With gold tumbling for the 6th straight week and the Dow nearing 20,000, the plunge in gold and silver is shaking the faith of even some of the long time holders of the precious metals.
By Bill Fleckenstein President Of Fleckenstein Capital
December 15 (King World News) – With so many markets in a borderline if not actual chaotic state, I thought it might be useful to review them all (i.e., bonds, stocks, FX, and metals) to see if what each market appears to be saying makes sense, and if not, can we at least ascertain what the current rationale (storyline) is for why it is behaving as it is, such that there might be a possibility to make money when those misperceptions change…
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Starting with the bond market, probably the most important market in the world given that everything is supposed to be priced off of it, it seems to me that the central banks have lost control, and yet there doesn’t seem to be any fear at all about what that might mean. Thus, the massive losses that have occurred — not to mention the prospective ones, and what that would mean for the price of everything from homes to the stock market — will be extremely hard for the central banks to rectify should they choose to do so, as it is not at all clear how they would try to “rescue” the declining fixed income markets.
One might imagine that if they started to ease, that may help, and would probably be good for a kneejerk bounce, but I don’t see how that could ultimately save them, nor would tightening, although the latter would cause all kinds of chaos. So the bond market signaling that central banks are losing control demonstrates how trapped they are, and yet it is mind-boggling that it doesn’t matter to any other market, except perhaps gold, which I will touch on below.
That said, the action in the bond market does make sense, as the fear of deflation has evaporated and there is at least lip service being paid to inflation concerns, which are slowly being priced back in, and there is also fear that the size of government debt, at least in America, is going to grow. (As an aside, the size of government debts has exploded, but no one has worried about that due to worldwide QE, but it will become a huge problem.)
Green Means Go
Turning to currencies, the dollar has obviously screamed higher over Trump euphoria and the prospects for Fed rate hikes (never mind that the Fed was supposed to hike four times last year but only managed to once, nor have they followed through on their plans to undo QE). So there is a storyline you can at least follow, even though it is flawed because obviously continued strength in the dollar will cause problems, in addition to the optimistic premise being wildly overdone.
I would also postulate that the Bank of Japan looks like it is looking control of both the yen and JGBs, and the ECB has similarly lost control of the euro. By that I mean the only way they can turn them around — short of a strong economic turnaround — is probably by hiking rates, and they are obviously not inclined to do that. So the central banks are in a really tight spot in FX land as well, though again there is no fear about that yet. Meanwhile, the steady decline of the Chinese yuan, which used to send markets into spasms, similarly creates no angst.
Similarly with the stock market, you can understand that people might be excited about proposed deregulation, lower taxes, more growth, etc. On the other hand, when you look at the valuations, the carnage in bonds, and what a strong dollar would do to profits, it’s impossible to reconcile all of that and thus I think that the stock market has anywhere to go but down once folks finally have to confront all the negative variables. Thus, while one can come up a thesis as to why it is happening, it is ephemeral and and will end in pain.
The Beatings Will Continue Until Morale Improves
Turning to the metals, where we have seen a six-week one-sided bloodbath, I must admit I don’t have a good explanation as to why they have been beaten as badly as they have. I can understand some pressure emanating from a stronger dollar and the euphoria previously discussed, but I don’t think that explains the amount of damage that has taken place.
My suspicion is that something is afoot in markets that we can’t really analyze, i.e., the chaos that has been unleashed in India by the canceling of two currency denominations almost certainly has something to do with the decline. I think the operators in the risk parity arena may also have have been an important factor, because anyone who is a risk parity manager has a leveraged bond position that is used to increase the risk (of other assets) so that they are at “parity” with the risk in equities — a concept that was doomed from the start but which has been a winner for some time.
My understanding is that said operators do hold gold and perhaps this is what has caused the correlation between weakness in fixed income and weakness in the metals. I wish I had a more satisfactory answer, but sometimes one has to admit that it is not clear what is moving a market in one direction or another.
Hopefully, this discussion will provide some food for thought for people trying to sort through all this seemingly inconsistent and wild action that we have seen.
If You Thought That Was Bad
As for today’s motion, bond markets were clobbered again, with 10-year yields in America reaching 2.62% overnight, which is an increase of around 65% since the beginning of October and 91% since the low on July 8. To put that decline in perspective, from October 1980 until the low in October 1981 yields “only” rose 41%. I keep bringing this up because the amount of destruction we have already seen in the bond market on a percentage basis is worse than what transpired from a month before the 1980 election and the ultimate low. Meanwhile, P/Es are two to two-and-a-half times higher, which just makes the math of the stock market unworkable, even with the hopes people have for Trump.
JGBs were thumped again last night and are now at 8 basis points. So the Bank of Japan has a situation where its currency is in freefall and the bond market won’t trade where it wants it to. That is a recipe for real trouble, although as I keep saying, no one seems to care.
Overnight equity markets were once again all higher despite the bond carnage, and that form held here in America where the stock market gained 0.5% to 0.75% through midday, with the Nasdaq the strongest index. In the afternoon the market drifted sideways to slightly lower, closing as you see in the box scores.
