The Gold Report: Ian, you have been involved in the markets for 50 years. How much of today's market is a repeat of a cycle you've seen before and how much is unique?
Ian McAvity: Cyclical and secular trends haven't really changed, but each one has slightly different characteristics. From 1982 to 2000, there was a powerful secular uptrend in the S&P 500. Since 2000, there's been a secular bear trend, sideways or downtrend not dissimilar to 1966–1982 or 1932–1949 that may run through 2016 or 2018.
The big change has been the utter corruption of Wall Street and that nearly 80% of the trading on the New York Stock Exchange now is being done by high-velocity computers. When an investor puts in an order, it's basically one computer versus another computer operating in nanoseconds. That's why all of a sudden the volume is up or down 10 to 1 and you get a couple of hundred points added on or taken off the Dow in minutes. To me that's a corruption of the process. "Ethics" and "Wall Street" are words you never use in the same sentence.
The trading mechanism is broken down. Leveraged exchange-traded funds (ETFs) are designed to consume the client's capital in leveraging and rebalancing premiums. The high velocity traders literally get the opportunity to "front-run" public orders as the order flow to "the market" is available to them for a fee. It's outrageous in the sense that they've legalized front running for those who pay up for the high-speed data feed. And then there's the initial public offering (IPO) business. Anytime the public can get shares in an IPO, they don't want it. If they can get some, it's only because it's not going to be that good a deal.
TGR: Is it the corruption of Wall Street or the development of Wall Street through technology?
IMcA: It's the culture of greed coming out of the banking system. The Street always wanted to make money. That's never gone away. But there was a time when good clients were actually respected by a firm. A firm wanted to do well for a good client because it wanted to keep the family assets in the firm. These days a client is considered to be a mark. The system is designed to convert the client's capital into their fees and income as quickly as possible. The public is being chased out. There have been persistent outflows from domestic equity mutual funds since 2007. A lot of people justifiably don't trust it.
TGR: Or perhaps the public just doesn't have the tools and the speed to become an influential member of the market?
IMcA: Let me give you an example. The average daily turnover for one gold mining junior ETF is $100 million (M). Probably $80M is day trading where there is no net investment. To call moment-by-moment trading "investment" to me is a sacrilege. There's no way that people are making a rational investment decision in that sense. I'd rather go to Vegas where they've got pretty girls serving you a drink while you gamble.
TGR: Aren't day traders just playing nagainst each other? Someone bets it goes up. Someone else bets it goes down. They wait a very short period. Ultimately, it just evens out.
IMcA: In theory it works itself out, but it creates an illusion of growth that distorts trends because it injects volatility. The majority of the billions of dollars that are trading every day is intraday noise. All the computers scalping each other for as little as a tenth of a cent.
TGR: The market was up the other day in reaction to the debt plan that came out of Europe. Is this a real increase or just more intraday noise?
IMcA: One batch of traders shorted at the opening burst, but that afternoon it didn't sell back. All the guys that shorted in the morning got their clocks cleaned and had to cover in the afternoon. That's why there was a second rush into the close. That trading activity is symptomatic of what's wrong with this market. Markets are being driven by headlines. Plus, the headlines are being misinterpreted most of the time. At first, it appeared that Europe had a perfect solution for everything. Then, by the end of the day, we were discovering that there were a lot of details missing and it was unclear how many parliaments have to approve the plan. Every day there's a leak of some unsubstantiated "plan" and later it's denied but the cheerleaders at CNBC seem to take every wiggle as gospel.
TGR: Is it driven by headlines or the 24/7 news cycle?
IMcA: I wish the news cycle was as slow as 24/7. When people are trading on one-minute and five-minute charts, a 24/7 news cycle can't keep up with it. It's not healthy to have this much liquidity. What it reflects is that the bailout of the banks has flooded the system with liquidity, but none of that is trickling down to Main Street or out into the real world. It's just sloshing around in the financial markets. The velocity of trading reflects that the system is swimming in liquidity and nobody is feeling sufficiently brave to take any risk home overnight. We'll churn the daylights out of it, but flatten the position before lunch or the close.
