Archive for September 16th, 2012
Sunday, September 16th, 2012
Much has been written over the course of the last few days/weeks about what Bernanke could do, has done, and the efficacy of said actions. Inflation, unintended ‘energy’ consequences, debasement, financial repression, scarcity transmission mechanisms all come to mind but realistically they are all just symptoms of what is really going on. As the following chart from Barclays shows, the real effect of LSAPs is to suppress the signaling effect of macro data from the real economy. During periods of extreme monetary policy, the stock market’s beta to macro-economic data surprises is dampened massively – and hence the forced mal-investment and mis-allocation of funds occurs. However, given the now open-ended nature of QE3, this may change with the ‘good news/bad news’ logic leading to a stronger market (higher beta) response (since all bad news is automatically attenuated by QEternity and thus all the good news is out there).
An important driver of this attenuated market response to economic news was the sense that important elements of the monetary policy framework were ‘in play’, and that policy was likely to respond if the economy weakened sufficiently, but not otherwise. In this context, bad economic news may not seem so horrible, if it is perceived to raise the probability of a market-friendly monetary policy response. In the run-up to June 2011, the question facing investors was whether the Fed would allow QE2 to end in June, in accord with the Fed’s stated intention. More recently, the question has been whether the Fed would put a more aggressive policy in place. But the ‘good news/bad news’ logic was much the same.
It seems to us that this logic will not, however, remain operative in the months to come, since the policy frameworks recently announced by both the Fed and the ECB have no stated end date on which markets can focus (as did QE2), and are not likely to be materially adjusted in response to economic data for some months to come. Economic news may have been a ‘good news/bad news’ story in the recent past. But now that the monetary policy responses to economic weakness are in place, markets have had the good news.
In the future, bad economic data will be, well, just bad, and good news will be unambiguously positive. This should lead to a stronger market response to economic data in the weeks and months to come.
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Sunday, September 16th, 2012
While Koo-nesianism is only one ideological branch removed from Keynesianism, Nomura’s Richard Koo’s diagnosis of the crisis the advanced economies of the world faces has been spot on. We have discussed the concept of the balance sheet recession many times and this three-and-a-half minute clip from Bloomberg TV provides the most succinct explanation of not just how we got here but why the Fed is now impotent (which may come as a surprise to those buying stocks) and why it is the fiscal cliff that everyone should be worried about. As Koo notes, the US “is beginning to look more like Japan… going through the same process that Japan went through 15 years earlier.”
The Japanese experience made it clear that when the private sector is minimizing debt (or deleveraging) with very low interest rates, there is little that monetary policy can do.The government cannot tell the private sector don’t repay your balance sheets because private sector must repair its balance sheets. In Koo’s words: “the only thing the government can do is to spend the money that the private sector has saved and put that back into the income stream” – which (rightly or wrongly) places the US economy in the hands of the US Congress (and makes the Fed irrelevant).
DEIRDRE BOLTON, BLOOMBERG NEWS ANCHOR: Based on the data points, the economic data points we’ve got in the past month, how likely is it that the U.S. is heading towards a lost decade? Is it more or less likely than what you told us about four to six months ago?
RICHARD KOO, CHIEF ECONOMIST, NOMURA RESEARCH INSTITUTE: Well, it is beginning to look more like Japan. The amount of house price declines, the commercial real estate price declines there, all following the Japanese pattern very precisely and very slow GDP growth, even with all this monetary easing, QE2, possibly QE3.
So yes, to me, the United States is going through the same process of what I call balance sheet recession, that Japan went through 15 years earlier.
BOLTON: You mentioned the possibility of QE3. What should Ben Bernanke do today in his speech and then what should he do as a follow-up action?
KOO: Well, actually, the Japanese experience told us that when private sector is minimizing debt or deleveraging with very low interest rates, there’s very little monetary policy can do.
In fact, Chairman Bernanke has been saying, since the middle of last year that this is no time to cut budget deficit. The fiscal stimulus should be in place because I think he also understands that under the circumstances, there’s so little that monetary policy can do.
But there’s a lot the fiscal policy can do to keep the U.S. economy from losing its bottom.
