Don Vialoux: Miners Recently Outperforming Bullion (August 9, 2012)

Thursday, August 9th, 2012

by Don Vialoux, EquityClock.com

Upcoming US Events for Today:

1. Weekly Jobless Claims will be released at 8:30am. The market expects Initial Claims to show 375K versus 365K previous. Continuing Claims are expected to reveal 3290K versus 3272K previous.
2. Trade Balance for June will be released at 8:30am. The market expects -$47.5B versus -$48.7B previous.
3. Wholesale Inventories for June will be released at 10:00am. The market expects an increase of 0.3%, consistent with the increase reported previous.

Upcoming International Events for Today:

1. The ECB Publishes the August Monthly Report at 4:00am EST.
2. Great Britain Merchandise Trade for June will be released at 4:30am EST. The market expects –9.0B versus –8.4B previous.
3. Canadian Housing Starts for July will be released at 8:15am EST. The market expects 210K versus 222.7K previous
4. Canadian Trade Balance for June will be released at 8:30am EST. The market expects -$0.9B versus -$0.79B previous.

LIVE SEASONALITY GANTT CHART

The Markets

Equity markets traded flat on Wednesday with little to move the tape one way or the other. Volume was once again light as conviction appeared lacking. The two consumer sectors bookended the days activity with Consumer Staples showing the best sector performance with a gain of seven-tenths of a percent, while Consumer Discretionary showed the worst performance, succumbing to a loss of half a percent.

Investors continue to remain hopeful for further monetary stimulus from any one of the major central banks, a fact which is clearly showing up in inflation expectations. The ratio of the Treasury Inflation Protected ETF (TIP) over the 7-10 Year Treasury ETF (IEF) continues to trend higher following an almost five month decline. Even the 5 Year Breakeven Rate has pushed higher since ECB President Mario Draghi hinted of further central bank intervention. Increased inflation expectations are bullish for stocks and commodities, both of which are at multi-month highs.

Inflation is particularly conducive to strength in the price of Gold, which has shown moderate improvement over recent weeks. Seasonal investors are well aware that we are within the period of seasonal strength for the yellow metal, but thus far the price action of bullion has been rather subdued, at least compared to years past. The metal is hinting of a breakout above a descending triangle pattern, a pattern that has bearish implications should the price of Gold fall below $1525. Further evidence is required to confirm the breakout. Hesitation from investors to believe in the stimulus hype is suspected to be culprit for the shallow returns.

The framework for a strong move higher in Gold has become established. In addition to increased inflation expectations, the US Dollar index has also come under pressure over the course of the past month and a minor head-and-shoulders top can be spotted on the charts. The target of this topping pattern points down to 81, also the point at which the price action would intersect with the rising intermediate trendline. The long-term trend for the US Dollar continues to look positive as the upside target derived from a head-and-shoulder bottoming pattern is fulfilled. The US Dollar Index seasonally declines, on average, between now and September, supporting commodity prices, such as Gold.

Another positive for the Gold trade is the fact that the miners have recently shown outperformance compared to bullion, a typical precursor to a positive move in the commodity. The relative performance chart for Gold Miners versus Gold bullion has shown a declining trend for over a year and a half, just recently charting the lowest level since the 2008 low. However, a double bottom has become apparent on the chart, hinting of positive things to come as investors become content with equity valuations at current gold prices. A positive trend still needs to be established, which may not be able to be confirmed until the ratio breaks above the 200-day moving average (0.29 on the chart below). The seasonal trade in gold currently looks appealing given the positive backdrop, but keep in mind that the trade could easily break if stimulus expectations are not confirmed.

Sentiment on Wednesday, as gauged by the put-call ratio, ended bullish at 0.80. The ratio continues to hold within a declining range as bullish expectations flourish.

S&P 500 Index

Chart Courtesy of StockCharts.com

TSE Composite

Chart Courtesy of StockCharts.com

Horizons Seasonal Rotation ETF (TSX:HAC)

• Closing Market Value: $12.40 (up 0.40%)
• Closing NAV/Unit: $12.36 (down 0.02%)

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Tags: 10 Year Treasury, 9b, Bullion, Central Bank Intervention, Central Banks, Consumer Sectors, Consumer Staples, Don Vialoux, Ecb President, ETF, ETFs, Half A Percent, Inflation Expectations, Initial Claims, Merchandise Trade, Seasonality, Sector Performance, Seven Tenths, Stocks And Commodities, Trade Balance, Weekly Jobless Claims, Wholesale Inventories
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Energy and Natural Resources Market Radar (May 21, 2012)

Saturday, May 19th, 2012

Energy and Natural Resources Market Radar (May 21, 2012)

Strengths

• According to the Shanghai Futures Exchange, its copper inventory fell 9,178 metric tons to 187,449 metric tons.
• China’s steel product output rose 7.9 percent last month to 81.1 million metric tons from a year ago, according to the National Bureau of Statistics.
• China imported a record high 25.05 million metric tons of coal in April, up 90.1 percent year-on-year, Platts reported, citing preliminary customs figures. Chinese year-to-date coal imports rose 69.6 percent year-on-year to 86.55 million metric tons of coal.

