Europeans view gold as a cash equivalent? August (Q) settle 1551

As we return from the extended weekend, markets had a slight bias to the upside. The main headlines over the weekend included news of capital injections into Spanish bank Bankia, Greece injecting more money (what money?) into their banks, and China continuing to state that it will promote growth (and consequently, as the FT put it, discourage savings). Gold was slightly positive, until mid-day when seemingly out of nowhere, it fell off a cliff. Top to bottom, gold dropped nearly 30 dollars. Why?

The only big headline out at the time of the sell-off was  that Egan-Jones had downgraded Spain from BB- to B with a negative outlook. The Euro got slammed, and as has been the case of late, gold followed suit. Interestingly, while the commodities complex was getting hit, the stock market only sold of minimally. Still I have to wonder; why is this announcement from Egan-Jones a big deal to anyone? Spain is in a lot of trouble. This is not news and it provides no new information. So why do we care?

I have to be careful, because as I write, I find myself tempted to use terms like "supposed to be". The market is "supposed to be" a discounting mechanism. As such, news effects markets because of the perceived interpretation of how it might impact the value of an asset. A company raises guidance, at an unchanged P/E multiple, their stock should rise given expectation of better earnings. The Euro-zone doesn't come to a resolution at an important meeting; the Euro might sell off because market participants become concerned that positive solutions will be harder to come by than had been anticipated. But of course, markets aren't "supposed to be" anything. They are simply markets. Nonetheless, material sell-offs prompted by news that is already known, means that markets are trading off of headlines, even if they do nothing to change the sphere of knowledge that exists among market participants. I could cry about it, or just say what is inherently obvious: Markets react to Ratings Agencies despite the fact that their calls are almost always entirely composed of information that the market is already fully aware of. 
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A friend of mine sent me the following article this afternoon, and it is very telling about the German stance on gold.
(http://www.telegraph.co.uk/finance/financialcrisis/9298180/Europes-debtors-must-pawn-their-gold-for-Eurobond-Redemption.html)


Conclusion?

It's bullish.

I thought the author, Ambrose Evans-Prichard, put it best stating "In effect, Germany would share its credit card to slash debt costs for Italy, Spain and others". The kicker is that Germany would require the countries they helped to put up gold as collateral. We already know that China and India believe that gold is a currency equivalent (if not better). With Germany indicating that they feel the same way, the long term bull case just gets better and better. Still, we are range-bound, and until we get at least above 1600, I see no reason to get your feet wet.

An Interesting Nugget from Art Cashin; settle 1588.7

Over the past few days I have found myself feeling compelled to hit the mute button on my TV multiple times. Few things get under my skin during the day more than the commercial with the AFLAC duck singing to newborn children. As the commercial gets more and more airtime, I take stronger vows to avoid ever buying supplemental insurance from them. The incessant coverage of the Facebook IPO also got to be a little bit much for me. While the IPO and all that came with it is rather fascinating, I just wanted to hear something different. Today, I got my wish in the form of commentary from Art Cashin.

The equities started in the green from the get go today, and extended those gains as the session pressed on. Still, Mr. Cashin was cautious. Tops on Cashin's mind was the topic of distribution days. A distribution day is when you see a broader index close lower on the day with higher volume than the previous session. (For a more in depth definition you can visit the following IBD link http://investdaily.custhelp.com/app/answers/detail/a_id/276/~/what-exactly-is-a-distribution-day-in-a-market-index%3F)

He pointed out that every day last week was a distribution day. How many times has the seasoned market vet seen this? Zero. On a less technical note, the same things that Cashin warned about before the selloff, are what have him concerned now. Namely, he is wary of the potential for spiraling bank run in Europe. It is common knowledge that withdrawals have begun to accelerate in both Greece and Spain, but so far they have been contained. If however there is a panic or scare, a bank run could cause chaos that policy makers simply wouldn't have the power and/or speed to stymie.

