Commodities Back in Bear Territory (Bespoke)

Monday, May 7th, 2012

With Europe mired in reces­sion and eco­nomic data in the US turn­ing soft in recent weeks, the com­modi­ties sec­tor has taken it on the chin recently.  With a decline of close to 2% today, the CRB Com­modi­ties index is once again down more than 20% from its highs in 2011.

Tags: Bear Territory, Commodities, Crb Commodities Index, Decline, Economic Data, Europe, Recession
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Inflation Anxiety is Spooking Investors (Tucker)

Wednesday, May 2nd, 2012

by Matt Tucker, iShares

Investors are spooked. They are so spooked that they are buy­ing an asset that cur­rently has a neg­a­tive yield. What is the cul­prit caus­ing so much con­cern? Curi­ously, it’s infla­tion. Investors appear to be so con­cerned about infla­tion that they are seek­ing pro­tec­tion against it with­out much regard to the cost of that protection.

This phe­nom­e­non is play­ing out in the mar­ket for Trea­sury Infla­tion Pro­tec­tion Secu­ri­ties, or TIPS. The US Trea­sury auc­tions TIPS secu­ri­ties every six weeks. In the last few auc­tions, the demand for TIPS by investors has been over­sub­scribed by almost 3X.  All this demand for infla­tion pro­tec­tion has con­tributed to neg­a­tive real yield level across the entire TIPS curve.

Why might investors be clam­or­ing for infla­tion protection?

TIPS are the only finan­cial asset that directly pro­tects an investor’s prin­ci­pal from changes in real­ized infla­tion.  While real estate and com­modi­ties are indi­rect means of infla­tion pro­tec­tion, the prin­ci­pal on TIPS adjust with changes in the non-seasonally adjusted con­sumer price index. But cur­rent lev­els of volatil­ity are mak­ing it dif­fi­cult for busi­nesses and investors to know if this is a risk they should hedge. The uncer­tainty regard­ing the direc­tion and impact of infla­tion is at 30-year highs.  The chart below show the volatil­ity of the CPI index over the past 50 years.

What is mak­ing this sud­den increased demand for infla­tion pro­tec­tion so curi­ous is that despite the rapid expan­sion of the money sup­ply in the past four years, infla­tion has not got­ten out of con­trol. In fact a warmer win­ter caused defla­tion of 0.5% in the fourth quar­ter of last year as energy prices fell. While the money sup­ply has increased as the Fed has injected liq­uid­ity, the weak econ­omy and tight lend­ing envi­ron­ment have not put upward pres­sure on prices. All this liq­uid­ity has not trans­lated into cur­rent inflation.

For investors, hav­ing a strate­gic allo­ca­tion to TIPS or the iShares Bar­clays TIPS Bond Fund (TIP) as part of an over­all port­fo­lio may be pru­dent. How­ever, it might make sense to ask your­self what your view is on infla­tion before invest­ing in TIPS. Neg­a­tive real yields in this con­text may be viewed as the “cost” of real­ized infla­tion pro­tec­tion, so you should have a view on how long that cost will likely be incurred before the pay­off in actual infla­tion occurs.

No mat­ter what your view is on infla­tion, you can look at these sign­posts for keys to future infla­tion – bid-to-cover ratio at TIPS auc­tions, flows into TIPS invest­ments like ETFs, monthly changes in the CPI and mar­ket expec­ta­tions of future infla­tion through “breakeven infla­tion” lev­els (the dif­fer­ence between nom­i­nal and real rates). Hope­fully these clues will give you some guid­ance on when to add infla­tion pro­tec­tion to your portfolio.

Bonds and bond funds will decrease in value as inter­est rates rise. TIPS can pro­vide investors a hedge against infla­tion, as the infla­tion adjust­ment fea­ture helps pre­serve the pur­chas­ing power of the invest­ment. Because of this infla­tion adjust­ment fea­ture, infla­tion pro­tected bonds typ­i­cally have lower yields than con­ven­tional fixed rate bonds and will likely decline in price dur­ing peri­ods of defla­tion, which could result in losses. Gov­ern­ment back­ing applies only to gov­ern­ment issued secu­ri­ties, not iShares exchange traded funds.

Tags: Commodities, Consumer Price Index, Cpi Index, Culprit, Curve, Energy Prices, Financial Asset, Fourth Quarter, Impact Of Inflation, Inflation Protection, Ishares, liquidity, Matt Tucker, Money Supply, Phenomenon, Rapid Expansion, Six Weeks, Upward Pressure, Us Treasury Auctions, Volatility
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Commodity Snapshot (Bespoke)

Wednesday, April 25th, 2012

Below is an updated look at our trad­ing range charts for ten of the most widely fol­lowed com­modi­ties.  For each chart, the green shad­ing rep­re­sents between two stan­dard devi­a­tions above and below the 50-day mov­ing aver­age.  Moves to the top of or above the green shad­ing are con­sid­ered over­bought, while moves to the bot­tom or below the green shad­ing are con­sid­ered oversold.

There are no com­modi­ties in rally mode right now, and oil is the only one that's still hold­ing onto a slight uptrend.  From the pre­cious met­als to wheat to orange juice to cof­fee, every­thing is cur­rently at the bot­tom of its trad­ing range.  Are we due for a rever­sal soon?

Tags: coffee, Commodities, Commodity, Orange Juice, precious metals, Rally Mode, Range Charts, Shading, Snapshot, Standard Deviations, Uptrend, Wheat
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Emerging Markets Radar (April 9, 2012)

Sunday, April 8th, 2012

Emerg­ing Mar­kets Radar (April 9, 2012)

Strengths

• The Hun­gar­ian PMI surged above expec­ta­tions in March to 56.8, the strongest read­ing in the last thir­teen months, reflect­ing the pos­i­tive impact of the open­ing of the brand new Daim­ler AG plant. The Czech man­u­fac­tur­ing PMI has also improved.
• Brazil’s con­sumer prices rose 0.21 per­cent in March from Feb­ru­ary, the government’s sta­tis­tics agency said in a report dis­trib­uted in Rio de Janeiro today. Econ­o­mists sur­veyed by Bloomberg had expected infla­tion of 0.37 per­cent, accord­ing to the median fore­cast of 50 analysts.
• Chilean con­sumer prices rose 0.2 per­cent in March from the pre­vi­ous month, less than ana­lysts’ fore­cast, bring­ing annual infla­tion back within the cen­tral bank’s tar­get range for the first time in four months.
• China offi­cial March PMI was 53.1 ver­sus the esti­mate of 50.8, ris­ing 2.1 from Feb­ru­ary; new orders were up 4.1 points at 55.1 per­cent. Nev­er­the­less, due to sea­son­al­ity, March’s PMI is usu­ally 3 points bet­ter than February’s, there­fore, the mar­ket is cau­tious about the better-than-expected PMI for last month. PMI above 50 indi­cates indus­trial activ­i­ties are expanding.
• China’s March non-manufacturing PMI was 58 ver­sus 48.4 in Feb­ru­ary, indi­cat­ing con­sumer con­sump­tion may be resilient.
• Philip­pines infla­tion eased to 2.6 per­cent on a year-over-year basis in March from 2.7 per­cent in Feb­ru­ary. A base-year com­par­i­son sug­gests infla­tion in the coun­try will remain sub­dued in April. How­ever, infla­tion trends should turn up from mid-year dri­ven by a resumed rise in oil and com­mod­ity prices and strength­en­ing domes­tic demand.
• March hous­ing trans­ac­tions increased 40 per­cent in Bei­jing, and sim­i­lar increases were also seen in other tier 1 and tier 2 cities. Some ana­lysts say buy­ers are encour­aged by the fact that the Chi­nese gov­ern­ment had his­tor­i­cally failed in curb­ing hous­ing prices, but oth­ers say March sales vol­ume is always the equiv­a­lent of com­bined sales of Jan­u­ary and Feb­ru­ary in the year and March of this year didn’t see bet­ter vol­ume than prior years.
• Indonesia’s par­lia­ment did not pass the fuel raise bill which was to remove the fuel sub­sidy and raise fuel prices by 33 percent.

Weak­nesses

• The Russ­ian cen­tral bank chair­man said the liq­uid­ity deficit faced by the finan­cial indus­try is the “new norm” this year. One of the rea­sons is a con­tin­ued cap­i­tal out­flow. Rus­sians spent $12 bil­lion on for­eign prop­erty last year, com­pared with $5.5 bil­lion a year in 2007 and 2008, accord­ing to the chairman.
• Colom­bian pol­icy mak­ers meet­ing last month were divided over the need to raise inter­est rates fur­ther to keep infla­tion in check. Ana­lyst Brian Lesmes, at Grupo Ban­colom­bia in Bogota, said that though infla­tion and credit demand have eased, fur­ther tight­en­ing may be needed to cool house­hold demand.
• Thai­land infla­tion edged up to 3.4 per­cent year-over-year in March from 3.3 per­cent in Feb­ru­ary, but base-year com­par­i­son sug­gests infla­tion in the coun­try will remain sub­dued in April.
• Indone­sia is to dis­cuss an export tax on coal and base met­als, which is neg­a­tive for local mate­ri­als com­pa­nies but good for global coal and base metal producers.
• Tai­wan may imple­ment a cap­i­tal gains tax on stock trad­ing profits.

Oppor­tu­ni­ties

• Cit­i­group Inc. raised South African equi­ties to over­weight, the equiv­a­lent of a buy, on expected strong earn­ings growth and com­pa­nies’ expan­sion into Africa’s fast-growing fron­tier mar­kets, the bank said.
• In the last decade, Indone­sia has restored sta­ble eco­nomic growth and, there­fore, has improved its wealth. With oppor­tu­ni­ties to build vast infra­struc­tures and indus­trial com­plex, for­eign direct invest­ments (FDI) now are return­ing to the coun­try. The increas­ing FDI has dri­ven up demand for indus­trial estate and build­ing mate­ri­als, such as cements.

Threats

• Brazil's tax agency said on Wednes­day that intra-company com­modi­ties exports and imports by multi­na­tional traders must be set­tled using inter­na­tional prices. The country’s Fed­eral tax author­ity said the mea­sures are aimed at end­ing "price manip­u­la­tion" of inter-company imports and exports that allow multi-national com­pa­nies to evade local taxes.
• Peru is rene­go­ti­at­ing with Mex­ico to cut nat­ural gas ship­ments after allo­cat­ing gas reserves to its domes­tic indus­try, a Peru­vian gov­ern­ment offi­cial said. Approx­i­mately half of the ship­ments will be cut, the pres­i­dent of state oil con­tract­ing agency Peru­petro said this week.
• The Chi­nese econ­omy is still in the process of a soft land­ing, but the pol­icy response may fall behind the curve. In 2012, cor­po­rate rev­enue growth is pre­dicted to be much slower than 2011, with gross mar­gins also expected to be lower due to weaker demand and a rise in input costs.

Tags: Beijing, Brazil, China, China Official, Chinese Government, Commodities, Commodity, Commodity Prices, Consumer Consumption, Daimler Ag, Economists, Emerging Markets, Four Months, inflation, Philippines, Pmi, Radar, Rio De Janeiro, Russia, Sales Volume, Seasonality, Statistics Agency, Target Range, Thirteen Months, Tier 2
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Commodity Snapshot (Bespoke)

Thursday, April 5th, 2012

Tags: April, Commodities, Commodity, Copper, Copyright, Corn, Gold, Gold And Silver, Gold Silver, Green Zone, Investment Group, Natural Gas, Orange Juice, Range Charts, Shading, Silver Platinum, Snapshot, Standard Deviations, Trading Ranges, Wheat
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3 Trends to Watch for Global Investors

Thursday, April 5th, 2012

Bloomberg announced over the week­end that China’s man­u­fac­tur­ing grew at the fastest pace in a year. We fol­low the government’s Pur­chas­ing Man­agers’ Index (PMI) closely, as we believe it is a bet­ter indi­ca­tor of China’s domes­tic demand than the HSBC PMI. Whereas HSBC PMI sur­veys 400 small and mid-sized com­pa­nies, which are typ­i­cally export-oriented, the government’s PMI sur­veys 820 mostly large, state-owned enter­prises across 20 indus­tries.
Though man­u­fac­tur­ing activ­ity exceeded ana­lysts’ esti­mates, some China bears focused on the fact that the March 2012 num­ber is lower than the aver­age dur­ing the third month from 2005 through 2011. What’s impor­tant for investors to con­sider is that the trend is your friend: It is the fourth month in a row where the PMI landed above the three-month PMI, and shows the econ­omy is on the right path.

Below are three addi­tional con­struc­tive trends we see in China.

1. China Returns Poised to Revert to the Mean

Over the past few years, Chi­nese stocks have lagged com­pared to their emerg­ing mar­ket peers. How­ever, the Peri­odic Table of Emerg­ing Mar­kets per­fectly illus­trates how last year’s loser can be this year’s win­ner. His­tor­i­cally, every emerg­ing coun­try has expe­ri­enced wide price fluc­tu­a­tions from year to year. Over time, though, each coun­try tends to revert to the mean.

In the visual below, we high­lighted China’s per­for­mance pat­tern over the past 10 years. Chi­nese stocks landed in the top half four out of 10 years—2002, 2003, 2006 and 2007. In 2003, China climbed an astound­ing 163 per­cent; in 2007, it was the top emerg­ing mar­ket again, return­ing nearly 60 per­cent.
Since then, the coun­try has fallen to the bot­tom half of the chart. If you apply the prin­ci­ple of mean rever­sion, his­tory appears to favor China land­ing in the top half dur­ing this Year of the Dragon.

See the orig­i­nal Peri­odic Table of Emerg­ing Mar­kets here.

2. Liq­uid­ity Cycle Could Ben­e­fit Stocks

Yet China lead­ers won’t leave its suc­cess to pure luck. If the Dragon doesn’t breathe fire into mar­kets, it may be a shot of liq­uid­ity injected by pol­icy eas­ing that could drive stock prices higher. Macro­eco­nomic the­ory states that when a country’s money sup­ply exceeds eco­nomic growth, the excess liq­uid­ity tends to drive up asset prices, includ­ing stocks.

BCA Research doc­u­mented this trend in China over the past eight years. The research firm com­pared the dif­fer­ence between the change in money sup­ply growth and nom­i­nal GDP growth and Chi­nese stock prices. In both instances when the change in excess liq­uid­ity fell to a low, so did stocks. Con­versely, the rise of money sup­ply growth com­pared to GDP growth “coin­cided with major ral­lies” for China’s stock mar­ket, accord­ing to BCA.

Today, it appears that the change in excess liq­uid­ity is just begin­ning to bounce off another low, as are stocks, indi­cat­ing another poten­tial inflec­tion point.

3. Incen­tive to Main­tain Growth

BCA hedges China’s pos­si­ble stock advance­ment in the short-term if signs of eco­nomic improve­ment con­tinue because they “reduce the odds of aggres­sive pol­icy eas­ing.” A few weeks ago, I dis­cussed how investors seemed to over­look China’s focused macro pol­icy strat­egy, with its actions delib­er­ate and pur­pose­ful. This year, the gov­ern­ment has extra incen­tive to sus­tain mean­ing­ful growth as it tran­si­tions to a new lead­er­ship by the end of the year. As Pres­i­dent Hu Jin­tao and Pre­mier Wen Jiabao depart, Xi Jin­ping and Li Keqiang are expected to take over.

Look­ing at his­tor­i­cal GDP growth per year since 1978, Deutsche Bank finds there’s prece­dence for this idea. Dur­ing the fifth year of the lead­er­ship tran­si­tion cycle, “high or sta­ble” GDP growth was main­tained, with the excep­tion being the Asian Finan­cial Cri­sis in 1997.

These trends will be cov­ered in my upcom­ing web­cast on China with CLSA’s Andy Roth­man. Join us as we dis­cuss what investors should expect from China in terms of long-term GDP growth, fixed asset invest­ment, exports and the hous­ing market.

When I was in Sin­ga­pore at the Asia Min­ing Con­gress last week, I was for­tu­nate to be among a group of sharp and intel­li­gent experts across the finan­cial and min­ing indus­tries. A China bull pre­sent­ing an excel­lent case for the coun­try was Jing Ulrich, JP Morgan’s man­ag­ing direc­tor and chair­man of China equi­ties and com­modi­ties group. She’s the Oprah Win­frey of the invest­ment world, as for the past three years, Forbes Mag­a­zine has ranked her among the 50 Most Pow­er­ful Women in Business.

Ulrich expressed sim­i­lar views toward China and its polit­i­cal will in a recent “Hands-On China Report” fol­low­ing her atten­dance at the China Devel­op­ment Forum in Bei­jing. She said that the gov­ern­ment min­is­ters empha­sized their com­mit­ment to rebal­anc­ing the econ­omy toward con­sump­tion. While “fun­da­men­tals are cur­rently sound, the nation must mod­ify its ‘imbal­anced, unco­or­di­nated and unsus­tain­able’ course of devel­op­ment,” says Ulrich. What investors should remem­ber is that the gov­ern­ment had the finan­cial resources to effect this change and con­sid­ered it impor­tant to main­tain sus­tain­able growth.

All opin­ions expressed and data pro­vided are sub­ject to change with­out notice. Some of these opin­ions may not be appro­pri­ate to every investor. The Pur­chas­ing Manager’s Index is an indi­ca­tor of the eco­nomic health of the man­u­fac­tur­ing sec­tor. The PMI index is based on five major indi­ca­tors: new orders, inven­tory lev­els, pro­duc­tion, sup­plier deliv­er­ies and the employ­ment envi­ron­ment. The Hang Seng China Enter­prises Index is a capitalization-weighted index com­prised of state-owned Chi­nese com­pa­nies (H-Shares) listed on the Hong Kong Stock Exchange and included in HSMLCI index (Hang Seng Main­land Com­pos­ite Index).

