“Resource stock turnaround: So far so good” by Eric Coffin, HRA Advisories

We’re one issue into the
cycle since I made the start of year predictions. I don’t look stupid yet which
might be some sort of record. So far, so good.

If the trend of the past
two weeks holds up the correction that started 2014 is already over.  If you use the Dow as the benchmark the dip
was eight percent. I’m not sure that is large enough to make me comfortable. 

I was hoping for
something in the 10% plus range. That would have been large enough to kill off
some optimism and bring some bears out of hibernation.  I’m not bearish myself—I’m looking for a
correction, not a crash—but I continue to be uncomfortable about the levels of
almost blind optimism in New York. 
NASDAQ is particularly scary.

Nothing seems to faze
traders on Wall St lately. True, that is the mark of a bull market but it’s
also the mark of a market that might still need a wakeup call. If I see more
negative slant on market coverage from people other than permabears then I’d
say 8% did the job but I haven’t seen that yet.

Since the last issue
went out there have been several major economic readings issued. In the case of
those out of the US the numbers were less mixed and more negative than readings
through late 2013. 

Market observers are
blaming everything on the weather. That could be true and certainly things have
been ugly through the NE states for weeks now. I’m sure weather is a big part
of it but we won’t know that for sure for a couple of months. 

I wasn’t that surprised
by another below consensus non-farm payroll number out of the US (113k vs. 185k
consensus) but it’s disconcerting that the much weaker December number (75k vs.
180k consensus) received only a nominal revision to 76k.  Not impressive, even with blizzards to lay
most of it off on. 

Consumer spending and
industrial production were also way below estimates, especially the former.
Again, maybe all weather related but we simply won’t know for a couple of
months at least. 

The poor consumer
spending number will get plugged right into the GDP calculation.  It looks now like Q1 growth in the US could
be under 2%.  If the US is to reach
growth near 3% this year we’ll have to see a significant acceleration in
activity later.

The bad news in the US
and worse news in emerging markets spooked traders—for about three weeks. The
market bottomed as we exited January and hovers near all-time highs again. The
S&P is less than one percent off its all-time high. So much for nervous
traders.

Braver traders extend
all the way down to the junior market as the graph above shows.  When I predicted a 30% plus year for the
Venture index I noted that gold would have to clear resistance in the
mid-$1280s and the Venture would need to turn around and get above its January
high. Both of those conditions have now been met.

The Venture index looks
stronger than it has at any time since the gold crash last April. It put in a
higher low and reached a 10-month high. The 200-day moving average now looks
like support. The 50-day average recently rose above the 200 day, a “golden
cross” if you pay attention to that sort of thing. Trading since the start of
the year has included more up days than we have seen in a long time, even if
some of them were barely in the green. 

As important are the
higher trading volumes, particularly in the past few sessions. There are still
plenty of traders who want out. In order for the market to generate the gains I
expect higher volumes are a necessity.

The financing
environment has also strengthened quite a bit in the past month but it’s a very
top down affair as I expected. There have been a number of bought deals
announced, some of them quite large. This will inflate the numbers for the
whole sector even though they are only helping a handful of companies so far.

Most bought deals are
being done at fairly big discounts and include high fee structures.  The fact they are happening at all is a
positive but we’re certainly not in a “rising tide lifting all boats” scenario. 

The better tone in the
Junior market relates directly to stronger markets for gold and other metals
since the start of the year. Gold continued its climb after the last issue and,
significantly I hope, was going up on both “bad news” and “good news” days.
Major markets lifting off their lows didn’t have much negative impact at all.

I’ve seen a number of
comments about the Fed taper being slowed due to weak economic readings. I
don’t think that is likely yet and it seems strange that traders would be
jumping back into equities with both feet and buying gold as an insurance
trade. I hope most of the buying isn’t taper related. I suspect it isn’t and
this is just lazy financial journalists looking for something to pin a trade
on.

My reasons for
predicting a $1400 high this year were simple supply demand. The market was
running out of sellers and physical buying in Asia was strong enough to lift
prices. That still seems the case. There is even sustained buying in the EFT
space for the first time since 2012. 

