Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. How to Cool an Overheated Bull. Here in the mountains of Colorado, you’ll sometimes find us outdoors, with the opportunity to climb mountains and ford streams. With calm repose, we will step through or even wade through ice-cold water as we move from one side of a stream or river to the other. This is a sort of mountain machismo, for ice cold is an apt description. When you emerge from a mountain stream, it is with a refreshed and grateful feeling coursing through your body. It seems almost cleansing. Certainly your mind is alive and focused in ways it was not prior to immersion.
To quote last week’s missive: “Looking at technical charts, silver needs to cool off (finishing the week at $48.00), gold not so much (new closing high of $1566.70).” You probably don’t equate this week’s market action in gold and silver with the cleansing effect of a mountain stream, or consider it particularly invigorating – but perhaps you will experience the sense of gratefulness described above when this consolidation concludes. And conclude, it will. In the meantime, we did get to cool off, didn’t we?
Our perspective is this: The fundamentals driving the fiscal and monetary debacle unfolding have not changed. Quite the opposite – fiscal and monetary decision makers are delaying tough choices, and, in so doing, are limiting those options. It would take a different leadership altogether to make the hard choices needed today. The cycles of history will replace the present incompetence with new leadership. The new politicians and civil servants will be born out of, and deeply scarred by, this crisis. There will ultimately be solutions, but they won’t be implemented before our economy and our society experience a high degree of pain. That is still many years into the future. But I digress.
If the fundamentals have not changed, then what has changed? As we discussed in this week’s audio commentary, CME had, by the program date, raised the margin requirement on silver contracts first 9%, then 10%, then a few days later 12%, with a final up-ratchet (quite unexpected and forceful) of an additional 16+%. With the compounding involved, this represents an 84% increase in a week’s time! An analogy would be for the banker to require you to place progressively more money down on your home after loan closing. Without extra cash to increase your down payment, you would be forced to sell.
The lesson here is that CME will take acceptable losses only on its way to more acceptable gains. We know something now in the first week of May that we didn’t know even 30 days ago. The CME does not like $50.00 silver. In fact, it doesn’t like anyone (perhaps you or me) who does like that number – or any beyond it. Still, this has been a fabulous week (a little cold and a little wet, perhaps) as we got close enough to the CME to see the beads of sweat building on their foreheads. That makes me smile.
2. Investing in Opportunities. What does this mean for us? It means that, as the bull market in precious metals continues unabated, consolidating at a normal seasonal inflection point and as a direct consequence of a domestic change to trading requirements, we will take the opportunity to judiciously deploy capital to your long term advantage. (We like to buy things when they are not trading at premium prices). Someone once told me that it’s not where you sell something but where you buy it that determines your profit. Chasing markets is our least favorite activity, and we’ve avoided it as much as possible. Now, with prices moving back into a more normalized trading range, we will deploy capital opportunistically.
This serves to illustrate the double advantage of our significant liquid positions. On the down side, volatility is muted by a healthy cash equivalent position, and on the upside it becomes a positive factor, allowing us to move in when others are moving out. Please trust that we are correct in this view. Our most exciting investment is cash – it’s like potential energy waiting to be unleashed.
I’d like to add to the brief chart observation made last week, and point out a few possible scenarios unfolding with both gold and silver. I assume the ratio between gold and silver, having pressed as low as 31:1 will now oscillate between 45:1 and 30:1. Assuming a 45:1 ratio, we may see gold trade as low as $1420 – a ten percent decline from the peak of $1577, and a picture perfect correction in the context of a bull market. Most corrections have been averaging 7%, so this may be slightly greater between May and July. On the basis of $1420 gold and a healthy return to 45:1, silver should find its best support at $30.00 (this falls between the 50% and 61.8% Fibonacci retracement levels – also textbook). Alternatively, 34-36 may hold, maintaining the 100-day moving average as support. We are interested between 30 on the low side and 35 on the high side.