Tags: 10 Years, China, Chinese Stocks, Commodities, Commodity, Dragon, Economy, Emerging Market, Emerging Markets, Estimates, Global Investors, Gold, History China, India, liquidity, Loser, Mining, Pace, Periodic Table, Pmi, Price Fluctuations, Principle, Purchasing Managers Index, State Owned Enterprises, Surveys, Year Of The Dragon
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Drilling into Fuel Prices (Templeton)

Wednesday, April 4th, 2012

by Franklin Tem­ple­ton Investments

Gaso­line, deodor­ant, dish­wash­ing, liq­uid, eye glasses, crayons….What does this list of seem­ingly ran­dom items have in com­mon? They are all made from refined crude oil.¹ So even if you don’t feel pain at the gas pump, you prob­a­bly rely on more prod­ucts made with or from crude oil than you’d think. And of course even non-oil based prod­ucts are gen­er­ally shipped via fuel-consuming trans­port vehi­cles, so you’re bound to feel the pinch in the form of fuel sur­charges or price hikes sooner or later.

But Beyond Bulls & Bears has never taken a fatal­is­tic view. If volatil­ity can present buy­ing oppor­tu­ni­ties, surely there’s a pos­si­ble sil­ver lin­ing to headline-making oil price heights. And so we turn to Fred Fromm, port­fo­lio man­ager for Franklin Nat­ural Resources Fund and part of the team that man­ages Franklin Gold and Pre­cious Met­als Fund, aka the guy with the inside scoop on all things oil, gold, and even those other less-talked-about commodities.

Fromm in brief:

• U.S. demand for gaso­line is actu­ally down, but demand out­side the U.S. is strong.
• Geopo­lit­i­cal issues, namely in Iran and Syria, are being fac­tored into oil pric­ing, but major dis­rup­tions may not occur.
• If China’s growth rate could con­tinue indef­i­nitely, its too-strong growth would likely strain com­mod­ity supply.
• Supply-demand bal­ance looks tight enough to sup­port gold, but demand can fall quickly and should be closely watched.
• Fromm opts for geo­graphic diver­si­fi­ca­tion to avoid the risk of hav­ing too many invest­ments in a coun­try with a high degree of polit­i­cal risk.

Oil prices tend to fol­low a sea­sonal rise in the sum­mer, but the recent run-up, much like the recent odd weather, has been out­side the expected norm. The price of a bar­rel of crude oil has risen above $100 this year, and the U.S. national aver­age for a gal­lon of gas rose to $3.867 in mid-March, up more than 30% over last year.¹ All this, and the tra­di­tional North Amer­i­can sum­mer dri­ving sea­son hasn’t even started yet. Fromm explains the dance of sup­ply and demand, as he sees it.

“We’re actu­ally see­ing U.S. demand down year-over-year for gaso­line, but demand out­side the U.S. has remained strong. Exports out of the United States have now reached a level we haven’t seen for sev­eral decades; we’ve actu­ally become a net exporter of fuel.¹ Of course, we still import quite a bit of crude oil, but demand in Latin Amer­ica, for instance, is quite robust and they don’t have a lot of refin­ing capac­ity com­ing on line there. China’s demand has also remained quite strong, even though there’s a lot of con­cern about slow­ing eco­nomic growth. In Feb­ru­ary, China set a monthly record for oil imports.² One of the other fac­tors is sup­ply. Non-OPEC sup­ply con­tin­ues to dis­ap­point, mean­ing it’s com­ing in lower than most peo­ple had expected it. And, as a result, that helps keep the sup­ply side fairly tight as well.

And then, of course, there are geopo­lit­i­cal ten­sions: what’s going on with Iran and the poten­tial for a sig­nif­i­cant dis­rup­tion to fuel sup­ply, and also the issues in Syria, which are ongo­ing. I don’t think we’re going to have a sig­nif­i­cant dis­rup­tion, but there is some prob­a­bil­ity that a dis­rup­tion could occur. I think that’s being fac­tored into crude oil prices.”

Impact of Chi­nese Demand

As Fromm men­tioned, the impact of Chi­nese demand is impor­tant for the oil mar­ket. China is the world’s second-largest con­sumer of oil, behind the United States,³ and is also a large con­sumer of other nat­ural resources. That con­sump­tion has been an eco­nomic dri­ver for sup­pli­ers, but it’s also been a source of con­cern for those who fear China’s con­sump­tion will drive up prices and leave the rest of the world with expen­sive table scraps. Regardless, China’s GDP is antic­i­pated to slow a bit this year from last year’s pace of 9.2%. In Fromm’s view, that’s not nec­es­sar­ily a bad thing, because he does believe com­mod­ity sup­plies would be strained if China sus­tained its recent high level of demand.

“I think one of the most impor­tant things to think about is that China had to slow: as I see it, there’s no way it could con­tinue at the pace that it was grow­ing, indef­i­nitely. The world just does not have enough com­modi­ties to sup­ply that level of growth. We do see some risk areas that have been grow­ing quite rapidly, like steel pro­duc­tion, which is a fac­tor in iron ore con­sump­tion and where China rep­re­sents a large part of world demand. That is an area, where, even if you see a lit­tle bit of slow­ing, it could have a big­ger impact. And it’s one of the rea­sons why in the fund we tend to focus more on energy, because we believe it’s a more durable com­mod­ity in terms of global demand, longer term.

Our main job, as we see it, is to iden­tify the areas that we think are going to be the strongest in terms of the supply-demand bal­ance and then iden­tify the com­pa­nies that we think are posi­tioned to ben­e­fit from that envi­ron­ment. So what we’re try­ing to do is fig­ure out which com­modi­ties we think will be best sup­ported by the envi­ron­ment that we see, and then stay away from those that might suf­fer from a slower environment.”

A Look at Gold

Gold is another com­mod­ity that’s been cap­tur­ing head­lines, per­ceived as a “safe-haven” asset class by many investors. Gold made a record run in the wake of the 2008–2009 finan­cial cri­sis. What does Fromm, think of gold? And what is his strategy?

“Gold is prob­a­bly the most dif­fi­cult to pre­dict among all of the com­modi­ties for var­i­ous rea­sons, so we don’t try to come up with a spe­cific com­mod­ity price for gold. We use ranges and try to estab­lish a level where we feel its price is well sup­ported. And then we look to see what the gold-based– equi­ties are reflect­ing, because that’s where we invest. We do not invest in gold bul­lion itself. The demand side still looks fairly robust around the world, even though we do have to watch that closely because invest­ment demand has become a much big­ger por­tion and that’s some­thing that, as we know, can go away pretty quickly.

But I think the sup­ply side and what’s going on there is more impor­tant. It con­tin­ues to strug­gle to grow, and what we are see­ing right now is that costs are ris­ing sig­nif­i­cantly, espe­cially for new projects. And what that could mean in the future is that there could be less invest­ment. We’re also see­ing a lack of explo­ration from some of the major min­ing com­pa­nies, which could impact sup­ply longer term. So as long as demand stays fairly healthy, and the sup­ply side con­tin­ues to strug­gle, we think the supply-demand bal­ance should remain tight enough to sup­port the com­mod­ity.

I also think that, as impor­tant as how the com­mod­ity itself is priced, is what the commodity-based stocks are reflect­ing, and the equi­ties have sig­nif­i­cantly under­per­formed the metal itself over the past year or year and a half. And because of that, in our view, the equi­ties are look­ing more attrac­tive now. So what we are try­ing to do is to deter­mine if the metal will be sup­ported at a level that will still make the equi­ties attrac­tive, and we do believe at this time that looks to be the case.”

Geopo­lit­i­cal Risks

Both oil and gold are mar­kets that can be sub­ject to geopo­lit­i­cal risk, which in turn can cre­ate price volatil­ity. Vet­ting each indi­vid­ual com­pany is always a very impor­tant part of the invest­ment process, but polit­i­cal unpre­dictabil­ity can add a layer of addi­tional chal­lenges. For Fromm, it boils down to thor­ough fun­da­men­tal research and due dili­gence, which often includes man­age­ment meet­ings and site vis­its in far-flung locales.

“We have ana­lysts going to small coun­tries in Africa.  I’ve been to the inte­rior in China vis­it­ing sin­gle gold mines. And this is a very impor­tant part of the research process. But I think what’s very crit­i­cal is a company’s man­age­ment and their abil­ity to find their way through the polit­i­cal land­scape in the var­i­ous coun­tries. And so, there­fore, we put a high degree of impor­tance on management’s abil­ity, their expe­ri­ence and track record to not only explore new areas but also deliver on projects.  One of the areas where we are see­ing costs really go up is the process of actu­ally bring­ing pro­duc­tion on line at these var­i­ous mines.

The other fac­tor is diver­si­fy­ing. You obvi­ously don’t want to put all your eggs in one bas­ket and be in too many invest­ments in one coun­try that has a high degree of polit­i­cal risk. You are always going to have some polit­i­cal risk; we even have it here in the United States. But in cer­tain coun­tries it is ele­vated, and we will attempt to man­age that risk through diver­si­fi­ca­tion and also through posi­tion size. So we will strive to have smaller posi­tions in names that we believe have a higher degree of geopo­lit­i­cal risk.”

Fromm’s phi­los­o­phy fits with Sir John Templeton’s thoughts on the sub­ject. “No mat­ter how care­ful you are, you can nei­ther pre­dict nor con­trol the future…so you diversify—by indus­try, by risk, and by coun­try.”

What are the Risks?

All invest­ments involve risks, includ­ing pos­si­ble loss of prin­ci­pal. Stock prices fluc­tu­ate, some­times rapidly and dra­mat­i­cally, due to fac­tors affect­ing indi­vid­ual com­pa­nies, par­tic­u­lar indus­tries or sec­tors, or gen­eral mar­ket con­di­tions.

Franklin Nat­ural Resources Fund: Invest­ing in a fund con­cen­trat­ing in the nat­ural resources sec­tor involves spe­cial risks, includ­ing increased sus­cep­ti­bil­ity to adverse eco­nomic and reg­u­la­tory devel­op­ments affect­ing the sec­tor. The fund may also invest in for­eign stocks, which involve expo­sure to cur­rency volatil­ity and polit­i­cal and eco­nomic uncer­tainty. The fund’s hold­ings in smaller com­pa­nies involve spe­cial risks asso­ci­ated with smaller rev­enues and mar­ket share, and more lim­ited prod­uct lines. The prices of such secu­ri­ties can be volatile, par­tic­u­larly over the short term. These and other risks are described more fully in Franklin Nat­ural Resources Fund’s prospec­tus.

Franklin Gold and Pre­cious Met­als Fund: Invest­ing in a non-diversified fund involves the risk of greater price fluc­tu­a­tion than a more diver­si­fied port­fo­lio. Also, the fund con­cen­trates in the pre­cious met­als sec­tor which involves fluc­tu­a­tions in the price of gold and other pre­cious met­als and increased sus­cep­ti­bil­ity to adverse eco­nomic and reg­u­la­tory devel­op­ments affect­ing the sec­tor. In addi­tion, the fund is sub­ject to the risks of cur­rency fluc­tu­a­tion and polit­i­cal uncer­tainty asso­ci­ated with for­eign invest­ing. Invest­ments in devel­op­ing mar­kets involve height­ened risks related to the same fac­tors, in addi­tion to those asso­ci­ated with their rel­a­tively small size and lesser liq­uid­ity. The fund may also invest in smaller com­pa­nies, which can be par­tic­u­larly sen­si­tive to chang­ing eco­nomic con­di­tions, and their prospects for growth are less cer­tain than those of larger, more estab­lished com­pa­nies. These and other risks are described more fully in Franklin Gold and Pre­cious Met­als Fund’s prospec­tus.

² Source: People’s Repub­lic of China, Gen­eral Admin­is­tra­tion of Customs.

³ Source: CIA World Fact Book 2010 – 2011.

Tags: China, Commodities, Commodity, Commodity Supply, Demand Balance, Eye Glasses, Franklin Templeton Investments, Fromm, Fuel Prices, Fuel Surcharges, Gallon Of Gas, Geographic Diversification, Geopolitical Issues, Gold, Liquid Eye, Mid March, Mining, Natural Resources Fund, Oil Price, Political Risk, Precious Metals Fund, Price Hikes, Price Of A Barrel Of Crude Oil, Seasonal Rise, Transport Vehicles
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The Fed’s Con Appears To Be Working But The Curtain Is Rising On The Third Act

Wednesday, April 4th, 2012

 
Cour­tesy of Lee Adler of the Wall Street Examiner

In today’s conomic news, the main­stream media focused on the dis­ap­point­ment sur­round­ing the FOMC Min­utes, the mas­saged and san­i­tized fairy tale about what the par­tic­i­pants said at last month’s FOMC con­fab. The mar­ket was shocked! SHOCKED! that most of the mem­bers saw no need for addi­tional QE, unless things got worse. I had con­cluded that a cou­ple of months ago based on the fact that every time QE spec­u­la­tion arose, not only did stocks rally, but so did energy and other com­mod­ity prices. The com­mod­ity vig­i­lantes, I thought, would tie the Fed’s hands. That and the fact that the conomic data was com­ing in rel­a­tively perky, at least in terms of the head­line data, made it highly unlikely that the Fed would do any more money printing.

But here’s the thing. The min­utes are fake. They are fab­ri­cated, false, phony, and ster­il­ized garbage, designed for pub­lic con­sump­tion. To put it bluntly, they’re pro­pa­ganda. They are what the Fed and Wall Street casino own­ers want you to think. They are a bla­tant attempt to manip­u­late the behav­ior of mar­ket par­tic­i­pants through the use of clever turns of phrase. The Fed wants the mar­ket to go higher, but it doesn’t want com­modi­ties to go with it, so its story line is that the con­omy is healthy enough to con­tinue grow­ing with­out more QE. That gives traders rea­son to con­tinue buy­ing stocks, and no rea­son to buy com­modi­ties, which every­one “knows” go up when the Fed prints, in spite of Bernanke’s denials. And besides, com­modi­ties are up for other rea­sons, not any­thing Ben did, accord­ing to Ben.

That’s what these “min­utes” are about, self jus­ti­fi­ca­tion and mar­ket manip­u­la­tion. We won’t know the real story until Feb­ru­ary 2018 when the Fed will release the tran­scripts of this year’s FOMC meet­ings. Why do they hold them back for at least 5 years? Because the Fed thinks that you can’t han­dle the truth. The prob­lem is that you can and they just don’t want you to know what it is, because if you did, you’d be able to make informed invest­ment deci­sions. The deci­sions the Fed wants you to make are to buy stocks, bay and hold Trea­suries, and sell com­modi­ties. They tai­lored the min­utes accord­ingly, so that the head­lines would elicit the desired response. They think that they’re Pavlov, and we’re the dogs.

Admit­tedly, I have not yet read the min­utes (I will for this weekend’s Fed Report), but I have read the news head­lines. Those head­lines are what the Fed-Wall Street-Media-Industrial Com­plex wants you to think, so you really don’t need to read the min­utes. Rest assured that the Fed got the pro­pa­ganda it wanted. The mar­ket reac­tion it wanted it hasn’t yet got­ten, yet, but the Fed is bet­ting that it will, and therein lies the rub. The Fed doesn’t always get what it wants. If traders decide to sell the Dow off 200 points in response to this news, then the next morn­ing, the Fed’s ven­tril­o­quist dummy, Jon Hilsen­rath, will float another QE3 trial bal­loon in the Wall Street Urinal.

So we’ll just have to see how traders respond. As for what the Fed really thinks, sorry, that will have to wait 6 years.

Mean­while, the other dat­a­point the con­o­mists focused on today was Feb­ru­ary Fac­tory Orders. This is an item based on a Cen­sus Bureau monthly sur­vey of a tiny sam­pling of US man­u­fac­tur­ers that extrap­o­lates that sam­ple into a total dol­lar esti­mate of new orders and other met­rics. The Bureau reports both the sea­son­ally adjusted result and the actual result, also known as not sea­son­ally adjusted. The only num­ber the pun­dits and media pay atten­tion to is the sea­son­ally adjusted, fic­tional num­ber. That’s just wrong, but that’s the way it is. It gives us the oppor­tu­nity to look at the actual data and know what’s really going on, rather than the smoothed fic­tion that the Wall Street mouth­pieces present on a sil­ver plat­ter as if it’s the grail.

The head­line num­ber for Feb­ru­ary was a 1.3% month to month increase, sea­son­ally smoothed. That was a miss. The conomic con­sen­sus was for a gain of 1.5%. But this is a minor item in the conomic firmament–durable goods orders out the week before are more important–and the pun­dits man­aged to spin it as bull­ish any­way. The bull­ish­ness is wild and uni­ver­sal, nary a con­trar­ian to be found in the pages of the Mur­doch, Bloomberg tout sheets.

The head­line num­ber isn’t always wrong or mis­lead­ing, and as it turns out, the actual, not sea­son­ally adjusted gain in Feb­ru­ary was impres­sive, up 4.7% from Jan­u­ary and up 10.6% over Feb­ru­ary 2011, both in real terms adjusted by CPI infla­tion. The 4.7% monthly gain com­pared with a decline of 0.7% in Feb­ru­ary 2011. Over the prior 10 years, monthly changes in Feb­ru­ary ranged from last year’s –0.7% to a high of +4.9% in Feb­ru­ary 2004. Any way you slice it this was a good num­ber. Did the warm weather in Feb­ru­ary have any­thing to do with that? Cer­tainly, but it’s impos­si­ble to say how much. If it pulled demand for­ward from March and April, we’ll see that in the next month or two.

I thought it would be inter­est­ing to over­lay the ISM’s not sea­son­ally adjusted New Orders Index on the chart of new fac­tory orders. I am using the fac­tory orders not sea­son­ally adjusted data, but adjusted for infla­tion in order to see the real change in unit vol­ume over time. The ISM­sur­vey should lead the Fac­tory Orders. The ISM data is for March. It turns out that the cor­re­la­tion with the between the ISM New Orders Index, and the 12 month rate of change in the Com­merce Department’s New Fac­tory Orders data is pretty close. Lately, how­ever, the ISM data sug­gests greater weak­ness than has been show­ing up in the gov­ern­ment data. Who’s right? I don’t know, but as with the ISM and the 50 line on its chart, an annual change in fac­tory orders of more than 1 to 2%, tends to cor­re­late with an ongo­ing uptrend in stocks. It will be time to start wor­ry­ing when the growth rate closes in on zero. That has cor­re­lated with a top­ping process in stocks.

