#$cef

This post first appeared at TheFelderReport.com.

Warren Buffett is famous for many things one of which is his general dislike for precious metals as an investment. But maybe you’re old enough to remember when, just over 20 years ago, he backed up the truck and bought a ton of silver – over 3,000 tons, to be more precise. From the 1997 Berkshire Hathaway letter to shareholders:

Our second non-traditional commitment is in silver. Last year, we purchased 111.2 million ounces. Marked to market, that position produced a pre-tax gain of $97.4 million for us in 1997. In a way, this is a return to the past for me: Thirty years ago, I bought silver because I anticipated its demonetization by the U.S. Government. Ever since, I have followed the metal’s fundamentals but not owned it. In recent years, bullion inventories have fallen materially, and last summer Charlie and I concluded that a higher price would be needed to establish equilibrium between supply and demand.

Maybe you’re even old enough to remember that earlier time, just about 50 years ago, when the Oracle of Omaha amassed a position in silver. Either way, it’s interesting to look back at why he did so. “Demonetization by the U.S. Government,” was his thesis back in 1967. Essentially, he made a bet on the devaluation of the dollar against the gold price and chose silver as his trade vehicle. And there are some interesting parallels between then and today.

The dollar is no longer convertible into gold as it was back then but the dynamics that forced the discontinuation of this convertibility are still at work. Wikipedia discusses the “Nixon shock” by explaining that, “from 1950 to 1969, as Germany and Japan recovered, the US share of the world’s economic output dropped significantly, from 35% to 27%.” The very same situation is happening again today, only it is China taking share of the world’s economic output even as the dollar remains the world’s reserve currency.

The story continues, “furthermore, a negative balance of payments, growing public debt incurred by the Vietnam War, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s.” The negative balance of payments is far greater today even when normalized for the relative size of the economy, again thanks to our relationship with China, as is the rapidly growing pile of public debt.

And if you haven’t noticed the monetary inflation created by the Fed over the past decade you must have been living under a rock. The currency component of M1 is currently growing at an annual rate of 7%, a growth rate it first hit in May of 1966. It’s no longer the president’s purview to demonetize the dollar; it’s the market’s. And I’ll leave you decide whether the market should do so today based upon the aforementioned dynamics.

But it’s also important to look at his later thesis for buying silver: “In recent years, bullion inventories have fallen materially, and last summer Charlie and I concluded that a higher price would be needed to establish equilibrium between supply and demand.” Currently, we have a very similar situation in gold. As my friend, Luke Gromen, recently pointed out on twitter, registered gold stocks are currently testing their lowest levels on record. Thus it appears that a higher price is, “needed to establish equilibrium between supply and demand.”

This post first appeared at TheFelderReport.com.

The gold price has risen about 20% since I wrote “It’s Time To Get Greedy In The Gold Market” but it looks to me like it could now get really exciting for gold bulls.

On the weekly chart there is now a clear head and shoulders bottom pattern in play. A break above the neckline would confirm the pattern and project an eventual target near $1,650. There is also a very interesting price analog from 2008-2009 (hat tip, @ECantoni) that suggests this breakout could be imminent.

Since it’s peak in late-2011 gold has acted very much like it did from 1996-2002 (hat tip, @NautilusCap) at least relative to the broad stock market. There is a 97% positive correlation between the past six years in the gold/SPX ratio and that earlier 6-year period. In fact, it now looks like the gold/stocks ratio could have some serious catching up to do to the upside.

Looking back to that 2001 low in gold it’s clear that, at the time, it was very cheap relative to the broad stock market. Today, you could argue it’s now even cheaper. Over the past 35 years or so, gold and the S&P 500 have essentially traded around parity. Should they see some sort of mean reversion now there are $1,300 points to be made up one way or the other.

And if the future for gold rhymes at all with the early-2000’s period it could have much more upside over the next several years than even that head and shoulders bottom pattern would suggest.

