the gryphon review a global market analysis2016/10/07 · 4 october 7, 2016 the gryphon review a...

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T H E G R Y P H O N R E V I E W

A G L O B A L M A R K E T A N A L Y S I S


H I G H L I G H T S

H I G H L I G H T S O F T H E W E E K B Y D A V I D C H A P M A N O C T O B E R 7 , 2 0 1 6

T O R O N T O , O N T A R I O The Economy is in Trouble The Stock Market is in Trouble Deutsche Bank (sigh) Again

Deutsche Bank can't stay out of the news Stock Market weekly review Bond Market weekly review Currencies weekly review David Chapman BMG Chief Economist T . 9 0 5 . 4 1 5 . 2 9 4 7 [email protected]

The internet contains any number of warnings about the coming demise of the US stock market, or the coming demise of the US economy. The reality is quite different though, as the US approaches the eighth anniversary of the bottom of the stock market following the 2008 financial collapse, and approaches the 28th consecutive quarter of positive GDP growth, with the last quarter of negative GDP having come in the fourth quarter of 2009.

Since the low of March 2009, the US stock market as measured by the S&P 500 is up 223%, and the US economy has grown 27% (14% in real terms), or barely 2% a year in real terms. Unemployment (U3) has fallen officially to 4.9%, a level considered to be close to full employment. The stock markets as measured by the S&P 500, the Dow Jones Industrials (DJI) and the NASDAQ have all hit record highs. The economy, while not growing at the same pace as it has in previous rebounds following a recession, nonetheless has been positive—at least officially.

Officially, the last recession lasted six quarters, from Q3 2008 to Q4 2009. Officially, those six quarters of negative growth was the longest stretch of negative growth seen since 1948. Previous stretches of quarterly negative growth were as follows for both the officially reported GDP and as reported by Shadow Stats www.shadowstats.com:

T H E E C O N M O N Y I S I N T R O U B L E

http://www.shadowstats.com/

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Recessions since 1948

Official Reported GDP Shadow Stats GDP Q2 1949 to Q4 1949 – 3 quarters Same Q1 1954 to Q3 1954 – 3 quarters Same Q1 1958 to Q3 1958 – 3 quarters Same

Q1 1961 – 1 quarter Same Q1 1970 – 1 quarter Same

Q2 1974 to Q2 1975 – 5 quarters Same Q2 1980 to Q4 1980 – 3 quarters Same Q1 1982 to Q 1982 – 4 quarters Same Q1 1991 to Q3 1991 – 3 quarters Q3 1990 to Q4 1991 – 6 quarters

So why the sharp difference between the officially reported GDP and Shadow Stats GDP? The difference did not become apparent until roughly 1983 onward. Following the 1980-1982 recessionary period, the US government changed the method of calculation for GDP. The methodology built in an upside bias. As time has passed, this built-in bias has become more pronounced. The methodology used by Shadow Stats is the same as it was calculated prior to 1983. According to Shadow Stats, the US economy has been in an ongoing recession since 2000.

According to the study put out by Harvard Business School titled “Problems Unsolved and a Nation Divided,” September 2016, the US averaged roughly 4.4% annual growth from 1950 to 1969, 3.2% annual growth from 1970 to 1999 and, since 2000 to the present, growth has averaged only 1.9%. US GDP growth has been in ongoing decline since 1950, with the most serious decline getting underway after 2000.



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One of the prime reasons for stagnant GDP growth is that income has been unevenly distributed, particularly since 2000. Real median household income has been falling since peaking back in 1999. It jumped in 2015 only because the bottom 80% actually saw some income improvement.

Source: www.stlouisorg.com

The reality is that while wages have been growing for the top 20% of the working population, they have been falling, or at least stagnant, for the bottom 80% of the population. Since 2000, the top 5% have experienced the best wage growth, followed by the next 5%. The next 10% has seen largely stagnant wage growth, while the bottom 80% has actually experienced negative wage growth in real terms. When one looks at age groups, families headed by a 25-34 year old have been experiencing declining income, while families aged 65-74 have been seeing rising incomes. All of this has helped erode the middle class, such that there is a professional coterie constituting roughly 20% of families in the US that have done well to quite well, while the remainder have been stagnant at best, to seeing declining income in real terms. The 20% have been the major contributors to GDP growth. This has resulted in growing anger and helps explain the rise of anti-establishment candidates such as Donald Trump.

These are themes that the “Gryphon Review” has noted in the past, and will continue to note going forward. We believe they are important and are being under reported. One key element regarding employment in the US has been the underreporting of unemployment. Again, the “Gryphon” has noted this theme in the past. If you are unemployed for more than one year, you effectively fall off the radar screen and are no longer considered to be part of the labour force.

