As of the close of business this coming Monday, CME Group has lowered the margin requirement for its gold contract from $6,751 to $6,075 per contract. Maintenance Margin also moves lower from $5,001 down to $4,500.
While not a large drop, it always helps on the speculative front when margin rates are lowered.
Friday, June 17, 2011
HUI - Gold ratio reflects the return of a deflationary mindset
If one examines the ratio of the HUI/Gold you can determine whether or not a deflationary mindset or psychology is prevalent among investors/traders.
Note that when the credit crisis erupted in full force in the summer of 2008, the mining shares underperformed drastically against the price of gold as the gold shares plummeted along with the rest of the broad stock market.
It was not until the Fed announced the inception of QE1 in the fall of 2008, that the gold shares began to outperform gold. As a matter of fact, they led the market higher.
Now that the Fed has announced the end of QE2, the gold shares are seriously underperforming against the price of gold bullion as you can see by the sharp move lower in the ratio early this year.
This is the basis behind the ratio spread trade being played by the hedge fund community and why they are able to push the shares lower seemingly at will. As long as a deflation mindset is in place, the shares will underperform against bullion. Not until we get a return of inflation fears (that will come if the Fed moves ahead with some sort of additional monetary stimulus) will the mining shares outperform gold.
I have had some critics rail against me for detailing this strategy but I can tell you from a trader's perspective, it has been an effective and extremely profitable trade. It will stay in place as long as it works and makes money for those who are using it. The hedge funds are simply too large for any other market players to take them on and challenge them on this trade. Only a shift in the deflation/inflation mindset will shake them out.
If rumblings of another case of Fed action on the stimulus front begin to surface, this ratio trade will begin to turn as the smartest ones plying it will exit while they can still secure those paper profits.
In the meantime, one has to be extremely selective in which mining stocks they buy. The weaker ones will be and are the targets of the ratio trade while the stronger ones are more resistant to its effects, even though they are seeing weakness at the present time. Once the market for the shares turns, the strongest ones now will be the leaders on the way back up. Fundamentals will ultimately determine their share prices even while these technical plays are dominating at the present.
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Note that when the credit crisis erupted in full force in the summer of 2008, the mining shares underperformed drastically against the price of gold as the gold shares plummeted along with the rest of the broad stock market.
It was not until the Fed announced the inception of QE1 in the fall of 2008, that the gold shares began to outperform gold. As a matter of fact, they led the market higher.
Now that the Fed has announced the end of QE2, the gold shares are seriously underperforming against the price of gold bullion as you can see by the sharp move lower in the ratio early this year.
This is the basis behind the ratio spread trade being played by the hedge fund community and why they are able to push the shares lower seemingly at will. As long as a deflation mindset is in place, the shares will underperform against bullion. Not until we get a return of inflation fears (that will come if the Fed moves ahead with some sort of additional monetary stimulus) will the mining shares outperform gold.
I have had some critics rail against me for detailing this strategy but I can tell you from a trader's perspective, it has been an effective and extremely profitable trade. It will stay in place as long as it works and makes money for those who are using it. The hedge funds are simply too large for any other market players to take them on and challenge them on this trade. Only a shift in the deflation/inflation mindset will shake them out.
If rumblings of another case of Fed action on the stimulus front begin to surface, this ratio trade will begin to turn as the smartest ones plying it will exit while they can still secure those paper profits.
In the meantime, one has to be extremely selective in which mining stocks they buy. The weaker ones will be and are the targets of the ratio trade while the stronger ones are more resistant to its effects, even though they are seeing weakness at the present time. Once the market for the shares turns, the strongest ones now will be the leaders on the way back up. Fundamentals will ultimately determine their share prices even while these technical plays are dominating at the present.
Gold holding relatively firm as its Safe Haven status comes to the forefront
With all the volatility in the markets attempting to decipher defined trends from short term price action has become a fool's game. Markets are torn between optimism that the global economy is not as bad as some have feared and worries over sovereign debt issues in Euroland, particularly Greece, which have the potential to carry a contagion effect and bleed over into that same global economy, mainly due to large bank exposure to Greek debt.
I should note however that there are several key markets that I am monitoring to try to cut through some of the uncertainty. Among those are gold, crude oil, copper and the bonds. Also, the broader measure of the commodity complex, the CCI, is most helpful in this regards.
Let's take a look at each of these key markets and see how the charts shape up and whether or not we can discern any message as to underying investor sentiment.
Starting first with the larger commodity complex, here is the CCI, Continuous Commodity Index. You will note that it has fallen back below what I consider to be a key level, namely 640, and is flirting dangerously with its chart support levels noted on the chart. A downside breach of this level which cannot be regained within the next week, should that event occur, would signal a longer term top among commodities in general and a shift back to a deflationary mindset among investors/traders. I am of the opinion that Chairman Bernanke is closely monitoring this chart and will be forced to act ( provide another round of monetary stimulus) should this break down as the current FOMC will not tolerate a deflationary mindset taking hold. We know that from reading his papers and his comments in general.
