Jeanne d'Arc Escapes From the Cellar

Hello, loyal readers of Screwtape. Sorry about my absence for the last month. I will give you three excuses, and you can decide for yourselves which, if any, of them are true. The first is that Her Majesty unexpectedly called upon me to represent her in a West African conflict zone, and I have needed to spend the last few weeks learning Bambara, improving my Walther-PPK handling, and brushing up on Land Rover maintenance.

The second is that I made GM Jenkins very, very cross indeed, and - for my own good, might I add - needed to spend a while in his coal cellar reflecting on my general attitude towards the silverogosphere, my bloggers-in-arms on other sites, and the over-rated value of sarcasm in a civilised world.

The third is that GM, Warren and I have been too busy preparing for Bilderberg, which we regularly attend as confirmed members of the Illuminati. This year has been especially pressing, given the coming financial apocalypse and all, and it's taken more time out of our busy schedules of whoring, renovating houses and hacking tax records (respectively) than we might otherwise have liked.

You pays your money, and you takes your chances. Anyway, I'm now back, and I'm ready to pwn the kidz like a boss [sorry - I don't know what happened to my more usually conservative diction there...]

So the gold market looks good, as does its unloved step-children: silver and the miners. Three months of punishment, and holding by many, seems to have been vindicated after the most extraordinary green candle was produced on the gold and miner charts. I was going to put up a load of TA and comment, but - to be honest - it's not really worth it. More has been written about the apparently seminal events in the PM world on Friday than has actually been read. Regardless, it was beautiful action, and - from a personal point of view - it means that at least half of the baby blue-eyed lemurs have been saved from a life of prostitution and/or presenting half-cocked efforts at satire about the cheese-investing world.

So let's take a step back from the more obvious TA commentary, and have a think about what's really going on here. Why did the PM's explode, with gold moving more in a day than it has since 2009? Well, let's look at a few credible reasons...

Quantitative Cheesing

The move in the PMs was definitively not [fundamentally] about an anticipation of more QE. The little discussed fact on the silverogosphere is that PMs are not - shock, horror, the only risk assets. Risk assets are the first to be sold off in a climate of fear, of course, but also are the first to benefit from an expectation of accommodative monetary policy. Therefore, a QE-inspired move would have pushed PMs and its miners at a similar rate to (a) financials, and (b) other (non-PM) miners. Let's have a quick squizz at a couple of pertinent ratios during the last couple of months:

So, if you're the sort of chap or chapesse who likes to invest in risk assets, then the month of May worked out jolly well for you if the particular risk assets you chose were gold-related [NB: the ratios here are to gold metal - the graphs are even more dramatic if presented as gold miner ratios]. But you'd be less likely to buy a round in your local Wetherspoons if your risk asset of choice had been a financial play (here JPM is used as an example, apropos of nothing, but I could have picked many others) or, crucially, a non-PM miner (here Rio Tinto is used - which, I know, does actually mine some PMs, but it's not their main thing).

QE anticipation would have fuelled all sets of 'risk-on' investments, and that clearly wasn't the case. The gold-bugs who say that there is some decoupling from the general stock market have actually got some hard evidence behind them.

None of this is to say that QE III (if [IF!] it happens) won't have an impact on all of these risk assets. But, as of Friday, we're talking about a non-QE III environment, and the discrepancy between gold miners and (say) copper miners is quite apparent. It is also not to say that the fairly bad (sorry - not so bad as to provoke an $80 move in gold) NFP numbers did not provide the spark to the fuse of gold's remarkable green candle on Friday. But more credible is the idea that gold, from a technical standpoint, was just itching and waiting for some kind of spark - any kind of spark - to take it back towards its long-term trendline.

The Dollar is King

The rise in the dollar is intriguing, and powerful. Here's a chart that I originally put up here, but is now forcefully updated with what has happened since. Golly.

The pennant initially broke down, but then quickly recovered on the back of Euro-fears and resolved firmly and sharply to the upside. This is the kind of move that traders have wet dreams about, and it didn't disappoint.

But it's looking overdone. Now I know that the Eurozone is in chaos and crisis, and that the expectation is that Greeks and Spaniards will be sleeping on dollar-filled mattresses and bartering with acorns by Thursday, but by Jimmeny, if the USDX was a stock, what would you be doing right now? If the answer to that question is (a) holding, or (b) going long, then you should take yourself outside and give yourself a sharp slap to the face with a wet tuna.

No. The USDX is going to correct, and soon. When CNBC and the proverbial shoe-shine boy start waxing lyrical about shorting the Euro and going long the Dollar, then you know it's dumb money time. Now, of course, I'm not so arrogant as to say that I know when the short squeeze will come. The USDX could go quite a bit higher. But the correction will come, and it will be hard, and it will be brutal, and the dumb money will suffer as much as the smart money will be laughing. The EUR:USD trade as of today looks about as intelligent as trading in your house for Facebook shares.

Which is not very intelligent at all.*

Anyway, we all know that a decline in the dollar is gold-positive. And Friday's move certainly feels like that gold and its miners are trying to tell us something. Let's be fair here: the miners have many faults, but By Thunder they are superb at hinting at what is to come. In 2008, they predicted the stock market crash. And just a few weeks ago, they predicted the sink in general equities. They're now rising - sharply - and we ignore that at our peril.

The thesis is, therefore, that the miners (and gold - as a secondary influence: yes, I think of the miners as better indicators than gold, which merely follows. I hope to write a lot more on this soon), are second-guessing a sharp fall in the USD, and their track record is pretty compelling.

