Gold: All Systems Go, Ready For Lift Off

by: Taylor Dart

- Despite the rout in gold prices, the metal is still showing a positive year-to-date return.

- Sentiment on gold is coming off of its most pessimistic level in over 30 years.

- A battle between bulls and bears should take place at $1,200/oz.

The price of gold (NYSEARCA:GLD) has plunged from its 52-week high at $1,378/oz, shaking the bulls out of the metal. Being long gold has become the most hated trade in the market and bears have been cheering. I've applauded the bears several times for their tenacity by staying short gold but couldn't entertain their calls for sub-$1,000/oz. Just as everyone was looking for $1,500/oz and $2,000/oz in August, most are now looking for sub-$1,000, and even $760/oz.
When everyone is in consensus on the direction of a market, I do not want to be on that side of the trade. This pervasive bearishness on gold is evidenced by sentiment, which touched its lowest reading in two years after the Fed meeting. Fortunately, for gold bugs, the despondent readings for gold sentiment have set up a launch pad, at least based on my system. The gold bears are biting off more than they can chew staying short here and could be in trouble going forward.
A couple weeks ago, I noted that we were in unprecedented territory, with the bullish sentiment on gold staying beneath 20% for 22 consecutive trading days. This beat the previous record in 2014 of 21 trading days, and was one of the most contrarian signals I have ever seen. Fast forward 11 trading days and we are still beneath 20% bulls. This is unheard of for any asset class, and I have never seen sentiment this pessimistic in any of the 20 futures markets I follow.
During the Global Financial Crisis of 2008, the 21-day moving average for sentiment touched a reading of 12% bulls. This came on the back of a 33% decline in the market in less than five weeks. The 21-day moving average for gold sentiment just recorded a reading of 9.5% bulls and is the lowest reading I have seen on any asset class before.
(Source: Daily Sentiment Index, Author's Table)
The above table shows the previous record for bullish sentiment staying below 20% bulls and the new record on the left. As we can see, we have exceeded the previous record by 11 days as of yesterday's close. This unprecedented bearishness in the metal has set up a launch pad for my sentiment system. Due to sentiment data staying so low for so long, all of the sentiment moving averages have begun to converge at a reading of 10% bulls. Setups like these are extremely powerful and have the ability to support strong moves without the asset class getting overbought. Due to this being such a rare signal, the most recent example I can think of is the S&P 500 (NYSEARCA:SPY) in February of this year.
  (Source: Daily Sentiment Index, Author's Chart)
The S&P 500 saw all of its moving averages converge near the 10% level in mid-January and this led to an explosive move higher. The S&P 500 gained over 20% from its February lows to its August highs, with only one real dip along the way. I have shown an image of sentiment data above to show a precedent for similar signals. This signal is nowhere near as coiled as the current signal but is the closest example I have from recent data.
  (Source: Daily Sentiment Index, Author's Table)
In the above table, I have shown what the current sentiment data looks like and what's happening underneath the surface. While sentiment on gold was extremely depressed in November, it was below its moving average. This was a large red flag for me as I don't believe depressed sentiment alone is enough to be a buy signal. Instead, I want to see sentiment reach depressed levels and then tick up above its sentiment moving averages.
December has seen a sea change for the metal as gold has closed on three similar instances above its sentiment moving averages. This occurred on December 13th, December 19th, and December 23rd. I have only chosen the first day that sentiment closed above its moving averages after falling back beneath it, as this represents a new buy signal. Between November and January of last year, gold recorded two sentiment buy signals. These signals allowed investors to get long the metal under $1,080/oz. As I have explained in previous articles, my Sentiment Trend system I have built is not a perfect timing indicator. Sentiment is a leading indicator, which means it warns of bottoms and tops before the price is done moving. This allows investors to position themselves in favorable risk/reward scenarios but is rarely perfect at timing the reversal. As we can see from the readings in gold last year (below chart), the first signal took two months to play out. The first buy signal was given in mid-November and gold did not begin its move until early January. Having said that, while the system did not time the move perfectly, it did catch the bottom.
Gold is currently in bull mode and above its sentiment moving averages. It recorded three buy signals in the past three weeks. This is telling us to be prepared for a reversal off the lows, and is giving us an opportunity to position long the metal. I have shown the three recent buy signals with circles in the below chart. There are no guarantees that this sentiment buy signal will play out like the last one. All one can do is put themselves in the market when the edge is in their favor and hope that the signal plays out.
