Sunday, February 14, 2016

Gold's Bull/Bear Status

The time tested proverb "A gold mine is a hole in the ground with a liar at the top" is generally attributed to Mark Twain, although he may have just popularized it. The last few years,  he has a lot of company in feeling that way. Other than the coal miners, gold miners have probably been the most despised stock sector on earth the last 3 years. But then along comes the surprise January beat down in the stock market, and gold is showing some signs of life. A passing two month start-of-the-year blip some are saying, just like the start of every year since 2011, except for 2013, the crash year for gold. But there are some big differences this time at the start of 2016.

There is a banking angst building over the malinvestment debt of the ZIRP years, as I've mentioned in previous articles, and that has been boiling over here in mid February with a decimation of the big bank stocks. The whole banking/bad commodities loan mess engulfing our markets nowadays is perhaps sparking a major turn to gold, not as a commodity but as an alternative currency. If you want to look at a leading edge in all this, the country of South Africa is a good place to look.

This nation is a major gold miner and is also caught up in the emerging market currency problems typical of nations exporting a lot of commodities. The leading export destination of the copper, nickel, and whatnot from South Africa is China. During the years they were producing 60% or more of the world's gold supply (to the late '80s) many South African gold companies became public mainstays in the stock market. Currently they have slipped just out of the top 5 global producers, but the 5 ahead of them are either not emerging market nations or don't have a lot of major public gold miners. As such, this nation's currency/gold situation is an early tell of any major turn in gold.  A Bloomberg article last month noted this South African thing as their gold miners pay all their costs in the local currency, the rand, and reap all their revenue in dollars:
“The gold price has held up pretty well, but the rand has blown off terribly,” Peter Major, a mining analyst at Cadiz Specialized Asset Management in Cape Town, said by phone. “Gold companies, which were marginal and barely making money when the rand was 13 to one, will benefit when the rand suddenly goes to 16 or 17. All of a sudden they’re making 20 percent more revenue and it all goes to the bottom-line.”
So how is this early gold tell doing? (click on images to enlarge)

Here I compared a half dozen of South Africa's largest gold companies with the gold price (GLD) and with the general gold miners ETF (GDX) over the last three months. A very large outperformance is clear and began even before the start of January. The above article points out that the currency problems of the world are responsible for some 20% more revenue coming the way of South Africa domiciled gold companies. And this is at no cost of revenue whatsoever for them and it all goes straight to profit, and stock values. If you average the performance of these stocks, you get a massive 98% outperformance over the GDX - in just three months. The market seems to think currency problems are here to stay, as well as better gold prices.

The steady decline of gold since the 2011 peak is generally thought of as a bear market. But I would like to explore the possibility that a very large scale bull market actually includes this 4 year decline, and may be departing into a phase 3 of this type of bull market, agreeing with the tell of the South African miners. Major bull markets tend to run in repeating patterns or fractals. Markets, as well as many things in nature, move in these patterns at different scales. One such pattern I have written about before is the separated parabola. An example of this is the currency market of 1920's Germany, which was the most prevalent scale of this fractal, the 64 month:

This basic pattern of a parabolic growth phase going into a cool down trend, then a new parabolic growth phase, typically more violent than the first, has been repeated many times in history totaling 64 months give or take a couple months. That sounds kooky when differing bull markets are controlled by vastly different causes in different times. But such is the fractal nature of markets. David Nichols is probably the leading explorer into market fractals and offers The Fractal Gold Report  where he explains some of this weird stuff and monitors mainly the gold market. Below is an example of his month counting on Toll Brothers during the housing bull alongside another national bull market of the 64 month variety that I found on my own:

Some other examples of the 64 month fractal that Nichols points out are the Dow of the 1920s, the Nikkei of the 1980s, and the Nasdaq of the tech boom. I have found several other examples similar to the case of Egypt above. Nichols doesn't discuss any time frame from other than 64 months for this pattern to play out over, but I have found that it shows up in both shorter and longer time periods. For example, there seems to be a 3 year version:

Homestake Mining was a major gold miner in the 1930s and led a huge boom in gold mining then. Brazil was a case of currency instability. Fractal behavior is primarily a reflection of human psychology. As such, it has particular utility with gold and currency issues. Gold, as Warren Buffett sarcastically points out, doesn't produce anything of value while we pay to dig it up, put it in another hole, and pay to have it guarded. The only value it has is what human psychology puts on it. It's true that 68% of gold demand is jewelry and technology, but that's always been true of gold, and it hasn't stopped these fractally charged bull markets of the past from occurring. Speaking of which, was the gold bull of the 1970s such a fractally charged thing?:

You would have to say yes, it was. It formed yet another twin parabola with the downtrend separator. Note that it was also a non 64 month case being 8 years long. I have shown another of the larger time scale versions alongside it, the runaway Swiss bull which ran 7 1/2 years.