Real Fac­tory Orders NSA Chart– Click to enlarge

Man­u­fac­tur­ing activ­ity lags stock prices. By the time new fac­tory orders go neg­a­tive, stocks will have already gone through their first leg down.  Con­sumers and busi­nesses take their cues from the stock mar­ket, and the stock mar­ket takes its cues from the Fed.

Every­body thinks that Dr. Bernankenstein’s mon­ster alpha­bet soup exper­i­ments, and Henry Paulson’s TARP saved the world from conomic col­lapse. The fact is that they caused, or at least exac­er­bated the conomic col­lapse. Take the man­u­fac­tur­ing orders data as an exam­ple of how that unfolded.

Fed, Stocks, and Fac­tory Orders Chart– Click to enlarge

The man­u­fac­tur­ing con­omy was doing just fine until Bernanke stopped feed­ing the Pri­mary Deal­ers and actu­ally starved them out early in 2008. He did that by pay­ing for his crazy alpha­bet soup pro­grams with cash from the Fed’s Sys­tem Open Mar­ket Account. In sell­ing and redeem­ing Trea­suries from the SOMA he rad­i­cally shrank the cash lev­els in Pri­mary Dealer accounts, ren­der­ing them  unable to main­tain orderly mar­kets. The deal­ers are, after all, not just mar­ket mak­ers in Trea­suries. They run all the mar­kets, stocks, bonds, com­modi­ties, futures, options, every­thing. They are the big mahoffs of all the mar­kets, and Ben is their banker and bagman.

So man­u­fac­tur­ing  was doing just fine in 2007 and 2008 until stocks broke down. Stocks broke because of the com­bi­na­tion of the Fed starv­ing out the Pri­mary Deal­ers in late 2007 and the first half of 2008, fol­lowed by Henry Paulson’s bravura panic per­for­mance before House and Sen­ate com­mit­tees, con­vinc­ing Con­gress to fund the $700 bil­lion TARP. Bernanke was best sup­port­ing actor at those hearings.

Faced with the tes­ti­mony of the two dyna­mite strapped sui­cide extor­tion­ists, Con­gress caved, and the Trea­sury raised that money in a few short weeks in Sep­tem­ber and Octo­ber 2008. That forced the deal­ers (and oth­ers) to absorb $100–200 bil­lion a week of new Trea­sury sup­ply at a time when the Fed had already cut their balls off. They were in no posi­tion to absorb any­thing.  The Fed had taken their man­hood and all their cash.

In order to per­form their func­tion as Pri­mary Deal­ers and absorb that part of the new Trea­sury sup­ply not pur­chased by oth­ers, the deal­ers had no choice but to liq­ui­date stocks. Because most eco­nomic units, both indi­vid­ual con­sumers and busi­nesses, base their pur­chase deci­sions on the stock mar­ket, when it cratered that was their sig­nal to con­sumers and busi­ness to be scared, be very scared, and hun­ker down in fear in their men­tal bunkers.

Man­u­fac­tur­ing orders were still very strong in June 2008. They didn’t col­lapse until after Bernanke and Paul­son trig­gered the panic.  In Octo­ber 2008, they col­lapsed on the heels of  the Bernanke-Paulson Panic.

The Fed finally fig­ured it out in Feb­ru­ary 2009, and it started a rad­i­cal pro­gram of pump­ing hun­dreds of bil­lions into the accounts of the Pri­mary Deal­ers with QE1. The stock mar­ket and man­u­fac­tur­ing orders rebounded almost imme­di­ately. When the Fed exper­i­mented with with­hold­ing funds in mid 2010, stocks plunged and man­u­fac­tur­ing activ­ity stalled. Dou­ble dip fears exploded and the Fed resumed pump­ing cash into dealer accounts.

Flash for­ward to today and the Fed is again on hold, although its MBS replace­ment pur­chase pro­gram helps to keep the deal­ers liq­uid. The effect of that pro­gram on dealer accounts is not reflected in the SOMA, but it does send cash to dealer accounts. The effects of the pro­gram on stock prices are clear.

The issue now is when will the Fed make its next cat­a­strophic blun­der. Just by tap­ping the brakes on the SOMA, it is cre­at­ing con­di­tions for another swoon. It is try­ing to hold back com­mod­ity prices while get­ting the ben­e­fit of conomic growth. The prob­lem is that that growth is a sec­ond order bub­ble effect of the ris­ing stock mar­ket. If they don’t feed the mar­ket, they won’t get their conomic growth. If they do feed the mar­ket, com­mod­ity prices will explode upward, and that will even­tu­ally put a stake in the heart of growth. For now, man­u­fac­tur­ing activ­ity is on a growth track. On the sur­face it appears that the Fed’s pro­pa­ganda and manip­u­la­tion is work­ing, but in truth Bernanke has laid the ground­work for the Fed’s next blun­der, panic move,  and mas­sive dislocation.

Copy­right © 2012 The Wall Street Exam­iner. All Rights Reserved. This arti­cle may be reposted with attri­bu­tion and a promi­nent link to the source The Wall Street Examiner.

Tags: Bernanke, Blatant Attempt, Buying Stocks, Casino Owners, China, Commodities, Commodity, Commodity Prices, Conomy, Denials, Fairy Tale, Fomc Meetings, Fomc Minutes, Lee Adler, Mainstream Media, Market Manipulation, Market Participants, Money Printing, Public Consumption, Qe, Self Justification, Street Casino
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Does China Hold the Winning Ticket?

Sunday, April 1st, 2012

By Frank Holmes, CEO and Chief Invest­ment Offi­cer, U.S. Global Investors

The odds of win­ning tonight’s Mega Mil­lions jack­pot are 1 in 175,711,536. This remote chance hasn’t stopped peo­ple from lin­ing up to buy a ticket, as the “what-if-I-win” idea seems so thrilling.

Some bears may think the odds of China being the win­ner among emerg­ing mar­kets in 2012 are also remote. Over the past few years, Chi­nese stocks have lagged com­pared to its emerg­ing mar­ket peers. How­ever, the Peri­odic Table of Emerg­ing Mar­ketsper­fectly illus­trates: last year’s loser can be this year’s win­ner. His­tor­i­cally, every emerg­ing coun­try has expe­ri­enced wide price fluc­tu­a­tions from year to year. Over time, though, each coun­try tends to revert to the mean.

In the visual below, we high­lighted China’s per­for­mance pat­tern over the past 10 years. Chi­nese stocks landed in the top half four out of 10 years—2002, 2003, 2006 and 2007. In 2003, China climbed an astound­ing 163 per­cent; in 2007, it was the top emerg­ing mar­ket again, return­ing nearly 60 percent.

Since then, the coun­try has fallen to the bot­tom half of the chart. If you apply the prin­ci­ple of mean rever­sion, his­tory appears to favor China land­ing on top dur­ing this Year of the Dragon.

See the orig­i­nal Peri­odic Table of Emerg­ing Mar­kets here.

Unlike the lot­tery sys­tem, China won’t leave its suc­cess to pure luck. If the Dragon doesn’t breathe fire into mar­kets, it may be a shot of liq­uid­ity injected by pol­icy eas­ing that could drive stock prices higher. Macro­eco­nomic the­ory states that when a country’s money sup­ply exceeds eco­nomic growth, the excess liq­uid­ity tends to drive up asset prices, includ­ing stocks.

BCA Research doc­u­mented this trend in China over the past eight years. The research firm com­pared the dif­fer­ence between the change in money sup­ply growth and nom­i­nal GDP growth and Chi­nese stock prices. In both instances when the change in excess liq­uid­ity fell to a low, so did stocks. Con­versely, the rise of money sup­ply growth com­pared to GDP growth “coin­cided with major ral­lies” for China’s stock mar­ket, accord­ing to BCA.

Today, it appears that the change in excess liq­uid­ity is just begin­ning to bounce off another low, as are stocks, indi­cat­ing another poten­tial inflec­tion point.

BCA hedges China’s pos­si­ble stock advance­ment in the short-term if signs of eco­nomic improve­ment con­tinue because they “reduce the odds of aggres­sive pol­icy eas­ing.” A few weeks ago, I dis­cussed how investors seemed to over­look China’s focused macro pol­icy strat­egy, with its actions delib­er­ate and pur­pose­ful. This year, the gov­ern­ment has extra incen­tive to sus­tain mean­ing­ful growth as it tran­si­tions to a new lead­er­ship by the end of the year. As Pres­i­dent Hu Jin­tao and Pre­mier Wen Jiabao depart, Xi Jin­ping and Li Keqiang are expected to take over.

Look­ing at his­tor­i­cal GDP growth per year since 1978, Deutsche Bank finds there’s prece­dence for this idea. Dur­ing the fifth year of the lead­er­ship tran­si­tion cycle, “high or sta­ble” GDP growth was main­tained, with the excep­tion being the Asian Finan­cial Cri­sis in 1997.

When I was in Sin­ga­pore at the Asia Min­ing Con­gress this week, I was for­tu­nate to be among a group of sharp and intel­li­gent experts across the finan­cial and min­ing indus­tries. One China bull pre­sent­ing an excel­lent case for the coun­try was Jing Ulrich, JP Morgan’s man­ag­ing direc­tor and chair­man of China equi­ties and com­modi­ties group. She’s the Oprah Win­frey of the invest­ment world, as for the past three years, Forbes Mag­a­zine has ranked her among the 50 Most Pow­er­ful Women in Business.

Ulrich expressed sim­i­lar views toward China and its polit­i­cal will in a recent “Hands-On China Report” fol­low­ing her atten­dance at the China Devel­op­ment Forum in Bei­jing. She said that the gov­ern­ment min­is­ters empha­sized their com­mit­ment to rebal­anc­ing the econ­omy toward con­sump­tion. While “fun­da­men­tals are cur­rently sound, the nation must mod­ify its ‘imbal­anced, unco­or­di­nated and unsus­tain­able’ course of devel­op­ment,” says Ulrich. Impor­tantly, the gov­ern­ment had the finan­cial resources to effect this change and con­sid­ered it impor­tant to main­tain sus­tain­able growth, writes Ulrich.

The ups and downs of this road toward a consumption-led econ­omy are top­ics I’ll cover in next week’s web­cast on China. I will be joined by CLSA’s Andy Roth­man. Together, we’ll dis­cuss what investors should expect from China in terms of long-term GDP growth, fixed asset invest­ment, exports and the hous­ing mar­ket. Be sure to sign up now.

Copy­right © U.S. Global Investors

Tags: Asset Prices, Chief Investment Officer, China, Chinese Stock, Chinese Stocks, Commodities, Commodity, Emerging Market, Emerging Markets, Excess Liquidity, Frank Holmes, Gold, India, Lottery System, Macroeconomic Theory, Mega Millions, Mining, Money Supply Growth, Nominal Gdp Growth, Periodic Table, Price Fluctuations, Ris, Stock Prices, Theory States, U S Global Investors, Year Of The Dragon
Posted in Brazil, Markets | Comments Off

Energy and Natural Resources Market Radar (April 2, 2012)

Sunday, April 1st, 2012

Energy and Nat­ural Resources Mar­ket Radar (April 2, 2012)

Strengths

• Recent data trends sup­port the Global Resources Fund (PSPFX) man­agers’ long-term invest­ment theme of higher food, agri­cul­tural com­mod­ity and land prices. After surg­ing over 6 per­cent on Fri­day, corn futures closed flat for the week at $6.44 per bushel. The Fri­day surge came after new gov­ern­ment data was released show­ing a drop in the amount of corn in stor­age. This raised con­cerns that corn sup­plies will remain tight and prices high in the near term.
• Iraq’s cen­tral gov­ern­ment has approved pay­ment of close to $560 mil­lion to oil pro­duc­ers in the autonomous Kur­dish region after Kur­dish author­i­ties threat­ened to halt exports due to a lack of pay­ments from Bagh­dad. Mean­while, Iraqi oil sales are head­ing toward a post-war high this month as a new Per­sian Gulf ship­ping out­let pro­vides a long-awaited boost to export capacity.
• Indian oil con­sump­tion increased by 67 thou­sand bar­rels per day (2.1 per­cent) on a year-over-year basis in Feb­ru­ary, the second-highest level on record. This was the fifth-straight month where demand totaled more than 3 mil­lion bar­rels per day, high­light­ing the country’s steady increase in oil con­sump­tion. Dri­ven by improv­ing indus­trial activ­ity and con­tin­ued pen­e­tra­tion of diesel in the auto­mo­bile sec­tor, diesel sales, which make up over one-third of Indian demand, increased by 8 per­cent year-over-year to 1.423 mil­lion bar­rels per day, the second-highest level ever.
• U.S. crude con­sump­tion is hold­ing up at around 14.55 mil­lion bar­rels per day, a 3 per­cent year-over-year rise so far this year. Despite high gaso­line prices, growth is expected to rise by 1.9 per­cent quarter-over-quarter and 5 per­cent year-over-year.

Weak­nesses

• The supply-side of the alu­minum mar­ket has expe­ri­enced a sharp bifur­cat­ing trend between China and the rest of the world so far in 2012 fol­low­ing sev­eral capac­ity cut­backs in North Amer­ica and Europe at the turn of the year. Data from the Inter­na­tional Alu­minum Insti­tute (IAI) showed that global alu­minum out­put exclud­ing China fell to 68,900 tons in Feb­ru­ary, the low­est level since Decem­ber 2010 and the first year-over-year decline since the begin­ning of that year.
• Barclay’s Com­modi­ties Research vis­ited China last week and met with a range of cop­per mar­ket fab­ri­ca­tors, smelters and phys­i­cal traders. Their key take­away was that spot demand for cop­per is weak and improve­ment in the sec­ond quar­ter may be tepid. Sen­ti­ment among cop­per fab­ri­ca­tors is neg­a­tive because orders have been slow to improve. Inven­to­ries of cop­per cath­odes are low, but inven­to­ries of fin­ished prod­uct are higher than usual for this time of year.

Oppor­tu­ni­ties

• The gov­ern­ment of Tan­za­nia plans to invite oil oper­a­tors to bid for 16 new off­shore blocks under a new licens­ing round sched­uled for Sep­tem­ber 2012.
• There are a num­ber of ana­lysts who now believe soy­beans can increase to $14-$15 per bushel by late May, due to South America’s har­vest progress and result. This drove Oil World to refine its fore­cast, say­ing that there was a "high prob­a­bil­ity that soy­beans will exceed $14 per bushel for the July 2012 con­tract." The com­ments came in a report that fore­casted world soy­bean inven­to­ries to plunge 20 per­cent to 60.6 mil­lion tons in 2011-12. This is a much steeper drop off than the 12.5 per­cent tum­ble expected by the U.S. Depart­ment of Agriculture.
• Despite price declines, Indonesia's coal pro­duc­tion is expected to rise up to 5 per­cent from a year ear­lier to 390 mil­lion tons in 2012. "This year we esti­mate that pro­duc­tion will reach 380–390 mil­lion tons even though prices have gone down," said Supri­atna Suhala, deputy chair­man and exec­u­tive direc­tor of the APBI-Indonesia Coal Min­ing Asso­ci­a­tion. Indone­sia, the world's top ther­mal coal exporter, pro­duced 370 mil­lion tons of coal in 2011. Suhala also fore­casted that Indonesia's domes­tic coal con­sump­tion would jump 15 per­cent to 75 mil­lion tons in 2012.

Threats

• On Tues­day, the Obama admin­is­tra­tion announced long-awaited rules to limit carbon-dioxide emis­sions from new power plants. The rules will effec­tively block the con­struc­tion of new coal-burning plants and make nat­ural gas even more attrac­tive as a fuel for gen­er­at­ing elec­tric­ity. The rules, which have been in the works since late 2009, will add more stress to the belea­guered coal-mining sec­tor while encour­ag­ing devel­op­ment of renew­able energy. The rules will also cer­tainly add to Repub­li­can com­plaints of reg­u­la­tory over­reach by the Obama admin­is­tra­tion ahead of the Novem­ber elec­tions. The rules face seri­ous oppo­si­tion in Con­gress and the legal under­pin­nings are already being chal­lenged in court.
• The pro­posed Vol­cker rule crack­down on trad­ing and invest­ing by banks could cause gaso­line, elec­tric­ity and nat­ural gas prices to rise, accord­ing to a new report from IHS. With the report, HIS is seek­ing to gauge the rule's impact on energy com­pa­nies and mar­kets, includ­ing oil refiner­ies, nat­ural gas pro­duc­ers, and elec­tric­ity providers. The report's authors said large banks play a key role in help­ing a vari­ety of energy com­pa­nies’ hedge risk and engage in timely trades on com­mod­ity exchanges. Accord­ing to the report, any reduc­tion in the banks' abil­ity to play this role because of the Vol­cker rule will cause the cost of doing busi­ness to rise and that will lead to higher energy prices for consumers.
• Four weeks before the country’s pres­i­den­tial elec­tion, France is in talks with the U.S. and Britain on a pos­si­ble release of strate­gic oil stocks to push fuel prices lower.
• Barclay’s Com­modi­ties Research also noted that although imports of cop­per are likely to remain strong in March and pos­si­bly April, they will likely trail off until later in the year. Over­all, they believe that short-term Chi­nese demand is likely to dis­ap­point before begin­ning on a recov­ery tra­jec­tory later in the sec­ond quar­ter. They also believe that imports will weaken until bonded stocks are run down, pos­si­bly in the third quar­ter of this year.

Tags: agricultural, Agricultural Commodity, Agriculture, Automobile Sector, Bushel, Commodities, Commodity, Corn Futures, Data Trends, Diesel Sales, Gasoline Prices, Global Resources, Government Data, India, Indian Oil, Iraqi Oil Sales, Kurdish Region, Long Term Investment, Market Radar, Mining, Oil Consumption, Oil Producers, Persian Gulf, Resources Fund, S Central, Shipping Outlet
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James Paulsen: Does Gold Still Glitter?

Friday, March 30th, 2012

Does GOLD Still Glitter?

by James Paulsen, Chief Invest­ment Strate­gist, Wells Cap­i­tal Man­age­ment (Wells Fargo)

Gold has been an invest­ment dar­ling in recent years. Indeed, it is often per­ceived as the cure for any invest­ment worry. Whether you are con­cerned about infla­tion, defla­tion, gov­ern­ment deficits, war, a U.S. dol­lar col­lapse, reces­sion, or depression—GOLD is the answer!

