Oct 31

King Dollar in a Bull Market

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But change your goggles and hey! Commodities in AUD not too bad…!

BORING as it sounds, I want to talk a bit about the end of US QE today, writes Greg Canavan in The Daily Reckoning Australia.
Because it’s very important to how markets are going to behave over the next few months.
As you probably know, yesterday the US Federal Reserve voted to end its policy of quantitative easing. But it will still be reinvesting the interest payments from its $4 trillion plus portfolio and rolling over any maturing treasury securities, so it’s balance sheet will continue to grow, albeit much more slowly.
On the surface, US markets didn’t seem too fussed about the end of an era. Shares sold off around the time of the Fed’s statement and then rallied towards the close. Probably a case of “algo’s going wild” as automated high frequency traders tried to make sense of the Fed’s statement.
And the Fed did its usual job of promising to hold rates as low as they possibly could, which markets seemed happy enough with.
But the real action took place under the surface. That is, the US Dollar spiked higher again. This is an important point because when the US Dollar rallies, it usually signifies tightening global liquidity.
Think of it as liquidity returning to the source (US capital markets) and drying up…or disappearing. That’s certainly what has been happening these past few months. Since bottoming in May, the US Dollar index (which measures the greenback’s performance against a basket of currencies) has increased by nearly 9%.
That might not sound like a huge spike, but in the world of currency movements, it is. Imagine if you’re an exporter and your product just became 9% more expensive…chances are it will lead to a drop in sales as customers look for a cheaper substitute.
This is the problem with the end of QE. It leads to liquidity evaporation as ‘punt money’ returns home…which leads to a strengthening US Dollar…which hurts sales of US multinationals.
It’s not going to happen right away though. Most companies have hedging strategies in place that protect them from sharp moves in the FX markets. But if Dollar strength persists…and the chart above says that it will, then you’ll see the strong Dollar hitting companies’ revenue line in the coming quarterly reports.
Not only that, but the evaporation of liquidity in general could lead to another bout of selling across global markets. QE is all about providing confidence. Liquidity is synonymous with confidence. Take it away and you’ll see the mood of the market change.
Getting back to the Dollar strength…it’s a headache for Australia too. It’s smashing the iron ore price, and the Aussie Dollar isn’t falling fast enough to keep up. In terms of the other commodities though, things aren’t quite so bad.
All you seem to hear lately is negative news about commodities. That’s because the world prices commodities in US Dollars, and as you’ve seen, the US Dollar is a picture of strength. But if you look at commodity prices in terms of Aussie Dollars, things look a little better.
The chart below shows the CRB commodity index, denominated in Australian Dollars. It’s a weekly chart over the past five years. And y’know what…it doesn’t look that bad! Since bottoming in 2012, it’s made considerable progress in heading back to the 2011 highs.
But you’ll want to see it start to bottom around these levels. If it doesn’t, prices could head much lower.
The thing to note about this chart is that it doesn’t include the bulk commodities – iron ore and coal. These commodities tend to dominate the headlines in Australia. Things like nickel, tin, copper and oil don’t get much of a look in.
Which reminds me, in case you missed it, Diggers and Drillers analyst Jason Stevenson recently released a report on some small Aussie oil ‘wildcatters’. With the oil price low, now could be a good time to sniff around the sector.
You could say that about commodities across the board. In the space of a few years, they’ve gone from hero to zero…or the penthouse to the…
That usually means there could be some good value around. One thing you need to look for in the current environment is a decent demand/supply dynamic. Iron ore in particular is heading towards massive oversupply next year. I reckon that makes it a poor investment choice for the next few years.
You’re better off to wait until the China slowdown and supply surge knocks out the juniors and all the marginal producers….leaving the market to BHP and Rio. You’ll then probably be able to pick these mining giants up at much lower levels.
Once you find a commodity with good supply/demand fundamentals, you need to make sure the producer is low cost. That protects it against further price falls…or a rise in the Australian Dollar.
It also protects it against foreign competition. One of the issues with the Aussie resources sector in recent years is costs. Other countries have much cheaper capital and labour costs and can therefore get stuff out of the ground cheaper than us.
That brings me to a final issue: Australia doesn’t really invest in its own resource sector. Via superannuation, we have a huge pool of capital. But this mostly goes into the banks or the major miners. Superannuation capital is not high risk capital.
That means a lot of the capital that flows into the resource sector is foreign. And when global financial conditions change…like the end of QE and the strengthening of the US Dollar…that capital departs.
This will create problems and opportunities for the sector. But given the bearishness towards commodities in general, it’s probably time to start getting interested again.
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Oct 22

How Much Like 1976 is Gold Today?

