Watch the Slope as the Price Curves Up

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Tuesday, April 12, 2016
Stephen Leeb, Ph.D.

Last week we emphasized the potential for a change in the relationship between oil and stocks. In the first quarter of 2016 oil was a deflationary barometer. I can still easily remember how odd it seemed for the nightly news to report that stocks had tumbled on a particular day due to a decline in oil prices. Now, those days are likely gone. As our chart shows, in the last week, while oil has climbed, stocks stagnated.

This does not mean oil at $40 or even $50 a barrel or more will mean a stagnant and eventually sliding market; it does suggest a reversion to past form in progress. And the chief takeaway from past form: a big run-up in oil could easily translate into a major fall in stocks. A gradual run-up in oil would very likely be positive. In other words, it is about the slope of the change.

Keep in mind the market is just a bunch of people reaching consensus on future economic activity. As long as key metrics such as oil trend relatively slowly in any direction, people can adjust. But any sudden and sharp change makes easy adjustment almost impossible.

We attribute the pace of the increase in the price of oil lately less than 5 percent to expectations on the upcoming confab in Doha and 95 percent to evidence that oil inventories are on the verge of dropping. According to Mike Rothman, one of the most knowledgeable analysts on black gold and a former gold medalist in the annual Institutional Investor poll, oil stocks in the OECD increased much less in the first quarter than consensus. He expects another inventory drop during the second quarter against expectations of a gain. Last week’s fall in inventories suggests that Rothman’s view is more sharply focused than appeared even a month ago.

The statistic to watch this week is the same as last week—oil inventories. Another below-expectation change in inventories would further the case that the oil world has indeed changed. You should then start to hope that the change can be managed and is gradual. The Doha meeting about capping oil production is a bit silly: other than Iran, whose increased production will likely be offset by falling Iraqi production (and probably Russian production too), oil production will likely fall—especially given the sharp drop in American production regardless of the capping. They might as well discuss capping the amount of rain that will fall in Springfield, Illinois next year. This meeting is for show.

Thus even if oil prices were to fall early next week because the Doha meeting did not reach consensus, it will mean little. Inventories and demand are the thing to watch from here on. Gradual gains in the price of oil will likely correlate with further gradual gains in the stock market.

Now let’s switch gears and discuss something so many have missed. From a certain perspective this amounts to a real economic and societal tragedy.

I mean gold. By far our strongest performers in TCI in the last six months have been gold and gold stocks—one has more than doubled, while another is close to doubling (see issue for details). Gold itself has increased a mere 20 percent from its December low. Historically, the sharp outperformance of gold stocks (over gold) is good news: in that it suggests further large gains in gold ahead and even larger gains in gold stocks.

Gold stocks would have to more than double just to return to their relationship to gold in 2011. In other words, since 2011, gold stocks have underperformed gold. Remember, that was a period in which the yellow metal declined. Now that gold miners are outperforming the metal, it is one more signal—of many—that gold should go higher.

Here is the tragedy: despite the correction in gold since its 2011 high, the yellow metal has far outperformed every major asset this century. More precisely, since the World Trade Organization (WTO) admitted China on December 11, 2001, gold—the metal—has climbed 360 percent, while gold stocks gained only about 80 percent. To repeat: gold outperformed gold stocks by more than four-fold. Moreover, if you divide the century into two, pre- and post-Great Recession, gold has outperformed all major assets during both periods.

Some might argue that if you look further back, say to the 1990s, we saw a much different story. And indeed we did: back then, China did not factor into the equation. Now, however, China and for that matter most of the East are rapacious—which inextricably intertwines gold with the Chinese dream. China’s 21st century ascendancy makes comparisons with earlier periods a little like a comparison of the behavior of a responsible person before and after he or she had children. Would it really make sense to say a responsible Dad with two kids has merely taken a breather and will soon again hang out with his buddies through all hours of the morning? Even after those kids have grown, you can forget that–trust me.

So it also is with China’s sudden emergence on the scene. Its arrival marked a major change in global economic calculus. For many reasons, for most of my life I eschewed gold, but one thing of which I am perhaps most proud: since writing Defying the Market (with my wife), I have aggressively recommended gold. I attribute that switch to my ability to recognize the role China would play in uprooting the prior economic calculus.

I am proud not that I was right but that over the longer term I may have done some good in assuaging the misery that left so much of our Middle Class in a funk, with anger pouring out of the country’s seams.

Gold is so easy to buy. You don’t need a brokerage account; you can buy coins of small denominations, for example. That’s just one way of many to buy gold. (You could even consider gold jewelry an investment, at least according to the vast majority of Chinese and Indians.)

If you can’t afford small denomination gold coins or gold jewelry, you can buy silver—a one-ounce silver coin costs $15. And while silver has underperformed gold since December 2001, it has nevertheless left stocks in the dust by more than 3 to 1.

For as long as I can remember, most advisors have considered gold a forbidden investment. The last I heard from the CFP Board—those people licensed to plan your retirement and give you financial advice at all stages of life—it would admit no one into the club who argues on their exams that gold and precious metals should compose part of one’s asset mix.

The statistics make me sick: they show that gold likely accounts for less than 1 percent of household assets in America. Imagine if the figure were closer to 10 percent. Of course the value of gold would stand far higher today than it does. More important, Americans might be a lot less angry. The U.S. would likely have many more options to handle economic vicissitudes.

The good news is that it’s not too late. Our target for gold is many times its current level: that means that for gold miners you haven’t seen anything yet. In our sister publication, Leeb’s Real World Investing, we focus solely on ways to survive these singular economic times. Gold and gold-related investments play a central role. Broad-based TCI should more than help you manage, but for those with patience and in want of extra protection, RWI may have some value.


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