The Love Trade for Gold is Still On!

By Frank Holmes

CEO and Chief Investment Officer

U.S. Global Investors

Are you heading to Pershing’s INSITE 2013 conference in June? Come and meet our team at booth #518. Also, look for U.S. Global’s director of research, John Derrick, CFA, who will be participating in a panel discussion on “Beyond Emerging Markets: The Evolution of Frontier Markets” on June 6. This is a dialogue you can’t afford to miss.

This week, investors should have gained confidence from Ben Bernanke’s testimony to Congress that the Federal Reserve intends on being accommodative as long as needed. He had a laundry list of job market conditions that needed improving and reiterated that inflation remains low. It’s his belief that “a premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.”

The Fed’s news is “great for all of us in stocks… and not so great for those with cash in a savings account, with real negative returns for the past four years,” reminded Money Map Press. Yet, at least in the short term, markets interpreted Bernanke’s testimony differently, as stocks dropped for the week.

The news should also be good for gold investors. Not only is the Fed maintaining its course, the world is also continuing its synchronized easing. According to Deutsche Bank, central banks representing almost 30 percent of global GDP are cutting rates.

The rate cuts are spread out over nearly every continent, as you can see on this great visual posted by Business Insider. Turkey’s central bank cut its benchmark interest rate more than expected in April by 50 basis points and then another 50 basis points in May. Serbia also slashed rates by 50 basis points, as did Sri Lanka. Even the European central bank reduced its main rate to a record low 0.50 percent. According to Bloomberg, ECB President Mario Draghi is “promising to provide as much liquidity as eurozone banks need well into next year.”

Worldwide easing continuesClick to Enlarge

With this global easing cycle, gold and equities had been moving together, but have been taking vastly diverging paths in the past six months. In fact, the gold-to-S&P 500 Index ratio has fallen to lows not seen since 2008, according to UBS Investment Research. This extreme indicates that the precious metal may be looking more attractive. In addition, "gold's resilience in spite of very weak investor sentiment is encouraging, with recent price levels having acted as a good floor so far," says UBS.

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As I often remind investors, gold buyers are a diverse group, but generally fall into one of two categories. Most of the attention gets focused on those who purchase out of fear of damaging government policies (i.e., the Fear Trade).

The more important demand for gold, in my opinion, comes from the enduring Love Trade, as countries like China and India buy the precious metal out of love and tradition.

Looking at a breakdown of gold demand from the World Gold Council (WGC) through March 31, 2013, the main source of weakness was the Fear Trade, as demand for gold ETFs and similar gold products plunged in the first quarter. However, the Love Trade scooped up jewelry and bars and coins, with the tonnage in each category growing 12 and 10 percent, respectively, on a year-over-year basis.

You can visually see the strength of the Love Trade below in the year-over-year change in total consumer demand in tons for gold jewelry, bars and coins. Indian demand grew the most, increasing 27 percent compared to the previous year. Demand for jewelry, bars and coins in the greater China area increased 20 percent, as “seasonal strength in China, related to Chinese New Year purchasing, exceeded all previous peaks, marking a new record quarterly high,” says the WGC. Even U.S. residents had a love for gold, with demand growing 22 percent over the previous year.

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The Love Trade doesn’t look like it’ll subside anytime soon. I recently discussed the record amount of coins purchased through the U.S. Mint and the buyers crowding stores in multiple Asian markets when gold tumbled in April. It appeared that gold was transferring from weak hands to the strong hands of the Love Trade.

As one example, on the Shanghai Gold Exchange, trading volume surged to a record 43.3 tons on one day in April, as buyers clamored to buy the metal at a great price.

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Gold purchases are getting so strong these days, buyers are willing to pay a premium, says Mineweb. The mining publication reported this week that premiums on gold bars are climbing to all-time highs in Hong Kong and Singapore, with Chinese residents paying $5 to $6 an ounce over the spot London price due to classic economic one-two punch of huge demand and tight supply.

According to data from the Hong Kong Census and Statistics Department, “net gold flows from Hong Kong to China jumped to 223.519 tons in March from 97.106 tons in February, smashing a previous record of 114.372 tons in December,” says Mineweb.

This is the Love Trade in action.