Just as widely anticipated, the Fed did raise rates today by 0.25% to a new range of 1-1.25%. The market’s response was mixed with DJIA finishing the day modestly higher while S&P 500 and NASDAQ finished modestly lower. Gold’s reaction was less favorable, finishing down nearly 0.5% after starting the day well into positive territory. Generally, the higher interest rates go, the less desirable gold can become. Gold does not have a yield and typically storage of physical gold has a cost. However, today’s weakness (or anytime throughout the remainder of the month) might just turn out to be a good buying opportunity for gold.

In the above chart, gold’s monthly performance from 1975 to 2016 is displayed. Historically, October has been gold’s worst month and June is a close second. However, after weakness in June, gold has, on average, enjoyed solid gains in July, August and September. Some of this strength in gold is likely due to safe haven demand during the stock markets worst two months, August and September.

Based upon continuously-linked, non-adjusted, front-month futures prices since 1975, April is the fourth worst performing month for gold and fifth worst for silver. In 42 years, gold and silver have advanced 18 times and declined 24 times in April. Gold has posted an average loss of 0.4% while silver actually recorded an average gain of 0.5%. Silver’s better average performance can be attributed to mighty gains of 15.2% in 2016, 28.3% in 2011, 18.3% in 2006 and 29.9% in April 1987. Gold and silver’s record over the recent 21 years (1996-2016) is better, but performance in April is still tepid. Gold up 12, down 9 average gain 0.4% in last 21 years while silver was up 8, down 13 with an average gain of 0.3%. Typical April performance can be seen in the following chart. Note weakness ahead of the eleventh trading (approximately tax deadline).

Since the start of 2016, gold has been outperforming, advancing nearly 30% through late July. Even after last week’s 5% loss, gold is still up over 18% year-to-date based upon continuously-linked non-adjusted front-month futures prices (used in all charts below). Using data from 1975 to 2015, gold’s average annual gain has been just under 7% in all years. In election years, gold has been substantially weaker, averaging a loss of 2.8% since 1975. Gold’s performance this election year has been well above average.

Removing 2016 from the above chart we are left with gold’s 1-year seasonal pattern in all years and in election years (below). Brief seasonal weakness is shaded in yellow. Early October declines tend to persist and lead to a lower low in November before gold rebounds to finish the year higher in “All Years.” In election years, gold’s October decline has been greater in magnitude, but shorter in duration with the rebound beginning near the end of the month.

Historically, there is a strong price period for gold (shaded in yellow in chart below) from late August until late September or early October as demand increases as jewelers again stock up ahead of a the seasonal wedding event in India and also, as investors return from summer vacations. Entering long positions on or about August 26 and holding until October 1 has worked 23 times in the last 41 years for a success rate of 56.1%. In the 19 years since 1996, this trade has been profitable 13 times with a cumulative potential profit of $17,550 per single futures contract.

Sizable losses were suffered in 2011, 2013 and 2014; however this trade’s best performance ever was in 2012. In recent years, gold’s seasonal strength has begun earlier; in late July or early August and finished sooner; sometime in September to early October. Last year’s trade would have been profitable with an earlier entry and/or earlier exit.

Canadian stocks are testing a potentially significant breakdown.

Believe it or not, the dog days of a Wall Street summer are just around the corner. And it appears as if the dog days of the post-February stock rally have already arrived. The rally has stagnated and stocks appear to be stuck in limbo. On the one hand, you have the former all-time highs and a slight deterioration in breadth conditions while on the other, you have conditions that are not yet ripe for any type of material breakdown in the broad stock market. Therefore, it would not be a surprise to see stocks continue to drift for a time while waiting for either side to build up a more convincing case.

That said, there has been one possible bearish change in character since the calendar turned to June. That is, while the post-February rally had thus far seen prices of most indices able to clear key resistance quite easily, that is no longer the case. We have seen multiple examples recently where various segments of the market have stopped precisely at obvious resistance levels -- like they’re supposed to. The Canadian stock market is one such example.