Weaknesses

• Stocks and commodities fell this week as the likelihood of a Greek exit from the eurozone has increased significantly during the past two weeks.
• Oil prices fell 4.8 percent this week. The current bout of concerns had arisen from the resurgent fears about the Spanish and Italian banking systems and speculation that Greece may have to exit the euro. Since then, for oil in particular, news reports suggesting that President Obama is seeking G8 cooperation on an oil stock release have compounded the depressing effect.
• Reuters reported that Chinese steel mills defer iron ore shipments owing to slowness in the steel market. Some Chinese steel mills are said to have postponed iron ore deliveries from suppliers such as Vale, given the slow steel markets. Producers are also expecting a further drop in prices.

Opportunities

• Global inflation might have already pushed the costs of exploring and producing oil from new most expensive projects, known in the industry as the marginal cost of production, above $100 per barrel, according to JBC energy consultancy. That compares to $50-$75 prior to the 2008 financial crisis. A decade ago, oil companies such as BP were saying they would start a project if oil traded above $17-$20. Even the International Energy Agency, which represents consuming nations, says production costs have gone up sharply. “There is not a single drop of oil in the world that cannot be produced at a price of oil of $85-$90,” IEA’s chief economist Fatih Birol told a summit.
• The Chinese government announced a new batch of new subsidies to promote the consumption of energy-efficient home appliances and autos on Wednesday. RMB6bn will be provided to fuel-efficient vehicles with engines below 1.6L, and an RMB26.5bn financial subsidy will be provided for energy-efficient appliance products, including all the major white goods products. This appears to be a clear signal of the government’s commitment to shift domestic demand toward more personal consumption and away from fixed asset investment.
• Oil industry executives and bankers are assuming oil prices will stay above $100 a barrel in the year ahead, despite mounting economic worries, as any fall below that level would trigger a cut in Saudi Arabia’s output and force closures at high-cost projects around the world. A Reuters straw poll of oil executives, traders, bankers and fund managers showed seven respondents predicting Brent crude trading at $100-$120 a barrel in the next 12 months.
• Boart Longyear, the world’s biggest provider of mineral drilling services, expects demand to remain strong as large mining companies proceed with projects. “We still see very strong demand, particularly from the majors,” Craig Kipp, CEO of the company said. “We haven’t heard from a lot of the majors outside of Australia that there’s a change in their plans or in their budgets. We haven’t seen any change in market dynamics – we’re operating all over the world,” Kipp said. “We do see that juniors, the second-tiers, have had problems getting financing,” he added.

Threats

• In a Wall Street Journal article last year at this time, Chief Executive Marius Kloppers said BHP would invest $80 billion by the end of 2015 to expand further. The eurozone crisis, slower Chinese growth, and falling metals prices are forcing BHP to now say it will be cutting those spending plans. Falling commodity prices and rising operating costs put its cash inflows at risk and, by extension, its commitment both to raising its dividend and keeping its single-A credit rating. BHP’s plans need to become clearer if it wants to reverse the 28 percent fall in its share price since a year ago.
• Agrimoney reported that the Federal Reserve has warned, “The surge in U.S. farmland prices, which in parts of the Plains achieved their strongest run of growth on record, may be about to fade, sapped by the worsened outlook for agricultural profits.” Farmland values posted sharply higher gains in states around Kansas in the year to the start of last month, reflecting higher crop prices and an easing in the drought which has plagued much of the area since 2010. “Strong farm incomes continued to fuel demand for farmland,” the Federal Reserve System’s Kansas City bank said, noting that values had now risen by more than 20 percent for two consecutive years for the first time since it began collecting data in the 1970s. Prices in Nebraska, which avoided drought, were particularly strong, with values of irrigated land soaring 41 percent.

Tags: Banking Systems, Bureau Of Statistics, Chinese Year, Coal Imports, energy, Energy Consultancy, International Energy Agency, Marginal Cost, Market Radar, Million Metric Tons, National Bureau Of Statistics, National Bureau Of Statistics China, Oil Prices, Oil Stock, Platts, Shanghai Futures Exchange, Steel Market, Steel Markets, Steel Mills, Steel Product, Stocks And Commodities
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Jim Rogers: Why He’s Shorting Stocks and Favouring Commodities

Friday, December 30th, 2011

Jim Rogers discusses his outlook for the economy, stocks, and commodities.