Index Summary

  • Major market indices closed lower this week despite setting a new all-time high for the S&P 500 Index on Tuesday. The Dow Jones Industrial Average fell 0.33 percent. The S&P 500 Stock Index moved lower by 1.07 percent, while the Nasdaq Composite lost 1.14 percent. The Russell 2000 small capitalization index fell 1.20 percent this week.
  • The Hang Seng Composite fell 1.99 percent; Taiwan lost 2.15 percent while the KOSPI fell 0.67 percent.
  • The 10-year Treasury bond yield gained 6 basis points this week to 2.009 percent.

Domestic Equity Market

The S&P 500 finished the week down 1.07 percent, the first weekly retreat in five weeks, as skeptical investors grappling with the market’s unseasonal strength seized upon any sign of negativity to take profits. Among the most cited excuse was Federal Reserve Chairman Ben Bernanke indicating in the Q&A session of his congressional testimony the possibility to taper quantitative easing “in the next few meetings” if the economy continued to improve in a sustainable manner. The index managed to stand above its twenty-day moving average in spite of the correction.

Domestic Equity Market - U.S. Global Investors

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Strengths

  • The healthcare sector was the leader this week in relative performance, as investors continued to prefer strong free cash flows, above average dividends and stable businesses uncorrelated with economic booms and busts.
  • The energy sector was the second-best performer, led by natural gas exploration and production companies as natural gas rebounded 4.4 percent this week following the Department of Energy’s conditional approval of exporting liquefied natural gas to countries without a free-trade pact with the U.S.
  • Hewlett-Packard was the best performer in the S&P 500 this week, gaining 13.8 percent. Cost-cutting measures have been successful in lifting quarterly earnings, and CEO Meg Whitman’s remarks raised investor expectations for a return to growth in 2014.

Weaknesses

  • The utilities sector was the worst performer this week, as the macro rotation continued from defensive to cyclical areas of the market.
  • The telecom sector also underperformed largely attributable to a recovery in investor risk appetite.
  • GameStop was the worst performer in the S&P 500 this week, declining 19.2 percent because of its downbeat, second-quarter guidance as well as uncertainty that new Microsoft Xbox consoles may include technology restricting use of pre-owned games.

Opportunity

  • There are signs in the U.S. and Europe that fiscal austerity may lessen in the second half of the year, a positive for growth recovery.
  • Lower food and energy prices globally are helping to keep a lid on inflation, a blessing for global central bankers pondering further accommodation of monetary policy.

Threat

  • A market consolidation could continue in the near term, as the S&P 500 kept trending higher beyond its all-time record for a month, defying the proverbial “Sell in May” seasonal pattern.
  • The U.S. dollar is lingering around its three-year high, which may translate into lower earnings for S&P 500 companies going forward, since around 50 percent of S&P 500 earnings are made from overseas.
  • Global central banks are literally pulling out all the stops in an attempt to ignite economic growth. The European Central Bank (ECB) cut interest rates last week, which is a move in the right direction as far as the market is concerned.

The Economy and Bond Market

The benchmark 10-year treasury yield climbed above 2 percent for the first time since March. Investors sold bonds in order to participate in a strong equity market as the S&P 500 stock index reached a new all-time high.

Domestic Equity Market - U.S. Global Investors

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Strengths

  • Durable goods orders rose 3.3 percent last month, U.S. Commerce Department data showed, compared with the median forecast of 1.5 percent in a Bloomberg survey. The orders dropped by a revised 5.9 percent in March. Excluding the more volatile transportation equipment component, durable goods orders climbed 1.3 percent, the first gain in three months.
  • Existing-home sales rose slightly last month to reach their highest level since late 2009. Total existing home sales increased 0.6 percent to a seasonally adjusted annual rate of 4.97 million in April from an upwardly revised 4.94 million in March, the National Association of Realtors said. At that level, sales were 9.7 percent above year-ago levels.
  • The latest University of Michigan current conditions index spiked higher this week. This index gauges consumers' views of their personal finances.

Weaknesses

  • The total number of mortgage applications filed in the U.S. last week fell 10 percent from the prior week, as mortgage rates rose to their highest level since March, the Mortgage Bankers Association said Wednesday.
  • China's factory activity shrank for the first time in seven months in May as new orders fell, a preliminary manufacturing survey showed, fueling fears that its economic recovery has stalled and that a sharper downturn may be forthcoming.
  • Despite growing at a faster-than-expected rate in the first quarter, Taiwan lowered its economic growth forecast for this year among signs that global growth is faltering.

