U.S. Global Investors
Would it surprise you to discover that China is planning to add 800 miles to its subway system over the next two years? That’s the distance equivalent to building a network from Dallas to Chicago in less time than the U.S. Congress can resolve a budget!
In 2015, when the infrastructure build-out is complete, China’s subway track alone will be a mind-boggling 1,900 miles, according to JP Morgan.
The Asian giant has been in the midst of constructing the world’s largest transportation system, laying mile after mile of high-speed rail and subway track. According to the World Metro Database, Beijing and Shanghai currently have the longest metro and subway systems, with about 275 miles each. The city of Guangzhou in China also falls in the top 10, with 144 miles of rail, beating Paris’ network length of 135 miles.
This ambitious program is part of the pragmatic solution to help 1.3 billion residents move around the country efficiently and reduce the increasing problem of air pollution due to car emissions in big cities including Beijing.
The circulating reports and photos of Beijing’s smog have recently become a dark cloud hanging over the country’s remarkable achievements, but it’s not a new issue. In the winter, smog conditions can seem much worse. Pollutants tend to linger when the air is heavier and colder compared to lighter, warmer air during the summer. In addition, the city is located near the Gobi Desert and has always been subject to sand and dirt storms, even back in the days when it was called Peking.
The U.S. experienced similar sand storms during the Dust Bowl in the 1930s, which caused catastrophic ecological and agricultural damage to the American prairies and made the economic impact of the Great Depression much worse. Sixty-five percent of the topsoil was blown away and millions of people were left homeless.
Industrialization in Beijing has certainly aggravated the matter, but Beijing is not the first city suffering from its horrible haze. The London smog of 1952 caused 12,000 total deaths, resulting in the Clean Air Act of 1956, and according to the U.S. Environmental Protection Agency, Manhattan suffered particularly poor air quality in the 1960s, affecting the eastern edge of the U.S.
Because of the government’s concerted effort to encourage consumption and help its residents achieve a higher standard of living in previous five-year plans, new cars congested the roads as fast as they were paved. Over the past decade, sales accelerated from less than 5 million vehicles in 2002 to nearly 20 million in 2012. About 114 million automobiles are now registered to Chinese residents, with ownership exceeding 1 million across 17 Chinese cities.
As we’ve discussed many times, the country is also the world’s largest energy consumer, with a huge dependence on fossil fuels, especially coal. You may think that the country’s use of coal would be the single largest factor driving air pollution, but, in Beijing, emissions from vehicles make up a bigger percentage. One-fifth of the fine particulate matter, which is made up of nitrates and sulfates, organic chemicals, metals and dust particles, comes from automobile and truck emissions in the city, according to JP Morgan. Across the entire country, automobiles cough out 27 percent of total nitrogen oxide emissions.
With residents dealing with increasing cancer-causing pollutants and vehicle congestion on roads, public discontent is rising, “adding particular urgency to causes such as environmental protection and public sector reform,” says JP Morgan.
China’s government policies were already addressing air pollution by “requiring thermal power plants to install desulphurization systems and progressively increasing vehicle-emission standards,” according to the research firm. As one recent example, last May, I discussed Beijing’s additional subsidies devoted to energy-efficient products, including fuel efficient cars, LED lighting, and high-efficiency motors.
This year, leaders appear ready to continue these environmental priorities. In comparison to last year’s budget, a larger portion of government spending will go toward environmental programs. While other areas will see a decrease in spending compared with last year, spending on environmental protection is projected to grow nearly 19 percent, says JP Morgan.
With a concrete plan and a budget in place, it all boils down to execution and enforcement. And this week, the once-in-a-decade transfer of power became official, as the National People’s Congress in China elected Li Keqiang as premier and Xi Jinping as president.
Xi now holds the three most powerful titles in elite Chinese politics: the Secretary General of the Party, the Chairman of Military Commission and President of the Nation. This “triple-power strength” positions him as an ideal reformer for China. He may likely have little interference from former leaders, giving him a freer hand to tackle some of the growth challenges in China today, including reforms to improve environmental protection.
