"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, February 5, 2014

Commodity Strength Aiding Silver, Helping Gold

There are several cross currents at work in the markets this week which are impacting the trading across the overall commodity sector.

Let's start with the worries in the emerging markets because that continues to be the dominant force impacting equities right now and by corollary, the commodity markets.

First, notice the S&P chart - this emerging market issue has resulted in the market being down 5% since the beginning of this year.

Coupled with this has been a rather sharp rise in the VIX or Volatility Index ( I prefer to call it the Complacency Index). Yesterday, the index hit an 8 month high.

What this is telling us is that there is some genuine fear/nervousness among the bulls in the equity camp for the first time in quite a while. The general feeling is that the long bull market in stocks into its 6th year and that has some perma bulls actually looking to book some profits as they wait to see what will happen in regards to these emerging market concerns. I must add however that the bullish tone is still quite obvious based on the majority of comments from analysts who are happy to see the correction lower in order to give them a chance to buy in at lower levels. In other words, while the VIX has risen, there is no panic whatsoever among the perma-bulls.

That brings us to the commodity sector - commodities in general have actually been outperforming equities this year. We have seen sharp rallies in coffee, sugar, hogs, soybeans, natural gas, etc. Natural gas strength has been tied to the severely cold weather the US has been experiencing while coffee, sugar and even OJ strength has been tied to hot, dry weather in certain growing areas in Brazil. However, it does look as if some of that money that was recently yanked out of equities might have found a home in the beaten-down commodity sector. The thinking behind that is the sector is undervalued or at the very least, not as dearly priced as stocks and thus a better risk in terms of risk/reward ratios.

That may well be true since several commodities have been trading at or below multi-year lows but I personally am very leery of wildly chasing commodities higher if the chance exists of this emerging markets crisis worsening. Any such deterioration will feed deflationary concerns as investors brace for a slowdown in global growth. Traders are especially nervous in regards to China and this can be clearly seen in the copper chart which is down nearly 7% on the year!

Oddly enough, this emerging market issue has not really benefitted the US Dollar to the extent that some of us were expecting based on the recent past. If anything, the Yen has been the favored currency along with the Swiss Franc. While the Dollar has not been weak, it certainly has not been powering higher as it is wont to do during these crisis events.

This has enabled gold to garner some inflows ( the ETF has actually reported some inflows and increases in reported holdings ). I have maintained for quite some time now that until WESTERN INVESTMENT DEMAND for gold increases, gold will be unable to mount any SUSTAINED move higher. That nascent increase in GLD's reported holdings therefore is noteworthy.

That being said, if a full fledged crisis were to erupt across the emerging markets, it is not a given that gold will shoot sharply higher. Much would depend upon the US Dollar movements. If the Dollar were to break down, it would amplify gold's chances at breaking higher. On the other hand, if the market takes a view that global growth is going to be impacted for the worse, we could very well see copper, silver and gold all moving lower in tandem while the US Dollar becomes the go-to currency again.

It is simply unclear to me at this point what the consensus is in regards to the overall commodity sector. These short covering rallies are so fierce and so dramatic that they inevitably result in wildly bullish calls immediately springing up but keep in mind that a flash in the pan can also startle only to then quickly subside.

Weather is volatile and attempts to dogmatically predict when/if certain patterns will change are bound to frustrate. In the short term, the change in the technical chart pattern that results from a mass exodus of bears giving up the ghost on their short holdings across a commodity market will bring in bottom picking and fresh buying. Any weather scare immediately impacts the current demand/supply scenario and forces a drastic revaluation of the mindset in place during the extended downturn in price. If traders feel that the equilibrium between supply/demand will be altered by the weather, they will immediately react and the market will come to reflect the new balance that is being sought by the movement in price to another level.

One thing I am noting is that once again the mining shares are weak - until I see the HUI trading consistently above the 225 level, but preferably the 235 level, I am going to remain a skeptic towards gold. For now, gold remains mired in a range trade