This Week in Barrons – 2-26-2017:
For quite a while it's been my thought that the metals markets might start to make a move in March. One reason is that the mining stocks have been left out of the overall stock market rally. Secondly, I sense some real creaks and groans in the precious metal exchanges as of late. In terms of background, gold and silver are not priced on physical demand, but rather by paper futures contracts that can be shorted. The world’s Central Banks (including our FED) have been manipulating gold and silver lower for over 20 years. They have plead guilty to gold and silver price fixing, but the problem still exists. For example, last Thursday (on a single exchange) over 1B ounces of silver were being shorted. Factually, there are only 800m ounces of silver globally mined in the entire year. It’s this HUGE paper short position that is causing the price of silver to be artificially held down. A short position of this size in any other market, would be sounding alarm bells to regulators – who would force the shorts to unwind their positions in order to reduce the likelihood of a short squeeze. However, precious metal regulators have been trained to look the other way. The only redeeming factor is that each time it takes more and more ‘paper shorts’ to keep the price of the precious metals down. What happens if they can't get the prices as low as they want? The market maker is left on the wrong side of the trade and the physical metal must be delivered at the lower price with the market maker taking the loss. These instances are growing but thus far still manageable.
The bigger problem that is brewing is due to the Chinese Government. The oil producing nations of Saudi Arabia, Russia and Turkey have decided that they don't like the old petro-dollar set up. Instead, they have started to sell their oil for Chinese Yuan, and then trade those Yuan on the Shanghai exchange for physical gold. This is causing the demand for physical gold to consistently be higher than the paper price. I have said for many years that the price manipulation of gold and silver will end when the physical delivery of the metals overwhelms their ability to lower the price via shorts. Due to the Yuan’s convertibility spreading around the globe, and the continued trust in the Shanghai Exchange – the demand for physical gold has almost been parabolic.
Central Banks and Treasury Departments have had to dramatically increase the production of their short-futures contracts for the precious metals – in order to offset all of this new physical demand. I think we could be nearing a tipping point where the ‘shorts’ lose control. After all, until recently oil producers have been forced to sell their oil in U.S. Dollars. As the U.S. Dollar lost its global luster, the Chinese crafted a way to exchange oil for assets that have maintained their value for over 5,000 years – mainly gold and silver. Currently metals brokers are having to make one-off deals with ‘vaults’ around the world - in order to find enough supply to satisfy demand.
But the demise of a currency is nothing new. The 2nd World War caused at least 95 currencies to vanish. When times are good, people are just fine using paper with pictures on them and digital entries as money. But when times get ugly, they will instinctually turn back to gold and silver. Gold/Silver World studied the demise of 599 paper currencies through the ages and found: (a) 30% ended by consolidation and other legal reforms – such as the creation of the Euro in 1999, (b) 15% ended through acts of independence – such as the United States, (c) 27% were destroyed by hyper-inflation through the over-issuance of paper money by governments and central banks, and (d) 28% were destroyed by war.
If I'm right, and the metals exchanges are losing control of the pricing mechanism, we could soon see a dramatic rise in both metals. Even if I'm only half right and they simply get forced to allow the prices to move higher in a controlled manner, it stands to reason that the miners are going to see another surge. If you do not own any physical gold or silver, I would recommend that you buy some. I have never wavered on my prediction that we will see gold upwards of $3,000/oz. (currently $1,250) and silver above $70/oz. (currently $18). Nothing feels better than having a roll of shiny silver eagles in your hand, and knowing that they can’t be re-created out of ‘thin air’ by a push of a button.
This week markets continued their march higher in the hopes of promised tax cuts, repatriation holidays, infrastructure builds (delayed 1 year), and regulation reductions. As the chart shows, most American's have seen little real growth in the past 30 years. For the first time, it is unlikely that our children will be better off than their parents. Factually:
- In 2016, S&P 500 corporations paid $20.2B (27%) LESS in dividends than in 2015. That's the largest number of dividend cuts since the height of the 2009 recession.
- Bloomberg reported that the U.S. currently has half as many publicly listed companies as it did 20 years ago.
- SocGen said that 40% of all U.S. publicly traded companies are NOT profitable.
- Our gasoline inventory glut is at a 27-year high.
- In January, the U.S. Manufacturing and Services PMI’s both came in much LOWER than expectations.
- Bloomberg also reported that most earnings reports are non-GAPP, and therefore – fictitious. Banks are being allowed to report ‘mark to model’ rather than ‘mark to market’. That means that banks can report what their ‘models’ say assets SHOULD be worth – rather than what the ‘market’ says that they are truly worth.