This is the same as in poker. There is no guarantee that one will win money by playing Texas Hold'em at the casino. But the odds are much better that a poker player will be profitable over the long run, if they play only the best starting hands. The gamblers that play the weakest starting hands like 10-5 off-suit, or Jack-6 off-suit will likely lose money over time. The poker players that put the odds in their favor and play suited connectors and high pocket pairs should make money over time. This is exactly how my Sentiment Trend system works, as well as my trend following system. I have no idea which trades will be winners and which losers but if I only enter the market when I have a positive edge, I should be profitable in the long run.
Ok, back to the launch pad I was talking about... It's time to unveil the current sentiment chart for gold. Below is a sentiment chart that I have built. It shows bullish sentiment on gold in relation to its sentiment moving averages. All of the circles are buy signals in the past year, and the two at the left side of the chart are the ones that setup the early 2016 bull market. We can see that a buy signal came in early October but unfortunately, this did not mark the bottom.
Having said that, it did provide a $90 move in gold in less than one month, from $1,248/oz to $1,338/oz on election night. As we can see from the below sentiment chart, the current setup for the moving averages is coiled like a spring.
This was not present in late 2015, nor was it present in early October. This leads me to believe that this move could be explosive if it does play out. In addition to potentially being an explosive move, it also means that gold sentiment has a long way to go before it gets exuberant. A sentiment moving average sentiment like this could easily support a $120/oz move higher before bullish sentiment reached 80-90%. Due to the below chart being a little unclear with the circles, I have provided another chart below so that readers can have a better look at the difference in this setup, and previous ones.
  (Source: Daily Sentiment Index, Author's Chart)
  (Source: Daily Sentiment Index, Author's Chart)
As we can see from a more zoomed in version, sentiment has made a long tight base in the current example, and was much less clean of a base in the 2015 example. This leads me to believe that this should be as powerful of a breakout as early 2016, if not more powerful.
So how am I positioning myself?
Those who have been following me know that I went long gold two weeks ago at $1,176/oz with a stop on my trade at $1,120/oz. This was a half position, and I stated that I would be doubling my position if gold could close above its 200-day moving average. By doubling my position, I would be averaging up on my trade, as gold's 200-day moving average currently sits at $1,275/oz.
The recent strength in the price of gold is encouraging and there is a possibility that we can close above 20% bulls as of today's close. This would be the first close in over 30 trading days above that level, and it would likely set the groundwork for a bottom to be in place. Having said that, I expect there to be a battle at $1,200/oz. The $1,200/oz level was support throughout most of 2016 and the bulls will need to get through this level to open up the possibility for the bull case. Currently, all we are seeing in gold is a dead-cat bounce and a close above $1,200/oz would certainly be constructive for the metal. Ultimately, I want to see gold get above $1,200/oz, in addition to its 200-day moving average. This would prompt me to double my position in the metal and instill confidence in me that we can see a move back to $1,400/oz or higher in 2017.
In addition to being long a half position in gold, I am currently at my largest net long position since February. In my most recent articles, I have shown my most recent purchases long gold, and they are all up an average of 20% or more from my entries the past two weeks. Last week, I unveiled my new positions in Osisko Mining (OTC:OBNNF) and Guyana Goldfields (OTCPK:GUYFF) in my recent articles, and both are up over 20% since. Despite the strong move in the mining stocks this week, I am remaining long my positions, and holding out for higher prices. I want to see what happens at $1,200/oz, an area where I expect there to be some brawling between bulls and bears.
With the strong move in the Gold Miners Index (NYSEARCA:GDX) today, the mining stocks have made decent progress. The index exploded through minor resistance at $20.45 with a gap up this morning. The next level of resistance comes in at $22.50, with six-month support and the downtrend line converge. This is not going to be an easy task for the bulls but we should see a violent short squeeze if this level is taken out. If we can get through $22.50, it is clear sailing until the 200-day moving average (yellow line) at $24.76. This is the last line in the sand for the bears and the only hope they will have to put a stop to a new bull market in the miners.