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The gold price drop of 1975-1976 bears comparison…

MARK TWAIN said history doesn’t repeat itself but it rhymes, writes Jordan Roy-Byrne, CMT, at TheDailyGold.
We often see that in the capital markets. The big decline in gold this year is reminiscent of that of 1975-1976. Yet, aside from that there are several other similarities between today and 1976. Gold, gold stocks, the stock market and commodities appear to be in a similar position today compared to 1976. We note and discuss the four similarities. 
1. Decline in Gold Miner Stocks
From 1974 to 1976 the Barron’s Gold Mining Index declined 67%. From 2011 to 2013, the HUI Gold Bugs Index declined 66%. The chart below is an updated chart of all of the worst cyclical bear markets in gold stocks, dating back to 1938.
The next shows three of the four major cyclical bear markets which occurred within secular bull markets. (The 2008 bear is omitted). Look at how close the current bear is to the 1974-1976 bear? They are nearly identical in terms of price and time. It’s also not far off from the other bear.
2. Gold Miner Stocks vs. S&P 500
While gold stocks experienced a 67% decline from 1974 to 1976, the stock market recovered strongly from the 1973-1974 recession. The chart below (rebalanced) shows the Barron’s Gold Mining Index against the S&P 500. The ratio declined 76% from 1974 to 1976. 
Just like from 1974 to 1976, the gold miners stocks from 2011-2013 have declined 77% when measured against the S&P 500.
3. Decline in Gold Price
From 1974 to 1976 the gold price declined 47%. From its 2011 top to 2013 bottom, gold declined 37%. Why was the decline in the 1970s more severe? Gold was only free trading for less than five years. In that period the price exploded about 457% whereas in the present bull market Gold had risen 650% in 11 years. In the three years prior to its end-1974 top gold gained 333%, which dwarfs the 130% gain in the three years before the 2011 top. These figures explain why gold in the present bull market hasn’t had a deeper downturn
4. Relative Strength in Commodities 
Typically gold leads an inflationary cycle. Gold leads silver which leads the commodity complex. However, in the mid-to-late 1970s, the CRB index (today’s CCI) bottomed before gold. The CRB bottomed at the start of 1975 while gold bottomed in summer 1976.
After gold bottomed, it regained relative strength. Interestingly, silver also bottomed in 1974 and basically held steady for a few years while gold prices declined. 
Today, the CCI (old CRB) closed at 519. At the 2012 low it closed at 504. Gold closed at $1541 then and closed today at $1320. The CCI has strongly outperformed gold over the last 17 months just as it did in 1975 and 1976. And in the second half of the 1970s, commodities followed their recovery from the nasty 1973-1974 recession to lead the new inflationary cycle (rather than precious metals).
Could we be seeing the same thing today? There are early indications. Oil has been strong for a while. Wheat and sugar have broken out of their downtrends. Silver has outperformed gold over the last few months. 
To conclude, it makes total sense that the current decline in gold prices and gold miner stocks is most similar to the 1976 decline. The current bear market followed 11 years of a bull market while the 1974-1976 correction followed 14 years of a bull market. None of the other bear markets are similar to todays.
The two worst declines were in 1980-1982 (72%) and 1996-1998 (67% in BGMI and 72% in GDM). The 1980 decline followed a 20-year bull market and a parabolic top in the metals. The 1996-1998 bear followed a three year cyclical bull that ended in a mania.
Meanwhile, we’ve noted the similarities beyond the precious metals sector. The stock market has had a great run and dramatically outperformed precious metals. The economy is several years past a severe recession. Commodities as a whole have held up better than precious metals. 
However, this counter trend move of the past two years is nearing its peak and its setting up a great opportunity in gold and silver stocks and a fantastic opportunity in select companies. As this bottoming process in precious metals moves to its final stages, readers are advised to identify the companies with the best fundamentals and growth potential that are showing relative strength. Focus on the leaders and avoid the laggards. If you’d be interested in our analysis on the companies we think poised to lead this new bull market, we invite you to learn more about our service.
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Nov 15

This Week on "States in Crisis"

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Ireland, Gold Futures, commodity speculation, and the rest of this week’s news – in advance…!

