As a general rule, the most successful man in life is the man who has the best information

Stocks and interest rates are back to late spring – pre latest European fear levels – and the Jefferies/Thomson Reuters CRB index is at a three-month high.

Risk assets are obviously back in favor with investors – possible action by the European Central Bank (ECB) and the US Federal Reserve (Fed) could offer an explanation why:

• There is speculation Fed Chairman Ben Bernanke could signal another round of quantitative easing at the Jackson Hole, Wyo. end of August Fed meeting
• ECB President Mario Draghi promised to defend the euro so markets are expecting a move from Europe’s central bank

The CBOE Market Volatility Index, the VIX or “Fear Index” as it’s known recently hit its lowest level since the global credit crisis erupted five years ago.

Mike Dolan offers us an explanation of what the VIX is and questions why such high levels of investors complacency…

“Given almost biblical gloom about the world economy at the moment, you really have to do a double take looking at Wall Street’s so-called “Fear Index”. The VIX, which is essentially the cost of options on S&P500 equities, acts as a geiger counter for both U.S. and global financial markets.

Measuring implied volatility in the market, the index surges when the demand for options protection against sharp moves in stock prices is high and falls back when investors are sufficiently comfortable with prevailing trends to feel little need to hedge portfolios. In practice — at least over the past 10 years — high volatility typically means sharp market falls and so the ViX goes up when the market is falling and vice versa. And because it’s used in risk models the world over as a proxy for global financial risk, a rising ViX tends to shoo investors away from risky assets while a falling ViX pulls them in — feeding the metronomic risk on/risk off behaviour in world markets and, arguably, exaggerating dangerously pro-cyclical trading and investment strategies.

Well, can that picture of an anxiety-free investment world really be accurate? It’s easy to dismiss it and blame a thousand “technical factors” for its recent precipitous decline. On the other hand, it’s also easy to forget the performance of the underlying market has been remarkable too. Year-to-date gains on Wall St this year have been the second best since 1998. And while the U.S. and world economies hit another rough patch over the second quarter, the incoming U.S. economic data is far from universally poor and many economists see activity stabilising again.

But is all that enough for the lowest level of “fear” since the fateful August of 2007? The answer is likely rooted in another sort of “put” outside the options market — the policy “put”, essentially the implied insurance the Fed has offered investors by saying it will act again to print money and buy bonds in a third round of quantitative easing (QE3) if the economy or financial market conditions deteriorate sharply again.” Mike Dolan, Put Down and Fed Up, blogs.reuters.com

reuters.com

Risk On

There is no doubt in this author’s mind most people believe the world’s governments and central banks will step in with some form of quantitative easing. Current market conditions are clearly showing this.

In a risk on type of situation, meaning Draghi and Bernanke come through, commodities would seem like a good place to have my money.

Why? Well the long-term average ratio of the Commodities Research Bureau Index versus the S&P 500 is 1.5 times. This ratio indicates how much S&P 500 stock you can buy with a fixed basket of commodities.

The ratio was recently at 0.2 times – an all time low valuation between hard assets and financial assets.

Risk Off

There are many reasons “risk on” could suddenly become “risk off”:

• Continued negative headlines from Europe
• Weaker U.S., Chinese and global growth
• Slowing corporate profits
• Draghi or Bernanke, or both, fail to act

Bonds and gold are “risk off,” Fear Trade investments people buy when they want safety.

Bonds

Unfortunately there’s something most bond investors do not understand – negative REAL interest rates.

“Over time even small levels of inflation can make a big difference in the purchasing power of your investment…If your rate of return isn’t greater than the rate of inflation, then the real value of your investment (the inflation adjusted value) drops and, with it, your spending power. So even though it looks like you have more money, you can actually buy less with it.” inflationdata.com

The benchmark US 10-year note currently yields 1.63 percent, yields on 30 year bonds are 2.75 percent.

The following is the inflation data for the first six months of 2012, the Inflation rate is calculated from the Consumer Price Index (CPI-U) which is compiled by the Bureau of Labor Statistics (BLS).

Jan 2.93%, Feb 2.87%, Mar 2.65%, Apr 2.30%, May 1.70%, June 1.66%

Treasury Inflation Protected Securities (TIPS) adjust your investment value according to changes in the Consumer Price Index (CPI) – the inflation rate – when there is inflation, or a rise in the CPI, the principal increases and, with deflation, the principal decreases.

John Williams, author of the newsletter Shadow Government Statistics, takes issue with the statistical methodology used by the US Bureau of Labor Statistics (BLS).