I remain bullish on gold here, and believe that today's move is a step in the right direction. Having said that, $1,200/oz is the real test, and a level I will be watching if this rally continues.
As long as gold remains above $1,120/oz on a closing basis, I will stay long gold, and I have a stop on my miners at the lows of this rally. This leaves me in a position to risk almost nothing on my miner trades, as I bought the majority of my positions within 3% of the lows the past two weeks. The bears have had a feeding frenzy the past few months but I believe they should be taking very careful at these levels. The risk/reward is no longer in their favor, and sentiment has set up an unprecedented launch pad to move higher from if this move does play out.
(Source: CIBC Investors Edge Account)
  (Source: TD WebBroker Account)
For full transparency, I have shown my main two investment accounts above so that readers can see my money is where my mouth is.

The Evolution of Italy’s Banking Crisis

The Italian banking crisis is not just an Italian problem.

By Cheyenne Ligon and Allison Fedirka

As the year draws to a close, we examine a critical forecast that will bridge 2016 and 2017: the Italian banking crisis. In our 2016 forecast, we discussed how the focal point of Europe’s financial crisis would shift from Greece to the Italian banking system, as Italy headed toward crisis. For the coming year, we forecast that the evolution of this crisis will eventually force a confrontation between Italy, Germany and the European Union. In this Reality Check, we establish a starting point for the looming Italian banking crisis in 2017, which will unfold over several months and have a range of consequences.

Italy’s banking crisis currently pivots around the fate of Banca Monte dei Paschi di Siena (MPS). The bank spent 2016 struggling to shed 28 billion euros ($29.6 billion) in non-performing loans (NPLs), which account for 36 percent of the bank’s loan portfolio. That is the highest proportion of NPLs of any bank in Italy. As a result, investors and depositors began withdrawing their money, compounding the bank’s financial crisis by creating a liquidity problem. Last week, MPS announced that its remaining 11 billion euros in liquidity would only last until April.

The bank’s efforts to privately solve its financial problems failed, leaving the Italian government as the bank’s only remaining recourse. MPS spent the fourth quarter of 2016 seeking 5 billion euros of capital and a fund to underwrite it. The bank failed to meet its Dec. 22 deadline, after the deal’s largest backer pulled out at the last minute causing the plan to fall through. With the private sector and outside financial institutions reluctant to help, MPS formally requested aid from the Italian government. On Dec. 23, the Italian Cabinet announced that the bank would be rescued with a 20 billion euro fund approved by Parliament earlier in the week.

The headquarters of Banca Monte dei Paschi di Siena on July 2, 2016 in Siena, in the Italian region of Tuscany. GIUSEPPE CACACE/AFP/Getty Images

The next obvious question is will 20 billion euros be enough to solve MPS’ problems? While the sum would address MPS’ immediate needs, estimated at about 8.8 billion euros, many independent researchers believe Italy’s current 20 billion euro fund is not enough to save the bank in the long run.

Goldman Sachs estimates that successful recapitalization would require 38 billion euros, while a senior market analyst at London Capital Group suggests the number might be closer to 52 billion euros.

As a member of the eurozone, Italy’s banking crisis is not just an Italian problem. Uncertainty in the Italian market could lead risk-averse investors to stay away from Italian assets, and thus the euro, impacting its value. Additionally, should MPS or other large Italian financial institutions fail, Italy would sink into a domestic economic crisis that would have significant systemic effects on the value of the euro. This would have negative repercussions for other economies in the eurozone.

