SBM’s Xmas party, a cataclysmic week for gold bugs and the “inflection” point

Well, last Thursday, the crew of SBM’s contributors partook in our very first Xmas lunch. As collective Indian food fans (which invariably are really Bangladeshi!), we happened upon the new restaurant Gymkhana in Mayfair (only the best for the SBM boys!) and a merry old afternoon was had by all which involved indulging in some rather fine bottles of wine… Only issue was my poor old head as the day progressed – once you hit that 4-0 mark, sadly the ability to process alcohol efficiently seems to diminish dramatically…

Of course, as collective stock market die hards, the conversation inevitably turned to where we each think we currently are in the market and it became apparent that I, and I alone, was the only real gold die hard amongst us. Dominic Picarda put up a strong technical case that the path of least resistance now remains down, whilst good ol’ Zak produced (as you do, mid “posh” chicken tikka) a couple of charts (see blog here –  http://www.spreadbetmagazine.com/blog/zak-mir-on-gold-and-silver-1.html ) arguing also for a continuation of the downtrend. Trading Academy winner John Walsh was probably the most “on the fence” although I do hear that his “Rolex challenge” is progressing nicely – see the next edition of our mag due out end next week for an update on this!

So, it was down to poor old me to sound the last horn for the gold bugs in the face of more negative price action. I pointed out that the news in recent weeks has been, to me, universally positive for precious metals holders – talk of negative interests for banks in Europe, largely softening data out of the US, the de facto rubber stamping by the Senate of uber dove Ms Yellen’s appointment to head the Fed (more on here also in the next edition of the magazine) and so likely more money out of thin air… Still, even I have to admit that the chart of gold is telling a different story though.

It is at times like this when the fundamentals seem to paint a different picture to the technical that it pays to re-test your stance. Which one should you go with? There is presently much talk of manipulation in the gold market which, I have to say, I am personally am a little sceptical of. The investigation in London into potential manipulation will be interesting to see what the findings finally are. Sure, the heavy volume smack downs in recent months, and in particular the shakeout in April raise eyebrows, but I doubt if the finger pointing at either the Squid or Morgan Stanley is based on solid foundations (who’d have thunk it – for once I’ve come to the aid of the muppet killer?!!).

Could there be an ulterior motive or concerted action to suppress the gold price by powerful banks and/or the US Federal Reserve? Never say never, and indeed the continued strong demand for the physical form of gold relative to continued paper weakness is difficult to square. The jury remains out but at the end of day, the 3^rd immutable universal law remains – “you can’t buck the market” – if there is manipulation, like all manipulators before, the market will ultimately find its real equilibrium and those trying to suppress the price will come unstuck.

What is the real equilibrium price of gold then? From a technical perspective, there is the possibility of a move back down to the $1180 – $1,200 /oz level and that should again provide strong support. There are no guarantees regarding price ever – particularly in the short term. What we must bear in mind though is that gold production will almost certainly fall at prices below $1,200/oz as it becomes uneconomical for many gold mines to operate profitably. In South Africa, no longer the world’s largest producer, (which is now China) but still a major producer, there are estimates that 36% of the South African gold industry are loss making even at today’s spot prices – $1,250/oz. The most recent data revealed that 28% of the South African gold industry was loss making based on a gold price of $1,330/oz. At a sustained sub $1200/oz price I highly doubt that the banks and/or shareholders will continue to pour money in to economically negative ventures (actually, I’m not so sure as they seem to do that with the likes of Twitter!!)

Gold 2 year daily chart

On the counter side to the bearish technical picture, November, December and January are traditionally strong months. The latest COT data also shows an increase in small speculator shorts (“dumb money”) back towards the highs seen in late June this year and that sparked the near 20% rally over early summer. Commercials reducing their shorts is a continuation of the positive signs seen in recent weeks given their moniker as the so called “smart money”.

It is certainly hard to be a bull of gold and gold stocks right now  that’s for sure – out of all our guides on this website the least popular is the gold mining stocks one, fellow industry participants (particularly the younger ones) tell me the only way is down and our Titan Precious Metals fund has proved difficult to garner any real capital – all great contrarian signals. Throw into the mix ever cheaper valuations of many of these stocks, with great swathes of the global gold mining spectrum nearing the 90% peak to current decline level then for those of a value inclination in their investment (the ONLY method that works long term), these continue to be the classic signals of bottoms. Of course, what very few realise is that bottoms take time to form. Price action confounds and very few people, aside from the experienced players and “smart” money managers have the ability to override the basic human emotion of “flight” (as opposed to fight) in the face of seemingly perpetual falling prices. Think about a stock market crash – the vast majority sell near the bottom and very few actually buy.

With news of continued ETP gold sales and the anecdotal evidence of the sector being almost universally hated, I am sorry to say to my lunch fellows and the connsensus, that this only hardens my bull stance. This does not mean I expect that prices will turn around on Monday morning, but that while the fundamental backdrop continues to play to the bull case at a macro and individual micro stock level, I believe that the money to be made on a 12-18 months view now is not from chasing the likes of Twitter and Facebook higher but from tucking away the miners that will be around in 2 years time and who will prosper under a reduced supply competitive landscape.

One of the few real hedge fund managers – Hugh Hendry

Contrast the current situation in the precious metals arena with the headline out late last week that retail investors poured the most money into equity funds for over 13 years – that’s right just ahead of the devastating bear market of 2000-2002 and I believe that we are nearing a major “inflection”point. Christ, with one of the few money managers I really respect – Hugh Hendry – also capitulating last week and saying he cannot remain a bear of equities any longer – his words “I can no longer look myself in the mirror” then to me, there are frankly no further signals left to tell me that those remaining long the “rich” stocks from a valuation basis here are playing the equivalent of picking pennies up in front of freight trains!

The highest CAPE valuation in 13 years, a technically heavily overbought market, the lowest insider buying (ex the mining sector intriguingly) for several years, extreme bullish sentiment, complacency in the VIX and also the options market skew on put:call positioning, a scramble to float all manner of tech crap that never has a hope of making the required money to justify the crazy valuations… Need I go on?

It pays to remember the old adage that the stock market is a “voting machine in the short term and weighing machine” in the long term. As one who has never been afraid to go against the crowd and who has seen a similar script before in 1999/2000 I believe we are now at the last stop at the OK Corral. For a much reduced risk way to play a reversal in the US stock market, be sure to read our Options Corner special in the next edition of this magazine.

Next years Xmas party will be interesting not least to see whether the “crowd” was right or the minority. I remain long of mining plays and continue to position short for the inevitable turn around in the equity market.

R Jennings, Titan Investment Partners