The Good, the Bad and the Opportunity
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
The press is demanding the attention of investors more than ever. Whether it was last week’s jobs report or this week’s testimony from Janet Yellen, sorting through the market noise is no easy task. Since the world is so interconnected from Facebook to WhatsApp, a spark of news can ignite unfounded fear in an instant. What’s truly significant when it comes to your investments?
Twice a day, in the morning and at lunch, our investment team sits down together to discuss what’s important and what’s immaterial. This past week, in my opinion, the good outweighed the bad. Much of the economic news was a direct result of government policies, both fiscal and monetary. Here are my findings, which I hope will help you filter through the noise.
What are the challenges?
1. As you probably know by now, the Global Purchasing Managers' Index (PMI) is one of the key metrics we pay attention to as a gauge of the global economy's strength. In April, the Global PMI fell from 52.1 to 52.0, and though the drop was small, investors who previously were encouraged by a synchronized growth cycle, lost some confidence. Japan's services and manufacturing PMI readings dropped precipitously. The services PMI plunged to 46.4 in April and the manufacturing PMI fell to 49.4. Both numbers were above the 50 mark in the previous month.
The reason for Japan’s slump lies in the consumption tax rate hike, from 5 percent to 8 percent, imposed on the country on April 1. The tax increase was aimed at decreasing the country’s huge public debt, nearly 245 percent of GDP. Just when Japan was finding its economic foothold for recovery, the restrictive fiscal policy caused economic activity to stumble.
Why it matters: The reason for the fall in Global PMI is directly related to Japan’s fall in PMI. Japan has become a drag on global growth. It’s important to recognize the root cause – increased taxes just as monetary stimulus measures were seeing results. This is not good for economic growth and should serve as a cautionary tale for other countries.
2. Another challenging area of the market is China. China’s manufacturing PMI came in lower at 48.1 in April, contracting for the fourth month in a row, and the country also saw a decline of 0.3 percent in its consumer price index (CPI). Employment in the Asian nation is also at a seven-month low, adding growth concerns for the country.
Why it matters: This negative data means there is potential for fiscal policy easing, allowing China to boost the economy in the coming months.
Focus on the strong points.
1. The rate of change of global industrial production (IP) was slowing until the close of 2013. Now, however, the global growth outlook is improving. You can see that an inflection point was hit in mid-2013, reaccelerating IP and coinciding with the global GDP outlook for 2014.
Europe is also doing well. The eurozone composite PMI, a good indication of growth, rose to 54.0 in April. In addition, Spain and the U.K. saw increases in GDP in the first quarter and Spanish banks are seeing a decline in bad debts.
Why it matters: When global IP moves up, this is a sign that momentum in the global economy has changed – for the better. This is good for commodities such as oil, gas and copper, but also for cyclical areas like energy and industrials. There is no doubt that people in every country want upward mobility for their families, and as the demand for better education, cars, etc. continues, commodities and cyclicals should benefit.
2. In a recent report, ISI also highlights that minimum wages are going up in the U.S., citing examples of multi-year wage increases for those who had not received pay increases for the last several years. Various groups who received no increase before will now see a 4 percent rise per year, a leading indicator of wage growth trends. Consumer net worth is also expected to rise by $7.1 trillion in the second quarter, taking it to $82.5 trillion.
Why it matters: Real incomes are expected to rise as wage increases outpace inflation. With the uptick in consumer net worth and steady job growth, consumers will feel more comfortable spending.
3. Bank loans have seen an increase of 10.4 percent annualized over the last 14 weeks. As you can see in the chart below, the number of loans continues to increase. According to the Wall Street Journal, one area where bank lending has accelerated is to commercial businesses.
Why it matters: This positive trend is a potential inflection point for the economy because it indicates economic acceleration. Not only are banks making it easier to borrow by relaxing lending standards, companies are confident enough about the economy to want more money to grow and invest. The WSJ goes on to say that earnings in April from the six largest banks in the U.S. pointed to an increase in commercial loans of 8.3 percent in the first quarter from last year.
Economic data around the globe continues to remain supportive. Even among challenges, there are opportunities to be found. For example, yesterday we heard that the European Central Bank is likely to ease interest rates in June. This could be another catalyst for Europe, which is already showing improving economic activity.
Similarly, China’s inflation is at an 18-month low as of yesterday, which could increase the odds of a policy response, a positive stimulus for the economy. Japan is dealing with the same thing; the country committed to Abenomics and will likely respond with additional policy support to get back on the recovery track. Don’t let negative news overshadow good news and keep in mind that bad news tells you where the opportunities are.