The result is the labour force participation rate has fallen from over 66%, a level that was seen consistently from the late 1980s until 2007, to the current level of 62.8%. First, as we have noted in the past, if the labour force participation rate was just back at 66%, the current unemployment rate (U3) would be 9.5%, not 4.9%. That is quite a difference. Second, the category “not in labour force” has jumped from 80.3 million in 2008 to 94.4 million today, an increase of 17.6%. The US population has gone up 6.4%, and the US labour force (employed plus unemployed) has gone up 3.5%. The army of “not in the labour force” has gone up faster than either the population or labour force. Not all are retired, or going to school, or stay-at-home mothers.

http://www.stlouisorg.com/

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The number of retirees has jumped sharply since 2008. The number of retirees is up 8.6 million, or 20.7%. That would account for 61% of the jump in “not in the labour force.” However, many retirees want to work part time just to keep busy. If so, they would be counted as employed and be a part of the labour force. The Bureau of Labor Statistics (BLS) does not count the category-discouraged workers. They are considered marginally attached to the labour force. These numbers can be seen in Shadow Stats unemployment numbers. Official unemployment is 4.9% (U3) and the U6 unemployment number (includes short-term discouraged workers and part-time workers for economic reasons) is 9.7%. But when one includes long-term discouraged workers and others marginally attached to the work force, the unemployment rate jumps to 23%—almost one-quarter of the working-age population.

Instead of reporting 7.8 million unemployed (U3), they could instead be reporting roughly 45 million unemployed. That is a considerable difference. Even included in the employed, roughly 4.8% of the workforce are multiple jobholders, while 17.9% are working part time, many because they can’t find full-time work. Fully half the working labour force makes $30,000 a year or less. These are not numbers that show up in the monthly job data unless one digs a bit.

Source: www.shadowstats.com


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The collapsing labour force participation rate.

Source: Bureau of Labour Statistics www.bls.gov

The so-called millennial cohort—those born generally between 1981 and 1997—are now the largest population by generation in the US. However, this generation is burdened with student loans and is struggling to find jobs, and often still living with their parents, struggling to get married, start families and have homes of their own. Student loans have soared from $589.5 billion in Q4 2007 to almost $1.4 trillion in Q2 2016, an increase of 131% in just 8.5 years. This is a burden they are carrying.

Meanwhile their boomer parents, those born between 1946 to 1964, are hitting retirement age, which means they will be hunkering down for a different reason as they take over the wealth inherited from their parents. All of these are having a negative impact on the economy, as the prime work force age known as Generation X (1964-1980) is caught in between.

When one combines all of these factors—underreported unemployment, dwindling labour force participation, income disparity between the top 20% and the remaining 80% who are facing stagnating and even declining real wages, overburdened millennials struggling to find a foothold in the work force burdened with debt and a retiring baby boomer generation—no wonder the economy is struggling to stay in growth mode and is in an ongoing rolling recession, as reported by Shadow Stats.



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http://www.bls.gov/

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The Stock Market is in Trouble

This is not meant as a substitute for the weekly stock market review. Its purpose is to point out a few key areas of concern that could suggest that the stock market could be in for a rough ride going forward. The US stock market has defied many a bear prognosticator. But an old adage is “don’t fight a rising tape.”

The first area of concern is the high S&P 500 P/E ratio.

Source: www.multpl.com

The Case Shiller P/E ratio is currently at 26.68, which is high, historically. The long-term mean is 16.7. It is higher than levels seen at market peaks in the early 1900s, and again higher than peaks seen in the mid-1960s. It is well below levels seen on Black Tuesday 1929, but is higher than levels seen on Black Monday 1987 prior to stock market crashes. But the record of 44.19 still stands in December 1999 prior to the internet/tech crash of 2000-2002. Current levels are about where they were prior to the 2008 financial crash. S&P 500 earnings are down 19% from their 2014 peak, and earnings growth has turned negative at 12.9%. This is down sharply from a growth rate of 793% seen in June 2010. Since there is no official recession at this time, it is of some concern that the growth rate has turned negative. This also bodes poorly for the stock market going forward, given the above-average P/E ratio.

The S&P 500 earnings chart is shown below.

http://www.multpl.com/

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Source: www.multpl.com

Another bad sign has been the high level of margin debt in play. The NYSE publishes margin data.

http://www.multpl.com/

http://www.dshort.com/

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Data was available through July 2016, so the NYSE margin debt has most likely come down somewhat from those lofty heights. But the reality is that, as the stock market moved higher, so did the margin debt. Margin debt growth was far outpacing the rise in the S&P 500 and at its peak, margin debt growth had outpaced the growth seen in the late 1990s prior to the internet/high-tech crash of 2000-2002, and the financial crash of 2007-2009. This is a warning sign that should not be ignored.

Source: www.stockcharts.com

Where’s the beef? Volume should drive a stock market higher. Except since 2010, the market has been driven higher on low volume. The huge volume was seen during the 2008 stock market crash. Volume also picked up during the decline seen into January/February 2016. Public participation in the rally from 2009 to present has been largely absent; they might be involved in equity funds. The main driver of the stock market has been institutional funds, and these are the type of funds that will exit even faster than they came in if there are any serious signs of trouble. Low volume is not the sign of a healthy stock market.

