Big Ideas in the Big Easy
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
For nearly four decades, curious investors have made their way to the Big Easy for a taste of New Orleans and several helpings of advice and perspective at the New Orleans Investment Conference.
Coincidentally, President Barack Obama was in the city recently, speaking at the Louisiana port, which was the setting to showcase his focus on the nation’s economy.
Although the speakers and audience at the Investment Conference will likely have very different political opinions from President Obama, we can all agree with him when he said, “The first thing we should do is stop doing things that undermine our businesses and our economy.”
I, for one, would love to have him read my blog post on this subject that discusses how Texas is becoming the nation’s poster child of how companies, communities, and individuals flourish when allowed to operate under a more business-friendly atmosphere.
This is likely a contrarian view to the folks in the White House, but I think investors benefit from being contrarian and thinking differently. In preparation for my presentations in New Orleans as well as for the Metals & Minerals Investment Conference in San Francisco and the Mines and Money in London in a few weeks, I’ve been pulling together this kind of research that we can all put to use now.
One contrarian idea these days is investing in resources. This is an unloved and underowned area of the market, but there is a case to be made for owning commodities.
Consider the low expectations that analysts have on earnings growth for cyclical industries. BCA Research looked at times when the ISM new orders index were more than 60, and calculated the average earnings growth in the following 12 months. The chart shows the gap between past earnings performance and what analysts are anticipating in the next 12 months.
According to BCA, sectors including energy and materials stand out “as having overly bearish expectations compared with their historical performance patterns.”
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These analysts are bearish even though the world is experiencing an earth-shaking resurgence in manufacturing. In October, the JP Morgan Global Manufacturing Purchasing Managers’ Index (PMI) grew to an incredible 29-month high, rising to 52.1 in October. A number above 50 indicates expansion in manufacturing, and if manufacturing is expanding, so should the economy.
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If you look at the PMIs of individual countries, including the data coming out of the U.S., Europe, Japan, China, Brazil, and Australia, more than 90 percent are above 50. Historically, when an overwhelming majority of countries see this level of manufacturing expansion, world-wide growth remains elevated for an extended period of time. Since January 2005, there were two previous times when PMIs remained high: From 2005 until the Great Recession in 2008, and from January 2010 through the middle of 2012.
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What’s exciting about this revival in global manufacturing is the relationship between growing strength in PMIs and higher returns from certain commodities, including copper, crude oil, as well as energy and materials stocks. Based on 23 observations from January 1998 to December 2012, there is a high mathematical probability that physical commodities and commodity stocks rise in the three months after the current PMI number rises above its 3-month moving average.
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In addition, the Organisation for Economic Co-operation and Development (OECD) Composite Leading Indicator has been heading in a positive direction. This leading indicator provides early signals of turning points in business cycles, including economic activity. Historically, metals performance has closely followed this leading indicator, so as developed markets improved, the S&P GSCI Industrial Metals Index increased.
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Gold is certainly a contrarian buy these days, but the big story that is affecting the supply of gold is how the physical metal continues to migrate east. According to Paolo Lostritto of National Bank, year-to-date net physical imports by China equate to approximately 50 percent of global mine supply. This is in addition to the reports from GFMS suggesting that China is the world’s largest gold producer with an estimated 400-plus tonnes annually, or roughly 14 percent of global mine supply.
As Portfolio Manager Ralph Aldis likes to say, the gold going into China won’t be coming back to the market. This journey is a one-way trip for gold.
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However, Chinese demand for gold is only one ingredient in the very significant Love Trade. With the increasing gold import restrictions in India, the country’s leading position as the world’s biggest buyer of gold is in jeopardy. I’d like to get a firsthand perspective on what is really taking place with the demand for gold and get a flavor for what’s going on, so I’ll be traveling to India later this month.
These charts are only a fraction of the slides I will be presenting to investors over the next several weeks. If you’d like a copy of the entire presentation, visit www.usfunds.com or email us at [email protected]. I hope to see many of you in attendance!
Thank You, Veterans
Benjamin Franklin said, “There never was a good war or a bad peace.” On this Veteran’s Day weekend, we are grateful to all veterans for their service. Thank you for protecting America’s freedom!
