A Violent Shift of Massive Inflows

Dear Readers,

Just when everyone thought the stock market was done, worldwide stocks decided to climb.

This week, Obama expressed confidence on a budget agreement with Congress while data from China and Germany boosted optimism about global growth; China data showed the first expansion in its manufacturing industry in 13 months and the Germans’ business climate index made an unexpected gain.

In the Middle East, Israel and the Palestinian militant group Hamas agreed to a ceasefire after a week of air strikes and missile attacks.

As a result, global stocks climbed and we had the biggest weekly rally for U.S. stocks since June. However,

the rally in the U.S. occurred with the lowest average weekly volume of the year. Considering that volume has been light on many of our moves to the upside this year, the recent climb may not be bullish as it appears. Why?

Short Squeeze

In a week of extremely low volumes, where bids and asks across the board were pulled, a massive and dramatic short-squeeze created a 200bps outperformance among the most-shorted Russell 3000 (the largest 3000 U.S. companies) stocks.

I can’t tell you exactly what or who was behind it, but when volume is low and everyone has taken an early vacation, it doesn’t take much for shorts to be squeezed by a group, or groups, of hedge funds or algo-traders.

Volume was so light this week that any one entity, such as the algo-trading, HFT (high frequency trading) platforms – which already control more than 10% of all trades in any given day (see The Business of High Frequency Trading) – could have its way with the market.

But if volume picks back up next week, is it sustainable?

While the holiday shopping euphoria and market boosted optimism may continue next week, we have to ask ourselves where this upside is coming from.

Are investors finally coming back to the market after a long hiatus? Let’s take a look.

Retail Investors Back in the Market?

Not so fast. Excluding the tiny inflows of $95 million in the week of July 18 and $907 million in the week ended May 30, the retail investor has pulled money from stocks for an unprecedented 39 consecutive weeks, with $6.6 billion pulled out in the last week, the most since the first week of October.

According to ICI, while $44.5 billion has been invested into domestic equity stock funds, $412 billion has been pulled out since 2010. So where has this money gone?

On an almost dollar-for-dollar basis: Bonds.

That means people would rather see their money returned, as opposed to risking it in the stock market – even if it returns with less purchasing power than when it went it.

fund flows

As a result, more money than ever is sitting on the sidelines.

Record Money on the Sidelines

Combined with the record amounts of printed dollars, we saw the largest ever weekly inflow (US$131.9 billion) into Savings Deposits at Commercial banks last week. This number continues to grow. Take a look:

Savings Deposits at Commercial Banks

Notice the strong upward trajectory after every U.S. recession (as represented by shaded areas.)

This type of rapid and violent shift of massive inflows into savings accounts have generally been associated with times of great monetary stress, with the three biggest inflows during the 2008 Lehman crash, the first Greek bailout in May 2009, and Debt Ceiling debacle in August 2011 (see Should You Be Worried?).

As a result of our current fiscal cliff fiasco, we just witnessed the largest weekly inflow into Savings Deposits at Commercial banks last week.

Perhaps people believe parking money with the banks – and away from the stock market – is the safest way to protect their wealth. Despite all that Bernanke has printed, people still won’t spend. That’s probably why we haven’t seen any signs of massive hyperinflation worries…yet.

But what happens when people start spending?

We’re now in an era where anything can happen as a result of the amount of fake dollars floating in the air via derivatives and other trading alternatives. Need clarification? There is currently over US$631 trillion (not a typo) of currency and credit derivatives in the U.S. market.

The world’s GDP in USD as of last year? $69.97 trillion.

That means there is nearly 10 times the amount of currency and credit derivatives in the US market, than the world’s current GDP. Go figure.

This leads me to talk about gold and silver once again; the things you can’t just magically create.

Gold and Silver

Last week, gold traded in a relatively tight range and showed a strong amount of strength and perspective towards the upside.

It surpassed a strong resistance level at $1739 on Friday, hitting a high of $1755 before settling at $1753 for the week.

Silver prices rallied Friday to reach $34.25 before settling at just under $34 in after hours trading. If silver breaks out above $35 and can maintain that level, $40 before year end is certainly attainable. While that may seem like a stretch from current levels based on how silver has traded all year, it’s not.

Silver has climbed more than 23% this year, but fundamentals still remain strong and there’s no signs yet that it has been overbought.

Gold has rallied 12 percent this year, led by central bank purchases and investment demand.

You’re going to hear a lot about jewellery demand in India and China slowing, but that is becoming less relevant given world circumstances. While jewellery demand represents a large portion of gold demand, gold prices are not so much affected by jewellery anymore.

