Thursday 5 August 2021

SILVER UPDATE

 

Silver Update


Back in March I wrote a post suggesting it was time to buy gold or gold related stocks (see https://kiwiblackers.blogspot.com/2021/03/is-time-right-for-precious-metals.html). At the end of that post I mentioned that whilst I was very bullish on silver in the medium and long term, I didn’t feel it had corrected enough at that point and that there was still the risk of a more severe correction. A few months have now passed and the situation has evolved a little more so it’s time to take a closer look.

 Since those March lows for gold, silver has continued to track gold’s movements as is normally the case. It did form a low in April, bounce into a May high and has since been correcting again. But despite these extra months, the picture is still unclear with a number of competing factors, so lets look at the positives and the negatives and see if we can draw a conclusion.

Positives

  1. Time
Corrections can complete in a number of ways. They can move dramatically, with steep price movements quickly taking the price back to areas of support, bleeding off the excesses, flushing sellers out and allowing the rally to continue. They can achieve the same end over a much longer time period with minimal price movement, but with the stagnating price slowly disheartening investors into selling their holdings. Once these investors have sold, the rally can once again continue. Finally and more commonly is a combination of the two. Price and time combine in order to drive out the sellers until only buyers remain. When we apply this to silver we can see that it currently has been consolidating for around 11 months since the spike highs of August 2020.


  It is worth pointing out that silver has a history of long consolidations, but t
his is a reasonable time period and has taken the technical indicators down into neutral or oversold positions

      2. Seasonality

As we know, gold and silver are highly correlated, so whilst there might be a lag or a more extreme move of one versus the other, there paths are generally aligned. As a consequence, when we are looking to predict silver's path, it makes sense to also look at what drives gold. One recurring factor is the seasonal aspect to gold's price movement, as there a discernable pattern of rallies and corrections, and this is in part driven by different cultures attitude to gold as an asset or store of wealth.  Unlike most of the western world which is entirely comfortable with banks and the banking system (although that is starting to change) in many parts of Asia, farmers in particular still tend to use gold as their primary form of savings. As we head towards late summer in the northern hemisphere, many of their crops are being harvested, and the profits from this activity start to be invested into gold. The other main driver is the Indian wedding season. August is a particularly auspicious time for weddings in India, and the custom of  using gold in jewellery and as dowries leads to a bulge of purchasing around this time. These two events combined, have over the years, contributed to the major uplegs that have been commonly seen over the next month to six week time frame.

      3. COT Chart

We've used the COT charts on numerous occasions to highlight how the professionals are positioned and whether it points to a potential price move.


Here we can see the red bars (professionals short positions) have been reducing, meaning they have been buying silver as the price has been falling. They are almost at the level that preceded the low in silver back in April.

      4. Earnings Season

There are a number of ways to invest in precious metals. You can own silver through coins or bullion. You can buy ETF's relating to silver thereby giving you exposure to the silver price, or you can invest in the mining companies themselves or ETF's of an index of these companies. For many people the last route is the most favourable. It avoids the need to physically store the silver (although this can be avoided if you invest using institutions like the Perth Mint for example), but more importantly it gives you leverage to the silver price.

 The mining companies have costs associated with the extraction and processing of silver. These costs can fluctuate depending on numerous factors, but as a general rule, they are creeping up. However the big variable is the silver price. When silver has a big move and effectively stays there for a period of time, it can have a profound effect on the earnings of these companies. They can explode higher, pushing their valuations down and making them a very attractive option to investors. We saw this during the bull market run up to 2011. As the silver price increased, the companies earnings rocketed up driving the share prices higher but without driving up their valuations. It's a virtuous circle in a bull market (however it is the exact reverse in a bear market!). Many of the companies will be reporting earnings over the next few weeks, and the consistently high silver price over the last few months bodes very well.

      4. Inflation 

When inflation first started to pick up a few months ago it was dismissed by virtually all analysts, pundits, central bankers and politicians as being transitory and nothing to worry about. Well unfortunately over the last few months inflation has strengthened and now there are some very nervous central bankers and politicians around the globe. They're worried because the only way they have been able to sustain economic activity is by keeping interest rates abnormally low and using various forms of money printing (quantitative easing). Without it we would have had a global recession and the incumbent politicians would have been voted out, so acting in their own best interests, politicians the world over have ensured that didn't occur. Unfortunately there is no free lunch. This course of action over many years has just encouraged the explosion in debt, and the actions taken to counter Covid 19 has now ballooned government debt to an unimaginable scale. These responses have also resulted in huge disruptions to food production and the supply chain generally. This, allied to the impact a rising US dollar will have on imported inflation will lead to a systemic inflation problem over a number of years. In the past, these periods have been very positive for precious metals as well as many other commodities, and I don't see why that should be any different now.

      5. Silver Miners 

We can get a feel for how the silver miners are faring by looking at an index of silver mining companies. Here we can see a similar picture to the silver price chart which is not surprising but does corroborate things.


We can see two areas of support at the blue line and the 100 day moving average. The indicators are also moving up from oversold positions which is positive.


Negatives

      1. Oversold Enough 

We saw from the weekly chart of silver that most indicators were either neutral or oversold currently, however if we look at the monthly chart it shows a different story.