- Major market indices finished mixed this week. The Dow Jones Industrial Average rose 0.94 percent. The S&P 500 Stock Index gained 0.51 percent, while the Nasdaq Composite fell 0.07 percent. The Russell 2000 small capitalization index rose 0.39 percent this week.
- The Hang Seng Composite fell 2.20 percent; Taiwan declined 1.89 percent while the KOSPI dropped 2.67 percent.
- The 10-year Treasury bond yield rose 13 basis points this week to 2.75 percent.
Domestic Equity Market
The S&P 500 ended the week strong, pushing into positive territory for the week. A strong employment report on Friday was the positive catalyst after a see-saw week with lots of conflicting signals. Cyclicals and financials led the way on improving growth prospects.
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- The materials sector was the best performer this week on broadly improving global macro environment. US Steel, Newmont Mining and Vulcan Materials led the way in a broad-based rally.
- The financials sector was also strong this week as insurance stocks such as Prudential Financial, Lincoln National and MetLife rallied after the strong employment report pushed bond yields higher, with the prospect that higher yields will boost investment income is positive.
- The Gap was the best performer in the S&P 500 this week, rising 12.64 percent. The company reported earnings that beat expectations and same store sales trends in October that remained positive.
- The telecom services sector was the worst performing group this week as AT&T fell by nearly 3 percent on news that T-Mobile reported 643,000 postpaid subscriber additions, while AT&T lost 25,000 subscribers.
- The utilities sector also lagged as interest rate sensitive groups were generally under pressure.
- WPX Energy was the worst performer in the S&P 500 this week, falling 14.74 percent. The oil and gas exploration company fell after posting a significantly larger loss than expected on lower realized prices on natural gas.
- The current macro environment remains positive as economic data remains robust enough to give investors confidence in an economic recovery, but not too strong as to force the Fed to change course in the near term.
- Money flows are likely to find their way into domestic U.S. equities and out of bonds and emerging markets.
- The improving macro backdrop out of Europe and China could be the catalyst for a rally into year end.
- A market consolidation could occur in the near term after such a strong year.
- Higher interest rates are a threat for the whole economy. The Fed must walk a fine line and the potential for policy error is large.
The Economy and Bond Market
Treasury bond yields rose sharply this week on stronger than expected employment and better than expected third quarter GDP growth. As we mentioned last week, the idea that the Fed will taper in December or January has quickly become consensus and is putting pressure on the bond market.
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- The employment report was much better than expected, with 204,000 nonfarm payroll jobs created in October and an additional 60,000 added to prior months through revisions to the data. Expectations were for growth of 120,000.
- The European Central Bank cut interest rates by 25 basis points. This rate cut came sooner than most analysts had predicted and was a catalyst for the U.S. dollar to rally this week.
- Third quarter GDP rose a better than expected 2.8 percent. The results were downplayed somewhat due to the replenishment of inventories, which is unlikely to repeat in upcoming quarters.
- Bond yields rose sharply this week on better economic data and the building expectations that the Fed will taper sooner rather than later.
- Mortgage applications fell five percent in the week ended November 1.
- The University of Michigan Confidence Index fell in November and was below expectations. This is consistent with other recent consumer surveys.
- Despite recent conflicting commentary, the Fed continues to remain committed to an overall accommodative policy and is unlikely to raise interest rates in 2013 or 2014.
- Key global central bankers remain in easing mode such as the European Central Bank (ECB), Bank of England and the Bank of Japan. This idea was reinforced this week with the ECB’s rate cut.
- There remain many moving parts to the taper decision and it is very possible that tapering could be delayed well into 2014.
- 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.
- The recent bond market sell off may be a “shot across the bow” as the markets reassess the changing macro dynamics.
For the week, spot gold closed at $1,288.60, down $27.60 per ounce, or 2.10 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 0.39 percent. The U.S. Trade-Weighted Dollar Index rose 0.61 percent for the week.