Retail buyers of gold jewellery and bars have slowed purchases this year, but central banks and exchange traded funds have sharply increased their buying.

Since 2003, investment has represented the strongest source of growth in gold demand. The last five years to the end of 2011 saw an increase in value terms of around 534%. Last week, holdings in ETFs backed by bullion rose to a record 2,605.318 metric tons.

Central banks have accumulated 373 tonnes in the first nine months of 2012. Kazakhstan, Turkey and Russia boosted reserves in October, while Brazil went on a bender and raised its holdings to the highest in more than 11 years. We’re still unsure how much China has truly accumulated this year.

The World Gold Council show that while world gold demand has expanded by 1,000 tonnes in the last three years, new supplies have only expanded by half this amount, leading to a tighter world market.

In the nine months ended September, new mine output of gold was enough to meet only two-thirds of the global demand.

And with gold output continuing to decline due to increased costs associated with the sector, the shortfall may widen dramatically next year.

As gold continues to move, I am confident that gold and silver stocks will move much higher as a result.

Precious Metal Stocks

When things were hit the week prior, everyone said that the growth was over; that gold and silver stocks were done. It wasn’t only your mom and pops who were scared; every broker, analyst, and industry professionals felt the same way.

While I know it was disconcerting, I told readers last week to hang tight and stay the course.

Despite low volumes for most of the week, many gold and silver stocks saw a major increase in volume on the buy-side Friday. This clearly shows me that the buy-side for gold and silver stocks remain strong, as long as gold and silver prices can continue to show strength.

While the market may not move as sharply as a normal bull rush in the gold sector, due to less participants in the market, the move up still shows that gold and silver stocks can, and will, rise with metal prices.

As the overall stock market becomes less enticing, much of the capital on the sidelines may finally move into the one sector that is outperforming from a fundamental standpoint: precious metals.

Take a look at this YTD chart showing the correlation of gold and gold miners:

miners vs gold
Source: Yahoo Finance

Aside from the dramatic sell-off in Q2, the chart shows gold stocks still move up with gold. Should gold move higher, I believe the miners will surpass gold’s performance to reclaim the leverage they deserve.
But don’t rush out and buy every gold stock out there. The cold hard truth remains; hard times are ahead and many of the juniors will fall by the wayside. Financing is nearly impossible for most juniors and those without cash will simply go bankrupt or be forced to restructure. However, those with strong fundamentals and cash, or the ability to raise it, will lead the pack and rise strongly with the broader gold market.

Gold for Cash, for Oil

Turkey just revealed an Iran Gold-for-Gas trade off.

According to the Turkish Weekly:

Turkish Deputy Prime Minister Ali Babacan has revealed a critical detail about a widely discussed Turkey-Iran gold trade boom, disclosing that the Islamic republic was transferring payments made for gas into Turkish gold.

Iranians are buying Turkish gold with the Turkish Lira, which is deposited into their bank accounts in exchange for Turkey’s natural gas purchases, the deputy prime minister said at midnight Nov. 22 during a parliamentary session. Iran cannot transfer monetary payments to Iran in U.S. dollars due to U.S sanctions against the country’s alleged nuclear weapons program.

“As Iran could not transfer the payment to [its own banks] in foreign exchange, the country buys gold with the lira and then takes the gold to its country. I do not know how Iran transports the gold, but this is the root of the matter. The gold export to Iran in reality becomes a kind of payment for the natural gas we buy from Iran in deed,” Reuters quoted Babacan as saying.

Turkey’s gold sales to Iran in the first seven months of the year were estimated at around $6.2 billion. In August and September, the United Arab Emirates bought around $3.1 billion of gold from Turkey, as many sector sources said this was also going to Iran.

The holidays are fast approaching which means tax loss selling may soon hit our junior markets. Be mindful that while this could force stocks down, we have a lot of near term catalysts for gold.

If you’re going to play, be smart and look at companies with truly strong fundamentals. Don’t make irrational bets on juniors wishfully drilling to hit the big homerun.

Until next week,

Ivan Lo

Equedia Weekly

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Disclosure: I am long gold and silver through ETF’s and bullion, as well as long both major and junior gold and silver companies. We also own every company, both corporately and personally, within the Equedia Select Portfolio. You can do the math. Our reputation is built upon the companies we feature in the portfolio. That is why we invest in every company we feature in our Equedia Reports. It’s your money to invest and we don’t share in your profits or your losses, so please take responsibility for doing your own due diligence. Remember, past performance is not indicative of future performance. Just because many of the companies in our previous Equedia Reports and in the Equedia Select Portfolio have done well, doesn’t mean they all will.

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