We look forward to watching these leaders in action.
- The major market indices finished higher this week. The Dow Jones Industrial Average rose 0.81 percent. The S&P 500 Stock Index gained 0.61 percent, while the Nasdaq Composite Index rose 0.14 percent. The Russell 2000 small capitalization index gained 1.06 percent this week.
- The Hang Seng Composite Index fell 3.13 percent; Taiwan declined 1.09 percent and the KOSPI fell 0.97 percent.
- The 10-year Treasury bond yield fell 5 basis points this week, to 1.99 percent.
Domestic Equity Market
The S&P 500 just keeps moving higher, continuing an impressive streak that began at the beginning of the year. Financials led the way this week but energy, materials and utilities weren’t far behind.
- Financials were the best-performing sector for the second week in a row, rising by 1.35 percent. Investors continued to react positively to the recently released Federal Reserve stress test and the numerous announcements regarding stock buybacks, dividend increases or both. Wells Fargo and Bank of America were among the best performers this week.
- Utilities were also strong this week. CenterPoint Energy was the best performer, rising by more than 7 percent as the company agreed to form a master-limited partnership with a jointly owned subsidiary, potentially paving the way for other utilities to follow.
- DirecTV was the best-performing stock in the S&P 500 this week, rising 9.76 percent. The company removed itself from bidding for a Brazilian phone and internet company, which was viewed positively by the market.
- The telecommunication services sector was down for the week as AT&T and Sprint Nextel suffered modest losses for the week.
- The consumer staples sector was essentially flat for the week as investors appeared to prefer areas with more growth potential as the economic momentum builds.
- Intuitive Surgical was the worst performer in the S&P 500 this week, falling 10.72 percent. The president of the American College of Obstetricians and Gynecologists discouraged the use of robotic systems for certain procedures, due to higher costs without necessarily better outcomes.
- The market continues to climb a wall of worry and is shrugging off any bad news. It may be a sign that investor confidence has returned and will propel the market higher.
- A market consolidation wouldn’t be a surprise after a strong start to the year.
The Economy and Bond Market
Treasury bond yields fell modestly this week as economic growth data out of China disappointed along with a weaker-than-expected University of Michigan Consumer Confidence reading on Friday. Inflation data was also generally viewed as benign this week with year-over-year Consumer Price Index running at 2 percent.
- Retail sales rose 1.1 percent in February. The surprisingly strong sales were largely driven by gasoline price increases but did show that the consumer still chose to spend and didn’t cut back elsewhere.
- Initial jobless claims fell again this week as the four-week moving average hit a new 5-year low.
- Industrial production in February increased more than expected and continues a broad recovery in manufacturing.
- Chinese economic data was weaker than expected and policymakers appear more inclined toward tighter monetary and fiscal policies.
- The University of Michigan Confidence Index was much weaker than expected in February, sending conflicting signals about the consumer.
- Industrial production in the United Kingdom fell 1.2 percent in January, fueling speculation that a “triple” dip recession is looming.
- The Fed still remains committed to an extremely accommodative policy.
- Key global central bankers such as the ECB, Bank of England and the Bank of Japan are still in easing mode. The Bank of Japan in particular appears to be willing to implement additional monetary policy easing in the near future.
- The economy appears to be gaining momentum. The risk for bondholders is that this trend would continue and bonds selloff.
- Inflation in some corners of the globe is getting the attention of policymakers and may be an early indicator for the rest of the world.
For the week, spot gold closed at $1,592.05, up $13.25 per ounce, or 0.84 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 0.60 percent. The U.S. Trade-Weighted Dollar Index lost 0.67 percent for the week.
