Thursday, December 13, 2012

McAlvany Weekly Commentary

War is Upon Us

About this week’s show:
-Bank of England sees war in 2013
-Central banks creating new/misleading realities
-Deflation is incompatible with democracy

The VIX – Is It Telling Us Anything? At All?

In the last 5 years several indicators have become extremely popular.  Perhaps none more so than the VIX.  That is, the volatility index.  The VIX is a measure of implied volatility for the S&P 500.  It’s also known as the fear gauge as it has a tendency to correlate decently with big moves in the market.   The only problem is that this index doesn’t tell you much except in rather extreme environments.   In fact, that might even be a stretch.
Anyhow, I was intrigued by these comments in a JP Morgan note recently which state that current economic indicators are consistent with much higher volatility (using a 100 year average):
“To compare the current VIX levels to macro fundamental risk, we have performed a simple quantitative exercise: we compiled a list of 484 macro indicators published by Bloomberg that have a significant correlation to the VIX index and regressed them against the current reading of the VIX. Results show that the current low VIX level is in stark contrast to virtually every macroeconomic indicator across the globe. These indicators include PMI, GDP, payroll and unemployment, housing, retail sales, consumption, inventory, business and consumer confidence, delinquencies, and other economic activity indicators. The 81 US macro series point to a VIX level on average 7.2 points higher, the 214 European indicators point to a VSTOXX level 9.7 points higher, and the 186 Asia economic indicators point to a VNKY level 8.9 points higher (Figure 8). While these results don’t signal an imminent increase in the VIX, they do point to a large discrepancy between the market volatility and macro fundamentals. As we do not think that the macro environment will drastically change over the next year, we believe risk for market volatility is to the upside.”
Don’t call me skeptical.  Call me more of a reversion to the mean kind of guy.  A brief glance at a 20 year chart of the VIX shows that we could actually go a lot lower in this index and that we’re still very much in an environment of persistent fear.  So I say wake me up when this index does something that sends us shooting (in either direction) away from the mean.  As opposed to what looks like a big coin flip here….After all, the fun in mean reversion is gone once we’re sitting right at the mean…

Arrow Electronics, Inc. (NYSE: ARW)

It is nearly impossible to talk about chart patterns on stocks without eventually discussing the very common head and shoulders (H&S) pattern. An H&S pattern is a reversal pattern that forms after an uptrend. A textbook H&S pattern starts to form when a stock rallies to a point and then pulls back to a particular level (shoulder #1). Next, the stock will rally again, but this time to a higher peak (head) than the previous shoulder. After forming the head, the stock will pull back to the same support as the first shoulder did. Finally, the stock rallies a 3rd time, but not as high as the head (shoulder #2). The level that has been created by all 3 of the pullbacks is simply a support level referred to as the "neckline". The formation of an H&S pattern warns of a potential reversal of the uptrend into a possible downtrend.

As with any chart pattern, a trader will usually not want to act on the pattern until the stock "confirms" the pattern. Confirmation is the break of the key level that has been created by the pattern. In the case of an H&S, confirmation would be when the stock breaks the neckline (support).

What some new traders do not know is that H&S patterns can also form upside-down after an uptrend as well. This pattern is a little more rare and would be called an inverse head and shoulders pattern. It would also be considered a continuation pattern, not a reversal pattern, and the neckline would be a resistance rather than a support. To see such a pattern formed, please take a look at the 1-year chart of ARW (Arrow Electronics, Inc.) below with my added notations:
1-year chart of ARW (Arrow Electronics, Inc.)
Although one cannot really consider ARW's rally from July to August and uptrend, the stock had moved over 20% higher when the stock formed what appeared to be an inverse H&S (blue). I have noted the head (H) and the shoulders (S) to make the pattern more visible. ARW's neckline was at the $38 level (red). ARW confirmed the pattern by breaking up through the $38 resistance/neckline earlier this week and the stock should be moving higher from here.

Lastly, keep in mind that simple is usually better. Had I never pointed out this inverse H&S pattern, one would still think this stock is moving higher simply because it broke through the $38 resistance level. In short, whether you noticed the pattern or not, the trade would still be the same: On the break above the key $38 level

More CEOs Buying Chinese Stocks—Time to Jump in?

On the subject of Chinese stocks, I think it’s fair to say that stock market investors should view all of them as 100% risk-capital securities. Anything could happen to any of these businesses, not the least of which are problems with accounting and transparency.
The number of U.S.-listed Chinese stocks that are unappreciated by the rest of the stock market is growing. These businesses can’t seem to be able to get their share prices moving. More and more Chinese stocks are now the subject of management-led takeovers and investments for the simple reason that they see their stock market valuations as too low.
E-House (China) Holdings Limited (NYSE/EJ) is a Chinese stock that just bounced off its all-time low on the stock market. Even though the company’s third quarter came in just shy of expectations, the business is still growing. The company just announced that its own CEO and other managers plan to purchase over 17 million shares of the business, representing about 15% of the total shares outstanding. E-House’s stock chart appears below:
EJ E-House Holidays Stock Market Chart
Chart courtesy of
Eventually, I do think that there is going to be a major resurgence in Chinese stocks, and it will likely be commensurate with a revival in the domestic Chinese stock market. Valuations have become extreme among U.S.-listed Chinese stocks, but this still doesn’t mean that they will go up in value. I would be bottom fishing in this group right now, but individual stock selection is key.
Noah Holdings Limited (NYSE/NOAH) is a Chinese wealth management business that just reported seemingly strong third-quarter financial results. According to the company, its third-quarter revenues grew a solid 34% to $25.8 million, while earnings attributable to shareholders grew 32% to $7.5 million. The company finished the third quarter with $122 million in cash, yet the stock isn’t doing much. Noah’s stock chart is featured below:
NOAH Holding NYSE Stock Market Chart
Chart courtesy of
It’s a tricky business speculating in Chinese stocks. The broader stock market was once very interested in this group. Now I think it’s fair to say that the market is very skittish on this sector. Perhaps it’s a case of once bitten, twice shy. Regardless, valuations among many Chinese stocks have become extreme, but it’s unclear if this will change.
The stock market is still in one big consolidation, and this could last right up until the end of the year. With little news for the stock market to go on, worries trump reality. Expectations for fourth-quarter earnings have come down a lot, so we’ll probably get a lot of companies beating consensus. It’s still very likely that large, international companies will have revenue troubles. It’s continued consolidation for now.