Call Notes:

Jim Rogers: I’m not optimistic about 2012, and maybe even not 2013.”

JR: “I don’t see much reason to own stocks, when one can own commodities. If the world gets better, i’m going to make a lot of money in commodities because of the shortages, and if the world doesn’t get better, governments will print money. Whenever governments have printed money, the only way to protect one’s self is to own real assets.”

China: Hard or Soft Landing?

JR: “Some parts of the Chinese economy will have a very hard landing; the Chinese government has been trying to kill the real estate boom for 2 1/2 years. They’ve raised interest rates 6 times, raised reserve requirements a dozen times; they’re gonna pop the real estate bubble, but that’s not the whole China story. There’s gonna be parts of the Chinese economy that are gonna boom no matter what happens to real estate in Shanghai and Beijing.”

How about beaten down stocks like Potash and Mosaic?

JR: “I’m not familiar enough to give you a good comment; I just remember in the 70s, stocks went down and did nothing, and economies did nothing, and yet commodities themselves went through the roof. Some commodities stocks did well in the 70s; A recent Yale study showed that you would have made 300% more investing in commodities themselves rather than commodities stocks, unless you were a very good stock picker. So I’m sticking with the real commodities.”

Comment: Jim Rogers travels everywhere in the world with his family, and he eats his own cooking.

What about the other BRIC nations? What about Brazil and its dependency on China? Would you short Brazil?

JR: “I’m short India, I’m short Russia. Brazil is a huge natural resource based economy, and in commodity bull markets they do well. Fortunately, I’m not long, I don’t have any positions – Unfortunately, the new Brazilian government is starting to do some pretty foolish things which I think will not make them participate as much as they could.”

Jim Rogers is long gold, long silver, expects correction to continue down to the $1300/oz. level.

JR: “I’m a terrible market timer, I’m a terrible trader. It would not surprise me if gold went down to $1,300-$1,200. If it goes that low, I’m going to buy a lot more. I’m not selling any ofo my gold or silver, but I’m not a good market timer. I’m just saying that gold has been up 11 years in a row, it deserves a substantial correction. Substantial corrections are not unusual in bull markets. If it goes that low, I’ll buy a lot more.”

Source: CNBC, December 28, 2011.

Tags: agricultural, Agricultural commodities, Agriculture, American Technology, Chinese Economy, Chinese Government, Cnbc, December 28, Economy Stocks, European Stocks, Gonna Pop, Good Stock, Investing In Commodities, Jim Rogers, Outlook, Potash, Real Assets, Real Estate Boom, Real Estate Bubble, Real Estate In Shanghai, Shorting Stocks, Stock Picker, Stocks And Commodities, World Doesn, Yale Study
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Cash Crunch in China Picks Up Momentum; Chinese Economy “Teetering On the Edge”

Tuesday, September 27th, 2011

Todd Martin, an Asia equity strategist at Societe General SA, talks about the outlook for China’s economy and credit market. Martin also discusses global stocks and commodities. He speaks with Rishaad Salamat on Bloomberg Television’s “On the Move Asia.”

The interview starts off with a very weak idea “fundamentals have been thrown out the window”. However the analysis gets much better as the video progresses. Here are a few key ideas from Todd Martin.

• RMB offshore vs. onshore rate is at a historic low. This shows Hong Kong or China mainlanders are hoarding cash, possibly to repay debts.
• The liquidation phase is concerning. Markets are looking into a deflationary abyss.
• Recent capital inflows into China are misleading. It was not investment but rather mainland money repatriated to repay debt.
• Cash crunch in China picks up momentum. We are going into a new down phase and true credit cycle in China. That can take on a life of its own.

Select Quotes

Rishaad Salamat: “Are you saying at the moment that the Chinese economy is teetering on the edge as a consequence of all this?”

Todd Martin: “It’s beginning to look like that. There are signals that there is a cash crunch and it is picking up momentum. The offshore RMB market for one. The repatriation of capital for two. This could cascade into a property correction. Once that gets going, you could probably get a lot of sellers jumping into the market.”

Rishaad Salamat: Is commodities the worst asset class to be in, at the moment?

Todd Martin: “Commodities is probability the worst asset class to get hit. If you are in a business seeing input prices fall and you have some pricing power downstream, then you could come out OK. Steel prices are still falling faster than iron ore, so that is still not one to be in yet. It’s pretty bloody. We are withing 15% of the bottom but the credit cycle concerns me.”