Opportunity

  • The Federal Reserve continues to remain 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 is aggressively easing and the ECB recently cut interest rates.

Threat

  • Inflation in some corners of the globe is getting the attention of policy makers and may be an early indicator for the rest of the world.
  • Trade and/or currency “wars” cannot be ruled out, which may cause unintended consequences and volatility in the financial markets.

Gold Market

strong global golds market

For the week, spot gold closed at $1,386.65, up $27.10 per ounce, or 1.99 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 4.14 percent. The U.S. Trade-Weighted Dollar Index lost 0.73 percent for the week.

Strengths

  • Continuing with the theme of skyrocketing physical demand for gold, the World Gold Council provided updated statistics on gold coin and bar consumption around the world. The data is very encouraging despite the fact that it was calculated for the first quarter of 2013 and ahead of the large price drop in April which spurred the latest rally in physical gold demand. Regardless, demand in India rose 52 percent year-over-year in complete disregard for the import duty hikes imposed in January. The U.S. demand remains below the five-year average, but significantly above last year’s 14.1 million tons, mainly on renewed appetite for American Eagle coins. Investment demand in China increased as expected, while demand from Middle Eastern nations was relatively flat. Surprisingly, Thailand rose to the third spot among coin and bar buyers, while Europe was the only major region to reduce its purchases, reflecting some of the tail risk resulting from the sovereign debt story.
  • The University of Texas Investment Management Co., the second-largest college endowment fund with assets under management of approximately $29.5 billion, is sitting on approximately $300 million in gold-related investments, according to the Wall Street Journal. Despite the recent weakness, the endowment continues to like gold and is considering increasing its position in the event of a pullback. According to the fund’s manager, the company is not worried about the recent volatility, as it considers itself a long-time holder rather than a day trader. The company values the hedging properties of its gold-related investments and will consider exiting its position if as the Fed’s quantitative easing program is discontinued.
  • Detour Gold announced a 17.5 million common share bought deal earlier in the week for gross proceeds of 153 million Canadian dollars. The company intends to use the net proceeds for working capital during the ramp-up of the Detour Lake mine. Similarly, Colossus Minerals announced a bought deal of 15.625 million common shares for gross proceeds of 25 million Canadian dollars this week. The proceeds will be used to fund development expenditures on the Serra Pelada project, and for working capital and general corporate purposes. It appears the Canadian capital markets have started to see a more steady flow of bought deals, which helps reiterate the fact that junior miners are trading at extremely discounted valuations.

Weaknesses

  • The release of some high profile hedge fund 13F filings revealed that noted hedge fund legends such as David Einhorn and George Soros held sizable stakes in gold-related investments. However, their largest gold weightings were assigned to gold mining ETFs, which are a convenient product – they contain the largest and most liquid stocks – but offer exposure without regard to quality of the companies. It is unfortunate some investors have resorted to ETFs versus buying into a gold mutual fund which is actively managed to select gold companies believed to possess the best investment fundamentals.
  • Chile's environmental regulator has stopped construction and imposed sanctions on Barrick Gold’s Pascua-Lama project, citing serious violations to the environmental permit originally granted to the company. A $16 million fine, the largest allowable under Chilean law, has been imposed on the company. News media reports the company acknowledged that it failed to build systems for containing contaminated water. The company is said to be exploring an alternative mine plan that would enable it to mine the resource from a smaller pit on the Argentine side of the deposit.
  • Goldcorp, the world’s biggest producer of the metal by market value, will be forced to renegotiate its rental agreement at its biggest mine in Zacatecas, a Mexican court ruled. The court invalidated Goldcorp’s temporary lease agreement as local farmers seek to regain control of about 1,483 acres within the Penasquito open mine land area. The increase in leasing payments demanded by locals appears negligible, and the company is focused on reaching a settlement that will allow it to minimize disruptions to its operations.

