How Helicopter Ben Helps Jobs and, Inadvertently, Gold

Monday, October 8th, 2012

How Helicopter Ben Helps Jobs and, Inadvertently, Gold

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

The world’s central bank leaders continue to spike the monetary punch bowl, with investors imbibing on gold once again. This flurry of gold buying prompts many curious investors and doubting media to ask me two questions: 1) How can demand for gold and gold stocks continue; and 2) How high can the precious metal go?

To answer these questions, we need to look at the intentions behind the economic and political decision-making across several developed countries, analyze the causes, the effects, and the possible ramifications.

For example, one of the most debated topics today is America’s ongoing unemployment situation. Job loss has affected the lives and pocketbooks of millions of Americans and our friends and families, culminating to a center-stage position in the election this year. All eyes turn to President Barack Obama and Mitt Romney to explain how each intends to create jobs.

During the two years following the Great Recession, Americans lost jobs at a similar rate to the employment losses during the Great Depression and in Finland after 1991. But two years after the crisis, U.S. employment losses stopped and reversed direction.

Compare this to the situations in Norway, Spain, Finland and Sweden, each of which had prolonged unemployment. After Norway’s financial crisis in 1987, it took 8.5 years to return to the country’s employment peak. It took 13 years for Spain’s employment to return to its 1997 peak. For Finland and Sweden, it took more than 17 years following their 1991 peaks.

Although the job losses in the U.S. don’t seem as dismal, “Helicopter” Ben Bernanke wants to avoid Europe’s and Japan’s catastrophic situations. To him, the economy “has not been growing fast enough recently to make significant progress in bringing down unemployment.”

In a speech to the Economic Club of Indiana on October 1, Bernanke explained that the Fed is “charged with promoting a healthy economy,” which includes “an economy with low unemployment, low and stable inflation, and a financial system that meets the economy’s needs for credit and other services.” With regards to the decisions relating to monetary policy, the Fed’s goals are dictated by Congress and are to seek “maximum employment and price stability.” He explains, “We would like to see as many Americans as possible who want jobs to have jobs and that we aim to keep the rate of increase in consumer prices low and stable.”

Ten years earlier, Ben hinted at the way he might accomplish such goals as a Fed chairman. In a speech regarding deflation, he shared his position on a government’s means to print money, referring to Milton Friedman’s comment about dropping money out of a helicopter into the economy. He stated, “The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost.” Since then, he’s been known as “Helicopter Ben.”

With unemployment continuing, the Fed’s helicopter drops another $40 billion per month to buy mortgage-backed securities, as well as an additional $45 billion of longer-term securities per month through the end of the year.

And, as Bank of America-Merrill Lynch says, “monetary policy is contagious.” The Fed’s money printing practice to help create jobs is only one part of the picture. Along with the growing U.S. monetary base, global liquidity has been growing every year for the past 12 years. As you can see, both of these factors have a close correlation to the rise of gold.

While well-intentioned, I believe these “quantitative infinity” programs may have a devastating devaluing effect on currencies, which has helped to spur gold prices over this entire time period.

Gold investors have recognized this correlation by returning to gold en masse. In August, investors rushed into gold, with the massive inflows of money going into the gold exchange traded products in August more than each of the prior five months.

Buying continued in September, with gold lovers loading up on coins. According to Bloomberg, people purchased the most American Eagles from the U.S. Mint in eight months. Almost 70,000 ounces were sold last month—the most sold since January when the U.S. Mint sold 127,000 ounces.

Miners also attracted interest, with the FTSE Gold Mines Index experiencing a rise of 13.25 percent and the NYSE Arca Gold Miners Index rising 12 percent during the month of September alone.

So how high can gold go? If you factor in only the Fed’s program to purchase mortgages and Treasuries, Bank of America-Merrill Lynch says that over the next nine months gold could go to $2,000, and by the end of 2014, gold could be at $2,400.

This target doesn’t take the Love Trade into consideration. Over the past several months, we’ve heard only chirping crickets from India, the country that has historically been the world’s largest consumer of gold. Demand suffered under a very weak rupee, as the price of gold in the local currency climbed to an all-time high.

The rupee’s recent strength has helped to increase Indian gold demand with flows climbing to a five-month high, according to UBS. What’s helped bring shoppers back to the market is the fact that the exchange rate is back to where the rupee was in April.

This improvement in the currency comes just in time, as the wedding season is in full bloom. Every year, about 10,000 weddings are held in India from late September through January, in between the monsoons and the summer heat. Gold has historically been closely linked with the celebration of weddings, as the bride wears the precious metal and gifts of gold coins are given to the newlyweds.

