The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, November 12th, 2013.
The best precious metals bull markets are defined by gold and silver shares outperforming bullion prices, however history has taught us this is not necessarily a prerequisite, at least not if you are looking for a runaway. This can be seen looking at this long-term chart of the Barron's Gold Mining Index, the primary measure of precious metal shares dating all the way back to the 30's, and beyond. Here, you can see that by this definition precious metals shares saw their largest gains between 1940 and 1980, and have essentially been going sideways ever since. What's more, in this most recent rally sequence, that being from the year 2000 to present, it should be noted it's taken a move from $250 to almost $2000 in gold just to get them back up to 70's optimum, but they have fallen back substantially over the past few years with commodity prices (gold and silver) pulling back.
The question then arises, why did precious metals shares rally hard from 1940 to 1980 and then essentially fall into a sideways funk? The answer to this question is not what most discerning minds would think, at least not the full answer. The straight forward and obvious answer to this question is when official policy and politics pushed investors towards the shares, however it not just purely precious metals centric reasoning, but also the public's increasing incomes and wealth during this period, with real wages rising rapidly into the mid-70's. Past this however, it's impossible to ignore the two monetary events that changed everything, that being Executive Order 6102 in 1933, making gold ownership for Americans illegal until Nixon took the world off the gold standard in 1971, with this being the second.
The common thread regarding these two events is the Fed began to debase the currency at accelerating rates in both cases (drastically so after going off the gold standard), however again, the shares outperformed primarily between 1940 and the time mid-70's, which could be looked at as a reflection of US citizen's newly found access to bullion; but more likely coincided with the trend in real wages. So, what does this mean you should do if looking to invest in precious metals moving forward given the trend in real wages is likely still down? Should one buy the shares or the bullion? And if you are considering buying riskier, but potentially more rewarding shares, when do you buy them? Because shares still have more leverage to the bullion despite the fact real wage gains are not going to help you out, with the big variable here being timing.
Answer: You might want to wait until the Fed repeats something as big as the 1933 or 1971 events before getting too bullish on prospects for precious metals shares, which could trigger another period of out-performance, which may be the first time Janet Yellen increases QE, arresting Bernanke centric speculation of the opposite. (i.e. tapering.) Such a move would signal the Fed, who still leads all other central banks (CB's) in the world in this regard (with the US dollar [$] still king, accelerating $ debasement would force other CB's to follow), has adopted a new and accelerated currency debasement policy, and everybody should take notice. The question in this regard then is when this will happen, where previously it took crashing asset bubbles to cause such a reaction. The fact the ECB could cut rates last week with no positive reaction in the precious metals complex is testament to this thinking.
That is to say, with the Fed's balance sheet already some 400 percent larger today than pre-2008 crisis, in order to have a meaningful impact on a measurable acceleration in the currency debasement rate, if that's what it's going to take to bring some life back into the shares, it's likely a good idea to wait until the broad stock market bubbles begin to deflate noticeably before swinging the bat at some precious metals sharers. (i.e. despite the fact the boys in New York would like you to believe the computers are programmed to buy precious metals shares as a negative correlation trade against the broads.) So, the answer to the above question set is it's likely a good idea to in fact wait to see a visible policy change on the part of the Fed before making a meaningful commitment into the shares, which would likely mark the beginning of a period of out-performance, the second such period in the precious metals 'dumb bell rally' currently underway.
From last weeks Junior Gold and Silver Stock Selections commentary in preparing for the 'big turn', below find two paragraphs explaining what I have dubbed, 'The Dumb Bell Rally', as follows:
"And that's what we are close to seeing a re-emergence in if my macro-work holds any value - a re-emergence of the bull market in precious metals shares sometime between November and January to mark absolute lows for the cyclical corrections gripping the sector, followed by the orthodox low (the momentum low) not long after in secular-timing terms, perhaps 6 to 8 months before any new highs (in any sub-sector) are witnessed. I am going to call the bull market that is expected to last in the vicinity of decade's end (2020) the 'dumb bell rally' because of it's distribution (shape), with the bulk of gains in the shares witnessed in the first three years of the bull market (2001 to 2004); and, future prospects looking like more substantive gains (relative strength in the shares) should also be expected over the next three to four years, with a straight bar (sideways price action) in between. (i.e. hence the dumb bell shape.)
Another reason to call the full extent of the present secular event the dumb bell bull market is because if one has not been humbled by this beast in one way or another these past eight years or so, well, you are better than most is all one can say. Therein, this has been one unpredictable bronco to say the least - counter intuitive, volatile, and highly manipulated by powerful groups of power barons and moneychangers worldwide. And it might get worse in this regard, because these guys are not good losers. As soon as the stock market game is no longer working in their favor, expect exchanges (banks, brokers, etc.) to be closed as part of what Jim Sinclair calls the 'Great Reset' (watch this video) beginning sometime over the next three years, by 2016. Therein, according to him, this will involve gold going to $50,000 per ounce as wealth attempts to flee the larger fiat currency economy, meaning any shares held by banks and brokers that don't make it could be confiscated."