Opportunities

  • David Rosenberg of Stifel Nicholaus noted in his commentary how the gold-silver ratio has risen to its highest point since August 2010, a level that has previously signaled an up and coming risk-off trade. The risk-off trade normally has the gold-silver ratio and the S&P 500 converging, which would mean a significant rise in the price of gold, a significant correction in the S&P 500, or both. Furthermore, Rosenberg commented he feels nervous about the market when reading news headlines such as: With Stocks This Hot, Why Worry? He eloquently argues this is the perfect cue to begin to worry as it is the usual confirmation of a bull market falling into complacency.
  • This week Sprott shared an essay from a longtime friend of theirs, Bill Bonner. In the essay, Mr. Bonner interviews Neil Barofsky, the person in charge of the original TARP, the Feds' $700 billion program to rescue the U.S. economy. Mr. Barofsky shared his dissatisfaction with the way the program unfolded, as banks used the funds to repay each other's loans, and reduce the amount of credit available, defeating the purpose of the program. It appears this may be one of the main reasons why inflation has been confined to financial assets, and not spread to real assets.
  • Moody’s Investors Service said U.S. policy makers must address debt concerns seriously if they want to avoid a credit-rating downgrade this year. “More needs to be done on the policy front to address this rising debt ratio,” said Steven Hess, a senior vice president at New York-based Moody’s. The ratio of debt to GDP is set to increase in the long term, according to a recent study led by the Congressional Budget Office. The wake up call for U.S. policy makers in Washington D.C. should bode well for gold prices as it brings back attention to the deficient efforts to balance the fiscal budget.

Threats

  • An article on last weekend’s Barron’s by Randall Forsyth caught our interest as it looked into some of the suspicious selling that has been taking place in the gold market. According to Forsyth, there were reports of very heavy buying of put options in the SPDR Gold Shares ETF (GLD). The curious thing is that these options expired on Friday and had a strike price of 132. That option, which was set to expire out of the money—and thus be worthless—wound up solidly in the money after two selling transactions of 17 tons of gold dropped the GLD price to 131.07 at the closing. Forsyth agrees that a large portion of gold investors are suspicious in nature, but this event is too coincidental to ignore.
  • A report issued by the Congressional Budget Office states President Obama vastly overstated the spending cuts and deficit reduction his budget plan would produce, while considerably undercounting the level of tax hikes the program would entail. Obama said his program would reduce deficits by almost $2 trillion in a balanced and responsible way. The CBO however finds that Obama’s budget will reduce deficits by only $1.1 trillion in the short term, and forecasts annual deficits would start to rise again after 2017. Despite the media coverage and numerous promises, it looks like the U.S. is nowhere near solving its fiscal budget imbalance problems.
  • Investors who dumped shares of gold bullion ETFs amid the April selloff may be in for a shock as capital gains taxes for precious metals are higher than for stocks and bonds. The gains obtained from investments in ETFs that back their shares with physical holdings of precious metals face taxes as high as 28 percent. This is the rate the IRS traditionally applies to items such as coins, art, silver and gold. Gains on stock and bond investments are traditionally taxed at a maximum 20 percent. This should not discourage long-term gold and precious metal investors, to whom it is recommended they hold their bullion investments in a tax-free individual retirement account or other non-taxable account, whenever possible.

Energy and Natural Resources Market

Peruvian Stocks vs. Emerging Markets

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Strengths

  • Natural gas futures gained for the second consecutive week, up over 3 percent, as a smaller-than-expected injection into storage boosted prices.
  • Soybeans advanced to a six-month high, heading for the best run in more than a year, on signs that demand will increase in China even as U.S. supplies shrink. Soybeans for July delivery gained as much as 0.6 percent to $15.025 a bushel, the highest for a most-active contract since November 8, on the Chicago Board of Trade. China’s soybean imports, the world’s largest, will start increasing sizably from this month onward and jump 17 percent in the next season, according to Oil World.
  • According to Deutsche Bank, U.S. seaborne thermal coal exports in the first quarter increased to 11.3 million tons from 9.4 million tons last year, despite better competitiveness of coal for power generation. A domestic oversupply of coal is likely to become a larger problem as more coal-fired power generation is closed in coming years as a result of anti-pollution legislation. The construction of West coast ports capable of handling coal is a key uncertainty as they face opposition from environmental and local interest groups. While three projects have been cancelled in the last year, two of the largest projects backed by coal producers are still in the planning process, holding out hope of opening a gateway for U.S. coal to the Pacific Basin.
  • China imported 32.28 million tons of iron ore from Australia in April, up 27 percent year-on-year and up 0.3 percent from March, data released Wednesday by the General Administration of Customs showed. Australia remained the top supplier of iron ore to China, accounting for 48 percent of total imports in April, compared with 50 percent in March. A Singapore-based trading source attributed the increase to more availability of Australian cargoes in the spot market. China's demand for steel products climbed in April as more construction projects gained traction on warmer weather.

