Is there still time to buy gold? As the markets whipsawed in response to news from China, North Korea, and Spain, Treasuries, Bund and emerging market bond yields might have been expected to fall with the flareup in risk. Instead, yields remained steady on ongoing concerns about inflation. Buyers in China and India continue to seek gold as both a luxury and an investment, yet gold is still below its peak in January, 1980, adjusting for inflation.
Jeffrey Saut, Raymond James
Investors got whipsawed last week. To be sure, Tuesday’s Tumble (-142 DJIA) caused many participants to sell, worried about the potential for another crashette. Regrettably, they sold into a vacuum because a lot of Wall Street’s pros took the week off, leaving their “juniors” on the trading desk with instructions not to be heroes. To wit, if sell orders arrive, just let the markets take stocks to where the selling abates. The quid pro quo is that if buyers show up, let the markets seek their natural upside “clearing price.” Plainly, both sellers and buyers showed up last week since Tuesday’s Dow Dump was followed by a Wednesday Win of some 150 points (or +1.49%). Of course, that “win” was consistent with history since there have been seven occasions when on the Tuesday before Thanksgiving the S&P 500 saw a decline of more than 1.0%. Six out of those seven times the S&P gained on the very next day for an average rally of 1.4%. However, the sellers returned on Black Friday, leaving the senior index down 95 points for the holiday-shortened session -- and off 1% for the four-session week.
The reasons for the weekly wilt ranged from Chinese monetary tightening, North Korea, insider trading ivestigations, Ireland, to Spain, etc. España is particularly concerning because Spain’s GDP in 2009 was $1.468 trillion. That’s roughly twice the combined GDPs of Greece,
Ireland, and Portugal. Moreover, Spain’s fiscal deficit, at ~7.9% of GDP, is double the legal limit prescribed by the EU. Accordingly, it is estimated that to “paper over” Spain’s fiscal fiascos would require some $600 billion. That number is twice the size of Ireland’s GDP, making Spain clearly the elephant in the proverbial room.
Nevertheless, I still think the approximate cause for last week’s stock slide was Ireland because unlike a sovereign debt crisis, where there are only two players (the sovereign state and its creditors), in a banking crisis there are numerous players. As the brainy folks at GaveKal write: “In a sovereign crisis, there are in essence only two key players: the state and its creditors. In a banking crisis, there are many more 'stakeholders,' including the government, the banks' shareholders and management (whose interests are supposed to be aligned though recent years have shown that this seems to be more the exception than the rule), the banks' depositors, and the banks' lenders (including, most notably, other banks). It is thus more challenging to ensure that everyone's interests are aligned. In a sovereign crisis, it is relatively simple to figure out how much debt is due for repayment, when that debt is due, etc. In a banking crisis, such type of analysis goes out of the window, not only because figuring out the balance sheet of a bank is monk's work in the first place; but most importantly because key psychological factors, such as the willingness of customers to keep deposits at a given bank, or the desire of other banks to lend to one another, simply cannot be modeled. Figuring out who owes what to whom is much more challenging in a banking crisis than in a sovereign crisis.”
So yeah, I think Ireland was the cause of last week’s weakness, which brings us to this week. Looking at the charts suggests the “buying stampede” ended during the first week of November. However, the markets have still not experienced more than three consecutive sessions on the downside; hence, the upside should continue to be favored. That is the strategy I have embraced since July, often scribing that I think it is a mistake to become too bearish. Further, I have opined that even if we get a correction, I think it will be contained in the 5% to 8% range. As stated, that targets the 1130 to 1170 zone on the S&P 500 (SPX/1189.40).
Coincidentally, the SPX’s 200-day moving average (DMA) currently resides at 1132, while its 50-DMA hovers around 1176. Also of interest is that despite the DJIA’s decline, the S&P MidCap (+1.07%), S&P SmallCap (+1.48%), Nasdaq (+0.65%), ValueLine (+0.45%), and the Russell 2000 (+1.16%) all closed higher last week. Then too, the Supply/Demand metrics, Advance-Decline Lines, New High/New Low readings, and Dow Theory all indicate the stock market’s primary trend remains bullish.
With the aforementioned “headline news” capturing the attention, there were some other items that escaped investors’ attention. First was Ben Bernanke’s unusually blunt plea for fiscal help from Congress and the Administration, which as of this writing has gone unanswered. I think the Fed will increasingly trumpet this plea after putting itself in the position to state – we’ve (the Fed) done everything we can do; now it’s up to you! Second was the environmental disaster that recently hit Syria whereby water shortages are forcing farmers off their land and into cities. Obviously this plays to my water, agriculture, and weather themes. Then there was Thailand’s PTTEP purchase of a $2.3 billion stake in Statoil’s (STO/$20.35) Canadian oil sands project. Given the Joint Chief’s recent Joint Operating Environment report warning, “By 2012, surplus oil production capacity could entirely disappear,” I was surprised Canadian oil sands stocks didn’t leap on that news. I like Alberta’s tar sand players and continue to urge investors to consider: Cenovus (CVE/$28.86), Canadian Oil Sands Trust (COSWF/$26.59) and North American Energy Partners (NOA/$9.29), all of which are followed by our Canadian research affiliate, Raymond James Ltd., with favorable ratings.
Finally, in Barron’s there is an excellent article titled “Going With the Flow.” The byline reads, “Generating a rich stream of post-retirement income these days requires investments that retirees once might have shunned.” In that article are a number quips discussing emerging market debt, high yield bonds, master limited partnerships, dividend paying stocks, senior bank loans, municipal bonds, etc. Readers will recall over the years I have avored all of these investments. Also recall that I think interest rates will rise in 2012. Therefore, for fixed income investors, I believe you have to be very selective going forward.