TGR: How does an individual investor operate in this environment?
IMcA: Basically hide. A number of people have told me that they've become day traders and I ask them how they're doing and they say, "Well, I'm not quite there yet. I know I can make money doing it." I tell them not to blow all of their capital while they try to learn. It's an exploitable game for somebody that has the self-discipline. But it requires a degree of self-discipline that 90% of the people that try it will never acquire.
TGR: At The New Orleans Investment Conference where you spoke in late October, many speakers talked about how junior gold stocks are essentially on sale, inferring that this is the time to buy. Should investors run and hide from a corrupt and frothy market, or go out and buy?
IMcA: You've got to watch the inter-market relationships. The gold stocks have been very poor performers relative to the gold price. In the last 12 months, the junior gold stocks have been particularly bad even relative to the senior gold stocks. That is creating an undervalued situation. But undervalued doesn't mean go out and buy it tomorrow morning. Yes, there was a marvelous October rally after five down months in the S&P. However, I believe that the S&P is going to go back down and at least probe the last lows, if not break them by year end or March. The junior gold mining shares will test their recent lows and then start to show relative performance where they're not falling as much as the stock market. I'm watching for that type of relative strength and that's when I would be looking to buy them. I wouldn't be surprised if the gold price came back down to $1,650 an ounce (oz) as well.
I'm looking for a point where I want to buy, where for several months I was saying I wouldn't even think about it. A lot of the excesses have been wound out, but the best buying opportunity still lies ahead. Year-end tax loss selling and a sharp down turn in the S&P where everyone is looking for a year-end rally could provide a great buying opportunity for the juniors soon.
TGR: You're a technical analyst who relies on a lot of charts. What are you seeing in charts that make you believe that the S&P is going to pull back to its lows?
IMcA: I'm basing that on cyclical analysis within secular trends of the Dow Jones Industrial Average. I believe the top this year goes back to February as the cyclical top of the rebound off the 2009 lows, while the S&P made its actual peak in May. On a secular basis, I view this as the second half of the bear market that started in 2007. The first half of the financial bubble was undone from 2007 to 2009. The second half will run through 2012. There could also be a final low that may be as far out as 2016.
The undoing of the debt bubble over the last three decades is not a short-term affair. It's going to take a long time to work off. The housing market has not seen its bottom. Job numbers are going to get worse. Everything that they are doing in Washington just says that they are looking for new ways to screw it up.
TGR: You're expecting a double-dip recession.
IMcA: It will be called a double-dip only because they've engineered what appeared to be a recovery, but there hasn't really been a recovery that restored many lost jobs or did much more than temporarily slow the pace of decline in the housing market. All of the money and the liquidity that they threw into the market tweaked a few of the numbers in the gross domestic product to create the appearance of a recovery, but barely a penny of it ever got to Main Street.
TGR: Main Street is starting to spend a bit more.
IMcA: That's like saying there is a housing recovery because housing starts went up from 420,000 to 425,000. Housing starts used to be 1 million.
TGR: When will the economy get through this mess and start on a real recovery?
IMcA: It's going to take several years. It might start to show some signs of recovery in 2013 or 2014, or perhaps as late as 2016.
If the S&P is below 1,258 on Dec. 31, 2011, it will be the first down pre-election year since 1939. Election years don't have as bullish a record as pre-election years. But how much fun has this year been so far? The market's going to find a bottom for bear market rally bounces. Ned Davis Research Group created a model that I've modified that projects a decline in the Dow to a prospective cyclical bottom between 8,200 and 8,400 in August or September 2012 if we experience only an "average" bear market. I fear that it could be a lot worse than "average" given the geopolitical uncertainties as a backdrop.
TGR: Wow, that's a claim.
IMcA: It's interesting to see a cyclical decline projected through an election year. It's not unprecedented, but it's quite unusual.
TGR: You said earlier that you expect the gold price to pull back again. Do you expect it to pull back below its 200-day moving average?