In addition, Diwali will be celebrated in November. The Festival of Lights is India’s biggest and most important holiday of the year and is celebrated by almost 1 billion Hindus around the world. Traditionally, on the first day of Diwali, it is considered auspicious to clean the home and shop for gold.

Why is India so significant to gold? As you can see below, from 2000 through 2011, the rising incomes in both China and India have been strongly correlated to the price of gold.

Investors now have two strong reasons to invest in gold: the Fear Trade, driven by an expanding monetary base, and the Love Trade, driven by rising gold demand in Chindia. If you’re already sold on gold, make sure to maintain a modest 5 to 10 percent weighting in gold and gold stocks. For those investors who aren’t in gold, what’s stopping you?

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U.S. Equity Market Radar (October 9, 2012)

Monday, October 8th, 2012

U.S. Equity Market Radar (October 9, 2012)

The S&P 500 Index rose 1.41 percent this week, as the market climbed higher on better economic news and a more optimistic sentiment. Financials led the way on broadly improving sentiment due to the rebound in housing, loan growth and Fed policy. Technology lagged and was the only group to post a loss this week as negative earnings preannouncements weighed in the sector.

Strengths

• The financial sector was the best performer this week rising 3.03 percent. Financials have quietly become the best performer in the market over the past month, three months and trailing year. Hartford Financial Services Group was the best performer this week, rising by more than 9 percent as the company announced it is selling its life unit, a broker-dealer and its individual annuities distribution business. This will free up capital that will likely be returned to shareholders.
• The healthcare sector registered the second best performance this week, rising by 2.59 percent. The managed care companies were among the best performers with Humana, WellPoint and Aetna all rising by more than 5 percent. Some of these gains were attributed to Mitt Romney’s performance in the presidential debate.
• Netflix was the best performing stock in the S&P 500 this week as the company rose by more than 22 percent.  An analyst reiterated his confidence in the company citing a proprietary survey showing improving satisfaction with the Netflix service.

Weaknesses

• The technology sector experienced weakness among a variety of industry groups.  Hewlett-Packard, First Solar and JDS Uniphase all dropped by at least 8 percent.
• Energy also underperformed as oil dropped 2.43 percent and fell below $90. Exploration & production and oil service companies tended to be the hardest hit.

• Hewlett-Packard was the worst performer in the S&P 500 this week, falling by more than 13 percent as the company reported that the turnaround plan it began a year ago is still a work in progress and lowered 2013 profit estimates. The company hit a 10-year low this week.

Opportunity

• While debasing the value of its paper currency in the long term, renewed money printing in the developed world may have the ability to send asset prices higher in the near term.

Threat

• The market will now shift to earnings announcements and the upcoming elections, which could cause some volatility.

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The Economy and Bond Market Radar (October 9, 2012)

Monday, October 8th, 2012

The Economy and Bond Market Radar (October 9, 2012)

Treasury bond yields rose this week on better-than-expected economic data. The ISM manufacturing index rose more than expected in September and moved back above the critical 50 level, indicating expansion in manufacturing. The unemployment report was released on Friday and was generally well received with a lot of focus on the headline unemployment rate falling below 8 percent to 7.8 percent. The change in nonfarm payrolls was only 114,000, hardly enough to push the unemployment rate down by 0.3 percent. It is estimated that all else being equal, nonfarm payrolls need to grow by 125,000 per month just to maintain the unemployment rate as new workers enter the market faster than people leave the market. The chart below depicts how the unemployment rate has fallen from a high of 9.9 percent in April 2010 to the current 7.8 percent. Since the end of 2009, nonfarm payrolls have averaged just 127,000 per month, essentially break-even job growth. The drop in the unemployment rate is due almost entirely to people leaving the labor force, as opposed to any significant job creation. There were also some seasonal adjustments in this report that helped drive down the unemployment rate. Ironically, the economy appears to be doing better because people have given up hope and are no longer even looking for jobs.

Strengths

• Nonfarm payrolls rose 114,000 in September and the prior two months were revised higher by 86,000. Overall, this was better than expected and a modest positive for the economy.
• The ISM manufacturing index rose to 51.5 in September, which was the best showing since May, indicating expansion in the manufacturing sector.
• The ISM nonmanufacturing index was also stronger than expected in September, indicating a broader economic improvement than many had expected.

Weaknesses

• JP Morgan’s global purchasing managers index improved but remained in contraction territory.
• On a year-over-year basis, auto sales fell 26 percent in Italy, 37 percent in Spain, and 18 percent in France. These are dramatic declines and give an indication of the severity of the economic situation in Europe.

Opportunity

• While Chinese authorities did not announce any substantial government policy changes during this past holiday week, there remains considerable speculation about the prospects for near-term government policy action that would support the economy or stock market.
• Interest rates are likely to remain very low for the foreseeable future, both here in the U.S. and globally.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.
• The International Monetary Fund’s chief economist stated that the recovery from the global financial crisis will take a decade. If that is a correct assessment, we are not even half way through the recovery process.

