Good to be back in Burbank

I came back from my trip, refreshed, and ready to read the responses I got from my letter to the Barron's authors. An empty inbox and a lump of coal in my stocking later, I still maintain high spirits because of my 12 confirmed blog followers. You all keep me up at my lowest moments. But, for those hoping I can show my gratitude by showering you with warm thoughts about gold, I am afraid you will be left disappointed. While I maintain my long term uber-bullish outlook, I just can't come up with the reason to step in and buy it here. Listening to technician Jeff Weiss on TV (I've met Jeff, he's a very nice guy) he warns that we are at a key point in the long term chart on GLD. As he put it, consecutive closes below 150 could be a real warning signal. So, for now, assuming we hold, perhaps we can make a case to buy. But unless we see that, you are working with significant downside risk, and little compensation for your upside.

Let's take a quick look at the story as its shaping up, and why I can be a short term bear and longer term bull. Gold is currently not a safe haven. I had thought that we might see gold regain its safety bid as the European crisis pressed on, but it looks like the dollar will steal the show. Despite an uncertain backdrop, sentiment has become more positive particularly with respect to US equities. All I seem to hear lately is how cheap US stocks are, how much cash the companies have, and how Europe has not brought down the US story. While some 40% (rough number) of S&P earnings come from Europe, optimism is maintaining strong footing (for now). But whether there is to be a pop in equities or not, our 10 year is still below 2% (even after our rally). My takeaway is that good stock market or bad, people want to have their money in US treasuries. I cannot say why, or that it makes sense, but that has been the trend and it has shown no signs of breaking.

The problem for gold is that the stronger dollar makes dollar denominated gold cheaper. If it is not perceived as a safe haven, than it will be difficult for gold to counteract the dollar's bid. But gold is an inflation hedge right? As my unanswered email points out, right now sentiment is not inflation fearing; rather the opposite. While we all know this is crazy, particularly given the mysterious rapid expansion of the ECB's balance sheet, for now, the environment is not inflationary (I have trouble writing that and believing I'm writing it). And besides, with this recent fondness for US equities, people will go with stocks instead of gold to counteract inflation.... especially with the expectation of continued dividend payments from cash rich stocks. Remember when gold was at 1200 on the way up and it seemed there was no downside scenario? If things were bad, gold was the safety play, if things got better, we were still printing, and that was good for gold. Now gold is in the exact opposite place. Nothing is good for it. If things are good, you'd rather be in equities. If things are bad, you'd rather be in treasuries. But this can't persist forever.

Treasuries do not have their best days behind them. Treasuries are the new gold, but that, like golds endless run up, will come to an end. If Kyle Bass knows anything (and we know he does), and if it is an indication of the systems fragility when we see as we do now that European banks are no longer lending to each other (and we know it is an indication) then we know that the likelihood of a liquidity crunch is high... and then? Print Print Print Print Print Print Print. If gold keeps getting smashed, it is highly probable that it will be at relatively depressed levels at the same time treasuries lose their luster. Then, the gold bulls can come back to the rodeo.

The Critical Market Perception... not if to delever, but whether to inflate or deflate

On the train out to Long Island this morning, I picked up this week's copy of Barron's. A lot came to light following just the first two pieces I read. Below, is a note I wrote to the authors, Jacqueline Doherty and Andrew Barry, of the second piece in this weekend's edition. The first, which I contrasted it with, was written by Alan Abelson. Below, is the greater part of the note I wrote to them. It speaks for itself.

Jacqueline/Andrew,

I wanted to write in response to the first part of your piece in today's Barron's, where you describe QB Asset Management's view of the pending "Face-Ripping" inflation. I thought it was a great touch (though I'm not sure if it was intentional) the way your piece directly followed Allen Abelson's recap of his conversation with Dave Rosenberg from Gluskin Sheff. Never do I think I have read two sequential articles show such stark contrast in thought. Mr. Abelson's piece concluded with deflationary outlooks, while yours began introducing the possibility of rampant inflation. The funny thing is, both the Rosenberg and QB outlooks are very reasonable arguments. However, I think we would be remiss to overlook this as a funny coincidence. Rather, we should recognize that this contrast in outlook might be an example of the most important debate to determine market direction in 2012.