IMcA: No. The market has come back and tested the $1,600/oz level twice. The last bounce off the $1,600/oz level was pretty credible. I'd be surprised if $1,600/oz is broken now.
TGR: You don't believe that gold is a bubble then?
IMcA: Whenever somebody talks about gold being in a bubble, I tell them to look at the credit and stock markets. If the gold price is at $1,900/oz, it's 2.2 times the high in 1980. However, debt in the U.S. is 12 times its early 1980 level. The S&P is trading at 10 times its 1980 level. The credit market and the stock market are about five times ahead of the gold price. I don't forecast that the gold price will reach five times its 1980 highs, but it might. If it gets there then you can start talking about a bubble.
TGR: Do you believe that gold will replace fiat currency?
IMcA: I don't know that it will ever replace fiat currency. The leadership of the G13, China, Brazil, and India, are probably going to push the old world to go back to some sort of a central discipline, such as indexing to a basket of commodities. It's too cumbersome in the modern world to return to a gold standard. But I can envision an international governing body being proposed to push for some discipline such as the Bretton Woods Agreement after World War Two.
TGR: What's in the basket?
IMcA: Gold, silver, oil, copper and conventional food.
The problem is no central banker ever wants to surrender sovereignty to some other body. The U.S. government is always going to want to call all the shots. But the U.S. government isn't what it once was. The rest of the world is increasingly going to communicate that message. At some stage, the world needs a globally accepted common denominator. China, Brazil, India and the G13 have nearly $7 trillion worth of the debt of the old world. There comes a point where the creditor will dictate the rules.
TGR: That's how the U.S. got to the position it's in.
IMcA: Exactly, exactly.
My biggest concern is increasing geopolitical risk for those that are exploring all over the world, the most recent example being the Argentinean government putting in a new set of rules. The same thing could happen in African countries. If the gold price gets much higher, the South African government will be talking about nationalizing. Too many of those countries will love you while you are bringing money in, but once cash flow begins to flow out, the politics of greed and envy takes over, typically under the guise of economic nationalism.
Politically stable jurisdictions are my preference. I am most attracted to seeking deposits in conventional mining districts in Canada or the U.S. where mining laws and practices are understood and respected. Even South Carolina is coming back again. I remember the previous go-around on it.
TGR: What happened then?
IMcA: It didn't work out because the gold price went down, as best I recall.
TGR: Any other last thoughts you'd like to leave our readers?
IMcA: The big contrast with this gold cycle and that of the '80s and '90s is that we haven't really seen a big discovery that excites the world. In that last cycle there were about a half-dozen companies built on new deposits that are already mined out and gone now. Names like Echo Bay, Hemlo, Amax Gold, FMC Gold, Pegasus and several others were launched and became the darlings of the last cycle, and they have already gone from the scene by the time gold got above $1,000/oz this time around.
At some stage somebody's going to make a discovery that's going to turn the lights on to get the speculative juices flowing, one good, exciting discovery in a prospective new camp. It looked like that might be taking place in the Yukon with the takeover of Underworld Resources Inc. (UNDWF:OTCQB). Will there be a sequel discovery up there? One solid drill hole can transform a junior explorer, but it does need to deliver follow-up success pretty quickly to build on it.
That's the nature of the drilling beast and discovery cycles. Others will remind you what the odds are. It's a very high-risk and capital intensive business. That's why I'm more attracted to the companies that are in that process of creating value out of the ground as opposed to having the political experience of dealing with environmental permitting and other regulatory impediments to getting a new mine into production. My idea is if you can make a discovery then God bless you and let somebody else have those future political and bureaucratic joys for the right price.
TGR: Ian, thank you for your time.