Here we can see that the indicators are at best mixed, with some still in overbought territory, some neutral and the RSI 3 nearing oversold territory. It can't be painted as a roaringly bullish picture, however there are some caveats. For almost the entirety of this chart silver has been in a bear market, and in fact that only changed with the rebound out of the 2020 lows. As a consequence the technical indicators will react differently going forwards. For example we can see that the RSI 3 indicator only made it into overbought territory on 6 occasions throughout the entire 9 year period. Now that we have flipped into a bull market we can expect the reverse of that, with the indicator hitting the oversold zone very infrequently. All this said, it still leaves room for a further consolidation in either price, time or both.

      2. Stock Market Correction

In my previous post I mentioned the potential for a stock market correction after their great runs from the 2020 lows. We did have a correction in June but have since rebounded, but the indicators have largely rolled over and a decline feels more likely at this point.


The silver mining companies are affected by both the price of silver and the wider stock market sentiment. Selloffs in the market can affect the price of silver but not always in a predictable way. However should we see a serious selloff  then the mining companies would almost certainly be affected  and we could see some serious if short lived declines. This doesn't affect my long term bullishness on the US stock markets and I don't believe there is anything indicating a crash at this time, but it is something to be aware of.

      3. A Strong US Dollar

As I've mentioned previously, excluding any other factors, silver and the US dollar tend to move inversely, and we have in fact seen that over the last few months. My feeling is that there will be other factors that will make them much more correlated as we have seen in the past. However the US dollar chart is looking interesting.


Here we can see that the price has moved down to a confluence of moving averages and that the technical indicators have all turned or are turning up. If we now look at the long term monthly chart we see a very bullish picture, and we must take on board that in 'normal circumstances' this would be silver bearish.


With price having bounced off the 100 day moving average and the indicators turning up from oversold levels, this is indicative of a very strong dollar moving forwards.

Conclusion

We are rarely given absolutely clear cut signals to invest. We are always looking for price and corroborating evidence to show us that the odds are swinging in our favour. There are still risks involved as I have highlighted, and I do think we are heading into a period of serious volatility where the costs of the Covid response and associated strain on government balance sheets, the psychological damage of repeated lockdowns, the disregarding of long held civil liberties and the associated civil unrest, will continue to impact investment decisions. This volatility may well result in opportunities to invest at lower prices, however on balance I don't think this is a time to finesse too much. Personally I would rather be invested to some extent and run the risk of some short term loss.

 I've long argued that as Europe and Japan struggle with their economic problems, the path of least resistance is to the US dollar. This flow of money has only just started, and with the impact of the Covid response bringing these issues to a head, this flow will become a stampede.

We are living in anything but normal times.

Take care


Wednesday 10 March 2021

Is the Time Right for the Precious Metals?


Back during those March lows of last year I wrote a post suggesting that it might be a good time to buy the Dow Jones index as it was sitting around some very strong support levels. This has proven correct, as the Dow has gone on to virtually double in price since then. However I was a little more reticent with the precious metals as I wrote at the time.....

There are some reasons to think that the precious metals have bottomed. With the exception of gold itself, silver and the miners have been hit hard and the charts are in oversold territory. However there are a few things nagging me. 

1.     Firstly, it feels like gold has benefited from a safe haven status (this is not surprising) and that some of that still needs to be washed out.

2.      The panic is not over yet, and forced liquidations should affect gold the same as everything else.

3.     The COT positions are still bearish despite some improvement.

4.     Despite being oversold, the technical indicators are not severely oversold which I would would expect to see at a major bottom.

5.     The 2015 low. It never felt like a true bottom to me. There just wasn't enough panic and liquidation for my liking. I may be wrong and we may not reach those levels on this move, but before going long I definitely want to see more downside, and I think the US dollar rally might be the trigger that causes it.

For the time being I'm happy to watch and wait with respect to the precious metals.

Unfortunately, my reticence was misplaced, with both metals proceeding to rally strongly, confirming that the corrections from the 2011 highs are over and that a new bull market has begun. Whilst missing the bottom is always frustrating, the good news is that now a bull market is confirmed we can look for a price correction to give us the opportunity to enter long positions. Which brings us nicely to the here and now.

Below is a weekly chart of the Gold price showing the collapse of March 2020, the subsequent bounce and the corrective wave since August of last year. We can see that the correction has now lasted for some time, that the technical indicators are all at the lower end of their ranges, and that gold is now around an area that has provided support in the past.




I have often used the Commitment of Traders reports in the past to give insights as to how the professionals are positioned relative to the speculators that tend to just follow the trend. If we look at the chart below we can see that the positioning has been pretty stable in the last year, with the professionals (known as commercials and represented by the red bars) maintaining a short position until the last few weeks when they have started to buy back their short position as prices have fallen.


The chart isn't yet compelling but it is reassuring, as if the commercials are now in the market buying gold on any weakness, this will act as a support to the price and likely reduce the magnitude of any further falls in price.

Lets now move on to the mining companies themselves. As we know, the miners tend to magnify the movements in the underlying metal by some margin, so are often the best place to take advantage of any price moves.

Below we can see the weekly chart of GDXJ, an index of some of the smaller gold mining companies. It unsurprisingly looks similar to the gold chart above, with a long correction, oversold technical indicators and price now close to areas of support.




So having outlined the bullish case for gold and the miners, what could go wrong?

