The US stock market successfully tests its low

I wrote in a TSI commentary published on Sunday that the S&P500 Index (SPX) appeared to have completed a successful test of its 24th August low early last week. This view meshed with the price action and the fact that by some measures, most notably the Investors Intelligence Bull/Bear Ratio, last week’s test occurred in parallel with extreme negativity.

More evidence of a successful test of the low emerged on Monday 5th October when the number of individual stocks making new 52-week lows collapsed while the number of individual stocks making new 52-week highs rose significantly on both the NYSE and the NASDAQ.

The SPX is now less than 1% from substantial resistance at 2000. I suspect that this resistance will cap the SPX’s rebound for now, but that it will be breached before year-end. Based on a number of long-term indicators, I also suspect that the July-September downturn was the first leg of a cyclical bear market and that several months of range-trading will be followed by a decline to well below the 24th August low.

The gold-mining indices are finally showing signs of strength

The gold-mining indices broke out to the upside last Friday. Furthermore, the breakout was solidified on Monday when the HUI/gold ratio closed decisively above its 40-day MA for the first time since April.

The breakout could still be a ‘head fake’, but it should be given the benefit of the doubt until proven otherwise.

Kinross Gold (KGC), the most under-valued of the major gold producers, broke above the top of a well-defined intermediate-term price channel on Monday. Based on this price action my guess is that it will rise to around US$2.40 within the next three weeks.

Ben Bernanke, Master of Tautology

Former Fed chief Ben Bernanke has apparently argued that poor productivity has held back growth in the US. This is like arguing that growth has been held back by a lack of growth, since the ONLY way that per-capita economic growth can happen is via an increase in productivity.

As a run-of-the-mill Keynesian, Bernanke is clueless about how fudging interest-rate signals and creating money out of nothing make an economy less efficient. If he had a clue he’d be arguing that the Fed has held back growth in the US.

This post is an excerpt from a recent TSI commentary.

Excited talk of a silver shortage has made its annual reappearance. This talk is always based on anecdotal evidence of silver coins or small bars being difficult to obtain in some parts of the world via retail coin dealers. It never has anything to do with the overall supply situation.

Shortages of silver and gold in certain manufactured forms favoured by the public will periodically arise, often because of a sudden and unanticipated (by the mints) increase in the public’s demand for these items. Furthermore, the increase in the public’s demand is often a reaction to a sharp price decline, the reason being that in the immediate aftermath of a sharp price decline the metals will look cheap regardless of whether they are actually cheap based on the fundamental drivers of value.

These periodic shortages of bullion in some of the manufactured forms favoured by the public are not important considerations when assessing future price potential. The main reason is that the total volume of metal purchased by the public in such forms is a veritable drop in the market ocean. For example, the total worldwide volume of silver in coin form purchased by the public in a YEAR is less than the amount of silver that changes hands via the LBMA in an average trading DAY.

If gold continues to rally over the weeks ahead then silver will also rally. By the same token, if gold doesn’t rally over the weeks ahead then neither will silver. In other words, regardless of any anecdotal evidence of silver shortages at coin shops, silver’s short-term price trend will be determined by gold’s short-term price trend. Furthermore, if the gold price rises then the silver price will probably rise by a greater percentage, the reason being that the silver/gold ratio is close to a multi-decade low (implying: silver is very cheap relative to gold).

A final point worth making on this topic is that the claims of silver or gold shortages that periodically spring-up are not only misguided, they are dangerous. This relates to the fact that the most popular argument against gold and silver recapturing their monetary roles is that there isn’t enough of the stuff to go around. The gold and silver enthusiasts who cry “major shortage!” whenever it temporarily becomes difficult to buy coins from the local shop are therefore effectively supporting the case AGAINST the future use of gold and silver as money. You see, a critical characteristic of money is that obtaining it is always solely a question of price.

Comments on the following charts will be emailed to TSI subscribers.

1) Gold

2) The HUI

3) The Dollar Index

4) The S&P500 Index (SPX)

I last wrote about BitGold (XAU.V), which is now called Goldmoney, most recently in a blog post on 26th May. In the linked post I expanded on my view that the company had a great product from the perspective of customers, but a very over-priced stock. I concluded that at some unknowable future time the “it’s a great product with smart management therefore the stock should be bought at any price” bubble of enthusiasm would collide with the “it will always be a low-margin business and therefore deserves a low valuation” brick wall of reality. Although the stock price has since dropped about 20%, the valuation of the stock still appears to be extremely high considering the profit-generating potential of the underlying business. It is therefore fair to say that the bubble of enthusiasm hasn’t yet collided with the brick wall of reality.

Every month, Goldmoney reports what it calls “Key Performance Indicators” (KPIs) of its business. These KPIs seem impressive at first glance and seem to justify the stock’s market capitalisation. For example, the company reported that at the end of August it had C$1.5B of customer assets under management (AUM), an amount that is several times greater than its current market cap of C$235M (55M shares at C$4.27/share). However, unlike a mutual fund that charges a fee based on AUM, Goldmoney charges nothing to store its customers’ assets (gold bullion). This means that the larger the amount of Goldmoney’s AUM, the greater the net COST to the owners of the business (Goldmoney’s shareholders).

This is an important point. Based on Goldmoney’s current fee structure, it will always lose money on customers who use the service primarily for store-of-value purposes. Under the current monetary system this is where PayPal has a big advantage over Goldmoney. Nobody views their PayPal account as a long-term store of value, but many of Goldmoney’s customers view the service as a convenient way to store their physical gold. They don’t want to spend their gold, they want to save it.

Another KPI that looks impressive at first glance is “Transaction Volume”. For example, the company reported total transaction volume of C$47M for August. However, not all transactions attract fees and for the ones that do the fee is 1%. This means that the revenue to Goldmoney will always be less than 1% of the total transaction volume.

What’s important in assessing the stock’s valuation is the revenue to Goldmoney relative to its costs. This information is not presented in the company’s monthly KPI reports, but it is presented in the quarterly financial statements. Unfortunately, the latest quarterly statements aren’t useful because a major acquisition happened after the 30th June cutoff date. The next quarterly statements will be more informative, but we probably won’t get a good indication of Goldmoney’s real financial performance and earning potential until the December-quarter results are published early next year.

At this stage I don’t have enough information to value Goldmoney, although I suspect that ‘reasonable value’ is a long way below the current price. I’ll post some updated thoughts when I have a clearer view of what the stock is worth, which might not be until February next year. In the meantime I’ll stay away. I have no desire to own the stock and, despite the apparent valuation-related downside risk, no desire to short the stock.