I am excited to be speaking on Monday at the Metals and Minerals Investment Conference in New York, and I will also be launching another episode of Gold Game Film with Kitco News that day. If you have the opportunity to view either of these, I encourage you to do so. Happy Investing!
- Major market indices finished mixed this week. The Dow Jones Industrial Average gained 0.43 percent. The S&P 500 Stock Index fell 0.14 percent, while the Nasdaq Composite declined 1.26 percent. The Russell 2000 small capitalization index dropped 1.91 percent this week.
- The Hang Seng Composite Index fell 2.41 percent; Taiwan gained 0.25 percent while the KOSPI declined 0.15 percent. The 10-year Treasury bond yield added 3 basis points to finish the week at 2.62 percent.
Domestic Equity Market
The S&P 500 Index ended the week with a small loss as the market continues to digest a multitude of earnings reports. The market experienced a large bifurcation this week with large-cap stocks significantly outperforming small-cap stocks. A good illustration of this is the performance of the Dow Jones Industrial Average (large cap), which rose 0.43 percent, while the Russell 2000 Index (small cap) fell 1.91 percent. Since March 31, the Russell 2000 has declined by 5.53 percent versus a gain of 0.55 percent for the S&P 500 and 1.02 percent for the Dow. The Russell 2000 has even breached its 200-day moving average. This narrowing breadth in the market is a potential warning sign that needs to be monitored closely.
- The telecommunication services sector was the best performer for the second week in a row as AT&T and Verizon both rose by around 2.5 percent. AT&T is in talks to possibly acquire DirecTV, which was discussed last week but intensified as the week progressed.
- The consumer staples sector continued to advance this week as traditionally defensive areas of the market tended to outperform. CVS Caremark, General Mills and Kellogg were among the best performers.
- Electronic Arts was the best performer in the S&P 500, rising 23.23 percent this week. The stock rose more than 21 percent on Wednesday as the company released fourth-quarter, fiscal results. This indicated that turnaround efforts are bearing fruit.
- The information technology sector was the worst performer this week in spite of Electronic Arts’ performance. The group was dragged down by wide range of companies, which included poor performances from Teradata, Yahoo, First Solar and Facebook.
- The utilities sector was a weak performer for the second week in a row as profit-taking appeared to be the driver after a run of strong performance.
- Whole Foods Market was the worst performer in the S&P 500, falling 20.81 percent. The company announced disappointing quarterly results and cut its full-year guidance. Competition in the organic food space is heating up as other grocery stores and even Wal-Mart have broadened their organic offerings.
- 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 Federal Reserve to aggressively change course in the near term.
- The sell off in high-quality companies offers an opportunity to pick up companies with robust fundamentals at attractive prices.
- Initial indications from retailers reporting same-store sales showed outstanding growth due to a late Easter pushing sales solidly into April. This should promote good reception from the retail sales report from the Census Bureau, scheduled for release next Tuesday.
- A short-term market consolidation period after such strong performance cannot be ruled out.
- Housing starts and building permits for April are scheduled for release next Friday. Housing is a key component to the recovery story and has disappointed so far in 2014. A disappointing report would weigh on the economic outlook as a good spring selling season is critical to regaining confidence that the recovery won’t fade as we move into the summer months.
- 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.
Treasury bond yields were mixed this week as long-term issues experienced rising yields, while the short and intermediate parts of the curve saw yields fall by a few basis points. Economic data was mixed and central bankers were actively jawboning this week. Federal Reserve Chair Janet Yellen stated that we still need “a high degree of monetary accommodation.” European Central Bank (ECB) President Mario Draghi is prepared to act next month if eurozone inflation remains too low and the euro too strong.
- Initial indications from retailers for April show some promise as same-store sales rose 4.7 percent. This was the best year-over-year performance since September 2011.
- The ISM’s non-manufacturing survey for April rose to 55.2 with particular strength seen in the new orders component. Combined with last week’s manufacturing purchasing managers’ index (PMI), which also had a strong showing, this indicates that U.S. economic growth may be accelerating.
- Gallup’s U.S. Job Creation Index rose in April, just below the high reached in January 2008. This indicates more hires and less layoffs within firms.
- The JP Morgan Global Manufacturing PMI hit a six-month low as weakness in Japan and sluggishness in China were drags on the index.
- The HSBC/Markit final Manufacturing PMI was 48 in April, indicating contraction for the fourth month in a row.