After topping out in September 2014, Canada’s main stock market index, the S&P TSX Composite (TSX) has made a series of lower highs and lower lows. That said, the rally in the TSX since January has been quite impressive, tacking on about 25% and making a slight higher high on a short-term basis. However, as mentioned the TSX rally stopped earlier this month right near resistance where it was supposed to. And it is fairly formidable looking resistance.

As the chart shows, there are several analyses around the 14,250 level that make the recent peak quite compelling as a potentially more substantial top. First off, we have the all-important 61.8% Fibonacci Retracement level of the decline from the 2014 top to the January low. Secondly, we have the breakdown level from August 2015, from which the decline in the TSX significantly accelerated. In addition, we have the 500-day moving average (not shown), which does a fairly good job of delineating longer-term trends.

Lastly, we arguably have a pattern traced out since the February lows called a rising wedge. A rising wedge consists of higher lows and higher highs, with the highs rising at a shallower trajectory than the lows. And despite the higher lows and highs, the pattern is actually a bearish formation. In our experience, more times than not. the rising wedge culminates with prices breaking down below the lower bound. That is precisely what happened in the TSX about 10 days ago.

This loss of the lower trendline of the wedge is potentially devastating for the TSX, in particular because it occurred just off of multiple, transparent resistance levels. The index is making a run right now, possibly, at testing the breakdown level of the wedge, etc. Should this test fail as soundly as the TSX did upon its initial foray into resistance, it may well be reasonable to begin considering that the early-June high was the top for the post-February rally.

Again, while the formidable resistance is the key takeaway as it pertains to the TSX, the larger message for the broader market is that rallies in various markets are beginning to fail right where they should. This shows a drying up of demand. It is also a far cry from the first several months of the post-February rally wherein markets around the globe were blowing through resistance levels that should have stopped them.

That action was likely the result of the breadth and momentum thrust off of the February lows that carried markets farther than expected. At this point, the benefits of that thrust have likely run their course. Markets are beginning to trade again based on their own, current merits. For the broader market, that may mean that stocks will continue to drift sideways until clearer evidence arises suggesting a big move, up or down.

However, based on its chart, and prices’ reliable adherence to it, the Canadian stock market would probably be lucky, at this point, if it was able to merely drift sideways.

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More from Dana Lyons, JLFMI and My401kPro.

Back in April I wrote a post titled, “how to trade like Stan Druckenmiller, George Soros and Jim Rogers.” It centered on a quote from Druck that really gets at the key to his incredible success in the markets:

The first thing I heard when I got in the business, not from my mentor, was bulls make money, bears make money, and pigs get slaughtered. I’m here to tell you I was a pig. And I strongly believe the only way to make long-term returns in our business that are superior is by being a pig. I think diversification and all the stuff they’re teaching at business school today is probably the most misguided concept everywhere. And if you look at all the great investors that are as different as Warren Buffett, Carl Icahn, Ken Langone, they tend to be very, very concentrated bets. They see something, they bet it, and they bet the ranch on it. And that’s kind of the way my philosophy evolved, which was if you see – only maybe one or two times a year do you see something that really, really excites you… The mistake I’d say 98% of money managers and individuals make is they feel like they got to be playing in a bunch of stuff. And if you really see it, put all your eggs in one basket and then watch the basket very carefully. -Stan Druckenmiller

The way Druck generated 30% average annual returns over a period of decades was by being a pig, by putting all his eggs in one basket and watching it very carefully. Considering he may be the most successful money manager alive, you may be curious to learn what Druck is buying today.

Well, you’re in luck! Druck’s latest 13F filing shows that he is currently backing up the truck and loading up on gold. In the second quarter, he bought over $300 million worth making it his single largest position. He now has more than 20% of his portfolio allocated to the SPDR Gold Trust (GLD). This position is more than twice as large as his next largest holding.