Fundamentals

I disagree with Martin about the fundamentals. I think fundamentals on China are horrible. I have been bearish on commodities because China is overheating at a time global demand from Europe and the US will collapse.

For further discussion, please see Michael Pettis: Long-Term Outlook for China, Europe, and the World; 12 Global Predictions written August 22.

Hopping into commodities or commodity-related currencies with a strengthening US dollar, falling global demand, a potential breakup of the Eurozone, a default by Greece, etc, was a poor investment idea.

Please see the link for a very nice discussion of 12 detailed ideas for the global economy.

This is what I said on August 22, in response to the ideas of Pettis.

Six Key Ideas

1. China Will Slow Much More than China Bulls and Commodity Bulls Think
2. Non-food Commodities Take Big Hit
3. Eurozone Experiment Ends in Breakup
4. US Protectionism Takes Hold
5. Deficit Countries Control Demand, Thus Have the Best Cards
6. Disaster Hits BRICs

Contrarian Thinking

Except perhaps for points three and four (and perhaps for all six points) investors and analysts have taken the opposite view. Most are looking to buy the dip, invest in commodities, invest in commodity producing currencies, and invest in the BRICs.

We did not have commodity producer decoupling in 2008 and there is no reason to expect it as debt-deflation plays out and China abandons its reckless investments in infrastructure.

I suspect China slows sooner than Pettis thinks, but no sooner than the next regime change in China. Markets, however, may react well in advance.

Global Deflationary Outlook

Pettis does not use the word “deflation” in his writeup, but he describes a very deflationary global outlook complete with protectionism, beggar-thy-neighbor policies, currency wars, and falling non-food commodity prices.

Pettis did not discuss energy, but the forces are clear: peak oil. vs. global slowdown. Given peak oil and the possibility of war over it, energy is a wildcard.

China did not decouple in 2008 (except perhaps in reverse), and it will not be immune from this global slowdown either.

Mike “Mish” Shedlock

http://globaleconomicanalysis.blogspot.com

Tags: Abyss, asset class, Bloomberg Television, Capital Inflows, Cash Crunch, China Economy, Chinese Economy, Commodities, Global Stocks, Infrastructure, Input Prices, Iron Ore, Liquidation Phase, Outlook, Repatriation, Salamat, Societe General, Steel Prices, Stocks And Commodities, Strategist, Teetering On The Edge, Todd Martin, True Credit
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Energy and Natural Resources Market Cheat Sheet (September 26, 2011)

Saturday, September 24th, 2011

Energy and Natural Resources Market Cheat Sheet (September 26, 2011)

Strengths

• The latest South Korean oil demand numbers released this week show the second straight month of year-over-year growth, following a weak second quarter. In August, Korean inland deliveries totaled 2.172 million barrels per day. In the year-to-date, South Korean demand growth has thus crept into positive territory, with the third quarter-to-date demand higher year-over-year by 4 percent.
• The American Institute of Architect’s Architecture Billings Index rebounded sharply in August to 51.4, shooting back above 50 (which indicates growth) for the first time since February.
• Despite a vicious bout of selling of stocks and commodities this week, the Global Resources Fund performed relatively compared to many of its peers over the past week as the fund management team has taken a more defensive position in the portfolio since early August.

Weaknesses

• Base metals prices fell sharply this week. The release of weak Euro area flash PMI data for September, suggesting a contraction is possible, combined with both a sub-50 China PMI reading for the same month and ill-received comments from the Fed on the state of the U.S. economy weighed heavily on broad market sentiment and drove risk aversion. Copper fell 17 percent this week to under $3.28 per pound, a 52-week low.
• The agriculture complex tumbled across the board as the downbeat economic outlook took its toll on market sentiment. Prices for corn futures fell 7 percent on the week.
• This week, metals giant Rio Tinto reported that some of its clients have begun asking to delay shipments of iron ore and other metals. Demand for coal is also decreasing, suggesting Asian activity could be waning.

Opportunities

• Peru’s government said it will not levy additional taxes on the country’s mining industry beyond those currently being debated in its Congress. Under the new law, mining companies will have to pay a sliding scale percentage of operating profits instead of the previous royalty system of 1 to 3 percent of revenue.
• At its Brazil Infrastructure Conference, Goldman Sachs estimated nearly R$85 billion of infrastructure projects will be executed over the next three to four years, including projects related to the 2014 FIFA World Cup, the 2016 Olympics in Rio de Janeiro, airports, subways, and highways.
• Oil supermajor Royal Dutch Shell’s CEO Peter Voser said in both the Financial Times and the Wall Street Journal that oil demand growth will outpace the growth in supply, so we should see “rising energy prices for the long-term.” Voser said that the reason for the shortage of supply was a lack of investment after the global financial crisis.
• Analysts at Macquarie noted the chance of another (albeit weaker) La Nina is starting to build in the Australian coal space. The latest median rainfall probability forecasts from the Bureau of Meteorology give a 65 to 70 percent chance of above average rainfall for the northern Bowen Basin between October and December 2011 versus a 70 to 75 percent probability for the same period last year. The probability of above median rainfall is lower in the Hunter Valley and Gunnedah Basin at 55 to 60 percent. The forecast raises the possibility that the Queensland met coal chain could again be disrupted by inclement weather, while steel mills’ inventories remain low.

