The VIX, the volatility  of the S&P 500, is sometimes touted as a “fear index.” Today is it extending its push below 10%, to fall to its lowest in nearly a quarter of a century.  

 

There has been four (Finland, Austria, the Netherlands, and France) successive European election that did not produce a victory for the euro-skeptics, who want to leave either the EU or EMU or both.  In Germany, the AfD has imploded and may be lucky to be represented in the Bundestag after the national elections in September.  A few months ago, some were talking about the possibility that Merkel is defeated in her bid for a fourth term as Chancellor.  Merkel and the CDU have done well in the state elections, and will likely do well in this weekend’s contest in NRW, the most populous German state.  

 

Three-month implied volatility in the euro, a common benchmark has broken below 7% to trade at its lowest level since late 2014.  The low since at least 1999 was set in 2014 near 4.75% and besides briefly in 2007, it has not traded below 5%.    The fact that volatility has come off suggests participants are less worried about macro-events and in terms of the spot are anticipating range trading.  

 

The risk-reversal (skew in the pricing of puts and calls equidistant from the money, in this case, 25 delta)  has steadily moved to reduce the premium that is paid for euro puts.  In February, the premium for (three months) puts over calls swelled to more than 3%.  This was the most in five years. The premium fell and today stands near  0.25%.   Calls were briefly at a premium last February for the first time since 2009.  

 

The yen, like the VIX, is often thought of as some sort of fear measure.  Yet to think of the yen as a safe haven may be misleading.  When anxiety is running high, and the pendulum of market sentiment swings toward fear from greed, global investors are not rushing to buy Japanese stocks or bonds.  

 

Instead, two things happen.  First, the US Treasury market is the safe haven.  Investors do in fact flock to the depth, breadth, and security of the US Treasury market.  This exerts downward pressure on US interest rates and weakens the yen through the differential.  Second, often in such anxious moments, Japanese investors who typically exports their savings, stop doing so.  Given Japan’s current account surplus (driven, incidentally, by investment income (e.g., coupon payments, dividends), without the export of savings to recycle the inflows, the yen “naturally” rises.  

 

In any event, the yen has been weakening steadily since the middle of April.  On April 17, the dollar bottomed in front of JPY108.   The US 10-year yield bottomed the next day near 2.16%.  The dollar poked through JPY114.00 for the first time since the Federal Reserve hiked rates in the middle of March.  The dollar has punched through the downtrend line from the year’s high and March highs to approach the 61.8% retracement objective of this year’s decline (~JPY114.65) 

 

Three-month implied yen volatility is a little firmer today after reaching its lowest level in more than a year yesterday a little ahead of 8.0%.  The correlation between the implied yen volatility and the VIX (percentage change 60-day rolling basis) is near 0.35 today, the highest so far this year.  

 

Looking at the put-call skew, one sees that the premium for dollar puts has been sharply reduced since the end of February when it reached 2%.  The skew is now less than 0.5%, the least since late January.  Historically, dollar puts (yen calls) often trade a premium.  The thought was that Japanese corporations who have dollar receivables hedge in the options market by buying dollar puts (yen calls).  One thing the options market may be telling us is that participants are less concerned about a weaker dollar.  

 

The price of gold has fallen for the past three weeks.  With today’s losses, the yellow metal is back to levels seen in mid-March when the Fed last hiked.  It fell through the 200-day moving average last week ($1250) and appears to be making a decisive break of the 100-day moving average (~$1224). Gold appears headed toward a test on the $1180-$1210 area, which may help shape the medium term view.  

 

One need not be a hardcore contrarian or an options trader to take notice of the markets’ calm.  Minsky warned that due to the perverse dynamics and incentive structure, stability could itself can fuel instability.   The French and UK elections next month are interesting but unlikely to shake up investors.    Success is an aphrodisiac, and the former Socialist Macron is drawing candidates that want on his banner.  In the UK there is little doubt that May will lead the Tories into victory.   The German election in September is Merkel’s to lose.  

 

Many observers seem to recognize that Italy’s election next year may be the next important European test.  However, it is a year away.  Perhaps Italian banks are the “ultimate” risk asset.  An index of Italian bank shares is up by more than a third since the end of February.  Yesterday, it reached its highest level since April 2016.  

 

Geopolitics can always come back to bite.  Consider that just yesterday, for the first time this year, a Russian jet violated Estonia’s airspace.  Reports indicate that it did so around half a dozen times last year.  Russia’s foreign policy agenda may not be dependent on who occupies the US White House. Recall, Russia invaded Georgia in 2008 when George W Bush was president.  General Eisenhower was president when the Soviet Union invaded Hungary.   Johnson, who had projected US power in Vietnam, the Middle East, and the Caribbean when the Soviet Union invaded Czechoslovakia.  

 

Russia’s asymmetrical warfare has been successfully deployed on what it calls the near abroad.  It borders.  It has harassed the Baltic States, like Estonia.  The airspace incursions are a subject of diplomatic protests, but not an escalation of tensions.  Where is that line?  Russia can find a small border town in a Baltic country that the majority of people speak Russian and may even have Russian passports.  Isn’t this a logical “next move” in the chess game Putin is playing in central and eastern Europe?  

 

Meanwhile, the Trump Administration is pursuing less antagonistic policies toward China. Remember, after the electoral college victory, Trump spoke to the president of Taiwan, and even questioned the US one-China policy. Trump has not levied a 25% tariff on Chinese goods.  China has not been cited as a currency manipulator.  The US may also be backing off from challenging China in the South China Sea.  The New York Times reported that the Department of Defense had rejected the last three proposals for freedom of navigation operations.  These essentially are a display of US force in waters that some countries, such as China, claim are theirs.  

