Stock jitters, Gold and JPY still compressed

Gold and the yen each worked still lower this week on highly depressed sentiment readings. Each of these has had a negative relationship with the “risk trade” lately, falling as stocks have rebounded from their oversold and overbearish condition of mid-November. Now, stock sentiment has recovered to neutral territory, and traders are afraid of these sometime “safety trades.”

Trader opinion gold has been very low since late October, a full eight weeks ago. Every similar instance in the past several years has been followed by a substantial multi-week rally. That said, if the bull markets in precious metals and the yen are indeed over, we should expect downtrends to become more protracted, with sentiment remaining low for longer.

Here’s a 1-year daily chart of gold:

1-year daily JPYUSD:

I’m holding to a thesis that the risk trade is topping out here as the US slides into a recession that remains largely unrecognised. Tops are rarely sharp peaks, but consist of several months of choppy sideways action during which sentiment deteriorates from giddy to nervous and the VIX picks up even before prices have fallen substantially. I view the rebound since mid-November with that context, akin to the action of April-July 2011 or pretty much all of 2007. ┬áLast nights mini flash crash in stock futures fits into that context of a increasingly jittery market.

We’re three months from the 4-year birthday of the (presumably) cyclical bull market. It is now older than most cyclical bulls within secular bears, though the last bull phase lasted from March 2003 to October 2007, 4.5 years.

Another cyclical bear and a recession and drop in corporate earnings may finally compress multiples to the investable levels required to build a solid base for another bear market. I don’t expect this to happen quickly, though, since prices have a long way to go before we see anything that can be called historically cheap. I wouldn’t be surprised to see stocks hold at or beneath current levels for the rest of this decade as inflation creeps in towards the end and boosts earnings, as happened during the latter stages of the last three secular bear markets (roughly the 1910s, ’30s, ’70s).


Hard to deny there’s a bearish pattern here:

TD Ameritrade

The precious metals have ambivalent correlations with stocks these days, so I’m not sure what the above means in the scheme of things, other than the commodities echo bubble slowly deflating. Sometimes the metals are high beta, sometimes negative, and sometimes they seem to have no correlation at all.

Still bearish on the yellow metal

As many readers know, I have been bearish on gold lately. I have been buying puts on GLD and GDX and bought more yesterday, though I do have a big chunk of assets in bullion (20x more than in puts). My bullion is not for sale, but I suspect that the reality of deflation and its likely duration has yet to fully sink in, and that we are due for a demoralizing event in the gold market.

Gold is not fully treated as money at the moment, though fiat currencies don’t satisfy all of the criteria for money either. Only precious metals can fully satisfy them, when governments allow.

So gold is not really money now, since its liquidity is limited, but it is a long-term store of value that outlasts currencies and governments. This is the key point: from the perspective of a large player who can afford warehouse costs, other metals or commodities can also serve as a store of value and hedge against fiscal calamity. Copper and cotton and rice will never go to zero either.

Almost all other commodities are down by huge percentages, though gold hangs on. It makes sense for gold to outperform the others, since it is more liquid and portable and people naturally prefer it during a crisis, but the premium seems way too high.

Once this panic phase of the depression is over, and a general funk and low-velocity environment settles in, with the dollar and other currencies having survived to the surprise of so many gold owners, the metal could be again seen as dead weight and fall as people still need plain old folding money to pay their bills, debts and taxes.

That is how I see things. Only time will tell if I am right.

Silver, platinum, palladium say gold needs to fall.

This spring, as gold topped out at over $1000 per ounce, platinum hit $2250, silver breached $20, and palladium reached $579. The ratios at the time were roughly 1:0.45, 1:50, and 1:1.75, respectively, about where they had been for the last several years.

Here are the five-year charts from Kitco, in order of descending pain:

I expected gold’s increase in relative value, since the other metals are considered more “risky” assets and depend more on industrial demand, but these ratios are looking a bit extreme. The one that jumps out at me is platinum priced only 10% higher than gold, at a level where gold was trading just two days ago!

With the deflationary carnage that has taken place in the rest of the precious metals (and base metals), gold’s grip on the $800 level is looking more and more tenuous. I have been figuring on $600 for some time, but now I am thinking that $400 is not out of the question. $400 sounds nuts, but there is a massive phase shift underway, in which cash is going from a hot potato to the one thing everyone needs but nobody seems to have.

That said, gold has been increasing in value against everything but dollars and yen, and to a lesser extent, euros, pounds, Swiss francs and some other currencies. It has been acting like a currency in this deflation, though one in need of a correction. In that regard, a fall to $400 would coincide with much more extreme dollar-denominated declines in almost all other assets.


For more on this shift, see:

Bond sell-off just a correction. Bailouts will not stop deflation.

Don’t worry about the Fed printing… yet.

Breakdown of paper gold market? Maybe not quite yet.

Thought provoking video interview here.

Could we see massive defaults in on futures contracts if a great number of traders decide to arbitrage the paper/retail spread? Sounds possible, but why hasn’t it been done already? Or is it being done, but restrained by a bottleneck at the mints?

There has been a great premium for small physical gold and silver over the futures market for some months now, well in excess of average seignorage. Small players are devouring coins as fast as they are minted.

I have been inclined to take this as a contrary indicator. While adding to my physical on dips, I have been shorting GLD on rallies with puts since March, when surveys showed 98% bullishness on precious metals. Also, the coin and small bar market is very small relative to the world gold market, according to the World Gold Council.

I suspect that the odds of default are still small, in large part because we are in deflation, not inflation, as most gold buyers believe, and many are likely to spook upon that recognition. Also, with everyone going broke, who can afford to bid aggressively on anything anymore?

That said, if larger players start putting away 400 oz bars en masse, watch out. We are now in the final stages of this paper currency system, so not owning gold or waiting for a better price to buy more is a game of musical chairs.