U.S. Debt Crisis Temporarily Resolved – Mining Stocks Yet to See a Resolution
Based on the July31st, 2011 Post-update Update. Visit our archives for more gold & silver analysis.
Yesterday, the U.S. House of Representatives gave a green light to President Barrack Obama’s debt ceiling agreement with the Republicans. Today, the Senate will most likely confirm the deal. The final compromise includes $2.4 trillion cuts over the next decade and the rise of the $14.3 trillion debt limit.
However, the general opinion is that the deal merely helps the U.S. avoid default (which would have happened today if the agreement had not been reached) as it does not tackle the main causes of the U.S. budget deficit, namely programs in the like of Medicare. What is more, most of the cuts are not coming until 2016.
Now, when the default seems further away, let’s remind why it is so scary. The worst case scenario was that the U.S. would miss payments on its bonds and default — which financial experts said would be disastrous with dire consequences around the globe. The U.S. would most likely lose its AAA bond rating for the first time leading to market panic. Ratings agency Standard & Poor's this month warned there is a 50% chance it will downgrade the U.S. within the next three months. Fellow ratings agency Moody's has also put the U.S. on review for a possible downgrade. In the long term it could push interest rates up for everyone and further weaken the dollar's position as the world's reserve currency.
After the announcement of the deal, the situation calmed down. The markets reacted positively with the U.S. dollar appreciating against main currencies. The optimism, however, may be premature as much of the uncertainty in the markets is deep rooted. This would be a bullish sign for gold in the long-term. With both the dollar and the euro in trouble, and the Swiss franc looking very expensive gold is one of the few safe havens left on the planet. Gold may dip in the short term and go into correction mode since the powers that be have reached a compromise and a new debt ceiling has been announced. But in the future it’s likely to bounce as the U.S. state situation is still shaky.
The math is simple. An article in Canada's The Globe and Mail's business section laid it out nicely:
US federal spending
Fiscal year 2010 (in billions of US dollars)
Other mandatory $416
Net interest $197
Medicare and Medicaid $793
Social Security $701
Defense Department $689
TOTAL: $3.456 trillion
Now, compare that to...
US tax receipts
Fiscal year 2010 (in billions of US dollars)
Social Security/Social insurance $865
Corporate income $191
Individual income $899
TOTAL: $2.162 trillion
As you can see, there is a bit missing.
With so much hanging on the balance, let's take a look at the chart featuring the stock market (charts courtesy of http://stockcharts.com), to make sure that it is indeed (weak economy) likely to move lower.
The problem is that stocks have most likely put a short-term bottom (they touched the rising support line visible on the DIA chart above on Monday) or are very close to doing so. Please recall that in the short term markets don’t act logically, but emotionally and analyzing charts is all about analyzing emotions (as strange as it may sound).
On the above chart we see that the volume on the SPY ETF was high, and other stock ETFs (like DIA), confirm that. Moreover, we saw an intraday turnaround in stocks and the financials (below) even managed to move slightly higher. Both of them are bullish signals.
In our July 15th, 2011 essay on gold & silver miners we wrote the following:
(…) [The] XBD Broker-Dealer Index (…) has reached new 2011 lows, moving below the lows seen last month. Since this is a leading indicator for the general stock market, the situation does not look good for stocks in the short term.
As a matter of fact, we have recently seen a decline in the general stock market. Now the situation is the other way around. If we acknowledge that the financial sector often leads the rest of the general stock market the fact that it has just refused to move lower is bullish.
With all these bullish stock-market-related factors in place it seems appropriate to expect higher values of the stock indices in the coming days.
So, what does it mean for gold & silver investors? Let’s take a look at the Correlation Matrix featuring gold & silver correlations.
Please focus on the values marked with orange arrows. The correlation between miners and stocks is quite important while the one between gold and stocks is rather small. Silver’s correlation numbers are somewhere in between. The point is that miners have been driven by stocks to a much greater extent than the rest of the precious metals sector. In other words, there was a good reason for mining stocks to decline on Friday – it was a sharp move lower in the general stock market. So – as stocks continue to move lower, the situation is going to become more bearish for miners and they will eventually drag gold lower – much lower – at least that’s what we might have inferred based on the above.
Summing up, the miners may be positively influenced by stocks in the coming days, which in turn may lead to them catching up with gold – naturally unless the latter declines.
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Thank you for reading. Have a great and profitable week!
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