Ian McAvity has been involved in the world of finance for more than 50 years as a banker, broker, independent advisor and consultant. He has produced his Deliberations on World Markets newsletter since 1972. He specializes in the technical analysis of international equity, foreign exchange and precious metals markets, and has been a featured speaker at investment conferences and technical analyst society gatherings in the U.S., Canada and Europe over the past 40 years.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Ian McAvity: Cyclical and secular trends haven't really changed, but each one has slightly different characteristics. From 1982 to 2000, there was a powerful secular uptrend in the S&P 500. Since 2000, there's been a secular bear trend, sideways or downtrend not dissimilar to 1966–1982 or 1932–1949 that may run through 2016 or 2018.
The big change has been the utter corruption of Wall Street and that nearly 80% of the trading on the New York Stock Exchange now is being done by high-velocity computers. When an investor puts in an order, it's basically one computer versus another computer operating in nanoseconds. That's why all of a sudden the volume is up or down 10 to 1 and you get a couple of hundred points added on or taken off the Dow in minutes. To me that's a corruption of the process. "Ethics" and "Wall Street" are words you never use in the same sentence.
The trading mechanism is broken down. Leveraged exchange-traded funds (ETFs) are designed to consume the client's capital in leveraging and rebalancing premiums. The high velocity traders literally get the opportunity to "front-run" public orders as the order flow to "the market" is available to them for a fee. It's outrageous in the sense that they've legalized front running for those who pay up for the high-speed data feed. And then there's the initial public offering (IPO) business. Anytime the public can get shares in an IPO, they don't want it. If they can get some, it's only because it's not going to be that good a deal.
TGR: Is it the corruption of Wall Street or the development of Wall Street through technology?
IMcA: It's the culture of greed coming out of the banking system. The Street always wanted to make money. That's never gone away. But there was a time when good clients were actually respected by a firm. A firm wanted to do well for a good client because it wanted to keep the family assets in the firm. These days a client is considered to be a mark. The system is designed to convert the client's capital into their fees and income as quickly as possible. The public is being chased out. There have been persistent outflows from domestic equity mutual funds since 2007. A lot of people justifiably don't trust it.
TGR: Or perhaps the public just doesn't have the tools and the speed to become an influential member of the market?
IMcA: Let me give you an example. The average daily turnover for one gold mining junior ETF is $100 million (M). Probably $80M is day trading where there is no net investment. To call moment-by-moment trading "investment" to me is a sacrilege. There's no way that people are making a rational investment decision in that sense. I'd rather go to Vegas where they've got pretty girls serving you a drink while you gamble.
TGR: Aren't day traders just playing nagainst each other? Someone bets it goes up. Someone else bets it goes down. They wait a very short period. Ultimately, it just evens out.
IMcA: In theory it works itself out, but it creates an illusion of growth that distorts trends because it injects volatility. The majority of the billions of dollars that are trading every day is intraday noise. All the computers scalping each other for as little as a tenth of a cent.
TGR: The market was up the other day in reaction to the debt plan that came out of Europe. Is this a real increase or just more intraday noise?
IMcA: One batch of traders shorted at the opening burst, but that afternoon it didn't sell back. All the guys that shorted in the morning got their clocks cleaned and had to cover in the afternoon. That's why there was a second rush into the close. That trading activity is symptomatic of what's wrong with this market. Markets are being driven by headlines. Plus, the headlines are being misinterpreted most of the time. At first, it appeared that Europe had a perfect solution for everything. Then, by the end of the day, we were discovering that there were a lot of details missing and it was unclear how many parliaments have to approve the plan. Every day there's a leak of some unsubstantiated "plan" and later it's denied but the cheerleaders at CNBC seem to take every wiggle as gospel.
TGR: Is it driven by headlines or the 24/7 news cycle?
IMcA: I wish the news cycle was as slow as 24/7. When people are trading on one-minute and five-minute charts, a 24/7 news cycle can't keep up with it. It's not healthy to have this much liquidity. What it reflects is that the bailout of the banks has flooded the system with liquidity, but none of that is trickling down to Main Street or out into the real world. It's just sloshing around in the financial markets. The velocity of trading reflects that the system is swimming in liquidity and nobody is feeling sufficiently brave to take any risk home overnight. We'll churn the daylights out of it, but flatten the position before lunch or the close.