The stock market rally of 2009 to present has been impressive, with the S&P 500 up currently about 220%. Historically, that makes it about the third largest rally from a major low behind the bull markets of the 1920s and 1990s. The bull market of 1949-1966 was also impressive, despite being interrupted by a number of mini declines, all under 20%. The current rally has seen corrections in 2011 and 2015-2016, but again they have all been under 20%. The question begs—is a bigger one overdue?

The current rally has been fueled by abnormally low interest rates, endless rounds of quantitative easing (QE) as financial institutions deployed funds to speculation rather than into the economy, and by a large number of stock buybacks rather than companies investing in new plant and equipment that would have created employment. Stock buybacks have also been fueled by additional debt, as corporate America (and corporations globally) have taken on record amounts of debt.

http://www.stockcharts.com/

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Warning signs are just that—warning signs. They do not mean the stock market is about to collapse. But given the warning signs, if a trigger were to occur, such as an unexpected event (black swan event), the ensuing stock market rout could be considerable, given the overvaluation in the markets. Two potential black swan events could be the bankruptcy of Deutsche Bank or war breaking out in the Middle East involving the US and Russia, given that all talks have broken off over Syria, and that the rhetoric from both sides is now largely belligerent and accusatory.

Deutsche Bank (sigh) Again

Deutsche Bank cannot stay out of the news. There have been numerous rumours surrounding their impending bankruptcy. They have been fined some $14 billion by the US, an amount they seemingly don’t have and an amount that they will contest. Their US business is uncertain as a result. There was word last week that they may have been able to secure the $14 billion required to pay the fine. Deutsche Bank stock jumped some 14% on big volume last Friday, September 30, 2016. The stock has followed through to the upside this week.


Some believe Deutsche Bank is technically insolvent. Many love to point to Deutsche Bank’s huge derivatives portfolio, estimated at anywhere from US$50 trillion to $75 trillion. But that is just a notional amount (meaning it is not a hard asset, but merely represents an underlying hard asset), and much of it would be interest rate swaps where the exposure is interest rate differentials, and would be subject to offsets with other financial institutions. Deutsche Bank’s biggest and most dangerous exposure is loans to sovereign countries such as Italy, Russia and Ukraine (and many others as well). The exposure is not necessarily sovereign debt, but corporate debt. Deutsche Bank is the Eurozone’s second-largest bank behind BNP Paribas, and the world’s twelfth largest bank by assets.


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Nonetheless, there is a bit of a fixation on the huge derivatives number. Valuations can be placed on much of their derivatives portfolio that is interest-rate based and exchange traded. A value can be placed on much of its loan portfolio. Deutsche Bank has a large mortgage-backed securities portfolio, and it is more difficult to value.

The most difficult to evaluate are derivatives such as Credit Default Swaps (CDS) and Collateralized Debt Obligations (CDOs). Overall they would likely constitute less than 10% of their derivative portfolio, and possibly even less than 5%. But the actual risk and exposure is difficult to determine. For example, a CDS that may have been written (like writing naked puts) could cost a considerable amount if the company that underwrote the CDS on were to actually go under. But if the CDS was purchased (like buying a put), the cost would already be accounted for and if the company went under, it would be Deutsche Bank that would be collecting.

Source: www.goldcore.com

Meanwhile, CDS spreads on Deutsche Bank have widened recently to 548 basis points, almost at levels seen back in January 2016. So the concern is out there that Deutsche Bank could collapse. Is Deutsche Bank too big to fail? Well, yes, but the regime today is not bailouts but bail-ins, and it is large depositors and Deutsche Bank bondholders that are at risk here. There were rumours that hedge funds were pulling funds out of Deutsche Bank, but the recent jump in the stock price seems to belie that story. Not that it isn’t true, but it is unsubstantiated rumours, something Deutsche Bank has had plenty of recently. Deutsche Bank could also be nationalized, something that is not unusual in the Eurozone, as it has happened before.