Though prices have risen
10% from the bottom and there are more stories about gold in the financial
press there is no danger of short-term euphoria. Most investment banks are
steadfast in their calls for lower prices and business reporters never tire of
starting stories with “after gold’s historic crash…” or suchlike.

It’s impressive how
little resistance buyers met to this point. The mid 1290’s took a few attempts
but the psychologically important $1300 level and the 200-day moving average were
cleared with ease. There has been short covering but overall the short position
is still high. 

We may need to see some
consolidation here before the bulls try to move the price to and through $1350.
I expect a lot more resistance there. That is where the price topped out in the
fall and may be a line in the sand for the shorts. If gold does clear $1350 we
could see a real short covering rally.

If gold buying is a fear
trade we’re not seeing the other side of that trade yet. The US Dollar index
looks weak and there hasn’t been much of a move in US Treasury yields either
way.  Some of the USD weakness is a pair
trade against the Euro. The EU is one of the few areas where economic readings
have provided positive surprises. 

While I focus on
physical supply demand gold does get traded against the greenback. I would be
surprised to see the $USD index break 80 but if that happens the next leg up
for gold could start. 

There are a lot of
moving parts on the currency side. As this editorial was being written the Bank
of Japan reiterated it would keep expanding the money supply and added new low
interest loan facilities. The Nikkei responded joyously but the reason for the
continued dovishness by the BoJ is less comforting. Japan grew at half the
consensus rate in Q4 and all the money printing still hasn’t moved the needle
on Japan’s disinflation. 

At the same time, and at
the opposite end of the spectrum, the Bank of China undertook repo trades to
drain liquidity from the Chinese banking system and tighten credit. I noted in
the last issue that the PBoC is not out of ammunition and many of the recent
interest rate spikes were probably intentional. The current one certainly was.

The latest action came
after reports showing credit expanded much faster than consensus in January.
The market took this as a positive sign for Chinese growth and it generated
gains across the commodity space. Beijing was clearly less thrilled about the
reading. They are struggling to clamp down on lending and the shadow banking
sector. I said in the last issue that this will be one of the biggest potential
risks this year and that remains true. 

The pie chart above
shows the distribution of lending by “investment trusts” which are marketed to
(hopefully) high net worth Chinese as savings vehicles with promised yields far
above the miserly rates offered by banks.

The quickest year over
year growth has been in products lending to infrastructure, industry and (go
figure) mining.  Infrastructure loans are
mainly to local and provincial governments—hopefully toll roads that can pay
them back. Most of the industrial/mining loans go to companies that cannot
attract traditional bank loans to over capacity industries like coal mining.

One trust was saved last
month by parties unknown but another, also loans to a coal miner, is now in
default. The latest, “Songhua River #77 Shanxi Opulent Blessing Project” (and
how could one resist a name like that?) was marketed by a regional bank that is
promising to “find the money”. Maybe it will but with a large number of these
trusts maturing in the next few months a couple of defaults seem guaranteed.
The markets are ignoring this one and assuming an implicit government guarantee
just as unit holders are. Let’s hope so.

After all these twists
and turns it seems it all comes down to weather. If weakness in the US is a
statistical blip markets should remain calm. If we see more weak readings once
things warm up another correction is highly likely. I do think weather accounts
for most of the weakness. I still expect the US economy to put in a decent
performance. That said, unbridled optimism may still generate another
correction. 

Metals have made a small
comeback. We’ll see how much of that is due to assumed weakness in the US as
more economic readings come in. Growing strength in Europe could help counter a
stronger $US even if the States gets back on track. 

We want to see
resistance levels just cleared become support levels. If the retail crowd
returns to gold at even a fraction of levels two years ago that could be enough
to support and lift precious metals through the next major price point at
$1350-60.

Resource stocks have
been the best performing sector this year. A bit more of that and fair weather
traders may again decide they are “cheap”. A lot of the time the market is just
about momentum. It’s been negative for most of the past three years but you can
sense a turn now. We’re in for a better year if we can get through the next few
weeks holding support levels.

Next the Juniors need to
survive the post-PDAC period. The idea of the “PDAC Curse” is so ingrained that
plenty of traders will be taking profits. We want a lasting uptrend so I am
fine with no premature euphoria. We need a wall of worry to climb.