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Eric Coffin

Eric Coffin

Eric Coffin has been publishing the HRA newsletters since 1995. During that period, HRA has become famous for in depth coverage, broad hands-on understanding of…

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Bipolar Markets

From the HRA Journal: Issue 213

Another period of sideways, with a few sharp turns along the way to keep traders on their toes. We basically stand where we were a month ago and we're still waiting to see if we get a spring rally in resource stocks that lifts us above the March high for the Venture index. Admittedly, there isn't a lot of "spring" left to work with and we all know how boring things can get as we exit May.

Like the last issue, I held this one for a few days hoping to see more news to report on and, like the last issue, not too much arrived. Things are warning up (weather wise). Summer exploration is beginning in the northern hemisphere so news should pick up. For the record, I did add a new company at the SD level and you can expect to see some new choices in these pages soon. I am waiting on technical data for a couple of stories I like. I need the data to cover them properly but I don't expect it to change my basic opinion so odds are you see one of these in the next issue.

The editorial in this issue helps make the case for physical demand underpinning the gold market. I think a lot of the obvious sellers are out and the price has found a higher base than late 2013. There is always room for a Ukraine boost but I hope for both humanitarian and practical reasons people just buy the yellow stuff because they think it's cheap.

For all the recent fear in the market after another flare up in the Ukraine its hard to complain about how the big indices are holding up. All are near their highs. That's good but there are some strange cross-market correlations that make one wonder.

Take the chart at the top of the next page. It displays the last year's trading for TNX, the ETF that mirrors the yield on the US 10 year treasury bond. Late last year the yield climbed consistently as the US Fed continued to threaten a start to the QE taper. It reached a high of 3% just before year end after the Fed made good on its promise. So far so good.

I noted at the start of the year that I expected the yield could rise to the 3.5-4.0% range by year end. Not at all a scary prospect. Slowly increasing yields is exactly what should be expected as an economy improves.

A funny thing happened after the start of the year though. Instead of continuing to climb bond yields dropped back as weather spooked traders got defensive. Even as markets recovered through February bond traders appear unmoved. Yields have stayed in a tight range well below their late 2013 highs.

$TNX 10 Year Treasury Note Yield INDX

What are we to make of this? It would be easy to blame Ukraine but the timing is wrong. Bond traders have steadfastly refused to generate the bear market that was universally expected last year. Indeed, long dated bonds have outperformed equities by a wide margin so far this year.

While I'm not sure bond traders will be "right" I do find their lack of conviction about accelerating growth in the US disquieting. The bond market is very large and, as a group, bond traders have as good a track record as anyone when it comes to gauging forward growth. Clearly, they are not sold on the higher economic growth estimates for the US. They are still taking a wait and see attitude, even with the Fed tapering its bond purchases and increasing supply.

The same could be said for the currency market. Most expected the US Dollar index to be much higher than current levels by now. It has gone basically nowhere since the start of the year and recently failed to break through its 50 day average.

Both of these markets have traded in tighter and tighter ranges. Markets tend to break out and make a sustained move after a period like this. At this point the move could still go either way. It still seems logical to me that both bond yields and the Dollar would rise but traders need to be convinced.

There will be a deluge of economic data in the next few days. A Fed meeting, April payroll numbers, Q1 GDP numbers and flash PMI numbers across the G8 among others will all be hitting traders screens over the next week. There could be enough "news" in this flood of readings to move the needle one way or the other and push both the USD and bond yields from their recent ranges.

Anything big enough to move both those markets will ripple through equity markets too. I don't expect big surprises from the next batch of readings, though a weak PMI or payroll number could have a big impact. I don't expect a change in Fed posture or timing.

Any of the above can impact metals. Strong numbers from Europe would put a floor under the Euro (even though that isn't a good thing for anyone) and the gold market with it. A strong PMI number from China would surprise just about everyone and could boost base metals and gold too. There are still too many funky statistics in China to bother even guessing at that one.

Hanging over all of this is the situation in the Ukraine. More gunfire will bring out insurance buyers in the gold market though, again, it's surprising not too see the USD getting more of a bid from all that.