Firstly is the fact that these corrections often take time to form a base, with a number of selloffs and rallies taking place in order to exhaust selling pressure and provide the basis for a sustainable rally. Therefore, just because the price reaches an area of support does not mean it just stops and rockets higher. The basing process can be a roller coaster, but this is where the charts come in. They give perspective, allowing us to see where the price is relative to any support levels and how oversold it is relative to previous corrections. Seeing the price with an historic context shows us that by previous standards, this seems a good entry point.

Secondly, whilst I've outlined many time previously why I am so bullish on US equities in the longer term, they have had a very good run recently. I don't think there is a crash coming, but there could be a short-lived selloff that should it occur would put downward pressure on the gold miners.

Lastly, the US dollar. Most of this last year it has been buffeted by the political circus going on in the US which has driven it down to its 100 day moving average as we can see in the chart below. However the recent uptick in bond yields in the US has got everybody worried about the likelihood of rising rates. This prospect of higher rates has been dollar positive and the price now seems to have turned with the technical indicators moving up from oversold levels, meaning it will likely resume its long term uptrend from 2014. 



Normally, a rising US dollar is bad news for any US$ based commodity, with their trends often inversely correlated.  And at this early point of the change in trend for the dollar, any strength will probably be taken as gold bearish and will put pressure on the gold price. However, we are living in anything but 'normal' times, and I expect to see both a rising dollar and rising commodity prices in the months and years ahead.

So if and when gold does rally, how do you get the best bang for your buck?

As I mentioned earlier, the miners tend to outperform gold itself, and the smaller miners tend to outperform the majors . There are numerous companies to choose from out there depending on your preference and risk profile, but one way of obtaining exposure whilst avoiding the 'eggs in one basket' problem from buying an individual share is by buying an exchange traded fund (ETF) of one of the gold mining companies indexes. These indexes are comprised of a number of underlying companies, with their profiles differing depending on what they are trying to achieve. 

One of the largest etf's is the VanEck  Vectors Gold Miners ETF (GDX). This contains some of the largest gold mining companies around and has traded for some years. An alternative is the VanEck Vectors Junior Gold Miners ETF (GDXJ). This contains some of the smaller companies and is therefore more volatile but with greater leverage to gold. Another to consider is the Sprott Junior Gold Miners ETF (SGDJ), which is also more focused towards the smaller companies with more volatility and more upside potential.

In conclusion, whilst the negative gold sentiment might continue a little longer and the price could well be buffeted accordingly, I think we are at or around a level where there is some good upside potential. It is always hard to buy when the price is falling and sentiment is rotten, but in bull markets they are the best opportunities, even when they don't feel like it at the time.

Lastly, you might be wondering why I haven't mentioned Silver. I am tremendously bullish on Silver in the medium to long term, but the price got taken up and over-extended on the recent Gamestop and Bitcoin frenzy and it has yet to fully correct. Historically, Silver is much more volatile than Gold and I expect there to be more downside before we reach a buying point. I will be doing an update on Silver shortly as that is one rally I don't want to miss.



Saturday 21 March 2020

A Time to Buy?


A Time to Buy?

In 1815 during the aftermath of the British victory over Napoleon at the battle of Waterloo, there was a crash in the British financial markets. It is rumoured that Baron Rothschild, an 18th century British noblemen and part of the Rothschild banking dynasty, got advanced word that the British had won the battle, went into the markets and sold heavily. Rumour spread that the battle had been lost and panic ensued with prices crashing. At the market lows, Rothschild went back into the markets and bought heavily, closing out his positions for huge profit.

Irrespective of whether he started the rumour or just capitalized on the panic, afterwards he was credited with the expression ‘Buy when there’s blood in the streets’. This rather graphic phrase perfectly illustrates the trauma associated with market crashes. When markets move from a correction to a crash, panic replaces rational thought. The fear becomes all pervasive and any thoughts of value fly out the window. It is simply about preserving what you can and selling at any price. This stampede to the exits is exciting to witness but gut wrenching for those investors caught on the wrong side of the trade.

The equity markets were probably due a decent correction after experiencing a particularly long and relentless phase of rising prices. As we know, even the strongest bull markets need periods of consolidation to blow off the froth that happens periodically and the longer a market moves without one, the bigger the consolidation will be when it arrives.

When news first started to emerge of a new virus in Wuhan, the markets were incredibly resilient. It was only when the virus appeared outside of China that the markets started to react. After an initial slump and rally, the world was greeted by the news that a price war had started in the crude oil market, after OPEC members refused Saudi Arabia’s suggestion to scale back their production in the light of falling demand due to the effects of the virus. As a result, Saudi scaled up production and offered deep discounts on its prices in order to force a resolution. As the world’s largest and cheapest producer of oil, this is a fight that Saudi will ultimately win, but until it resolves, it will cause immense damage to the other oil exporting countries around the world. This turmoil led to oil prices falling 30% initially, and the price falls have continued.

This kind of move would upset the financial markets at any time, but in their current fragile state, it was particularly damaging. As liquidity in markets dries up and losses mount, banks and other financial institutions are forced to start selling other assets in order to raise funds. This drives the volatility, leading to wild swings and mounting losses. As credit conditions become tight, banks refuse to lend to each other, fearful that the other institutions might be in trouble. At this point the central banks have to step in to provide liquidity to prevent the whole system blowing up. We have seen this recently with the US Federal Reserve offering up to $500 billion daily to ensure adequate functioning of the credit system. Central banks around the world have also made drastic cuts to interest rates in order to support the system and try to offer some relief to borrowers. These stresses and strains within the system have resulted in some financial institutions facing huge losses.

