Dressed to the Nines with Gold

By Frank Holmes

CEO and Chief Investment Officer

U.S. Global Investors

While paper gold is getting the cold shoulder in the West, the Love Trade buyers in the East are wrapping their arms around all the physical gold they can get their hands on.

In the third quarter, gold jewelry demand was at the highest level since 2010. Buying out of love in the East was significantly higher during the first nine months of the year compared to demand the same time last year, according to the World Gold Council (WGC). As the chart shows, buyers in Hong Kong and China went on a shopping spree for gold jewelry, as demand rose 40 percent and 35 percent, respectively, on a year-to-date basis in 2013 compared to the same period last year.

Asia Clamors for Gold Jewelry

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Another way to look at the strong demand coming from the East is to compare it to Western demand. As you can see below, so far in 2013, the East purchased 5 times more gold bars, coins and jewelry than the West. Together, Chindia purchased a whopping 1,500 tonnes in physical gold in nine months.

Gold Demand 5 Times Stronger in the East

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It's important to note that despite the government's efforts to stop Indians from buying gold, jewelry demand in India was still about 12 percent higher in the first nine months of 2013 compared to same time frame last year. The buying continued despite the fact that premiums were above the international price of gold.

Indian gold demand did weaken in the third quarter, as consumers were discouraged from loading up on the yellow metal through official channels. Residents faced a depreciation of the rupee, the tight restrictions, and confusing regulation, as gold bullion imports were tied to a fixed level of exports, says the WGC.

An emphasis should be placed on gold demand recorded by “official channels," as “gold entering the country unofficially through India's porous borders helped to meet pent-up demand," according to the WGC.

While traveling in India, I'm anticipating that I'll gain tacit knowledge on this topic. I'm eager to learn how locals think the government will contain its current account deficit that has weighed on the economy. It seems the slowdown in GDP per capita has created a short-term setback for gold, but when the economy picks up, there should be ready buyers lined up outside the gold shops.

Dressed to the Nines in Gold

What's interesting about gold demand today is that more and more investors around the world are buying higher-end, more expensive gold. Specifically in China, 24-karat gold jewelry and ‘four nines' gold gained market share in the third quarter, says the WGC.

‘Four nines' is named for the almost pure gold content of 99.99 percent; in comparison, 24-carat jewelry has a purity of 99.95 percent. According to the WGC, ‘four nines' gold is “unique to China and has proved to be most popular with consumers in lower tier markets and rural areas, again reflecting the investment qualities offered by such jewelry," says the WGC.

I point this out because investors should take note of the emerging trend for luxury goods as a result of growing incomes in emerging markets around the world.

Take the buying of high-end products such as Chanel and Louis Vuitton bags, Rolex watches, and Chow Tai Fook jewelry in China, for example. From 2009 to 2012, the luxury-goods sector grew by 41 percent, due primarily to “lavish spending by rich Chinese and aggressive gift giving," according to research from CLSA. Looking over the next five years from 2013 though 2018, the middle class in China will increasingly be participating in this boom, as “income levels pass critical inflection points for spending on luxury items," says CLSA.

Jewelry is only one of many luxury items that has been seeing significant growth year after year. CLSA finds that from 2009 to 2012, jewelry sales increased 115 percent in Hong Kong and 172 percent in China.

Rising Jewelry Retail Sales in Hong Kong and China

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So even as hearts beat fast for gold in the East, the yellow metal continued to lose its luster in the West. According to Bloomberg's precious metal mining team, gold ETF holdings have fallen nearly 30 percent since the all-time peak earlier this year. It's no surprise that the selling has been a big contributor to the decline in gold prices in 2013.

The good news is that gold ETF redemptions are no longer the main driver of gold prices. You can see below how the selling out of gold ETFs holdings has been slowing, but the metal has not followed the same path. Instead, gold has moved sideways over the past few months, with the price “supported at about $1,200 to $1,300 an ounce," says Bloomberg. We believe this shift provides an opportune time to buy, especially with the tremendous physical demand continuing to emanate from the East.

