From the HRA Journal: Issue 225
Eric Coffin, January 4, 2015
There was enough good news in the US through December to send all the
major indices in New York except NASDAQ to new all-time highs and the tech
index isn't far off. It's all rainbows and ponies on Wall St right now which
should make any sensible person a bit nervous.
As I expected oil is still in the dumps and that state of affairs
should last for a while. As noted in the last issue this big a drop in oil
prices is a stimulus though it's a smaller stimulus in the US than Wall St.
wants to believe. Expectations are high after the US printed 5% GDP growth in
Q3. That was indeed impressive and cheaper oil should help generate good
growth numbers in Q4 and Q1 2015. Things may tail off after that though.
There is a lot of detail and nuance in the markets. After struggling to
get it all into a manageable serving for you I've decided that's not in our
best interest. For that reason you should expect to see three issues (this
one included) in quick succession that will deal with my outlook for
different metals, regions and currencies. All will be in play against each
other in 2015. In this issue I'm focusing on the Euro and oil, two things
both the $US and gold react to on a day to day basis. The € may bounce after
the ECB meeting but (as usual) we may get the pain before the gain.
I wish all of you a happy, healthy and prosperous 2015.
Eric Coffin
It's been a wild ride since the last Journal issue. The ride isn't over
though things should get briefly smoother as we get through year end. Not
necessarily "better" but volatility in the metals markets may ease
off a bit when we return to a post-holiday trading environment. Whatever the
hell "normal" is these days.
I don't expect the major theme of the past month--weak oil prices--to
change any time soon. I'll go into more specifics on a range of commodities
in this and in the next two issues. There are more moving parts and
contradictory influences than I've seen for a long time.
While I think there will be relative calm at the start of the year storm
flags have been raised. There is plenty of room for surprises in 2015. I'll
concentrate on oil and EU--particularly Greece--in this issue.
One potential mover for markets is the anticipated start of a QE program
by the ECB. Another is renewed instability in Greece. Both of these issues
will come to the fore in January with Greek elections closely following the
next ECB monetary policy meeting.
I remain a skeptic about large scale QE by the European Central Bank. It's
not that I think it's unnecessary or a bad thing. I think QE helped the US
and the ECB, unlike the Fed, has a balance sheet that is one trillion Euros smaller
than it was a couple of years ago. The ECB has actually been tightening which
is insane given the Continent's economic situation.
For the ECB the question is whether Mario Draghi and a few other fiscal
doves are willing to push QE through without unanimous consent. I think there
is no way the Germans will vote for it and several Nordic countries share the
German opinion.
Draghi isn't going to change their minds on the subject. Technically, a
majority vote of the ECB ruling council is all that is required but the bank
has never taken this major an action in the past without a unanimous vote. Is
Draghi willing to ignore convention?
It seems increasingly likely. Draghi is impatient and hinting he is
willing to go it alone if he has to.
I would expect a QE announcement, if it comes, after the next scheduled
monetary policy meeting on January 21. How the Euro reacts to that is going
to be interesting. It will partially depend on how big a QE program Draghi is
willing to commit the bank to.
The Euro has trended down for months and the QE question has created some
of the selling pressure. The chart above shows its been nothing but down for
the Euro since early in the year.
It's taken as a given that the Euro will have another big drop if and when
the ECB finally pulls the trigger. That's certainly possible but the market
is already plenty short and most traders seem less skeptical than I about
this situation. Expectations are high the ECB will act and go for shock and
awe.
It seems counter intuitive but I would not be surprised to see a Euro
rally after the announcement. That's not what the ECB wants. They want the
Euro to weaken further but there will be some "sell on news" trades
on the short side. By the same token, long Dollar is an extremely crowded
trade and some pullbacks along the way should be expected.
The market is expecting something impressive from the ECB but the fact is
Draghi as been all talk and no action for the past year or more. He's gotten
away with that as traders remember his "do whatever it takes"
speech during the last Euro crisis. That can't go on forever. I think traders
lose patience (and start closing Euro short positions) if he doesn't announce
something soon.
Unless Draghi builds a consensus for a large QE program--which I do not
think is possible where Germany is concerned--a QE announcement will be a
disappointment. It seems everyone and their dog is calling for Euro-Dollar
parity in 2015. Expectations are high for a QE program of at least €1
trillion. We'll see.
There are of course valid reasons to expect the Euro to keep falling based
on growth differentials but don't be shocked if the Euro actually rises later
in January. I think that is a real possibility if short trades are unwound
after a disappointing QE announcement. If there is no announcement after the
next meeting the bounce would be that much larger. I don't think Draghi can
jawbone any longer and get away with it.
The other January event just added to the calendar is a new election in
Greece. The large graphic below shows the results and percentage vote in the
2012 election for the currently ruling New Democracy and challenger Syriza
parties as well as the current poll standings for different Greek political
parties. The graph below that compares the current "recession" in
Greece to recent historical depressions, all courtesy of The Economist.