Mr. Abelson writes in summing Rosenberg's thoughts,"it {"extinguishing debt"} will be accomplished by a combination of default and write-downs, debt repayment and rising savings rates. All of which, he warns, will tend to be very deflationary". In your article, you point out that "the QB duo is convinced that central bankers will start printing money to pay off public debts and keep the banking system solvent". QB makes a good case for just how hyper, hyperinflation could get by pointing out that "the system's base money (bank reserves at the Federal Reserve and currency in circulation) is dwarfed by the claims on it. When I Contrast the deflationary and hyper-inflationary cases that both sides make, I am more struck by the similarity in their tone than the difference. Both Rosenberg and QB are believers that an inevitable "face the music" moment with our over-levered system is soon coming. What they disagree about is the likely policy response the world will take when we get to that fateful moment.

The need to deal with this situation is looming imminently upon us; both QB and Rosenberg agree. But, will it be through the pain of taking our lumps to pay off these vast sums? Or will it be the money printing party that enables us to pay back our debts with money that is worth far less? Either way the deleveraging is taking place. And here we meet the fork in the road. We are forced to make a decision about whether we think it will be inflation or deflation. Last week's gold beat down really began following the uneventful Fed announcement. With few changes from the previous release, QE3 thirsty investors were apparently looking for some hints at stimulus. No easy money, gold gets smashed. And nothing really happened. As ridiculous as it is to expect QE pre-US recession (if there is to be one), last week showed us just how fickle the market is. Without a "hint" in the language of the Fed, that we "might" get some easy money on the horizon, and gold prices (which are highly correlated to inflation expectations) plummet. I think your article, contrasted with Alan Abelson's demonstrates just how central the market perception of inflation vs. deflation is to the world of capital markets.

Wrong on The Vixx

I got this one wrong; The vixx has continued to stay at depressed levels. While I continue to believe that this lull will likely end soon, and with a strong spike, for now the timing in my call looks pretty poor. If however, I were a money manager, I would be loading up on puts on the S&P. My stock market bearishness, which has now been here for some time, was only made stronger by reading Kyle Bass' December letter to investors (http://www.scribd.com/doc/75784106/Hayman-Capital-Letter-Dec-14). It is worth a read. A focal point of the letter is how investors' counter-party risk concerns are such that they would rather give up the yield they could attain by parking their shares at banks' for prime brokerage use (the banks would lend those shares to other clients looking to borrow stock) and put them at third party custodians. This lack of trust is the natural beginning of the de-leveraging process, one that even central bankers might not be able to contain.

Gold didn't quite plummet  100 dollars on Wednesday, but it came awfully close. As has been the case, the sell offs in gold are pronounced, while the rallies are slow. Today, we are seeing gold continuing to rally nearly every time it comes into the 1590 area. So what happened to the gold story? The problem for gold right now is that we're in a deflationary environment. The market wanted QE3, but didn't get it. Europe hasn't indicated that they will print money, and for now, that will keep a lid on gold. Eventually however, the story will change. When push comes to shove, the European countries will have no choice but to print, and inflationary pressures will re-emerge which is positive for gold. 

I will be away for the next week, but will be getting back to it upon my return. Everyone have a great holiday.

-Ben 

QuEstionable rumor

Trading near unchanged for the greater part of the morning, gold rallied 7 bucks in about a minute. A rumor that today's Fed announcement would involve hints of QE3 got people excited, as it should were it to have had any merit. I have noticed (though I believe the last reaction was pretty much null) that even if there is fairly bullish news, traders tend to sell gold after the announcement. Buy the rumor sell the event I suppose. Today's drop, while not precipitous from the outset began to really pick up momentum. 