Barclays Capital, Emerging Markets Weekly
Two concerns have weighed heavily on the market. First, continued anxieties about peripheral Europe, which we expect to linger at least in the medium term. Second, hostilities between North and South Korea have re-emerged. While it is unclear what path these will take, we would hope that the current scenario will dissipate as a driver or market prices.
Interestingly, despite a flare-up in risks, there has not been a concomitant fall in either Bund or Treasury yields. For Treasuries, this likely also reflects brewing inflation fears. We note that EM local yields have not fallen either, contrary to the May-June period following the announcement of the loan programme for Greece. This fits with our view that the helpful tailwinds, which drove EM local yields lower in the year to date, are probably exhausted, with idiosyncratic inflation risks rising as well.
The announcement that EU ministers have agreed to a request from Ireland for financial aid – with details regarding size and conditionality expected by the end of this month - offered only temporary relief. On Friday 17 November, the need for such a package had been largely anticipated and, after the agreement, markets quickly turned their attention to Portugal and Spain, pushing Spain 5y CDS to a new record level. Portugal’s spreads also widening substantially. A two-notch downgrade of Ireland by S&P has not helped either. The underlying issues and anxieties about vulnerable banking sectors and debt sustainability in the developed world, which continue to condense into wider Western European spreads, have also shown their effects in EM asset markets. With fiscal issues remaining in investors’ spotlight, it is unsurprising that EM countries with uncertainties around their respective fiscal situations remain under pressure. In the case of Hungary and Poland, close geographical and economic links to Western Europe have not helped, and the 5y CDS spreads for these countries were clear underperformers this week in the global EU credit space.
Another leg in the Axis of Anxiety for the markets is the North Korean shelling of a sparsely populated South Korean Island (near a disputed maritime border). This is one of the most serious provocations by North Korea to date. For a more detailed analysis, please refer to our focus piece, but to summarize, our Korea specialists are mindful of the fact that the firing of artillery into a contested area has happened in the past. Ultimately, historical reactions by the international community to similar scenarios suggest that China and the major powers will take action to prevent the crisis from escalating. Should this arise, the length of time it would take is unclear, but once the dust settles, we would expect underlying fundamentals to reassert themselves, with investors still screening Emerging Asia as one of the cyclically strongest blocks in EM and the global economy. However, a sharp rebound is unlikely, in our view. This is probably true for most EM asset markets, taking into account seasonal effects.
Currently, a more cautious tone seems warranted, perhaps more in some markets than others. Local rates and government bonds had been a huge beneficiary of inflows in the year to date. However, as we have opined in recent weeks, these inflows and the sharp ytd compression in yields have also made them vulnerable. The margin of error in receiving nominal rates has fallen and hitherto helpful tailwinds risk turning into headwinds, in our view. One such tail wind was the bull flattening in Treasury and Bund yields, which appears to have ended. The announcement of QE2 in early November was followed by higher Treasury yields, suggesting that the market, at the very least, thinks the Fed will be successful in pushing up inflation. It seems unlikely to us that the market will shake off this sentiment imminently.
EM policymakers’ initial response to abundant global liquidity has been directed at trimming currency strength, which amid rising commodity prices, means heightened inflation risks for some. This would fit with the mixed price action in local rates over the past month (contrasting with the bull-flattening in May, following the announcement of the loans programme for Greece).
Recent CPI data releases, with some notable upside surprises, have contributed to the mixed performance. For now, the menu of safe nominal receivers in mainstream EM is very short and potentially, South Africa is one of the rare cases that still falls into this category.
LPL Financial Research, Market Insight, Fourth quarter 2010
With gold prices sitting at all-time highs, some investors may be questioning how much upside potential the precious metal has from current levels. Over the past 18 months, gold has garnered much attention as a hedge against the government’s potentially inflationary policies in the battle against the Great Recession. It is important to remember, however, that gold’s rally is not a recent phenomenon and that additional factors have been driving prices upward for quite some time. Gold, in fact, has been in a powerful bull market over much of the past 10 years.
Gold Prices Driven by Multiple Factors: The drivers that have continued to lift gold prices to all-time highs of over $1,300 per troy ounce include the following:
The actions by the Fed to stimulate the economy have led to weakness in the dollar. As the dollar goes down, the price of gold in dollars goes up. While gold has surged to an all-time high in dollar terms, gold has been falling recently in euros. In fact, the high in gold denominated in euros was back in early June 2010. Measured in Japanese yen, the peak in gold was back in May 2010 and has posted a gain of only 6% year-to-date through September 28, 2010, according to Bloomberg data. The move to record highs in the price of gold is due, in part, to the fact that it is measured in terms of a weaker U.S. dollar.
Gold is becoming more expensive to mine as the most accessible areas have been depleted and new mines are in increasingly remote or hard-to-mine locations. The price to mine and transport gold has soared to about $1,000 per troy ounce when fully expensed.
Central banks have all but stopped selling gold. European Central Bank sales are 96% lower than last year and amount to the lowest total since 1999. Given the current economic environment, we believe central banks may begin to add to their gold reserve base as further currency debasement and long-term inflation concerns persist.
Gold demand from the emerging markets continues to be strong. As the middle class in China and India continues to grow, they seek gold as both a luxury and an investment.
As a beneficiary of a pullback in riskier investments, investors have increasingly embraced gold as a perceived insurance against a return to recession. However, rather than act purely as a defensive investment, gold has risen this year alongside stocks and bonds.
It is worth noting that gold is still well below its inflation-adjusted peak of January 1980 when it reached $850. In today’s dollars, that peak is equivalent to a gold price of $2,383, due to the erosion of the value of the dollar due to inflation.