Nonetheless, the saga of Deutsche Bank seems destined to darken the clouds for some time to come. Will it go under? We don’t know. Could it go under? Of course. Could it cause a stock market panic? Well, it might, but then it might not, given that it has been in the news now for some time, and we always love the old adage of “sell the rumour, buy the news.”

http://www.goldcore.com/

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K E Y E C O N O M I C I N D I C A T O R S

USA CANADA

Source: Bullion Management Group: www.research.stlouisfed.org, www.bankofcanada.ca, www.shadowstats.com ,www.statcan.gc.ca

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CURRENT YEAR AGO CURRENT YEAR AGO US YIELDS CANADA YIELDS

Fed Rate 0.25%-0.50% 0%-0.25% BofC Rate 0.50% 0.75% 3-month T-Bill 0.27% 0.01-% 3-month T-Bill 0.52% 0.43%

Real Interest Rate (3 mth T-Bill-% chg. CPI)

(0.78%) (0.19%) Real Interest Rate (3 mth T-Bill-% chg. CPI)

(0.61%) (0.56%)

GDP GROWTH GDP GROWTH GDP $18.5 trillion $18.2 trillion GDP $2.0

trillion $2.0 trillion

USA (official) 1.2% 3.0% Canada (official) 0.9% 1.0% USA (Shadow Stats) (2.0%) (1.2%) UNEMPLOYMENT UNEMPLOYMENT

USA (U3) 4.9% 5.1% Canada (official) 7.0% 7.1% USA (U6) 9.7% 10.3% Canada (R8) 10.3% 10.1%

USA (Shadow Stats) 23.0% 22.9% US Labour Force 159.6 million 157.0 million Can Labour Force 19.4

million 19.3 million

USA Part Time Workers % 17.9% 17.5% Can Part Time Workers % 19.1% 18.6% USA Labour Force Participation Rate

62.8% 62.6% Can Labour Force Participation Rate

65.5% 65.9%

Not in Labour Force 94.4 million 93.7 million Not in Labour Force 10.1 million

9.9 million

DEBT & MONEY (US$) DEBT & MONEY (CDN$) US National Debt (Federal

only) $19.5 trillion $18.2 trillion Canada National Debt (Federal

only) $1.05 trillion

$1.05 trillion

US Total Debt (Federal, State, Business &

Household)

$66.3 trillion $61.8 trillion Canada Total Debt (Federal, Provincial Business &

Household)

$5.2 trillion

Debt per family $812,521 Savings per family $10,138

Unfunded Liabilities $103.6 trillion Liability per taxpayer $865,756 US M2 Money Supply $13.0 trillion $12.0 trillion Canada M2 Money Supply $1.4

trillion $1.3 trillion

US Monetary Base $3.8 trillion $3.9 trillion US Debt to GDP 105.4% 102.8% Government Debt to GDP (All) 91.5% 86.2%

US Total Debt to GDP 358.3% 351.1% Canada Total Debt to GDP 345.5% 328.1% US Budget Deficit Est. $590

billion Canada Budget Deficit Est. $29.5

billion

Budget Deficit as a % GDP 3.2% Budget Deficit as a % of GDP 1.7% INFLATION INFLATION

US Inflation (official) 1.1% 0.2% Cdn Inflation 1.3% 1.0% Shadow Stats Inflation 8.7% 7.8%

OTHER OTHER Baltic Dry Index 912 889

US Living in Poverty 43.3 million 45.3 million

Food Stamp Recipients 42.9 million US Recession Probabilities 22.5% 13.3%



http://www.research.stlouisfed.org/

http://www.bankofcanada.ca/


http://www.statcan.gc.ca/

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W E E K L Y M A R K E T R E V I E W

S T O C K M A R K E T S


It’s October, and something scary might happen in the markets. October is known for its stock market crashes in 1929 and 1987. Somewhat less known were back-to-back stock market massacres in October 1978 and 1979, Friday the 13th in 1989, and while the 2008 financial crash got underway in September, the first good bottom was not seen until October. Oddly enough, October is not the worst month of the year. September is, but October has the cachet because of the famous stock market crashes of 1929 and 1987.

October can also be a “bear killer.” Numerous markets saw important bottoms in October, including 1946, 1957, 1960, 1962, 1974, 1990, 1998, 2001, 2002 and 2011. But tops can occur in October as well, harking back to the key top that was seen in October 2007. Overall, October ranks seventh for key indices such as the Dow Jones Industrials (DJI) and the S&P 500. As to presidential election years, October is, on average, a loser for the DJI, the S&P 500 and NASDAQ, especially from 1993 onwards. It’s an election year, so scary things might happen.

Since breaking back on September 9, 2016 following musings about the Fed interest rate hike, the US stock markets have largely gone sideways, with a slight upward bias. The S&P 500 has remained under the 50-day MA, except for a brief “pop up” on September 22, 2016, not long after the FOMC announcement, where they stood pat. The S&P 500 is appearing to remain in what looks like a potentially large ascending wedge triangle. Ascending wedge triangles are bearish. The breakdown currently appears to be around 2,135. To confirm a breakdown is underway, the S&P 500 should then


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break under 2,050. Potential minimum targets could be the January/February 2016 low near 1,810. The pattern could be negated with a break above 2,180, and especially above 2,190.


The pattern for the DJI is very similar to the S&P 500. An ascending wedge triangle appears to be forming. For the DJI the breakdown zone is now at 18,140, with confirmation coming with a break under 18,000. The pattern would be negated with a move back above 18,500, with the potential for new highs after that.