Williams says if the BLS hadn’t altered its statistical practices over the years, inflation, as measured by the governments CPI, would have been reported about seven percentage points higher each year.

“the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent…at least through late 2014. The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities…This continuation of the maturity extension program should put downward pressure on longer-term interest rates” U.S. Federal Reserve Reaffirms Low-Rate Policy, June 20th 2012

Gold

The demand for gold moves inversely to interest rates – the higher the rate of interest the lower the demand for gold, the lower the rate of interest the higher the demand for gold.

The reason for this is simple, when real interest rates are low, at, or below zero, cash and bonds fall out of favor because the real return is lower than inflation – if your earning 1.6 percent on your money but inflation is running 2.7 percent the real rate you are earning is negative 1.1 percent – an investor is actually losing purchasing power. Gold is the most proven investment to offer a return greater than inflation (by its rising price) or at least not a loss of purchasing power.

Gold’s price is tied to low/negative real interest rates which are essentially the by-product of inflation – when real rates are low, the price of gold can/will rise, of course when real rates are rising, gold can fall very quickly.

Fact – as long as real interest rates are low gold is in a bull market, there are no plans to raise interest rates for at least two years, indeed the Fed is actively working to lower longer term rates.

Consider:

• Since 1913 the US dollar has lost over 95% of its purchasing power
• Gold has gone from US$20 an ounce to currently over US$1600.00 per ounce in the same time frame
• Continuing low interest rates, combined with higher inflation rates will continue to cause low to negative real rates of return  

The “Fear” Trade comprises bonds and gold, if bonds aren’t worth holding because of negative real interest rates that leaves gold as the only true safe haven asset.

Conclusion

Is it risk on, or risk off? Are we looking at a fear trade situation where gold is the only true safe haven asset? Or will the world’s central banks open the monetary floodgates as many suspect is going to happen?

The actions of the world’s central banks should be on everyone’s radar screen. Are they on yours?

If not, maybe they should be.

Richard (Rick) Mills

rick@aheadoftheherd.com

www.aheadoftheherd.com

If you’re interested in learning more about the junior resource and bio-med sectors please come and visit us at www.aheadoftheherd.com

Site membership is free. No credit card or personal information is asked for.

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Legal Notice / Disclaimer

This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.

Richard Mills has based this document on information obtained from sources he believes to be reliable but which has not been independently verified; Richard Mills makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Richard Mills only and are subject to change without notice. Richard Mills assumes no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission.

Furthermore, I, Richard Mills, assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information provided within this Report.

The chart below reveals the month of August has not been kind to Bond investors. 

Bond buyers in a death-grip. Investors looking for safety have been piling into US Treasuries, even though it cost them, since they were receiving negative yields. It was one of the biggest bond bubbles in history. But now, it seems that the fun’s over. The yield on the bellwether 10-year note is spurting higher as you can see on the daily chart below. As investors flee the notes and bonds, the yields (which are inverse to the price) head higher. The drop in bonds is going to cost investors billions in losses.  – Richard Russell of Dow Theory Letters: 

Suddenly a lot of cash suddenly lose and searching for a return.  The chart below argues powerfully that investors “fleeing” the Bond Market are going to lose a lot of purchasing power if they just put the money in their pockets.

With the Dow Jones moving up to less than 30 points from a 4 year high, cash is moving into Stocks.

 Richard Russell, a Dow Theorist again:

“Finally, a hopeful signal. Yesterday, amid all the low volume and sluggishness, the Transports gave us just a hint of something hopeful. It was a breakout of the declining trendline, as you can see on the chart. The Transports have been the laggers all year, and it seemed as though if the Industrials closed above their May peak, the Transports would not confirm. Now with this little upside breakout, the Transports are giving us a ray of hope. Maybe, just maybe, the Transports will add on a few more point,s and get in the game.

So investors are selling into 32 year Bond Bull Market that hit an extreme, never a bad idea. With that massive amount of cash flowing from a Bond Mkt that is 3 times bigger than the Stock Mkt, how high will that Stock Market go:

 Ross Clark of Institutional Advisors: 

“Historically the Sell Side Indicator, which is the consensus of opinion of the analysts in New York of what percentage of an investors portfolio should be in equities,  has ranged as low as 47% when everybody is quite negative to the high 60’s when everyone is extreme bullish. Remarkably right now the Sell Side Indicator is only 44%! Plotted against the S&P 500, the sell Side indicator phas a phenomenal record of revealing big upside moves in the market in the 20-30% bracket. 

In summary, at this moment Stocks not only appear to be a safer investment than Bonds, history say’s they are about to rally  20-30%. 