If all these factors weren’t already enough to induce a panic, the authorities reaction to COVID-19 has been nothing short of astounding. As the virus has progressed we have seen differing responses from governments around the world. Some have been almost relaxed in the face of its progress, others, including many of the countries that felt the force of the SARS outbreak of 2003, have been more proactive in reducing its transmission. China has shown what can be achieved when draconian measures are taken to shut down all movement. Drastically reducing the number of people infected, reducing the speed of transmission and buying the health services time to respond and not be overloaded. This now seems to be the template that governments are following around the world and it will work. It is undoubtedly the most effective way to combat the transmission of any and all infectious diseases.

The question though is at what cost?

The measures being enacted around the world will have a dramatic effect on the global economy, the likes of which we have never witnessed before. We will see a truly global recession, with many businesses being bankrupted and millions of people losing their jobs. The costs associated with fighting COVID-19 and the lasting repercussions will be staggering.

I could understand it if we were facing a global outbreak of Ebola. With a mortality of rate of up to 90% it truly is something to fear. In those circumstances, shutting down the global economy would make perfect sense, as failing to act would result in there not being a global economy! But should we really be acting the same way for a virus that although likely more dangerous than seasonal flu, still only appears to have a mortality rate of 1.4%  https://www.statnews.com/2020/03/16/lower-coronavirus-death-rate-estimates/  Are there really no other measures we could be taking? As the mortality rate is so much higher amongst over 70's and those with underlying health issues  https://www.bloomberg.com/news/articles/2020-03-18/99-of-those-who-died-from-virus-had-other-illness-italy-says, would it not have been more sensible to spend money and resources isolating those people and allowing the global economy to continue to function? 

Are we going to stop the global economy the next time a virus appears? 

Because there will be a next time.



I think we are witnessing a version of the panic we normally associate with stock market crashes. In the media’s quest for click bait, the avalanche of evermore lurid and fear mongering news headlines has had an effect on peoples psyche until we have finally arrived here, with the economy in almost total lock-down and people fighting in supermarkets over toilet paper, a situation that most people couldn’t have imagined even three weeks ago.

For a final word on human nature we can turn to the wisdom of Agent Kay in the Men in Black movie. In response to Will Smith saying that people are smart, he replies,
“A person is smart, people are dumb, panicky, dangerous animals and you know it!”

In a years time, when the dust has settled on all this, there will be some serious questions to answer. I fear we are currently using a seriously big sledgehammer to crack a nut.

So, having got some perspective as to why the markets are reacting so violently, has this changed my views that the US equity markets will turn around and go to new all time highs? Or that the US dollar will continue to strengthen? Or that the precious metals will once again show some spectacular gains? The simple answer is no, because once we have worked our way through this period of turmoil, investors will once again face the same challenges they did before. And the shortlist that existed before this crash will remain the same.

 Currency risk will be the key driver. As I've mentioned many times before, there are only three currencies that can cope with the volume of trade needed to be a truly global currency, they are the Euro, Japanese Yen and the US Dollar. The euro zone was already in serious strife before this crash, with the financial hole left by Brexit finally highlighting how financially exposed and disparate the zone really is. The COVID-19 effects will expose the harsh reality of a flawed political union as member states abandon the one zone theory and return to every country for themselves. We were already seeing weakness in the euro as money left the zone in search of US dollars. This was temporarily reversed in the early stages of this crisis as emotions took over and money was repatriated, however we have now seen a surge in US dollar buying as we can see from the chart below. Sidebar (you might also ask why money doesn't flow into the Yen instead of the Dollar. The reason is that Japan has its very own set of mammoth problems that will manifest in the not too distant future, so for the present time, the US Dollar will remain king).



  We are also able to get an idea of the potential upside for the Dollar by looking at a P&F chart. 


These charts are useful as they give an idea of the potential strength of the move. They are not guaranteed by any means but it is uncanny how often they are proved right, and in conjunction with other analysis they can be extremely helpful. In the last two bars of the chart we can see the price move down to the 94 level, then the powerful bounce up to 103. If we look to the top of the chart we can also see the Bullish Chart Objective which is the level the rally could potentially reach.

These charts, together with the fundamentals suggest that the dollar rally has an awful long way to go. Which leads on to the next question, which is, once all this money moves into US Dollars, where will it be invested?

Again, fundamentally within the US there are only two markets big enough to cope with a massive influx of funds, the bond market and the equity market. Bonds have seen a surge of safe haven buying which is the usual dynamic in times of panic. The US bond market is still seen as the safest place on the planet in times of trouble. However, these bonds are now yielding virtually nothing. Even locking your money up for 10 years will get you less than 1%! These are ludicrously low yields and institutions simply cannot stay invested in them for any period of time as they need a better return on their capital. Once the absolute panic subsides, they will be desperate to find better returns, which leads us nicely to the only game in town..........the stock market.

So now that we understand why the stock market will rally once we pass peak fear, let’s turn our attention to whether now is the right time to dip our toe. 

In short..............Is there enough blood in the streets?


Lets take a look at the Dow Jones index to see where we stand.




We can see the two lines of support between the 17000 and 18000 area, and the major support at the 15000 area. This is also where the 200 day moving average currently resides. Looking at the technical indicators we can see the 14 day RSI at the top just about to enter the oversold zone, and the shorter term 3 day RSI at the bottom well into the oversold zone (As a reference, we would need to go back to 2009 for the last time these indicators were that oversold).