According to a Bloomberg article, the performance of the stock market after July 31 to the end of October can be a predictor as to who might win the election. It is noted that everyone should take this with a grain of salt. The premise is as follows: If the stock market records a gain after July 31 to October 31, the odds favour the election of the incumbent, or the incumbent’s party. But if the stock market records a loss after July 31 to October 31, the odds favour the other party http://www.bloomberg.com/news/articles/2016-09-30/this-chart-predicts-trump-will-win-unless-the-s-p-rallies-in-october.

As the chart below shows, the predictor was 82% successful in predicting the re-election of the incumbent or the incumbent’s party, while it was 86% successful in predicting that the other party would win. Since July 31, 2016, the S&P 500 is down a small 0.5% (as at October 5, 2016). If the S&P 500 were to stay that way or go lower by October 31, 2016, the predictor suggests that Donald Trump could win the election. As the article notes, the predictor has failed three times since 1944. Failure years were recorded in 1956 when geopolitical events dominated the headlines with the Suez Crisis and the Hungarian uprising; 1968, when a third-party candidate George Wallace took 14% of the vote; and 1980, when the Iranian hostage crisis dominated the headlines.

It is an interesting theory, especially given that other cycles are also suggesting a possible change in power for the 2016 election. With a month to go before the election, anything could happen to sway the election results. It is, however, interesting.


http://www.bloomberg.com/news/articles/2016-09-30/this-chart-predicts-trump-will-win-unless-the-s-p-rallies-in-october

http://www.bloomberg.com/news/articles/2016-09-30/this-chart-predicts-trump-will-win-unless-the-s-p-rallies-in-october

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Source: www.bloomberg.com




http://www.bloomberg.com/


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The NASDAQ is showing a similar pattern as the S&P 500 and DJI. The NASDAQ even has a small ascending wedge triangle forming, so it should be watched carefully. The NASDAQ breaks down under 5,250, but the secondary confirmation breakdown does not occur until the NASDAQ breaks under 4,850. New highs above 5,342 would negate the potentially bearish pattern.


The S&P TSX Composite is displaying similar patterns as the DJI, the S&P 500 and NASDAQ, except that the S&P TSX Composite remains well under its former high at 15,525. The S&P TSX Composite appears to be rolling over, and is also forming a potential bearish rising wedge pattern. The S&P TSX Composite under 14,600 looks increasingly weak. The S&P TSX Composite was hurt by the collapse in gold and gold stocks on October 4, 2016.

October could be a month of surprises. Deutsche Bank remains in the news, and the Italian banking system is effectively insolvent. The tensions continue in the Middle East, where the US and Russia have stopped talking to each other, and the US is weighing alternative military options. An October surprise could occur with any of the major political candidates. October promises to be an interesting month.


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B O N D S


Prices for the iShares 20-year Treasury Bond ETF (TLT/NYSE) continue to work their way lower. The chart above looks negative, having broken down from a topping pattern. A break to new lows under 132.80 could prove fatal. The final breakdown zone is at 131.25 and the 200-day MA. It seems counterintuitive that bond prices should be falling at a time when economic numbers have been anything but robust. Even the IMF has weighed in and lowered the growth forecast for the US to 1.6% from 2.2%. The IMF lowered its growth forecasts for others as well, so it is not just a US phenomenon. The IMF was especially negative about the United Kingdom, and Japan is expected to barely show any growth in 2016.

Could falling bond prices be a reflection of growing illiquidity in markets? Corporate defaults are rising, and that in turn is causing growing illiquidity, especially in the corporate bond market. The other aspect is participants selling long bonds and moving into shorter-dated maturities, where they feel they have more safety. Finally, it is possible that the TLT is responding to the continued rumours that the Fed will hike interest rates at the December FOMC. Nonetheless, falling bond prices are not a positive sign. The yield on the US 10-year Treasury note has jumped back up to 1.69% this past week, from 1.57%.

This Friday’s October 7, 2016 release of the employment numbers could help determine whether the bond market bounces back, especially if the numbers come in weaker than expected. As of the time of writing, the expectation is for a rise in nonfarm payrolls of 180,000 jobs for September, following the 151,000 nonfarm payrolls that were announced for August.


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C U R R E N C I E S


Despite an up week for the US$ Index (gain 0.7%), the story remains the same for both the US$ Index and the euro (down 0.1% this past week). Both continue to trade within the confines of the triangle patterns that have been forming over the past year. The prime reason for the rise in the US$ Index was the drop in the pound sterling (down 2.1%), given more fears over the Brexit and a sharp decline in the Japanese yen (down 2.9%). But recall that the prime component of the US$ Index is the euro that makes up 57.6% of the index. The Japanese yen makes up 13.6% and the pound sterling 11.9%.

The result: Nothing has changed. The breakout for the US$ Index is currently at 96.60 (the high this past week was 96.39). The US$ Index breaks down under 95.00. Potential targets for the US$ Index remain ultimately up to 106 to 108. Downside targets could be 86.