The extra­or­di­nary pop­u­lar­ity of gold today is easy to understand—it has done so well for so long! Since the end of the 1990s, the price of gold has risen almost six-fold from less than $300 to its cur­rent price of almost $1,700. Many expect the price of gold to rise con­sid­er­ably higher in the next sev­eral years and per­ceive the mod­est decline in the gold price since its all-time peak last Sep­tem­ber as a buy­ing oppor­tu­nity. While own­ing some gold is fine for all investors (diver­si­fi­ca­tion is para­mount), we think gold weight­ings should be scaled back in most port­fo­lios. The yel­low metal may soon lose some of its lus­ter as its strug­gles with its newly ele­vated val­u­a­tion and with the like­li­hood that con­fi­dence through­out the econ­omy is begin­ning to improve.

Gold is OVERVALUED!

Unlike stocks or bonds, gold has always been more dif­fi­cult to value since it pro­duces no cash flow (i.e., earn­ings or coupons) that can be dis­counted to arrive at a present (fair) value. How­ever, Exhibit 1 illus­trates a sim­ple “rel­a­tive val­u­a­tion” method­ol­ogy pro­vid­ing an his­tor­i­cal per­spec­tive against most other invest­ment classes (e.g., stocks, bonds, com­modi­ties, and real estate) and rel­a­tive to the value of labor and a bas­ket of con­sumer goods and ser­vices. In each of the six charts shown, the price of gold on a rel­a­tive basis is either near­ing or is at one of its high­est val­u­a­tions of the last 50 years. At the end of the 1990s, it took almost 5.5 ounces of gold to buy the S&P 500 Stock Price Index. Today, it only takes 0.8 of a sin­gle ounce to buy the stock mar­ket. Rel­a­tive to stocks, gold is almost as expen­sive today as it was in the late 1970s when the price of gold had surged after its peg was elim­i­nated and after the stock mar­ket was rav­ished by a decade of run­away inflation.

Rel­a­tive to Trea­sury bonds, the price of gold cur­rently trades near an all-time, post-war record high sur­pass­ing its old rel­a­tive val­u­a­tion record estab­lished in the late 1980s when bonds were incred­i­bly cheap. It is indeed remark­able that gold today is this expen­sive rel­a­tive to an asset class (bonds) which most agree is prob­a­bly itself extremely overvalued.

In recent years, while gold prices have soared, U.S. home prices have col­lapsed. Although the price of gold rel­a­tive to U.S. homes is not yet as high as it reached in the late 1970s, its cur­rent rel­a­tive val­u­a­tion com­pared to house prices leaves lit­tle opti­mism about the future poten­tial for gold prices. Gold is also expen­sive rel­a­tive to worker pay. In 2000, it took less than 20 hours of work (at the aver­age hourly wage rate) to pur­chase a sin­gle ounce of gold. Today, by con­trast, it takes almost 90 hours of labor to buy an ounce of gold! In a sim­i­lar fash­ion, the price of gold rel­a­tive to the bas­ket of con­sumer goods and ser­vices com­pris­ing the Con­sumer Price Index is near its all-time record high reached in the early 1980s.

Finally, even com­pared to other com­mod­ity prices, the price of gold is near­ing its all-time record rel­a­tive price reached in the late 1980s. Even though com­mod­ity prices in gen­eral have increased sig­nif­i­cantly in the last decade, the price of gold has risen even more dramatically.

While val­u­a­tion met­rics have not tra­di­tion­ally been a good invest­ment tim­ing tool, they have pro­vided a use­ful indi­ca­tion of the future upside/downside price poten­tial of an invest­ment. Rel­a­tive to other invest­ments, the charts in Exhibit 1 not only sug­gest upside is prob­a­bly lim­ited for gold but also cau­tions that down­side price risk could be sig­nif­i­cant. At a min­i­mum, these charts do not seem to sup­port the wide­spread pop­u­lar­ity and opti­mism con­cern­ing gold investing.

Gold and the “Fear Premium”?

Exhibit 2 shows the price of gold rel­a­tive to other com­mod­ity prices. Although gold has been a spec­tac­u­lar invest­ment since 2000, so have other com­modi­ties. Sur­pris­ingly, since 2000, the price of gold has only sig­nif­i­cantly out­paced other com­mod­ity prices dur­ing a few months in late 2008 when the “Great Finan­cial Cri­sis” erupted. Between 2000 and late 2008, the rel­a­tive price of gold to other com­modi­ties remained flat at about 1.5 imply­ing both gold prices and other com­mod­ity prices rose by equal amounts dur­ing the period. Sim­i­larly, the rel­a­tive price of gold was also unchanged between early 2009 and today. That is, “all” com­mod­ity prices rose just as much as gold prices between 2000 and late 2008 and again between early 2009 until today (despite this, how­ever, gen­eral com­modi­ties remain a much less pop­u­lar invest­ment than gold).

The only time gold sig­nif­i­cantly out­paced other com­mod­ity invest­ments was when investor “fear” surged. Exhibit 2 illus­trates the “fear pre­mium” the price of gold received rel­a­tive to other com­mod­ity prices dur­ing the 2008 cri­sis and how much of this pre­mium is still embed­ded in its price today. Between 2000 and late 2008, the price of gold oscil­lated in broad range about 1.4 times the value of the S&P GSCI Com­mod­ity Price Index. Today, gold trades at about 2.4 times the value of this com­mod­ity index. The risk or fear pre­mium embed­ded in the price of gold (i.e., about 1.0, the dif­fer­ence between the rel­a­tive price of gold today at 2.4 and where it used to trade prior to the 2008 cri­sis at about 1.4) is quite large and needs to be assessed when con­sid­er­ing an invest­ment in gold. A pri­mary risk for gold investors is the poten­tial for decay in this fear premium.

Gold’s Best Friend (Fear) May be Fading?!?

Exhibit 3 illus­trates the chal­lenge gold investors may face in the next few years should con­fi­dence slowly improve and “cri­sis fears” fade. This exhibit com­pares the rel­a­tive price of gold to the Con­sumer Con­fi­dence Index. The con­fi­dence index (dot­ted line) is shown on an inverted scale so a rise (fall) in the dot­ted line illus­trates peri­ods when con­fi­dence is declin­ing (increasing).

While not a per­fect rela­tion­ship, the rel­a­tive price of gold rel­a­tive to other com­mod­ity prices seems impor­tantly dri­ven by con­fi­dence. Gold’s best friend in recent years has been fear! As con­fi­dence col­lapsed in 2008, the rel­a­tive price of gold far out­paced other com­mod­ity invest­ments. Like­wise, the decline in con­fi­dence after the tech wreck and after 9/11 in the early 2000s pro­duced a sim­i­lar “fear pre­mium” in the rel­a­tive per­for­mance of gold prices. How­ever, between 2003 and 2007, the “fear pre­mium” embed­ded in gold even­tu­ally evap­o­rated once con­fi­dence again revived as the eco­nomic recov­ery matured. A sim­i­lar revival in eco­nomic con­fi­dence may be emerg­ing today. If the Consumer

Con­fi­dence Index does recover to at least 100 in this recov­ery, a good por­tion of the “fear pre­mium” embed­ded in the price of gold may evap­o­rate pro­duc­ing dis­ap­point­ing results for gold bugs.

Sum­mary

Main­tain­ing some gold expo­sure within port­fo­lios makes sense. Should cri­sis fears con­tinue to peri­od­i­cally flare in the next sev­eral years, gold should pro­vide the port­fo­lio with some defen­sive prop­er­ties. How­ever, we believe investors should con­sider reduc­ing gold expo­sure. This is an invest­ment which today seems far too pop­u­lar among the masses, appears extremely over­val­ued rel­a­tive to most other asset classes and faces a chal­leng­ing envi­ron­ment should eco­nomic con­fi­dence slowly improve in the next sev­eral years. The val­u­a­tion of gold rel­a­tive to vir­tu­ally any other asset class (stocks, bonds, real estate or com­modi­ties) seems to sug­gest the price of gold is either extremely rich today and at risk of sig­nif­i­cant decline or sug­gests most other asset classes are very cheap. Either way, it is prob­a­bly time to posi­tion port­fo­lios to ben­e­fit from a slow but steady revival in con­fi­dence rather than in an asset which only “glit­ters” when fear predominates.

Copy­right © Wells Cap­i­tal Management

Tags: Chief Investment Strategist, Commodities, Commodity, Consumer Goods, Diversification, E G Stocks, Glitter, Gold, Gold Price, Government Deficits, Historical Perspective, Last September, Luster, Price Of Gold, Relative Basis, Relative Valuation, Stock Market, Stock Price Index, Stocks Bonds, Time Peak, Valuations, Wells Capital Management, Wells Fargo
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Sprott: Investment Outlook (April 2012)

Wednesday, March 28th, 2012

The [Recov­ery] Has No Clothes

By Eric Sprott & David Baker, Sprott Asset Management

"I believe that there have been repeated attempts to influ­ence prices in the sil­ver mar­kets. There have been fraud­u­lent efforts to per­suade and devi­ously con­trol that price. Based on what I have been told by mem­bers of the pub­lic, and reviewed in pub­licly avail­able doc­u­ments, I believe vio­la­tions to the Com­mod­ity Exchange Act (CEA) have taken place in sil­ver mar­kets and that any such vio­la­tion of the law in this regard should be prosecuted."

- Bart Chilton, Com­mis­sioner, U.S. Com­mod­ity Futures Trad­ing Com­mis­sion (CFTC), Octo­ber 26th, 2010¹

What a dif­fer­ence a month makes. Now that Greece has been papered over, the bulls are back in full force, pump­ing up the equity mar­kets and cel­e­brat­ing every pass­ing data point with pos­i­tive exu­ber­ance. Let's not get ahead of our­selves just yet, how­ever. Very lit­tle has actu­ally changed for the bet­ter, and it's cer­tainly too early to start cheer­lead­ing a new bull market.

Take the lat­est US unem­ploy­ment num­bers, for exam­ple. There was much excite­ment about the lat­est Bureau of Labor Sta­tis­tics (BLS) report which announced that US unem­ploy­ment remained unchanged at 8.3% dur­ing the month of Feb­ru­ary.² The mar­ket was par­tic­u­larly enam­ored by the BLS's insis­tence that non-farm pay­rolls increased by 227,000 dur­ing the month, as well as its upward revi­sion of the Decem­ber 2011 and Jan­u­ary 2012 jobs num­bers. Lost in all the excite­ment was the Gallup unem­ploy­ment report released the day before, which had Feb­ru­ary unem­ploy­ment increas­ing to 9.1% in Feb­ru­ary from 8.6% in Jan­u­ary and 8.5% in Decem­ber.³ Granted, the Gallup method­ol­ogy is slightly dif­fer­ent than that used by the BLS, but even if Gallup had applied the BLS's sea­sonal adjust­ment, they would have still come out with an unem­ploy­ment rate of 8.6%, which is con­sid­er­ably higher than that pro­duced by the BLS.⁴ We all know which num­ber the pun­dits chose to cham­pion, but the Gallup data may have been closer to the truth.

For every semi-positive data point the bulls have empha­sized since the mar­ket rally began, there's a counter-point that makes us ques­tion what all the fuss is about. The bulls will cite expand­ing US GDP in late 2011, while the bears can cite US food stamp par­tic­i­pa­tion reach­ing an all-time record of 46,514,238 in Decem­ber 2011, up 227,922 par­tic­i­pants­from the month before, and up 6% year-over-year.⁵ The bulls can praise February's 15.7% year-over-year increase in US auto sales, while the bears can cite Europe's 9.7% year-over-year decrease in auto sales, led by a 20.2% slump in France.^{6, 7} The bulls can exclaim some­what firmer hous­ing starts in Feb­ru­ary⁸ (as if the US needs more new houses), while the bears can cite the unex­pected 100bp drop in the March con­sumer con­fi­dence index⁹, five con­sec­u­tive months of man­u­fac­tur­ing con­trac­tion in China¹⁰, and more recently, a 0.9% drop in US Feb­ru­ary exist­ing home sales.¹¹ Give us a half-baked bull­ish indi­ca­tor and we can pro­vide at least two bear­ish indi­ca­tors of equal or greater significance.

It has become fairly evi­dent over the past sev­eral months that most new jobs cre­ated in the US tend to be low-paying, while the jobs lost are gen­er­ally higher-paying. This seems to be con­firmed by the monthly US Trea­sury Tax Receipts, which are lower so far this year despite the seem­ing improve­ment in unem­ploy­ment. Take Feb­ru­ary 2012, for exam­ple, where the Trea­sury reported $103.4 bil­lion in tax receipts, ver­sus $110.6 bil­lion in Feb­ru­ary 2011. BLS had unem­ploy­ment run­ning at 9% in Feb­ru­ary 2011, ver­sus 8.3% in Feb­ru­ary 2012.¹² Bar­ring some major tax break we've missed, the only way these num­bers bal­ance out is if the new jobs cre­ated pro­duce less income to tax, because they're lower pay­ing, OR, if the unem­ploy­ment num­bers are wrong. The bulls won't dwell on these details, but they can­not be ignored.

Then there are the banks, our favourite sec­tor. Need­less to say, the lat­est Fed­eral Reserve's bank stress test was a great suc­cess from a PR stand­point, con­vinc­ing the mar­ket that the highly over­lever­aged bank­ing sys­tem is per­fectly capa­ble of weath­er­ing another 2008 sce­nario. The test used an almost apoc­a­lyp­tic hypo­thet­i­cal 2013 sce­nario defined by 13% unem­ploy­ment, a 50% decline in stock prices and a fur­ther 21% decline in US home prices. The stress tests tested where major US banks' Tier 1 cap­i­tal would be if such a sce­nario came to pass. Any­one who still had 5% Tier 1 cap­i­tal and above was safe, any­one below would fail. So essen­tially, in a sce­nario where the stock mar­ket is cut in half, any bank who had 5 cents sup­port­ing their "dol­lar" worth of assets (which are not marked-to-market and there­fore likely not worth any­where close to $1), would some­how sur­vive an oth­er­wise mis­er­able finan­cial envi­ron­ment. The mar­ket clearly doesn't see the ridicu­lous­ness of such a test, and the mean­ing­less­ness of hav­ing 5 cents of cap­i­tal sup­port $1 of assets in an envi­ron­ment where that $1 is likely to be almost com­pletely illiquid.

That any­one still takes these tests seri­ously is some­what of a mys­tery to us, and we all remem­ber how Dexia fared a mere three months after it passed the Euro­pean "stress tests" last Octo­ber. There has since been some good analy­sis on the weak­nesses of the US stress tests, includ­ing an excel­lent arti­cle by Bloomberg's Jonathan Weil that explains the hypocrisy of the test­ing process.¹³ Weil points out that stress-test pass­ing Regions Finan­cial Corp. (RF), which has yet to pay back its TARP bailout money, has a tan­gi­ble com­mon equity of $7.6 bil­lion, and admit­ted in dis­clo­sures that its bal­ance sheet was worth $8.1 bil­lion less than stated on its offi­cial bal­ance sheet. An $8.1 bil­lion write-down plus $7.6 bil­lion in equity equals bank­ruptcy. But the Fed­eral Reserve's ana­lysts didn't seem to mind. It came as no sur­prise to see that Regions Finan­cial took advan­tage of its pass­ing "stress test" grade to raise $900 mil­lion in com­mon equity on Wednes­day, March 14, which it plans to put toward pay­ing off the $3.5 bil­lion it received in TARP money. Well played Regions Finan­cial. Well played.

Our skep­ti­cism would be sup­ported if not for one thing — the recent weak­ness in gold and sil­ver prices. Given our view of the mar­ket, the recent sell-offs have not made sense given the con­sid­er­able cen­tral bank inter­ven­tion we high­lighted in Feb­ru­ary. Although both met­als have had a dis­mal March, we must point out that they were both per­form­ing extremely well going into Feb­ru­ary month-end. Gold had posted a return of 14.1% YTD as of Feb­ru­ary 28th, while sil­ver had appre­ci­ated by 32.5% over the same period. And then what hap­pened? Leap Day happened.

In addi­tion to being Leap Day, Feb­ru­ary 29th also hap­pened to be the day that the Euro­pean Cen­tral Bank (ECB) com­pleted its sec­ond tranche of the Long-Term Refi­nanc­ing Oper­a­tion (LTRO), which amounted to another €529.5 bil­lion of printed money lent to roughly 800 Euro­pean banks. Feb­ru­ary 29th also hap­pened to be the day that Fed­eral Reserve Chair­man Ben Bernanke deliv­ered his semi-annual Mon­e­tary Pol­icy Report to Con­gress. Need­less to say, dur­ing that day gold mys­te­ri­ously plunged by over $100 at one point and closed the day down 5%. Sil­ver was dragged down along with gold, drop­ping 6%. Any rea­son­ably informed gold investor must have ques­tioned how gold could drop by 5% on the same day that the Euro­pean Cen­tral Bank unleashed another €530 bil­lion of printed money into the EU bank­ing sys­tem. But all eyes were on Bernanke, who man­aged to con­vince the mar­ket that QE3 was off the table for the indef­i­nite future by sim­ply not men­tion­ing it explic­itly in his Con­gress speech. Given that Trea­sury yields have recently started ris­ing again and that US fed­eral debt is now offi­cially over $15 tril­lion, do you think QE3 is offi­cially off the table? We don't either. Just because Bernanke sig­nals that the Fed is tak­ing a month off doesn't mean they're done print­ing. It doesn't mean they have sud­denly become respon­si­ble. It's sim­ply a mat­ter of timing.

Look­ing back at the trad­ing data on Feb­ru­ary 29th, the sell-off in gold and sil­ver appears to have been an exclu­sively paper-market affair. We were sur­prised, for exam­ple, to note that between the hours of 10:30 am and 11:30 am, the vol­ume of the COMEX front month sil­ver futures con­tracts equaled the paper equiv­a­lent of 173 mil­lion ounces of phys­i­cal sil­ver. Keep in mind that the world only pro­duces 730 mil­lion ounces of phys­i­cal sil­ver PER YEAR. The prob­lem from a pric­ing stand­point is the sim­ple fact that the par­ties who were on the sell­ing side of those 173 mil­lion paper ounces couldn't pos­si­bly have had the phys­i­cal sil­ver to back-up their sell orders. And the way the futures mar­kets are designed, they don't have to. But if that's the case, how can the sil­ver price be smashed by sell orders that don't involve any real physical?