The USDCAD has given a short term sell signal on the InvesTRAC model...all it needs to do is take out the .9860 support to oen the way for lower levels. The daily chart above highlights the fact that the uptrend has been violated and the rate is below its moving averages which is evidence of weakness. The InvesTRAC forecast is for weakness to continue until January 21.

Palladium Stock Up 65% Since Coverage; More Room to Run?

With the recent volatility in the gold and silver markets, having some portion of a portfolio in palladium investing might make long-term sense, as it is an industrial metal, as well as a store of value. While the economies around the world are slowing, this obviously is impacting many markets, including palladium investing. While the demand side of the equation might not be growing rapidly, there could be supply issues that might propel prices higher. If that were to be the case, some people might want to consider palladium investing and junior mining companies for additional upside capital appreciation.

An interesting report by the company Johnson Matthey stated that it’s highly likely that the palladium and platinum market will be in a deficit. Such a scenario would certainly be bullish for palladium investing and junior mining companies. Jonathan Butler, the author of the report, states that he believes there will be a significant reduction in the supply for two precious metals: palladium and platinum. (Source: Matthey, J., “Platinum Market Forecast to be in Deficit in 2012,” Platinum Today, November 13, 2012.)

The report states that for the palladium investing, there will be a two-million-ounce swing from a surplus to a deficit this year. According to the findings within the report, palladium supplies from South Africa are forecasted to decrease by six percent this year, along with a decrease in the sale of Russian stock of precious metals. Conversely, palladium demand for catalytic converters is expected to rise seven percent, to what the report states is a new high of 6.5 million ounces. With vehicle sales continuing to move up strongly, this increased demand will help propel the supply and demand dynamics towards palladium investing.

While there are short-term worries about world economic expansion, over the long term, there will continue to be growth in terms of the population and the percentage of the world that is moving up into the middle classes. This means increased consumption for both automobiles and electronics, driving demand and interest in palladium investing over the next several decades.

There currently is a lack of junior mining companies specifically involved in palladium investing, as many extract multiple precious metals. One of the more interesting junior mining stocks for those interested in palladium investing is Stillwater Mining Company (NYSE/SWC). This company extracts, processes, refines and smelts a variety of precious metals, including palladium and platinum.
 SWC Stillwater Mining NYSE Stock Market Chart
Chart courtesy of
I made my readers aware of Stillwater Mining back in July when it was trading at $8.45. In September, the stock price jumped to $14.00 per share, a 65% return in two months. Clearly, such a move as this is unsustainable, and a pullback was in order. As can be seen quite evidently on the chart, the stock pulled back within the Fibonacci retracement levels. Following this consolidation, I believe a sustained breakout to either side will signal the most likely direction for Stillwater.

Junior mining companies are closely tied to the spot price of the commodity. As palladium investing goes, so do the interconnected junior mining companies. Junior mining companies are inherently risky, but also provide a high level of potential reward. At this point, while there is economic weakness as a possible headwind, we have three underlying drivers for the fundamental case for palladium investing; these include extremely easy monetary policy by central bankers around the world, a massive increase in new car sales, and a potential supply disruption that might create a deficit in both palladium and platinum.

In addition to the fundamental drivers for palladium investing, as long as the junior mining companies remain above support, we should see the bullish situation continue. If junior mining companies fail to hold support, this would be a sign that large institutional investors and insiders knowledgeable with the underlying business are questioning the future viability of the company, and possibly this sector. This type of warning sign should alert investors in junior mining companies to take profits and wait for a clearer picture to emerge.

Fed to Hold Rates Down Until Jobless Rate Is Below 6.5%

The Federal Reserve said Wednesday that it would maintain its efforts to revive the economy in the new year by continuing its monthly purchases of $85 billion in Treasury bonds and mortgage-backed securities.

The Fed said it would keep buying bonds until the outlook for the labor market improves substantially, reiterating a policy it first announced in September. 

Looking even further into the future, the Fed said that it expected to maintain short-term interest rates near zero, even after it stops buying bonds, for as long as the unemployment rate remained above 6.5 percent, provided that medium-term inflation does not exceed 2.5 percent. The November jobless rate was 7.7 percent. 

That replaces the central bank’s earlier guidance that it expected interest rates to remain near zero at least until mid-2015, further emphasizing that reducing unemployment is now the Fed’s priority.(more)