In the world of gold we had a rather uneventful day. We reached a 1599 handle but were unable to work through resistance at 1600. We also found support at the 1585 level, keeping us rather range-bound on the day  (fuller analysis can be viewed at Dan Norcini's blog;  http://www.traderdannorcini.blogspot.com/2012/05/gold-continues-its-bounce.html)

July Gold options volatility came in over 2 full vols today. The big data point we'll all be looking to will come next Friday, the 28th, in the form of the employment report. While we will get consumer sentiment this Friday, last reading was the highest its been in years, and that was certainly not a good short term indicator of market direction. As such, absent any unforeseen insanity out of Europe, I imagine we will stay relatively range-bound, and for vol to continue coming in.

-Ben

Kyle Bass, QE, and Japanese Pension Funds (Settle 1591.9)

As I perused the blogs this morning, I saw that Zero Hedge had a link to a Kyle Bass case study on Japan. I decided to take a look, and as tends to happen when reading  about Bass' work,  became captivated. The link is available here (http://www.zerohedge.com/news/presenting-kyle-bass-harvard-business-school-case-study#comments) for anyone interested in reading. I wanted to point out one particular passage at the bottom of page 9 which reads as follows.

"The mechanism Bass had in mind was that as a country attempted to "monetize" the debt, the resulting increase in inflation expectations would push up nominal interest rates, as well as increasing the interest rate risk premium. When this happened, interest payments on debt would have to increase, creating further need for monetization, and ultimately, a restructuring. In arguing this view, Bass cited work by economists Carmen Reinhart and Kenneth Rogoff, who had shown that soverign debt crises often precipitated inflation, exchange rate crashes, and banking crises".

On Wednesday June 20th, at 12:30 we will get the next FOMC announcement, followed by a press conference by Chairman Bernanke at 2:15. The decisions made at that meeting will certainly be based on events yet to come. If we are to see some stabilization in Europe over the next few weeks, one can reasonably assume that nothing except for maybe a few phrases (that we will all overanalyze) in their minutes will change. So is Goldman's call that more quantitative easing will be announced on this day a bet that the next few weeks will be painful? I think so.

I suggested to a colleague that the mere fact that Goldman's Hatzius went public with this call a few weeks back, meant we certainly wouldn't be getting QE anytime soon. Knowing what we do about Goldman, if they were really anticipating such policy action, would they tell all of us? Unless the new "mea culpa" public relations shift among banks is real (Dimon/Blankfein admitting faults and mistakes), it is safe to assume Goldman would be better served to position its own trades according to this thesis. But hey, perhaps they already have the trades on, and are thus already in front of the trade. This call seemed just so surprising at the time, that I felt I had to pay attention to it. Things have since played out in a way that makes me think this call may be real.

 Hatzius has said the following for with regard to the potential for a QE announcement at the June meeting.

"After June the probability goes down. June is the time that Operation Twist is scheduled to end, and that's a natural time to decide whether you want to have a successive program," he says. 

"Our baseline is still that we will see something in the second quarter by the June meeting."
(http://www.newsmax.com/StreetTalk/Fed-easing-1940census-hatzius/2012/04/03/id/434703)

It makes sense that the end of the twist would be a natural time to bring back QE. Still, this reasoning seems too simple. The Fed is running out of policy options. Hatzius knows that. "The end of the twist" does not seem to be a good enough reason for the Fed to enter back into another round of quantitative easing UNLESS it is amidst a backdrop of economic frailty. Namely, a weak stock market. Bernanke has said that the first thing he thinks about when he wakes up is where the stock market stands. It is well known that Bernanke thinks that a robust or at least stable stock market is vital to the recovery. Recent price action has shown a stock market with very little fight in it. Is it possible that the Goldman call was really a bearish call on the stock market? While June 20 is a month (eternity) away, the way the tape has behaved, and the dramatic sentiment shifts (hard to believe consumer confidence was at a multi-year high just a few weeks ago) we have seen set up perfectly for a scenario grave enough in which Bernanke's all in "growth" bet will require some candy (QE) to give the stock market a sugar rush.