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Gold Market Radar (October 9, 2012)

Monday, October 8th, 2012

Gold Market Radar (October 9, 2012)

For the week, spot gold closed at $1,780.60 up $8.50 per ounce, or 0.48 percent.  Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost 0.07 percent. The U.S. Trade-Weighted Dollar Index fell 0.75 percent for the week.

Strengths

• This past week, gold prices hit a new high for the year following a couple of weeks of consolidation around $1,770.  Although it is still early in the month, we have not seen much in terms of profit taking since the rally started in August.
• Senior gold stocks were flat for the week with mid-tiered gold plays putting in a slight gain, but silver stocks were the strongest, climbing almost 2 percent on average.
• Gold held in exchange traded funds reached a new record high and sales of gold and silver coins by the U.S. Mint were very robust in September.

Weaknesses

• South African gold mining shares traded on average 4.8 percent lower over the course of the week.  The Chamber of Mines and the unions reached agreement on a one-page framework document that may provide the common ground needed to get the gold miners back on the job.
• Labor relations may not be progressing as smoothly for the platinum miners.  Anglo American Platinum dismissed 12,000 workers for participating in the illegal strikes at the company’s operations and some fear this could lead to escalated violence.
• A small silver lining to the labor problems in South Africa is that the rand fell 5.7 percent over the last week.  Should the currency continue to fall, the profit margins of the miners should expand, perhaps nullifying some of the wage increases being sought.

Opportunities

• Pretium Resources reported a number of new high-grade gold intercepts from recent drilling at the Valley of the Kings zone at Brucejack.  Highlights include concentrations of gold ranging from 260 ounces per tonne to 32 ounces per tonne over some relatively narrow intercepts, but certainly economic.  Importantly, the continuity of the deposit is being proven up and the structure is now known to extend for 800 meters and is still open to the east, west and at depth.
• Rob McEwen, CEO of McEwen Mining and a former CEO of Goldcorp, was interviewed on Mineweb and stressed that now is a great time to buy gold stocks due to their underperformance relative to bullion during the debt crisis.  Rob noted that the message sent by shareholders to management regarding properly running a mining company has been heard loud and clear.
• India has seen a resurgence in gold buying as the rupee has regained some of its value, lowering the local gold price. In addition, the Indian stock market has surged, creating more confidence for spending.  India, traditionally being the largest gold buyer, has seen falling gold purchases for most of the year. Should there be a turn in India’s gold purchases, it would be supportive of higher gold prices.

Threats

• As we mentioned last week, a strong move in the gold price was still missing two things – China and India.  While it looks like we are getting somewhat of a turnaround in India’s gold appetite we really haven’t seen a turn in its stock market yet.  The Shanghai Composite Index rallied in the last couple of days, but we have not seen a major policy announcement such as QE3 in the U.S. to get the market going yet.
• As a reminder, gold demand in China during the second quarter was 145 tonnes, down 43 percent from the first quarter.  Retail Chinese gold buying picked up during the recent Golden Week holidays with some retailers seeing sales pick up by close to 60 percent.
• While it is too early to see meaningful improvements in the management practices at mining companies from growing the size of the company versus the profits, as discussed at the Denver Gold Forum last month, we still remain cautious going into earnings reporting season this October.  On average, you don’t get good news when gold companies report, partly due to a historical lack of focus on delivering profits. Hopefully, all the bad news will be put out and companies will get down to the business of delivering profit growth going forward.

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Energy and Natural Resources Market Radar (October 9, 2012)

Monday, October 8th, 2012

Energy and Natural Resources Market Radar (October 9, 2012)

Strengths

• Natural gas futures closed at their highest level this year at $3.53 per mmbtu early in the week as a forecast for a blast of cold air in the U.S. signaled stronger demand for heating fuel.
• The shale revolution continues as U.S. oil production climbed last week to the highest level since December 1996 to 6.52 million barrels a day in the week ended September 28, the Energy Department reported. America met 83 percent of its energy needs in the first six months of the year, department data shows.

Weaknesses

• The latest data from the American Iron and Steel Institute shows that U.S. weekly crude steel output dropped to the lowest level thus far in 2012 in the week ending September 28. Output dropped 2.4 percent week-over-week to 83.6 million tonnes per annum, while capacity utilization fell to 72 percent from 73.8 percent the previous week. The slowdown suggests some wider weakness in the overall U.S. economy, and has been accompanied by sharp falls in hot rolled coil and steel scrap prices over the past couple of weeks.
• Iron ore miner Vale said it would temporarily idle three iron ore pellet plants comprising about 20 percent of the company’s pellet capacity in response to falling demand. The company said it would boost supply of sinter feed instead as it reduces iron ore supplied to pellet plants.