For the time being however, this chart is signaling that traders do not fear inflation at the current time but are seeing the overall global economy as slowing. Keep in mind that I am just the messenger and am reporting what the current thinking of the market is as reflected in the charts. That is the role of a trader - not imposing your view on the market but allowing the market to speak to you and attempting to interpret that speech so that you can profit accordingly.
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I want to repeat here, particularly to my silver bull friends, that silver will UNDERPERFORM gold in such an environment. Silver will only outperform gold in an inflation biased environment.
Now let's take a look at the crude oil markets. I say, 'markets', because we are going to look at both WTI and at Brent. WTI is becoming less and less of a reflective market in the sense of giving us an accurate read on the value of oil in general. The reason for that is because of the nature of the oil that this contract is based on. I prefer to look at Brent crude as a better benchmark for gauging oil supply and demand but old habits die hard and therefore we want to also look at WTI.
Note on the weekly NYmex crude oil chart that the market has broken down below a horizontal support level near the $95 level. While price is still in an uptrend as it remains above the upsloping trend line, it will need to hold there as that is also the confluence of the 50 week moving average. If crude is going to hold, it should not fall below $90 or if it does, should immediately pop back up through that level. In other words, a sharp spike below that level and an upside recovery leading to a close above $90 would be okay but if it cannot recover $90, the technicals would point it lower as that would confirm a bearish flag formation with the potential for a move towards the $80 level.
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Brent crude has a much stronger looking chart. It is not yet signaling a breakdown of the nature that WTI crude is and as such, I believe is a better indicator that oil demand is still relatively firm. I would have to revise that view if it closes below the $108 level and particularly if it were to then move towards $100 and not hold there. We are a long way from the $100 level however so for now this market has yet to signal a deflationary bias.
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Let's now turn our attention to Copper, a very good market for gauging sentiment towards the health or lack thereof of the global economy.
I am providing both a dail chart and weekly chart. On the daily chart, the market is in a bearish posture trading below its 50 day moving average. Instead of providing buying support as it does in a bullish trend, that average is providing a place for sellers to enter. This tells us that sentiment towards higher copper prices has shifted in favor of lower prices as we move forward. Clearly copper is signaling more of a deflationary mindset at the current time.
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On the weekly chart we get a different perspective. This chart shows the copper market remaining in a longer term uptrend as it holds above both the 50 week moving average and the upsloping trendline. It is therefore not yet reflecting any deflationary mindset. That would change should if close below the red support line shown on the chart. For the inflationist mindset to be reflected detailing a shift back towards growth in the minds of investors, copper will need a pair of consecutive weekly closes above the $4.50 level. Until it does, the short term bias is down with the market moving into a level where buying should soon surface. If that buying does not surface, then copper will be voting for deflation. Again, Mr. Bernanke and company will be watching.
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turning lastly to gold - its daily chart reflects the safe haven status of the metal in the midst of the uncertainty and confusion currently reigning over the markets. You can see that unlike some of the other members of the commodity complex, gold is above its 50 day moving average and holding horizontal chart support. The market is range bound on the daily chart with a slight bias to the upside. A drop through $1510 would dent sentiment towards the metal as it would turn the technicals bearish on this chart but as long as it holds $1480 it will not be signaling deflation. Should this market take out $1550, it will signal a move back towards inflation fears based on currency woes.
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Incidentally, Gold, priced in terms of the British Pound, scored a new all time today. This is one of the reasons that in spite of the "risk off" trades that are currently in vogue, the bears are having trouble breaking it down in terms of the US Dollar at the Comex. Gold is trading as a CURRENCY and not so much as a commodity. When gold bears look at the strength in the metal when priced in terms of the other various majors, they lose conviction, even in the midst of large amounts of risk off trades while the gold bulls take heart and step up to buy.
Markets making new all time highs (even if priced in terms of another currency) are not in bearish phases - period! US centric traders do not seem to be able to understand this. For gold to enter a bearish phase, we would need to see it break down across the board, whether priced in Dollars, Euros, British Pounds, etc. The reason for this is that the surge into new highs or near all time highs reflects FEAR about currency stability in the various countries where the gold market is performing so well. That generates buying of gold as a safe haven and reveals strong demand for the metal from those quarters of the globe.
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I should note however that there are several key markets that I am monitoring to try to cut through some of the uncertainty. Among those are gold, crude oil, copper and the bonds. Also, the broader measure of the commodity complex, the CCI, is most helpful in this regards.
Let's take a look at each of these key markets and see how the charts shape up and whether or not we can discern any message as to underying investor sentiment.