TGR: How does an individual investor operate in this environment?
IMcA: Basically hide. A number of people have told me that they've become day traders and I ask them how they're doing and they say, "Well, I'm not quite there yet. I know I can make money doing it." I tell them not to blow all of their capital while they try to learn. It's an exploitable game for somebody that has the self-discipline. But it requires a degree of self-discipline that 90% of the people that try it will never acquire.
TGR: At The New Orleans Investment Conference where you spoke in late October, many speakers talked about how junior gold stocks are essentially on sale, inferring that this is the time to buy. Should investors run and hide from a corrupt and frothy market, or go out and buy?
IMcA: You've got to watch the inter-market relationships. The gold stocks have been very poor performers relative to the gold price. In the last 12 months, the junior gold stocks have been particularly bad even relative to the senior gold stocks. That is creating an undervalued situation. But undervalued doesn't mean go out and buy it tomorrow morning. Yes, there was a marvelous October rally after five down months in the S&P. However, I believe that the S&P is going to go back down and at least probe the last lows, if not break them by year end or March. The junior gold mining shares will test their recent lows and then start to show relative performance where they're not falling as much as the stock market. I'm watching for that type of relative strength and that's when I would be looking to buy them. I wouldn't be surprised if the gold price came back down to $1,650 an ounce (oz) as well.
I'm looking for a point where I want to buy, where for several months I was saying I wouldn't even think about it. A lot of the excesses have been wound out, but the best buying opportunity still lies ahead. Year-end tax loss selling and a sharp down turn in the S&P where everyone is looking for a year-end rally could provide a great buying opportunity for the juniors soon.
TGR: You're a technical analyst who relies on a lot of charts. What are you seeing in charts that make you believe that the S&P is going to pull back to its lows?
IMcA: I'm basing that on cyclical analysis within secular trends of the Dow Jones Industrial Average. I believe the top this year goes back to February as the cyclical top of the rebound off the 2009 lows, while the S&P made its actual peak in May. On a secular basis, I view this as the second half of the bear market that started in 2007. The first half of the financial bubble was undone from 2007 to 2009. The second half will run through 2012. There could also be a final low that may be as far out as 2016.
The undoing of the debt bubble over the last three decades is not a short-term affair. It's going to take a long time to work off. The housing market has not seen its bottom. Job numbers are going to get worse. Everything that they are doing in Washington just says that they are looking for new ways to screw it up.
TGR: You're expecting a double-dip recession.
IMcA: It will be called a double-dip only because they've engineered what appeared to be a recovery, but there hasn't really been a recovery that restored many lost jobs or did much more than temporarily slow the pace of decline in the housing market. All of the money and the liquidity that they threw into the market tweaked a few of the numbers in the gross domestic product to create the appearance of a recovery, but barely a penny of it ever got to Main Street.
TGR: Main Street is starting to spend a bit more.
IMcA: That's like saying there is a housing recovery because housing starts went up from 420,000 to 425,000. Housing starts used to be 1 million.
TGR: When will the economy get through this mess and start on a real recovery?
IMcA: It's going to take several years. It might start to show some signs of recovery in 2013 or 2014, or perhaps as late as 2016.
If the S&P is below 1,258 on Dec. 31, 2011, it will be the first down pre-election year since 1939. Election years don't have as bullish a record as pre-election years. But how much fun has this year been so far? The market's going to find a bottom for bear market rally bounces. Ned Davis Research Group created a model that I've modified that projects a decline in the Dow to a prospective cyclical bottom between 8,200 and 8,400 in August or September 2012 if we experience only an "average" bear market. I fear that it could be a lot worse than "average" given the geopolitical uncertainties as a backdrop.
TGR: Wow, that's a claim.
IMcA: It's interesting to see a cyclical decline projected through an election year. It's not unprecedented, but it's quite unusual.
TGR: You said earlier that you expect the gold price to pull back again. Do you expect it to pull back below its 200-day moving average?