The U.S. is sitting atop $20T in debt. Our President is advocating big tax cuts, deficit spending to create jobs, cuts in regulations, and trade protectionism. All of these will contribute to rising inflation and interest rates. The jury is still out as to whether he will be successful in ‘draining the swamp’ before it ‘swallows’ him, but his contempt for lobbyists, political bureaucrats, media, and most members of Congress is well-known. This week’s ‘Vegas line’ on whether President Trump finishes out his term is: 50-50. After all, you can’t take over the world’s most powerful nation, and threaten to overthrow a multi-decade system that has empowered a class of global elites without a fight.
Investor bullishness (as shown by the chart on the left) has entered into extreme optimism territory. And just last week CNBC had an enthusiastic panel discussion entitled: "Best Move: Just Buy Everything?"
Thanks to CW for producing the following graph showing that the S&P 500 median Stock Price-to-Sales ratio is at its highest level in history. This means that the average stock today is significantly more overvalued NOW than it was during the Internet Bubble of 1999. While Trump’s proposals may eventually stoke the flames of economic growth, the reality is that (2nd chart) earnings estimates are actually being revised downward as the months go on.
If the markets were to substantially decline from here, all of the preventive measures put in place post 2008 would quickly implode due to the enormity of the derivative exposure. I remember years ago Warren Buffet warning that our true ‘weapons of mass destruction’ were our derivatives – and there are over $700T of them out there right now.
Market bubbles tend to lull J.Q. Public into a ‘Stocks must go Up’ psychosis – only to have ‘Stocks start to Fall’ and then:
- Instead of SELLING, J.Q. Public is conditioned to buy the dip.
- And as prices continue to decline, they buy more.
- They then stop buying, and start to make excuses for why it's best to hold.
- Then one day they can't take it anymore, and sell it all.
- This ‘capitulation’ sale usually occurs within 30-days of the absolute bottom, and the market starts running higher again.
- But they don't get back in because they were ‘burned’, and no longer ‘trust’ the market.
- The market continues higher without them, and after a few years they start thinking that this time it is ‘different’.
- They begin to nibble, and as the market goes higher they get braver and buy more.
- Then just about when the market is at its absolute top, they go ALL IN and get smashed – again.
This is the ‘rinse-n-repeat’ fear I have. The most important job you have as an investor is to train yourself to sell when you sense the wheels about to come off. If you hold through the first dip of a pull back and the next bounce doesn't take you to higher levels – that is your signal that you should be looking for the exits. Art Cashin (head of floor operations for UBS) said: “We are wildly overbought", and believes that the President’s State of the Union Address on February 28th could mark a top in the markets. Art is worried that tax reform will not be revenue neutral, the Tea Party Republicans will vote it down, and the market will come down hard in response. The market has been up 11 days in a row. That is something not seen since 1987. It's overbought, extended, expensive, and stupid – but it can get more of each of those. We need to lean into it, but the air up here is certainly thin.
With unusual options activity beginning in the mining sector, keep an eye out because this sector tends to move quickly. For example, back in December I saw some unusual options buying on several mining companies including PAAS. It soared from under 14 to over 21 in just a few weeks. Last Friday I saw some similar, bullish options activity in JNUG. If it continues to warm up, it could turn into a nice trade.
When is the last time you saw a trade with an 81% chance of success, and one that you could adjust to suit your own timeframe and risk criteria? As I said last week, this is the 1st in a series of 3 types of transactions that will achieve over 80% probability of success with minimal risk.
Above is a transaction set-up on IWM (a Russell 2000 index), but you could use virtually any index product. The index currently sits at $138.65 (dark vertical line on graph), and the expected move between now and March 17th is a little over $4. Looking at all 3 scenarios:
1. If the IWM were to fall $4 by March 17th – you would be up over $1,000, and would have taken a little over $1,500 in risk.
2. If the IWM were to go UP rather than DOWN, your upside risk is $0.
3. If the IWM were to go down MORE than $4, it would have to go through the $4 level first, and therefore give you a chance to get out of the deal at a profit before incurring the loss.
The particulars of the deal are as follows:
- IWM is currently at $138.63.
- March 17th Expected Move = $4.40
- The Downside Deal (shown) – Cash-Flow neutral:
o Buy 3 March 17, of the 135 / 139 Put Debit Spread, and
o Sell 7 March 17, of the 131 / 135 Put Credit Spread.
- The Upside Deal (not shown) – Cash-Flow neutral:
o Buy 3 March 17, of the 139 / 143 Call Debit Spread, and
o Sell 7 March 17, of the 143, 147 Call Credit Spread.
You can shorten or lengthen the timeframes on this type of trade in order to suit your particular trading style and risk criteria.
To follow me on Twitter.com and on StockTwits.com to get my daily thoughts and trades – my handle is: taylorpamm.
Please be safe out there!
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