Gold Price Stabilizes While Gold ETF Selling Continues

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Earlier this week, The Wall Street Journal asked several “gold enthusiasts" and me about our case for gold investing. Reporter Lindsay Gellman highlighted many of gold's important attributes, including inflation protection and diversification, and discussed one of the most important points I often make about gold: Make sure you allocate only 5 to 10 percent of your portfolio to gold and gold stocks, and have the discipline to take profits.

You can read the article here.

Europe is on the road to recovery. Are your investments positioned to benefit?

Index Summary

  • Major market indices finished higher this week. The Dow Jones Industrial Average rose 1.27 percent. The S&P 500 Stock Index gained 1.56 percent, while the Nasdaq Composite advanced 1.70 percent. The Russell 2000 small capitalization index rose 1.48 percent this week.
  • The Hang Seng Composite rose 1.27 percent; Taiwan declined 0.64 percent while the KOSPI gained 1.05 percent.
  • The 10-year Treasury bond yield fell 4 basis points this week to 2.71 percent.

Domestic Equity Market

The S&P 500 rose again this week hitting the highest levels this year. The market rally was broad based with every sector posting gains for the week. All eyes were focused on Federal Reserve Chairman nominee, Janet Yellen who at her senate confirmation hearing reiterated her dovish outlook for monetary policy, which should continue to be a tailwind for equities.

S&P 500 Economic Sectors

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Strengths

  • The consumer discretion sector was the best performer this week led by retailers and home builders. Macy’s reported and beat expectations sending the stock up roughly 10 percent for the week. JC Penney also rose roughly 10 percent for the week as the stock continues to climb after a sharp sell off earlier in September and October. Homebuilding stocks also rose as DR Horton reported better than expected earnings results.
  • The healthcare sector was also strong this week in a broad based rally. Outperformers included Forest Labs, Allergan and Actavis.
  • Iron Mountain was the best performer in the S&P 500 this week rising 12 percent. The company’s attempt to convert to a Real Estate Investment Trust (REIT) structure is getting closer and the IRS could render a decision as soon as the end of the year.

Weaknesses

  • The telecom services and utilities sectors were the worst performing groups this week but still rose for the week as defensive areas of the market just couldn’t keep up.
  • The market exhibited broad based strength this week but areas of weakness included coal, agricultural products and steel.
  • Denbury Resources was the worst performer in the S&P 500 this week, falling 8.84 percent. The oil and gas exploration company fell after revising its corporate strategy and announcing slower growth expectations.

Opportunities

  • 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.

Threats

  • 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 potentially large.
  • The debt ceiling and government shutdown has passed but the economic fallout will likely be felt over the next weeks and months as it negatively affects upcoming economic data releases.

The Economy and Bond Market

Treasury bond yields fell by a few basis points this week as Janet Yellen’s Senate confirmation hearing turned out to be largely a non-event as she stuck to her dovish roots. Economic data was mixed at best. This was true both domestically and abroad.

10-Year Treasury Yields

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Strengths

  • Chinese economic data continued to show year-over-year strength in October with industrial production rising 10.3 percent and retail sales rising 13.3 percent.
  • Japanese GDP rose 0.5 percent in the third quarter, which was better than expected and a fourth straight quarterly increase.
  • Fed Chairman nominee Janet Yellen reiterated her stance for accommodative monetary policy for the foreseeable future.

Weaknesses

  • The housing market continues to have challenges with housing affordability dropping to nine year lows on higher interest rates and rising home prices. On a related note, mortgage applications fell 1.8 percent in the most recently reported week.
  • Small business optimism fell sharply in October with many citing Washington as the problem.
  • Eurozone GDP grew a disappointing 0.1 percent in the third quarter.

Opportunities

  • 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. An ECB policy maker commented this week that the ECB could adopt negative interest rates or quantitative easing to lift inflation.
  • There remain many moving parts to the taper decision and it is very possible that tapering could be delayed well into 2014.