- Mexico cut its benchmark interest rate by 50 basis points last week after holding it flat for almost four years. This announcement would normally carry little weight into our gold valuation analysis, however, as ISI reports this week, Mexico’s rate cut is the 351st stimulative policy initiative announced around the world over the past 19 months. Furthermore, Roberto Perli, ISI’s Policy Research Managing Director, reiterates his belief the ECB, Bank of England, and Bank of Japan will ease further on the back of reports stating current job upturn is not near to satisfying the Fed.
- The U.S. Consumer Price Index for the month of February rose 0.7 percent month-over-month, surpassing analysts’ forecast of a 0.5 percent increase. This may be the first indication of rising inflation which should bode well for gold as an inflation hedge.
- The two gold equity rallies from 2012 have an important similarity that can help investors learn how to best position their portfolios for a gold equities bounce, according to Dundee Securities. In both rally periods, May 15 to June 5 and from July 23 to September 21, gold explorers and developers had the strongest performance, followed by the intermediates, seniors, junior producers, and finally, gold. We maintain significant exploration and development exposure in our funds, and we select companies with liquidity and superior management teams we believe capable of delivering on their promises.
- BCA Research reports this week that its gold advance/decline model has broken below its key support level and is now charting at a 2-year low. It is the research company’s opinion that the negative sentiment towards gold is now widespread and the option-based momentum should lead further outflows out of gold ETFs.
- Deutsche Bank adopted an all-in cost to analyze gold miners. In its Australian gold miners industry update, Deutsche Bank concluded all-in cash costs have ballooned year-over-year. The bank reports average all-in cash costs across its covered stocks were $799 per ounce in 2011 and increased by nearly 40 percent in 2012 to $1,108 per ounce. Despite the fact that we continue to believe the all-in cash costs promoted by the World Gold Council, its members, and most analysts, fall short of capturing the true sustaining and replacement costs of an ounce of gold, we agree with Deutsche Bank in its assertion that ballooning costs together with lower average gold prices will increase the challenges for companies trying to turn their gold into profits.
- According to BCA’s Emerging Market Strategy, credit expansion in China has reached unsustainable levels; over the past four years non-public debt to GDP has expanded from 120 percent to 190 percent. BCA argues that most of these transactions take place behind several layers in order to hide the true levels of credit expansion, with banks being accomplices to these schemes. According to the research, some major Chinese companies are operating under unsustainable leverage levels and will crumble at some point. It will be up to the central government to bail out both local governments and corporations. We believe gold could benefit from this situation as a safe heaven in volatile times.
- Christopher Wood of CLSA noted on his Greed & Fear report this week that gross short positions in Comex gold rose to a high of 13.1 million ounces on February 19, and were last reported on March 5 at 12.6 million ounces. These are the highest levels sine July 1999 and are likely held as speculative investments. A breakdown below $1,550 per ounce cannot be dismissed according to Christopher Wood; yet, he believes the gross short positions are a powerful contrarian indicator and sees a massive buying opportunity for bullion at current levels.
- Firm debit balances in margin accounts at the end of January 2013 rose to $364 billion. Many analysts continue dismiss comments on market speculation, but, margin debt level is at its highest level since October 2007, and dangerously close to its July 2007 peak of $381 billion. The leverage excesses investors have been taking on are an unambiguous reminder of the irrationality and aggressiveness of the market participants at that time. It is clear there is abundant enthusiasm to buy the market and shun gold, which in our view is a grand opportunity to buy beaten down gold stocks.
- Yi Gang, a deputy Chinese central bank governor, said a 2 percent ratio of gold holdings to China’s total foreign exchange reserves is likely to be the limit. The People’s Bank of China (PBOC) last released data on its gold reserves in 2009, when it announced that it held 1,054 tons. There have been no revisions since then and it is speculated the PBOC has continued to accumulate gold reserves by purchasing domestic production. Yi Gang was quoted stating, “We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small.” His assertion serves to reinforce the theory that it is only a matter of time for the unprecedented monetary expansion and high debt to GDP ratios around the world to drive up prices of hard assets such as gold.
