of things, though, gold and silver will likely benefit in the early stages of QE.

The U.S. experience with QE from 2009 through 2014 teaches that the precious metals benefit from the first few years of QE.  The reason is because it usually takes investor psychology a good three years to adjust to the reversal of a major economic or financial market trend.  Gold’s price rallied from late 2008 through the summer of 2011 before entering a bear market.  That’s pretty close to the traditional 3-year period of psychological adjustment. 

If the U.S. QE experience teaches us any lesson it’s that a pan-European and pan-Asian QE should have a similar impact on investor psychology.  The foreign investors who have incessantly worried about the impact of deflation will likely take a while to completely shake off these fears.  It certainly won’t happen overnight.  As long as even the vestige of fear persists, gold can benefit from it. 

Monday, January 19, 2015

Q&A: Moving averages and the A-D line

Question: Why do you use 60-day and 150-day moving average rather than 50-day and 200-day MAs?  And do you have a way of computing the NYSE Advance-Decline (A-D) line sans the bond funds?

Answer: I’ve found the 60-day MA to be more responsive for the major indices than the 50-day MA, which everybody uses.  Also, quite a few individual stocks and industry groups seem to be more responsive to the 60-day MA.  The 150-day MA is a good one to use for evaluating the intermediate-term trend for the S&P 500 and the XAU Gold Silver Index.  Of course the 200-day MA is still useful for the major indices, but right now the S&P is testing the 150-day MA which makes it more important right now.  The 150-day MA also answers to the 30-week MA, which is used by many fund managers and therefore has technical significance.

I’m not sure there is a way of obtaining the NYSE A-D line without bond funds, but then again I’m not sure it would be any more helpful.  My research over the years indicates that the A/D line is quantitative, not qualitative.  In other words, it’s the number of advancing issues over declining issues that matters most, not the types of stocks or funds which are advancing or declining.  

Wednesday, January 14, 2015

Will the oil crash spell ruin for stocks?

Talk of deflation was overheard on the Street as a few analysts quoted by the news wires mentioned the D-word.  One reason for the recent equity market weakness is the uncertainty among investors as to whether lower oil prices are ultimately beneficial or detrimental for the economy.  In one camp are those who maintain that lower oil prices will boost consumption; on the other side are those who claim that plummeting energy prices can only lead to outright deflation.  Because neither side has a decisive majority right now, equities are caught in the imbalance of opinion which explains much of the recent volatility.

Adding to the uncertainty this week was the latest research note from Goldman Sachs.  Goldman’s chief commodities analyst Jeffrey Currie wrote: “To keep all capital sidelined and curtail investment in shale until the market has re-balanced, we believe prices need to stay lower for longer.”  Goldman made a high-profile call for $40/barrel oil before the bottom has been seen in the crude market.

Both sides of the argument have merit, but history shows that there comes a point at which falling oil prices eventually exert a negative on equities.  The two examples that come to mind are the 2008 oil collapse, which increased downside volatility for the credit crisis.  Before that, the 1998 plunge, which took crude prices below $10/barrel, aggravated the Russian Ruble crisis and LTCM hedge fund collapse of that year and had a decidedly negative spillover impact on stock prices for a while. 

I would also point out that in the Kress cycle forecast for 2015 the 6-year “echo” suggests that the first few weeks of the New Year could be negative for stocks.  The Kress cycle echoes tend to be fairly accurate in warning of broad periods of above-average volatility and of the years which most closely align with 2015 in terms of the key Kress cycles, January was shown to be a particularly vulnerable month for selling pressure. 

Meanwhile commodities continue to take center stage as concerns mount that the weakness in the energy market may spill over into other areas of the financial system and the economy at large.  On Wednesday, Citigroup cut its iron ore and coal forecasts due to supply costs and signaled that the oil price crash is feeding into other commodity markets.  An even bigger sign that that weakness is having an impact on global demand can be seen in the chart for copper futures.  Copper is a widely watched gauge of global economic strength and the following graph suggests diminishing demand.

One of the major culprits for the weakness in oil and other commodities is the austerity policies in Greece and other euro zone countries, which is coming home to roost right now.  While the U.S. Federal Reserve responded to the unmitigated demand for money during the critical years 2009-2012, other countries chose to ignore the need for increased reserves and liquidity and instead initiated an ill-timed tight money policy.  Fast-forward to 2015 and while the U.S. finds itself the envy of the world in terms of its domestic economy, other nations are showing major signs of weakness with some verging on recession. 

The risk is that the commodities bear market continues exerting a negative influence on economies in Europe and Asia with weakness eventually being exported to the U.S.  This is what happened, on a temporary scale at least, in 1998.  While we’re a long way from the danger zone, there are preliminary signs that some of that weakness is already showing up.  The latest U.S. retail sales numbers, for instance, showed a 0.9 percent drop for December in what should by all accounts have been a positive month.  Electronic and clothing retailers were among the nine of the 13 leading categories that showed a decline in sales as Americans chose not to spend the extra money from gasoline price savings. 

