As a brief update to Monday's missive on the gold sector, we wanted to appraise readers of the fact that the HGNSI (Hulbert gold newsletter sentiment index) plunged Monday to a new low for the move of minus 15.7.
This means that gold timers now recommend a net 15.7% short position, which is actually quite rare. There have been forays into negative territory by this indicator before of course, but they were generally short-lived. A reading of 15.7% is among the most extreme seen in the course of the past several years. In fact, not since the depths of the 2008 crash have such extreme readings been recorded.
Since gold stock indexes have broken below an important support level, this deterioration in sentiment is understandable, but it is also a sign that the remaining downside potential is becoming more and more limited.
Click charts to enlarge
The break of lateral support in the HUI has turned gold timers mega-bearish. The last two times they were this negative on the sector were in October/November 2008 and March 2009. Those dates should ring a bell.
As the past examples of HGNSI plunges into double-digit negative territory show, one needs to be alert to a potential turning point when they occur. The HUI's 200-week moving average in the 443 area is probably the level that will contain a putative 'worst case' decline, but a turn could easily happen sooner than that. If the market were to turn around very quickly and managed to close above the broken support level again, we would regard that as a very bullish development.
Bond Market Sentiment
We were struck Monday by a sudden proliferation of expressions of bearish sentiment on the US treasury bond market in the financial media. One market commentator proclaimed that the 'mother of all shorts has begun'. Investment banks were mailing out advice to their clients as to 'what to do if bond yields rise' (as an aside, we have a suggestion in this context: whenever t-bond yields rise, the developed world's best performing stock index is usually Japan's Nikkei).
In the FT Alphaville article on the topic (linked above), the following chart by HSBC was helpfully provided – it shows which stock market sectors are likely to do best when t-bond yields rise:
Above is the 'What to do if/when t-bond yields rise' manual by HSBC. We would simply buy the Nikkei.
Reuters meanwhile informs us that 'bond bears growl again as US yields surge':
“The rout prompted investment bank UBS to declare the start of a long bear market and even prominent investor, and one-time bond bull, Jeffrey Gundlach says yields will rise further.
What has investors questioning the bond market's ability to sustain super-low bond yields is the steady improvement in U.S. economic data that has buoyed the stock market to four-year highs. It means the flight to safety that has underpinned capital flows to U.S. debt in recent months may be eroding.
"There appears to be an asset allocation shift out of Treasuries and into risk assets that includes equities," Tom Sowanick, chief investment officer at OmniVest Group LLC in Princeton, New Jersey, said on Friday.
News that a majority of banks passed the Federal Reserve's stress test is another reason for investors to gain confidence to take more risks. "Banks now have been given a green light from the Federal Reserve to return capital to shareholders. This is positive," Sowanick said.
Treasuries are the worst performing U.S. bonds so far this year. Barclays Capital's Treasury total return index was down 1.68 percent after a stellar 9.81 percent gain in 2011. As Treasuries prices drop, yields go up.
What? Even Jeffrey Gundlach is turning bearish on treasuries? Shiver me timbers! If we had a single cent for every time the bull markets in JGB's and US treasuries have been prematurely declared to have expired by a sheer endless parade of experts, we'd have bought the entire US by now and used it as decoration for our front lawn.
Let us see: the ten-year note yield is at 2.35% at the time of writing, and a veritable herd of bond bears is suddenly crawling out of the woodwork? Color us unconvinced. Just because stock prices have risen for a few months, nothing has really changed fundamentally. Europe remains in as critical a condition as before. The probability of a US recession happening this year remains quite high. China has just created a fresh growth scare as well (more on this in a follow-up post).
As our readers know, we don't like government bonds as an investment vehicle for a number of reasons – chiefly due to the fact that the income one derives from them is obtained by coercion instead of voluntary exchanges in the marketplace.
However, this does not mean that we have no opinion on the market's trend. As to that, please wake us up when the big bad bear has really arrived. As the long-term chart of the 30-year bond depicted below shows, there could be quite a big correction in prices before the trend is actually in danger. Moreover, the cumulative net cash flows into the bearish Rydex Juno fund (which shorts treasury bonds) are currently higher by a factor of 11.5 than the cumulative cash flows into the Rydex long bond '1.2 times' strategy fund. Bond bears lost no time whatsoever to jump aboard the shorting train, as the cash flows into the Juno fund have jumped by more than 30% since the beginning of the year.
There is certainly room for treasuries to fall (and yields to rise) further in the short term – there could be a brief bounce as equity markets correct, followed by a new leg down in bond prices. That should create sufficiently oversold conditions to allow for the bull market to resume. Speculators are currently net short t-note futures, but their position is not yet at an extreme. We think it will get closer to such an extreme before the market actually turns up again. While we agree with Bill Fleckenstein and others that there will eventually be a 'funding crisis', i.e., a fiscal crisis in the US, we think we are still years away from that point (obviously we may be forced to reevaluate this view depending on future developments).
Above is the 30 year T-bond price and yield since 1980. It will take a big price decline to endanger the long term uptrend.
Above is a weekly chart of the 10 year t-note yield. The recent fast move higher has brought bond bears out of the woodwork. Yields are now at a first level of resistance, but this could easily be broken in coming weeks. However, we would not expect to see much more than a test of the downward sloping long-term channel.
It is a bit surprising to us that an increase in the t-note yield from 1.90% to 2.35% has created so much anecdotal bearish sentiment. We don't think that when the actual long-term turn in the bond market finally comes, it will be advertised that well. It seems far more likely that it will sneak up on people who by the time will have become quite complacent about bonds, similar to the secular upturn in US yields that began in 1942. The JGB market looks actually 'riper', as people have indeed become quite complacent about it. Japan is also quite likely to experience a fiscal crisis sooner than the US, as its public debt situation is already quite stretched, to put it mildly.
Charts by: Decisionpoint, StockCharts, HSBC