IMcA: No. The market has come back and tested the $1,600/oz level twice. The last bounce off the $1,600/oz level was pretty credible. I'd be surprised if $1,600/oz is broken now.
TGR: You don't believe that gold is a bubble then?
IMcA: Whenever somebody talks about gold being in a bubble, I tell them to look at the credit and stock markets. If the gold price is at $1,900/oz, it's 2.2 times the high in 1980. However, debt in the U.S. is 12 times its early 1980 level. The S&P is trading at 10 times its 1980 level. The credit market and the stock market are about five times ahead of the gold price. I don't forecast that the gold price will reach five times its 1980 highs, but it might. If it gets there then you can start talking about a bubble.
TGR: Do you believe that gold will replace fiat currency?
IMcA: I don't know that it will ever replace fiat currency. The leadership of the G13, China, Brazil, and India, are probably going to push the old world to go back to some sort of a central discipline, such as indexing to a basket of commodities. It's too cumbersome in the modern world to return to a gold standard. But I can envision an international governing body being proposed to push for some discipline such as the Bretton Woods Agreement after World War Two.
TGR: What's in the basket?
IMcA: Gold, silver, oil, copper and conventional food.
The problem is no central banker ever wants to surrender sovereignty to some other body. The U.S. government is always going to want to call all the shots. But the U.S. government isn't what it once was. The rest of the world is increasingly going to communicate that message. At some stage, the world needs a globally accepted common denominator. China, Brazil, India and the G13 have nearly $7 trillion worth of the debt of the old world. There comes a point where the creditor will dictate the rules.
TGR: That's how the U.S. got to the position it's in.
IMcA: Exactly, exactly.
My biggest concern is increasing geopolitical risk for those that are exploring all over the world, the most recent example being the Argentinean government putting in a new set of rules. The same thing could happen in African countries. If the gold price gets much higher, the South African government will be talking about nationalizing. Too many of those countries will love you while you are bringing money in, but once cash flow begins to flow out, the politics of greed and envy takes over, typically under the guise of economic nationalism.
Politically stable jurisdictions are my preference. I am most attracted to seeking deposits in conventional mining districts in Canada or the U.S. where mining laws and practices are understood and respected. Even South Carolina is coming back again. I remember the previous go-around on it.
TGR: What happened then?
IMcA: It didn't work out because the gold price went down, as best I recall.
TGR: Any other last thoughts you'd like to leave our readers?
IMcA: The big contrast with this gold cycle and that of the '80s and '90s is that we haven't really seen a big discovery that excites the world. In that last cycle there were about a half-dozen companies built on new deposits that are already mined out and gone now. Names like Echo Bay, Hemlo, Amax Gold, FMC Gold, Pegasus and several others were launched and became the darlings of the last cycle, and they have already gone from the scene by the time gold got above $1,000/oz this time around.
At some stage somebody's going to make a discovery that's going to turn the lights on to get the speculative juices flowing, one good, exciting discovery in a prospective new camp. It looked like that might be taking place in the Yukon with the takeover of Underworld Resources Inc. (UNDWF:OTCQB). Will there be a sequel discovery up there? One solid drill hole can transform a junior explorer, but it does need to deliver follow-up success pretty quickly to build on it.
That's the nature of the drilling beast and discovery cycles. Others will remind you what the odds are. It's a very high-risk and capital intensive business. That's why I'm more attracted to the companies that are in that process of creating value out of the ground as opposed to having the political experience of dealing with environmental permitting and other regulatory impediments to getting a new mine into production. My idea is if you can make a discovery then God bless you and let somebody else have those future political and bureaucratic joys for the right price.
TGR: Ian, thank you for your time.
Ian McAvity has been involved in the world of finance for more than 50 years as a banker, broker, independent advisor and consultant. He has produced his Deliberations on World Markets newsletter since 1972. He specializes in the technical analysis of international equity, foreign exchange and precious metals markets, and has been a featured speaker at investment conferences and technical analyst society gatherings in the U.S., Canada and Europe over the past 40 years.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