It is hard to envision a scenario in which institutions don't buy the stock market on a QE announcement, but that pop might be short in duration. The Bass commentary offers food for thought about what really happens when a debt laden nation engages in QE. The government issues money to buy its own debt. As such, there is more money in the system. More money in the system gives at least two reasons to buy stocks. More money in the system, in theory, will cause money pass through the system at an accelerated rate, promoting growth. Additionally, in a more inflationary environment (which money printing promotes) bond holders will see erosion in the real value of their bond holdings, causing them to reach for growth opportunities (ie equities). The second reason is clearly not going to cause people to buy stocks, as currently the 10 year note yields less than the "2%" inflation rate. But whatever the reason, its QE! Buy! Buy! Buy!

Bass' case study points out a more economically fundamental reason why this should not work. If investors really did leave the bond market, the lack of demand would push interest rates higher.

" The mechanism Bass had in mind was that as a country attempted to "monetize" the debt, the resulting increase in inflation expectations would push up nominal interest rates".

As interest rates rise, the cost of funding our (American government debt) debt increases. If the Fed wants people to allocate their money to the stock market over time, it will have to pick up the slack in demand by continuing to buy treasuries ad infinitum. In our kick the can down the road world, QE will simply drive us further into the misunderstood government martingale strategy inwhich we are all unfortunately investors.

To be fair, Bass' case study relates to Japan, but I believe that the general underlying thesis applies. Interestingly, last week, Okayama Metal and Machinery, became the first Japanese pension fund to invest in gold. (https://www.kitcomm.com/showthread.php?t=104768) Perhaps  government monetization of its debt is a downward spiral for governments as discussed. Regardless, its implementation becomes freakishly bullish for gold. When you see a previously absent player in the gold market decide to get its feet wet to hedge its sovereign risk, especially at a time where gold held support above 1522 last week, it looks more and more like a buy. Incredibly, following what pundits were calling "the end of the gold trade", gold closed up on the week. The volumes and resiliency on COMEX futures contracts shows the metals strength. The aforementioned economics behind likely central bank actions support the bullish case as well.

Gold Rallies, Stocks Sell off; Settle 1574.9

It feels like a long time since we have seen gold up nearly 40 dollars in a day. Making a high of 1579.8, gold was not able to quite make it back to the 81 level it had broken down from. I mentioned last Friday that I suggested a friend sell his GLD because gold trailed off below that 81 level late in the day. As such, trading action tomorrow could be critical for gold going forward. While we dipped as low as 1526.7 this week, a close near 1581 would make us nearly unchanged on the week... hard to believe.

As I write, 15 minutes before the stock market close, I am watching gold holding still at 1573 as the S&P makes new lows for the day. I think the persistent sell off in the stock market makes sense. The risk of contagion in the European banking system is being taken more seriously with every headline about deposits leaving European banks. I woke up today to read about how massive bank withdrawals were taking place in Spain, not just Greece. At a time like this, the "value investor" who snootily boasts of the great value they find in this market because they "take a long term view" has the potential to get crushed. Why is risk greater now than say 3 months ago? Has much changed? Not much and no, not really. So the cheap valuation shopper will use this as logic for why they are buying and not concerned with the erosion of their portfolios. I sure hope no such person would ever manage one of my portfolios, because they clearly miss the point about how perception drives the market.

Perception can be a self fulfilling prophecy. It does not matter if those who are withdrawing their life savings are being silly or shrewd. All that matters is that they are doing it. A few headlines here and there, and the run on the banks can happen so quickly that the situation can spiral before anyone can do anything to fix it. Let us not forget that there are a limited number of tools central banks have at this time as well. Cutting interest rates is hard to do when they are already nil. So stop looking at P/E multiples and comparing them to historical levels. Stop questioning if this is "sell and May and go away". And stop wondering if it is possible that the stock market can really continue at such a steep trajectory to the downside. It doesn't matter. The truth is, the cards are all in place for what historians might later incorrectly deem to be a "black swan" event. If you want to stick your neck out and try to buy the stock market, you well might see yourself up 8% in a very short period of time. But in my eyes, such a play has a very poor risk reward profile.