Threats

• The IMF forecast a decline in commodity prices in the second half of 2011 and in 2012 based on bigger harvests of food crops and slower economic growth weighing on demand for base metals. The IMF’s index of non-fuel commodities is forecast to slip about 5.5 percent in the second half of 2011 on better harvests, while base metal prices are expected to decline “modestly” in 2012 on improved supply, the IMF said in its World Economic Outlook report. The world economy will expand 4 percent this year and the next, the IMF said, down from June forecasts of 4.3 percent in 2011 and 4.5 percent in 2012.

Tags: Base Metals, Brazil, Broad Market, Cheat Sheet, Commodities, Contraction, Corn Futures, Defensive Position, Early August, Economic Outlook, Fund Management, Giant Rio Tinto, Global Resources, Gold, Infrastructure, Iron Ore, Market Sentiment, Metals Prices, mining companies, Mining Industry, Oil Demand, Outlook, Resources Fund, Risk Aversion, Stocks And Commodities
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Jim Rogers: “Bernanke Is A Disaster” Who Will “Bring QE Back”

Wednesday, June 8th, 2011

Jim Rogers spoke to a very dramatic and even more hoarse Bartiromo, touching on old and well-known themes, namely that the administration is essentially using up its last stimulus bullet with the current recession: “When the problems arise next time what are they going to do? They can’t quadruple the debt again. They cannot print that much more money. It’s gonna be worse the next time around.” Alas, as Obama appears to be preparing, “they” will simply do more of the same: the same payroll tax that was supposed to cure all evils in December.

The fact that nobody anticipated something so stupid is probably indicative of the administration’s genius. Or lunacy. Followed by more dollar printing of course. On what needs to be done to avoid the debt ceiling breach which will shut down the government, Faber believes that nothing short of Draconian measures will be relevant: “We’ve got troops in 150 countries around the world. They’re not doing us any good, they’re making enemies. They’re costing us a fortune.” On the other hand he acknowledges: “we can never pay off these debts.” As usual, Rogers saved the best for Bernanke: “Since the first day Mr Bernanke went to Washington I knew he was going to be a disaster.

He has never been right about anything in the 7 or 8 years he has been there. I hope he doesn’t come back with QE3 but that’s all he knows. The only thing he knows to do is to print money. He doesn’t understand finance, he doesn’t understand currencies, he doesn’t understand economics. He understands printing money. It’s the wrong thing to do but that’s what he’ll do… They’re gonna bring QE back because he will be terrified and Washington will be terrified,” he said. “There’s an election coming in November 2012. Washington’s gonna print more money.”

Lastly, in terms of investments, Rogers is long the dollar but only “for a rally”, and also owns Chinese stocks and commodities, would be buying more gold and silver if the price were to go down, and is short tech stocks and JP Morgan. Like we said nothing new. With one addition: the republicans will now get tax cuts, so democrats get QE3. As we have been saying – 2011 is nothing other than 2010 all over again.

Tags: 8 Years, Bernanke, Breach, Chinese Stocks, Commodities, Countries Around The World, Debt Ceiling, Debts, Draconian Measures, Enemies, Evils, Faber, Jim Rogers, Lunacy, Payroll Tax, Printing Money, Qe, Qe3, Recession, Stimulus, Stocks And Commodities
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The Economy and Bond Market Cheat Sheet (May 9, 2011)

Saturday, May 7th, 2011

The Economy and Bond Market Cheat Sheet (May 9, 2011)

Treasury bonds rallied for the fourth week in a row, sending yields lower across the maturity spectrum. The bond market is reacting to a bout of risk aversion as stocks and commodities sold off this week.

The chart below depicts the cost of protecting U.S. municipal debt from default for five years.

The municipal market suffered during the final few months of 2010 and has recently seen renewed interest as investor’s expectations surrounding the potential for widespread default has been roughly cut in half. Credit fundamentals continue to improve as tax revenue increases and fiscal strains appear less daunting than they did a few months ago. The Barclay’s Municipal Bond Index rose 1.79 percent in April and is off to a strong start in May.