THIS WEEK’s episode of “The WelfareState in Crisis” features a guest appearance by the Emerald Isle,currently seeking about $110 billion in bailout money from theEuropean Union, writes Dan Denning in his Daily Reckoning Australia.

Actually, Ireland is not seeking that money, and that appears to be a part of the problem. The Irishgovernment is content that it’s managing its problems well,independent of European meddling.

But with 10-year Irish bond yieldsblowing out to a spread of 646 basis points over 10-year German debtlast week, European officials are worried that problems in Irelandare problems for the Euro. And if problems for the Euro get worse,that means problems for Portugal and Spain too.

No wonder the US Dollar quit fallinglast week. And no wonder commodities fell like a stone. Friday was anugly day for commodities speculators. The CRB Index in New York fell3.6%. Every single one of its 19 components was down. Sugar contractsfell 12% in London and corn and soybeans traded limit down.

Part of the shocking action incommodities futures markets is the raising of margin requirements byexchanges. It happened in silver last week. And it happened for sugartoo, when the ICE futures boosted margins on sugar contracts by 81%to shake out speculators. It will probably happen on Gold Futurestoo, and that might explain the $40 thud last Friday, among otherthings.

No one is forced to speculate, ofcourse. But this is what the Bernanke Fed has wrought. ItsQuantitative Easing action has put dollar owners in the position ofdoing nothing and losing money to inflation, or speculating intangible assets that go up in price relative to the dollar. And it’s not just commodities. It’s currencies too.

The G-20 summit in Seoul failed toproduce any result on competitive currency devaluations. No onereally expected it to. But what’s next? Since there is no quick andeasy solution to replacing a broken world currency system, the slow,difficult, and ugly scenario must take place. It will probably beslow, difficult, and ugly.

One thing you should expect more of isan escalating level of capital controls. Ironically, the firstmanifestation of this has been in export-oriented economies likeBrazil, where the government tripled a tax on foreign investment inlocal bonds from 2% to 6%. It was designed to prevent furtherappreciation in Brazil’s currency, which yields over 10% and is up35% in trade-weighted terms since last year.

China, South Korea and other countriesare taking similar measures. For big exporters, a stronger currencytranslates into a loss of competitiveness. And when capital marketsare wide open and you find yourself on the receiving end of hugeinflows, it can lead to rapid asset price appreciation and otherforms of less desirable inflation.

By the way, this shows you how everyoneis complicit in trying to return to the status quo ante GFC. Theexport-driven BRIICs want to pretend that the credit-financed Welfarestates don’t have real structural deficit and demographic issuesthat prevent a return to “normal” rates of consumption. They wantthe world be the way it was.

Here in Australia, other than houseprices being utterly unaffordable, it looks like things have neverbeen better. The rising Aussie dollar (up 17% since the end of Junealone) helps “contain” some of the inflation from booming coaland iron ore exports. That’s why the Reserve Bank of Australia isone of the only central banks in the world that does not appear to beactively trying to weaken its currency.

Maybe the RBA agrees with Bloombergthat on a purchasing power parity basis, the Aussie is trading at a30% premium to fair value. That makes it the most over-valuedcurrency in the world at the moment. If it’s a short-term trade(instead of long-term or secular trend in which the Aussie surpassesthe USD), the currency will weaken and not do any permanent damage toAustralia’s own export competitiveness by making Aussie exportsmore expensive than alternatives from Africa.

For now, the Aussie is the placeeveryone wants to be as well; a high-yield commodity currency from acountry with comparatively low public sector debt (although highhousehold debt), low unemployment, and economic growth correlated toAsia. What could possible go wrong when things can’t’ get anybetter?

Speaking of Asia, the other non-Irishnews that rocked commodity markets last week was that China againraised reserve requirements at key banks and may raise interest ratesto ward off inflation being poured into China from the U.S. Stocksand commodities fell hard.

What do you make of all this mess?

To us, it means that anxiety about theAussie being too strong for too long may be short-lived. China couldbe doing a dress-rehearsal for a much more dramatic fall in assetprices as the authorities try to prevent inflation from surging. Thishas obvious and bearish implications for commodity prices.

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