Away from stocks, green paper was on fire to the upside with both the yen and the euro losing around 1%. How people think large American companies are going to be immune to the consequences of a strong dollar I don’t know, especially as so many of them have piled on debt, i.e., IBM or companies in the chip sector being perfect examples. They all now have mountains of debt and the dollar is going to hurt their business, yet the stocks go up every day. There is real trouble on the horizon for heavily indebted export-oriented companies, of which America has plenty, but there is literally no angst about that at the moment.
The Fright At the End Of the Tunnel
Turning to the bond market, as noted, it was spanked again initially, oil lost 1%, and the metals were mauled, led lower by silver, which lost about 5% to gold’s 1%-plus. As I previously stated, I really don’t have a good explanation for the carnage in the metals other than the ones I have already offered. I would also note that the selling is obviously feeding on itself and has turned into a panic. However, that does not tell you when and where it will stop, although it does suggest that we are likely in the late innings of this decline, which is small comfort itself, as the size of changes in price toward the end of moves (in both directions) can be quite large.
Included below are four questions and answers from the Q&A’s with Bill Fleckenstein.
Bonus Q&A
People Are Losing Faith
Question: Bill: I’ve been reading you since Real Money, I am a charter subscriber, I own and have read an autographed copy of your book. I consider myself a true-believer. The problem is, I cannot afford to be a broke “true-believer.” I think you are right, but I guess I am losing faith that the “when” will come any time soon. It seems obvious to me that Trump will bring on inflation and higher deficits if he does any portion of what he says (less regs, lower taxes, infrastructure stimulus). I can’t understand why a bond sell-off supposedly driven by inflation fears doesn’t help the precious metal complex. It astounds me the market gives these Fed idiots so much credence. As I write this, gold is at $1140 and far away from $1200. My question is, does this drop change your view on whether this correction is near an end? Regards
Answer from Fleck: “Deciding when a gold decline has ended can be very tricky (metals are far more difficult than stocks in general). Obviously, this one has fed on itself and has been a somewhat perfect storm of issues for gold… The dollar, Trump euphoria, the debacle in India, and then gold selling feeding on itself, which began with Druckenmiller selling.
I had hoped that the fact the miners have been digging in for a couple weeks, combined with the action in silver and copper, meant that gold would find a low around the FOMC meeting. That could easily still happen. It is very hard to predict precisely how these things will turn out in the midst of panic selling. I was gone last year the week of the meeting but I remember being very demoralized the day after when gold tanked to a new low. But that was it, even though we didn’t know that the bear market was over at the time.
I am trying to keep an open mind, but be objective too. This decline could be ending now, though it may not, and no one knows. There are two components of trying to gauge where we are. One, does the decline stop and reverse and two, will the ensuing rally be the start of a new leg in a bull market? For the second to be true we have to get over some higher number. Is it $1,180, $1,200, $1,220? No one knows. I have my guesses, but they are just that and I will have to evaluate the next rally when we get it. I am not ready to give up on the idea at all, but I have reduced my (speculative, though not investment) risk along the way because I started with lots of exposure and needed to deal with that risk (as I have noted, big positions make you a speculator and you have to follow different rules than what an investor would do). I wish I had a black-and-white answer that would work for everyone, but I do not. Hope this discussion helps.”
“The Worst Market Timer In The World”
Question: Wife told me to sell all the gold stocks today. She said “she’s tired of looking at them go down”. I bought a few more miner shares at the end of the day knowing that she’s the worst market timer in the world hence I don’t let her make our long term financial decisions. Wish I knew more about what India citizens will do once they get money again. I would guess they will buy more gold as they can’t trust the politicians to seize cash again. Do you agree they will buy more gold and carry less cash in the future?
Answer from Fleck: “Yes, Indians will only want gold even more after the dust settles.”
Question: Fleck, Great article on KWN. It sums it up nicely. I feel like a red headed stepchild again. I put in a crazy pre-market order in on PVG for $7.05 today and thought it may hit and then thought it may go even lower. If it does I will buy more.
Answer from Fleck: “Complete chaos in metals at the moment. The update today on PVG was positive, though no one care.”
Question: Bill, kingworldnews.com a good interview. your honesty is always refreshing . i can see how people want to give up, for i do, too, but i still believe and want to add on the pullback. interested to see if you add for trades before it goes through 1200 or when and if it breaks 1100. seems like people still believe in yellen and trump. housing sentiment soared. don’t higher mortgage rates tamper the demand for housing?
Answer from Fleck: “Yes, rates impact house prices. There is so much that seems to make no sense, I will try to tackle it all in Thursday’s Rap. I would not buy weakness in the metals/miners yet. Let them stabilize first. It could happen at any time, but make something constructive happen and if you are speculating, be disciplined about your game plan.”
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***ALSO JUST RELEASED: Another Brutal Takedown In The Gold Market As Western Central Banks’ Psychological Warfare Intensifies CLICK HERE.
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