- Japan's composite PMI, which includes both manufacturing and services, fell sharply in April and well into contraction territory.
- Fed Chair Janet Yellen appears to be in no rush to raise interest rates and stated that “a high degree of monetary accommodation” is still needed.
- The President of the ECB, Mario Draghi, suggested the bank could ease monetary policy in June in response to the strong euro and low inflation.
- There are many moving parts to the taper decision and while the Fed began the process, it is very possible that tapering could be delayed if the economy stumbles.
- Long-term bonds have posted strong returns so far year-to-date, and with economic data looking supportive, a modest sell off wouldn’t be surprising.
- Trade and/or currency “wars” cannot be ruled out, which may cause unintended consequences and volatility in the financial markets.
- China remains a wildcard for economic recovery and the economy has shown some cracks in recent months. This is similar to how last year started when China found its footing. Something similar needs to happen this time around.
For the week, spot gold closed at $1,289.10, down $10.52 per ounce, or 0.81 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, declined 2.37 percent. The U.S. Trade-Weighted Dollar Index rose 0.43 percent for the week.
|May 8||Bank of England Bank Rate||0.5%||0.5%||0.5%|
|May 8||ECB Rate Announcement||0.25%||0.25%||0.25%|
|May 9||Japan Leading Index CI||106.7||106.5||108.7|
|May 9||China Consumer Price Index||2.1%||1.8%||2.4%|
|May 9 - 15||China Money Supply M2||12.2%||-||12.1%|
|May 14||Japan GDP 1Q Preliminary||4.2%||-||0.7%|
|May 14||Germany Consumer Price Index||1.3%||-||1.3%|
|May 15||U.S. Consumer Price Index||2.0%||-||1.5%|
- The People’s Bank of China has approved the bourse to set up an international board in the Shanghai free-trade zone, thus allowing foreign institutions and individuals to trade gold on the exchange. The measure is expected to make it easier to bring gold into the country, where strong physical demand remains robust, as evidenced by gold consumption in China increasing slightly from last year. However, jewelry purchases rose 30.2 percent over the same period, highlighting the importance of what we call the “love trade,” which represents nearly 80 percent of all Chinese demand for gold.
- Global open interest for palladium is up 401 thousand ounces year to date, or 18.4 percent, leading to a spike in palladium ETF holdings to an all-time high. This is particularly significant, since the market is set to record a major deficit this year, which has sent prices up 16 percent from the lows in early February to new 32-month highs above $800 per ounce. In addition, Impala Platinum announced it may reduce its PGM supply by 60 percent over the next three months as it remains unclear how long the platinum strike might last.
- Mandalay Resources reported higher first-quarter production and lower costs, reflecting the rapid scaling up of the mines. The company also reported planned expansions at both mines are on time and on budget, and declared a quarterly dividend. Roxgold encountered high grade mineralization as part of its ongoing drilling program at Bagassi South in Burkina Faso, with intercepts as high as 226.76 gram per tonne gold over 3.1 meters. Trevali Mining reported newly discovered mineralization approximately 450 meters below the currently defined resource at the Caribou project in New Brunswick.
- UBS recommends selling gold on any price rallies, arguing bullion lacks the incentives to push higher, and more importantly, to maintain its “elevated perch.” The bank’s analysts added that recent gains were aided by “nervous shorts.” Similarly, Goldman Sachs argues gold’s recent gains are a result of transient factors, implying prices are expected to grind down from here.
- Gold prices slid this week as signs of an improving global economy reduced the appeal of haven assets, according to a Bloomberg report. The U.S. trade deficit narrowed in March, with exports growing the most in nine months, while the Purchasers Managers’ Index for the eurozone climbed to 53.1 in April from 52.2 the previous month.
- Dick Poon, general manager at Heraeus Metals in Hong Kong, expects China’s gold demand to be muted in the coming months, thus keeping prices at current levels. In Poon’s view, 2013 was an exceptional year, evidenced by large physical delivery premiums, which have subsided in 2014. Poon argues the level of buying last year will not be repeated as consumers bought forward in 2013 after the price drop.
- The downturn in gold exploration will hit future gold production. Michael Chender of Chender’s Metals Economics Group, one of the foremost researchers into mineral exploration trends, has presented gold exploration statistics that are likely to impact gold supply going forward. According to Chender, not only have exploration expenditures declined 33 percent year-over-year, but exploration activity by juniors was hit harder as funding dried up. Overall, Chender expects exploration spending to drop an additional 20 percent this year, with most of the decline coming from cuts to grassroots exploration.