BOLTON: Richard, how.
KOO: And so I think he should continue to push that line. Yes?
BOLTON: Continue to push that line and maybe try to subtly encourage Washington to take a little bit more control. Sounds like you think that Congress should do something.
KOO: Yes, because when people are deleveraging even with zero interest rates, that means they are very sick. The private sector is very sick and in need of help because their balance sheets are under water.
And then that’s the case, even if Federal Reserve lowers interest rates, puts liquidity into the market, the private sector cannot really respond because they have balance sheet problems.
And the government cannot tell the private sector don’t repay your balance sheets because private sector must repair its balance sheets. So the only thing the government can do is to spend the money that private sector has saved and put that back into the income stream.
And that, I think is what the U.S. has to do. And that means this is no time to cut budget deficit. You have to maintain the fiscal stimulus until private sector is healthy enough to start borrowing and spending money again.
And at that point, Federal Reserve will become all very irrelevant. But at the moment, I think the control of the U.S. economy is really in the hands of Congress.
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Sunday, September 16th, 2012
U.S. Equity Strategy, September 14, 2012
What’s Driving the Equity Market? P/E or the E?
Prepared by Ryan Lewenza, CFA, CMT, V.P., U.S., Equity Strategist, TD Waterhouse
- From the June low of 1,266.74, the S&P 500 Index (S&P 500) is up over 13%, which has entirely been driven by multiple expansion. As we have outlined in recent publications, it’s our belief that the move higher in the S&P 500, due to an expansion in valuation multiples, has been driven in part by the prospect of additional central bank liquidity.
- The European Central Bank (ECB) followed through on its strong signals of additional stimulus, with President Mario Draghi announcing that the ECB would launch a new bond buying program on September 6th. The Federal Reserve (Fed) then followed up on September 13th by announcing yet another bond buying program, which will see the Fed buy $40 billion of mortgage-backed securities per month, with an open-ended mandate. This action led to a strong rally in the equity markets, with the U.S. equity market rallying over 1.5% on the day, being driven by continued P/E expansion.
- As history has shown, equity markets perform well in periods of additional monetary stimulus, such as QE, which we believe could occur with the latest round as well.
- We are introducing our 2013 S&P 500 earnings forecast of $102.25, which if realized, would represent a significant slowdown in corporate profit growth next year. Based on our estimates, profit growth would slow to 3.3% in 2013, compared to 7.1% expected for 2012, and the 15.2% growth seen in 2011. The bottom-up consensus estimate for 2013 stands at $115.43 (11.7% Y/Y growth), but we believe the current consensus estimate is too high, and is likely to be revised lower in the coming months
- All told, our EPS models point to continued healthy earnings in 2013, however we believe earnings will come in below the current optimistic consensus estimates, and that U.S. earnings could peak in 2013. If correct, further upside in equity prices will have to be driven by continued P/E expansion, as the support of higher earnings growth begins to wane.
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Sunday, September 16th, 2012
All Signs Pointing to Gold
September 14, 2012
By Frank Holmes, CEO and Chief Investment Officer
U.S. Global Investors
With another syringe of quantitative easing being injected into the U.S. economy’s bloodstream, Ben Bernanke is giving the markets their liquidity fix. The Federal Reserve’s action reaffirmed my stance I’ve reiterated on several occasions that the governments across developed markets have no fiscal discipline, opting for ultra-easy monetary policies to stimulate growth instead.
The government’s liquidity shot promptly boosted gold and gold stocks, as investors sought the protection of the precious metal as a real store of value. You can see below the strong correlation between the rising U.S. monetary base and growing gold value. Since the beginning of 1984, as money supply has risen, so has the price of gold.
The dollar declined due to the Fed’s easing, which isn’t surprising, given the fact that gold and the greenback are often inversely correlated, and increasing money supply generally causes the currency to fall in value.
What’s interesting is that currency decline was what Richard Nixon sought to avoid when he ended the gold standard in 1971 and announced that the country would no longer redeem its currency in gold. During his televised speech to the American public, Nixon translated in simple terms the “bugaboo” of devaluation, saying, “if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.”