As I’ve already mentioned, we have been witnessing mass liquidations by funds desperate for cash, and as I don’t think we are at peak fear yet surrounding the COVID-19 end game, there may be a little more downside to come. We could well see a flush out panic low going all the way to the 15000 mark, however I think this would be extremely short lived and difficult to actually trade. My view is that anything bought between the 18000 to 15000 zone presents a great long term buy so there is no need to try to finesse it too much.

To be clear, I firmly believe that the market will be back up to the highs within a year and will then push on to new all time highs.

Other equity markets around the globe will likely be pulled up with the Dow but to varying degrees, and the advantage to all non US dollar denominated investors of being invested in the US Equity market is that you will get both the currency appreciation from a rising US Dollar as well as the benefit from a rising stock market.

Lastly lets take a look at the precious metals and see how they are faring.




Gold had been trading strongly through early 2020, continuing an uptrend from the $1045 low back in 2015. In fact, as the COVID-19 crisis unfolded it continued to gather support, bolstered by its traditional safe haven status, reaching a high of $1704 only a couple of weeks ago. However it was also looking extremely overbought and ripe for a correction. Unsurprisingly, also during this period, the commercials (professionals) were expanding their short positions and selling into this rising market. We have seen a number of times in the past that when the commercials build up a big position it serves to pay attention.

We can see from this chart of the Commitment of Traders that the commercials had their biggest short position of the year when gold finally started to crack, and even with the fall in the gold price, they still have a very large short position, suggesting that there is a lot more downside.



If we look at Silver by comparison, it has been absolutely thumped.



It too had rallied from the lows of late 2015 but never as enthusiastically as gold. Its COT figures were even more impressive than gold with a huge short position, and during this panic it has been hammered down to new lows. 

The precious metals shares have unsurprisingly also suffered some major falls as we can see in this chart of the GDX, an index of precious metal companies.


There are some reasons to think that the precious metals have bottomed. With the exception of gold itself, silver and the miners have been hit hard and the charts are in oversold territory. However there are a few things nagging me. 

  1. Firstly, it feels like gold has benefited from a safe haven status (this is not surprising) and that some of that still needs to be washed out.
  2.  The panic is not over yet, and forced liquidations should affect gold the same as everything else.
  3. The COT positions are still bearish despite some improvement.
  4. Despite being oversold, the technical indicators are not severely oversold which I would would expect to see at a major bottom.
  5. The 2015 low. It never felt like a true bottom to me. There just wasn't enough panic and liquidation for my liking. I may be wrong and we may not reach those levels on this move, but before going long I definitely want to see more downside, and I think the US dollar rally might be the trigger that causes it.
For the time being I'm happy to watch and wait with respect to the precious metals.

Overall, this panic will throw up some fantastic buying opportunities, but it's one thing to recognize them, it's quite another to actually trade when every bone in your body is telling you not too. Ultimately that's what separates the true trader from everyone else.

Sometimes you just have to hold your nose and jump.




Thursday 30 August 2018

The Property Bull is Dead – What Happens Now?


The Property Bull is Dead – What Happens Now?

“The Trend is your Friend, until it Ends!”

The trend in the property market has been up for so many years now, that for a sizable part of the population it is all they have ever experienced. Starting in the early 1980’s from a point where property was seriously undervalued by historical standards, global real estate began a multi decade climb that has seen valuations go from undervalued to reach stratospheric heights in some parts of the world.

When the trend changed in favour of property, the recovery was initially driven by investors lured by high yields and the added benefit of falling interest rates - a virtuous combination. However as the years have progressed and debt has become easier to obtain, cheaper to borrow, and easier to leverage, the property market has morphed into a speculative frenzy driving valuations to excesses never seen before.

However, before we look at how the bull market will end, its worth taking a look at how it develops in the first place.


The Three Phases of the Property Bull Market

THE Stealth PHASE

The first stage of a property bull market we can think of as the stealth phase, which is the start of the upward trend. The stealth phase typically comes at the end of a downtrend, when everything is seemingly at its worst. But this is also the time when the price of property is at its most attractive level because by this point most of the bad news is priced into the market, thereby limiting downside risk and offering attractive valuations.
This is therefore also the point at which informed investors start to enter the market, looking for property investments offering fantastic yields and growth opportunities.
The majority of this phase will be characterized by persistent market pessimism, with most people thinking things will only get worse.
It is only towards the mid-to-latter stages of the stealth phase that we see the price of the market start to move higher.

The awareness PHASE

When informed investors entered the market during the stealth phase, they did so with the assumption that the worst was over and a recovery lay ahead. As this starts to materialize, the new trend moves into what is known as the awareness phase.
During this phase, negative sentiment starts to dissipate as lending becomes cheaper and more affordable. As the good news starts to permeate the market, home owners start to trade up and first time buyers come to the party. Attracted by the now steadily rising prices, this is also the time when the number of speculators increases, creating more demand and sending prices higher.

