Gold Makes A Bottom

"We need only take our heads out of the sand to see clearly that interventionism not only has failed to provide the promised something-for-nothing, but has led to all sorts of undesirable consequences. Indeed, many are just beginning to realize that we are moving towards disaster even though we have been on a wrong heading for decades." - Leonard Read

The speculator attack on gold that was endured over the last few months was tried again recently but the successes were limited and the result was that the gold price did not test the previous lows.  Since then gold has consolidated and has been slowly rising from the dead.  The massive short positions held by speculators will need to be unwound and this should result in another positive move for gold but outside of the trade why should gold go higher?

With the continued money printing from America, Britain and Japan not working it is clear that investors are turning once again to the metal as a store of value.  It is also a sign of fear.  As was seen last week with the sudden drop in the Nikkei, money printing can only hold a market up for so long and when the bottom drops it will be fierce.  This fear of market manipulation and the expectation for inflation is showing up in physical demand for gold and this is putting the brakes on any speculator lead attack.  Furthermore, as I have mentioned, speculators have a very short timeline and once that timeline draws to an end they need to close out their positions.  Now if they do a good job and manage to create a market panic then investors start to dump their positions right at the time the speculators are buying theirs back.  As the speculator is buying back their position into a weak market they make a small fortune on the trade.  Alternatively, if the market does not panic they are forced to buy into a strong market causing a massive spike in the price.  As investors did not panic and are buying physical gold in ever larger quantities I am expecting the latter to play out relatively soon.

One trader that I follow closely is Peter Brandt, a commodity trader who has successfully traded all commodities for years.  He has his hand on the pulse of the commodity markets and made a good amount of money betting on gold's decline.  I was therefore very interested to note that the other day he tweeted that he felt that the next major market bull move would take gold to $17,000 an ounce!  Now I am not sure how he came up with that number and I cannot fathom gold that high, but I do expect a massive run in the price of gold and advise you to take advantage of this move.

If you do some research you will find that gold stocks have been pummeled a lot harder than the drop in the gold price so I would start your research with them as to me they have hidden value that is greater than buying the physical commodity.  One thing to be warned of is that while gold is a very volatile commodity, these stocks are even more wild so if you do invest make sure that you do not get shaken out as you will then end up being speculator lunch!

Japan's House of Cards is Toppled

"The difference between playing the stock market and the horses is that one of the horses must win." - Joey Adams

On Thursday this week the Nikkei, Japan's main stock market index, tumbled 7.3% in one day.  It was the biggest one day decline since March, 2011, when the Tsunami hit Japan's coast.  Up to that point Japan's market had been on a one way tear higher, up over 45% year to date and 70% since November.  The reason for the massive stock appreciation was due to the enormous money printing efforts of Japan's central bank (sound familiar).  On Thursday however weak economic news out of China which imports a lot of Japan's products spooked investors and set off a spiral down.  Friday saw a slight recovery of 3% but during the day the enthusiasm waned and the market ended essentially flat. 

For me this week turned out to be a pretty good one due to my shorts on the Japanese stock market.  I had placed these shorts a month ago expecting some form of a significant draw down in the market and was rewarded for my investment.  That said I have reduced the short as I have no doubt that all hands will be on deck next week to try to rally the troops and take the Nikkei back higher.  Once again, as with the United States, the success of all the government intervention has been essentially limited to a rallying market and so with this one trophy in their cabinet, there is no way that they are going to let one poor day spoil the party.

Whether they will be able to drive the market higher or not is irrelevant because what is abundantly clear is that the market is teetering on the edge of a very sharp blade.  One slight gust of wind will be enough to send it into a tailspin.  The sell off certainly spooked global markets but for the time being it appears that the issue has been contained however if there is another one it could topple the house of cards.  As we witnessed it will not take a lot for investors to run for the exits and right now the only thing preventing this is more money being thrown at the problem by central bankers.

This contraction gave a clear indication that when the confidence in the reserve bankers of the world wanes, the sell off will be sharp and ruthless.  There will not be many stocks left standing as speculators rush for the exit.  The problem is that there is only one exit and with everyone trying to squeeze out of the door at the same time the last person will take the brunt of the hit.  Do not let this person be you.  See the warning signs and make sure that you are already out of the door safely before the alarm bells start to ring.  You have seen the smoke now don't wait for the fire to appear.