Weaknesses

  • Crude oil, copper and several industrial commodities fell this week after weak economic data was released out of China. HSBC-Markit's China Flash Manufacturing Purchasing Manager’s Index (PMI) fell 0.9 points to a seven-month low of 49.6 in April, pointing to a potential dip in the country's manufacturing output over the next few months. One potential positive for commodities further ahead is that the latest data suggest destocking of inputs into manufacturing continued, and at an accelerating rate in April, which cannot carry on indefinitely.

Opportunities

  • The approval of exports to non-Free Trade Agreement (FTA) countries from the Freeport LNG project by the U.S. Department of Energy marks the first such approval since Sabine Pass in May 2011. This brings the approved volume of LNG exports to non-FTA countries from the two projects together to 25 million tons per annum, or 3.6 billion cubic feet (Bcf) per day. Opposition to further approvals will certainly grow louder with each new approval, so the thresholds used in the EIA and NERA export studies (6 & 12 Bcf per day) may serve as opportune pausing points in the approval process as the impact is re-assessed. Next on the list is the Lake Charles project by Southern Union and BG, which would bring the total approved volume to 5.6 Bcf per day, while an additional five projects, in the order of processing, would bring the total to 11.75 Bcf per day,
  • Mongolia's parliament finally passed a long-awaited securities law on Friday that will allow the state-owned firm mining the enormous Tavan Tolgoi coal deposit to launch a $3 billion initial public offering at home and overseas. Khangai Altai, the chief executive of the fledgling Mongolian Stock Exchange said the new law would also help attract more companies to the exchange by introducing international standards, adding that it could eventually bring total market capitalization to around $30-$40 billion, from only around $1.3 billion at present.
  • Corn sales to China, the world’s second-biggest grower, probably will triple as the government rebuilds inventories with imported grain that now costs less than domestic crops, according to Archer Financial Services. Imported corn has been cheaper than Chinese grain values since April, spurring increased purchases of U.S. supplies. China imports may jump to 10 million metric tons in the year that begins October 1, up from 3 million this year, said Gregg Hunt, a grain analyst at Archer Financial. “There is a growing economic incentive for China to import corn, most of which will come from the U.S.,” said the Chicago-based Hunt, who has been trading commodities for more than 30 years. “The record prices indicate China doesn’t have much corn left from the previous harvest, because of rising feed demand. The government will be looking to replenish supplies with imported corn.”
  • India's metallurgical coal imports are likely to grow by 8.7 percent to 35 million tons in 2013-2014 as additions to its steel-making capacity lift demand, four traders and a steelmaker said. India, the world's fourth-largest steel producer, is expected to add around 5 million to 6 million tons of steel-making capacity in this fiscal year to March-end, said an official at JSW Steel.

Threats

  • South African power utility Eskom said on Thursday that the reserve margin between forecast demand and capacity in the evening was only 132 megawatts, or less than 0.4 percent of available power. Eskom is battling to keep the lights on in Africa's largest economy with the approach of the southern hemisphere's winter. Earlier in May, the national grid came within a hair's breadth of overloading, when the gap between demand and supply was only 0.06 percent.
  • Australian coal miners are steeling themselves for years of production cuts, job reductions and asset sales as swelling shipments from international rivals lower hopes of a recovery in prices for coal. Prices have slumped around 30 percent since their peak two years ago as coal flooded global markets, especially from the United States where cheap gas has cut domestic demand and led to a nearly 50 percent jump in thermal coal exports last year. Even robust Chinese and Indian demand growth is failing to soak up the plentiful supply
  • Serious overcapacity in China's steel industry is unlikely to ease in 2013, which could hamper steel prices and jeopardize Chinese steelmakers' performance, a China-based analyst said Thursday. China is set to produce about 750 million metric tons of crude steel in 2013, while capacity will rise to 950 million tons a year, as some 50 million tons new capacity is being built, said Jing Zhang, an analyst with Platts, during the company's Steel Markets Europe congress. This will bring the country's overcapacity to around 200 million tons, she said. "Any demand recovery or price rebound during the rest of the year could easily trigger a production jump which could in turn hamper steel prices and jeopardize Chinese steelmakers' performance," Ms. Zhang said. “Seventy percent of Chinese steelmakers lost money in April and May."