As you can see below, more than 40 years later, a dollar is worth only 17 cents. This significant decline in purchasing power only strengthens the case of gold as a store of value, likely prompting Global Portfolio Strategist Don Coxe to propose making Nixon the “patron saint of gold investors,” during this year’s Denver Gold Forum.
As Milton Friedman once said, “Only government can take perfectly good paper, cover it with perfectly good ink and make the combination worthless.”
In its long-term asset return research charting economic history in comparison to current markets, Deutsche Bank illustrates multiple ways how “the world dramatically changed post-1971 relative to prior history.” While the research firm makes it clear that returning to the gold standard would be “disastrous,” DB finds that the “lethal cocktail of unparalleled levels of global debt and unparalleled global money printing” are relatively new governmental developments.
Prior to the last four decades, deficits only occurred in extreme situations of war or severe economic setbacks, such as the Great Depression. Balanced budgets were a “routine peace time phenomena in sound economies.” Since 1971, surpluses have been rare. The U.K. has had an annual budget deficit 51 out of the past 60 years and Spain has had 45 years of deficit spending over the past 49 years, according to DB.
Many developed countries are in a predicament, as fiscal austerity attempts have led to weaker-than-expected growth in Greece, Ireland, Portugal, Spain and Italy. DB asks, “Can we really be confident that the developed economies that we have created over the last 40 years have the ability to withstand the effects of austerity and cut backs? Do our modern day econometric models have the ability to understand the impacts of fiscal retrenchment after a financial crisis having been calibrated in a period of excessive leverage?”
Countless discussions over fiscal and monetary policies will carry on, but time will tell. Ian McAvity, editor of Deliberations on World Markets, says, “Excessive debt creates deflationary drag that they repeatedly fight by throwing fresh ‘liquidity’ or ‘stimulus’ at, to debauch the currency of that debt … For private investors, gold is the best medium for self-protection and preservation of purchasing power in my view.” I agree. Rising money supply, declining purchasing power and annual deficits are giving the all-clear to include gold in your portfolio.
Many others appear to agree with us, as sentiment has shifted in favor of the metal in recent days: According to Morgan Stanley’s survey of 140 institutional investors in the U.S., gold sentiment was at its highest bullish reading since July 2011 and the largest month-over-month increase during the survey’s three-year history!
So, gold investors, if you haven’t put in your orders, consider getting them in quickly, because the bulls are buying. Credit Suisse saw “massive inflows” into gold exchange-traded products in August after experiencing significant outflows compared to crude oil and the broader market in March, April, May and July. August shows a clear preference toward gold.
We generated lots of interest when we showed our standard deviation chart a few weeks ago, so I updated it through September 13. Although gold has been on a tear recently, breaking through the stumbling block of $1,600 and climbing to $1,770 by the end of the week, bullion still looks attractive, with a low sigma reading of -1.7
A look at a histogram shows how many times gold bullion historically fell in this sigma range. Today’s sigma of -1.7 has occurred only about 2 percent of the time. Bernanke and Draghi only made the decision more obvious for gold and gold stock buyers.
The Fed and ECB also make my job presenting at the Hard Assets conference in Chicago very exciting. Don’t miss my presentation on September 21. I invite you to be there in person if you live in close proximity to Chicago, or you can download a pdf at www.usfunds.com following the meeting.
You might also learn something you didn’t know with our newest interactive slideshow, the 10 Surprising Uses of Commodities. Check it out and share with a friend.
Sunday, September 16th, 2012
U.S. Equity Market Radar (September 17, 2012)
The S&P 500 Index rose 1.94 percent this week as the markets embraced additional Federal Reserve policy in the form of quantitative easing and a promise to keep interest rates exceptionally low through mid-2015. This follows last week, when the European Central Bank announced “unlimited” sovereign bond purchases out to three years for countries that meet certain conditions. We often cite government policy as a precursor to change and that has definitely been the case over the past week or so. These events allow the market to look beyond the current economic malaise and focus on improving fundamentals over the next 6-12 months.
- The energy sector rose 4.06 percent, leading the way as the Fed sped up the printing presses. Commodities were strong across the board. Halliburton, Southwest Energy and Pioneer Natural all rose by more than 9 percent this week.