Italy, in theory, also needs to comply with EU regulations. The divergence between Italy’s national needs and the EU’s needs has made finding a solution acceptable to both parties extremely difficult.

Italy wants to protect taxpayers while the EU wants depositors to assume the burden of debt instead of the European Central Bank (ECB). The solution thus far has been to promote a plan in which Italy appears to be following EU regulations, but which provides enough wiggle room to protect the bank’s domestic investors. Article 32 of the EU’s Banking Recovery and Resolution Directive, which took effect at the beginning of this year, states that banks must first go through a “precautionary recapitalization,” also known as a bail-in, before they are allowed to receive state funds. This is meant to protect taxpayers from shouldering the entire burden of a bailout. In MPS’ case, this would mean that bondholders must take an 8 percent loss in assets before the government is allowed to inject capital into the bank. However, the ECB is currently negotiating a plan with the Italian government in which the bank would be allowed to protect these retail investors by swapping their riskier junior bonds for more stable senior ones.

Germany, as de facto leader of the EU, is the main force behind the ECB’s opposition to supporting bailouts. Germany has elections next year and is also facing a looming exporter crisis. Politically and economically, it cannot assume the high burden of propping up the eurozone. The EU must walk a fine line of being flexible enough to avoid financial collapse, but stringent enough to preserve the union's institutional integrity – at least what remains of it.

This approach has already been seen with France and Spain obtaining more flexibility with budget targets. But Italy’s Dec. 4 constitutional referendum created more leverage for the Italian government. Italian voters clearly rejected former Prime Minister Matteo Renzi and his negotiator approach with the EU, and this reflects the public's growing desire for Italy to do what is best for Italy, even at the expense of the EU.

These economic problems naturally affect the lives of average Italians. Problems like inflation, stagnating growth and unemployment affect the pocketbook and daily life. A 4 billion euro bail-in for four smaller banks in Italy last year led to the suicide of a pensioner and protests, after 130,000 bank shareholders and bondholders lost their investments. Renzi was fiercely criticized, and residual anger drove many voters into the arms of anti-establishment parties.

Paolo Gentiloni, Italy’s new prime minister, has asked the EU to allow Italy to protect retail investors to avoid a repeat of Renzi’s experience. An estimated 40,000 households in Italy hold 2 billion euros of MPS’ subordinated bonds. The loss of life savings for 40,000 families in Italy has the potential to spark domestic unrest and lead to a flare-up in anti-EU sentiment.

All parties understand that if the EU does not allow the Italian government to protect its retail investors, nationalist parties like the Five Star Movement and the Northern League will become more popular. Both political parties have promised a Brexit-style referendum should they come to power in Italy’s legislative elections in 2018. It would also cause public pressure that the future prime minister, selected in February, would not be able to ignore. This would not only jeopardize the fragile political and economic landscape in Italy, but also the entire eurozone.

While MPS is just one bank, the ripple effects of one Italian bank failing are numerous and deep. The bank’s failure would severely escalate the crises already underway. Its salvation would allow Italy and the EU to fight another day, but it’s a far cry from solving the underlying structural causes of Italy’s problema.