A better reflection of what the average consumer is doing with his money is visible in the New Economy Index (NEI).  NEI is a basket average of several stocks within the consumer retail and business sectors.  For years it has provided an accurate real-time picture of the overall state of the U.S. retail economy.  Here’s what the NEI looks like right now.

NEI reached an all-time high last January and has spent the past year consolidating its gains since 2009 by tracing out a lateral range.  The NEI chart looks decent but could certainly use some improvement.  My interpretation of the NEI pattern is that while consumers have been spending at moderate levels, they haven’t completely “let loose” with those frenetic spending binges that have always characterized strong economies of the past. 

Although joblessness isn’t a major problem like it was in years past – the latest jobs report showed a surge of 321,000 new jobs in November – consumers are apparently concerned enough about keeping their jobs that they haven’t accelerated their spending.  It will be interesting to see how they respond to the continued weakness in the commodities market.

Tuesday, January 6, 2015

Deflation and the year ahead

Stocks were hit by selling pressure on Monday as the S&P 500 (SPX) declined 1.83% and the Dow 30 shed 1.86%.  The energy sector bore the brunt of the selling with the NYSE Oil Index declining 4.61%.  Crude oil prices also dropped nearly 5% for the day to close at 5 ½-year lows.

Fears that Greece may exit the euro zone are being blamed on the latest broad market decline.  Upcoming elections in Greece have spooked many investors, who feel that the country’s exit from the euro zone would be disastrous.  The most likely reason for the market decline, however, is the fact that investor sentiment has been excessively bullish in the last couple of weeks.  A pullback in the major indices should remove much of the excess optimism and pave the way for a sounder market environment. 

Many investors are also concerned over the potential for a bad year based on the so-called January Barometer.  This indicator is predicated on the belief that as goes the month of January, so goes the entire year.  Some even place emphasis on the first five days of January as having prognosticative value.  Yet the January Barometer was wrong in 2014 – the month of January last year was resoundingly negative, yet the year as a whole was positive.

As discussed in previous commentaries, the year ahead should be a bullish one overall based on the Year Five Phenomenon, notwithstanding the possibility of a volatile January.  This particular market maxim has held true for over 100 years, namely that there has never been a losing year in the fifth year of the decade.  The reason for this is that the 10-year Kress cycle bottoms at the end of the fourth year and the resultant upward pressure from the new-born 10-year cycle is beneficial for equity prices. 

Turning our attention to the crude oil collapse, weakness was once again in the oil price on Monday.  The crude oil price was 3% lower for the day after hitting a 5 ½-year low.  Adding to pressure against crude oil prices has been persistent strength in the U.S. dollar index (see chart below).  Recent dollar strength and oil price weakness has once again stirred up concerns among investors that deflation could be a problem in 2015. 

While I don’t envision deflation being a dominant theme for most of 2015, it could be problematic during the early part of the year.  When the 60-year Kress cycle of inflation/deflation entered its final “hard down” phase in 2008 it created major problems for the U.S. financial sector in 2008-2009.  Yet except for a brief period in 2008 and early 2009, it failed to deliver the anticipated deflationary collapse in essential commodity prices and the corresponding increase in the dollar’s value.  Many investors jumped to the conclusion that the long-term Kress cycle was either broken or else mitigated by the monetary policy actions of the Federal Reserve. 

Bud Kress always used to say that ultimately “Mother Nature and Father Time” would prevail when it came to the financial market.  That is, the natural forces of inflation and deflation will always manifest sooner or later – even when central bankers do their utmost to stifle it.  Viewed from this standpoint, the recent oil price collapse, dollar rally and overseas turbulence can be attributed to the cycle somewhat belatedly having its way despite the efforts of central banks.  Central bankers thought they could completely eliminate the impact of the cycle but it would seem that the cycles are having the last laugh.

On the subject of the oil price collapse, a recent Bloomberg article entitled “Oil below $60 tests U.S. drive for energy independence” provided some background for the ongoing crisis.  Asjylyn Loder, who wrote the article, observed: “The U.S. shale boom that’s brought the country closer to energy self-sufficiency than at any time since the 1980s will be challenged in 2015 as never before.” 

The article also pointed out that some of the largest U.S. shale drillers “have been spending money faster than they make it, borrowing to pay for their expansion.”  It would appear then that the fracking boom which provided a much needed stimulus to the U.S. economy at a time when it was needed most will face its first major obstacle in the coming year.  The oil price collapse and dollar rally has been a boon for consumers – Goldman Sachs analysts have said that cheaper U.S. gasoline will boost economic growth by 0.5 percentage points this year.  Economist Mark Zandi of Moody Analytics estimates that if oil prices stay at $60/barrel it will result in $150 billion in savings on gasoline for consumers. 

However, the oil price collapse will also eventually run headlong against the old market bromide that “low prices cure low prices.”