The graph really jumps out at you and shows why Greeks are so fed up.
Whomever is at fault, Greece is suffering a depression that so far looks like
it will be worse than the Great Depression was for the US. Little wonder the
place is volatile.
The current voting intentions show Syriza is ahead but by only a small
margin. This may be why markets outside of Greece have taken this news
calmly. Syriza wants to renegotiate or repudiate the debt deal with the EU.
Interestingly, the majority of Greeks say they want to stay in the Euro so
New Democracy may gain in the polls leading up to the election if Syriza
scares voters with promises to leave the Euro. Either way its going to be an
unruly coalition. It's not likely any party can win a majority.
Does this have the potential to crash the Euro? Perhaps, though the
potential for contagion is far less than it was in 2011. Almost all external
Greek debt is held by EU institutions and the IMF, not private banks or
funds. The debt stands at about €300 billion. That's a big number but nowhere
near large enough to destabilize these institutions.
Even if Syriza wins they haven't got much negotiating leverage. If they
repudiate the debt they'll be tossed out of the Euro. I don't see northern
Europeans being cowed by them.
If Greece exits it would be years before they could borrow externally.
That would be a disaster but they would have a much smaller debt load and
could devalue their currency at will. Inflation would explode but so would
tourism as Greece again became the cheap destination.
The biggest danger for the EU would be Greece exiting and appearing to
come out of a devaluation well. That could have other Europeans thinking it
was a chance worth taking. The majority of Italians, for instance, think the
Euro is a bad thing for their country. Italy has over €2 trillion in debt,
plenty of it held by foreign and domestic banks. If it looked like Greece was
weathering an exit from the Euro Italians (and French and...) might start
wondering. That's the real nightmare for Brussels.
A big stimulus package or disastrous election in Greece. Those are the two
potential negatives for the Euro. It matters for resource investors because,
right or wrong, most commodities are heavily impacted by moves in the US
Dollar and the Euro is the big pair trade. I think traders should worry less
about the Dollar where gold is concerned. I'll touch on that again briefly at
the end of this piece after some comments about oil.
The 1 year oil chart above says it all. This doesn't look like a chart
that has found its bottom yet, though oil stocks have been getting support in
the market lately.
Oil and gas (the natural gas chart doesn't look a lot better) traders
obviously think a bottom is very close. Energy indices had a good bounce in
mid-December when oil had a dead cat bounce. Oil stocks have been holding
those gains but oil itself is at new lows again so I'm not convinced the
bounce will hold.
The top chart on this page shows US crude inventories and helps explain
why the oil price bounce didn't hold. It shows crude inventories since
mid-2013 superimposed on the five year range. Not surprisingly the inventory
rises during shoulder seasons in the spring and fall and dips as summer
driving and winter heating increase demand.
What freaked traders out was the rise in current inventories--the blue
line--going through December when it would normally be starting to fall.
Inventory levels have been high for over a year. A few weeks of cold
weather could turn things around but this doesn't look like a blip. It's an
indication of oversupply and the reason hopeful hedge funds started to panic
and close long oil positions as the year wrapped up.
Much has been made of falling rig counts in North America but the drop has
been small in percentage terms and its coming off decade highs. The count
will keep falling but as I noted last month this is not a situation that will
correct itself quickly.
Unless one of main oil producing nations cuts production unilaterally oil
will stay under pressure for some time to come. That is a good thing for the
world economy and will help a lot of bulk miners, especially ones running off
generators as many remote ones do. It will take time for lower prices to work
through the supply chain but it could be a nice bonus in the Q1 and Q2
reporting for many miners.
I'm going to focus on gold and a couple of other things in the next issue
but I wanted to leave you with one important chart.
The chart on this page compares the performance of gold and the US Dollar
since gold fell to the $1130 range in early November. There is an important
message in this chart. Both gold and the $US have gained since early
November. It would surprise most dollar bulls to realize the percentage move
in gold has actually been larger.
The greenback as surged since mid-December. That hurt the gold price but
less than it "should" have and bullion recently found a bid and
held higher lows, though volatility has been high.
That is not how it's supposed to work according to Wall St. Gold is
assumed to have a near perfect negative correlation with the $US. Most of the
calls for sub $1000 gold this year are based simply on that assumed
correlation. Wall St expects the dollar to keep rising which, ipso facto,
means gold prices must fall.
It doesn't always work that way though, as I have pointed out several
times recently. The chart above indicates a moderate positive correlation,
not a perfect negative one. This could be hugely important to how the gold
price acts this year. And, it makes sense if you think of gold in currency
rather than commodity terms.
As I'll show in more detail in the next issue gold is the world's second
strongest major currency. The market is obsessed by the dollar gold price but
when viewed in terms of other currencies its appeal is easier to understand.
That appeal is our best chance for a better 2015.