- Financials were also very strong this week, rising by 3.82 percent. Commercial real estate firm CBRE Group jumped by 15 percent and large banks such as Bank of America and Citigroup were up about 8.5 percent on the back of Fed easing.
- Alpha Natural Resources was the best performer in the S&P 500 for the second week in a row, rising by 23.91 percent. The stock continued the “bounce” that began last week as beaten down areas such as coal were among the week’s best performers.
- Defensive sectors were the laggards again this week as the “risk on” trade roared back and sector rotation was the theme. Consumer staples fell 11 basis points while health care was modestly positive in a strong market.
- The utilities sector lagged for the fifth week in a row as the market continued to rotate into other areas.
- Monster Beverage was the worst performer this week in the S&P 500, falling by more than 7 percent on news of continued investigations into the safety, labeling and marketing of energy drinks in general.
- The market reacted very positively to this week’s Fed announcement, hitting a four-year high. The old saying, “Don’t fight the Fed” is probably appropriate here.
- The market will now shift to earnings preannouncements and the upcoming elections, which could cause some volatility.
Sunday, September 16th, 2012
The Economy and Bond Market Radar (September 17, 2012)
Treasury yields rose sharply this week as the Fed announced a new round of quantitative easing (QE). The Fed announced an open-ended QE program, purchasing $40 billion in mortgage backed securities each month until the program is no longer needed, and committed to keeping interest rates exceptionally low through mid-2015. It is somewhat counterintuitive for bonds to react negatively to this news, we saw a very similar pattern with prior QE programs; bonds sell off on the announcement as prospects for economic growth increase. This pattern began last week as the European Central Bank decided to implement unlimited EU sovereign bond purchases out to three years. The global easing cycle began a year ago and intensified this week. Even though economic data looks dismal, the market is now able to look past it and toward a recovery.
- The Fed exceeded market expectations with an “open ended” QE program and also pledged to keep interest rates exceptionally low through mid-2015.
- The University of Michigan Confidence Index showed surprising strength in September.
- Inflation data remains muted with both Consumer Price Index (CPI) and Producer Price Index (PPI) reported this week, giving the Fed confidence to act.
- Industrial production was very weak in August, falling 1.2 percent versus expectations for no change.
- Consumer credit unexpectedly fell $3.3 billion in July, the first decline in 11 months.
- Moody’s warned that if lawmakers don’t agree on policies to address the budget deficit next year, the U.S. would be downgraded.
- The Fed and ECB have both enacted new easing policies over the past two weeks and the third leg of the stool is China. China is currently going through a leadership transition that should be finalized by mid-October and that will likely allow the new leadership to take stimulative action.
- Interest rates are likely to remain very low for the foreseeable future.
- Europe remains a wildcard with the markets shifting focus on a weekly basis.
- China also remains somewhat of a wildcard with the current leadership shift and lack of recent actions targeted at boosting the economy.
Sunday, September 16th, 2012
Gold Market Radar (September 17, 2012)
For the week, spot gold closed at $1,770.75 up $35.10 per ounce, or 2.02 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 6.62 percent. The U.S. Trade-Weighted Dollar Index slumped 1.76 percent for the week.
- The turn to higher prices in the gold market has been a welcome relief from the despair many were feeling during the summer doldrums.
- Bernanke’s Fed has come through on a new quantitative easing program that is open-ended, which should provide a new floor for gold prices. In addition, there will be a push to keep interest rates very low and the Fed has suggested the punch bowl of stimulus will not be taken away early even if the economy appears to be turning around.
- Generalist and fast money players have shunned the precious metals sector since the February highs with a zeal that has now turned to a grimace as they consider buying back their positions.
- Even in a great gold market you shouldn’t buy just any stock that has been knocked down. Great Basin, which previously fell by about 50 percent a month ago, tumbled another 65 percent this week as it announced it would suspend operations at its Burnstone mine due to an inability to continue to fund operations.
- The West African nation Ivory Coast announced it will increase taxes on gold miners operating in the country. Perseus Mining’s grow plans to put its Ivory Coast Tengrela Gold project into production could be put on hold pending the resolution of the tax issue.