Threats

  • 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.

Gold Market

For the week, spot gold closed at $1,290.20, up $1.60 per ounce, or 0.12 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, fell 0.34 percent. The U.S. Trade-Weighted Dollar Index lost 0.61 percent for the week.

Strengths

  • Gold rose on Thursday after Federal Reserve Chairman nominee Janet Yellen spoke in testimony before the Senate. Yellen commented that the economy and labor market are performing far below their potential and pointed that large improvements must be made before the Fed reduces its unconventional asset purchase stimulus. The continuation of ultra accommodative monetary policies, together with Yellen’s dovish tone, is viewed as supportive of gold prices.
  • Last week saw more action in the Comex warehouses, with a net gain in gold inventories for the week. However, registered gold stocks hit a new all-time low at a little under 639,000 ounces. The ratio of registered Comex gold inventory also hit a new low, reiterating the impending physical delivery shortage. In China, demand volumes for cash gold on the Shanghai Gold Exchange climbed to a one-month high this week, leading traders to cover some their short positions early in the week. In addition, the U.S. Mint sold 764,500 ounces of American Eagle coins as of November 8, compared with 753,000 ounces in all of 2012, according to data on the mint’s website.
  • Platinum Group Metals reported assay results from drilling on the Waterberg extension property, delivering better than estimated results. The holes intercepted Super F (3 to 5 meters wide) mineralization grade and average true thickness of 11 meters. Grades of 3.03 grams per tonne platinum, palladium and gold were recorded over 10.5 meters. According to Leon Esterhuizen of CIBC, the value added through drill bi at present is enormous and will attract attention from bigger players in the space. Klondex Mines announced that Barry Dahl has been appointed Chief Financial Officer effective Friday November 15. Dahl comes from Argonaut where he acted as CFO for the last four years. Prior to Argonaut, Dhal served at two successful ventures which include Andean Resources, sold to Goldcorp, and Meridian Gold, acquired by Yamana Gold.

Weaknesses

  • Barrick Gold’s recently announced $3 billion bought deal equity raise did not go all too smoothly. Reports of one-third of the deal being hung, rapidly circulated through both buy and sell-side traders. Part of the relief may have come from an unexpected announcement by the Company revealing that Peter Munk, founder and co-chairman of Barrick’s Board of Directors, intends to retire by the Company’s annual general meeting next spring. Investors have been critical of Munk over his most recent actions, which included the purchase of Equinox Minerals, eventually written down by $4 billion, as well as the granting of an excessive signing bonus for a new member of the board.
  • Hedge funds cut bullish gold bets late last week, adding the most short contracts in four weeks, as U.S. economic growth fuels speculation that the Fed will trim stimulus. Gold’s negative price reaction to the possibility of a December Fed tapering indicates that the bullion market is likely to remain sensitive to expectations for changes in monetary policy, according to Howard Wen of HSBC. Short bets jumped 37 percent, the most since October 15.
  • Ed Yardeni, in his daily commentary this week, thinks that there are lots of grey shades in the latest batch of global economic indicators as well as in the stock market’s reaction to them. For one, U.S. GDP growth isn’t “red hot” as initially believed. When excluding inventory build-ups, real final sales in GDP increased by only 2.0 percent, shy of the headline 2.8 percent. Yardeni adds that real final sales to domestic purchasers rose just 1.7 percent, following a gain of 2.1 percent during the second quarter. All that glitters is not gold, as they say.

Opportunities

  • Bloomberg published a brief exhibit this week highlighting that China’s buying and holding of gold has increased contango to $134 per ounce on the five-year futures contract, from $94 over the course of six months. This is because the gold moved from London gold ETP liquidations to China during 2013 may no longer be available should ETP demand return. China has been the world's largest buyer of gold this year, and it is widely known that gold going into China is not expected to hit the international market again. This is due to the country’s view of gold as a long-term investment, leading traders to increase contango as a result.