The fixed gold price of the '60s possibly warped the shape of the '70s bull market, as an article at Kitco recently speculated naming the piece "The Problematic Comparison With The 1970s". Instead of looking at the government fixed gold price part, they look at the gold bull via the BGMI (Barron's Gold Mining Index) to see where the '70s gold bull really might have been born. They suggest it really started in the 1960s when, despite the fixed gold price, the miners shot up before the US allowed gold to trade per a free market, except for the central banks, in 1968.

As Nichols does, I assign a "sprout" point to these things, which is somewhat subjective. But it is the point where a downtrend, flat, or mild rise behavior changes to a stronger, smooth rise, a notable change in trading patterns. Gold traded freely for years after 1968 before a notable sprout point arrived in 1972. So I assign the length of this fractal as 8 years. The miners jumping first in the  1960s was probably just a case of them typically leading the price of gold.

So what does all this have to do with gold today? Well, if we are indeed in a larger scale version of the twin parabola bull fractal, you have to scale everything up proportionately. That's the main principle of fractals - same thing different scale:

If you take the four year downtrend from the 2011 peak as the separator, the trend of which is now breaking, we are transitioning into the second parabolic rise. I wrote some pieces back a couple years speculating that the 2007/8 weakness was a separator of about 1 3/4 years. But it wasn't a pronounced downtrend as is typical in this fractal and was caused mainly by hedge funds having to dump their most profitable holdings in the face of the market crash - an anomaly in the first parabola as it may turn out to be.

Gold is now the most hated and purged from funds it has been since 2001, so it has the freedom to run inverse to stocks in what I think is a current bear stock market, similar to the way it ran in the 2002 brutal bear.

Scaling a length of the current separator is a little tricky. The '70s first parabola transpired from 1972 to 1975 - about 3 years. The current first parabola could be taken from September, 2005 (Nichols' fractal sprout point) to September, 2011 - about 6 years. So if we are doing a 2X scale up now, the two year separator (1975 and 1976) should scale to 4 years. We are at 4 years with the post 2011 trend, so it could be breaking up, as the miners are clearly suggesting. And it is noteworthy that 4 years is a major fractal period for gold per the research of David Nichols:

Nichols has his hits and misses like any of us in the markets. In 2010, he forecast a peak in gold and silver for February, 2011 - silver peaked in March and gold formed the first peak of a double top in August. So he was a little early, but right. I guess that's better than being a little late and right. But the fractal art is not infallible.  He goes a lot by the major period times for gold, one of which is 21 months, as the above graph shows. In 2012, he had been projecting a major power move in gold peaking in mid 2013, which was 21 months after the peak of 2011. He showed his fractal dimension algorithm chart showing an extremely high energy build, just like the one going into 2009 in front of the blitz to the 2011 top.

He assumed this would be a renewed upsurge, but as we know now, it was indeed a power move, only down. This was the sharp collapse in gold down from about $1800 going into late 2012, and the fractal stuff had it right, because all it tells us is that a big move is likely, but it doesn't tell us the direction. That's the contrary nature of the fractal dimension, it just suggests when and how energetic a big move will be, not where it's going. That's the math of a market fractal dimension, it just tells you how pent-up a moving object is in two planes, and that is equally resolved with a big move up or down. You can improve the up/down odds in your favor with other means of analysis, however, like good old fashioned technical and fundamental considerations. My own algorithm has gold's fractal dimension at a higher level right now than in 2009 before the big move up. And the miners are at the highest levels they've been at in years (on the weekly scale) so a big move seems likely.

Applying some technical principles to gold's current status:

The falling wedge with a heavy volume breakout has one of the highest bullish success rates of any indicator, rated as high as 98% by Options4Income. The volume break of the miners, South African or not, is even more convincing.

So is gold in a bull or bear market? Well, in the world of fractals, the usual definitions don't mean much. Something can be off well over 20% from its high and still be in a rip roaring bull market fractal. And length of time in a decline doesn't really classify a market in a fractal. I think your investment time frame and level of patience have more to do with the label you wish to use than percentages do.

If our present gold market plays out as a twin parabola, it would be the largest scale for this fractal that I have ever seen. But that makes sense considering that we are in the midst of the grandest global currency debauchery in all of history. Certainly the fundamentals have to favor any gold move being up. Other than the jewelry demand aspect, about the most common fundamental reasoning you here nowadays against gold is that if we are going into an interest rate tightening cycle, it will surely kill gold. But did that happen in the 1970s?

Gold and a super-aggressive tightening Fed climbed in near lock step clear to the end of the gold bull market in 1980. So are rates bullish or bearish for gold? We seem to have a plethora of bullish fundamentals for gold. We have currency instability, a global economy tilting into recession, a fast growing crisis of confidence in central banking solutions, and an unprecedented malinvestment debt avalanche about to come at us from the bankers' many years of lunacy.

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