- Kevin Kerr, editor of CommodityConfidential.com, is of the opinion that a downside in gold bullion is very limited, and not taking a long position at this stage is “somewhat foolish.” It would appear that Dundee Capital Markets’ chief economist Martin Murenbeeld agrees. According to Murenbeeld, one of the more prescient gold forecasters, gold is likely to end 2014 at $1,367 per ounce, before climbing to $1,438 in 2015.
- De Beers, the largest diamond supplier, has announced its plans to raise diamond prices 5 percent per annum until 2016, as it projects a return on capital of 15 percent for its operations. On a related note, Lucara Diamonds reported first-quarter results, beating analysts’ profitability expectations, and closing the quarter with a large net cash position of $56.8 million. In addition, the company announced its maiden semi-annual dividend.
- Gold traders are the most bearish in seven weeks as we head into next week, with the majority of them citing the developments in Ukraine and the continued cuts in U.S. stimulus as reasons to hold or sell bullion. Similarly, speculators have argued mounting confidence in the U.S. economy as a reason to lighten their long gold bets.
- Randgold CEO Mark Bristow has criticized the proposed mine code change in the Democratic Republic of the Congo (DRC) as it may curb investment. The proposed changes seek to raise taxes and royalties from miners, cut exemptions and institute a windfall-profit tax. Miners in the country stated they could consider a tax increase as long as the country provides them with reliable power to run their operations. The DRC is currently in an electricity-rationing program amid a power shortage that is unlikely to be reversed in the short term.
- The Office of the Inspector General announced it will commence a preliminary investigation to determine whether the U.S. Environmental Protection Agency (EPA) violated laws, regulations, policies and procedures in its assessment of mining impacts in Alaska. A pre-emptive veto by the EPA against the Bristol Bay Watershed has raised serious questions over its independence. Previous, numerous controversies have surrounded the EPA, especially those where green group lawsuits against the EPA have resulted in changes to regulations. This strategy has been criticized as a go-around process to circumvent the legislative process and enact regulations that would have otherwise failed in congress.
- Energy accounted for nearly two-thirds of the $8 billion of inflows into sector-based, exchange-traded funds this year, according to data compiled by Bloomberg.
- China crude oil imports increased 18 percent year-over-year to 6.8 million barrels per day. The sharp rise in April imports is counter seasonal, suggesting additional supplies will support the new 240,000 barrel per day Quazhou refinery.
- The price of nickel on the London Metals Exchange gained 9 percent this week, hitting a new 52-week high, and breaching the key $20,000 per tonne level. News of a Vale plant shutdown in New Caledonia added to further concerns over supply deficit.
- China imported 83.39 million tonnes of iron ore in April, the second-highest monthly figure on record and up 12.75 percent from March. This was driven by seasonal demand from Chinese steel mills for the raw material. Iron ore imports in the first four months of 2014 were 305.3 million tonnes, up 21 percent on the year, data from the customs authority showed on Thursday.
- Natural gas futures slid to the lowest level in three weeks on forecasts that stockpiles will build at a faster pace as demand falls due to mild weather.
- China’s HSBC final PMI shrank in April to 48.1 compared to an initial reading of 48.3, although slightly ahead of the March reading of 48.0. China’s manufacturing sector contracted for the fourth consecutive month in April. This compares to last week’s official final PMI reading of 50.4 versus 50.3 in March, according to Reuters.
- Natural resource equities could provide a better hedge against inflation than commodities themselves, according to a white paper from The Boston Company Asset Management group. The paper noted that it may be an appropriate time to consider strategies against a rise in inflation as interest rates appear to have bottomed.
- According to a recent investor panel, global oil supply will need to grow by 5 million barrels per day every year in order to offset production declines and keep supply flat. All of the U.S. shale oil from 2009 to the peak in 2019 is not expected to completely offset that required growth. Accordingly, oil prices could be higher for longer to incentivize exploration and development.
- Mining mergers and acquisitions (M&As) could double in 2014 on a shift in Chinese government policy and a decline in commodity prices. China’s new rules allow overseas deals under $1 billion without government approval. Mining acquisitions by Chinese companies surged 63 percent year-over-year in the first four months of 2014. Iron ore, coal and copper remain top targets given the decline in prices.
- BHP said the gain in global iron ore production is led by Australia and Brazil and their new low-cost output will displace marginal suppliers in China. Vale plans to raise output almost 50 percent by 2018.