Gold Contango Steepens Sharply on Supply Concerns

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  • In regard to China’s physical demand, a gold vault capable of storing 2,000 metric tonnes, or twice the amount of China’s expected demand this year, opened in Shanghai and is seeking to benefit from rising physical demand in Asia’s largest economy. The facility is a massive vote of confidence for the Chinese gold market, according to Philip Klapwijk of Precious Metals Insights. In addition, recent World Gold Council data shows that China’s demand for gold jewelry, bars and coins rose 30 percent, while gold usage in India rose 24 percent, adding that the bulk of year-to-date growth in consumer demand came from eastern markets. Both Klapwijk and two Bloomberg research analysts have come to the conclusion that the People’s Bank of China (PBOC) has taken 300 tonnes of gold into reserves in the first half of the year, just under 15 percent of global supply. The key highlight of the report is that the co nclusion was reached independently. At such a massive rate of accumulation, China could match or even surpass U.S. gold reserves within the next 10 years.
  • In his Friday commentary, David Rosenberg of Gluskin Sheff gave his take on Yellen’s Senate testimony. According to Rosenberg, Yellen not only pointed towards endless quantitative easing (QE), she also indicated that the Fed will consider lowering the meager 0.25 percent it pays for bank deposits to kick start a more vigorous credit cycle; the era of free money is alive and well, he asserted. The result of Yellen’s nomination, and impending ratification, is that liquidity will remain friendly and will fuel risk appetite for the foreseeable future, implying that investors will be punished for at least another five years of decay, if they are overweight cash underneath Yellen’s mandate. In essence, Rosenberg summarizes to borrow short and lend long and start going long hard assets since we will come out of the other side with inflation.

Threats

  • Despite an expected solid underpinning from industrial demand for silver prices, the possibility of the Fed tapering its stimulus, along with the resulting weakness in gold, should send silver tumbling, according to Thomson Reuters. Thomson Reuters’ analysts add that the rising physical demand for the metal will not be enough to sustain prices when faced with the unwinding of the massive U.S. government QE program, and the stronger U.S. dollar. Despite this opinion, it is necessary to highlight that the 2011 record of 39.869 million American Silver Eagle bullion coin sales was shattered this Tuesday as the U.S. Mint revealed sales of 40.175 million coins sold so far this year.
  • Colossus Minerals provided a corporate, operational and financial update this week. In the update, the company announced that underground water problems remain persistent and that targeted initial production had to be pushed out to the second quarter of 2014 from year-end. As a result, multiple directors have resigned and the company’s financial condition continues to weaken. The combination of ongoing technical and financial issues, along with questions regarding its ability to source additional capital, have led analysts to believe that the risks of investing in Colossus Minerals exceeds the potential rewards during this time. Despite completing a $38 million financing on August 13, Colossus ended the third quarter of this year with just $19 million in cash and negative working capital. According to Joseph Fazzini of Dundee Capital Markets, the $19 million in capital are deemed to be an insufficient amount to resolve the c ompany’s technical issues and finance the company through to a production stage.
  • Turquoise Hill Resources Ltd announced its plan of a rights offering of up to $2.4 billion, due to the uncertainty regarding the timing of when permits will be awarded by the Mongolian government. The remaining issues to be finalized in the ongoing discussions between Rio Tinto and the Government of Mongolia pertain mainly to the sharing of economic value of the project and the clarification over initial capital expenditure. The Memorandum of Agreement stipulates that in the event that Oyu Tolgoi project financing funds are not available to repair $2.4 billion in commitments by year end, Turquoise Hill will be forced to launch a rights offering. The exercise will be highly dilutive on a per share basis.