The Fed announcement, which was made a little bit after 215 last time was actually made early today. So not only do we tend to be wrong about what the Fed will say, we can also be fooled about when they'll say it. In all seriousness, if you have a position on, its worth being by your computer a few minutes before the announcement. Why such a rumor would get out, or how it is possible that anyone with any inside knowledge would spread such a rumor is beyond me. But what is even more beyond me, (and I recognize I have hindsight here, but I have said this before) is why the Fed would ever make such a move now. Without anymore room to lower interest rates, and an increasingly small bag of tools left, it would seem that the Fed would probably rather wait until something got really bad, before it broke out the big guns.

Pre-announcement, Gold, which has been getting trashed like no other of late, was trading 1663. It then continued lower coming into the 1636 level, which is the 61.8% Fib retracement number (a number traders watch closely). As would be customary, bids came in at this level, pushing gold back into the low 40s, before it broke 36, trading as low as 1625.5. I thought we had a shot at 1617 (the approximate 200 DMA in gold) but apparently the selling had reached a temporary climax. we ended the session around 1634.

3 quick noteworthy points:

1) Dennis Gartman has liquidated his personal holdings in gold. This is no reason for hitting the panic button, but so far (very short term) he has been right, and the fact that gold has under-performed so much of late must keep us short term bearish. To put it simply, it just doesn't seem like anyone wants to buy gold (though the exception is there has been persistent demand for the physical... particularly from India of late)

2) The S&P closed below 1225. Last time we came tumbling down, the S&P was unable to make a close above 1225, which signaled a downward move. A close below 1225 tomorrow would be very bearish.

3) And 3 is less of a point, but do you ever wonder if maybe we haven't grown accustomed to Angela Merkel the way we should in America? Everytime she says something negative, like today, when the pop from the QE rumor halted post her comment they would not raise upper limits on the bailout fund, we sell off. While I am no German political expert, it would seem to me that Merkel uses the public sphere to help her gain leverage in negotiating. She always seems to say "no" to new proposals putting a damper on short term euphoria. But wouldn't it make sense that she's just doing that as a base position from which to make concessions such that some less extreme version of whatever is on the table gets done? Fool me once... Fool me two times... It feels like we are all fooling ourselves constantly and not learning from the same old tactics. No wonder Merkel says the things she says.... we actually keep listening!

As a final note, my "buy the dip in the Vixx" was looking pretty awful today though it stormed back as the vixx closed only slightly lower today. As stated in my second point, A close below 1225 tomorrow should definitely have that trade in the black.

Yes, the week really is over

Having not written since Monday, I realize that doing a recap of the whole week is impossible. Why? Because with all of the different things we hear out of Europe, it is hard to remember what happened 20 minutes ago. Wednesday afternoon around 3:30 the rumor re-emerged that the G-20 nations would be providing a 600 billion dollar bailout fund for Europe. About 20 minutes later, we learned that this was a false rumor. And you wonder why volumes are low in equities? Why would anyone try to trade a market like this when a solid fundamental thesis based on "facts" can be derailed by our trusty news anchors reporting falsehoods?

Rather than regurgitate the thousands of news headlines and try to make conclusions (I'm hearing desks with resources and personnel far more robust than me aren't trying either), I'd like to point a few things out that I've seen. First, the divergence in gold and equities for most of the beginning of the week reminded me why I didn't name this blog after an equity index. It is possible to see gold and equities trade differently. The more divergence we see the more long term bullish this should be for gold. Gold bulls are generally not those who believe that the world debt problem will finish in a soft landing. If gold remains correlated with equities, and the world debt bubble bursts painfully, then gold will go down with the equities. As we start to see divergence, we are more likely to see gold re-emerge as the safety play that it once was.

Earlier in the week (Tuesday I believe) I kept hearing about how people were liquidating gold to fund equity trades. Gold did sell off hard only to rebound back above 1750 Thursday morning (before selling off hard again). However, I'm not sure that this thesis had too much in the way of accuracy. With so many investors in cash, selling gold wouldn't be necessary to finance trades. Additionally, there was no tactical reason to go long equities/ short gold (at least none that I heard expressed). And how could there be a pairs (short one long the other) trade when they had been so correlated? I wish I could say there was more of a story to it, but for now, I'm just happy to see that the two are not trading completely in step.