Of course if Jim Sinclair is right and gold goes to $50,000 per ounce this would likely make taking risks in shares unnecessary, not to mention it's difficult envisioning the shares out-performing. Perhaps silver out-performs, which addresses the unanswered element of the question set above (why take unnecessary risks in the shares when one can buy silver for out-performance), which is an important consideration. Because making a big mistake in this regard will leave you feeling like a 'dumb bell', so please don't over do it in the shares. Of course the rewards are there if one can get his timing right in this game, which is why the 'die hard' precious metal share traders continue to bet bullish is the gambling pits, the options and leveraged ETF markets, rolling the dice to make their fortunes.
We know this from the extensive and continuing sentiment related studies we perform regularly in order to keep abreast of speculator betting practices because they remain the single most important factor in terms of price discovery while Western price discovery mechanisms (options, futures, etc.), and the machines that exploit these markets, continue to control the trends. This is all managed by what we will call the 'bureaucracy's price managers' simply because the nexus involved is quite extensive, from high level bankers who control monetary policy, to regulators who shape market(s) structure, to the various prop desks that actually carry out the 'dirty work', applying what appears to be an unending supply of monetary largesse in the desired locations. And then there are the plutocrats that ride above these sorts, but we will leave this for another day.
But in order to build a hypothesis as to what is most likely to occur in this regard, first one needs to not only understand the above, but also that these sorts will not give up on the Keynesian experiment, their fiat currency economies, or most importantly, their greed, until it's too late. We recently commented again on this vein of thinking here, drawing a parallel to present circumstances in our larger Keynesian / Marxists experiment to that of a 'suicide mission', where our illustrious leaders (goaded on by a largely debased mob) are systematically and progressively using up all of our resources, leaving prospects for the future bleak save increasing the junkies dosage in an effort to delay the inevitable. This is of course why any talk of exiting QE is horse pucky, because as the ECRI confirms, the US economy is 'still in recession' and fragile with leverage in the system (ex. markets), never higher.
And this is the single most important understanding to have if one is to place an educated bet on precious metals shares moving forward, that the 'powers that be' will stop at nothing to keep the stock market levitated because unfortunately they have allowed it to move from just being important - to become 'everything'. This is why they suppress interest rates and precious metals, to create the illusion inflation is under control (think financial repression), and this is also why a system reset, like Jim Sinclair discusses in the attached above, will be necessary when they fail. So, in the meantime, one should attempt to first, secure core wealth in 'lasting stores', with gold and silver bullion at center; and then, past this, possibly speculate in leveraged markets with excess funds.
Of course far too many ignore sound portfolio planning principals and lay the whole thing down on red, which is a large part of the reason the bureaucracy's price managers have found it so easy to push around the 'moronic gamblers' that unfortunately comprise a large enough component of the total precious metal investing population to make a difference, at least for now. This is why it was so easy to topple precious metals shares over these past two years, because aggressive bulls in the sector made it easy for the machines to push prices lower as traders were forced to abandon losing positions, bringing down even the strongest of large cap producers. (i.e. think options, leveraged ETF's, etc.) And this extended to the juniors as well, where in fact an unprecedented divergence between the Canadian small share market (the world's premier venture finance platform for precious metals / resource start-ups), as measured by the S&P/TSX Venture Exchange (CDNX), and the broad market, as measured by the S&P 500 (SPX), has developed over the past two years. (See Figure 1)
Despite the appearance precious metals being attacked so viciously over the past two years smacks of desperation on the part the 'powers that be', still the campaign was quite successful on all fronts, not the least of which is measured in the shellacking juniors have taken, again, as evidenced in the glaring divergence denoted above. That being said, the task at hand now is to attempt to calculate just how this divergence will be closed; with the juniors making a miraculous recovery, or the broads toppling over as well. This is definitely not an easy question to grapple with at this juncture given how stretched the markets, economy, debt levels are, where previously there would be no question of the outcome. (i.e. the broads would crash too.) And with other technical considerations seen both above and below (the unfinished head and shoulders pattern measure down to 400, the continued bullish posturing of speculators, etc.), one would be bold to bet against such an outcome occurring again. (i.e. based on these charts, expect the broads to roll over too, with further weakness in precious metal juniors as well.) (See Figure 2)
What's more, and to focus on the above, it's almost unbelievable to have seen relative strength in the juniors against the larger cap precious metals shares this past year given all that's happened, which means these speculators have not given up the ghost yet, indicative of further downside. (i.e. and this is also evidenced in still low open interest put / call ratios on key ETF's and indexes.) You should take notice of this fact. It's important because what it means is the head and shoulders measured move in the CDNX down to 400 will likely trace out once the broads begin to break lower as well. This just makes sense from an intuitive standpoint, because juniors generally only perform well when credit is readily available, which is almost solely a function of buoyant equity markets these days. Small caps that comprise the non-resource related Russell 2000 are certainly doing well based on this premise, making the divergence in the CDNX that much more suspect. (i.e. it's purely a reflection of New York fraudsters, their machines, etc.) Sure, once the Fed (and other central banks) begin to debase the currencies with abandon again things will be different, because they will not be able to keep gold (and silver) down anymore, but we are not there yet. (See Figure 3)
Technical Note: Watch for a potentially violent reversal higher in the CDNX / Gold Ratio once the Dow / Gold Ratio hits the 233 EMA. (See below.)