Energy and Natural Resources Market

Strong Performance Expected for Commodity-Related Stocks

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Strengths

  • U.S. oil production surged last week to its highest level since January 1989, almost 25 years ago. Compared to a year ago, U.S. oil production during the first week of November increased by almost 19 percent. In the last two years, U.S. oil production has risen by 2 million barrels and to put this in perspective, Brazil produced 2.1 million barrels per day in June and Nigeria/Venezuela both produced 2.3 million barrels per day in June.
  • World Steel Dynamics released its latest SteelBenchmarker assessment, which highlights a steady upward trend in steel prices. At $734 per tonne, the U.S. domestic hot-rolled-coil assessment is now almost $100 per ton above the lows seen in May 2013, and is at the highest level since May 2012.

Weaknesses

  • West Texas Intermediate crude posted its sixth weekly decline, the longest in 15 years, as rising supplies in the U.S. countered speculation the Federal Reserve will maintain economic stimulus.
  • China's overseas mining investments have slowed after experiencing a rapid period of growth earlier this year, with investors from non-mining sectors being advised to be cautious when investing in the area, reports Shanghai's Oriental Morning Post. At the 2013 China Mining Congress and Exhibition held in Tianjin on November 2, China Mining Association (CMA) vice chairman Wang Jiahua revealed that approximately 80 percent of China's overseas mining investments have failed. Investors in China are also slowing down the pace of their investments in the overseas mining sector amid changing preferences for a particular kind of mine and location, the paper said. "China's mining investment in Australia during the first half of the year dropped to its lowest point in history," said Wang in the days leading up to the expo, adding that the two sides need to find out the reasons and seek effective ways to revive the China-Australia cooperation in the mining sector.

Opportunities

  • Refiner Johnson Matthey in its Platinum 2013 Interim Review indicated that the platinum market was expected to show a shortfall of 605,000 ounces this year from 340,000 ounces last year. The company expects palladium will be in a deficit of 740,000 ounces this year.
  • The International Energy Agency (IEA) is forecasting higher oil prices for 2014 despite increased non-OPEC production as the IEA cited continued supply losses from the Middle East as well as Northern Africa as catalysts for increased prices.
  • Eastman Chemical is converting some of its power generation units from coal to natural gas beginning in 2016. This fuel switching will reduce demand by 850,000 tons per year of Central Appalachian coal.
  • China, the world’s top producer of wheat, is likely to import 8 million tonnes of the grain in 2013/14, the highest in nearly two decades, after the domestic harvest was damaged by bad weather, said an official think tank.

Threats

  • A 90-car train carrying North Dakota crude derailed and exploded in a rural area of western Alabama early on Friday, leaving 11 cars burning and potentially bolstering the push for tougher regulation of a boom in moving oil by rail. Twenty of the train’s cars derailed and a number were still on fire on Friday afternoon, local officials said. Those cars, which threw flames 100 meters into the night sky, are being left to burn out, which could take up to 24 hours, according to the train owner, Genesee & Wyoming. No injuries were reported. A local official said the crude oil had originated in the booming Bakken shale patch.
  • Platts reported that U.S. manufacturers are requesting that the Department of Energy postpone new liquid natural gas (LNG) exports rulings until the agency develops legal standards on the application approval process
  • Eight power plants fired by coal in Alabama and Kentucky will be closed, although the exact timetable for the closings was not provided by the Tennessee Valley Authority (TVA). The TVA said it would invest about $1 billion to construct a new natural gas-fired plant in Kentucky to partly replace lost electric power output. The action, announced on Thursday, added to the number of closings previously announced and which are part of a comprehensive understanding between the TVA and the Environmental Protection Agency (EPA) to cut 18 of 59 coal plants. The new announcement increases the number of closures to 26 plants.