Everyone was sitting on their hands waiting until today's EU summit. Perhaps unprepared for any early negative news, we learned yesterday morning that Draghi (ECB president) was (for now) not encouraging sidestepping  rules regarding money printing for the EFSF (bailout fund). I, like many, was a believer that since the ECB legally can't print money and hand it over to the bailout fund, the simple fix would be to hand the money to the IMF who would then hand it to the bailout fund. In the lawless land of Europe, it seemed to me, and apparently a few others, to be the logical 'legal' step. Draghi saying that this was not in the plans spooked the markets a bit. Gold actually got hit harder than the equities, trading from a high around 1760, gold made a low of 1707 (a nice 50 dollar plunge). Gold was trading 1727 and plunged violently to make its first low on Thursday at 1711.7 in just minutes. As has been the case for some time, the down moves in gold tend to be rapid while the up moves are more contained.

In an interview a few years back at B of A, the interviewer asked me to discuss my thoughts on the market/ trade ideas. Without much thought, I responded that I would buy volatility on any major dip. The thesis behind the trade was simply that throughout the financial crisis, we saw that volatility always spiked after a lull. In a headline driven market, one stimulus package or sign of unity among congressmen could put the markets at ease temporarily. But we were always one headline away from panic and massive influx among traders looking to protect themselves with options. As such, We're at a point where the S&P has failed to break the 200 Day Moving Average at 1264. Until we go above, it is safe to be short (a tight stop considering we're settling about 10 handles away). Vol will get bid if the trend of the market is down. For now, we're happy with Europe; trust me, soon we'll be panicked again. And then we'll be calm when they pacify us, before the pattern repeats itself like it has for months already. Buy the dips in volatility. It simply takes too little in this environment to trigger panic to not be long S&P puts.

What is the role of a rating's agency?

Today S&P (The ratings agency) put 15 Eurozone countries on negative credit watch. Friday, December 9th we are looking to hear what the EU summit comes up with as far as plans to fix the Eurozone. A friend of mine suggested that perhaps this was their way of putting pressure on the EU to make sure that it comes out with something concrete on Friday. While such a pro-active stance in the markets is probably not what ratings agencies are for, it seems to be the only thing that could've possibly prompted such a negative outlook. It is not as if there is new information that S&P has provided that changes the picture in Europe. Nothing is any different today than it was yesterday, so this negative outlook might as well have been made weeks ago. Without any materially new information, one has to scratch their head and wonder if there is any reason to pay any attention to the reminder of already-known information.

Unfortunately, part of the reason we have to pay attention to the news is that funds have mandates about the types of securities they can invest in according to the ratings that S&P among others put out. For instance, wealth managers might have an agreement with conservative investors that they will only invest in AAA rated securities. If a security that once had a AAA rating is downgraded, the portfolio manager may be forced to sell out. So it is a self-fulfilling prophecy. Now, while we can only hope that any PM managing a conservative portfolio has steered far clear from Euro sovereign debt (because it is not conservative regardless of rating) the fact that Rating Agencies' ratings are used as a barometer for eligible securities in a portfolio requires that we at least open our ears when they talk. The S&P dropped about 14 handles peak to trough after the news, but closed the day higher. Still, we did not manage to close above the 200 DMA on the S&P, though we did hit it intra-day.

While I tend to focus on my negativity toward Europe, it is important to note that there has been a real shift in sentiment towards the sovereign crisis. We are certainly not out of the woods, but there has been, starting late last week, a rally in the Euro sovereign bonds. I have mentioned previously that while equity markets have rallied, the Euro sovereign debt continued to drop. The debt generally tells the more important story as stocks can rise in an inflationary environment even if the economic backdrop is ugly. We have seen a rally in both bond and equity markets, indicating there is some actual positive (or better put less negative) sentiment surrounding Europe right now.