Look­ing at this issue from a broader per­spec­tive, we've dis­cov­ered that sil­ver is indeed in a unique sit­u­a­tion from a paper-market stand­point. We com­pared the daily paper-market futures vol­ume of var­i­ous com­modi­ties against their esti­mated daily phys­i­cal pro­duc­tion. We dis­cov­ered that sil­ver is dis­pro­por­tion­ately traded 143 times higher in the paper mar­kets ver­sus what is pro­duced by mine sup­ply. The next high­est paper mar­ket com­mod­ity is cop­per, which is traded at roughly half that of sil­ver on a paper mar­ket vol­ume basis.

FIGURE 1: MULTIPLES OF DAILY PHYSICAL PRODUCTION TRADED IN FUTURES MARKETS
Source: Bar­clays, Sprott Research

We don't know why the paper mar­ket for sil­ver is so huge, but we have our sus­pi­cions. Sil­ver is obvi­ously a much, much smaller mar­ket than that for cop­per, gold or oil. It could very well be that paper mar­ket par­tic­i­pants like sil­ver because they don't need as much cap­i­tal to push it around. The preva­lence of paper trad­ing in the sil­ver mar­ket is what makes the dras­tic price declines pos­si­ble by allow­ing non-physical hold­ers to sell mas­sive size into a rel­a­tively small mar­ket. It's not as if real own­ers of 160 mil­lion ounces of phys­i­cal sil­ver dumped it on the mar­ket on Feb­ru­ary 29th, and yet the futures mar­ket allows the sil­ver spot price to respond as if they had.

Same goes for gold. Although gold paper-trading isn't as lop­sided as silver's, it too suf­fers from the same paper-selling issue. Indeed, as we dis­cov­ered for Feb­ru­ary 29th, it appears to be one large seller of gold that sin­gle hand­edly downticked the spot price by $40/oz in roughly ten min­utes.¹⁴ The trans­ac­tion rep­re­sented approx­i­mately 1.8 mil­lion ounces, rep­re­sent­ing roughly $3 bil­lion dol­lars' worth of the metal. Who in their right mind would even con­tem­plate dump­ing $3 bil­lion of phys­i­cal gold in so short a time span? Den­nis Gartman's Let­ter on March 2, 2012, also men­tioned an unnamed source who described an order to sell 3 mil­lion ounces of gold that same day, with the explicit order to sell it "in just a few min­utes". As the Gart­man Let­ter source states, "No investor or spec­u­la­tor would 1) han­dle it this way and 2) do it at the fix­ing only… This [has] hap­pened this way three times in the last year, yes­ter­day being the fourth time. Ben Bernanke had done noth­ing yes­ter­day to trig­ger this the way it hap­pened. I [have done] this now for 30 years and this was no free mar­ket yes­ter­day."¹⁵

The fol­low­ing three charts show the price action and vol­ume for the Feb­ru­ary, March and April Comex Gold con­tracts. You'll notice that the Feb­ru­ary con­tract stopped trad­ing on Feb­ru­ary 27th to allow time for set­tle­ment between the buy­ers and sell­ers who intended on clos­ing the con­tracts in phys­i­cal. The March con­tract had hardly any vol­ume at all, leav­ing the major­ity of gold futures that traded on Feb­ru­ary 29th tak­ing place in the April con­tract. This speaks to our frus­tra­tion with futures con­tracts. The major­ity of trad­ing that pro­duced the Feb­ru­ary 29th gold price decline took place in a con­tract month that won't set­tle until April 26th at the ear­li­est, giv­ing plenty of time for the shorts to cover and exit with­out hav­ing to back their sales with phys­i­cal delivery.

FIGURE 2: FEBRUARY COMEX GOLD CONTRACT Source: Bloomberg

FIGURE 3: MARCH COMEX GOLD CONTRACTSource: Bloomberg

FIGURE 4: APRIL COMEX GOLD CONTRACTSource: Bloomberg

All of this non­sense brings us to the crux of our point. If we are right about gold and sil­ver as cur­ren­cies, and if we are right about the con­tin­u­a­tion of cen­tral bank print­ing, both gold and sil­ver will con­tinue to appre­ci­ate in var­i­ous fiat cur­ren­cies over time. If there is indeed some sort of manip­u­la­tion in the futures mar­ket that is designed to sup­press the prices for both met­als so as to detract from the main­stream investor's inter­est in them as alter­na­tive cur­ren­cies, then both met­als are likely trad­ing at sup­pressed prices today. This means that there is an oppor­tu­nity for investors to con­tinue accu­mu­lat­ing both met­als at much cheaper nom­i­nal prices than they would do oth­er­wise. While the volatil­ity of the price fluc­tu­a­tions may be unset­tling, they ulti­mately won't change the under­ly­ing fun­da­men­tal direc­tion of both met­als, which is upwards.

The equity mar­ket rally that began in late Decem­ber appears to be gen­er­ated more by excess government-induced liq­uid­ity than it does by any raw fun­da­men­tals. We con­tinue to scour the data for signs of a true recov­ery and we are sim­ply not see­ing it. Until those signs come through, we would be very wary of par­tic­i­pat­ing in the equity mar­kets with­out a strong defen­sive stance. We would also expect the pre­cious met­als com­plex to enjoy renewed strength as the year con­tin­ues. One bad month does not change a long-term trend that has been build­ing over 10 years. Gold and sil­ver will both have an impor­tant role to play as the cen­tral bank-induced print­ing con­tin­ues, and we expect more on that front in short order.

PS — if there is any group that can effec­tively address silver's con­tin­ued paper mar­ket imbal­ance, it is the sil­ver min­ers them­selves. Despite the best efforts of a select few at the CFTC, it is unlikely that there will be any res­o­lu­tion to the CFTC's inves­ti­ga­tion announced back in Sep­tem­ber 2008.¹⁶ Sil­ver min­ers have the most to lose from the con­tin­ued "fraud­u­lent efforts" that Com­mis­sioner Bart Chilton refers to in the open­ing quote above. They also have the most to gain by con­fronting the con­tin­ued paper cha­rade head-on.

Copy­right © Sprott Asset Management

Tags: Bureau Of Labor, Bureau Of Labor Statistics, Chilton, Commodities, Commodity, Commodity Exchange Act, Commodity Futures Trading, Commodity Futures Trading Commission, commodity futures trading commission cftc, David Baker, Eric Sprott, Exuberance, Futures Trading Commission, Gallup, Investment Outlook, Mining, Non Farm Payrolls, Seasonal Adjustment, Silver Markets, Unemployment Numbers, Unemployment Rate, Unemployment Report, Upward Revision
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Buy Commodities, Sell Brands (Smead)

Wednesday, March 28th, 2012

by William Smead, Smead Cap­i­tal Management

We saw War­ren Buf­fett quoted the other day say­ing, “We like com­pa­nies which buy a com­mod­ity and sell a brand”. We thought it would be very help­ful to unpack his thought and put it into the con­text of today’s cir­cum­stances. We at Smead Cap­i­tal Man­age­ment believe these cur­rent cir­cum­stances are framed by the his­tor­i­cal over-pricing of com­modi­ties, the com­ing eco­nomic con­trac­tion of China, the suc­cess­ful cleans­ing of the income state­ments of US house­holds and the inevitable rebound in hous­ing in the US. We will look at the makeup of our port­fo­lio com­pa­nies which buy a com­mod­ity and sell a brand to con­sider their upside poten­tial in this inter­est­ing environment.

When non-economic investors load up on invest­ments in any­thing which has had a big run up, please cir­cle the wag­ons. When com­modi­ties were at their low point in 1999, it was hard to find any insti­tu­tional investor or finan­cial advi­sor rec­om­mend­ing expo­sure in com­modi­ties for investors. As of the end of 2010, insti­tu­tions are ded­i­cat­ing as much as 52% of their port­fo­lio to alter­na­tive invest­ments. This includes com­modi­ties, gold and energy. These invest­ments are made today for diver­si­fi­ca­tion pur­poses and are sim­ply bets on ris­ing prices. These bets look good in a rearview mir­ror as we’ve had a once in a gen­er­a­tion move into this asset class. We believe that com­modi­ties have never been more over-priced in the US and are enter­ing a decade-long bear market.

We believe the rea­son com­modi­ties have been in a bull mar­ket for so long is the unin­ter­rupted eco­nomic boom in China. When a coun­try with 1.3 bil­lion peo­ple grows at over 10% for a num­ber of years with­out an occa­sional reces­sion, it ends up rely­ing on fixed asset invest­ments for growth. When fixed asset invest­ments dom­i­nate your GDP num­bers, bor­rowed money pre­pares to turn sour and ulti­mately lead to a recession/depression. This is some­thing that “get­ting rid of cable” can’t cure.

The Fed­eral Reserve came out with their house­hold debt ser­vice ratio (HDSR) last week. It shows that by the end of 2011, Amer­i­can house­holds had brought the ratio down below 11% to 10.88%. This matches up with the lev­els seen in the early 1980’s reces­sion and the “ane­mic” eco­nomic recov­ery of 1990–93. These ear­lier read­ings pre­ceded two of the best mod­ern eco­nomic growth peri­ods since World War II. While the doom­say­ers moan about absolute debt lev­els, we feel they are miss­ing the story on the health of the income state­ment of the aver­age house­hold. This has boded well for the econ­omy his­tor­i­cally. Also, if we con­tinue to be slow to buy houses and cars, this HDSR could put dis­cre­tionary spend­ing into its most favor­able posi­tion in decades.

Lastly, this cur­rent “ane­mic” eco­nomic recov­ery has been severely retarded by the boom com­mod­ity prices of the last two years, in our opin­ion. We’ve had to work off a huge num­ber of fore­closed and short-sale hous­ing inven­to­ries, while the deep reces­sion tem­porar­ily crip­pled house­hold for­ma­tion (Jeff, Who lives at Home). It is rebound­ing as 20-somethings get sick of liv­ing with the par­ents and the par­ents get sick of liv­ing with Jeff. As Mr. Buf­fett said recently, “even­tu­ally hor­mones take over” and as Brett Arends pointed out in Smart Money,” rent­ing is more expen­sive than buy­ing in about 75% of Amer­i­can cities.” You add high lum­ber, cop­per, iron ore and oil prices to this mix and you get the worst depres­sion in hous­ing and blue-collar employ­ment since the depres­sion. All these head­winds are about to become tail­winds, in our vision, over the next five years.

There­fore, bet­ting on the US econ­omy and the US con­sumer looks very favor­able to us, espe­cially where the rebounds in employ­ment and con­sumer con­fi­dence have an impact. In fairy tales, peo­ple are asked to spin straw into gold. We like to own com­pa­nies which spin milk and cof­fee (SBUX), cot­ton (JWN and CAB), inter­net access (EBAY and ACN), tax returns (HRB) and chem­i­cals (MRK, AMGN, BMY, ABT, PFE and MYL) into gold. Profit mar­gins on commodity-related com­pa­nies and com­pa­nies reliant on emerg­ing mar­ket growth could plum­met in the near future. Just ask the folks at BHP Bil­li­ton. They announced March 20th, 2012 that they are see­ing in a big drop off in demand from China. In turn, we believe mar­gins could go up for any­one who is pos­i­tively impacted by lower energy prices and/or com­mod­ity prices in gen­eral. This is espe­cially true if you “buy com­modi­ties and sell brands”.

Best Wishes,

William Smead

The infor­ma­tion con­tained in this mis­sive rep­re­sents SCM’s opin­ions, and should not be con­strued as per­son­al­ized or indi­vid­u­al­ized invest­ment advice. Past per­for­mance is no guar­an­tee of future results. Some of the secu­ri­ties iden­ti­fied and described in this mis­sive are a sam­ple of issuers being cur­rently rec­om­mended for suit­able clients as of the date of this mis­sive and do not rep­re­sent all of the secu­ri­ties pur­chased or rec­om­mended for our clients. It should not be assumed that invest­ing in these secu­ri­ties was or will be prof­itable. A list of all rec­om­men­da­tions made by Smead Cap­i­tal Man­age­ment with in the past twelve month period is avail­able upon request.

Tags: Alternative Investments, asset class, Asset Investments, Bear Market, Bets, Capital Management, Circle The Wagons, Commodities, Commodity, Diversification, Economic Boom, Economic Contraction, ETF, ETFs, Generation Move, Income Statements, Institutional Investor, Portfolio Companies, Rearview Mirror, Rebound, Recession, Warren Buffett
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Scratching My Head Till it Bleeds & The 5 classes of Corporate Bonds

Tuesday, March 27th, 2012

by Peter Tchir, TF Mar­ket Advisors

The mar­ket has ral­lied more than 2% since the lows on Fri­day morn­ing.  The rally has been almost exclu­sively cen­tral bank and gov­ern­ment driven.

On Fri­day the rally started with rumors of ECB bond pur­chases, it con­tin­ued Mon­day morn­ing with Merkel soft­en­ing her stance on how much Ger­many is will­ing to risk, and momen­tum accel­er­ated to a crescendo once Bernanke made it clear that not only is QE not off the table, but he is dying to do more QE ASAP.

Equi­ties seem to have com­pletely accepted that cen­tral banks and gov­ern­ments can only be good for the mar­ket.  That is what has me scratch­ing my head so hard.  Does noth­ing other than cen­tral bank pol­icy make a dif­fer­ence?  Any­one who nailed the eco­nomic data last week has to feel like an idiot. The Chi­nese land­ing ques­tion has not been answered, but there is grow­ing evi­dence that it could be the hard sort.  The Euro­pean econ­omy dete­ri­o­rated and some of the weaker coun­tries did the worst – Spain as a not so shin­ing exam­ple.  Hous­ing data in the US missed across the board, and gen­er­ally the data was weak.  Yet here we are, back to new highs in equities.

So it is true that flood­ing the world with money has helped stocks, there have also been peri­ods where stocks did poorly in spite of all these pro­grams being in place.  Are we now sup­posed to believe that we can never go down again while cen­tral bankers are at work? That doesn’t match with his­tory, yet yes­ter­day seems to have con­vinced many that the only direc­tion for stocks is up with Ben­draghi in charge.  The S&P is trad­ing at 14.7x earn­ings.  Maybe not over­val­ued, but also hard to argue that they are extremely cheap – espe­cially with eco­nomic indi­ca­tors not only a lit­tle weaker than expected, but show­ing signs that a lot of the strong data early this year truly was a func­tion of weather, and rather than being able to jump­start the econ­omy, merely pulled activ­ity for­ward and we are now see­ing the impact of that.

While equi­ties and com­modi­ties (except for nat­ural gas) knew exactly what to do with the Ben’s state­ment, trea­suries had more dif­fi­culty fig­ur­ing it out. They seemed to be left scratch­ing their heads and were torn between the desire to rally on the back of more gov­ern­ment sup­port, or sell­ing off as part of a “risk on” rally.  Trea­suries seem to be caught in no man’s land.  Fed pur­chases keep them arti­fi­cially low, but with any poten­tial for sta­bil­ity in the world, any signs of infla­tion, and a stock mar­ket this high, it is hard to be an “investor” in trea­suries here.  There is real fear that you do not want to be the one left hold­ing trea­suries once the QE game is over.  It is a bit sur­pris­ing that Ben wasn’t able to do more for trea­suries yes­ter­day.  The long bond is actu­ally 2 bps higher than it was on Friday.

Cor­po­rate bonds were okay.  Not as enthu­si­as­tic as stocks and com­modi­ties, but more excited by the prospects of addi­tional QE than trea­suries.  On the credit ETF side, it looks like most of the appre­ci­a­tion went into increas­ing the pre­mium as the NAV didn’t move as quickly.

Mort­gages should do best on any QE as it seems that will be the pri­mary ben­e­fi­ciary.  In the mean­time, cor­po­rate bonds seem to be 5 dis­tinct assets classes:

Invest­ment Grade Cor­po­rate: These are already trad­ing tight, but should have lit­tle volatil­ity.  I would want to own them on a hedged basis, if at all.  Noth­ing wrong with the bonds, but lit­tle upside left.

Finan­cial Bonds: Bonds issued by banks still have the most spread and best chance of appre­ci­a­tion.  They also clearly have the most risk.  I pre­fer bonds of the biggest Euro­pean banks (DB and SG), but would want to avoid or be short the banks that have used LTRO the most aggressively.

“Short Dated” HY Bonds: There are a lot of high coupon hy bonds trad­ing to call dates within the next two years.  Nor­mally these offer lim­ited upside, but it might be worth buy­ing some.  Retail investors seem to have their eyes on these bonds, and there is now at least one ETF specif­i­cally tar­get­ing these bonds.  There isn’t much value here, but retail is likely to drive these bonds up a cou­ple points higher than insti­tu­tional investors ever would – espe­cially with the econ­omy being sta­ble.  Decent carry and real chance that retail chases these bonds higher than they should be.

“Story Credit” HY Bonds: These have ral­lied but still have some poten­tial.  It really is a “close your eyes” and hope for the best at this stage as the down­side is prob­a­bly greater than the upside, but if you truly believe in QE and its abil­ity to make things good, you are sup­posed to close your eyes and buy these.  Not a strat­egy I like right now as I believe that in spite of (or because of) all the gov­ern­ment and cen­tral bank inter­ven­tion we are a long way from hav­ing resolved anything.

“high qual­ity non-callable” HY Bonds: These are poten­tially the most dan­ger­ous.  These are typ­i­cally BB com­pa­nies with bonds that have good call pro­tec­tion for at least 5 years.  Spreads are rel­a­tively tight, though have room to move tighter, but in spite of many arti­cles say­ing that HY doesn’t move with rates, these will.  We are in a pretty unique sit­u­a­tion in the credit mar­kets.  Trea­sury yields are very low.  Spreads on these bonds are okay, and could tighten, but the yields are very low.  The abil­ity for this class of bonds to rally in a ris­ing rate envi­ron­ment is low.  On a spread basis, they could tighten as they should out­per­form trea­suries, but they can still go down on price.  They will be squeezed out by BBB bonds in a ris­ing rate envi­ron­ment.  The analy­sis of HY cor­re­la­tion to trea­suries that I have seen is too sim­plis­tic.  The first two cat­e­gories of hy bonds that I men­tion do not have much rate risk.  This cat­e­gory does.

