This Week in Barrons – 4-13-2014
“Somewhere between Brave and Stupid…”
I had the pleasure on Friday evening to eat dinner with an old friend, and he asked me: “So what should I invest in?” After giving him my correlated assets talk (about bonds, the yen, oil, gold and stocks no longer moving as they should), he politely looked at me and asked me the same question – again. I honestly couldn’t help myself but answer with: Gold and Silver. He then asked me: “So why do they remain 30% off their highs?” And that’s when I felt “somewhere between brave and stupid.”
Gold and Silver (after hitting their highs in 2011) have been beaten down and kept in some kind of dungeon. Considering all of the ills of this world, inflation, and instability – does it make sense that gold and silver can't move up? It does if you understand some of the rationale behind why both precious metals remain ‘capped’.
With Silver, the two most common reasons for its ‘cap’ are:
- Most of it’s demand is industrial. With China slowing, and the remainder of the world crippled with their lousy economies, silver demand has been reduced.
- Silver hasn't been thought of as a form of money since we stopped using it in coinage; therefore, there’s no ‘investment’ demand as alternative currency.
Allow me to address both of those concerns. In terms of demand, something quite spectacular is occurring in the energy world. The dream of solar energy actually being price-competitive with hydrocarbon fuels is very near. The newer technologies have been able to ‘regionally’ reduce the price of solar energy to compete with gas and coal on a kilowatt per hour cost basis. Because of that, demand for new high tech solar is increasing exponentially, and these solar technologies use more and more silver for their critical electrical connections because of it’s super efficiency.
Along with the rising energy demand, silver is increasingly being used as a medicinal remedy. Silver has tremendous anti-biological properties, and has been found to be more effective against the most serious of bacterium than even our more high-powered antibiotics. The demand for silver infused drugs has exploded; therefore, while silver demand in standard industry (including China) may fade, that demand is being replaced by energy and medicine.
In terms of silver supply, there are very few true ‘silver mines’. 90% of all the mined silver is a by-product of looking for other metals like copper and zinc. As demand for copper, zinc or any of the other industrial metals fall, mines will be closed. And since silver is found mostly as a co-inhabitant of those same ‘other’ mines, the supply of mined silver will also decrease.
What about Silver as a currency? Well, of course Wall Street doesn't think Silver is currency – they can't make it out of thin air like they can dollar bills by fractional banking. It has been a form of wealth and money for thousands of years. Even in the Bible people talked of land being worth ‘400 pieces of silver’. I guess the thought of it being worth: ‘400 Federal Reserve notes’ escaped them.
So, if demand is level, supply is falling, and if Silver is still some ‘form’ of currency – why is the price capped? Simple, Silver (being such a small market) has become the single most manipulated commodity on the planet. If you thought LIBOR was a scandal, the naked shorting of silver (by J.P. Morgan (JPM) in particular) makes LIBOR look like a kids game. JPM systematically worked the ETF's, the COMEX, and the miners to drive the price of ‘paper’ silver lower, while the ‘real’ ratio of physical demand to supply continues to increase.
In Gold, the situation is even more bizarre. When Gold hit its high in 2011, the entire world (simultaneously) became ‘disgusted’ with the incessant devaluing of the U.S. dollar – the ‘world’s global reserve currency’. As one Chinese finance minister said: “What good is the dollar as the global reserve currency, if they're devaluing it by 40% every year?” So, around the globe countries decided that they wanted gold, and not U.S. dollars. Unfortunately, the FED’s business is U.S. dollars and U.S. power – through regulation of our money supply. If the world doesn’t want U.S. dollars, then they don’t want U.S. Treasuries, and then we can't keep rates low or fund our Government.
Knowing that, our government held talks with the Chinese and agreed on an exchange rate for gold and U.S. Treasuries – as long as the Chinese continued to purchase more U.S. Treasuries. Currently, however the U.S. has somewhat boxed itself into a corner. The Chinese want absolutely nothing to do with the U.S. dollar or the Federal Reserve. They would like their own currency to rank as a global reserve, and they have used the attacks on gold to amass large amounts of it. Honestly, it was the FED's only way out of a bad situation, and the Chinese used it to their advantage.
So are gold and silver destined to ‘live somewhere between brave and stupid’ and go higher? If I’m correct, China is going to assert itself as one of the big players in a new global reserve currency, and it’s Gold holdings will play a large part in that. With talks of a new global reserve, Silver will stop being manipulated, first by JPM and then by the FED. Unfortunately there are ‘no rules’ when negotiating a new global reserve currency.
- Maybe Russia and China are pushed to a point that they speed up the ‘reset’ of the global reserve process.