 THE MANIA PHASE
As the market inexorably moves higher and the move starts to age, we begin to head into the mania phase. At this point, property is the ‘go to’ investment. Credit is cheap to get and banks are falling over themselves to lend it. Increasing numbers of property owners, seduced by the seemingly never ending gains, join the ranks of property investors, thereby competing with the desperate and hugely leveraged first time buyers.
With valuations now reaching ludicrous levels, this last stage in the upward trend is the one in which the smart money starts to scale back its positions, selling property off to those now entering the market. The perception is that everything is running great, that only good things lie ahead and that the market will keep on climbing higher.
This is also usually the time when the last of the buyers start to enter the market - after large gains have been achieved. Like lambs to the slaughter, the late entrants hope that recent returns will continue. However, with valuations incredibly over stretched and the interest rate cycle about to turn against them, they are buying near the top.

The Tipping Point

There are a number of factors that can affect the price of property. The level of interest rates and inflation, the outlook for the economy, the availability of credit, and changes in the population numbers to name a few. All these factors can help accelerate, or slowdown a trend for a period of time, but none of them are capable of changing or reversing the dominant trend in motion. Property, like all assets, move in long term repeating cycles from under-valued to over-valued and back again, in a process we have observed for millennia. And although certain measures may delay the inevitable (usually with more painful consequences later on), once the peak of overvaluation is reached, the market will start its long, painful journey to once again reach undervalued levels, where finally a new bull market will spring forth.

In many parts of the world we have witnessed a change in the property market dynamic since the global financial crisis of 2007. Up till that point we saw a broad based bull market with massive participation and prices rising across the board. But since the price falls triggered by the GFC a change has occurred. Once the dust settled, prices once again started to rise, but this time the rise was driven by big money looking for safe havens in the large centres of the world, not by broad based buying. We witnessed new highs in many of the worlds biggest cities, but the breadth of the market was slowly falling away, and in many countries the gains in the wider property market has seriously lagged behind. This 'two-tier' market, and distillation of the gains into an ever decreasing pool of investments is classic sign of the late stage of a bull market. And in the last year or so we are seeing price falls in those large centres as the cycle rolls over. As the process moves on, we will start to see these falls ripple out until the entire global property market is in retreat.

What we have witnessed since those far off days of the 1980’s is a global property market moving from extreme undervaluation to extreme overvaluation, and the current combination of sky high valuations and enormous levels of property debt leave us awaiting the catalyst that will propel the market lower. 

Which brings us to interest rates.

The Power of Interest Rates

Contrary to popular belief, Central Banks around the world do not control the interest rate market. They do have the power to set the official cash rate (called various things around the globe), but unless they intervene directly into the bond market by buying or selling (as we have seen with quantitative easing), all other rates, be it 3 month, 1 yr, 5 yr or 10 yr etc are set by how those bonds are trading in the market. It is therefore the supply and demand for bonds that is the critical factor in establishing the interest rates that matter to you and I, not the rates that the central banks control. So just because the central bank changes its rates, does not mean it will be mirrored in your mortgage rate, credit card rate or deposit rate. 

But it gets worse.

The US dollar is the world’s reserve currency, meaning that the US Bond Market is seen as the safest investment in the world, and therefore bond markets around the world are all referenced to what happens in US bonds. In simple terms this means that if investors start to sell US bonds, thereby driving interest rates up, this will also be reflected in interest rate movements around the globe – when US interest rates go up, so do ours!

We can now see that the domestic factors that affect interest rates in our own countries can be overwhelmed by the movements of US interest rates. So bearing in mind the importance of interest rates on property prices, it is critical that we pay attention to the outlook for US interest rates, and it is not a pretty picture.


Here we can see a chart of the US 10 yr bond yield from 1960 to the present day. It illustrates the rise in rates from the 60's, through the inflationary period of the 70's and finally peaking in the early 80's. Since then, rates have ground inexorably lower until finally reaching a bottom in 2016. This snapshot only shows the cycle from the 1960's to the present day, however if I were able to obtain the data you would be able to see this pattern repeated time and time again. Unfortunately for us, the lows we have experienced through this particular cycle have carried interest rates to levels never experienced before, and as high interest rates follow low interest rates as sure as night follows day, we have much higher rates in our future. 

To get a better timeline on that, we need to look at a shorter term chart.

In this chart we get to see more detail of the US  10 yr bond yield over the last 10 year year period. It is apparent that we have experienced a huge basing pattern as rates have moved between the 1.3 to 3% zone ( the rates in the charts are expressed as 10x the rate ie 13.36 rather than an actual rate of 1.336). Basing patterns are important to pay attention to, as the rule is that the longer the pattern lasts, the greater the move will be when it finally breaks out. And although only by a small margin, prices have broken out and exceeded the previous highs established back in 2014.


Overhead resistance will still be offered by the falling 200 day moving average (green line on chart) so it may take a little while to work through this. However once that is overcome, much higher rates await.

This picture is corroborated when we look at a point and figure chart.


Here we can see the big move up from the lows of 2016, giving us a projected target of 4.967% (49.67 on the chart) resulting in a 70% increase in borrowing costs from the current level. But this will only be the start. Having fallen so far for so long, history tells us that we should expect a protracted rise in interest rates, and as we now know, once the trend is in motion there is no stopping it.

This rising interest rate environment, allied to stratospheric property valuations and huge leverage is the recipe for a housing price disaster. It has been an incredible ride, but contrary to popular thinking, interest rates do not stay low indefinitely and housing bull markets don't last forever.

What Happens Now?