My name is Bond, Jeanne de Bond

I should've really titled this post something like "Bonds: the only story in town". I try not to give away too much about my real life on the intertubes, for obvious reasons, but as a teaser to loyal readers, I work fairly deeply in politics and international relations, rather than in finance. Last week I got my staff together, and I (rather pompously, I do realise that) said:

'politics is dead, and there is now only economics.'

I then followed that up with:

'And economics is dying. The only story left is bonds. THE STORY IS BONDS. Anything else - anything - that future historians write about regarding 2012, will be a footnote compared to what is happening in the bond markets. So I'm not interested in Iran, or Syria, or even in QE. As big as those events might be, they will be seen as irrevelent in terms of the effect yielded by the hot money flow into safe bonds.'

The Bund, the T-Bill and the Gilt now am become death [sic.], destroyer of worlds.

I first got into trading, not through a desire to become sick-makingly rich (like GM) or to understand the philosophy of man (like Warren), or even to get a few decent academic papers out of it (like Larry). For me, it was a fascination with money flows. So forgive this digression...

There's a lot of money in the world, no matter how devalued you think it might be. And it has to go somewhere. It moves, often quickly and mercilessly, between equities, commodities, sovereign debt, and other places. The only drivers are that (a) you need to make a return, and (b) in the absence of (a), your money needs at least to be safe.

If you have $10,000 and you think that the world is about to end and you don't trust the banks any more, then you might choose to stuff that $10,000 in your mattress. Sovereign debt is like the mattress, but for those who have millions or billions, rather than thousands. Rich people naturally tend to like to do rather better than the 'mattress return', however (i.e. zero minus inflation), and so bonds are generally 'stopping points', where money can be thought of as taking a breather before zooming back into stocks or commodities or whatever takes your fancy. Most professional traders keep a strict ratio of bonds:other investments, and they constantly adjust their portfolios to reflect this. Classic risk:reward in fact.

I don't generally invest in bonds. The return is minimal and, as a relatively small investor, keeping a balance between my trading account and my bank account/mattress works just as well. But no-one sticks $500 billion in their local branch of Lloyds-TSB, so bonds serve a useful purpose for serious investors and institutions (as well as naive retail bond purchasers, such as in Japan).

Sadly, however, the system just went to shit. The standard balance between risk assets (stocks, commodities, etc.) and risk-off assets (bonds, and other things) has just been utterly perverted. One must now pay for safety, as the German 2-year Bund now exemplifies (i.e. it is paying a negative yield).

Now, such a state of affairs can only go so far. What we have is an astonishing quantity of money parked in bonds that are giving either virtually no return or are charging for the privilege (i.e. effectively charging someone for the rent of the mattress in which he's going to store his banknotes), and which is waiting - correction, I mean DESPERATE - to get out. Funds and HNW individuals do not enjoy paying for the privilege of keeping their fiat risk-free. What we have here, ladies and lemurs, is an unsustainable bubble in the bond markets. Here's just one chart, to make my point:

The oversold conditions exemplified by the RSI in this chart belie belief. Now, given any normal 'rules' of TA, one would be given to think that the hot money is about to flow uncontrollably out of low or negative yield bond 'investments' into other instruments. The choices are few, so PMs and their miners would naturally stand to benefit (not least given their 'beaten up' status over the last three months. It's a natural conclusion to draw that Friday's massive rise in PMs (and the miners) was a predictive response to what is anticipated in the bond markets.

For what it's worth, I think that is probably what is most likely to happen. But. as we all know (and as 2008 teaches us), oversold RSIs can still allow for further dramatic drops. The best I can say is that at some point there will be a dramatic exit of hot money from the bonds, and the most credible homes are the most beaten-up assets, i.e. PMs and the miners. Other risk assets may benefit too (I'm thinking of financials here - still my biggest overall return of my trading career, despite the abuse I received for pointing them out last year...)

We may already be at that point, but - equally - a doom-monger could argue that we are also at the end of the world. The flow out of bonds into productive assets (or even non-productive assets, such as gold) may not come this year. We may see the opposite, in fact, as the flight into Bunds, Gilts and Treasuries sucks all liquidity out of the system. The RSI says 'no-way' to such a proposition. But the Bund may choose to disagree with the RSI, and give it a quick kick in the short and curlies. In such circumstances, you may re-read this article in twelve-months time and laugh at my naivety, as the 30-year T-Bill yields a return of -15%. But I would submit that in such circumstances, the resultant liquidity drain on the system would be of such consequence that not only would you not be reading this on the internet (due to the lack of electricity), but that you would probably be dead. The apocalypse cuts two ways, I'm afraid, and even if you want to vomit at the idea of Bunds becoming the 'safe haven' for the world's ill-gotten cash rather than, say, gold, one might find oneself living the ultimate reality of the market staying irrational longer than one can stay alive.

But the last paragraph feels fanciful at best, and my point, which as usual has been arrived at by an over-wordy post, is that gold and, especially, its miners are playing their usual 'predictive' role in terms of the the next turn in their markets. It may be dramatic, or it may be a damp squib, but given the overbought conditions in bonds, the threat of QE III, and a potentially breath-taking reversal in the USDX, those in the PM community might well stand to benefit to an unexpected degree over the next few weeks and months.

But, this being Sulky Screwtape, I do feel the need to warn that in the event of gold moving hard and fast, along with its miners, the pumpers will be out in force. So please be assured that we will not rest on our scrutinising laurels (as the self-appointing police of the silverogosphere, if you like) as the usual candidates roll themselves out to draw in as much retail investment as possible in order to enrich themselves regardless of which way the market goes.

Peace out ;-)

* unless you do it when the RSI is screaming 'oversold', and everyone on the web is saying how FB will go to $12, in which case there will be a sharp bounce-back and you'll be very happy. Thankyouverymuch.