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- Bloomberg reports total known gold ETF holdings have fallen 29 percent since their all-time peak earlier this year, contributing to the almost 25 percent decline in gold prices. However, as the chart above shows, gold investors have found solace recently as gold ETF redemptions have ceased to be the main driver of gold prices. As reported previously, increased physical demand emanating mainly from China has been supportive of gold prices at the $1,300 per ounce level. Recent data shows physical demand remains at its strongest level with China importing an additional 109 tonnes of gold from Hong Kong during the month of September. At the current pace, Chinese imports would reach over 1,150 tonnes for 2013. Similarly, U.S. Mint American Gold Eagle coin sales recovered to 48,500 ounces in October, while gold sales from Australia’s Perth Mint climbed 13 percent to 77,255 ounces.
- HSBC Precious Metals analyst James Steel reports that despite the strengthening of the U.S. dollar on good macro news, commitments of traders’ data gathered by the CFTC showed a 2.46 million ounce increase in net long speculative positions in gold to 10.68 million ounces in the most recent report available. Silver net long speculative positions increased by 6.3 million ounces to 130.7 million ounces. For platinum, net long positions increased by 157,800 ounces to 1,689,800 ounces, while palladium net long positions increased by 85,100 ounces to 2,740,200 ounces.
- Randgold Resources’ third quarter profit increased by 80 percent quarter-on-quarter to $97.5 million, despite a 3 percent drop in the average gold price, owing to strong performance at its flagship Loulo-Gounkoto in Mali. Gold sales increased by 38 percent from that of the previous quarter driven by increased grades and recoveries. Gold Standard Ventures announced that the next two core holes drilled into the North Bullion deposit on its 100 percent controlled Railroad Project in Nevada’s Carlin Gold Trend have extended the mineralization to the north and east. These increase confidence that the North Bullion gold deposit represents a major Carlin-style discovery. Mandalay Resources announced impressive third quarter results this week. Worth highlighting are cash costs which decreased nearly a third to $696 per ounce from a year ago. In addition, throughput was ahead of 2014 expectations, which gave the company confidence to raise 2014 guidance.
- Ernst & Young’s report on third quarter merger and acquisition (M&A) activity shows a significant decline in value and volume transacted. According to the report, companies participating in the M&A sector are doing so mainly to take advantage of synergies to improve the bottom line, yet risk adversity is limiting the number of deals being made. Regardless, gold continues to be the sector with the largest number of deals, 55 in total. The big improvement in M&A activity was the rise of financial investors as main buyers of deals, highlighting that private capital has started to flow into the sector. Going forward, a recovery in gold stocks must be driven by interest from the generalist investors, who appear to be waiting on the sidelines until year end when impairment charges may hit balance sheets before they buy into the sector.
- A recent Pricewaterhouse Coopers (PwC) report on junior miners summed the carnage the sector has sustained in the recent past. Market caps in the junior space have fallen to $6.5 billion from $20 billion in 2011, while trading volumes have fallen to 38 billion from 79 billion over the same period. Despite the severity of the decline, the PwC report commends the resiliency of juniors, which surprised the authors.
- Detour Gold announced third quarter results this week to great disappointment, sending the stock down more than 18 percent. While analysts reported a much better than expected overall cost per tonne, the mill processed 3.88 million tonnes grading 0.72 grams per tonne gold during the quarter, a far cry from the expected 0.90+ grams per tonne. As a result, the company has lowered 2013 production guidance to a 250 thousand ounces midpoint, from the previous 270 thousand ounces. The outlook for 2014 was weak at a 470 thousand ounce midpoint, with analysts’ consensus above 500 thousand ounces.
- Despite the negative publicity in the junior sector, there is evidence that stock indices on the main exchanges where most juniors are listed have flattened off after months of steady downturns. Ernst & Young is of the opinion that junior mining indices are bottoming as positive press releases, new discoveries, and successful new financings provide floors for these stocks. But, according to Mineweb contributor Lawrence Williams, the most significant sign of bottoming is that private equity and small specialist funds are beginning to take a strong interest in the junior mining sector.