Keynes Reborn

Koichi Hamada

Yama-dera cityscape

TOKYO – In the fourth century, Japan’s emperor looked out from a small mountain near his palace and noticed that something was missing: smoke rising from people’s kitchens. While there were some faint trails here and there, it was clear that people were facing such harsh economic conditions that they could barely purchase any food to cook. Appalled at the circumstances of the Japanese people, who were largely peasants, the emperor decided to suspend taxation.
Three years later, the palace gates were in disrepair and the stars shone through leaks in the roof. But a glimpse from the same mountain revealed steady plumes of smoke rising from the peasants’ huts. The tax moratorium had worked. The people were so grateful to the emperor – who became known as Nintoku (Emperor with Virtue and Benevolence) – that they volunteered to repair his palace.
Almost two millennia later, the Japanese people are, again, under economic pressure. A steep hike in the consumption tax in 2014, together with another hike expected in the near future, has undermined household spending. As in the Nintoku story, it is the wealth of the people – not that of the government – that dictates consumption.
Of course, the wealth of the government does play a role in economic performance. But excessive concern about government’s solvency can cause the private sector to be reluctant to spend. That is what has happened in Japan.
Excessive government debt can be highly damaging. In inflationary periods, high outstanding government liabilities impair fiscal policy, because higher taxes are needed to finance the same level of real government spending. Making matters worse, governments can be tempted to inflate their debts away – a power that has been abused since the age of monarchs, resulting in a uniform inflation tax on asset holders.
But large public debts are not always bad for an economy, just as efforts to rein them in are not always beneficial. The focus on a balanced budget in the United States, for example, has led some elements of the Republican Party to block normal functions of state and even federal authorities, supposedly in the name of fiscal discipline. Likewise, the eurozone’s recovery from the 2008 financial crisis has been held back by strict fiscal rules that limit member countries’ fiscal deficits to 3% of GDP.
To understand the relationship between public debt and economic performance, we should look to the fiscal theory of the price level (FTPL), a macroeconomic doctrine that has lately been receiving considerable attention. In August, at the annual conference of central bankers in Jackson Hole, Wyoming, Princeton’s Christopher Sims provided a lucid explanation of the theory.
As Sims explained, contrary to popular belief, aggregate demand and the price level (inflation) are not dictated only – or even primarily – by monetary policy. Instead, they are determined by the country’s net wealth and the liabilities of the central bank and the government.
When government deficits are lower, investing in government debt becomes more attractive. As the private sector purchases more of that debt, demand for goods and services falls, creating deflationary pressure. If the central bank attempts to spur inflation by expanding its own balance sheet through monetary expansion and by lowering interest rates, it will cause the budget deficit to fall further, reinforcing the cycle. In such a context, Sims argued, monetary policy alone would not be adequate to raise inflation; fiscal policy that increases the budget deficit would also be necessary.
The FTPL provides a clear diagnosis of the Japanese economy’s problems – and points to solutions.
When Abenomics was introduced in 2012, a massive injection of liquidity by the Bank of Japan was supposed to offset deflation. But, as both traditional Keynesians and FTPL followers would note, quantitative easing – which amounts to an exchange of money for its close substitutes (zero-interest bonds) – becomes less effective in stimulating demand over time. Add to that Japan’s fiscal tightening – and, especially, its consumption-tax hike – and it is no surprise that demand has remained repressed.
More recently, Japan’s negative-interest-rate policy worked rather well to push down market interest rates. But the policy also impaired the private sector’s balance sheet, because it functioned as a tax on financial institutions. As a result, it has failed to provide the intended boost.
During periods of recession or stagnation, additional interest payments by banks would burden the economy, whereas public debt may enable the economy to reach full employment. (Neo-Ricardians would argue that public debt in the hands of people is worthless, because consumers internalize their children’s future tax payments by holding debt certificates. But, as David Ricardo himself recognized, people are rarely that smart.)
John Maynard Keynes’ The General Theory of Employment, Interest, and Money,which argued for active fiscal policies, was published in 1936. Forty years later, a counterrevolution took hold, reflecting sharp criticism of fiscal activism. After another 40 years, Keynes’ key idea is back, in the form of the FTPL. This may be old wine in a new bottle, but old wine often rewards those who are willing to taste it.

Climateers Can’t Handle the Truth

Lee Raymond’s 1997 climate speech in China is looking better than ever.

By Holman W. Jenkins, Jr.

    Exxon Mobil CEO Lee Raymond testifies on Capitol Hill, November 2005. Photo: Bloomberg News

Congrats are due for the term “climate denialist,” which in 2016 migrated from Paul Krugman’s column to the news pages of the New York Times.