Starting first with the larger commodity complex, here is the CCI, Continuous Commodity Index. You will note that it has fallen back below what I consider to be a key level, namely 640, and is flirting dangerously with its chart support levels noted on the chart. A downside breach of this level which cannot be regained within the next week, should that event occur, would signal a longer term top among commodities in general and a shift back to a deflationary mindset among investors/traders. I am of the opinion that Chairman Bernanke is closely monitoring this chart and will be forced to act ( provide another round of monetary stimulus) should this break down as the current FOMC will not tolerate a deflationary mindset taking hold. We know that from reading his papers and his comments in general.
For the time being however, this chart is signaling that traders do not fear inflation at the current time but are seeing the overall global economy as slowing. Keep in mind that I am just the messenger and am reporting what the current thinking of the market is as reflected in the charts. That is the role of a trader - not imposing your view on the market but allowing the market to speak to you and attempting to interpret that speech so that you can profit accordingly.
I want to repeat here, particularly to my silver bull friends, that silver will UNDERPERFORM gold in such an environment. Silver will only outperform gold in an inflation biased environment.
Now let's take a look at the crude oil markets. I say, 'markets', because we are going to look at both WTI and at Brent. WTI is becoming less and less of a reflective market in the sense of giving us an accurate read on the value of oil in general. The reason for that is because of the nature of the oil that this contract is based on. I prefer to look at Brent crude as a better benchmark for gauging oil supply and demand but old habits die hard and therefore we want to also look at WTI.
Note on the weekly NYmex crude oil chart that the market has broken down below a horizontal support level near the $95 level. While price is still in an uptrend as it remains above the upsloping trend line, it will need to hold there as that is also the confluence of the 50 week moving average. If crude is going to hold, it should not fall below $90 or if it does, should immediately pop back up through that level. In other words, a sharp spike below that level and an upside recovery leading to a close above $90 would be okay but if it cannot recover $90, the technicals would point it lower as that would confirm a bearish flag formation with the potential for a move towards the $80 level.
Brent crude has a much stronger looking chart. It is not yet signaling a breakdown of the nature that WTI crude is and as such, I believe is a better indicator that oil demand is still relatively firm. I would have to revise that view if it closes below the $108 level and particularly if it were to then move towards $100 and not hold there. We are a long way from the $100 level however so for now this market has yet to signal a deflationary bias.
Let's now turn our attention to Copper, a very good market for gauging sentiment towards the health or lack thereof of the global economy.
I am providing both a dail chart and weekly chart. On the daily chart, the market is in a bearish posture trading below its 50 day moving average. Instead of providing buying support as it does in a bullish trend, that average is providing a place for sellers to enter. This tells us that sentiment towards higher copper prices has shifted in favor of lower prices as we move forward. Clearly copper is signaling more of a deflationary mindset at the current time.
On the weekly chart we get a different perspective. This chart shows the copper market remaining in a longer term uptrend as it holds above both the 50 week moving average and the upsloping trendline. It is therefore not yet reflecting any deflationary mindset. That would change should if close below the red support line shown on the chart. For the inflationist mindset to be reflected detailing a shift back towards growth in the minds of investors, copper will need a pair of consecutive weekly closes above the $4.50 level. Until it does, the short term bias is down with the market moving into a level where buying should soon surface. If that buying does not surface, then copper will be voting for deflation. Again, Mr. Bernanke and company will be watching.
turning lastly to gold - its daily chart reflects the safe haven status of the metal in the midst of the uncertainty and confusion currently reigning over the markets. You can see that unlike some of the other members of the commodity complex, gold is above its 50 day moving average and holding horizontal chart support. The market is range bound on the daily chart with a slight bias to the upside. A drop through $1510 would dent sentiment towards the metal as it would turn the technicals bearish on this chart but as long as it holds $1480 it will not be signaling deflation. Should this market take out $1550, it will signal a move back towards inflation fears based on currency woes.
Incidentally, Gold, priced in terms of the British Pound, scored a new all time today. This is one of the reasons that in spite of the "risk off" trades that are currently in vogue, the bears are having trouble breaking it down in terms of the US Dollar at the Comex. Gold is trading as a CURRENCY and not so much as a commodity. When gold bears look at the strength in the metal when priced in terms of the other various majors, they lose conviction, even in the midst of large amounts of risk off trades while the gold bulls take heart and step up to buy.
Markets making new all time highs (even if priced in terms of another currency) are not in bearish phases - period! US centric traders do not seem to be able to understand this. For gold to enter a bearish phase, we would need to see it break down across the board, whether priced in Dollars, Euros, British Pounds, etc. The reason for this is that the surge into new highs or near all time highs reflects FEAR about currency stability in the various countries where the gold market is performing so well. That generates buying of gold as a safe haven and reveals strong demand for the metal from those quarters of the globe.
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