Why do I keep mentioning the stock market? Because it is the only thing that keeps me from being massively bullish on gold. Over 200,000 contracts traded yesterday (June futures), and gold was never able to even re-test the overnight low of 1527.6. Today, another 200,000 traded (this is very high volume compared to the last few months where you would often not see volumes exceeding 100,000) on a nearly 40 dollar up move. While one would be right to argue that yesterday's volume was on a down move, a closer look at the trading action yields a bullish signal. The lows from yesterday were made overnight, but the bulk (about 2 times as much) of the volume traded during the American session (8:20am- 5:15pm). During our session the range was not as wide, and as aforementioned, found a floor about 5 dollars above the over night lows. Clearly, there is no need to make the case for why today's high volume on an up day is bullish.

Looking back a few posts, I referred to futures trading as a losing game. I spoke to one trader I knew and he disagreed (he makes money). My thesis at the time was that the algos were working overdrive and making trading human vs algo (which is a losing game). The one thing that I recognized at the time that did not fit with my thesis was the volumes given the ranges. The ranges were not particularly wide, but you were still seeing strong volume. When ranges are wider, it stands to reason that stop fishing algos will be more active, because there are more stops for them to trigger. But by that logic, it doesn't make sense that the algos are accounting for the extra volume when the trading range is tight. So maybe there was some real positioning going on. Seeing the support yesterday tells me that trend might be continuing. The algos, were they having their way, would've pushed to see what stops they could trigger below the low. Their inability to do so indicates that there was real buying.

This real buying is why I believe the bull case is building for gold. The reason I do not think it is so easy to jump in, has everything to do with concerns that a lower stock market could lead to forced selling in gold for margin purposes. I am not sure if and what policy responses could be capable of stopping a bank run. And even if a bank run were to be stopped, I question what stimulative measures could possibly be enacted by both Euro countries and the US that would make people giddy about the stock market. If Goldman's Jan Hatzius is right then we will see QE3 at the next Fed meeting in June. But we have a month until then. Even if our fears are quelled about Europe, I do not see a catalyst that would cause a rush of buying other than the notion that again "risk is off the table and stocks are cheap". As such, I see continued risk to owning stocks, and consequently, short term risk in holding gold. That being said, I see no reason to delve into deep conversation about where to get in. It is better to let the market tell you. Anyone could buy at a random level and get lucky, but lets first see if gold can build a base. If we have more days like today, where gold and stocks trade in a near perfect inverse correlation, then we can decide that a pattern has been established, and re-initiate longs. But one day does not a pattern make, and I believe it makes more sense to wait until the gold market signals that it has stabilized before initiating longs.

And it begins... the run on Greek banks

What was a positive day for equities has just gone negative. I won't give numbers, because they're not official; but one thing is clear, its fear of the Greek bank run.

Gold has made new lows on the day, the S&P is down about 6 following a day where they were up as much as 13. Can't blame the Greeks, I would've done the same thing. What is most impressive to me is that the sell-off has not been more drastic. The thesis continues; sell your risk assets.

Greek exit? Gold circa 1557

Following my post on Friday where I suggested the risk reward made selling a gold position reasonable, I was curious to see where gold opened up Sunday night. I saw we opened only slightly lower, with the S&P off about 5 handles. I took a quick look at some headlines and saw it was all about Greece's possible Euro exit. How quickly we've moved. Looking at all the headlines, it was as close to a gimme as you get in this game that gold was going to sell off today.

Do not under estimate the speed with which this market sentiment has changed. Last week Citi raised its probability of a Greek Euro exit from 50 to 75%. Now everyone is starting to take notice. Zero Hedge posted a piece from Citi's Willem Buiter from 2011 (link at end of this post), discussing the potential implications of a Greek Euro exit. What I found striking was the similarity between what Citi was saying then, and comments Art Cashin has made of late with respect to the topic. It is merely that the awareness of such an exit from the Euro currency would cause a run on the banks by Greeks looking to recover money before it was converted. Such a bank run, as Cashin pointed out, could spook the most sickly Euro debtor nations, and cause bank runs there.