As the combined factors of over leverage, over valuation and rising interest rates start to take affect we will see the property market change:
  1. The volume of sales starts to fall as the cash buyers at the top end of the market dry up.
  2. There is a growing disconnect between sellers expectations and what buyers will pay, decreasing the level of sales still further.
  3. As the market stagnates buyer perception of potential gains changes and bidding prices start to drop.
  4. Sellers start to become aware that the market has changed, and that they need to lower prices if they wish to sell.
  5. Usual real estate bullshit around it being a good time to buy.
  6. As interest rates start to rise, banks start to reduce their exposure to mortgage debt and make it harder to obtain a mortgage.
  7. Speculators leave the market, reducing the demand for property still further.
  8. The first whiff of fear takes hold. Property owners that are forced to sell have to accept much lower prices.
  9. Some over leveraged property owners, squeezed by falling prices and rising mortgage costs , hand back the keys.
  10. The constantly rising interest rates and falling prices creates a vicious cycle. Sellers keep reducing prices but buyers are squeezed by reducing access to credit and rising debt service costs, reducing the amount they can pay.
  11. Usual real estate bullshit around it being a good time to buy.
  12. The volume of property for sale, and the length of time it takes to sell both increase. This overhang of property is an added deterrent to buyers. Why buy now when they will be cheaper next month.
  13. Over leveraged property speculators start to sell down property to avoid going bankrupt.
  14. Banks balance sheets are affected by the volume of failed mortgages they have, and the number of properties they now own as a result of owners giving back the keys. As a consequence, mortgagee sales increase and drive the market still lower.
  15. Finally the market reaches a point of equilibrium as all the forced sellers have sold. Prices stabilize. 
  16. Activity is very low. Buyers, now conditioned to falling prices, sit with bids below the market price. There are only cash buyers as credit is extremely hard to access. Sellers, wanting but not needing to sell, sit with asking prices above the market price, waiting for an uptick. Time drags by.
  17. Real estate agents go bust due to low volumes. Number of agents is radically reduced.
  18. Driven by a combination of falling prices, inflation and the passage of time, property is once again finally undervalued.
  19. Buyers, unable to obtain property with low-ball offers finally have to pay market rate.
  20. The stable prices encourage value investors to once again enter the market.
  21. The overhang of property is slowly eaten into and prices start to rise.
  22. The process is ready to start all over again. 
  23. The usual real estate bullshit around it being a good time to buy.........finally they are right.


Dependent on where in the world you are, you will likely face some if not most the outcomes listed above. There will always be variations, for example in the US property loans are non-recourse, meaning that you can hand back the keys without the debt hanging over your head. This pushes the risk back to the banking sector which is where it should lie, and speeds up the process of falling prices and the correction to undervaluation. However, in places like the UK and New Zealand, mortgage debt stays with you, so defaulting on a mortgage is a last resort. This slows down the correction and can force the economy into a slow, grinding retreat. Whatever the local variables, the big picture is clear.

When it comes to property, the trend has indeed been our friend, but nothing lasts forever.

Good luck.

Tuesday 26 September 2017

Time To Buy The US Dollar!

Time To Buy The US Dollar!

For most of this year the US Dollar has been correcting its explosive gains from its breakout back in 2014. This process of big moves followed by consolidation is fundamental to the way asset prices move, and once the primary trend is established, these periods of consolidation provide excellent opportunities to invest, safe in the knowledge that once the correction is over, the primary trend will re-establish itself.

If we look at the chart below we can see the huge correction in the US Dollar from 2001, then the massive contracting wedge basing pattern through to 2014, followed by the emergence of a new uptrend and breakout to the early 2017 highs, and finally the correction through to now.


The correction we have seen through most of this year is perfectly normal in terms of price, however it has coincided with an increasingly negative view on President Trump, and his inability to actually get anything done. Whilst in Europe, after the wailing and gnashing of teeth that greeted the Brexit vote, there is now a more positive view after the three major elections in the Netherlands, France and Spain preserved the status quo, pro Euro bias. These combined events have lead to the weakening dollar and strengthening euro, but is this dollar pessimism and euro euphoria justified? Well unsurprisingly no!

The negativity surrounding Trump is hardly surprising as he has been outmaneuvered on all sides by the very establishment he is trying to reform. This allied to a concerted effort by the mainstream media to undermine him at every opportunity has destroyed any credibility he may have had. And on those rare occasions when he has caught a break, he has quickly managed to shoot himself in the foot by his seeming obsession with inappropriate tweets. However, whilst President Trump's slide into tragic farce has impacted the dollar, the fundamental reasons to be bullish on the dollar strength remain.

Similarly, when we scratch beneath the surface of the renewed euro positive sentiment we can see that it is baseless. The fact that no anti-euro party was able to take control in any of the recent elections cannot hide the fact that the surge in anti-euro sentiment was substantial. This sets the stage for increased tensions as the global economy rolls over, the anti-euro vote grows and the two sides become more polarized.

These two trends have combined to create the dollar correction/euro gain that we have witnessed throughout 2017. However they are now getting long in the tooth, and a resumption of the primary trend is almost upon us. A view that is reinforced if we take a look at the technical picture.

Here is a more condensed version of the dollar chart showing the long basing pattern and the breakout. We can see that price has now arrived at a zone of support, and if we look at the RSI indicator at the bottom of the chart we can see that it is at its most oversold since 2008.


In we move in closer still, we can see that both the indicators at the bottom are starting to turn up, and that the RSI at the top of the chart, having reached a very oversold level, is also turning up, suggesting that the bottom is in.