The euro breaks down under 110.25, with potential targets down to 97-99. The breakout is above 115, targeting potentially up to 126. Indicators for both the euro and the US$ Index remain largely neutral, giving us little in the way of information as to which way the market should break.

The rise in the value of the US$ Index remains largely dependent on the euro. The “Gryphon” does not attempt here to predict which way this is going to break, as these triangle patterns could, in theory, go either way. We await clarification.



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Percentage Gains Trends

Stock Market Indexes Close Dec 31

Close Oct 5

Week YTD Daily (Term)

Weekly (Intermediat

e)

Monthly (Long Term)

S&P 500 2,043.94 2,159.73 (0.5) 5.7 down (weak) up up (topping)

Dow Jones Industrials 17,425.03 18,281.03 (0.3) 4.9 down (weak) up up (topping) Dow Jones Transports 7508.71 8,128.01 1.5 8.3 up up neutral

NASDAQ 5007.41 5,316.02 flat 6.2 up up up (topping) S&P/TSX Composite 13,009.95 14,610.58 (0.8)

12.3 down (weak) up up

S&P/TSX Venture (CDNX) 525.59 778.50 (2.9) 48.1 down up neutral (bottoming)

Russell 2000 1,135.89 1,248.37 (0.6) 9.9 up up up MSCI World Index 1,693.06 1,701.51 0.1 0.5 neutral up down

Gold Mining Stock Indices

Gold Bugs Index (HUI) 111.18 205.28 (12.7) 84.6 down (weak) up (weak) up TSX Gold Index (TGD) 129.30 211.25 (12.3) 63.4 down (weak) up up Fixed Income Yields

U.S. 10-Year Treasury 2.27 1.72 9.6 (24.2)

Cdn. 10-Year Bond 1.39 1.06 10.4 (23.7)

Currencies

US$ Index 98.75 95.94 0.7 (2.9) up neutral up (topping?) Canadian $ 0.7233 0.7600 0.4 5.1 down neutral down

Euro 108.59 112.07 (0.1) 3.2 down (weak) neutral down British Pound 147.37 127.47 (2.1) (13.5) down down down Japanese Yen 83.12 96.46 (2.9)

16.1 down up up

Precious Metals

Gold 1,060.50 1,268.60 (4.2) 19.6 down up (weak) up (weak)

Silver 13.82 17.69 (7.5) 28.0 down up (weak) neutral Platinum 892.90 976.60 (4.9) 9.4

down neutral down

Commodities

Palladium 562.00 675.60 (5.4)

20.2 down (weak) up neutral

Copper 2.135 2.164 (1.1) 1.4 up (weak) up (weak) down (weak)

Energy

WTI Oil 37.07 49.83 5.9 34.4 up up down Natural Gas 2.35 3.041 1.4 29.4 up up neutral



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M A R K E T S A N D T R E N D S

SEE GLOSSARY AT END FOR AN EXPLANATION OF THE TRENDS

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but not the euro. Hardly the stuff to cause a $40-plus decline in the price of gold.

Then came word that someone unknown dumped 1,000 tonnes of gold, or 3.2 million ounces, on the market open October 4, 2016. Now, that would do it. Of course, it begs the question as to why anyone would want to do this, as it is the equivalent of a big chunk of the year’s mine supply, even as there is no evidence that mine supply is suddenly going to rise sharply. The selloff in the gold (and silver) market occurred despite no earth-shattering news, no major upheavals in the FX market, oil markets, or even in the stock markets.

Selling it all at once could only be translated one way. Someone wanted to push gold prices lower. Once under $1,300, it triggered sell stops and washed out numerous weak longs in the process. The usual suspects were trotted out as being the perpetrators of the selloff, including central banks and large financial institutions such as JP Morgan Chase.

Last week there was a big jump in the commercial COT as it fell to 22% from 23%. More importantly, there was a large 27,000-contract jump in short open interest. Even so, there was also a 3,000-contract rise in long open interest. Meanwhile, the large speculators (hedge funds, managed futures etc.) were getting long again as their COT rose to 84% from 82%, with a 32,000-contract jump in long open interest and a 3,000-contract decline in short open interest. The suspicion here is that a lot of the sell stops under $1,300 probably emanated from those same large speculators. We will be watching this Friday’s COT to see if the commercials covered much on this plunge, and conversely the large speculators bailed.

Tuesday, October 4, 2016 was a very unpleasant day for gold, silver and the precious metals stocks. The day brought back memories of the wipeout of April 12-15, 2013, when gold fell some $200. This time the decline was $43. Silver plunged to a $17 handle, and the gold stocks fell 12%.