Tags: 7x, Asap, Central Banks, Chinese Landing, Commodities, Commodity, Corporate Bonds, Crescendo, Economic Data, Economic Indicators, European Economy, Friday Morning, Lows, Match, Merkel, Momentum, Monday Morning, New Highs, Qe, Spite, Tf, Weather
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Bill Gross: Investment Outlook (April 2012)

Tuesday, March 27th, 2012

The Great Escape:
Deliv­er­ing in a Delev­er­ing World

by William H. Gross, PIMCO

April 2012

• When inter­est rates can­not be dra­mat­i­cally low­ered fur­ther or risk spreads sig­nif­i­cantly com­pressed, the momen­tum begins to shift, not nec­es­sar­ily sud­denly, but grad­u­ally – yields mov­ing mildly higher and spreads sta­bi­liz­ing or mov­ing slightly wider.
• In such a mildly reflat­ing world, unless you want to earn an inflation-adjusted return of minus 2%-3% as offered by Trea­sury bills, then you must take risk in some form.
• We favor high qual­ity, shorter dura­tion and inflation-protected bonds; div­i­dend pay­ing stocks with a pref­er­ence for devel­op­ing over devel­oped mar­kets; and inflation-sensitive, supply-constrained com­mod­ity products.

About six months ago, I only half in jest told Mohamed that my tomb­stone would read, “Bill Gross, RIP, He didn’t own ‘Trea­suries’.” Now, of course, the days are get­ting longer and as they say in golf, it is bet­ter to be above – as opposed to below – the grass. And it is bet­ter as well, to be deliv­er­ing alpha as opposed to delev­er­ing in the bond mar­ket or global econ­omy. The best way to visu­al­ize suc­cess­ful deliv­er­ing is to rec­og­nize that investors are locked up in a finan­cially repres­sive envi­ron­ment that reduces future returns for all finan­cial assets. Break­ing out of that “jail” is what I call the Great Escape, and what I hope to explain in the next few pages.

The term delev­er­ing implies a period of prior lever­age, and lever­age there has been. Whether you date it from the begin­ning of frac­tional reserve and cen­tral bank­ing in the early 20th cen­tury, the debase­ment of gold in the 1930s, or the ini­ti­a­tion of Bret­ton Woods and the coör­di­nated dol­lar and gold stan­dard that fol­lowed for nearly three decades after WWII, the trend towards finan­cial lever­age has been ever upward. The aban­don­ment of gold and embrace­ment of dol­lar based credit by Nixon in the early 1970s was cer­tainly a lever­ag­ing land­mark as was the dereg­u­la­tion of Glass-Steagall by a Demo­c­ra­tic Clin­ton admin­is­tra­tion in the late 1990s, and else­where glob­ally. And almost always, the pri­vate sec­tor was more than will­ing to play the game, invent­ing new forms of credit, loosely known as deriv­a­tives, which avoided the con­cept of con­ser­v­a­tive reserve bank­ing alto­gether. Although there were acci­dents along the way such as the S&L cri­sis, Con­ti­nen­tal Bank, LTCM, Mex­ico, Asia in the late 1990s, the Dot-coms, and ulti­mately global sub­prime own­er­ship, finan­cial insti­tu­tions and mar­ket par­tic­i­pants learned that pol­i­cy­mak­ers would sup­port the sys­tem, and most indi­vid­ual par­tic­i­pants, by extend­ing credit, low­er­ing inter­est rates, expand­ing deficits, and dereg­u­lat­ing in order to keep economies tick­ing. Impor­tantly, this com­bined fis­cal and mon­e­tary lever­age pro­duced out­sized returns that exceeded the abil­ity of real economies to cre­ate wealth. Stocks for the Long Run was the almost uni­ver­sally accepted mantra, but it was really a period – for most of the last half cen­tury – of “Finan­cial Assets for the Long Run” – and your house was included by the way in that cat­e­gory of finan­cial assets even though it was just a pile of sticks and stones. If it always went up in price and you could bor­row against it, it was a finan­cial asset. Secu­ri­ti­za­tion ruled supreme, if not subprime.

As nom­i­nal and real inter­est rates came down, down, down and credit spreads were com­pressed through pol­icy sup­port and secu­ri­ti­za­tion, then asset prices mag­i­cally ascended. PE ratios rose, bond prices for 30-year Trea­suries dou­bled, real estate thrived, and any­thing that could be lev­ered did well because the global econ­omy and its finan­cial mar­kets were being lev­ered and lev­ered consistently.

And then sud­denly in 2008, it stopped and reversed. Lever­age appeared to reach its lim­its with sub­primes, and then with banks and invest­ment banks, and then with coun­tries them­selves. The game as we all have known it appears to be over, or at least sub­stan­tially changed – mov­ing for the moment from pri­vate to pub­lic bal­ance sheets, but even there fac­ing investor and polit­i­cal lim­its. Actu­ally global finan­cial mar­kets are only selec­tively delev­er­ing. What delev­er­ing there is, is most vis­i­ble with house­hold bal­ance sheets in the U.S. and Euroland periph­eral sov­er­eigns like Greece. The delev­er­ing is also rel­a­tively hid­den in the recap­i­tal­iza­tion of banks and their looka­likes. Increas­ing cap­i­tal, in addi­tion to hair­cut­ting and defaults are a form of delever­ag­ing that is long term healthy, if short term growth restric­tive. On the whole, how­ever, because of mas­sive QEs and LTROS in the tril­lions of dol­lars, our credit based, lever­age depen­dent finan­cial sys­tem is actu­ally lever­age expand­ing, although only mildly and sys­tem­i­cally less threat­en­ing than before, at least from the stand­point of a growth rate. The total amount of debt how­ever is daunt­ing and con­tin­ued credit expan­sion will pro­duce accel­er­at­ing global infla­tion and slower growth in PIMCO’s most likely outcome.

How do we deliver in this New Nor­mal world that levers much more slowly in total, and can delever sharply in selec­tive sec­tors and coun­tries? Look at it this way rather sim­plis­ti­cally. Dur­ing the Great Lever­ag­ing of the past 30 years, it was finan­cial assets with their expected future cash flows that did the best. The longer the stream of future cash flows and the riskier/more lev­ered those flows, then the bet­ter they did. That is because, as I’ve just his­tor­i­cally out­lined, future cash flows are dis­counted by an inter­est rate and a risk spread, and as yields came down and spreads com­pressed, the greater return came from the longest and most lev­ered assets. This was a world not of yield, but of total return, where price and yield formed the returns that exceeded the abil­ity of global economies to con­sis­tently repli­cate them. Finan­cial assets rel­a­tive to real assets out­per­form in such a world as wealth is brought for­ward and stolen from future years if real growth can­not repli­cate his­tor­i­cal total returns.

To put it even more sim­ply, finan­cial assets with long inter­est rate and spread dura­tions were win­ners: long matu­rity bonds, stocks, real estate with rental streams and cap rates that could be com­pressed. Com­modi­ties were on the rel­a­tive los­ing end although infla­tion took them up as well. That’s not to say that an oil com­pany with reserves in the ground didn’t do well, but the oil for imme­di­ate deliv­ery that couldn’t ben­e­fit from an expan­sion of P/Es and a com­pres­sion of risk spreads – well, not so well. And so com­modi­ties lagged finan­cial asset returns. Our num­bers show 1, 5 and 20-year his­to­ries of finan­cial assets out­per­form­ing com­modi­ties by 15% for the most recent 12 months and 2% annu­ally for the past 20 years.

This out­per­for­mance by finan­cial as opposed to real assets is a result of the long jour­ney and ulti­mate des­ti­na­tion of credit expan­sion that I’ve just out­lined, result­ing in neg­a­tive real inter­est rates and nar­row credit and equity risk pre­mi­ums; a state of finan­cial repres­sion as it has come to be known, that promises to be with us for years to come. It reminds me of an old movie star­ing Steve McQueen called The Great Escape where Amer­i­can pris­on­ers of war were con­fined to a POW camp inside Ger­many in 1943. The liv­ing con­di­tions were OK, much like today’s finan­cial mar­kets, but cer­tainly not what they were used to on the other side of the lines so to speak. Yet it was their duty as British and Amer­i­can offi­cers to try to escape and get back to the old nor­mal. They inge­niously dug escape tun­nels and even­tu­ally escaped. It was a real life story in addi­tion to its Hol­ly­wood fla­vor. Sim­i­larly though it is your duty to try to escape today’s repres­sion. Your liv­ing con­di­tions are OK for now – the food and in this case the returns are good – but they aren’t enough to get you what you need to cover lia­bil­i­ties. You need to think of an escape route that gets you back home yet at the same time doesn’t get you killed in the process. You need a Great Escape to deliver in this finan­cial repres­sive world.

What hap­pens when we flip the sce­nario or per­haps reach the point at which inter­est rates can­not be dra­mat­i­cally low­ered fur­ther or risk spreads sig­nif­i­cantly com­pressed? The momen­tum we would sug­gest begins to shift: not nec­es­sar­ily sud­denly or swiftly as fat­ter tail bimodal dis­tri­b­u­tions might warn, but grad­u­ally – yields mov­ing mildly higher, spreads sta­bi­liz­ing or mov­ing slightly wider. In such a mildly reflat­ing world where infla­tion itself remains above 2% and in most cases moves higher, deliv­er­ing double-digit or even 7–8% total returns from bonds, stocks and real estate becomes prob­lem­atic and cer­tainly much more dif­fi­cult. Real growth as opposed to finan­cial wiz­ardry becomes pre­dom­i­nant, yet that growth is stressed by exces­sive fis­cal deficits and high debt/GDP lev­els. Com­modi­ties and real assets become ascen­dant, cer­tainly in rel­a­tive terms, as we by neces­sity delever or lever less. As well, finan­cial assets can­not be ele­vated by zero based inter­est rate or other tried but now tired pol­icy maneu­vers that bring future wealth for­ward. Cur­rent prices in other words have squeezed all of the risk and inter­est rate pre­mi­ums from future cash flows, and now finan­cial mar­kets are left with real growth, which itself expe­ri­ences a slower new nor­mal because of less finan­cial leverage.

That is not to say that infla­tion can­not con­tinue to ele­vate finan­cial assets which can adjust to infla­tion over time – stocks being the prime exam­ple. They can, and there will be rel­a­tive win­ners in this con­text, but the abil­ity of an investor to earn returns well in excess of infla­tion or well in excess of nom­i­nal GDP is lim­ited. Total return as a super­charged bond strat­egy is fad­ing. Stocks with a 6.6% real Jeremy Siegel con­stant are fad­ing. Lev­ered hedge strate­gies based on spread and yield com­pres­sion are fad­ing. As we delever, it will be hard to deliver what you have been used to.

Still there is a place for all stan­dard asset classes even though betas will be lower. Should you desert bonds sim­ply because they may return 4% as opposed to 10%? I hope not. PIMCO’s poten­tial alpha gen­er­a­tion and the sta­bil­ity of bonds remain crit­i­cal com­po­nents of an invest­ment portfolio.

In sum­mary, what has the poten­tial to deliver the most return with the least amount of risk and high­est infor­ma­tion ratios? Log­i­cally, (1) Real as opposed to finan­cial assets – com­modi­ties, land, build­ings, machines, and knowl­edge inher­ent in an edu­cated labor force. (2) Finan­cial assets with shorter spread and inter­est rate dura­tions because they are more defen­sive. (3) Finan­cial assets for enti­ties with rel­a­tively strong bal­ance sheets that are exposed to higher real growth, for which devel­op­ing vs. devel­oped nations should dom­i­nate. (4) Finan­cial or real assets that ben­e­fit from favor­able pol­icy thrusts from both mon­e­tary and fis­cal author­i­ties. (5) Finan­cial or real assets which are not bur­dened by exces­sive debt and sub­ject to future haircuts.

In plain speak –

For bond mar­kets: favor higher qual­ity, shorter dura­tion and infla­tion pro­tected assets.

For stocks: favor devel­op­ing vs. devel­oped. Favor shorter dura­tions here too, which means con­sis­tent div­i­dend pay­ing as opposed to growth stocks.

For com­modi­ties: favor infla­tion sen­si­tive, sup­ply con­strained products.

And for all asset cat­e­gories, be wary of lev­ered hedge strate­gies that promise double-digit returns that are dif­fi­cult in a delev­er­ing world.

With regard to all of these broad asset cat­e­gories, an investor in finan­cial mar­kets should not go too far on this defen­sive, as opposed to offen­sively ori­ented sce­nario. Unless you want to earn an infla­tion adjusted return of minus 2–3% as offered by Trea­sury bills, then you must take risk in some form. You must try to max­i­mize risk adjusted carry – what we call “safe spread.”

“Safe carry” is an essen­tial ele­ment of cap­i­tal­ism – that is investors earn­ing some­thing more than a Trea­sury bill. If and when we can­not, then the sys­tem implodes – espe­cially one with exces­sive lever­age. Paul Vol­cker suc­cess­fully redi­rected the U.S. econ­omy from 1979–1981 dur­ing which investors earned less return than a Trea­sury bill, but that could only go on for sev­eral years and occurred in a much less lev­ered finan­cial sys­tem. Vol­cker had it eas­ier than Bernanke/King/Draghi have it today. Is a sys­temic implo­sion still pos­si­ble in 2012 as opposed to 2008? It is, but we will likely face much more mon­e­tary and credit infla­tion before the bal­loon pops. Until then, you should bud­get for “safe carry” to help pay your bills. The bunker port­fo­lio lies fur­ther ahead.

Two addi­tional con­sid­er­a­tions. In a highly lev­ered world, grad­ual rever­sals are not nec­es­sar­ily the high prob­a­ble out­come that a nor­mal bell-shaped curve would sug­gest. Pol­icy mis­takes – too much money cre­ation, too much fis­cal belt-tightening, geopo­lit­i­cal con­flicts and war, geopo­lit­i­cal dis­agree­ments and dis­in­te­gra­tion of mon­e­tary and fis­cal unions – all of these and more lead to poten­tial bimodal dis­tri­b­u­tions – fat left and right tail out­comes that can inflate or deflate asset mar­kets and real eco­nomic growth. If you are a ratio­nal investor you should con­sider hedg­ing our most prob­a­ble inflationary/low growth out­come – what we call a “C-“ sce­nario – by buy­ing hedges for fat­ter tailed pos­si­bil­i­ties. It will cost you some­thing – and hedg­ing in a low return world is harder to buy than when the cot­ton is high and the liv­ing is easy. But you should do it in amounts that hedge against prin­ci­pal down­sides and allow for prin­ci­pal upsides in bimodal out­comes, the lat­ter per­haps being epit­o­mized by equity mar­kets 10–15% returns in the first 80 days of 2012.

And sec­ondly, be mind­ful of invest­ment man­age­ment expenses. Whoops, I’m not sup­posed to say that, but I will. Be sure you’re get­ting value for your expense dol­lars. We of course – per­haps like many other firms would say, “We’re Num­ber One.” Not always, not for me in the sum­mer of 2011, but over the past 1, 5, 10, 25 years? Yes, we are cer­tainly a #1 seed – with aspi­ra­tions as always to be your #1 Champion.

William H. Gross
Man­ag­ing Director

“Safe Spread” also known as “Safe Carry” is defined as sec­tors that we believe are most likely to with­stand the vicis­si­tudes of a wide range of pos­si­ble eco­nomic sce­nar­ios. All invest­ments con­tain risk and may lose value.
Past per­for­mance is not a guar­an­tee or a reli­able indi­ca­tor of future results. Invest­ing in the bond mar­ket is sub­ject to cer­tain risks includ­ing mar­ket, interest-rate, issuer, credit, and infla­tion risk. Equi­ties may decline in value due to both real and per­ceived gen­eral mar­ket, eco­nomic, and indus­try con­di­tions. Com­modi­ties con­tain height­ened risk includ­ing mar­ket, polit­i­cal, reg­u­la­tory, and nat­ural con­di­tions, and may not be suit­able for all investors. Invest­ing in for­eign denom­i­nated and/or domi­ciled secu­ri­ties may involve height­ened risk due to cur­rency fluc­tu­a­tions, and eco­nomic and polit­i­cal risks, which may be enhanced in emerg­ing mar­kets. Sov­er­eign secu­ri­ties are gen­er­ally backed by the issu­ing gov­ern­ment, oblig­a­tions of U.S. Gov­ern­ment agen­cies and author­i­ties are sup­ported by vary­ing degrees but are gen­er­ally not backed by the full faith of the U.S. Gov­ern­ment; port­fo­lios that invest in such secu­ri­ties are not guar­an­teed and will fluc­tu­ate in value. Inflation-linked bonds (ILBs) issued by a gov­ern­ment are fixed-income secu­ri­ties whose prin­ci­pal value is peri­od­i­cally adjusted accord­ing to the rate of infla­tion; ILBs decline in value when real inter­est rates rise. Tail risk hedg­ing may involve enter­ing into finan­cial deriv­a­tives that are expected to increase in value dur­ing the occur­rence of tail events. Invest­ing in a tail event instru­ment could lose all or a por­tion of its value even in a period of severe mar­ket stress. A tail event is unpre­dictable; there­fore, invest­ments in instru­ments tied to the occur­rence of a tail event are spec­u­la­tive. Deriv­a­tives may involve cer­tain costs and risks such as liq­uid­ity, inter­est rate, mar­ket, credit, man­age­ment and the risk that a posi­tion could not be closed when most advan­ta­geous. Invest­ing in deriv­a­tives could lose more than the amount invested. There is no guar­an­tee that these invest­ment strate­gies will work under all mar­ket con­di­tions or are suit­able for all investors and each investor should eval­u­ate their abil­ity to invest long-term, espe­cially dur­ing peri­ods of down­turn in the mar­ket. An investor should con­sult their finan­cial advi­sor prior to mak­ing an invest­ment decision.