- As the gold price flirts with the $1,600 per ounce level, junior gold explorers that were already cash starved may now be well out of it. Lawrence Williams reports that even in minimum survival mode including layoffs and/or no salaries, there are always ongoing costs to further deplete the treasuries. Stock exchange fees, concession fees, and commitments to ongoing office costs may not be cancelled due to contract terms. It is a pretty dire position for some juniors who will, most likely, not be around by year end. However, the situation also offers the opportunity to invest in sound businesses with cash on hand and good exploration potential, all for a few pennies.
Energy and Natural Resources Market
- The price of natural gas rose to a 16-week high of $3.85 per Mmbtu this week. This is a fourth-straight weekly gain on speculation of further late winter cold weather.
- U.S. crude oil output rose 0.9 percent to 7.159 million barrels a day in the week ended March 8, which is the highest level since July 1992, due to improvements in hydraulic fracturing and horizontal drilling, the Energy Information Administration (EIA) said.
- Chinese steel output soared in January-February 2013. Reported crude steel output for January and February combined was 125.452 million tons, up 10.6 percent year-over-year. Over the same period, reported pig iron production rose 7.8 percent year-over-year to 115.792 million tons and coke production was up 9.8 percent year-over-year to 73.607 million tons.
- Nickel stockpiles at the London Metal Exchange rose 0.4 percent to 161,646 metric tons, which is the highest since March 3, 2010.
- BHP Billiton reportedly settled April pricing for coking coal at $172-173 per ton FOB (HCC Peak Downs) as quarterly contract discussions dragged on. This price represents no month-over-month change and reflects weaker sentiment in recent weeks as HCC indices have declined about $12 (7 percent) since late-February.
- Brazilian iron-ore miner MMX scrapped a mining project in Chile over costs (write down of $114 million); walking away from investments it has already made to focus on primary projects at home.
- Vale suspended a $6 billion Argentine potash project on deteriorating economics. The company has shelved its Rio Colorado potash project (4.3 million tons per year of potash) in Argentina’s Mendoza; however, Vale left the door open to restarting the project if terms were to improve. The company has invested $2.2 billion in the project to date.
- Port data from Queensland shows minimal impact from the weather-related disruptions which took place in February. According to DTC, February exports from the main coking coal exporting ports of Queensland were 12.86 million in February and 26.66 million in the first two months of the year, up 11.3 percent and 6.4 percent year-over-year, respectively.
- Wilbur Ross is seeking funds for a new private equity fund that will buy distressed shipping and other transportation assets, according to three people familiar with the situation. WL Ross is teaming up with Oslo-based Astrup Fearnley AS to make investments in distressed assets tied to transportation.
- Peru’s mining sector will likely continue to see rising costs, making it more expensive for companies to develop projects, reports National Mining, Oil and Energy Society. Also opposition from rural communities that are worried about the environmental impact of new projects is another major challenge for firms, which have lined up a pipeline of projects that will require investments worth about $53 billion this decade, as per industry and government figures.
- China’s residential floor space sales surged 55.2 percent year-over-year in the January to February period, the fastest pace since late 2009, reflecting pent-up demand after two years of stagnation. Residential investment rose 23.4 percent and residential starts increased 17.5 percent for the same period.
- China’s passenger vehicle sales rose 20 percent year-over-year in the January to February period to 2.84 million units, in stark contrast to India’s 11 percent decline in the same period.
- Fitch raised Thailand’s credit rating to BBB+ with a stable outlook four years after political turmoil in the country, a positive recognition of Prime Minister Yingluck Shinawatra’s ability maintain social stability.
- Stocks in Poland and Turkey are entering their annual dividend season, and payments look particularly attractive this year, with yields reaching double-digit percentage points
- The Latin American corporate debt market is seeing increased demand allowing borrowers to fund their expenditures at significantly lower interest rates. Investors are boosting their risk tolerance amid near zero U.S. and Europe benchmark interest rates. Last month Colombia’s Banco de Bogota issued $500 million in 10-year bonds at 5.375 percent. Earlier this month, Cosan SA Industria & Comercio, a Brazilian large cap sugar and ethanol producer, sold $500 million in 10-year bonds at 5 percent. This week, CEMEX, the largest cement maker in the Americas, sold $600 million of 6-year callable bonds at 5.87 percent.