- The gold debate has crossed the line and turned argumentative according to Bullionvault research. Numerous high profile articles, most recently in the Wall Street Journal, argue that gold should be eliminated as part of your portfolio with the main argument being that it has decreased in price. The fact that price is front and center of the debate shows the misunderstanding of gold as a uniquely valuable asset. David Rosenberg agrees with this view in his commentary, where inflation has been diligently scrutinized. According to Rosenberg, there is little objection to the fact that housing and food inflation are a serious threat at the moment. Yet gold no longer makes the front pages of newspapers. Back in 2011 when gold rose to $1,900, investors were kicking themselves for having missed the bull run. Now, with gold around the $1,300 mark, gold has been relegated to “page B7 news.” When gold is on the front page you can count on all good news being priced in; when it is on page B7, which is reserved for unloved areas of the market, Rosenberg argues this itself is the most comforting news.
- Chinese appetite for gold will continue to be the key gold price driver in the months and years ahead. According to Mineweb, ever since China legalized private gold investment, demand has grown every year. The main rationale in China remains gold psyche as a store of wealth and inflation protector, especially as the Chinese middle class continues its extraordinary growth. But private investors are not the only sector accumulating gold in China; the People’s Bank of China has been clear in its objective to support the Chinese yuan in growing to the stature of an official reserve and settlement currency, which would be likely accelerated by a rapid accumulation of gold reserves.
- South Africa’s Parliament has delayed until next year the adoption of changes to its mineral law. Senior miners in the country have voiced their concern on the measures being considered as they will hurt business and discourage investment. Among the changes being proposed, the African nation will have the right to a free 20 percent stake in all ventures considered to be “compelling.” In addition, the government, through its Mines Minister, has the right to designate any mineral product for “local beneficiation” after considering “national development imperatives.” The lack of clarity, timeframe, and proper consultation with the affected enterprises is the greatest concern to the local mining industry.
- Allied Nevada released its third quarter results showing the lenders of its revolver credit facility amended, for the third time, the definition of the ratio covenants so that the company wouldn’t be in breach of covenants at the end of the third quarter. The company is currently working to renegotiate other covenants that are threatening to have it default both on the revolver and other senior note, term loan, and capital lease obligations. Michael Gray of Macquarie believes the company needs to secure $400 million in new financing between now and the second quarter of 2014.
- The U.S. derivatives regulator Commodities Futures Trading Commission (CFTC) has reintroduced a plan to set caps on the number of contracts held by a single trader. However, far from benefitting market participants and defeating speculative trading, the rules will benefit the largest market participants, such as Goldman Sachs and Barclays. For these type of participants, the maximum size of positions could rise dramatically rather than become tighter, in specific cases as much as tenfold. In addition, Commissioner Bart Chilton, a strong proponent of position limits, is set to leave the agency in the near future, leaving a power vacuum that will likely be filled by people akin to the largest market participants.
Energy and Natural Resources Market
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- Natural gas rose for a fourth day on speculation that colder temperatures will lift demand to heat homes and businesses. The price for December natural gas rose to $3.56 per Mmbtu, 1.4 percent above last week’s closing price.
- Steel and iron ore exports from Australia’s Port Headland (about 20 percent of global iron ore trade) to China hit a record high of 25.2m metric tons (10 percent above the prior month and 43 percent higher than a year ago) in October, according to data from Port Hedland Authority.
- The benchmark lumber price gained 2 percent this week to close at $375 per 1,000 board feet, and is up 10 percent quarter to date.
- Forbes reported that the American hydrocarbon energy boom is driving a massive resurgence in domestic manufacturing. The U.S. is the world’s fastest growing and now number one producer of oil and natural gas. The shale hydrocarbon revolution has already driven a 45 percent reduction in oil imports, contributed over $400 billion a year to the U.S. economy, and attracted nearly $200 billion in foreign direct investment in America over the past five years alone. And America is now a net exporter of refined hydrocarbons — manufactured gasoline and diesel – for the first time since 1949 and on track to become a net exporter of natural gas.
- China's October data saw a seasonal pullback in most commodity imports, as industrial activity took a breather during the Golden Week holiday. Imports will likely normalize into year end as industrial activity expands moderately.
- Latest numbers from the China Iron & Steel Association (CISA) show that average daily crude steel output in the last 11 days of October fell 0.43 percent from the preceding 10-day period to 2.098 million tonnes – the third consecutive decline. A likely contributing factor is that since mid-October margins for flat products have been negative.
- Latest U.S. auto sales numbers, important for palladium demand, show that the seasonally-adjusted annual selling rate (SAAR) of light vehicles (cars plus trucks) fell to 15.15 million units in October, from 15.21 million units in September. This is the weakest rate of sales since April.