Its all setting up nicely for the story the long term gold bulls tell, but I believe there is selling to come. People will sell whatever they can to fund their margin accounts and gold, the so called "broken story", will be on peoples' liquidation radar. We will continue to watch the market, but it is too early to stick your neck out and get long. Those who try to push the market know which way will be easiest to push.....and its not up. The risk reward for being long any risk asset is unfavorable. The "we've been down so many days in a row it has to change" logic will cause a lot of pain. There is something brewing in this market, but you will get a chance to get back in on the way up. You might not be so lucky to exit quickly on the way down.

http://www.willembuiter.com/exit.pdf

Should a long-term holder of gold take profits?

A friend of mine, who is long GLD from approximately the futures equivalent of 1250 texted me this week asking whether he should dump his gold. My answer was that he should wait it out and be patient. Yesterday afternoon I gave him a call and I said I had changed my mind and that he should sell it. Here was my reasoning.

Speed is everything. I am a believer that the direction of gold is determined largely by the difference in the relative speed of the market on down moves as compared with up moves. What does this mean? Right now, as has been the case for some time the most swift moves in gold are to the downside. Is it because someone repeatedly comes in and dumps about 7000 contracts in one fell swoop? Perhaps. But whatever the reason, the bigger sweeps tend to be downward. A trader who sees this in the market is more likely to play from the short side because he knows that if he has a position on and the market sweeps, he is probably a lot safer being short. Over the past few weeks and months we have seen multiple market sweeps of between 8 and 20 dollars. I have often stared in disbelief at the screen thinking my trading system had failed. Each of these times, we have moved downward. A month of profitable trading can be swept away in a second when your talking about moves of that magnitude. Until there is a balance in which way the market sweeps (or simply less quick drastic moves all together), downward movement snowballs because the risk of stepping in from the long side can be that great.

It is not fear of getting caught in a sweep however that made me tell my friend to sell. As a holder of the GLD, he is not playing for 5 bucks the way a futures trader would. To a gold investor, these market sweeps are rather irrelevant. That being said, daily moves are quicker to the downside as well. Gold tends to test the numbers that are obvious. The 1530 area is on everybody's radar, and with the way gold trades you can ascribe a high probability that it will test at some point soon. While I continue to be a believer in the gold story and someone who believes we will probably make new highs in the next year, the likely speed of a down move is too great to risk being long here. My final words to my friend were this:

If we can manage to hold this 1581 number and build a base, then you can always get back in. If the story changes, and the downward momentum stalls, you can note that the environment has changed, and buy back your sales. Given what we are seeing now however, which is all we can really work with despite any long term feelings we might have, being long does not make too much sense. If it is 50/50 as to whether we move up or down next, then you would want to be short, because you will likely get more out of the down move. If I am wrong, and we move higher, I think you can probably buy it back giving up no more than 30 dollars. If we head down to 1530 (50 dollars lower) you have the benefit of watching the market, rather than panicking about where to stop yourself out.
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One thing I have learned is just how hard it is to time change in correlations between markets. In my philosophical mind, I believe that gold should trade inversely with the S&P, as people will once again flock to gold when things are bad. In my practical mind though, I see that gold is trading with the Euro, the Euro has broken 1.30, and the 10 year is now trading with a yield of 1.83%. 1.83% is lower than the stated (and I use the word stated intentionally) rate of inflation of 2%. While practically it makes no sense that we could even be having a conversation about a higher stock market in a world where people will let inflation outpace their income, we just have to accept it for what it is. There is demand for dollars in tough times, and it makes buying gold in dollar terms that much less attractive for now.

The losing futures game

After persistent sell offs for the last few days the market took a bit of a breather today. Futures trading was slow, but surprisingly a solid 125,000 contracts exchanged hands. With nearly 200k the last two, more volatile days, it is clear that volumes are picking up a bit. With open interest still hovering around the 400,000 level, we are seeing days where nearly half of the open interest trades. Need anymore be said with regards to how much of this market is being day traded? I don't think it would be much of a stretch to say that the algorithms are doing a lot more of the trading then the people are. In such an environment it becomes very difficult to trade without keeping wide stops. Yesterday, I had the direction and size of direction called perfectly, and still lost money. Why? Because I kept stopping out only to watch the futures retrace to the levels I was buying them at, and then higher. As I have written about before, the algos are constantly searching for large stops to trigger. As such, in an algo heavy market the probability of getting stopped out is that much higher. Without strong conviction about the markets' direction, the risk reward makes short term human futures trading a pure loser's game.