 

The point here is to note the extremely low levels of anxiety in the market.  The VIX, US Treasuries, gold and the volatility of the yen and the euro, all are pointing in the same direction.  There is not the reason it cannot continue, and this should not be read as a call that the Sky is Falling.  It is meant to show how extreme the calm is, and remind ourselves, that large moves typically do not happen when volatility is high, and investors are anxious and nervous.  It happens when things are calm, and investors see TINA (there is no alternative).   Geopolitics and the divergence of policy, and asset/liability and duration mismatches have not gone away.   It is a reminder that we are often lulled into complacency just before being shocked by how treacherous things really are.  

I want you to take a close, hard look at this chart: 

The GDXJ (VanEck Vectors Junior Gold Miners ETF) is the ETF that has become one of the world’s most popular investment vehicles for gold investors over the last decade.

The idea behind ETFs is luring many investors by allowing you to buy and sell broad baskets of stocks with a single trade.

It’s a one-click way to buy a basket of small-cap gold exploration, development and production companies, and from January 2010 to May 2017, the market capitalization of the GDXJ grew by 480%. 

Since it became so popular, a technical challenge has emerged: by definition, junior gold stocks don’t have large market caps and their shares don’t have tremendous trading liquidity. The GDXJ grew in popularity so much that it had too much cash and not enough places to put it.

Here’s where this becomes interesting. I know many precious metal investors who are hurting big time right now because they missed the phenomenal move between January and August of 2016 and have been seeing nothing but a massacre ever since. 

My gut and the research I’ve put together suggests that we are about to undergo a frenzy sell-off, something that will cause some gold investors (who have too much of their net worth weighting in gold-related stocks) to feel like puking, but for those who prepare, I am telling you that this is your “Bitcoin at $3” moment.

The sell-off has already begun, and it’s due to no fundamental reason at all—it is a “forced selling” based on technical issues.

Many junior gold stocks are Canadian. As soon as an entity owns more than 20% of a Canada-listed company, regulations restrict its trading ability and make holding the position a bureaucratic mess.

Because the ETF got so popular and the small-cap miners are truly a tightly knit group of companies that are not collectively worth that much, the ETF couldn’t find ways to deploy cash. As a result, it now has to rebalance its components.

This rebalancing is already underway, with hedge funds, short-selling funds and retail investors all looking for a way to either make a killing due to this selling avalanche or protect their holdings from further declines.

The rebalancing is set for June 16.

Between now and then, expect significant volatility in all the sub-$1 billion market cap junior and mid-tier gold companies. Shares of companies will be sold by the GDXJ so the new ETF can become a “large mid-tier to small major” gold ETF.

The Chain Reaction: Margin of Safety Will Be at All-Time High 

Margin of Safety is the most important term in finance, according to Warren Buffett and his mentor, Benjamin Graham. Essentially, the idea is that no investment—and certainly no trade—are bulletproof, therefore the cheaper you can buy it, the better. 

It goes deeper than that: a more effective use of Margin of Safety is contrarianism.

This means that you’re buying when assets are out of favor (and therefore cheap), with the certainty that demand will be increasing later.

But the most effective use of Margin of Safety is buying so cheap that the company actually trades at or below its liquidation value.

The GDXJ is going to dump close to $4 billion worth of junior mining shares—that’s a massive amount.

We all know how the market reinforces our most innate emotions, and as this forced regulatory selling commences, panic selling will ensue.

Gold stock investors will hit stop losses and dump shares, which will create more selling.

What may be in the cards here is a self-reinforcing cycle of forced, ignorant selling that will feed on itself and cause a panic in some of the world’s best small-cap gold stocks. It could be a chain reaction, and again, this is coming on June 16, right when the Federal Reserve next announces an interest rate decision.

Wealth Research Group’s Strategy
We follow a proprietary due-diligence process in order to sift through the hundreds of publicly traded companies.

We are currently reviewing all the companies that the GDXJ will be forced to sell. I can already tell you that I have personally taken profits on a number of dividend-paying stocks and liquidated a real estate holding in order to be cashed-up. 

The reason I did this is because at the bottom, after some companies’ stock prices basically go back in time to levels lower than 2015’s historical lows, guys like my partners and I—or funds like Marin Katusa’s, or Sprott Asset Management and Peter Schiff’s Euro Pacific—and other legendary investors in the space will be making our most aggressive move yet.

Gold is not in a bubble, nor has it displayed any “bubble-like” golf stick-shaped chart.

Instead, it’s a highly depressed market where demand is high, but concentrated short positions by large funds who are long the S&P 500 are absolutely creating havoc for the retail investor. As I said last week, once the entire investment community begins taking profits after a nine-year bull market, the over-leveraged short positions they currently hold in mining shares will be liquidated, and you will most likely be among the rare breed of investors that get to experience a 100-fold move in a stock you own.

At the moment, a total of 52 companies are estimated to be under excessive liquidation by the GDXJ, and we’re preparing for this as we speak.

You need to make a decision—one that will define you regarding gold stocks from here on out. You need to be absolutely sure that you can stomach high volatility, which will test every fiber of your being, because buying when Margin of Safety is at an all-time high is not as easy as it sounds. It requires nerves of steel, and most of all, it entails forgetting all about the pain you endured (if you endured any) by mismanaging positions in the past or getting the timing wrong.

There’s no escaping this—it will get bloody before we get our chance to create dynasty money.

Now is the absolute ideal time to learn exactly how industry insiders are finding the best values.

Lior Gantz, an editor of Wealth Research Group, has built and runs numerous successful businesses and has traveled to over 30 countries in the past decade in pursuit of thrills and opportunities, gaining valuable knowledge and experience. He is an advocate of meticulous risk management, balanced asset allocation and proper position sizing. As a deep-value investor, Gantz loves researching businesses that are off the radar and completely unknown to most financial publications.

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