So what happened? The newspapers suggested it was fear of an interest rate hike at the December FOMC, that the US economy was improving and that, in turn, pushed the US$ up. That was a head scratcher given that, as we noted earlier, a new IMF forecast has lowered growth projections for the US for 2016, along with lowering growth projections for a number of other countries. . If the Fed wants to raise rates it is not because they think rates should be raised, but because by raising them, they would be in a position to lower them when the economy weakened once again. While the US$ inevitably strengthened as a result, it somehow caused gold to go off the cliff. But as we noted under “Currencies,” the up move for the US$ Index was not a big move and was caused mostly by a sharp drop for the pound and the Japanese yen,

G O L D A N D P R E C I O U S M E T A L S

GOLD INDICATORS

CURRENT (Oct 5, 2016)

YEAR AGO

Gold in US$ $1,268.60 $1,146.80 Gold in Cdn$ $1,669.87 $1,494.98 Gold in Euros €1,132.00 €1,017.00 Gold in British Pounds £995.00 £753.00 Gold in Japanese Yen ¥133,135 ¥137,900 Dow Jones/Gold ratio 14.41 14.64 Gold Volatility Index 15.21 17.54 Gold/Oil ratio 25.46 23.38 Gold/HUI ratio 6.18 9.11 Gold/Silver ratio 71.69 72.19 Gold Sentiment Index 126.8 80.0 PERFORMANCE (2000-Present)

2000 to Present Year to Date

Dow Jones Industrials (DJI)

59.0% 3.9%

S&P 500 47.0% 4.7% Gold 338.1% 19.6% Silver 224.5% 27.5% WTI Oil 94.7% 35.3% DJI REITS 188.9% 2.9% Source: Bullion Management Group Inc.

http://www.bmgbullion.com/

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O C T O B E R 7 , 2 0 1 6

Manipulation in markets is not unusual. All markets experience it to some extent, and some more than others. It is not difficult when conditions are thin, such as when the market opens, or at certain times during the day. Manipulation also works both ways—up and down. Were there signs that the market might drop?

Well, yes, there were. We had been warning for weeks that, while a triangle pattern was forming, it was ambiguous enough that arguments could be made both ways. However, the pattern did become clearer, but only over the past week or so. Technical analysis is a useful tool, but even it can be cloudy at times in attempting to determine a pattern. The telltale was the series of falling, or lower highs that formed once the July/August double top was in. That was the classic sign of a descending triangle, even as it did not become more obvious until after the top of September 22, 2016. They usually break to the downside, but not always.

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O C T O B E R 7 , 2 0 1 6



Once $1,310 broke, again the writing was on the wall, and the market plunged through $1,300. That’s the bad news. The good news is that, whether one uses the double top or the descending triangle pattern, the potential target zone is around $1,240. Most of that was accomplished with the plunge on October 4, 2016 with a low of $1,269. The major support zone that the “Gryphon” had noted for weeks was between $1,240 to $1,260. Gold is now falling into that zone.

If there is an even steeper drop to come, as some have alluded to, then gold must break under $1,240, and then break down under $1,200. Under $1,200, a test of the December 2015 lows of $1,045 would then get underway. We doubt that scenario, but it shouldn’t be dismissed, at least not until gold recovers.





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Silver has fallen into a major area of support, down to $17.50. Under $17.50, the next major zone of support is at $16, with interim support at $17. We doubt very much that silver will fall that far, but the potential shouldn’t be ignored.

Gold needs to regain first above $1,300, then above $1,350, to suggest this corrective phase is over. While we did not label gold, we suspect that it completed an ABC Elliot pattern from the $1,045 low to complete an A wave of a higher degree. The A wave topped at $1,287 in March, the B wave bottomed in May at $1,201 and the C wave topped in July at $1,377. What is underway is the B wave of a higher degree. A normal Fibonacci 38.2% correction of the advance from $1,045 to $1,377 would come in at $1,250.

Silver’s advance from the $13.62 low in December 2015 took it to a high of $21.23 in July. An ABC advance appears to be visible on silver as well, with the A wave topping at $18.06 in May and the B wave bottoming in June at $15.83. The C wave topped in July at $21.23. A normal Fibonacci 38.2% correction would come in at $18.32, and the 50% correction would be at $17.42. The recent low was seen at $17.59. For the record, the Fibonacci 61.8% correction is at $16.52.

Gold sentiment has fallen sharply. According to the Daily Sentiment Index (DSI), the percentage of bulls has fallen to 5%. That is darn near as low as it was at the December 2015 low. Silver was down to 12%. While they could go lower, the low readings are suggesting that a low could soon be at hand. While volume did rise on the plunge on October 4, 2016, it was not abnormally large. This is fitting with a corrective move and not with the start of a new bear market.

The gold stocks fell as well, and the Gold Bugs Index (HUI) and the TSX Gold Index (TGD) have now fallen to the 200-day MA. A decline of that magnitude following the large rise from the 2015 low is not unusual. A corrective decline of 30% is not unusual either, following 100%-plus moves off the lows. When the HUI rose from 150 to 640 from the 2008 low to the 2011 high, there were corrections of 25% and 30% along the way.