Such an outcome, and move lower in the CDNX to 400 with a break lower in the SPX, would match the year 2000 sequencing, where the golds did not bottom for six-months after the SPX topped in March. So, if the larger cap precious metals shares can at least begin to show increased stability when the Dow / Gold Ratio reaches the 233-month exponential moving average (EMA), which corresponds to the 23.6% retracement off the 2011 lows, with the 38.2% retracement up at approximately 20. And that's where it could go if things don't stabilize at the 233-month EMA, however because the Dow / Gold Ratio plunged all the way from generational highs in excess of 43 in a straight line to 6, and the fact a 23.6% retracement is to be expected (a limited response) because of the strength of the secular trend (down), and the fact the counter-trend / cyclical correction is now two-years old, a move to 20 must be viewed as unlikely at this point. (i.e. is this why it could happen?)
Because don't forget, we are caught in a liquidity trap (due to diminishing returns, growth dependency, etc.), which is why Janet Yellen will undoubtedly be confirmed as the first woman chair of the Fed this week, because of the 'need for speed' (in currency debasement), and her determination to provide what is necessary to keep the illusion alive (the bubbles inflated), come hell or high water, to prove she can do it. This is a perfect set-up for the mother of all bubbles economies - you should realize that now - because nothing that has happened to this point will compare to what is about to happen. The only question in this regard is just how fast she would go at it with abandon, before, during, or after a crash in the broads. My vote is during, which if proven accurate, may shorten the time it would take for precious metals to begin outperforming again. Of course if the Dow / Gold Ratio turns hard once the 233-month EMA is reached, this may signal Yellen will prove 'proactive'.
This is all speculation on my part however, where we should continue to do nothing but observe the markets with great interest for clues as to what to expect, because as it stands right now anything can still happen. Never have the markets been more complicated, followed closer, and been more important to the establishment, people's retirement accounts, and in too many cases to be considered 'healthy', people's daily needs; so, perhaps things don't turn out as expected by the consensus at all. Maybe stocks correct hard for a few weeks once the Dow / Gold Ratio hits the target at 14.5 and then rallies right back up to the highs again because too many speculators / hedgers go short again. Who knows! One thing is for sure however, once speculators stop being so darn bullish on precious metals, as measured by the key open interest put / call ratios we follow, we will certainly be far more constructive on the group, especially if this occurs in tandem with our Dow / Gold Ratio targeting.
Until this point is attained however, and I want to be clear about this, one would be foolish to be aggressive with the group (precious metals) considering the mounting parallels to previous equity bubble tops, with special attention to the year 2000, especially with the dumb money partying like it's 1999 again, the strength in tech, and similarities in precious metals sector behaviors. Because as much as the bureaucracy's price managers would like you to believe a highly reactive negative correlation exists between precious metals and the broads one does need wonder just who will be buying the former when the latter runs out of steam for real (on a lasting basis) with margin debt levels so high, the middle class increasingly wiped out financially (over-indebted), and Western authorities hell bent in keeping a lid on prices (until they are not, which is coming); again, caution (only speculate with money you can afford to lose) is the word until we see how the markets react once the 233-month EMA is attained given the risks. (i.e. which are very real as evidenced in the charts above.)
If the patterning is similar to the year 2000, with a six-month lag between an orthodox (momentum) low in precious metals and the broads, it should be pointed out this does not mean the dumb bell patterning of the larger move will be affected, where in fact one should expect mania like conditions to unfold in real money (and its related equities), once currency debasement rates explode higher. It does mean however that one should be very slow to accumulate new positions until more is known; meaning bullion accumulation is likely fine in the initial stages of the larger turn, like in the year 2000, but precious metals stocks could still be halved (like 2000), so be patient with the shares.
See you next time.