- Consumers in the U.S. may pay the most they have in a long time for meat this grilling season as costs for pork and beef surge, according to the American Farm Bureau Federation. “Farmers and ranchers are raising smaller numbers of hogs and cattle,” John Anderson, the bureau’s deputy chief economist, said in a statement. “This is the key factor contributing to higher retail meat-prices, a trend that is likely to continue through the summer and, at least for beef, into next year.” The U.S. cattle herd started the year at the smallest since 1951 as ranchers struggled to recover from years of drought.
- The latest Greek unemployment reading provides more evidence that suggests the dire jobs situation in Greece is stabilizing. The country’s unemployment rate improved in February to 26.5 percent, easing to its lowest in more than a year, and having fallen for the fifth-straight month. It is another sign that the Greek economy, and peripheral Europe in general, is emerging from a six-year slump, during which the unemployment rate has more than tripled.
- Hungary's manufacturing purchasing manager index (PMI) rose to 54.6 points in April from 53.7 in March, according to the Hungarian Association of Logistics, Purchasing and Inventory Management. The production quantity sub-index rose relative to March and is now signaling an expansion for the sixth-consecutive month.
- The Philippines won a credit rating upgrade, to BBB from BBB-, from Standard & Poor's. The upgrade comes a year after the country was raised to investment grade, aided by President Benigno Aquino's ongoing reforms to address shortcomings in structural, administrative, institutional, and governance areas.
- Expansion in China's services industry slowed slightly in April, with employment growth slipping to a seven-month low, according to the Markit Services PMI survey. Markit’s manufacturing PMI showed that activity contracted for a fourth-consecutive month in April, with the index at 48.1. The consumer price index, which fell to an 18-month low, and the producer price index both continue to show weakness in the domestic economy leading to speculation that the government may implement more easing measures in the coming weeks.
- Germany's industrial output dropped unexpectedly in March, largely driven by contraction in construction activity. Industrial production fell 0.5 percent in March from February, the first decrease in five months. Similarly, German factory orders fell 2.8 percent in March, missing economists' expectations for a 0.3 percent rise, signaling that growth in Europe's largest economy remains uneven.
- Czech retail sales grew at a slower than expected pace in March, after posting the fastest gain in more than five years in the previous month. Retail sales rose a working-day-adjusted 5.2 percent from last year, while economists predicted a 7.3 percent growth. The measure rose 8.1 percent in February.
- China’s exports and imports unexpectedly rose in April, with overseas shipments increasing 0.9 percent from a year earlier, beating analysts’ estimates for a 3 percent drop. Imports gained 0.8 percent, bringing the trade surplus to $18.46 billion. The trade figures may prove to be even stronger considering last year’s April trade numbers were reportedly inflated by fraudulent invoicing. The Chinese economy is benefitting from the strength of its main trading partners, as export growth to the U.S. and EU rose 12.0 percent and 15.1 percent from last year.
- Indian stocks rallied to a record on speculation that election results next week may show a victory by the main opposition party. The index has climbed 8.6 percent this year supported by a $5.6 billion inflow by foreign buyers, as investors bet a win from Bharatiya Janata Party’s Narendra Modi will allow him to boost economic growth from the lowest level in a decade.
- Dubai banks are reportedly seeking Islamic bank acquisitions overseas as new capital rules limit their opportunities at home. Domestic loan growth is constrained by central bank rules limiting exposure to a rapidly rising property market. For Islamic banks, markets including Turkey and Indonesia are especially attractive because they have predominantly Muslim populations with double-digit loan growth.
- Thai Prime Minister Yingluck Shinawatra was removed from office by the Constitutional Court, accused of violating the constitution and abusing power in the appointment of the secretary-general of the National Security Council. The government’s supporters have called for marches into Bangkok to oppose the ruling, increasing the risk of political instability ahead of the July elections.
- Macau casinos dropped heavily in Hong Kong trading amid concern that a crackdown on illegal money transfers will pare demand. China is cracking down on the use of hand-held card-swipers within casino resorts amid concerns that tens of billions of yuan in illicit funds are being taken out of the mainland and into Macau. China may tighten rules for visitors to Macau which could translate into lesser visitor demand to the casinos.
- Russia's private sector output shrunk for a second-straight month in April and at the fastest pace in nearly five years, according to HSBC. The Markit Russia composite PMI fell to 47.6 in April from 47.8 in March and the lowest since May 2009. Total new orders, both manufacturing and services, fell at the quickest rate in nearly five years. As a result, private sector employment fell for the tenth month in a row and at a near-record pace. Russia may already be in a technical recession according to the IMF.
(c) US Global Investors