Rob Zurrer for MoneyTalks.net

As we alluded to last week, there is an overflowing amount of evidence that both the metals and the shares have bottomed. Price action, sentiment indicators and fundamentals more than confirm a market bottom. Does this mean the market is ready to zoom much higher? Not necessarily. The sector must contend with some overhead supply as well as repair technical damage that caused a loss of both short and long-term momentum. Once the market forms higher highs and higher lows then its momentum can start to build. Until then, investors have some time to figure out which companies could be the big winners of the next cycle.By now, speculators and investors should have learned some lessons about investing in this sector. After three cyclical bulls and three cyclical bears, the cyclicality of this industry should be more than obvious. Most mining shares are not permanent buy and holds. Juniors or non-producers cannot sustain gains over the long-term and ultimately retrace the vast majority of their gains during the next cyclical bear. Even producers struggle to maintain gains beyond the current cycle.

Furthermore, it is true that the mining stocks have badly underperformed the metals. Yet, for anyone who has followed history this is not news nor surprising. As Steve Saville shows here, the mining stocks consistently underperformed Gold during the last bull market. You can throw out your XAU/Gold or HUI/Gold charts as buy signals because history tells us further lows could be ahead even as the bull market continues. I wonder if the conspiracy brigade thinks there was nefarious shorting of the miners in the 1970s.

The reality is two-fold: mining stocks as a group are notoriously unreliable even in a bull market yet many individual companies are capable of spectacular gains every cycle. This is exactly why stock picking is extremely important to success in this sector. In reviewing our own personal performance and performance for subscribers, we find that stock picking is far more important than market timing. Market timing should be used to find low risk and high risk points for your favorite stocks. The bulk of your time should be spent identifying those stocks.

Here is an example of how stock picking can make a big difference in your portfolio. Below is performance chart of six silver stocks and their performance over the past four years. These are brand name, well known silver stocks. We are not talking about obscure juniors. See how important it is to be in the leading stocks?

In the past year, those who owned Franco Nevada and Royal Gold are much happier than those who owned Agnico Eagle and Kinross. These are just two of numerous examples.

Pros like Rick Rule and Brent Cook often remark how too many investors load up their portfolios with too many companies and then have no idea why they bought them and why they still hold them.

Ok Jordan, so how do we find the big winners?

First, you need to define your goals and develop a philosophy to achieve those goals. Are you looking for income, growth or speculation? Realize that producers and non-producers are quite different. Non-producing companies are not going to provide you income or growth. They are a tool for speculation. We should know by now that large producers struggle to provide leverage even in a favorable environment. We prefer smaller, growth-oriented producers that have the ability to become mid-tier or larger producers. When it comes to juniors, we prefer management teams with a track record and companies with a strong capital structure. Lastly, buy on the cheap. Even in a rip-roaring market, the sector will have several 25% corrections per year. This is where patience is important.

As we confirm the start of the next cyclical bull, hopefully we’ve learned some lessons. This is a tough, bad business and even so in the best of times. Yet, the rewards are immense for those who are able to separate the wheat from the chaff. The good news is right now the wheat isn’t much more expensive than the chaff. Therein lies your opportunity. Ignore the pessimists and those who say mining stocks are manipulated. They just lack the attitude or skills to find the big winners. If you’d be interested in professional guidance, then we invite you to learn more about our premium service in which we focus on the producers and explorers best positioned for and most likely to take advantage of the next leg up in this bull market.   

Good Luck!

Jordan Roy-Byrne, CMT
Jordan@TheDailyGold.com

Jordan Roy-Byrne, CMT is the editor and publisher of The Daily Gold. Visit the newsletter page for information on our premium service.

INSTITUTIONAL ADVISORS

WEDNESDAY, AUGUST 15, 2012

BOB HOYE

PUBLISHED BY INSTITUTIONAL ADVISORS

The following is part of Pivotal Events that was

published for our subscribers August 9, 2012.

SIGNS OF THE TIMES:

“Sandy Weill, whose creation of Citigroup ushered in the era of U.S. banking conglomerates a decade before the financial crisis, said it is time to dismantle the nation’s largest lenders.”

This is Bloomberg’s July 25th article, and the Wall Street Journal had the  headline: “Sandy Weill Regrets Breaking Glass”.

Weill is quoted “What we should do is go and split up investment banking from banking.”

He was instrumental in the 1998 merger of Citicorp and Travelers Group, which was the deal that required the repeal of Glass-Steagall.  And, as the saying goes “The rest was history”, as Citi stock collapsed from 515 in 2007 to 9.70, repeat 9.70, in 2009. The best on the rebound was 51.50 in January 2011.

