The Plan (aka I Love Being Right)

Over Easter weekend I sent my subscribers a report outlining how I see things right now and what it means for the stocks in the Maven portfolio.

While I am not going to reveal the portfolio, here’s a run through of the rest.

Bottom line: it’s a complicated world out there right now. Rather than supply and demand, metal prices and mining investment dollars are responding to macroeconomic issues: interest rates, inflation versus deflation, bond yields, dollar strength, earnings-per-share projections for US large caps, unemployment and payroll numbers, and the like.

The data weave themselves into a web almost too dense to penetrate – but through the fabric I am see signs that the US markets are near their top.

And that matters, because the mining rebound depends on weaker US markets for two reasons.

As I wrote on the weekend…

“First, generalist investors have had no reason to invest outside of US large caps for the last five years. Why would they put any money into high-risk equities when giants like Amazon, Google, Bank of America, and Walmart have offered share price gains plus dividends for five years?

Now investors will not step away from the US markets until it is clear those reliable returns are over. When that happens, they will look elsewhere – en masse – for the next sector set to grow.

Mining is that sector. After four (going on five) bear years, production is down and companies are starved for capital. Supply crunches are looming for several metals (zinc, gold, uranium, platinum). Companies are incredibly cheap, whether based on asset valuations, production profiles, or historic prices.

But something is only valuable if is it cheap and expected to gain in value. For mining that second factor requires rising metal and equity prices.

Those are the second reason miners need US markets to weaken.

Strong US markets acting as a safe haven not only take investment capital away from other equities; they take dollars away from gold. That matters, because mining doesn’t rebound unless either gold or copper rallies.

This chart of the TSX Venture Exchange going back to 1991 is a good proxy for the health of the mining markets. In the last 23 years we have had four rallies: 1993, 1996, the big bull run from 2003 to 2007, and the 2009-2010 rebound.

Three of those rallies correspond with a rising gold price:

The 1993 rally does not appear very significant on this chart, but it mattered at the time: gold started the year at US$329 per oz. and finished the year at $385, a gain of 17%.

The 2003 to 2007 mining market rally was, of course, associated with the biggest gold bull run in history. That run continued almost unabated through the financial crisis and fueled the 2009-2010 mining rally as well.

The only mining market rally not associated with a rising gold price was in 1996 – and that market instead got its impetus from copper:

It’s no surprise that mining rallies require either a rising gold or copper price. When it comes to metals, gold and copper are the two biggies. Others can help – high prices for rare earth metals, molybdenum, and uranium certainly deserve credit for helping propel the Venture to such epic heights in 2007. But the baseline push came from the 1-2 combo of rising gold and copper.

And after these four bear years, it is going to take some excitement around gold or copper to reawaken the dormant mining markets.

Copper doesn’t have much excitement on the horizon. The price is down almost 10% in the last year and the always-tight market seems fairly well supplied going forward. Demand keeps inching upward but, barring a Black Swan event, there’s no reason to expect a supply crunch.

Gold, on the other hand, has fundamentals on its side. Production likely peaked in 2014 and will decline going forward because of a long-term lack of exploration spending and a recent spate of output reductions and project deferrals or cancelations. Demand continues to climb, grounded in constant buying by Chinese and Russian state entities and supported by Asian and Middle Eastern individuals stocking up while the yellow metal is cheap.

With gold, though, supply and demand is only one part of the picture. The rest of the picture relates to macroeconomics and geopolitics – which brings up right back where we started.

Gold can’t rise until the US markets and the US dollar stop competing with the yellow metal for safe haven status.”

I then laid out my reasons for believing that the US economy – and thus its markets – are losing momentum.

• Employment data are weakening. The jobs data for March missed expectations broadly and came in below 200,000 for the first time late 2013. Business isn’t going as well as expected.
• Labour force participation is low and wages have grown by only 2% annually since 2010, barely covering inflation. Americans are short on cash.
• Many economic indicators are flashing warning signs. The Survey of Manufacturing index fell from 58 in late 2014 to 51.5 today, just barely in growth territory.
• The greenback may have topped. A weaker dollar will help US corporations down the road but, just as the confidence created by a rising dollar lifts US markets, the broad worries around a falling dollar drags on markets.

Share prices (in general) move based on earnings reports and earnings are under threat. Earnings-per-share is a go-to indicator of basic profitability but more and more companies are projecting negative EPS readings.

In other words, US markets and share prices are sky high while a host of factors pinch earnings, including a stronger dollar, weak demand from consumers getting small paycheques, and low oil prices. (Cheap oil does lower energy costs but oil, oil services, and related sectors play such an important role in the US economy that earnings and job losses hit hard.)

The chart below jams all those ideas into one image (borrowed from this ZeroHedge article):

The chart was crafted before Friday’s economic data, so the picture is now just a bit worse, with the upticks for forward earnings and US macro data erased.

After all that, I predicted gold would tick up on Monday. I do so love being right. Gold jumped $20 off the open yesterday.

What now lies ahead?

“Macro issues are difficult to predict in the long term. Folks with PhDs in economics are confounded by today’s situation, so I am not about to make any specific long-term forecasts.

I will stick to my notion that the top is near (if not already past) for US markets and the greenback. I don’t expect Yellen to touch interest rates until late this year, if at all.

I am bullish on gold in the near term, which means I see gold generally moving up over the next 10 to 15 trading sessions. I think $1,230 per oz. is probable, $1,240 possible. Gold is currently just above $1,200 per oz., so my target suggests a 2 or 3% gain.

That’s not a lot, but remember that gold equities benefit from leverage when gold rises. During gold’s January run, gold producers rose three times the amount gold gained. That means gold producers could be in for 6 to 9% gain from here – on top of the 5% they have already gained since gold bounced in mid-March.

After that, beware the summer slide. Gold does not perform well in May and June.

The reason this little April bounce matters is that, for investors who want to make money this year, risk management is essential. Investors need situation-appropriate expectations: doubling or tripling your money will be really hard this year, but 20 to 40% gains are very possible if you lock in at those levels.

If a stock is up 25%, sell some to lower your cost base or sell all and take that 25% gain home. If you wait for the gain to grow it could just as easily disappear, oftentimes based on macro factors completely outside the company’s control.”

That is how I see things from here.