- Maybe the currency wars continue and everyone starts dumping U.S. dollars and treasuries.
- Maybe the world agrees to ignore the U.S. dollar, and buy energy in any currency.
- Maybe a lot of things, but in the end – Gold and Silver go higher.
Silver will NOT be a part of any new currency, but should revert to the fundamentals of supply and demand which should be between $70 and $100 per ounce (currently at $20/ounce). Gold, however, is a wildcard. Under normal conditions it should be around $2,400 per ounce. But, if China continues on it’s course, then gold could easily be valuded between $4,500 and $7,000 per ounce. And that’s what I recommended at the dinner.
Is it here? After 30+ months are we finally going to have a true, 10% correction in the markets? It certainly feels like it. But, we’ve been in this position so many times, that I feel like the ‘boy who cried wolf’. Over the past few years, we've had no less than 11 set-ups where the market should have put in such a correction. The news flow was ripe, the technicals were ripe, and yet the FED took their funny money and drove the market higher.
Here is where (I think) the supporting evidence allows us to reach a different conclusion. We’ve had many 2% to 4% hiccups in the past. For example: on January 7th the DOW cratered 7% - from a high of 16,560 – all the way down to 15,356 on February 3rd. It then (of course) rebounded to set new, all-time highs in the first days of April.
In just a couple of months we've hit an all-time high, dropped a quick 7%, rebounded to new all-time highs, and now we're dropping in ‘free fall’ again. In other words, the speed and the ferocity of the pops and drops are becoming exaggerated and closer together. Often, when a market becomes this volatile (with it’s frequency and amplitude), it usually mark a trend change.
If you remember back a couple of months, I did a commentary about the FED as it started the QE Tapering program. I remarked that it was very odd that the FED would be ‘tapering’ when clearly the economy was barely scraping by. At that time I suggested that if by the summer we hadn’t see a reverse in course and the FED stopping it’s taper and starting putting money back into the system – then a major shift has indeed occurred. The most recent FED stance to any market weakness has been to slash rates and print money. This FED is now slashing the printing of money and threatening rate increases starting next year.
This coming week will produce a lot more bank earnings reports. JPM’s report last week was a complete disaster. Wells Fargo was better – which rescued the bank panic temporarily. But, if the bank reports continue to be poor – it will drag the sector down sharply. This market usually keys off of the financials. So, if the financials are flat to rising, then the market should level out; however, if the financials are declining then the market will head lower and everyone along with it.
Thus far we’ve only seen a 4% dip in the S&P and 3.6% drop in the DOW. Most of the damage has been done to the NASDAQ and to the ‘high-fliers’. For next week, I will be watching:
- The YEN (FXY) – if it moves higher it will be tough for the S&P to move higher,
- The Treasuries (TLT) – if bonds move higher, it’s tough for stocks to ‘catch a bid’,
- Gold (GLD) and Oil (USO) – if money moves into these benchmark commodities, then stocks should move lower,
- And Financials (XLF) – if the financials are moving lower (even slightly) – stocks should follow their lead.
Let’s not try and ‘catch a falling knife’ just yet. There will be plenty of time to play this correction once we see that the FED is allowing it to play out. Personally – I’m sitting in cash, or at minimum covering what stocks I’m playing by selling ‘covered calls’. I see no reason to be ‘brave or stupid’ right here. If you go short (buy PUT options) – and this is just another in the FED’s long string of ‘head fakes’ – you’ll be burned. If you load up on longs with a ‘buy the dip’ strategy, and this time the financials don’t produce – you’re going to scramble to sell back out. Sometimes the best play – is not to play.
This week the FDA pushed back it’s overall approval date for Mannkind Pharmaceuticals (MNKD) until June 15th. However, I’m still holding a position in (MNKD), but simply for it’s 3 to 4% PER WEEK yield on it’s call options. Last week I cashed in some USO options for a nice gain, and correspondingly purchased more June, $35 – USO – call options. I also cashed in my TLT options last week for a nice profit – and will potentially purchase more early on in the week – if the market continues to sell-off.
My current short-term holds are:
- MNKD – in @ $6.35 – currently ($6.51)
- USO (Oil) – in @ $37.19 - (currently $37.18),
- SIL (Silver) – in at 24.51 - (currently 12.81) – no stop,
- GLD (ETF for Gold) – in at 158.28, (currently 126.93) – no stop ($1,318 per physical ounce), AND
- SLV (ETF for Silver) – in at 28.3 (currently 19.19) – no stop ($20.00 per physical ounce).
To follow me on Twitter and get my daily thoughts and trades – my handle is: taylorpamm.
Please be safe out there!
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