- Manufacturing PMIs – a good and timely indicator of manufacturing output growth – showed an accelerating expansion in almost all key manufacturing countries or regions in October. This should be good for commodity demand, especially base metals
- Southern Copper submitted a key environmental study to develop the 120 thousand per annum Tia Maria copper project in Peru to the Mines and Energy Ministry. Work at Tia Maria was suspended in 2011 after violent protests by local residents. The company’s CEO expects work to resume in early 2014 with first production in 2016.
- Demand for OPEC crude could fall by a million barrels per day within five years, as North American tight oil chips away at the group’s influence on global markets. OPEC, which has long dismissed North America’s tight oil production surge as marginal, said in its annual report Thursday that shale’s impact could be “significant,” and the combination of production from North America and other rivals would reduce demand for OPEC crude to 29.2 million barrels per day in 2018, compared to 30.3 million barrels per day today. “The strong rise in tight oil supply in the U.S. – and to some extent Canada, which accounts for a little under 10 percent of OECD America tight oil supply – is expected to dominate the medium-term non-OPEC supply volume increases,” the group said in its report. Last year’s OPEC annual report said that “shale oil should not be viewed as anything more than a source of margi nal additions.”
- The South African parliament deferred mineral law changes to next year. The proposed changes to the 2002 Mineral and Petroleum Resources Development Act include giving the state the right to a free 20 percent stake in all new energy ventures as well as compelling some mining companies to sell part of their output to local processors.
- Poland left its main interest rate unchanged at a record low to spur a quicker recovery in the largest Eastern European economy. Central Bank Governor Belka said the central bank is considering extending the period of record low rates into 2014 after inflation slowed to 1 percent in September. Price increases have stayed below the central bank’s 2.5 percent target throughout 2013.
- Capital Economics is of the opinion that October’s Manufacturing PMIs for Emerging Europe provide further evidence that the region’s recovery continued at the start of the fourth quarter. The Czech PMI is now consistent with manufacturing production, rising by around 2.5 percent from last quarter. The general picture is one of gradual improvement in the region and suggests that the recent recovery in Central Europe is in full swing.
- Despite an unexpected fall in Taiwan exports last month, the island nation’s trade surplus rose to $3.52 billion from $2.53 billion in September, also beating the analyst forecast for a $3.23 billion surplus. The 1.5 percent decline in exports was offset by a 2 percent increase in export orders during the month.
- China October exports were up 5.6 percent versus the 1.7 percent market consensus and -1.5 percent for September. Improving global PMI clearly had a positive impact on China’s exports, particularly exports to Europe rising 12.7 percent. Exports to the developed markets were better than to emerging markets since those markets are in the normalization stage as the economies are coming down from high growth rates in the last decade. China October imports also beat expectations by rising 7.6 percent versus the market consensus of 7.4 percent.
- As of November 7, 177 overseas-listed Chinese companies had reported their third quarter results. The total earnings of those companies grew 18 percent year-over-year in the quarter, up from 12 percent in the first half. So far, more than 2,400 A-share companies have also reported. The total earnings of those companies rose 21 percent in the third quarter up from 12 percent in the first half and 5 percent in 2012, according to Deutsche Bank Asia equity research group.
- China’s PMI for the non-manufacturing sector hit 56.3 percent in October, its highest level this year and up 90 basis points from 55.4 percent in September, indicating strong activities in tourism and consumer services.
- Political turmoil may be averted in Thailand after the amnesty bill failed to pass the parliament and the senate speaker promised to vote down the bill as well. Thailand Prime Minister Yingluck also softened her stand as the lower house wouldn’t resubmit the bill, though the issue will exist. Also in Thailand, the disinflation cycle ended as October headline inflation and core CPI edged up to 1.46 and 0.71 percent, respectively.
- Russian inflation unexpectedly accelerated in October, strengthening the case for the central bank to refrain from cutting borrowing costs. The cost of living rose 6.3 percent from a year earlier, leaving it above the central bank’s target range for a fourteenth straight month. The central bank has kept interest rates unchanged since September 2012 even as the economy faces its worst slowdown in four years.