Emerging Markets

Strengths

  • Romanian GDP is growing at the fastest pace in two years, with third quarter GDP posting a 4.1 percent increase year-over-year, shattering forecasts of a 3.5 percent expansion. Hungary joined the club of nations that are beating economic growth forecasts with its GDP accelerating to 1.7 percent in the third quarter from a year earlier, more than the 0.8 percent forecast. Poland’s GDP grew 1.9 percent, also beating estimates. A strong rebound in agricultural production was the main driver behind the sharp pickup in third quarter economic growth.
  • South Africa halved its trade deficit for the first nine months of 2013 after revising the data to include exports and imports from a customs union with neighboring Botswana, Lesotho, Namibia and Swaziland. The trade deficit was lowered to $6.3 billion, helping the South African rand climb about 1 percent to 10.18 against the dollar. The report is relieving to the currency of Africa’s largest economy, which has come under strain this year falling 17 percent against the dollar.
  • China’s third plenary session closed this week with a strong declaration to reform the economic and political system in order to transform the structural growth drivers and improve the lives of the people. Although the communiqué usually doesn’t provide detail other than headline statements, the nuances are slowly disclosed which should be positive for the stock market. China Xinghua News reported this morning that China vowed to allow private investments in state sectors and that the one-child policy is changing to a two-child policy, which was not provided in the communiqué. The significance of the reform policies is that if implemented, China will move up to another level both economically and socially.
  • China’s money supply (M2) growth was 14.3 percent in October versus 14.2 percent for consensus and in September. Fixed asset investments grew 19.2 percent, slightly below 20.2 percent in September. Retail sales growth was 13.3 percent versus the market consensus of 13.4 percent and 13.3 percent in September. China’s October consumer price index (CPI) was 3.2 percent, slightly above 3.1 percent in September, but lower than the market consensus of 3.3 percent. China’s producer price index (PPI) was down 1.5 percent in October. Industrial production was up 10.3 percent, better than the market consensus of both 10.1 percent and 10.2 percent in September. Exports were up 5.6 percent versus being down 0.3 percent in September, while imports were up 7 percent. The macro data from China showed strong economic growth.
  • Malaysia’s third quarter GDP was a surprise on the upside at 5.0 percent year-over-year, as net export contribution turns positive. This was above the 4.7 percent consensus. The current account surplus rebounded to 9.8 billion ringgit (RM9.8bn) or 4 percent of GDP versus RM2.6bn and 1.1 percent of GDP for the second quarter. The improvement was led by the widening of the goods surplus to RM25.7bn, with a sharper rebound in exports versus imports. Better domestic demand was reflected in a wider services deficit of RM4.3bn in the third quarter versus RM3.7bn in the prior quarter.
  • Indonesia’s current account deficit narrowed to $8.4 billion in the third quarter or 3.8 percent of GDP, down from $9.9 billion in the second quarter. Foreign direct investment (FDI) was also relatively strong at $5.4 billion. The country needs continued improvement to lift up the basic balance. This way, Indonesia can arrive at a comfortable level for the currency to stabilize. Bank of Indonesia, the central bank, raised its benchmark rate by 25 basis points (bps) to help defend its currency.
  • The Bank of Korea, the central bank, left the policy rate unchanged as expected at 2.5 percent in November. The central bank cut the rate once this year in May by 25 bps. For the second month, Korea’s jobless rate stayed at 3 percent in October.
  • The Philippines’ manufacturing index went up 16.2 percent in September. However, this week the Haiyan typhoon was an enormous disaster for lives and property within the area.

Weaknesses

  • Renewed concerns about the Federal Reserve quantitative easing (QE) tapering happening sooner rather than later, induced a broad sell-off across emerging market funds and related assets. According to a recent HSBC research report, the stronger U.S. dollar, together with market expectations about a more hawkish outlook on emerging market monetary policy are driving equity investors’ fund flows toward developed markets. As a result, outflows from emerging market equity funds reaccelerated.

