Saturday, April 13, 2013

Macro Analysis 4/12/2013

Stocks continued their march higher this week but a spate of negative economic data on Friday as well as weaker earnings reports from JP Morgan and Wells Fargo on Friday finally slowed the relentless climb and stocks closed the week on a sour note.  For the week, however, all the major indices finished the week higher and we have a new all time high in the S&P 500.

Gold, on the other hand, was massacred on Friday and I'm going to attempt to delve into the reasons why, given that central banks have the liquidity spigots wide open.

As stated in my previous two commentaries, I'm going to attempt to shorten these and just focus on what I believe are the main undercurrents that are driving these markets in the short to intermediate term.

Considering the unprecedented steps central banks worldwide are implementing in the attempt to spur growth and/or avoid a deflationary spiral I offer the following charts that, to me, characterize the results of their actions:

Here's a long term view of the S&P 500 which just hit a new historic all time high:

(click on chart for larger image)
I've pointed to the three tops on the S&P and outlined a few historic "tid bits" for those of us who can remember.  The stock market crash of 1987 will never be forgotten by anyone who was in any way connected with the markets.  The blue arrow highlighting the incredible march upward in stocks will be remembered by anyone who was invested at the time.  People would check their 401ks on a weekly basis to see how many thousands of dollars their accounts had gone up ...  But I have a question:  Can anyone say that the economy is better today than at the time of the black arrow?  Or how about the green arrow?  OK,  hold that thought ...
Here's a daily chart of the iShares Barclays 20+ Year Treasury Bond ETF (TLT); a proxy for the long end of the US Treasury yield curve:
(click on chart for larger image)
I circled the week's price action.  Admittedly, the apparent volatility of the price action could be an excuse to discount the spectacular rise in Treasuries.  But there's a reason why PIMCO's Bill Gross has turned bullish on Treasuries.  More on this below .
Considering the actions of the Bank of Japan last week I'm frankly astounded about what happened to Gold this week:
(click on chart for larger image)
This is a daily chart so I can show the true extent of the beating the yellow metal took on Friday(black arrow).  But the bleeding didn't stop with Gold.  Here's "Dr. Copper":
(click on chart for larger image)

This is an update of the same weekly chart I posted in last week's commentary.  I circled the week's price action.  The long stem above the body denotes a failure to rally. 
(click on chart for larger image)
Here's an update on the Dow Jones industrial Metals Index.  We were down on the week and are penetrating long term support.
Finally, here's the US Dollar-Japanese Yen cross:
(click on chart for larger image)
I circled what amounts to the last week and a half which reflects the price action since the BoJ (Bank of Japan) launched it's unprecedented effort to stem the deflationary tide in that country.
 So, let's solve the riddle. 
First of all, you would be clueless if you followed these markets and didn't give obeisance to the Fed for what it's done to bolster risk assets.  But the actions of the BoJ are already creating contortions that supersede anything the Fed has done to this point.  This has created a number of consequences that are manifesting themselves in our markets:
1.  US and European sovereign debt is rallying with the commensurate drop in yield.  Why?  The BoJ is pumping money into the system by buying up their debt.  Japanese interest rates are already super low but are going lower (actually negative yields).  So, what are Japanese investors doing?  They're searching the globe for yield and are buying it in the US and Europe.  And this phenomenon is just starting.
2.  Commodities continue to tell us that the global economy is anemic at best.
3.  Gold - this one is trickier.  As stated in last week's commentary, I hinted that the BoJ's actions might be the catalyst for the resumption of the Gold rally.  When Goldman Sachs came out with their "sell" recommendation on Wednesday I was frankly surprised.  But their call ended up being prescient.  What do I think is going on with Gold?
Let's look at a brief history of the precious metal.  Gold bottomed in July 1999 at $253.20. The bull market started in May 2001 in response to continuing monetary accommodation from the Fed.  From May 2001 to mid 2008 gold increased in price approximately five times.  Then came the great "margin call" caused by the Lehman meltdown where everything was liquidated for cash (specifically the US Dollar).  Gold, all commodities and paper assets suffered simultaneously.  However, in response to quantitative easing it took off once more hitting historic highs in September 2011 at a time when the global economy stood at the precipice of a deflationary meltdown due largely to events in Europe.  From there it's been all downhill.  On Friday, spot gold dropped $80.00!
Clearly, gold's meteoric rise over the past decade can be attributed to concerns over inflation.  And one would think that the continued monetary accommodation from the Fed coupled with the unprecedented policy being implemented in Japan would reignite the precious metal bull market.  But just the opposite is occurring. 
There are three plausible explanations for what is happening to gold:
1.  Markets are pricing in better economic times with higher interest rates.  In an improving economic environment investors will dump non interest bearing assets for interest bearing assets.  Gold traditionally does well when yields are low and will under perform when yields are trending higher.  The situation in 1979 - 1980 was different as investor fears over wage/price inflation trumped this traditional paradigm.
But if times are getting better why aren't commodities turning up?
2.  Gold may be telling us that all the central bank efforts to stem the deflationary tide are not going to work.  Remember, the financial markets are future discounting mechanisms.  They discount events in the future as they are the collective knowledge and wisdom along with the greed and fear of all their participants.  Which dovetails into my third possible explanation:
3.  What we saw last week in the Gold market was "capitulation selling".  Capitulation selling is when an asset that is in a downtrend steadily continues to build momentum to the downside until the selling reaches a crescendo in frantic dumping of the asset.  This is exactly what we saw on Friday where the vicious downdraft was accompanied by extremely heavy volume.
We'll know whether my "capitulation" thesis is correct in the next two or three weeks.  The gold price will be distorted for weeks to come as it attempts to find it's footing after the drubbing it took.  This could be an incredible buying opportunity but if we continue to see a steady march lower in price then my second explanation is the right explanation.  And that is a SCARY foreboding!
In my opinion, the concerted action of central banks (especially Japan) will accomplish their goal of turning the deflationary tide.  And up until this point, I believed there was an even chance that our Fed could unwind the liquidity they put in the system in an orderly manner.  But I hold no such confidence in the BoJ.  Their policies are already causing massive distortions in the global financial system and I'm having a difficult time seeing a good end to all of this.
But hey, in the meantime, central banks are blowing a massive paper asset bubble so don't hesitate; jump in!  I'll do my best to inform you when I see some stupid politician or banker take a pin out of his pocket to pop the bubble!
Have a great week!