- The Brazilian real fell the most among emerging-market currencies on concern Brazil is not doing enough to curb its budget deficit. The government reported that the budget deficit increased in September to 3.3 percent of gross domestic product, the largest in four years, prompting plans by the government to eliminate tax breaks to shore up public finances.
- Stock markets in China, Hong Kong, Korea, Taiwan, and Association of Southeast Asian Nations (ASEAN) countries fell for five consecutive days this week as investors took profits after the summer’s market rallies. This decline was in spite of improving industrial activities globally and recovery in Europe and the U.S.
- The four biggest Chinese banks lent Rmb182 billion in October, the lowest monthly new loans in the year. The declining new loans are primarily due to decreases in interbank transactions in an effort to deleverage the financial system exposure in non-standardized wealth management products.
- Malaysia left its policy rate unchanged at 3 percent, fearing creeping inflation driven by domestic cost factors.
- Taiwan headline inflation moderated to 0.64 percent in October from 0.84 percent in September, surprising the market on the downside.
- To ease pollution and traffic jams, Beijing will reduce the number of new passenger vehicles allowed on the road by 38 percent next year.
- Indonesia GDP growth moderated to 5.6 percent in the third quarter from 5.8 percent in the second quarter this year after the trade deficit and currency depreciation affected domestic consumption and investments.
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- A BCA Research commentary shows investor sentiment towards the eurozone continues to improve, which has helped a recovery in equity prices. In BCA’s opinion, much of the optimism is warranted, as the eurozone continues to benefit from Mario Draghi’s “whatever it takes” pledge, improved export competitiveness in the periphery, and growing pent-up demand for capital expenditures and consumer durable purchases. Despite the progress, European stocks still appear to be discounting a more pessimistic outlook than is warranted. The chart above shows that European stocks currently trade at a Shiller P/E of 13x, compared with 24x in the U.S. Although U.S. stocks have historically traded at a premium to their European counterparts, the current valuation gap is close to a historic high.
- Over the last couple of days, there have been increasing reports on plans to expedite the re-privatization of Greek banks from the Hellenic Financial Stability Fund (HFSF). The idea would be to have the HFSF make a public offer for the outstanding warrants in exchange for the common shares of the banks currently held by the HFSF. Warrant holders, largely hedge funds and other private financial institutions, could see a lift in the value of their holdings as it is expected the HFSF will provide a sweetener for investors to convert into common shares ahead of expiration. Similarly, the HFSF would benefit from disinvesting assets acquired during the peak of the crisis.
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- As shown in the chart above, there is plenty of room for China's service sector to catch up with the percentage of the service sector of national GDP in developing countries. China October non-manufacturing PMI was reaching a yearly high at 56.3, showing robust expansion. The Chinese government policies now are making it possible for private capital to enter service sectors such as banking, social services, and insurance. Among service sectors, tourism and e-commerce are the fastest growing sectors in China, which are dominated by private entrepreneurs.
- The European Commission has lowered its 2014 eurozone economic growth forecast to 1.1 percent, as it expects unemployment to remain high at 12.2 percent. The Commission also highlighted that it estimated the eurozone's economy will contract 0.4 percent this year following a decline of 0.7 percent in 2012. The Commission anticipates that the majority of core countries will gain momentum in 2014; however it warned that Spain, Greece, Italy and Portugal likely will continue to experience much weaker growth.
- Brazil Finance Minister Mantega announced the country’s plan to reduce lending by its development bank BNDES by about 20 percent next year. The plan is being implemented to shore up the country’s finances after posting the biggest budget deficit in almost four years, which some analysts believe could lead to a credit rating cut. BNDES, whose loan portfolio is larger than the World Bank’s, is responsible for more than half the credit creation in Brazil. A 20 percent credit reduction would imply a minimum 10 percent decrease in overall loan growth and would threaten the nation’s recovery prospects at a time of sluggish economic growth.
- Municipality governments in Beijing, Shanghai, and Shenzhen had announced tighter housing market rules by raising the down payment to 70 percent from 60 percent for second home buyers after rapid housing price appreciation in those first tier cities. The move, which may not be able to dampen housing prices and sales, has weakened stock prices of developers in the last three weeks
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