Opportunities

• Chinese iron ore output rose only 2.6 percent year-to-date through August, the weakest growth for the month since 2009. Average capacity-weighted cash costs are about $100 per metric ton, and the Metallurgical Mines’ Association of China recently claimed that nearly 40 percent of domestic iron ore mine output has been halted, which could support prices.
• Iraq’s crude oil exports are likely to exceed 2.7 million barrels a day in October and the country’s Kurdish northern region is expected to increase its crude exports to 200,000 barrels, the Oil Minister said.

Threats

• A global nickel surplus may expand for a third year to the highest level since 2008 as supply from new mining projects outweighs China’s demand growth. Supply will likely exceed demand by 60,000 metric tons in 2013, said Toru Higo, Sumitomo Metal Mining’s general manager of nickel sales and raw materials. Supply outstripped demand by 40,000 tons this year and 22,000 tons in 2011, he said in an interview with Bloomberg news.
• The World Steel Association (WSA) said China’s expected steel demand growth may not materialize. WSA said that expectations of a recovery in Chinese steel demand after years of declining growth may not materialize given the likelihood of less intense usage of steel as the country moves to a different stage of its economic growth. This may worsen the oversupply problem.

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Emerging Markets Radar (October 9, 2012)

Monday, October 8th, 2012

Emerging Markets Radar (October 9, 2012)

Strengths

• China’s September PMI rose to 49.8 from 49.2 in August, closer to the 50 level, above which economic activities are expanding. The good news inside the index was that the output component rose from 50.9 to 51.3; new orders increased to 49.8 from 48.7; and new export orders jumped to 48.8 from 46.6.  The finished goods inventory edged down to 47.9 from 48.2, indicating the de-stocking process in China is reaching an end.
• Philippines’ net bank lending expanded by 16 percent on a year-over-year basis in July, while non-performing assets eased to 2.67 percent from 3.07 percent a year ago. Also in the Philippines, September inflation eased surprisingly to rise just 3.6 percent, versus the consensus 3.8 percent, and lower than the 3.8 percent seen in August.
• Indonesia’s headline CPI inflation rose only 4.3 percent in September from a year ago, significantly below the market expectation of 4.6 percent. Also in September, Indonesia’s current account showed a surprising surplus of $249 million, in spite of a bigger drop for exports than for imports.

Weaknesses

• Indonesia’s exports decreased 24.3 percent in September, worse than the 12.6 percent decline expected by Bloomberg, while imports decreased 8 percent.
• Thailand’s September inflation was 3.38 percent year-over-year, slightly higher than the market expectation of 3.3 percent.
• Singapore’s manufacturing PMI fell in September to a four-month low of 48.7, with falling new orders, new export orders and productions. PMI below 50 indicates that economic activities are contracting.
• Macau’s September gaming revenue rose 12.3 percent year-over-year to MoP 23.9 billion, below the street estimate of MoP 25 billion. The lower growth was partly caused by the Mid-Autumn holiday which fell on the last day of the month while it was in mid-September last year.
• Malaysia’s exports in August fell 4.5 percent from a year ago, the largest contraction seen since September 2009. The export decline was led by crude petroleum and palm oil, falling 28.8 percent and 27.2 percent, respectively.

Opportunities

• The graph above shows the stages of urbanization driven by growth of GDP per capita. It shows Thailand probably has the most potential to urbanize from the current level. The urbanization process will drive demand for bank loans and housing sales, along with other big-ticket item consumer goods.
• Despite the recent push higher, the rupee remains fundamentally undervalued.  As the chart below shows, India’s real effective exchange rate (REER) – that is, the trade weighted average of the country’s currency adjusted for inflation – remained near record lows in September, at more than two standard deviations below its 10-year average.

• The next chart shows India’s REER against a host of other emerging markets.  Again, the rupee appears fundamentally undervalued across the emerging market universe.

Threats

• Diesel demand growth in China is now only 0.7 percent year-to-date as of the end of August, much lower than gasoline demand growth of 10.9 percent. Since 50 percent of the diesel consumption is for logistics, and 70 percent for industrial sectors, it confirms slowing industrial activities in China this year.
• Bond investors were frightened after shelling in Syria spilled over the border into Turkey, sending yields up to the highest level in two months as the government in Ankara retaliated against the shelling. The incident shows the mounting risks for Turkey of the violence that has engulfed Syria. Turkey is a NATO country with the second largest army among NATO countries, after the U.S.
• Russia’s central bank held back from raising interest rates after a surprise increase last month, a pause that may prove brief after inflation quickened past the target range to 6.6 percent, the highest in 10 months.

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