Emerging Markets

Strengths

Dividends Key Factor in Easing the Decline of Latin American Stocks

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  • Fund flows into Turkey continue at an unstoppable pace. It is now evident that much of the strength in the domestic stock and bond markets has been driven by foreign investors redirecting their capital into the country. As the chart above demonstrates, foreign inflows to both the stock market and the debt market have been on an uptrend for the most part of the last 12 months. Following the second credit upgrade last week, the inflows are expected to continue rising – especially now that investment-grade only institutional investors have more reason to look into the country – which should continue to support the higher valuations.
  • The Colombian Energy and Mining Minister announced the country is submitting a voluntary application for membership at the Extractive Industries Transparency Initiative created by former U.K. Prime Minister Tony Blair. The organization is set to promote the use of transparency policies at the government level, with an emphasis on full disclosure – by both governments and companies – of payments and receipts resulting from the extraction of natural resources. The Ministry aims to ratify its commitment to the implementation of best practices (in governance) and address public concerns of misuse of royalties resulting from natural resource extraction.
  • Passenger vehicle sales in the first three weeks of May in China rose 20 percent on a year-over-year basis.
  • Thailand’s April exports were up 10.5 percent, exceeding the market estimate of 5.3 percent. In particular, intra-Asia ex-Japan trades were up 15.7 percent year-over-year. Imports went up 8.9 percent.
  • The Beijing municipality sold three land plots in Wednesday’s auction for RMB 3.52 billion, the highest single-day land sales since the government launched property-curbing measures. Nearly 40 residential property projects are waiting for pre-sales approval from Beijing’s land authority, causing a short-term supply shortage and putting upward pressure on home prices in the city. At present, Beijing’s housing inventory level is less than 40,000 units, far below the quantity needed – 90,000 units. With a weak May PMI number, the street consensus is that the government will not further tighten the housing market since it is one of the most important drivers for GDP growth. If that is true, supply will be increased and developers will continue to grow their sales.
  • Singapore’s first-quarter GDP grew 0.2 percent versus the market expectation of -0.6 percent. Construction accelerated 7.3 percent in the quarter, offsetting manufacturing weakness being down 6.8 percent. Singapore’s April Consumer Price Index (CPI) was 1.5 percent versus the market forecast of 3 percent due to a sharper-than-expected fall in transportation costs.
  • Indonesia’s new budget draft increased deficit spending to 2.5 percent of GDP from 1.7 percent previously, which should benefit infrastructure investments.
  • In Hong Kong, major banks, including HSBC and Citibank, decreased mortgage rates back to 2.15 percent from 2.4 percent previously.
  • The Philippines asked trust companies to reduce investment holdings in Special Deposit Accounts (SDA) by 30 percent, which potentially creates a positive money flow into the equity market.

Weaknesses

  • April retail sales fell unexpectedly in Poland, disappointing analysts who forecasted a 1.1 percent rise for the month. In addition, reports from the statistics office earlier in the week highlighted a decrease in industrial output, as well as a marked decrease in employment numbers. Central Bank member Bratkowski was quoted as saying he will seek a 50 basis-point cut at the June meeting as the slow recovery harms the economy’s output.

