Deflation's Final Curtain Call
Gold has once again begun to assert its safe haven value after the recent drop in equity prices. Last week's Argentina bond default scare coupled with rising tensions between Russia and Ukraine have combined to spook global equity markets.
On Thursday NATO warned that Russia was preparing to send 20,000 troops into eastern Ukraine under the pretext of a humanitarian mission to save separatist rebels. Due to these concerns gold's value has risen to a 2-week high. Gold's rally is all the more conspicuous in light of the recent rally in the U.S. dollar index.
Adding to gold's growing attraction as a safe haven was Thursday's decision by the European Central Bank (ECB) to leave the benchmark interest rate unchanged at record lows. This was preceded by news on Wednesday that Germany experienced a second monthly decline in factory orders (-3.2% versus an expected +1.0%, according to Briefing.com). Elsewhere in the euro zone, Italy's economy sank into recession after two consecutive quarters of contraction in its GDP. The economic trouble in Italy is reflected in the iShares MSCI Italy ETF (EWI) chart shown below.
The MSCI France ETF (EWQ, not shown) is also reflecting weakness within France. Meanwhile the former star of the last global economic crisis two years ago ago, namely Greece, is once again showing signs of weakening. The Greece 20 ETF (GREK), a proxy for the country's stock market, recently plunged to a new low for 2014. The financial press hasn't yet begun to focus on Greece, but it would appear that several countries in the European Union are struggling with economic problems. The last vestiges of the longer-term deflationary (Kress) cycle are in evidence right now as the 60-year cycle is scheduled to bottom in late September/early October.
To date the rally in gold futures price has beaten gains made in equities, Treasuries and commodities, according to a Reuters report. Indeed, many commodity prices have taken a beating this summer as the deflationary cycle nears its terminus. Corn and wheat prices are at multi-year lows while oil and gasoline prices have recently begun to retreat. Treasury prices are on the rise as anything with safe haven quality has been the focus of investors' attentions lately as the long-wave deflationary cycle makes it final curtain call.
By contrast silver was lower on Thursday and continues to lag the yellow metal as safety concerns fuel gold's latest rally. Silver is likely to continue its position of relative weakness as long as the climate of investor fear remains the driver for gold. Only when fear subsides does silver typically see increased demand due to its greater exposure as an industrial metal.
My contention over the last several months has been that as the 60-year cycle of deflation nears its final low this autumn the gold price would likely benefit from it. We're beginning to see an uptick of interest in gold as now that fear has taken the front seat again in the news. Until recently investors cheered all the positive economic news that came out while ignoring bad news pertaining to Russia/Ukraine and the Middle East. Now good news is routinely ignored while bad news is amplified by investors, a tell-tale sign of a fear-driven market as the long-term cycle bottoms. A further acceleration of fear should serve to increase investors' interest in gold.
Let's once again turn our attention to the investor sentiment picture. Last year's decline in the gold price was blamed in large measure on ETF managers dumping physical gold from their funds. According to a recent report from Commerzbank, ETFs have repeated this action through much of this year. Commerzbank observed:
"Over the year so far on balance, there has still been an outflow of some 30 tons of gold from ETFs. In view of the headwinds presented by additional demand components, [any] ETF inflows will probably merely have slowed down the price decline in recent weeks."
The bank emphasized that while gold prices may have been somewhat stabilized by last month's ETF inflows, it doesn't foresee a revival in the gold price anytime soon:
"While the present negative factors remain - a strong US dollar, weak physical demand in Asia, and weak coin sales in the west - we do not envisage any serious price gains. In addition to modest coin sales in the US, Australian coin sales too, for example, dipped sharply month on month in July to 25,100 ounces."
Thus another major bank has joined the ranks of the gold bears in what could be setting up another contrarian play for gold. Adding to the contrarian factor is the behavior of small speculators of late. According to Barron's, speculative investors have been cutting back on Comex gold futures and options.
Meanwhile, the latest data from the SPDR Gold Trust (GLD), the world's largest gold-backed ETF, showed that holdings fell 1.79 tons to 800.05 tons, according to Reuters. This marks the first drop since July 24. Thus we see that even ETF managers are once again turning bearish on gold.
The overall sentiment backdrop that is forming is gradually changing more in gold's favor. An ideal market environment is one where most retail traders and institutional investors are bearish on the metal, which in turn sets up a potential technical rally as short interest increases. If the fuel (i.e. bearish sentiment) for the next gold technical rally is ample enough, it could go beyond a simple technical bounce to something more extended.
Cycle analysis is essential to successful long-term financial planning. While stock selection begins with fundamental analysis and technical analysis is crucial for short-term market timing, cycles provide the context for the market's intermediate- and longer-term trends.
While cycles are important, having the right set of cycles is absolutely critical to an investor's success. They can make all the difference between a winning year and a losing one. One of the best cycle methods for capturing stock market turning points is the set of weekly and yearly rhythms known as the Kress cycles. This series of weekly cycles has been used with excellent long-term results for over 20 years after having been perfected by the late Samuel J. Kress.
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Clif Droke is a recognized authority on Kress cycles and internal momentum, two valuable tools which have enabled him to call most major stock market turning points from 1997 through the present. He is the editor of the Momentum Strategies Report newsletter, published three times a week since 1997. He has also authored numerous top-selling books, including his most recent one, "Kress Cycles." For more information visit www.clifdroke.com