- The document outlining the rationale for the increase in taxes stated, “The price of gold, which was around $300 per ounce in 2002, is today above $1,700, or practically a six-fold increase without any comparable increase in production costs.” For those mining companies that espouse to investors that their “cash cost” to produce an ounce of gold is, for example, $400 with $1,200 margins at $1,600 gold, take notice. The only people that believe these metrics are governments! Presently, the all-in cost to produce an ounce of gold is running closer to $1,375.
- Both the Denver Gold Forum and the Precious Metals Summit took place over the past week. Despite the rise in gold prices, investors were guardedly optimistic on their outlook, versus euphoria which leads to runaway prices.
- The mood for acquisitions was very strong by the companies that are in a position to acquire cheap assets, but there are few sellers to accommodate them. We expect that deals will get done and this should be an extra boost for those companies with desirable assets that make sense to put into production.
- There was discussion at the World Gold Council meeting held in Denver that companies may move away from quoting “cash cost” numbers to produce an ounce of gold. After all, this was a non-GAAP metric that was invented to hide the fact that gold companies did not make any profits when gold prices were depressed. Better transparency for investors will be good for the industry. In addition, companies emphasized the need to refocus their priorities on growing their profitability versus the number of gold ounces produced.
- Conflict with labor unions continues to be a problem in South Africa. This has largely impacted the platinum miners, pushing up the price of platinum and palladium, but some of the gold companies are being impacted, too.
- With the drought of equity financings over the last six months, be prepared for some companies to come to the market to raise money. There certainly are some quality projects that should be funded and make economic sense, but be wary of just investing in any deal that comes along. Investors were shocked when their $9.50 investment in NovaGold Resources back in February traded down to $3.68 per share in August.
- In addition, profit taking is always a concern. In the next two weeks, everybody will be watching to see if the gains in gold and in the equity prices can be maintained. The arguments for staying long are extremely compelling because the woes of the economy cannot be fixed in any magical way. If no correction takes place in the near term, caution would still be appropriate after the closing of the September quarter.
Sunday, September 16th, 2012
Energy and Natural Resources Market Radar (September 17, 2012)
- Commodities across the board gained strongly this week leading up to and following the announcement of QE3 by the Fed. WTI Crude oil was up 4.5 percent, LME copper was up 9 percent, NYMEX natural gas was up 5.9 percent, and zinc was up 10.7 percent.
- Oil prices increased 2.6 percent this week after two events – the deadly attack against the U.S. consulate in Benghazi, Libya and the Fed announcing an open-ended QE program. Events in Libya remind us that supply risks persist beyond Iran. Tight OPEC spare capacity levels serve as a supportive oil price backdrop for these supply risks.
- Aluminum markets remain oversupplied. In an editorial in the Financial Times this week, the CEO of RUSAL said aluminum producers should cap their output, as downward pressure on prices is expected to continue into 2013 as reported by Reuters. Also, Tajikistan’s state-owned aluminum smelter, the largest in Central Asia, cut its production forecast for the year by 15 percent.
- The Australian government announced that employment in the mining sector declined 4,600 during the three months ending August, the first quarterly decline since mid-2009. Several of the country’s largest miners, including BHP Billiton, Xstrata and Fortescue, have recently announced job reductions amid a difficult environment of declining prices, higher costs and a strong Australian dollar.
- The downward revision of the coal production forecast by the Indonesian Coal Mining Association signals a quantifiable supply response to lower prices which could provide meaningful fundamental price support to the market.
- A slide in iron ore prices to three-year lows is forcing many high-cost miners in top consumer China to curb output, industry sources say, in a move that could reduce the surplus in a market weighed down by near record Chinese stocks. China produces about 1 billion tons a year of iron ore and buys 60 percent of the steelmaking raw material traded globally. But a slowdown in its economic growth has undermined demand assumptions and hit prices hard. Iron ore fell last week to $86.70 a ton, a level unseen since October 2009. Traders and major miners have been waiting for evidence that China is cutting output to help rebalance supply with the slowdown in demand from steel mills, per Reuters.