Equity Fund Flows: Emerging Markets vs Developed Markets

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  • The economy of the Czech Republic unexpectedly shrank 1.6 percent in the third quarter, reinforcing central bank concerns about deflation that prompted policy makers to start currency interventions. Central Europe’s economy is struggling to gain traction after a record-long recession, leading the central bank to begin Czech koruna sales to dissuade consumers from deferring purchases and to improve exporters’ competitiveness.
  • In October, China’s total social financing was Rmb 856.4 billion, down Rmb 574.8 billion in September due to decreases in interbank lending, trust loans and the issuance of wealth management products. New bank loans were Rmb 506.1 billion, down Rmb 280.9 billion month-over-month due to a loan-deposit ratio (LDR) limit and credit quota. China property starts slumped to -3.4 percent year-over-year in October from 41 percent in September. Growth in floor sales slowed to 12.1 percent from 22.8 percent in September, and real estate investment growth also slowed to 15 percent versus 22.3 percent in September.
  • Singapore’s September retail sales declined 5.9 percent year-over-year versus -7.7 percent in August, which is worse than consensus of -4.4 percent. In real terms, retail sales fell a smaller 3.4 percent.
  • Third quarter GDP in Hong Kong expanded 2.9 percent year-over-year and grew 0.5 percent from the prior quarter. This shows that the economy is slowly growing, although the reading is lower than the market consensus of 3.2 percent.
  • Industrial production in Malaysia was up 1 percent in September, lower than 2.7 percent in August and lower than the market consensus of 2.5 percent.

Opportunities

Valuations in China are Subdued

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  • As shown in the chart above, China stocks, represented here by the MCSI China index, are currently priced at historically low price to earnings (PE) multiples. Industrial companies have seen about 21 percent earnings growth as reported in the third quarter earnings release. Particularly after China’s third plenary meeting, policy details on reform will be a catalyst for companies that benefit from deregulations and urbanization.
  • Inflation in the eurozone fell further below the ECB’s target of 2 percent, slowing to an expected 0.7 percent in October from 1.1 percent in September. This decline in inflation allows the ECB greater flexibility to cut interest rates further, following the surprise reduction last week of the benchmark rate to 0.25 percent.
  • Finland, the Nordic eurozone member, is now pegging its trade-led recovery on Russia. The former Soviet nation has once again emerged as a destination for the Nordic nation’s exports and a source of imports. Finnish exports to Russia have grown 143 percent in the past decade, while direct investments rose eightfold to $4.3 billion, according to the Bank of Finland. The statistics underpin the importance and the growing role of Central European and Eastern European nations in the trade dynamics of developed Europe. They provide a blueprint for smaller nations in the region to profit from better commercial agreements with Western Europe.

Threats

  • Indian stocks declined to a five-week low after consumer prices rose to 10.09 percent in October, missing forecasts. Similarly, industrial production grew 2 percent missing estimates of a 3.5 percent increase. The acceleration in inflation adds pressure on India’s central bank governor Raghuram Rajan to raise interest rates; however, the lackluster economic growth evidenced by the recent industrial production numbers may force the central bank to defer any tightening monetary action going forward.
  • The Indonesian rupiah dropped about 7 percent in the last two weeks versus the U.S. dollar due to continued current account deficit and the prospect of U.S. Federal Reserve tapering next year. In spite of correcting 17 percent from the peak in the year, the Jakarta Composite Index is still at price to earnings (PE) multiples of 18.6x, which may deter investors from embracing the market in the short term.
  • OAO Mechel, Russia’s largest coking coal producer, sank on the news that it is holding talks with banks about restructuring debt. Mechel, which has delayed publication of its first-half financial report, possibly to avoid a technical default, is one of Russia’s most indebted mining companies, with net debt of $9.55 billion. The situation could renew speculation on the high levels of corporate leverage in Russian large capitalization stocks, and may result in increases to the required rates of return on Russian corporate debt.
  • Tinkoff Credit Systems TCS, a Russian online banking service platform fell over 40 percent on Friday following a news article which cited a Senator’s proposal to ban the online sale of credit cards. The issue appears to be the proper identification of customers along with the avoidance of fraud; however, TCS has implemented a system to properly identify the customer by passport upon courier delivery. The theory of analysts is that the policy seeks to protect traditional lenders by preventing credit growth outside conventional channels, as well as acting as a means to curtail retail purchase growth that is keeping inflation above the central bank’s target rate.

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