The sentiment for gold stocks has also fallen sharply and is at its lowest level since January/February 2016. Again, none of this is to suggest that a low is at hand, but the market is getting closer to one following the plunge of October 4, 2016.

Gold’s fundamentals remain strong. Real interest rates remain negative; global debt levels are unsustainably high and the IMF has expressed grave concern about the estimated $150 trillion of non-government debt around the world; currency debasement continues to be major factor; the global military situation remains tenuous, particularly with the recent breakdown in relations between the US and Russia over Syria; the stock market remains at overvalued levels often associated with a top; bond prices have begun to fall, which is counterintuitive and could be signaling a potential bond crash; gold remains a tiny portion of investment portfolios, yet gold has returned, on average, 8.3% annually since becoming free trading in 1971; gold is negatively correlated to stocks and bonds; political risk is high, given unrest in many European countries and growing unrest and a deeply divided election in the US; and central banks have been steady buyers of gold since 2008. Gold remains a key reserve asset in the world’s central banks, yet gold is under-owned in investment portfolios.

Tuesday’s plunge was somewhat unexpected, and given what was behind it, with the unload of 1,000 tonnes of gold on the open, it is not surprising that gold fell so sharply. It may be manipulation, but hopefully the parties shorting are now covering their shorts, even as others panic and sell.

O C T O B E R 7 , 2 0 1 6



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David has worked in the financial industry for over 40 years. He spent most of his career on the trading desks of a few large Canadian financial institutions where he was a manager and dealer in money markets, foreign exchange and financial derivative portfolios. These included Export Development Corporation (EDC), Canadian Imperial Bank of Commerce (CIBC) and Confederation Treasury Services Ltd. (CTSL), the treasury arm of Confederation Life Insurance Co. (CLIC). David moved into the brokerage industry in 1995, where he applied his experience in financial markets and technical analysis to writing market commentaries and articles as well as acting as an investment advisor. David spent several years writing columns for Investor’s Digest of Canada, as well as institutional and retail clients, and appearing as a guest market analyst on the Business News Network (BNN). David is a Fellow of the Canadian Securities Institute (FCSI) and a Canadian Investment Manager (CIM).

O C T O B E R 7 , 2 0 1 6



This is not the situation the market faced in April 2013. Potential targets are at hand, although one should keep in mind that a break under $1,200 would be of graver concern, and a test of the December lows. As to timing of the low, well, October/November has seen some important lows in gold in the past, the most notable being in 2008.

The plunge in gold could also be signaling that a plunge in the stock market may not be far behind. In 2008, gold started to break down prior to the stock market breaking down. But gold then bottomed sooner and, by the time the stock market was making its final low in March 2009, gold had already recovered to its pre-crash high. Worth noting, and keeping an eye on.

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H I G H L I G H T S O F T H E W E E K B Y D A V I D C H A P M A N O C T O B E R 7 , 2 0 1 6

T O R O N T O , O N T A R I O

The Economy is in Trouble The Stock Market is in Trouble Deutsche Bank (sigh) Again

Deutsche Bank can't stay out of the news Stock Market weekly review Bond Market weekly review Currencies weekly review David Chapman BMG Chief Economist T . 9 0 5 . 4 1 5 . 2 9 4 7 [email protected]

G L O S S A R Y T R E N D S

DAILY – Short-term trend WEEKLY – Intermediate-term trend MONTHLY – Long-term secular trend UP – The trend is up. DOWN – The trend is down NEUTRAL – Indicators are mostly neutral. A trend change might be in the offing. WEAK – The trend is still up or down but it is weakening. It is also a sign that the trend might change. TOPPING – Indicators are suggesting that, while the trend remains up, there are considerable signs that suggest that the market is topping. BOTTOMING – Indicators suggest that, while the trend is down, there are considerable signs that the market is bottoming. * - Indicates that the trend has changed.

Disclaimer This report is provided by BMG and Bullion Marketing Services Inc. It is for informational and educational services only as of the date of writing, and may not be appropriate for other purposes. BMG and Bullion Marketing Services Inc. may include information obtained from sources believed to be reliable and accurate as of the date of this publication, but no independent verification has been made to ensure its accuracy or completeness. Opinions expressed are subject to change without notice. This letter is not intended as investment advice, and its use in any respect is entirely the responsibility of the user. Past performance is never a guarantee of future results.

B U L LI O N M A N A GE M E N T G R OU P IN C . 2 8 0 – 6 0 R e n f r e w D r i ve Ma rk ham , O n t a r i o C a na d a L 3R 0E 1 .

9 0 5 . 4 7 4 . 1 0 01 T o l l F re e . 1 .8 8 8 . 4 7 4 . 1 0 01 F . 90 5 . 47 4 .1 0 9 1 B M G B U L L IO N . C OM


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