Strengths

• Non-farm payrolls rose 244,000, beating expectations and providing some evidence of an improving economy.
• April retail sales were surprisingly strong, rising 8.7 percent year-over-year, helped by a late Easter.
• The ISM manufacturing index fell 0.8 points in April but beat expectations and remains at a very high level.

Weaknesses

• The ISM nonmanufacturing index fell by a shocking 6.5 points in April indicating a rapid deceleration in the service portion of the economy.
• Initial jobless claims rose to 474,000, which is the highest level in eight months.
• India raised interest rates by a greater-than-expected 50 basis points, highlighting the inflation-fighting tendencies from other central banks around the world.

Opportunities

• In an interesting twist, higher oil prices may actually act as a deflationary force if it materially slows the global economic growth.

Threats

• Budget cuts and austerity measures in Europe and the U.S. are necessary “evils” but will likely be a considerable drag on global growth.

Tags: April Retail Sales, Austerity Measures, Bond Index, Bond Market, Budget Cuts, Central Banks, Fiscal Strains, Global Economic Growth, Global Growth, India, Initial Jobless Claims, Ism Manufacturing Index, Maturity Spectrum, Municipal Bond, municipal debt, Necessary Evils, Revenue Increases, Risk Aversion, Stocks And Commodities, Treasury Bonds, World Opportunities
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Monetary Policy in 3-D (Hussman)

Monday, April 25th, 2011

Monetary Policy in 3-D

by John P. Hussman, Ph.D., Hussman Funds

One of the most important factors likely to influence the financial markets over the coming year is the extreme stance of U.S. monetary policy and the instability that could result from either normalizing that stance, or failing to normalize it. It is not evident that quantitative easing, even at its present extremes, has altered real GDP by more than a fraction of 1% (keep in mind that commonly reported GDP growth rates are quarterly changes multiplied by 4 to annualize them). Moreover, it’s well established – on the basis of both U.S. and international data – that the “wealth effect” from stock market changes is on the order of 0.03-0.05% in GDP for every 1% change in stock market value, and the impact tends to be transitory at that.

Still, by replacing an enormous quantity of interest-bearing assets with non-interest bearing money, quantitative easing has created profound distortions in asset prices, where Treasury bills now yield less than 5 basis points annually, while “risk assets” such as stocks and commodities have been driven to prices high enough that their likely future returns now compete perfectly (on a time-horizon and risk-adjusted basis) with the zero expected returns on cash.

Taken together, despite the limited and transitory real effects of QE on output and employment, the Federal Reserve has created an unprecedented monetary position that creates an extremely unstable equilibrium for the financial markets. There are several ways that this might be resolved. Based on the very robust relationship between short-term interest rates and the monetary base, it is clear that a normalization of short-term interest rates, even to 0.25-0.50%, would require the Federal Reserve to fully reverse the $600 billion of asset purchases it conducted under QE2. Alternatively, with the monetary base now exceeding 16 cents for every dollar of nominal GDP, any external upward pressure on interest rates (that is, not produced by a Fed-initiated reduction in the monetary base) would quickly provoke inflationary pressures.

Last week, my friend John Mauldin reprinted our April 11 market comment Charles Plosser and the 50% Contraction in the Fed’s Balance Sheet . John told me that he had received several nearly identical questions, along the lines of “Wait, now I’m confused – I thought that the Fed reduces inflation pressures by raising interest rates. Why would higher interest rates trigger inflation?”

So, this is where that phrase “external upward pressure” comes in. We have to distinguish between what economists would call an “endogenous” increase in interest rates – one that the Fed itself provokes by reducing the monetary base – and an “exogenous” increase in interest rates – one that is produced by changes in the behavior of investors and the economy, independent of actions by the Fed.

See, when the Fed decides to raise interest rates, it does so by reducing (or slowing the growth) of the monetary base, which can reasonably be viewed as an “anti-inflationary” policy. However, if interest rates rise independent of any change in the monetary base, then cash – which doesn’t bear interest – becomes a “hot potato” that is suddenly less desirable. In that case, you get one of two outcomes: people holding cash may bid up Treasury bills, lowering short-term interest rates to the point where people are again indifferent between cash and non-cash alternatives, or failing that, the attempt to get rid of cash holdings in other ways provokes inflation and a depreciation in the foreign exchange value of the dollar (which was the outcome in the 1970′s).

As I’ve argued elsewhere, one of the primary sources of exogenous inflationary pressure is growth in unproductive forms of government spending (spending that creates demand but does not expand capacity or incentive to produce), but I’ll leave that feature of the argument for another time.

Monetary Policy in 3-D

The extreme stance of monetary policy is such a critical factor in the financial markets here that it is worth spending a bit more time on the relationship between interest rates, inflation, and the monetary base.