The latest bounce in the gold price was related to the deaths of several "pro-Russian agitators" in east Ukraine. It came as gold tested and fell through the $1280 level, reaching a lower resistance level that many technical analysts thought was a necessary stopping point.

Gold briefly recaptured the $1300 level and is trading just below it as this is written. I think it will have to reclaim its 50 day moving average at the $1320 level at a minimum for traders to take this advance seriously.

weekly addition or redemption of gold by GLD

The chart above displays weekly addition or redemption of gold by GLD, the most broadly held gold ETF. The chart comes from iaconoresearch.com, the website of Tim Iacono who is one of the more sensible commentators on the gold market in my opinion. It's a good proxy for "western" investment demand for gold.

Not surprisingly, purchases and disinvestments by GLD closely mirror movements in the gold price itself. During most periods GLD is following not driving the gold price. Retail traders react to large price moves or changes in direction of the spot market by buying and selling GLD shares in the market. You can see that in late 2013/early 2014 the buying started after the gold price started to rally and it was heaviest at the top.

For the past few weeks the gold price and GLD holdings have gone the other way. GLD traders have been selling and GLD has been divesting gold, though redemptions have recently dried up. Cumulatively, GLD gold holdings have now fallen back to the levels they were at when the gold rally started last December. I assume the pattern is the same for other ETFs. It may be significant that even after the reversal of recent ETF holdings bullion is still $110/oz above where the rally started.

The chart below shows the last two and a half years for the Gold Forward Rate (GOFO) as calculated by the London Bullion Market Association. The GOFO measures the interest rate on gold/dollar swap transactions. It's generally positive but when negative it indicates LBMA participants are willing to pay interest in order to borrow gold using USD as collateral.

the last two and a half years for the Gold Forward Rate (GOFO)
Larger Image

This measure is a proxy for how tight the physical gold market is. When GOFO is negative, and its strongly negative now, the implication is that traders are finding it tougher to source bullion for good delivery.

It's not perfect but this indicator has a good track record as a leading indicator of gold price rallies. GOFO was negative at the start of the last few gold price rallies and larger rallies accompanied more strongly negative GOFO rates. The rate is currently near the lowest level in recent memory. It's hard to reconcile mainstream media reports of weak physical demand with GOFO near record lows.

Another big factor in gold's recent price decline was comments in a World Gold Council report that estimated there is 1000 tonnes of gold being used as loan collateral in China. That number freaked the market out, not surprising after recent drops in both copper and iron ore that were blamed on sales of metal held as loan collateral in China.

Is the number accurate? I have no idea and neither do the authors of the study. They made it clear that the estimate was effectively a plug number since there are no public records for this sort of thing. It's possible but that doesn't mean 1,000 tonnes can or will be sold tomorrow or that more than a small fraction is in danger of being sold for that matter.

Gold is not an overextended sector. Steel making in China is which is why I am more concerned about iron ore, and to a lesser extent copper, as collateral than I am about gold. I suspect the true number is quite a bit smaller than the one that made the rounds after the WGC report. Copper has had a decent bounce after loan collateral related selling though is still below start of the year levels.

As expected, March gold imports to China through Hong Kong dropped from the record level last year. There were the usual "gold demand plummets" headlines but the more relevant number is the Q1 total since monthly numbers are extremely volatile. Gold imports by China grew 27% in Q1 compared to Q1 2013. There is still every reason to expect another record year for demand.

We may get an assist from India soon as well. Results of the national election will be out mid-May and everyone expects the BJP to be the winner. Many reports indicate the BJP will ease gold import restrictions. Personally, I have had trouble figuring out any of the BJP economic platform. They have done a brilliant job of promising everything and nothing. It seems that the current restrictions are a reasonable "worst case scenario" for Indian gold demand. Odds are imports by India increase in coming months.

All this should generate a stable gold market, with room for some upside if there are disappointing US stats. I will probably add a couple of explorers in the next issue or two that I'm waiting on technical data for.

It's still a "watching paint dry" market out there. The Venture has had its pullback and stable metals prices should give it at least a bit of lift in coming weeks. Excitement, if there is any, will be reserved for that small set of companies that are promising actual news. As noted in the last issue a broader rally needs a bigger list of active companies delivering real, new, results. That list is slowly growing.

 

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