On Dec. 7, the term ascended to a place of ultimate honor when it figured in the headline, “Trump Picks Scott Pruitt, Climate Change Denialist, to Lead E.P.A.”

Unfortunately, never to be explained is precisely which climate propositions one must deny in order to qualify as a denialist. In zinging Mr. Pruitt, currently Oklahoma’s attorney general, the Times rests its unspoken case on a quote from an article this year in National Review, in which he and a coauthor wrote: “Scientists continue to disagree about the degree and extent of global warming and its connection to the actions of mankind.”

But this statement is plainly true. No climate scientist would dispute it. Through all five “assessment reports” of the Intergovernmental Panel on Climate Change—sharer of Al Gore’s Nobel prize—the central puzzle has been “climate sensitivity,” aka the “degree and extent” of human impact on climate.

Greenpeace adopts the same National Review article to attack Mr. Pruitt, lying that he and a coauthor “claimed the science of climate change is ‘far from settled.’”

The science is not settled (science never is), but this is not what Mr. Pruitt was referring to. His plain, unmistakable words refer to a “major policy debate” that is “far from settled”—a statement that indisputably applies even among ardent believers in climate doom. Witness the battle between wings of the environmental movement over the role of nuclear power. Witness veteran campaigner James Hansen’s dismissal of the Paris agreement, which other climate campaigners celebrate, as “worthless words.”

These lies about what Mr. Pruitt wrote in a widely available article aren’t the lies of authors carried away by enthusiasm for their cause. They are the lies of people who know their employers and audiences are beyond caring.

Which brings us a two-part article in the New York Review of Books by representatives of the Rockefeller family charity, desperately trying to make the world care about their fantasy that Exxon is somehow a decisive player in the policy debate—Exxon, not voters who oppose higher energy taxes; Exxon, not the governments that control 80% of the world’s fossil fuel reserves and show no tendency to forgo the money available from them.

The Rockefeller family’s charitable attachment to the climate cause is understandable, though.

Their money might instead be used to bring clean water to poor villages, immunize kids against disease, or improve education. But such programs can be evaluated and found wanting due to fraud or incompetence, whereas climate change is a cause to which money can safely be devoted to no effect whatsoever without fear of criticism.

Twenty years before his successor became Mr. Trump’s nominee to be secretary of state, Exxon’s then-CEO Lee Raymond gave a much vilified speech in China—a much misrepresented speech, too.

He did not say humans were not influencing climate, but the degree was highly uncertain, and future warming was not a “rock-solid certainty,” he said.

He could not have known he was speaking near the peak of an observed warming trend, and that relatively little or no warming would be recorded over the next 20 years.

He said poor countries would and should choose economic growth over suppressing fossil fuel use. They did, and some one billion fewer people today are living in extreme poverty (as defined by the World Bank).

He said fossil energy would continue to fuel economic prosperity, though consumption growth would moderate with increased efficiency, and as poor countries devoted a share of their increasing wealth to environmental improvement. He was right.

He predicted that technology would open up new reserves to fuel the global economy, though he didn’t mention and perhaps didn’t know about fracking.

All in all, it was a performance, in many fewer words, far more cogent than the Rockefeller pieces, notable mainly for their childishness about both climate science and climate politics.

Donald Trump, our new president-elect, has been tagged for indiscriminately referring to climate change as a hoax. Here’s what he actually said at a campaign rally in South Carolina one year ago about climate advocacy: “It’s a money-making industry, OK? It’s a hoax, a lot of it.”

This statement, with its clearly framed qualifications, is true and accurate in every detail. It’s a statement of basic truth that can be embraced, and increasingly should be, by exactly those people most concerned about man-made climate change.

Yet it won’t be, for reasons demonstrated by the New York Times’ adoption of the term climate denialist, whose deliberately non-discriminating function we now take care to state precisely: It enables a kind of journalism that is unable—incapacitates itself—to stumble on truths that would be inconvenient to climate religion.