Tags: Adjusted Basis, Asset Prices, Asset Purchases, Enormous Quantity, Extreme Stance, Future Returns, Gdp Growth Rates, Gold, Hussman Funds, Monetary Base, Nominal Gdp, Qe2, Quarterly Changes, Real Gdp, Stock Market Changes, Stock Market Value, Stocks And Commodities, Time Horizon, Treasury Bills, Unstable Equilibrium, Wealth Effect
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Does QE = Quantitative Exuberance?

Monday, October 25th, 2010

Does QE = Quantitative Exuberance?

David Andrews CFA, Private Client Strategist, Richardson GMP

Unless you have been living in a bunker deep underground for the past month or so, you are likely aware of the Federal Reserve’s well advertized intention to become a large buyer of U.S. assets in the near future. Quantitative Easing has put a floor under riskier assets (like stocks and commodities) and QE expectations have supported the upward price surge of the past six weeks.

What you may be less certain about is how much ‘buying’ the Fed will do and what has already been ‘priced in’ to riskier assets like stocks, commodities, and precious metals? The Fed’s intentions to boost asset prices and increase the pace of re-employment are well known but how much stimulus will be required to achieve these goals? The common thinking is somewhere between $800 million and $1 trillion will be spent over the coming twelve months. Japan’s tepid QE in the 90s brought about poor results suggesting the Fed will be rather aggressive when it does start buying.

How much has the stock market priced in? Credit Suisse recently estimated that for every $100 million of QE, the S&P500 goes up by 9 points which would suggest 70-90 points of the current S&P500 level (1 ,1 83) can be attributed to anticipation of large scale asset purchases by the Federal Reserve. As perverse as it sounds a self-recovering economy could effectively weigh on a stock market already hooked on the notion of stimulus.

September U.S. economic data was again mixed with September housing starts and the weekly jobless claims better than expected, but fewer building permits were issued and industrial production weakened in September. The “U.S. dollar up, risk asset prices down” trade was popular in what turned out to be a choppy trading week. The commodities-heavy S&P/TSX was volatile but finished higher, largely taking its cues from gyrations of the U.S. dollar. The S&P500 finished this week slightly higher but rode a seesaw range of 1 ,1 59-1 ,1 89 to get there. Perhaps another bright sign for stock market investors was that both the NASDAQ and the S&P500 went through a Golden Cross; where the 50 day moving average crosses above the 200 day moving average. Historically, the market performs better for 3-6 months following a Golden Cross.

G7 Shrinkage

The ‘Group of Seven’ will see its share of the world economy fall below 50% by 2012 confirming the shift of economic power and potential investment market returns to the developing world. MSCI Emerging is up 1 2% year to date; almost twice the return of the S&P500. Getting coordinated action among the G7 was a challenge, but the G20 is the new forum for global cooperation. G20 Lite takes place this weekend where currency manipulation and trade deficits will be discussed.

Looking Forward

The last week of October will again be a busy one. Over the weekend, the G20 will be meeting in South Korea to discuss trade and currency imbalances that could jeopardize the global economic recovery. Countries from China to the U.S. are accused of relying on artificially weak exchange rates to spur growth. Participants have so far balked at the idea of capping trade surpluses and deficits so it is unlikely to result in any significant policy changes. At least they are talking…

Earnings Season continues to roll with many bellwether Canadian companies reporting their quarterly results. Last week, saw a flurry of companies report mostly better than expected results. Key notables included strong results by Apple, IBM, Citigroup, and Goldman Sachs. Earnings Season to this point has been better than expected with 85% of companies beating expectations. We look for that to continue in the week ahead with several consumer and energy companies due to report.

Investors will get an updated look at the state of the U.S. housing market with existing and new home sales as well as CaseShiller price data early in the week. Uncertainty over the Foreclosure uncertainty, overhang of inventory, and little Consumer confidence (an offshoot of housing and employment) does not bode well for U.S. real estate.

Copyright (c) Richardson GMP

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Marc Faber 2010 Outlook: Go For Gold, Oil & Agriculture, But Watch Out For PIIGS & U.S. Equities

Wednesday, January 20th, 2010

Here is the summary and my thoughts on a trio of Dr. Marc Faber’s latest interview where he discussed his 2010 outlook on China bubble, sovereign default risk, stocks and commodities.

Faber is most famous for advising his clients to get out of the stock market one week before the October 1987 crash. News just broke that Faber, a famed contrarian investor often known as Dr. Doom, has joined Sprott Inc. SII-T as director and member of the money management firm’s audit committee.