One chart I often look at to corroborate what the price charts are telling me is the Commitment of Traders. These charts break down the ownership of different instruments, and allow us to see what positions the speculators (amateurs) and commercials (professionals) are taking. The commercials are rarely if ever wrong, and whilst the price reaction might not happen immediately, it pays to know what they are doing and not to bet against them. This is important to monitor because when positions become extreme they are often warning signs that a move is about to happen.

If we look at the Euro chart below, we can see that the commercials (red bars on the chart) were very long the Euro before it started its rally against the dollar back at the tail end of last year. We can also see that as the rally has progressed, the commercials have sold their positions and gone aggressively short. This is indicative that they are expecting a sell-off in the Euro, and corresponding rally in the dollar, at which point they can buy back their positions for a profit.


In conclusion, the fundamental reasons for a strong dollar have not change and the euro enthusiasm is past its sell by date. The technical picture backs up this view, with prices over-extended and the professional investors already positioned, suggesting a big move won't be far away.

This is an opportunity to get out of the euro and into the dollar for an impending rally that I believe will make most investors eyes water.

Tuesday 28 March 2017

Financial Markets Update

Financial Markets Update

Many of the financial markets around the globe have enjoyed strong moves since Donald Trump's election as President of the US back in November. The perception that he would cut taxes and increase spending triggered a rapid re-adjustment in a number of markets including the precious metals, the US dollar and stock markets. Initially we saw all these markets show strong gains, as cash that had been sitting on the sidelines during the election process was finally put to work. However, as the weeks have gone by and Trump has become increasingly bogged down by the political maneuverings of both the Democrats, his own Republican party and a hostile media, this enthusiasm has started to wane. The failure last week to get Congress to endorse his attempt to repeal the 'Obamacare' healthcare program is symptomatic of the struggles Trump will face during his presidency. This ending of the honeymoon period for both the Trump presidency and the economic euphoria that accompanied it, makes for a good time to review the financial markets.

The US Dollar

During the early stages of the Trump presidency the dollar enjoyed a strong rally fueled by the belief that a more lenient fiscal policy would lead to a huge repatriation of overseas earnings by US companies. This allied to a generally improving US economy would all be dollar positive. I have spoken at length about why I believe the US dollar is going much higher in the medium and longer term ( for a recap see  http://kiwiblackers.blogspot.co.nz/2013/11/the-coming-us-dollar-rally.html ) but lets now take a look at the chart.


We can see the rally that occurred from early November through to the start of 2017, followed by a correction since. More recently this correction has gathered pace, as the defeat of the populist Geert Wilders and re-election of Prime Minister Rutte in the Netherlands has breathed some hope back into the euro project and led to some investors selling dollars to move back into euros. This reaction will likely run a little longer, but as we can see from the technical indicators at the bottom of the chart, price is starting to get oversold. I have highlighted an area of potential support on the chart, and this zone is further reinforced when we look at a point and figure chart for the dollar.


With this chart we can see the potential target price of 95.45. As always, there are no guarantees that it will be reached but it does give us a little more confidence.
 In conclusion, the US dollar will ultimately resume its climb to new highs, and this correction provides a great opportunity to go 'long'. I would rather be long a little early than try to finesse it and miss out!

The Dow Jones Index

The Dow reacted very strongly to the Trump election victory rising over 18% to its high of 21169 on 1st March. As is often the case with financial markets, the more the price goes up, the more bullish investors get until we reach a point where all the potential good news is priced in and prices only have one way to go. The Dow held out for a long time but finally it is easing off as the promise of tax cuts and increased spending becomes less certain. If we look at the current chart of the Dow Jones we can see that it reached very overbought levels and as a consequence is at great risk of a more concerted reaction. 



I have marked the more likely areas that support will be found on the chart, and we can once again look at the point and figure chart for any clues. 


Here it gives us a downside count of 19772, a correction that would finish at the first support level. Here as with the US dollar investors might be wise to invest too early rather than hope for a large correction. I have explained in prior posts why the US stock market will be the only game in town once funds start pouring back into US dollars, so trying to pick the bottom and time your investment to perfection could prove very frustrating.

Gold

Gold also fared well in the aftermath of Trumps election. It was also given a second wind by the subsequent dollar weakness. However, unlike the the dollar and the stock market, Gold (and its compatriot Silver) are still in their long term corrections from the highs of 2011, and whilst the rally has been impressive, it still has a long way to go before we can be convinced that the low is truly in.


We can see that Gold is still in the downtrend that started in July last year, and that whilst a near-term weaker dollar might give it a bit of a fillip, it is getting into overbought territory. Once the dollar starts to rally, I would expect to see gold fall hard, with the critical point being the 1124 support level. If that is broken, it opens up the 1045 level as the next target.

The point and figure chart for Gold is giving us an objective of 1119, which seems to reinforce how important that 1124 support level is. We shall just have to wait and see.

Conclusion

What I believe we are currently seeing are counter-trend moves in all these markets. With the Dollar and US stock markets, once the corrections are over they should resume their track to new highs, fueled by the increasing turmoil in Europe and the rush to find safety in the US dollar. Ultimately Gold will also find favour, but first it must finish its multi year correction. This is something we must keep a very close eye on, as when that bottom is finally reached, the upside potential will be huge.
I shall endeavour to keep you up to speed as the moves unfold and do my best to pick those entry points as they manifest.