This mate­r­ial con­tains the cur­rent opin­ions of the author but not nec­es­sar­ily those of PIMCO and such opin­ions are sub­ject to change with­out notice. This mate­r­ial is dis­trib­uted for infor­ma­tional pur­poses only. Fore­casts, esti­mates, and cer­tain infor­ma­tion con­tained herein are based upon pro­pri­etary research and should not be con­sid­ered as invest­ment advice or a rec­om­men­da­tion of any par­tic­u­lar secu­rity, strat­egy or invest­ment prod­uct. Infor­ma­tion con­tained herein has been obtained from sources believed to be reli­able, but not guar­an­teed. No part of this arti­cle may be repro­duced in any form, or referred to in any other pub­li­ca­tion, with­out express writ­ten per­mis­sion of Pacific Invest­ment Man­age­ment Com­pany LLC. ©2012, PIMCO.

Tags: Bill Gross, Bond Market, Bretton Woods, Central Banking, Commodities, Commodity, Commodity Products, Debasement, Dividend Paying Stocks, Financial Assets, Financial Leverage, Future Returns, Global Economy, Gold Standard, Great Escape, Gross Investment, Inflation Protected Bonds, Investment Outlook, PIMCO, Three Decades, Treasury Bills, William H Gross
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Gold and China: Where the Bulls and Bears Square Off

Sunday, March 25th, 2012

Gold and China: Where the Bulls and Bears Square Off

By Frank Holmes, CEO and Chief Invest­ment Offi­cer, U.S. Global Investors

To para­phrase the great Steve Mar­tin, today’s investors are very pas­sion­ate peo­ple and pas­sion­ate peo­ple tend to over­re­act at times. An over­re­ac­tion is exactly what’s hap­pened in gold and global mar­kets in recent weeks. While mar­ket bulls have been sniff­ing out data points to sup­port their case, mar­ket bears have con­tin­ued to take a glass-half-empty approach.

Gold and China are two areas that have been caught in the bear trap this week, but we believe the gold and China bulls still have room to run.

Short-Term Chal­lenges for Gold
Ris­ing bond yields, a stronger U.S. dol­lar and an improv­ing U.S. econ­omy have squelched expec­ta­tions for a third round of quan­ti­ta­tive eas­ing (QE3) and con­se­quently, spelled trou­ble for gold. Since late Feb­ru­ary, gold has declined more than 7 percent.

As con­fi­dence improves, UBS says the yel­low metal is los­ing the dual role of safe haven and risk asset: “Gold is mov­ing off cen­ter stage, while growth assets are mov­ing to the fore.” Ear­lier this month, we saw the largest weekly con­trac­tion in long gold posi­tions on the Comex since 2004.

As I wrote in my blog this week, the sell­off has pushed the price of bul­lion below its 200-day mov­ing aver­age for only the 30th time over the past 10 years. Over this time period, gold has declined on aver­age 2.1 per­cent over the 10 days fol­low­ing the cross-below date. This means we’re likely only one-third into the cor­rec­tion in terms of price and duration.

All is not lost for gold. In his lat­est Gold Mon­i­tor, Dundee Wealth Eco­nom­ics Chief Econ­o­mist Mar­tin Muren­beeld lists 10 pos­i­tive fac­tors for gold, one of which is mon­e­tary refla­tion. We are cur­rently expe­ri­enc­ing one of the great­est global liq­uid­ity booms the world has ever seen. Over the past seven months, there have been 122 stim­u­la­tive pol­icy ini­tia­tives from cen­tral banks around the world, accord­ing to ISI Group.

You can see from Canaccord’s chart below that inject­ing liq­uid­ity into the global mon­e­tary sys­tem has been a steroid for stronger gold prices over the past decade. The global mon­e­tary base has bal­looned three times larger, with gold increas­ing nearly six-fold.

While we are see­ing strong signs of improve­ment in the global econ­omy, it’s impor­tant to remem­ber that the recov­ery has been built upon a moun­tain of printed money that can­not be hastily unwound. Dr. Muren­beeld explains, “money doesn’t grow on trees; it will have to be bor­rowed by some gov­ern­ment and/or it will have to be printed by some cen­tral bank.”

This is why we believe the bull mar­ket for gold remains intact.

Over­re­ac­tion on China
Indi­ca­tion of a Chi­nese eco­nomic slow­down and neg­a­tive com­ments from BHP Bil­li­ton regard­ing its out­look for Chi­nese demand caused anx­i­ety for investors this week.

The March HSBC Flash Man­u­fac­tur­ing Pur­chas­ing Man­agers’ Index (PMI) fell 3 points from the pre­vi­ous month due to weak­en­ing domes­tic and exter­nal demand.

How­ever, Mac­quarie says, “it’s not that bad out there.” The firm’s research shows that rel­a­tively strong demand from China dur­ing the first two months of the year has had a pos­i­tive impact on global com­mod­ity prices. Mac­quarie says, “while there is undoubt­edly a slow­down tak­ing place in Chi­nese eco­nomic growth as a result of domes­tic pol­icy tight­en­ing and weaker export growth, the impact on com­modi­ties demand has been negligible.”

As for the BHP com­ments, Bar­clays says that they were mis­con­strued, stat­ing the “BHP exec­u­tive was by no means bear­ish on near-term Chi­nese demand prospects and com­ments refer­ring to a soft­en­ing in Chi­nese steel demand were largely focused on the sce­nario post 2025 … the notion that iron ore and steel demand growth is unlikely to grow at a double-digit pace for­ever is not a sur­prise to the market.”

Bright spots in China’s econ­omy aren’t hard to find. Bar­clays reports that the back­log of man­u­fac­tur­ing orders saw its largest month-over-month increase since 2005 from Jan­u­ary to Feb­ru­ary of this year. Sup­ported by an all-time high in gaso­line demand, Chi­nese oil demand reached a record high in Feb­ru­ary. Gaso­line demand was resilient despite Bei­jing hik­ing prices by 4 per­cent in Feb­ru­ary due to higher oil prices. The Chi­nese gov­ern­ment fol­lowed that up with an addi­tional 7 per­cent hike ear­lier this month. Auto sales increased nearly 24 per­cent year-over-year (13 per­cent sequen­tially) in Feb­ru­ary, the largest increase since Novem­ber 2010, accord­ing to UBS.

While ris­ing fuel costs are a hot-button issue here in the U.S., CLSA’s Andy Roth­man says that the higher fuel prices will only mod­estly impact Chi­nese con­sumers because few come in direct con­tact with unsub­si­dized gaso­line. CLSA esti­mates that fuel accounts for only 2 per­cent of China’s Con­sumer Price Index (CPI) bas­ket, com­pared to 5.4 per­cent in the U.S.

We’re also see­ing pos­i­tive devel­op­ments in an area where Chi­nese con­sumers are vulnerable—housing prices. Accord­ing to CLSA and China’s National Bureau of Sta­tis­tics, home prices fell in 27 cities on a year-over-year basis dur­ing Feb­ru­ary, three times the vol­ume in Decem­ber. In addi­tion, none of the 70 cities tracked reported more than a 5 per­cent increase in new home prices. A grad­ual reduc­tion in home prices is exactly what the coun­try needs to pre­vent a major hous­ing crash, but don’t expect the Chi­nese gov­ern­ment to let the bot­tom fall out.

Remem­ber, the min­i­mum cash down pay­ment for a Chi­nese home buyer with a mort­gage is 30 per­cent. Investors are required to put 60 per­cent down in cash. Cur­rently, about one-third of home buy­ers are pay­ing all cash, accord­ing to CLSA. Andy says the gov­ern­ment is poised to relax the country’s strict hous­ing pol­icy mea­sures as soon as this sum­mer if the decline accelerates.

Tags: Bear Trap, Bond Yields, Bulls And Bears, Case Market, Central Banks, Chief Economist, Chief Investment Officer, Commodities, Commodity, Dual Role, Dundee Wealth, Frank Holmes, Global Liquidity, Growth Assets, Martin Murenbeeld, Moving Average, Overreaction, Policy Initiatives, Qe3, Selloff, Term Challenges, U S Global Investors
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The Oil Conundrum Explained

Friday, March 23rd, 2012

Sub­mit­ted by Bran­don Smith of Alt Mar­ket

The Oil Conun­drum Explained

Oil as a com­mod­ity has always been a highly valu­able early warn­ing indi­ca­tor of eco­nomic insta­bil­ity.  Every con­ceiv­able ele­ment of our finan­cial sys­tem depends on the price of energy, from fab­ri­ca­tion, to pro­duc­tion, to ship­ping, to the consumer’s very abil­ity to travel and make pur­chases.  High energy prices derail healthy economies and com­pletely dec­i­mate sys­tems already on the verge of col­lapse.  Oil affects everything.

This is why oil mar­kets also tend to be the most mis­rep­re­sented in the main­stream finan­cial media.  With so much at stake over the price of petro­leum, and the cost steadily climb­ing over the past year return­ing to dis­as­trous lev­els last seen in 2008, the Amer­i­can pub­lic will soon be look­ing for some­one to blame, and you can bet the MSM will do its utmost to ensure that blame is focused in the wrong direc­tion.  While there are, indeed, mul­ti­ple rea­sons for the cur­rent high costs of oil, the pri­mary cul­prits are obscured by con­sid­er­able disinformation…

The most promi­nent but false con­clu­sions on the expand­ing value of oil are cen­tered on asser­tions that sup­ply is decreas­ing dra­mat­i­cally, while demand is increas­ing dra­mat­i­cally.  Nei­ther of these claims is true…

The sup­ply side of the oil equa­tion is the absolute last fac­tor that we should be wor­ried about at this point.  In fact, global oil use since the credit cri­sis of 2008 has tum­bled dra­mat­i­cally.  This decline accel­er­ated at the end of 2011 and the begin­ning of 2012 all while oil prices rose:

http://www.energyasia.com/public-stories/markets-world-oil-demand-fell-3...

In its Feb­ru­ary Oil Mar­ket Report, the Inter­na­tional Energy Agency (IEA) fore­cast a reduc­tion in the growth of demand into the Spring of 2012, despite reports from the main­stream media that oil prices were spik­ing due to “recov­ery” and “high demand”.  Simul­ta­ne­ously, the IEA reported that petro­leum inven­to­ries rose to the high­est lev­els since Octo­ber, 2008:

http://omrpublic.iea.org/currentissues/full.pdf

The Baltic Dry Index, which mea­sures global ship­ping rates and the demand for freight in gen­eral, has fallen off a cliff in recent months, hov­er­ing near his­toric lows and sig­nal­ing a sharp decline in world demand for raw mate­ri­als used in pro­duc­tion.  A fall in the BDI has on mul­ti­ple occa­sions in the past been a pre­dic­tive indi­ca­tor of stock mar­ket chaos, includ­ing that which struck in 2008 and 2009.  A sharply lower BDI means low global demand, which should, tra­di­tion­ally, mean decreas­ing prices:

http://investmenttools.com/futures/bdi_baltic_dry_index.htm

So, sup­ply is high across the board, inven­to­ries are stocked, and demand is weak.  By all com­mon mar­ket logic, gaso­line prices should be plum­met­ing, and far more Amer­i­cans should be smil­ing at the pump.  Of course, this is not the case.  Prices con­tinue to rise despite defla­tion­ary ele­ments, mean­ing, there must be some other fac­tors at work here caus­ing infla­tion in prices.

Iron­i­cally, stock mar­ket activ­ity in the Dow has now come under threat from this infla­tion­ary trend in oil.  Ris­ing energy costs have essen­tially put a cap on the epic explo­sion of equi­ties, and many main­stream ana­lysts now lament over this Catch-22.  The prob­lem is that these investors and pun­dits are oper­at­ing on the assump­tion that the Dow bull mar­ket is legit­i­mate, and that the rally in oil is some­how an exten­sion of a “health­ier econ­omy”.  This ver­sion of real­ity, I’m afraid, is about as far from the truth as one can stretch…

In the candy coated world of Oba­ma­nomics, high priced stocks are a valid sig­nal of eco­nomic growth, and oil is ris­ing due to demand which extends from this growth.  In the real world, stock val­ues are com­pletely fab­ri­cated, espe­cially in light of record low trade vol­ume over the past sev­eral months:

http://money.cnn.com/2012/01/19/markets/trading_volume/index.htm

Low trade vol­ume means very few investors are cur­rently par­tic­i­pat­ing in active trade.  This lack of invest­ment inter­est in the mar­kets allows big play­ers (such as inter­na­tional bankers) to use their mas­sive cap­i­tal to swing stocks whichever way they choose, even to the point of cre­at­ing false mar­ket ral­lies.  Throw in the fact that the pri­vate Fed­eral Reserve (along with help­ful hands-off approach by our gov­ern­ment) has been con­stantly infus­ing these banks with fiat printed from thin air, and one can hardly take the cur­rent ascen­sion of the Dow or the S&P very seriously.

Another issue which should be stressed is the renewed ten­sions in the Mid­dle East, namely, the very dis­tinct pos­si­bil­ity of an Israeli or U.S. strike in Iran, and the pos­si­bil­ity of NATO involve­ment in Syria (which has exten­sive ties to Rus­sia and Iran).  Cer­tainly, this is a tan­gi­ble dan­ger that would have unimag­in­able con­se­quences in global oil mar­kets.  How­ever, the threat of grow­ing war in the Mid­dle East is in no way a new one, and has been ever present for the past decade.  It hardly explains why despite hol­low demand and extreme sup­ply, the price per bar­rel of oil has been an unstop­pable ris­ing tide.  Attempts by Saudi Ara­bia to reverse infla­tion­ary trends by promis­ing increased pro­duc­tion in the wake of Iran tur­moil has so far been ineffective.

Simul­ta­ne­ously, large oil reserves have been dis­cov­ered off the coast of Greece:

http://www.balkanalysis.com/greece/2010/12/08/greek-companies-step-up-offshore-oil-exploration-large-reserves-possible/

Off the coast of Ireland:

http://www.independent.ie/national-news/ireland-on-the-verge-of-an-oil-and-gas-bonanza-679889.html

Mas­sive fields in Mon­go­lia have been uncovered:

http://www.chinadaily.com.cn/bizchina/2009–08/08/content_8544985.htm

And of course, the vast shale oil fields in North Dakota and Mon­tana are finally being tapped:

http://www.mtpioneer.com/archive-July-oil-reserves.htm

Oil sup­ply has been ample and large oil reserves are being dis­cov­ered yearly.  Spec­u­la­tion would be the next obvi­ous assumed cul­prit, and there are cer­tainly some sig­nals of such activ­ity.  Oil spec­u­la­tors tra­di­tion­ally use the forced accu­mu­la­tion of oil inven­to­ries to reduce mar­ket sup­ply and arti­fi­cially increase prices.  Inven­to­ries have indeed been high.  How­ever, as pre­vi­ously stated, demand for oil has been sta­tic or fallen in most coun­tries around the world since 2008, and there has been NO petro­leum short­ages due to manip­u­lated mar­kets.  In fact, there have been no petro­leum short­ages period.  Spec­u­la­tion has the poten­tial to cause sharp but short term shifts in mar­kets, but one must take into account the long term trend of a par­tic­u­lar com­mod­ity to under­stand the root cause of its increas­ing or decreas­ing value.  Again, inad­e­quate sup­ply is NOT the trig­ger for the ongo­ing oil price prob­lem, whether by threat of war, or by reduc­tion through speculation.

This schiz­o­phrenic dis­con­nec­tion between the stock mar­ket, and oil, and true sup­ply and demand, is, though, a symp­tom of one very dis­turb­ing ill­ness lurk­ing in the back­wa­ters of the U.S. fis­cal blood­stream; dol­lar devaluation.

We all under­stand that the Fed­eral Reserve has been engaged in non-stop quan­ti­ta­tive eas­ing mea­sures in one form or another since 2008.  We don’t know exactly how much fiat the Fed has printed in that time, and won’t know until a full and com­pre­hen­sive audit is finally enacted, but we do know that the amount is at the very least in the tens of tril­lions (be sure to check out page 131 of the GAO report below to find their break­down of Fed QE activ­i­ties.  This is just the money print­ing that has been ADMITTED TO, in excess of $16 trillion):

http://www.gao.gov/assets/330/321506.pdf

The dol­lar is being thor­oughly squashed.  Why is this not show­ing in the dol­lar forex index?  The dol­lar index is yet another exam­ple of a use­less mar­ket indi­ca­tor, being that it mea­sures dol­lar value rel­a­tive to a bas­ket of world fiat cur­ren­cies, ALL of which also hap­pen to be in decline.  That is to say, the dol­lar appears to be vibrant, as long as you com­pare it to sim­i­larly worth­less paper cur­ren­cies that are being degraded in tan­dem with the green­back.  Once you begin to com­pare the dol­lar to com­modi­ties, how­ever, it soon shows its inher­ent weakness.

The dollar’s only sav­ing grace has long been its sta­tus as the world reserve cur­rency and its use as the pri­mary trade mech­a­nism for oil.  This, how­ever, is changing.

Bilat­eral trade agree­ments between China, Rus­sia, Japan, India, and other coun­tries, espe­cially those within the ASEAN trad­ing bloc, are slowly but surely remov­ing the dol­lar from the game as these nations begin to replace trade using other cur­ren­cies, includ­ing the Yuan.  I believe com­modi­ties, espe­cially oil, have been reflect­ing this trend for quite some time.  The con­se­quences of the dollar’s ties to oil are detri­men­tal to all nations that con­sume petro­leum, and they are clearly mov­ing to insu­late them­selves from fur­ther devaluation.

Even after the release of strate­gic oil reserves back in the sum­mer of 2011 in an effort to dilute prices, and the announce­ment of an even larger pos­si­ble release of reserves this month, oil has not strayed far from the $100 per bar­rel mark.  High Brent crude price have held for years, even after numer­ous promises from gov­ern­ment and media enti­ties admon­ish­ing what they called “spec­u­la­tion”, and promises of a return to lower energy costs.  Not long ago, $100 per bar­rel oil was an out­landish premise.  Today, it is com­mon­place, and some even con­sider it “afford­able” com­pared to what we may be fac­ing in the near future, all thanks to the steady decon­struc­tion of the last pil­lar of the U.S. econ­omy; the dol­lar, and its world reserve label.

