Bob Hoye: “So we’re fairly confident that the recession will have been seen to have started in the month of May”. Michael Campbell: Since we are talking about pivotal times what is the interest rate scenario?
Bob Hoye: It’s a Pivotal Time
Michael Campbell: Very pleased to have with me on the show again Bob Hoye Institutional Advisors.
Bob can you provide some perspective for us on the kind of movements we’ve seen in the markets. Is that the beginning of something far more significant or is this the buying opportunity I’ve been waiting for?
Bob Hoye: Well it was violent that was for sure Mike. Going back some months ago we have a model we call the Momentum Peak Forecaster, and when it clicks in it means that speculation is going to surge and become absolutely irresistible. Now the signal was given at the end of December and typically, like for example in commodities in 1973 or in the big gold and silver market that peaked in January 1980, it really just goes straight up. When it gives the signal typically the play will blow out about three months later, or in this case around the end of March. Now we’ve seen the end of February the agricultural commodities stocks stopped going up and then later in March you saw the base metal prices stopped going up. Within our work we also expected that gold and silver would run further than the rest of the pack, and then separately on a seasonal basis we had crude oil, it would rally through April. Well that was the change. So here you a raging speculation, but we it reached measures. We do the silver gold ratio, and when you have a good bull market for these two markets silver will outperform gold, so the silver gold ratio was going up. We watched RSI momentum, and if it gets into the high 80s that’s dangerous territory. Well this got up to 92 which was in the neighborhood of where the speculation got in gold and silver in 1980.
So we had momentum, we had the timing within the window from which a violent reversal could follow and that was indeed our April 25th brief comment on gold and silver was that the reversal would be violent. Last Thursday’s pivotal events comment we sent out used the term violent, and then wham it came in violent.
Mike there’s a bigger picture here than making just the call, it’s that the street was fully believing that the Federal Reserve and the Treasury operations in the states would depreciate the dollar forever, and you could get on board and you could ride commodities all the way up. But what happens is that the fed can’t control the speculation and any speculator [worth his salt] is going to be highly leveraged in this. Of course a futures contract is greatly leveraged. So when the play runs out of momentum and you get the first crack in the price, the speculators are forced to sell. On the way up everybody believes the fed can drive prices forever, then when the price drops the power shifts immediately to the margin clerks and they can outdo a fed or a central bank any time.
Michael Campbell: You said in October of 2007 the tsunami’s coming, the credit crisis is going to be in earnest and we are going to feel it in the most abrupt and aggressive ways. Clearly that came to pass but that it was a financial issue and the economics were the byproduct of that. What you’ve just described is the same thing meaning people borrowed money, those that have a lot of profit so they say this is an excuse to take profit. Others are getting forced out of the markets they borrowed too much to get into. Is that the dynamics of what’s going on?
Bob Hoye: Yes, but then you have the silver community. They were all doing the supply demand analysis and you can go year after year and it’ll always show silver in short supply, like there’s greater demand than what’s coming. That’s a misleading game because in the credit cycle the gold silver ratio will ultimately perform like a credit spread. So this is where silver gave up 25% in four trading days and that’s horror show stuff. Then of course what you had was an artificially high price for crude oil. You had the seasonal rally and then you had an artificially high price because the terrorists were not taking shots at oil production or oil transportation and yet there was a big bid there on the fear that that might happen. It didn’t happen and silver and crude oil more or less reversed at the same time. What we want to look at is how severe this is beyond just the 25% drop in silver. How severe beyond the sell-off in crude, so horrendous it took three trading days to take away about three months of advance including dropping 9% in one day.
Again we’ve referred to our model the Momentum Peak Forecaster. When we had a big mania for commodities in 1973 you also at that time had trouble in the Middle East with the Yom Kippur war. The signal was given in November and the markets completed three months later. After that the National Bureau of Economic Research came along and said that the recession started in November of ’73 and that happened to be the month our Momentum Peak Forecaster gave its signal. Then we move ahead to the next big event which was the gold and silver speculation of 79/80, On that one our model gave the signal in November and the play blew out, and I always remember the date, January 21st of 1980. Later on the National Bureau of Economic Research, which is the semi official body that determines when recession starts and when they end, said that the recession started in January i.e. the month that this speculation completed. So here we are now. You had the signal of the Momentum Peak Forecaster given at the end of December, you had the play complete in March April, and now you’ve had the harsh hit to it. So we’re fairly confident that the recession will have been seen to have started in the month of May. It reminds me of the line “sell in May and go away” even though we didn’t get much into May.
Now, on crude oil that reminded me of the top of the bubble in crude oil in 2008 when it soared up to 147. That of course gave us all kinds of excessive signals on the way up. My colleague Ross Clark had a very good technical call on that one. The action in July of that year was that crude had a higher high than the month before, a lower low and then a close with a lower low. Here we are only a few trading days into the month of May and it’s already set the first part of an outside reversal to the down side. It’s had a higher high and a lower low and now we just have to be patient to the end of the month to see if it closes with a lower close. When we had the crude crash after that one from 147 it went all the way down to the 35 level. So yes, I think the speculative community has had severe damage.