OIl - Could It Be The Game Changer?

"Let me tell you something that we Israelis have against Moses.  He took us 40 years through the desert in order to bring us to the one spot in the Middle East that has no oil!" - Golda Meir

The Platts Annual Crude Oil Summit was held in London recently and the projections from the conference are incredibly interesting in particular as it relates to global growth and the outlook for the United States' global military footprint.  The expected trend in oil production could have a significant impact on how the world models itself in the coming decade and it gives the United States a wonderful chance to get its finances in order.  The question is will the opportunity be taken or lost?

The most amazing chart to me is the one below showing the expected flow of oil exports and imports.  In years past the heavy blue line would have been pointed directly at the United States but now that the oil found in the shale estimated to be a whopping 7.4 billion barrels, by 2018 it is expected that the United States will only be importing 3 million barrels a day.  This is down from a peak of 10 million barrels a day in 2005.

So most of the global oil production and particularly Middle Eastern production will be moving to China and this will change the global landscape tremendously.  First of all the United States will be less concerned with protecting its oil supply in the Middle East.  The United States has already limited their import to just a hand full of countries and this will more than likely shrink over time.  At present over 70% is imported from Canada, Saudi Arabia, Iraq, Venezuela, Mexico and Nigeria and this number should fall further allowing the United States the opportunity to pull back from its overextended military presence in the rest of the world.  At present the US spends $680 billion a year on its military (this does not include war expenditure and assisting veterans which takes the number a lot higher) and this number could be slashed closing the budget gap.

Second with more and more oil being sent to China it will become more common for payments to be made in Renminbi rather than dollars.  This will create the platform necessary to turn China's currency into a major global currency and will begin the demise of the dollar as the globe's de facto standard.  While this will be welcome in certain parts of the world it will have an impact on the United States' ability to finance their large budget deficits.  The simple reason is that if China is seen as being a global heavy weight then safety may be found outside of the US reducing foreign capital to finance budget deficits.

Third there is a chance that the oil market itself will become more regional much like the natural gas market.  So for example oil produced in the United States and used in the United States will command a different price from Middle East crude shipped to China.  As one of the main drivers of inflation is from oil inputs, if the United States can supply much of its own demand then inflationary shocks from limited oil supplies outside of its borders will have minimal impact on inflation.  This insulation would allow for a more stable inflationary platform from which to grow an economy.

Fourth is that the trade deficit will shrink and could even move to a positive number.  A trade surplus would be very welcome and would allow the country to reduce its reliance on foreign investment to finance deficits.  This is one of the reasons that Japan has managed to continue to raise its level of debt while remaining solvent (a situation that will more than likely reverse with the final push by the government to spend more than they should on wasted projects).

Fifth is that the wealth that will be created in the build out of mining operations and the subsequent revenues generated from operations will provide a nice boost to GDP.  On the back of this will come some much needed tax revenues which should help to shrink the budget deficit further.

All of this is positive news and gives the politicians another chance at repairing the economic damage but the main question remains, will they take the opportunity presented or once again squander it?  I am hopeful that the size of the opportunity is so large that even our lost leaders will not be able to destroy this opportunity.  If in fact they continue down the path toward fiscal austerity then this economic boost will be felt and could once again put the United States back in the pound seat in terms of an economic super power.  Furthermore as the country becomes more and more insulated the pressure will finally be off to police the rest of the world and that should help with national security which would be worth its weight in gold!

A Man Named Soros

"Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and and betting on the unexpected." - George Soros

"Once we realize that imperfect understanding is the human condition there is no shame in being wrong, only in failing to correct our mistakes." - George Soros

George Soros, the Hungarian born investor, is an industry icon.  He has called more investments correctly than incorrectly and when he wins he wins big.  This ability to invest on the right side of the market has created enormous wealth for him and his investors.  He has also given away more than $8 Billion to philanthropic organizations over the years and is still active in his company at 83 years old.