Charlie Munger "Gold is a great thing to sew onto your garments if your a Jewish family in Vienna in 1939 but civilized people don't buy gold"

http://video.cnbc.com/gallery/?video=3000088395#eyJ2aWQiOiIzMDAwMDg4Mzk1IiwiZW5jVmlkIjoieU10VDJBbWtabDRocG4rRVRNSHRLQT09IiwidlRhYiI6ImNvbW1lbnRzIiwidlBhZ2UiOjEsImdOYXYiOlsiwqBMYXRlc3QgVmlkZW8iXSwiZ1NlY3QiOiJBTEwiLCJnUGFnZSI6IjEiLCJzeW0iOiIiLCJzZWFyY2giOiIifQ==

The above is a video of Becky Quick's interview with Charlie Munger. Approximately 9 minutes and 15 seconds into the video Munger says the following "Gold is a great thing to sew onto your garments if your a Jewish family in Vienna in 1939 but civilized people don't buy gold".

Bullish or bearish on gold, one has to scratch their head and wonder what prompts Mr. Munger to use this reference to 1939 Viennese Jews. We can all go back and forth ad infinitum about the merits of investing in various asset classes, but we should be able to do so in a far more civilized way than Mr Munger chose to in this interview.

Did Mr. Munger intend to come off as anti-semitic in his comments? He will be the only one who ever truly knows the answer to that question. Nonetheless, such comments cannot be taken lightly. Particularly at this time of financial instability in Europe, where socialist parties are gaining increasing popularity and power, it would be historically ignorant to flippantly sweep such comments under the rug. How Berkshire has yet to apologize for such commentary is far beyond me, but I sincerely hope that viewers of this blog do their part to make sure others are aware that these comments were made. Warren Buffet is not simply an investor, he's an American icon. He has been one of America's biggest cheerleaders and has become adored  (deservedly so in my opinion) by many. Charlie Munger's words were not his, but as the head of his organization, Buffet has a moral obligation to come out and denounce the comments his right hand man made in this interview.

Einhorn's Jelly Donut Piece

http://www.huffingtonpost.com/david-einhorn/fed-interest-rates_b_1472509.html

The above is a link to today's Einhorn piece talking about Fed Policy. It's a great read; While Einhorn doesn't like Fed Policy, he is long gold because of the current policy.

Awaiting tomorrow's big Employment Number (circa 1635)

The market's eyes all face toward tomorrow's Employment number. There is a tangible shift in the way in which market is looking at economic data.  Today we saw weekly employment claims come in on the low end of the range (fewer claims) and stocks quickly rallied. At 10am, when the Non-manufacturing ISM number disappointed, the equities went negative and gold got a small pop. The momentum is certainly to the downside here, but tomorrows number can change everything.

As for gold, open interest is increasing everyday (currently at paltry levels) which could signal new longs coming into the market.While I anticipated that we might hold the 1650 level and build a base higher, we have seen weakness in the past two days. Still, I believe the trend will remain higher. With decent earnings the stock market has seemed to lose its steam. A disappointing jobs number tomorrow could really cause things to tumble. If the recent inverse correlation between equities and gold continues, then we can expect a bad number to be the beginning of a gold bull charge....and you might just start to hear the phrase "safe haven" a whole lot more.

Recently (Fed announcement for example) large sell orders come in right before economic data to push the market. If the number is a big miss, a tremendous opportunity to buy gold on the dip might present itself (operating on the assumption that gold picks up a safety bid). While 1625.5 was support last Wednesday, I am hearing 1610 as the first level of support, and 1580-1590 as the next level one could buy it.