Peruvian Stocks vs. Emerging Markets

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  • With unemployment levels at historical lows in Chile, Colombia and Peru, it is not surprising that labor cost pressures have been on the rise. Morgan Stanley’s Andean Equity Strategy compared the exposure of eight sectors to labor inflation by measuring labor costs as a percentage of operating earnings. Its analysis suggests the worst-performing sector in a continued labor inflation period would be industrials, since labor costs approximate 252 percent of operating earnings. However, the research also shows how the utilities and financial sectors are candidates for outperformance given their lowest ratio of labor costs to operating earnings, 26 percent and 56, percent respectively.
  • The HSBC China Flash PMI for the month of May is 49.6 versus the consensus 50.4. A PMI below 50 indicates the economy is in contraction, which will add pressure to China’s government to keep easing monetary policy and to consider certain fiscal spending. One of the reasons for slowing growth this month may be the austerity policy and anti-corruption measures, which drive away consumption spending by governments and state-owned enterprises. People said they saw empty high-end restaurants in Beijing where business deals usually are discussed and closed.
  • In preliminary solar trade talks, the E.U. and U.S. rejected China’s proposal to settle solar products. This may lead China to retaliate by imposing a tariff on silicon imports from the U.S. makers.
  • Rumor says that China may cut the coal power tariff to pass the lower coal price benefit to consumers. China had just cut a power tariff for the agricultural sector. China will also ban low-quality coal imports. Overall, China will discourage coal-fired power in favor of alternative energy and gas.
  • On Friday, a Reuters’ article alleging the “new” urbanization plan was rejected by China’s Premier Li Keqiang triggered a cyclicals selloff, although this was denied by the National Development and Reform Commission. It seems the Chinese government is still in the process of fine-tuning urbanization plans.

Opportunities

  • VTB Bank, Russia’s second-largest bank, is calling on policymakers at the Russian Central Bank to cut interest rates to help spur credit as the country’s Producer Price Index slowed to 1.6 percent from the previous 3.4 percent. President Vladimir Putin said the central bank would refrain from monetary easing, forcing private banks to contract their interest margins and pass on the lower rates to creditors. In June, Elvira Nabiullina will take over as Central Bank Governor, which has led local bank executives to believe central bank monetary easing measures should not be ruled out, which would benefit Sberbank and VTB, the country’s largest banks.
  • The Pacific Alliance bloc – formed by Chile, Colombia, Mexico, and Peru – held its seventh summit in Colombia on Thursday. The Alliance, whose goal is to drop barriers on labor, finance, and trade and consolidate itself as a nexus for commerce with Asia, agreed to begin dropping tariffs on 90 percent of all goods traded among members. More than a dozen countries attended the event as observers following the international attention drawn by the Alliance’s ambitious goals. Canadian Prime Minister Stephen Harper and his Spanish counterpart Mariano Rajoy attended the event, raising hopes that the Alliance could expand beyond Latin America.

Mobile Internet Adoption 4.5x Faster than Regular Internet in China

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  • As shown in the graph above, coal is still the primary energy source in China, which will be changed. China has targeted 20 percent for natural gas consumption in its energy mix by the year 2016, up from 6 percent currently. This creates a huge opportunity for natural gas producers and distributors.

Threats

  • Amid falling electricity prices in the region, a new dispute has sparked between the finance minister and the prime minister of the Czech Republic over a $10 billion nuclear power expansion project. Finance Minister Kalousek has questioned the economic sense of the investment at a time when electricity prices are in continued decline across the region, and given the little interest the project has sparked among firms invited to participate in the bidding process. Meanwhile, Prime Minister Petr Necas said the country’s energy strategy will be hard to imagine without building new reactors, in what appeared to be a justification of his persistent support for the project.
  • UBS Global Emerging Markets Strategy studied numerous corporate governance rankings and concluded emerging market companies continue to have a lower corporate governance score than U.S. companies. Moreover, there is little evidence of emerging markets converging to the corporate governance ratings obtained by developed markets. In fact, over the last two years, corporate governance in emerging markets appears to have declined more pronouncedly, moving further away from an already declining score in developed markets. Strong economic growth in emerging markets appears to have masked this phenomenon, but if growth were to recede, governance risks would pose a serious threat to the markets.
  • China’s austerity measures probably have negatively affected second-quarter GDP growth, which will be released in July. Already the street had downgraded China’s GDP growth after weaker-than-expected first quarter and April economic statistics. In the long-term, anti-corruption and government spending austerity are good for the economy and efficiency of enterprises. Investors should know the difference between China’s austerity and the eurozone’s. While the eurozone tightens lavish social spending, China bans government officials and state-owned enterprise executives from corruption and personal gifting and entertainment spending. However, the side effect of these measures is to temporarily slow down business activities before things reverse to normal.

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