Michael Campbell: You’re saying that this is a very pivotal time. Should we wait to see how it closes in the next three or four weeks, wait to and see how the market behaves despite the bounces that happening now?
Bob Hoye: The market’s are experiencing a bounce because it was a high velocity drop. I think that a lot of damage has been done. Also there’s other markets out there. For example the sovereign debt bonds, you had those out to new high yields some of them at 20%. Since the crash in March of ’09 you’ve had a fabulous rally, bull markets for corporate bond prices, they’ve been away up there. Nothing technically excessive over the last while, but back in ’07 what we were watching that was very good for us was those evil sub prime mortgage bonds. Well I’ve been watching those and they’ve had a good rally out of the disaster in ’09. Then in February a couple of the issues we were watching did a spike up in price and came down. One has broken down completely which says that that fun in the sub prime market is over and there’s going to be problems.
Also you had a very good rally in the municipal bonds out of a horrendous disaster and it’s now up to a technical top and could roll over in the next little while. So the damage, or let’s say the future troubles may not just be in what follows an excessive bubble in commodity prices. You have other markets out there. The corporate market is now vulnerable, and the sub prime market is telling us as it did in ’07 that there could be problems in credit markets. So it’s best to be wary in all departments.
Michael Campbell: What does that tell you interest rate wise? Your models which I find absolutely fascinating are suggesting that maybe we are entering another slow growth period recessionary period. Do interest rates go up against that back drop?
Bob Hoye: Oh yes. The debt has to be serviced and the US is a terrific example now whereby government employees, municipal employees have unions and they are they are taking above market returns for their wages and also for their pension benefits and they won’t back off. I figure we’re just in the next recession already so you’re going to have tax revenues flowing down while you have horrendous demands by the Government unions. So I think the only way out is that these many cities have to go broke in order to get the pensions and the power of the union’s diminished. I think that’s probable so you don’t want to be in those bonds. Then on the corporate bond side, for ages, for most of financial history rising prices are associated with good times, and falling prices with hard times. Indeed it shows up in, for example, S&P earnings. They go up and down with commodity prices. The way it works is that when commodity prices are going up it reflects a good pricing power by businesses and then when they go down that shows the pricing power is not so good. Their margins begin to get tight, their earnings diminish, and when earnings go down they have difficulty servicing debt.
Then of course you always got the rating agencies out there looking and watching for credit changes. When you’re in a condition where companies are unable to service debt they get the down grade and the price of their bonds go down. So it’s not a pretty picture. It’s highly probable that another business cycle recession is will be the dominant feature for the next year or so.
Michael Campbell: Since we are talking about pivotal times what is the interest rate scenario?
Bob Hoye: If you’re talking about the Treasury bill rate I don’t see it going up too much. We were on a very good long government bond rally with US Treasuries then they got super bearish a couple of months ago on the credit down rating. Bill Gross at Pimco said that he was actually short US Treasuries at the 118 level and now they are up to 124. All of these instruments have to be traded but then what you do for the quiet investor? Well this government rally is on and it could go for a while yes, but one would be a little careful in here and you’re going to get the safest return out of the three to four year maturity. If you’re in too short an instrument every roll over you’re going to get next to nothing. If you’re out at the long end and the bond market decides to take a price drop you get hit that way. In stormy times we kind of like to be in the three to four year maturity and just on what we call the cusp of the curve there. As for mortgages I guess lock in short rates, because mortgages will eventually be a problem in a market where credit worthiness is disappearing quickly.
Michael Campbell: What’s your forecast for the Canadian dollar?
Bob Hoye: I like the high price Canadian dollar. I think it’s good all around. It’s forcing business in Canada to be competitive rather than have the prop of a depreciating dollar.
From the point of a trader it went up with commodities and it was particularly tied to crude oil and now it’s heading down. We think we’re in a cyclical decline in all commodity prices, so I think the Canadian is going to go down. But if this new government is wise, and I don’t think they can move quickly on it, it would be best all round to keep the Canadian dollar at par with the US, it takes a whole lot of friction and hedging out of the game. I think the Canadian dollar will drift down and one obvious target is tar.
Michael Campbell: I want to just sum up. We should be very vigilant in the next four weeks and people have to check their risk profile and what kind exposure they have. Do they want that level of exposure? Do they want to get some powder dry?
Bob Hoye: Yes. Another one way you can look at this, for example, I think we are in a long bull market for junior gold exploration stocks, it’s just the way it works after a great bubble. But a number of the ones I was in just got up in price, I mean a great zoom and as a trader you just can’t help but trade. So you got the end of the month and you’ve got a large amount of cash in my account. So you’ve got a cushion so that if there are some stocks that are not yet moved yet you can acquire those, or you can reenter the ones you bought previously at lower prices. The way Ross and I work is that we have some targets for the decline in gold, for the decline in silver and crude oil. When those targest approach then we’ll have opportunity and buying levels for individual gold and silver stocks. You end up being methodical and it’s a nice thing, it’s a nice place to be so.
Michael Campbell: That’s great advice. Institutional Advisors Bob Hoye