It is always fascinating to see examples of how the culture of finance changes from the habits of probity learned in the previous depression to “anything goes” in a new financial era. And, eventually, back to probity, for which Weill seems to be an agent.

It should be emphasized that in the early 1930s most in the establishment understood that the depression was caused by the financial collapse inevitable to a bubble. Since the 1950s too many academics believe that the post-1929 crash was due to the policy error of raising the discount rate from 5 percent to 6 percent in early August of that fateful year.

On the certain knowledge that the boom caused the bust, Glass-Steagall split ordinary banking from Wall Street banking. It made sense, as did the formation of the SEC with the mandate to prevent a repeat of the “Roaring Twenties”. Well, with 2007 recording most of the features of a great bubble the SEC failed on its mandate. Also, one of the promoters of the SEC Act boasted that it “would put a cop on the corner of Wall and Broad Streets”.

The Madoff fraud had a number of whistle-blowers and the SEC did not act on the biggest Pozni Scheme in history.

Glass-Steagall was thrown out in 1998 as part of another cultural change to reckless financial speculation. Now one of the key agents of change is exploring remorse and repentance.

Perhaps, the SEC will try to assume the mantle of responsibility and accountability that it was originally charged with.

Attached is a copy of our “Book Report” of September 7, 2007. The Ropespinner Conspiracy is a satire published in 1987 on the corruption of banking by “modern” concepts, otherwise known as borrowing short and lending long.

“The European Central Bank is edging toward a bond-buying program that investors say could end up printing money, echoing efforts by the Federal Reserve and other central banks to fix a credit crisis nearing its sixth year.”

– Bloomberg, August 3

The article did not include that the Bank of Japan has been similarly aggressive since around 1991. Some of this summer’s interns in the BoJ’s research department could have been born after their Great Depression began.

*   *   *   *   *

PERSPECTIVE

Fortunately, the “good vibes” have appeared again. Stock market action has been “choppy” and the latest rush has moved the S&P to 1407. This compares to the natural high of 1422 at the end of March and the test of that high at 1415 at the beginning of May. Unfortunately, trading breadth is deteriorating. We are watching for some ending action – seasonally and dynamically.

This has been supported by similar swings in commodities that are beginning to look tired. Other support has been provided by continued narrowing of the Ted Spread. The weekly RSI has traded from very overbought with last fall’s financial pressures to rather oversold this week. The swing is big enough to be significant.

Longer-dated corporate spreads have narrowed significantly since early July.

CREDIT MARKETS

Since the high on July 26 the long bond has set a downtrend to 147.5. While declining with the joy of risk elsewhere, the key thing is that the top has been made.

Since the first of the month, investment grade corps (LQD) have rolled over, and the emerging market bonds (EMB) have declined a little.

The point is that long treasuries have been leading the action as lower-grade issues continued to party. Over the past week, the yield for Baa has increased from 3.54% to 3.63% as junk declined from 11.46% to 11.23%.  Such divergences are typically found at important tops for the whole bond market.

And really in the party mode, sub-prime mortgage bonds have soared to new highs for the move. The one we monitor set a low of 38 in October and rallied to 52.6 in February. After slumping to 48 in early June, it rallied to 54 three weeks ago. The set back was to 52.5 and now it is at 56. The latest surge is getting compulsive.

This celebration of risk could expire within a few weeks.

The reversal could lead to serious dislocations in bond sectors that have yet to be hammered by the great global contraction.

CURRENCIES

Today is interesting. The dollar and most commodities have been firm. The stock market has been firm to steady.

On the near term, the DX could rise for a few trading days and that would stall out the rally in orthodox investments.

This could be brief as the good vibes could run for up to a couple of weeks.

Otherwise, the Dollar Index is in a solid uptrend. As troubles appear in the fall the dollar could take out resistance at the 89 level. That was set with high momentum as the financial crash completed in March 2009.

Using a different model, the ChartWorks has had a target of 90.

Link to August 10 ‘Bob and Phil Show’ on TalkDigitalNetwork.com:

http://talkdigitalnetwork.com/2012/08/happy-birthday-credit-crisis/

 BOB HOYE,   INSTITUTIONAL ADVISORS

E-MAIL  bhoye.institutionaladvisors@telus.net“>bhoye.institutionaladvisors@telus.net

WEBSITE:   www.institutionaladvisors.com

People put too much store in central bankers and hang on their every word as if they are prophets with a direct line to the divine. It seems that no one does this more than gold investors. In the past gold has shown itself to be super sensitive to monetary policy announcements and investors hope that any indication of further easing would give gold a joy ride.