The home stretch

"There is no such thing as reality; there is only perception in trading". These words, recently said in response to my maintained bearish stand on the markets due to the unchanged nature of the Euro sovereigns, ring so true at a time like this. As mentioned in Wednesday's post, the liquidity program the central banks agreed upon does not solve the sovereign problem, it merely makes it easier for banks to stay afloat. Few would dispute that my last statement is accurate, but so what? If our perceptions are warm in feeling, and we want to buy up the market; we will. So bearish reality sustained, is this the time to buy for a quick upside profit? Let's look at a few of the things that I think play out in making that decision.

1) approximately 1250, is the number that gets the S&P to even on the year. With the Cash S&P settling below this number on Friday, we saw an inability to follow through into positive territory on the year. But O well; market sentiment has changed. Lots of bullish sentiment grew this week after a great slew of US economic numbers. So we could get a follow through on Monday, and the chase begins when we get into positive territory. The hedge funds down on the year do not want to see the S&P go positive while they're un-invested. They don't want to face potential redeemers and have to admit that they were down in a year that the benchmark was up. So if we go positive, some sidelined money could really pump things up. It would be like a short covering rally...only in the case its uninvested money that feels it can't afford to be anything but long (and probably in a levered way). This is the great bull scenario.

2) The VIX is lower. The vix, which is a short term gauge of volatility on the S&P, has remained low. Closing below 30 for multiple days, we are seeing a market that doesn't seem to be signaling that it feels the same desire for downside protection it did just last week. This great article by Daniel Putnam http://www.investorplace.com/2011/12/two-possible-signals-from-the-vix/

takes a recent look at the historical trends in the VIX and how it correlates with the market. Read the article for full understanding, but his overall point is we are reaching levels that are generally signaling a short term bear move, but if we stay below 30 on a longer term basis, it will be a signal of a rally to come.

3) In the near short term (next few days) no big news is due out of Europe. We could easily hover here for a few days until big news comes out.

How do you reason all of this and try to make a trade? The funny thing is that as I reread it, it seems that the bull case might be the better one. If you subscribe to my argument that above 1250 could mean its chase time, then the bull move will be swift and strong. I don't know what the magnitude of a move below here would be, but we can feel pretty confident that if the market goes up, it will start to accelerate in that direction. So if you had to choose, long or short right now, you might say you're 50/50 on whether we're up or down; and if so, then you should be going long, because your upside is more probably more accelerated than the down.

Still, I maintain a bearish stance on the market. For historical reasons listed in the Daniel Putnam article above, we are probably more likely to move down in the short run. We also weren't able to close above 1250, and while the Dow is above, the S&P still hasn't broken its 200 day DMA (daily moving average) to the upside (it is around 1265 as the image below shows.

(also note all the chart congestion from November around 1250... This should make for more resistance, making it tougher to rise above.

And lastly, how could I not discuss the muddling US congress and their likely stoppage of life upcoming. Sentiment which was as good as its been in a long while late this week, got a little more sour when it came to Friday afternoon. The Republicans indication that they would block bills enabling the IMF to fund Europe could slow things down and bring this little party we had for the past few days to a halt. I take it so seriously because we're coming up on an election year, and we already know how ridiculous the political posturing can get. Notwithstanding, this is more than just a political issue for politics; this one actually matters. Discussing "bailing out Europe" will be an easy brand job for the Republicans opposing giving the IMF power, helping them cater to republicans voters who hate the concept of bailouts. This issue is almost too good for the republicans to stand on, because it can lead as a conduit to discussions about all the other financial failures that have taken place under the Obama administration. Fool me once shame on you, fool me twice, shame on me. There's going to be a lull period here, and some of the jubilation may naturally cool off, or will be forced to if the republicans really go hard on this point. America contributes 17% of the money that goes to the IMF... how hard is it to say "Don't bailout foreign countries... use money for jobs here in America. "Oh I can almost see they wry smile on Boehner's face as he tears up because it just sounds so good. I'm happy to say that being short makes plenty of sense for now.