Euro Death By PIIGS

Faber believes the countries most likely to blow up are the “PIIGS”: Portugal, Ireland, Italy, Greece, and Spain. One or more of them will likely default in the next couple of years, which could mean the death of Euro.

Debt Interest Costs to Triple

According to Faber, the U.S. annual interest costs, currently around 12% of the government’s tax revenue, will soar to 35% of tax revenue within five years. This will force the government to cut spending (an unlikely scenario), and/or frantically print more money

U.S. & Japan – Default in 5 to 10 Years

Excessive money printing and debasing of the Dollar would most likely result in the United States defaulting on its debt within 5 -10 years Japan could face the same fate as well. (See more U.S. debt crisis charts from Faber here.)

Note: Jim Rogers sees U.K as in danger of an implosion as well.

U.S. Stocks – Correction Coming

After noting in his January 2010 newsletter that he was bullish on U.S. stocks, Faber changed his mind after participating in Barron’s round-table discussion. Faber says the overly bullish consensus worries him.

He now believes a correction in U.S. stocks could come much sooner than most expect as momentum players could “pull the trigger relatively quickly.” Faber is now looking at a 5%-10% rate of return for global investors.

Bonds

Bonds could be in for a rebound near term, but longer term, investors should look for exit opportunities in Treasuries.

Note: Jim Rogers also sees the U.S. government bond as overpriced and “in a bubble”.

Asia

Asia is likely to have longer term favorable growth. Faber favors India and Japan. In a December 2009 interview with Economic Times, Faber liked Japan as a contrarian play for 2010.

China Bubble

Faber indicated it is difficult to pinpoint a day when China will implode. But he does not think it will happen right away. However, when it does happen, investors can expect a hit on commodities and emerging markets.

Gold

Gold is going through a correction phase and probably will test the lows of $1,050 or $1,100 levels, but is still a long term buy through exploration companies and physical gold holdings.

Crude Oil

Prices may come off somewhat. Marginal cost of finding oil is around $70. Longer term, prices are expected to continue rising as demand increases from the developing world.

Agriculture Commodities

In the short term, Faber likes wheat as it is “very, very cheap”. But he advises against buying the wheat ETFs because they’re “very expensive” due to the rollover costs. Instead, he suggests play it through companies with farm land and plantations or potash companies.

China Bubble? Views from Rogers & Mobius

“China Bubble” has been in the media headline a lot lately; whereas in fact, the liquidity bubble created by the central banks’ loose money policy could easily trump China as the biggest bubble in the world most likely to burst first.

Investment guru Jim Rogers, while acknowledging Shanghai and Hong Kong property is in bubble during a Bloomberg interview today, debunked James Chanos yesterday, as quoted by China Daily, saying:

“It is absurd to say China is in a bubble when the stock market is 50 to 60 percent below its all-time high….After 300 years of decline everything is coming together for China in the 21st century”

Meanwhile, Dr. Mark Mobius, who oversees $34 billion of developing-nation assets at Templeton Asset Management Ltd., said Jan. 7 the bubble in China’s property market isn’t about to burst, and that

“The Chinese will act rationally and they’re not going to kill the market…There’s still a lot of savings in China. Prices are high but I don’t see a crash.”

My Take on The China Bubble

As stated in my article – China Is No Dubai or Enron.

“Overinvestment and overbuilding is sometimes a prerequisite of an anticipated mass urban migration such as the one China is destined to experience.”

Beijing is taking measures to prevent a bubble-burst predicament ahead of the U.S. and most of the industrialized countries. Unlike Dubai or Enron, the country is in a better position, with tremendous resource at its disposal that could power through a bubble or two.

Moreover, whether there is a bubble to burst in China is still a matter of great debate among market pundits, as cited here.

My Thoughts on U.S. Equities

The CBOE Volatility Index (VIX) of S&P 500 options fear gauge has crashed more than 63% over the last 12 months and down 18% this month alone, retreating to pre-Lehman levels. Though the VIX index roared 6.14% to 18.66 today, it has trended consistently lower since late 2008. This is causing a great deal of consternation among some investors that the higher investor complacency level is a signal that equity prices are peaking.

The equity market, particularly tech and financials, is quite vulnerable as the current valuation suggests a high earnings expectation, which will most likely disappoint this year in the context of a still hazy global recovery picture, and weak consumer spending. The earnings release and outlook from Citigroup, Inc. (C) & JP Morgan Chase (JPM) and IBM Corp. (IBM), etc. this week do not seem to have suggested otherwise.

So, it is quite sufficient to say when complacency and speculation has returned en masse, commodities and emerging markets will likely to be better bets than U.S. stocks and bonds.

And as the famous Wall Street adage goes, “VIX low, time to go”.

Video Source: Yahoo TechTicker

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