- China’s real retail sales expanded by a lower-than-expected 10.4 percent year-over-year in the January to February period, the slowest pace since September 2011, affected by the communist party’s campaign against corruption and extravagance. Revenue from large caterers including high-end restaurants declined 3.3 percent vs. 14 percent gain a year earlier.
- South Korea’s unemployment rate unexpectedly rose to 3.5 percent in February from 3.2 percent in January, the highest in the last 12 months, as a result of moderating export growth and expanding the labor force.
- Higher-than-expected February inflation in China and the government’s renewed focus on curbing speculation in the residential property market weighed on both Chinese and Hong Kong markets this week.
- Renaissance Capital estimates that the Russian economy will grow by 1.4 percent in the first quarter, and is forecasting second-quarter growth of only 1 percent year-over-year. If these yearly forecasts materialize, it would mean consecutive quarters of negative quarter-over-quarter growth, technically qualifying as a recession.
- Dollar bonds sold by Argentine consumer products companies are missing out on the biggest rally in Latin American debt on concerns a price freeze by supermarkets will squeeze profits. President Cristina Fernandez pressured supermarkets to fix prices until April in an effort to contain inflation that economists estimate at 26 percent, more than double the official rate. Candy maker Arcor’s bonds returned 0.9 percent since the price freeze was enacted, while Latin American companies in the same sector returned 2.9 percent over the same period.
- The Chinese regulator’s invitation of overseas institutions to reinvest their Chinese yuan on hand in mainland markets, coupled with the country’s robust trade surplus and lingering international expectation of appreciating yuan, should help sustain foreign capital inflows to China. Ample liquidity lends support to domestic Chinese A-share equities, a strong sentiment indicator for Hong Kong traded Chinese names, amid an increasingly uncertain government policy environment.
- Over a 12- to 24-month horizon, earnings momentum within emerging Europe is strongest in Hungary and Turkey. Polish companies’ earnings are not expected to accelerate until 2014.
- Mexico’s credit rating outlook was raised from stable to positive by Standard & Poor’s on increased confidence that President Enrique Pena Nieto’s proposed legislation will boost growth in Latin America’s second-largest economy. The news dropped yields on benchmark peso bonds to a record. The news follows the March 8 move by Fitch Ratings, which revised the rating outlook from stable to positive on Colombia’s BBB sovereign rating, and the upgrade of Uruguay’s sovereign ratings to investment grade.
- Market perception of potentially more strong-handed new administration in China could increase near-term volatility of its residential property sector.
- President Vladimir Putin named Elvira Nabiullina, his chief economic aide, to become the next head of the Central Bank of Russia (CBR). In a parting shot, outgoing CBR chairman Sergey Ignatiev said that the capital flight out of Russia is controlled by a criminal, “well organized group of individuals,” costing the country 2.5 percent of GDP, or $49 billion last year, a claim immediately disputed by a presidential spokesman. The appointment of Nabiullina, a Tatar, aims to appeal to ethnic and religious minorities, but will she manage to preserve the independence of CBR?
- Chile has posted some remarkable numbers over the first two months of the year; retail sales, manufacturing index, economic activity, exports, and trade balance have all beaten analyst expectations. Furthermore, inflation is the lowest in Latin America, and one of the lowest among Organization for Economic Co-operation and Development members at 1.3 percent year-over-year, and GDP grew at 6.7 percent in January. Such successful economic indicators have driven the country’s multilateral exchange rate against its major trading partners to a 20-year high. Chile’s commodity exports give the country little pricing power and are highly sensitive to exchange rate fluctuations, a situation that threatens to slow down its spectacular growth this year.
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