We have had enough evidence that central bankers are no super heroes able to leap tall buildings at a single bound and save the economy. There are plenty who contend that if the Fed had not stimulated the economy with zero percent interest rates, two rounds of quantitative easing and the so called “operation twist”, the economic fiasco would have been much worse and the recession much deeper, perhaps even a depression. They go even further and say that the Fed has not done enough, and if only it had printed more money, we would be out of the woods by now.

The Austrian economists, on the other hand, counter that there is no free lunch and the tab will be paid later. The short-term pain of a deep recession would have been more salutary to the economy and would have eventually built a more robust sustainable recovery, they say. They argue that the Fed’s actions simply delay, or numb the pain. So far, even with all the quantitative easing, we have not seen much of a recovery as the employment report released on Friday confirms. In the best case scenario the U.S. economy is stagnant. At the worst case scenario it is going down the hill. That the economy is a mess is the one thing that Barack Obama and his Republican challenger, Mitt Romney, agree on.

We believe that interest rates cannot stay low forever. The Fed’s interest rate was bought down from 5.25% in August 2007 to 0.25% in December 2008.  When interest rates finally rise, the prophets of doom and gloom will have plenty to rant about.

Just what did QE do for gold? One could argue—plenty. On November 24th, 2008, which is the day that QE1 was announced, the price of gold was $819.50. It rose to $1,113.30 by March 31st 2010, which is when QE1 ended. This was a hefty increase of $293.80. The price of gold rose from $1,337.60 on November 3rd 2010, the day QE2 was announced, to $1,502.50 on June 30th 2011, which is when QE2 ended. This was a sizeable increase of $164.90, but smaller than in the first round. Does the smaller increase in the second round suggest that investors are becoming less sensitive to such measures by the Fed? Has gold lost its “safe haven” status and become a “risk on” asset?

Without any clear signs of the next round of QE, we will search the stock market for clues regarding gold and silver. We will start with the S&P 500 Index long-term chart (charts courtesy by http://stockcharts.com.)

In the chart, we see that stocks have rallied recently and approached but not yet moved above the level of the previous 2012 high. It seems that once the S&P moves above the $1,425 level and verifies this move, the picture will be bullish here once again. For now, we continue to view the outlook as mixed with a resistance line around 1.5% above Thursday’s closing price level and RSI levels neither overbought nor oversold at this time.

Let us now move on to the financial sector.

In the Broker Dealer Index chart (a proxy for the financial sector), we saw a bit of a rally for the financials last week, but their underperformance over the past five months remains clearly evident. The small rally seen last week does little to atone for the declines seen in two-thirds of the weeks since the mid to late-March high. In short, there is really no good signal for the stock indices in general here.

To better see what possible effects could higher stock prices have on the precious metals market, should a rally in the S&P 500 emerge, let’s take a look at our own tool intended for measuring intermarket correlations.

The Correlation Matrix is a tool which we have developed to analyze the impact of the currency markets and the general stock market upon the precious metals sector.

Both gold and silver are positively correlated with the S&P 500 Index in the short and early medium term. Hence the possible rally in the stock market could help these two metals reach higher prices in this time horizon.

Yet one cannot forget that the currency markets are strongly and negatively correlated with precious metals at this time. If the medium-term rally in the USD Index continues, the downward pressure on precious metals prices will remain in place as well. Note that the metals’ reaction may be delayed by a day or a few of them in response to strong moves in the USD Index, because the nature of the relationship is medium-term, not a short-term one.

Summing up, the overall picture for stocks is best described as mixed or unclear at this time. A short-term rally has been seen recently but an important resistance line is in place and the strength of the rally will be determined when this previous 2012 high price level is tested. It simply seems best to wait and see before commenting further here. Should such a rally in the stock market emerge, gold and silver could benefit from it in the short and medium term, as suggested by the Correlation Matrix. For now, this bullish factor is not in place. One should still bear in mind that such a scenario would be thwarted by a strong rally in the USD, as the correlation between these two metals and the dollar is still strong.

Thank you for reading. Have a great and profitable week!

P. Radomski

Editor

www.SunshineProfits.com

To make sure that you are notified once the new features are implemented, and get immediate access to my free thoughts on the market, including information not available publicly, we urge you to sign up for our free e-mail list. Gold & Silver Investors should definitely join us today and additionally get free, 7-day access to the Premium Sections on our website, including valuable tools and unique charts. It’s free and you may unsubscribe at any time.