- Anglo American Platinum said it had halted work at its four Rustenburg Platinum Group Metals mines, which account for 17 percent of its output, due to fears for the safety of its 19,000 staff after labor unrest spread throughout South Africa.
- According to OPEC, global crude supplies are likely to be abundant and an expected slowdown in oil demand growth next year may be more severe than forecast if the global economy deteriorates. The world oil consumption is expected to decline to 800,000 barrels a day in 2013, from 900,000 a day this year, and OPEC members would need to pump an average of 29.5 million barrels a day next year.
- Reuters reported that the Côte d’Ivoire government plans to unveil a windfall profit tax on gold miners to benefit from higher prices for the metal. The new tax is expected to yield about $79 million of additional revenues to the state. It produced 12 tons of gold in 2011.
Sunday, September 16th, 2012
Emerging Markets Radar (September 17, 2012)
- New home sales, residential investments and housing starts in China all showed an encouraging recovery in August, registering 13 percent, 10 percent, and 5 percent year-over-year growth, respectively, as lower interest rates and policy relaxation for first-time home buyers continued to help housing transactions normalize.
- South Korea announced a $5.2 billion stimulus package aimed at reducing taxes on individual income and home and auto purchases as well as expanding social welfare programs. Combined with $7.5 billion introduced in June, cumulative government initiative for this year equals 1 percent of GDP. The country’s debt rating was upgraded one notch to A+ by S&P this week.
- Turkish Airlines’ passenger numbers increased by 19 percent year-to-date in August. After a slowdown in July 2012 due to Ramadan, which negatively affected mainly Middle Eastern air traffic, the carrier again posted a strong increase in load factor, up 5.2 percent. Meanwhile, favorable passenger mix development continues as business class passenger count was up 45 percent year-to-date.
- China’s industrial production growth in August came out lower than expected at 8.9 percent year-over-year, the first monthly pace below 9 percent since May 2009, as a slight stabilization in heavy industry output failed to offset a retreat in light industry. Deterioration in the metric with the highest historical correlation to GDP lowers the probability of a near-term growth recovery in China.
- China’s passenger car sales grew 11 percent year-over-year in August to a lower-than-estimated 1.22 million units, as dealer inventories remained higher than normal and consumers postponed purchases in anticipation of more price discounts. Total auto sales rose 8.3 percent to 1.5 million, as commercial vehicle sales stayed weak.
- China’s total imports declined by 2.6 percent year-over-year in August, the first year-over-year decline since October 2009 excluding seasonal distortions from the Chinese New Year, another indicator of feeble domestic demand and continued de-stocking.
- New EU banking union proposals are designed so that non-euro countries can join if they wish. Austrian bank regulators expressed their support for the new eastern members of the EU to join. Austrian banks are the biggest lenders in Southeastern Europe.
- Iraq’s central government and the Kurdish regional government struck a preliminary deal on Thursday on a months-long oil dispute that will see the autonomous region export 200,000 barrels of oil per day, officials said. Any resolution of the long standoff will help crystallize valuation of the energy companies with exploration projects in the area.
- The launch of the third round of quantitative easing (QE3) by the U.S. Fed brings new hope for emerging Asian markets in general. Based on the historical parallel of what happened to different equity sectors in the near term after the Fed’s formal announcement of QE2 in early November 2010, the technology sector in Asia tends to consistently outperform in this environment.
- A risk exists that policymakers in Asia may overreact to inflation prospects as a result of QE3-induced commodity price rallies and hot money inflows. The earliest sign was observed when Hong Kong’s monetary authority tightened mortgage lending immediately after the Fed’s QE3 announcement.
- According to the Turkish banking regulator bulletin, a large corporate loan on the banking sector’s balance sheet has gone bad. Next week, the list of banks that potentially have been hit by this default should be narrowed down.
- Moving counter to the global easing cycle, the Central Bank of Russia (CBR) decided to hike key interest rates by 25 basis points, with another hike now expected in the fourth quarter. The CBR elaborated on inflation risks and stated that headline inflation advanced to 6.3 percent, exceeding its target.