Ulti­mately, no mat­ter how manip­u­lated and overindulged the stock mar­ket becomes, no mat­ter how many fiat dol­lars are injected to prop up our fail­ing sys­tem, the price of oil is the great game changer.  As infla­tion is reflected in its price, and energy costs burn out of con­trol, the Dow will begin to fall, regard­less of any low vol­ume or quan­ti­ta­tive eas­ing.  In all like­li­hood, this conun­drum will be blamed on as many scape­goats as are avail­able at the moment, includ­ing Iran, or China, or Rus­sia, or Japan, etc.  Each and every Amer­i­can, and espe­cially those involved in track­ing the econ­omy, will have to remind them­selves and the pub­lic that at bot­tom, it was the Fed­eral Reserve that cre­ated the con­di­tions by which we suf­fer, includ­ing cur­rency deval­u­a­tion and high oil prices, NOT some for­eign enemy.

The one pos­i­tive ele­ment of this entire dis­as­ter (if one can call any­thing “pos­i­tive” in this mess), is the man­ner in which the high price of oil tends to dash away the illu­sions of the com­mon cit­i­zen.  It is an issue they sim­ply can­not ignore, because it affects every aspect of their lives in minute detail.  Costly energy awak­ens the oth­er­wise igno­rant, and forces them to see the many dan­gers lurk­ing on the hori­zon.  Hope­fully, this awak­en­ing will not be too lit­tle too late…

Tags: Assertions, Brandon Smith, Commodities, Commodity, Conundrum, Credit Crisis, Culprits, Disinformation, Economic Instability, Energy Prices, False Conclusions, Global Oil, Iea, International Energy Agency, Inventories, Mainstream Media, Markets World, Oil Market Report, Oil Markets, Oil Prices, Russia, World Oil Demand, Wrong Direction
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The HARPEX Index is superior to the Baltic Dry Index!

Friday, March 23rd, 2012

Like many ana­lysts and econ­o­mists I have been an avid fol­lower of the Baltic Dry Index (BDI) as a so-called lead­ing indi­ca­tor of global eco­nomic activ­ity. How­ever, I have come to the con­clu­sion that the BDI as such is of no fur­ther use to me. The mas­sive growth in demand for com­modi­ties from espe­cially China from 2005 to 2008 led to a sig­nif­i­cant increase in capac­ity as the num­ber of ships built surged through until the 2010 cri­sis that resulted in a major change in sup­ply from rel­a­tively inelas­tic to highly elas­tic. Fur­ther­more, it means that changes in the Baltic Dry Index occur in what is essen­tially a down­trend or, put dif­fer­ently, in a bear market.

How­ever, I have dis­cov­ered an indi­ca­tor that is far supe­rior to the BDI. The HARPEX Index was devel­oped by Harper Petersen, a global lead­ing char­ter­ing agent. The Index is cal­cu­lated by using the actual time char­ter rates for seven classes of ships. This index there­fore mea­sures the rates of mov­ing mostly fin­ished goods glob­ally and is an excel­lent indi­ca­tor of global con­sumer activ­ity. Unfor­tu­nately the his­tor­i­cal data on the web­site only date back to 2009. (http://www.harperpetersen.com/harpex/harpexVP.do)

In the graph below I depicted the HARPEX Index against my GDP-weighted Major Economies Man­u­fac­tur­ing PMI as well as the Markit Euro­zone PMI, with both the PMIs lead­ing by two months. In the graph it is evi­dent that the HARPEX Index should be rated highly as a coin­cid­ing indi­ca­tor in any eco­nomic fore­cast­ing model. The value of man­u­fac­tur­ing PMIs as lead­ing indi­ca­tor comes to the fore as it is evi­dent that the GDP-weighted man­u­fac­tur­ing PMI of the major economies leads the HARPEX Index by two months. The bot­tom­ing and sub­se­quent rise of the PMIs in Jan­u­ary this year indi­cated that the HARPEX Index would rise through end March.  It has indeed risen from $376 at the end of Feb­ru­ary to $393 cur­rently. The slight weak­en­ing of the major economies’ PMI in Feb­ru­ary indi­cates that freight rates in April are likely to go nowhere and even decline.

Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management.

The value of the HARPEX Index can be seen in the fol­low­ing graph. Dur­ing the great finan­cial cri­sis in 2008/2009 the HARPEX Index fell to $300 and remained rel­a­tively unchanged until Feb­ru­ary 2010. The global man­u­fac­tur­ing sec­tor started to expand in August 2009 when the GDP-weighted Major Economies Man­u­fac­tur­ing PMI rose above the 50 level in August 2009. It there­fore took six months of global expan­sion to take up the slack in the con­tainer ship­ping indus­try. There­after the PMI and the HARPEX Index moved in the same direc­tion, with the PMI lead­ing by approx­i­mately two months.

Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management.

The cur­rent level of the HARPEX Index is indica­tive of how weak the global man­u­fac­tur­ing sec­tor really is. This sec­tor is still in a much bet­ter shape than in 2009 as the HARPEX Index is still 30% higher than the pre­sum­ably $300 absolute min­i­mum level at which ships can oper­ate. In my opin­ion any fur­ther strength in the global man­u­fac­tur­ing sec­tor is likely to have an imme­di­ate impact on global con­tainer­ized freight rates as the sec­tor is not recov­er­ing from a deep reces­sion as it did in 2009.

In a recent arti­cle I pre­sented you with a graph of my cal­cu­lated PMI sea­sonal fac­tors of the CFLP Man­u­fac­tur­ing for China against the Baltic Dry Index, which  not only explained the weak­ness in the BDI but also the shorter-term move­ments in the BDI. I argued that January/February would also mean a sea­sonal low for the Baltic Dry Index and a major rever­sal would be evi­dent in March and April.

Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Asset Management.

The BDI sub­se­quently made a low of 647 on 3 Feb­ru­ary and is cur­rently at 897. Although the BDI is up 38.6% it is still a far cry from what it should nor­mally have been in light of the usu­ally strong sea­sonal period. It is there­fore an indi­ca­tion of the under­ly­ing weak­ness of China’s man­u­fac­tur­ing sector.

Although I argue that changes in the Baltic Dry Index occur in a bear mar­ket due to the under­ly­ing fun­da­men­tal fac­tors, the BDI should not be dis­carded in total as it does give an indi­ca­tion of the under­ly­ing strength of China’s man­u­fac­tur­ing sec­tor. I regard the HARPEX Index as a bet­ter coin­ci­dent indi­ca­tor of global eco­nomic activity.

Tags: Actual Time, Baltic Dry Index, Baltic Dry Index Bdi, Bear Market, Charter Rates, Commodities, Commodity, Conclusion, Economic Forecasting, Economists, Follower, GDP, Global Consumer, Global Economic Activity, Graph, Leading Indicator, Massive Growth, Pmi, Pmis, Ships, Time Charter
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Silver Slumps As Risk Broadly Recovers

Tuesday, March 13th, 2012

Global risk mar­kets and US equity futures were drift­ing lower together (post China trade deficit data) into this morning's con­fu­sion in Europe but around 430ET, equi­ties pushed higher, Trea­suries ral­lied rapidly as we approached the US day ses­sion open and broadly speak­ing risk was off (in every­thing except stocks). Com­modi­ties dropped notably with Oil and Sil­ver los­ing over 1.5% from Friday's close before head­ing into the US open. The across-the-board weak­ness in credit and our broad risk asset proxy (CONTEXT) reversed, as if by magic, as the day-session open in the US dawned and led gen­er­ally by Trea­suries, which staged a 4-5bps sell-off from overnight low yields (with 2s10s30s notably ris­ing on 30Y out­per­for­mance and 10Y under­per­for­mance), we leaked back to unchanged in ES (the e-mini S&P 500 futures con­tract) hav­ing traded in a very nar­row range all day on low vol­umes (across MAR and JUN). VIX made head­lines for its low lev­els but the steep­ness of the term struc­ture should be a much big­ger con­cern. AUD weak­ness spurred much of the early risk-off but accel­er­ated stringer into the US close to main­tain equi­ties as close to green as pos­si­ble. A very noisy day given very lit­tle news/event risk and the gen­eral con­fu­sion in Euro­pean sov­er­eign mar­kets which all leaked wider. Credit and the vol term struc­ture remain notable canaries as it appears EURJPY has become carry trade-of-the-day once again.

Credit and equity resynced into risk-on from the start of the US day ses­sion but credit (espe­cially HY) remains notable under­per­former post Greece...

It is worth per­haps not­ing that HYG ended very mar­gin­ally in the red while SPY very mar­gin­ally in the green and 4 of the 5 times this has occurred this year, SPY has under­per­formed the fol­low­ing day (and we note HYG pulled rapidly up to its VWAP at the close — sug­gest­ing some sell­ing pressure).

Com­modi­ties showed some fur­ther diver­gence as Sil­ver lost its lus­ter today rel­a­tive to the other met­als (and WTI)...

Broadly speak­ing though the under­per­for­mance of Oil and AUDJPY kept CONTEXT weaker while the recov­ery in EURJPY and sell-off in Trea­suries (and 2s10s30s) is what kept the spirit alive in stocks — even though vol­umes were abysmal...

Tags: 10y, Canaries, China Trade Deficit, Commodities, Divergence, Futures Contract, Global Risk, Little News, Luster, Metals, News Event, Outperformance, Risk Markets, Slumps, Stringer, Term Structure, Treasuries, Vix, Vwap, Wti
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The Stranger Beside You — Spouses and ETFs

Friday, March 9th, 2012

ETF fund flows have been a uni­formly pos­i­tive source of cap­i­tal into U.S. risk mar­kets in 2012. Look­ing a lit­tle deeper at the decid­edly 'risk-on' flows, Nic Colas (of Con­vergex Group) notes per­haps their most provoca­tive fea­ture has been their high degree of net con­cen­tra­tion.  When you look at the entire “ETF Ecosys­tem” of listed funds, just 6 funds rep­re­sent all the net gains in assets over the past month ($5.4 bil­lion in net inflows) – LQD, HYG and JNK in fixed income, VWO in emerg­ing mar­kets, VXX in risk, and GLD in com­modi­ties. With 1,433 dif­fer­ent ETFs listed on U.S. mar­kets now, Colas likens the com­pre­hen­sion of the $1.2 tril­lion in AUM across these ETFs to how well you know your spouse as we know ETF flows are impor­tant (just like a wed­ding anniver­sary date or what day the trash is picked up at home) but with their still-evolving pro­lif­er­a­tion it seems a daunt­ing task to keep tabs on them.

The Stranger Beside You – Spouses and ETFs

Sum­mary:  ETF fund flows have been a uni­formly pos­i­tive source of cap­i­tal into U.S. risk mar­kets in 2012: $39 bil­lion of new cash over­all, with equi­ties up $20 bil­lion and fixed income flows at +$13 bil­lion.  Com­mod­ity ETFs make up most of the bal­ance, with $5 bil­lion in new cap­i­tal thus far in 2012.  Look­ing a lit­tle deeper at the flows, per­haps their most provoca­tive fea­ture has been their high degree of net con­cen­tra­tion.  When you look at the entire “ETF Ecosys­tem” of listed funds, just 6 funds rep­re­sent all the net gains in assets over the past month ($5.4 bil­lion in net inflows) – LQD, HYG and JNK in fixed income, VWO in emerg­ing mar­kets, VXX in risk, and GLD in com­modi­ties.  Over the year to date, 35 funds (out of 1,433 in total) rep­re­sent all the new “Net” monies.  The direc­tion of this mar­ginal cap­i­tal is “Risk On,” if by degrees.  Fixed income is still the largest chunk, at 29%, fol­lowed by for­eign equity (28%) and domes­tic equity (17%).  Other win­ners include Com­modi­ties (+6%) and Lever­aged Prod­ucts (+4%).

How well do you know your spouse or sig­nif­i­cant other? Could you pass one of those U.S. Immi­gra­tion and Nat­u­ral­iza­tion Ser­vice inter­views, where the gov­ern­ment seeks to con­firm that you are ‘Really’ mar­ried, rather than get­ting paid to help a non-citizen stay in the coun­try?  Cour­tesy of an arti­cle from The New York Times a few years back, here is a sam­ple of actual ques­tions asked dur­ing live inter­views by an INS official:

• On the day of your wed­ding, where did you wake up?  What about your spouse?
• Are you paid weekly, every two weeks or twice a month? How about your spouse? (And, of course, does your sup­posed spouse know the answer to this about you?)
• When you first met your now-spouse, who spoke the first words?
• Where do you keep your clean under­wear?  What about your spouse?  (And does your spouse answer cor­rectly about you?)
• What is the name of your spouse’s man­ager at work?
• What day is the trash picked up at your house?

Of course, even gen­uinely mar­ried cou­ples have their mem­ory lapses. Men who for­get anniver­saries or that they’ve already given some­thing as a present before.  Women who for­get….  Well, they must for­get some­thing.  The point is that famil­iar­ity may not nec­es­sar­ily breed con­tempt as much as a som­nam­bu­lant par­tial memory.

That’s some­thing like I think many mar­ket observers treat the world of Exchange Traded Funds – we know they are impor­tant to under­stand­ing cap­i­tal flows, but with their still-evolving pro­lif­er­a­tion it seems a daunt­ing task to keep tabs on them. There are, after all, some 1,433 dif­fer­ent ETFs listed on U.S. mar­kets, with 64 new ones (net) intro­duced in 2012 alone.  As of Wednesday’s close, ETFs had $1.2 tril­lion in assets under man­age­ment, with net inflows of $39 bil­lion to date in 2012.  Thus far in the year, total AUM is actu­ally up $115 bil­lion with the gen­er­ally pos­i­tive per­for­mance of cap­i­tal markets.

That inflows num­ber is what gets the most atten­tion, in that it is a use­ful proxy for where cap­i­tal is mov­ing at any given time. ETFs have been the most con­stant source of new money – notably into U.S. stocks – for sev­eral years, espe­cially as com­pared to mutual funds.  Con­sider that thus far in 2012, mutual fund man­agers have seen $22 bil­lion in out­flows from domes­tic equity mutual fund prod­ucts, only par­tially off­set by $4 bil­lion of fresh cap­i­tal into for­eign equity funds.  Com­pare that with the $20 bil­lion of new money into equity ETFs thus far for 2012, and it is easy to see that ETFs are adding to avail­able cap­i­tal at a faster rate than mutual funds are shrink­ing that same pool of money.

But the prob­lem of pro­lif­er­a­tion when it comes to ana­lyz­ing ETF money flows per­sists for mar­ket observers, espe­cially as the indus­try con­tin­ues to answer investor demand with new prod­ucts. How do we think about the spate of recently announced volatility-target funds, such as iShares MSCI Emerg­ing Mar­kets Min­i­mum Volatil­ity Index Fund (sym­bol EEMV, just to call out one prod­uct that fits this new approach)?  Or Index IQ’s plans to launch a phys­i­cal dia­mond fund?  Or the recent suc­cesses in asset gath­er­ing for the ProShares and Veloc­i­tyShares and iPath volatil­ity prod­ucts.  You get the idea – it is easy to feel like a for­get­ful spouse rush­ing to buy an anniver­sary present.

There is a “Brute force” way to look at fund flows, and it cen­ters on the fact that a fairly nar­row band of ETFs actu­ally get the bulk of the mar­ginal cap­i­tal flows at any time. For exam­ple, take a look at the money flows for the last month in ETF land.  Lit­er­ally hun­dreds of funds gained assets, and almost as many lost some cap­i­tal.  But if you look at the $5.4 bil­lion of fresh cap­i­tal that made its way into ETFs in the last 30 days, you can sum­ma­rize where that money went with six funds.  Here are some details:

• Two large fixed income ETFs – iShares iBoxx High Yield Cor­po­rate Bond and iShares iBoxx Invest­ment Grade Cor­po­rate Bond – raked in a com­bined $1.6 billion.
• The SPDR Gold Trust – GLD – received $957 mil­lion in fresh capital.
• The SPDR Bar­clays High Yield Bond ETF got $829 bil­lion in new money.
• In emerg­ing mar­kets, the Van­guard MSCI Emerg­ing Mar­kets fund saw $1.2 bil­lion in new capital.
• The iPath S&P 500 VIX Short Term Futures ETN saw $845 mil­lion in new money in the last month, adding well over 50% to its cap­i­tal base.

So there you are – with six names you can tell the tale of the tape in the last month. Even at low inter­est rates, there is still ample demand for cor­po­rate debt.  Investors still feel plenty of appre­hen­sion even four months into the most recent up move from the Octo­ber lows – cue the gold and VIX invest­ments.  And emerg­ing mar­kets, with their higher betas, get the nod as well.  Risk on, as the say­ing goes, with a side of risk hedges.

This same approach works for the year-to-date, with 35 funds essen­tially cap­tur­ing all the mar­ginal cap­i­tal added through ETFs (that $39 bil­lion we men­tioned ear­lier).  We’ve included sev­eral tables and charts, with data cour­tesy of www.xtf.com (an excel­lent resource for all things ETF-related), to high­light the fol­low­ing points:

• The largest incre­men­tal invest­ments year to date through ETFs have been in fixed income (29% of mar­ginal demand), for­eign equity (28%) and domes­tic equity (17%).
• This indi­cates that investors have grown a lit­tle more cau­tious as the year has pro­gressed, since fixed income mar­ginal flows were 42% over the past month, and for­eign equi­ties were 19% of the “Net” flows.

All in all, this brief analy­sis points to more of a pause in investor sen­ti­ment rather than the open­ing for a more full-blown cor­rec­tion in the com­ing weeks. ETF buy­ers – who are both retail and insti­tu­tional play­ers at the end of the day – aren’t really pulling in their horns just yet.  And yes, these flows also rep­re­sent demand from hedge funds to pro­vide short posi­tions, so I wouldn’t paint higher asset lev­els as uni­formly bull­ish.  But there is no deny­ing that ETF fund flows con­tinue their steady drip-drip-drip higher, on the back of bet­ter over­all cap­i­tal mar­kets performance.

Tags: Aum, Chunk, Colas, Commodities, Daunting Task, Domestic Equity, Ecosystem, Emerging Markets, Etf Fund, Fixed Income, Fund Flows, GLD, Hyg, Jnk, Monies, Risk Markets, Source Of Capital, Trillion, Vwo, Wedding Anniversary
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