One of my friends happens to have a direct link to Soros and has commented to me that while I continue to expect the market to fall precipitously, Soros has continued to enjoy the fruits that the market is producing for him.  His thought is that as long as the central bankers of the world continue to print money unabated, the stock markets around the world will continue their upward spiral.  I happen to agree with him to a certain extent but the issue is that most investors are not as shrewd as Soros and will be taken to the cleaners when the market capitulates.

There is a famous story about Soros that occurred many years ago when at a meeting of the top 10 traders in New York each trader put forward their best trading idea.  Soros spent his time explaining in great detail why his best trade was to be long the US dollar.  Other traders put forth their ideas and the last person to go was the newest member to the group.  He was very intimidated and did not want to say what his trade was, but under duress he confessed that he was heavily short the United States dollar for the many reasons that he then described.

The next day he woke to find that the dollar was being pounded into the dust making him a lot of money.  His thoughts turned to Soros when suddenly the phone ran and it was Soros.  Expecting to hear a sob story from him he was surprised to find George in a very good mood.  Soros then explained that after listening to the trader that he realized that he was wrong so he had switched his position from long to short and was also making a fortune!

The reason for the story is that while I agree with Soros in the short term the trade is becoming more and more dangerous with every tick higher.  For the average investor who gets wedded to a position or just blindly adds to his or her mutual fund it is not the time to go all in but if you have the ability to trade the market there may still be some upside left but be very careful.

Another All Time high

"Experts often possess more data than judgement." - Colin Powell

One thing I try to do when I review data is to make sure that I am not fitting the data to my hypothesis as doing this would play right into the quote above.  This week I spent some time looking at data from the S&P 500 stocks.  These companies are the 500 largest represented on the United States stock markets and they command a huge slice of the economy.  In addition as the economy seems to be skewed towards the larger capitalized businesses this group should be performing well to drive the stock market to its new highs.

I looked at the historical company earnings as company earnings drive stock prices.  I then created two charts that show the relationship.  As the most recent quarter's numbers are not yet completed I could only take the study to the end of 2012.  Each chart shows the trailing twelve months earnings per share for the S&P 500 in blue and the S&P 500 stock index in red.  The first chart goes back to the year before the bubble burst (2007) and the second looks at earnings from December 2011.

As you can see in the first chart the blue line (company earnings per share) is falling while the red line continues to rise.  When I drill into those numbers a bit more in the second chart you can see that the fall off in earnings per share is relatively steep while the market trajectory continues unabated.  The obvious answer to the market's continued trajectory is that investor expectations are that this is a short term lull before earnings once again ramp up.  However at just past the half way mark through the earnings season it is looking like earnings may not grow.  Worse than that only 44% of companies that have reported have beaten their revenue projections.  So while a number have beaten their earnings numbers, these numbers are being squeezed out of a shrinking lemon.  As an example IBM missed revenues by $1.3B!

Today however the market is higher by more than one percent to fresh all time highs on the back of some decent looking employment numbers.  As I have mentioned repeatedly the economy will not get into its stride until the employment picture improves so on the surface it seems that the market has what it wants (in order for earnings to accelerate, revenues need to grow and this will only come from the consumer).  More jobs means more spending and after a decline in retail sales in March, the market is buying that this will mean a resurgence in spending in April.  The opposite is likely as most of the job growth came from part-time workers.  In fact the average number of hours worked per  week fell.  If the savings rate resumes its normal level of 3.5% it is likely that April retail sales will decline for a second month.

This is not good news for a market that is buying future growth however once you have taken a sip of the juice it is hard to see straight.  Further with the tail wind of continued government stimulus there is no reason to think that the market will drop any time soon (tongue in cheek as you should know by now)!  This is precisely why I am not long as this is exactly what it felt like in 2000 and again in 2007.  I remember all too clearly the pundits applauding more stimulus and a forecasting the Dow at 20,000 in a few years and it appears to be more of the same but looking at the two simple graphs above the earnings signals are clear. 

In addition margin accounts at brokerage companies are once again at levels not seen since 2007 right before the market crashed so as painful as it is to watch I have stepped aside.  This is the only prudent thing to do if you have data to validate your hypothesis and you have ensured that you have not manipulated it to fit your theory.