If the silver market keeps to more of a 40:1 ratio, the steep correction would be largely behind us. I’m quite comfortable seeing these and lower numbers, and have found the market behavior “refreshing” as a normal two steps forward in price action, followed by one step back. Such action conveys that we are still in the second phase of the bull market, where logic and normalcy are concepts that still apply. As and when we enter the final phase of the bull, there will be no corrections to speak of, and moving averages will become irrelevant. Anyone caught trading the market in the third phase will likely be left behind. Patience is needed to be a successful investor. We will act decisively on your behalf as, and when, a long term reduction in exposure is necessary. Until that time, we will be utilizing liquidity to add to positions – an opportunity we’ve been expecting.
3. Liquidity Trap is Sprung. Central Bankers in both Europe and the U.S. are giving up on the prospects of fighting inflation in exchange for providing continued aid to their dwindling economies. We have said it before, but you can’t print or borrow your way out of a crisis. It appears that bankers with only one politically correct option will not learn this lesson anytime soon. With more blatant and hard to conceal signs of weakness in the U.S., the U.K., and the eurozone, monetary policy appears to be set on autopilot.
Here in the U.S., once again, economic data was questionable at best – promoting failed rallies in stocks throughout the week. The April ISM non-manufacturing index marked the low point of the week, dropping to 52.8 from 57.3 in March. Economists were expecting 57.5, but, to their dismay, not one component of the index showed improvement.
The “new orders” component of the ISM, a more forward-looking data point, dropped to 52.7 in April from 64.1 in March. Initial jobless claims, ending April 30th, rose again to 474K from 429K the previous week. Continuing claims ending April 23rd also rose again to 3,733K from 3,641K the prior week.
Domestic vehicle sales and factory orders were a bright-spot, coming in better than expected during the months of March and April. However, inventory increases are mounting to uncomfortable levels compared to last year. GM in particular now has over 2½ months worth of inventory build (also known as channel stuffing) at dealerships across the country.
Today, Friday, non-farm payrolls (jobs created) for April posted a larger-than-expected gain of 59K. Payrolls were 244K in the month of April, exceeding the 221K jobs created in March. Manufacturing jobs showed the most improvement, once again rising 70.5%, while private payrolls increased by 16.5% over March data. One caveat, though, is that manufacturing jobs created are 1/10th the size of private payrolls. Still, it’s a step in the right direction for jobs.
Overall though, the jobs-created number was not as rosy as one would prefer. The birth/death (or fictitious) jobs-added component boosted payrolls by a whopping 175K. Last month, McDonalds Corp. held a national job-hiring event, in which 62,000 jobs were created, the nature of the jobs were unclear, and this may be a one-off event for this month’s jobs data, but the interesting part is that 1M people showed up to apply. Wage gains were slight, at 1.9% year over year, still trailing the rate of inflation (7% plus) by a wide margin.
Overseas, the eurozone, its partners, and the U.K. all saw an increased risk of economic contraction. Eurozone retail sales slipped a full percentage point in March, now down 1.7%, YOY (even after an increase of 1.3% in February). Portugal agreed to a $116B bailout, while Portugal’s finance minister warned of an eventual collapse, despite ongoing aid efforts.
Greece announced that it is in dire need of debt restructuring, affecting primary lenders France and Germany. “Debt Restructuring” is code for bankruptcy, in our view, but that fate will likely be postponed as maturity dates for repayment are extended. U.K. manufacturing and housing data also disappointed to the downside, causing gilt yields (central bank rate indicator) to drop to their lowest level since December.
The not-surprising and flawed reaction by central bank leaders to the aforementioned conditions was to postpone rate increases, thereby extending QE into the indeterminate future. We deem this reaction flawed because inflation, the very cause of our economic quagmire, is the conclusive result of monetary easing. This is exactly the pattern witnessed during the days of the Weimar Republic, and is unequivocally bullish for the metals. This, of course, is ironically juxtaposed with heated negativity in the commodities markets this week – explained in part by events, internal to the markets, discussed by Dave McAlvany above.
Have a great weekend!
President and CEO
VP Investment Management