There’s no other way to put it: Commodities took it on the chin last month.
July was the seventh worst performing month for the S&P Goldman Sachs Commodities Index, going back to January 1970. Crude oil saw its steepest monthly loss since October 2008. Both copper and aluminum touched their lowest levels in six years. And on July 19, possibly as a result of deliberate price manipulation, gold experienced a mini flash crash, sending it down to five-year lows.
Regardless, several commodities are beating the exchange-traded funds that track them for the one-year period, according to the Wall Street Journal. Our Gold and Precious Metals Fund (USERX) is over 1,900 basis points ahead of the Market Vectors Gold Miners ETF (GDX) year-to-date.
But that hasn’t stopped many gold bears from using this as an opportunity to disparage the yellow metal. A recent Bloomberg article points out that the gold rout has cost China and Russia $5.4 billion, an amount that would sound colossal were it not for the fact that U.S. media companies such as Disney and Viacom collectively lost over $60 billion for shareholders in as little as two days this week.
Below are the weekly losses for just a handful of those companies. Compared to many other asset classes, gold has held up well, even after factoring in its price decline.
And isn’t it funny that the Federal Reserve doesn’t keep other countries’ currencies, but it continues to hold gold—and in larger amounts than any other central bank? China and Russia have two of the biggest gold reserves in the world—and have added to them recently—but they don’t come close to the Fed’s holdings, even when combined. What’s more, the U.S. Treasury’s Office of the Comptroller of the Currency just classified gold as money by placing gold futures in the foreign exchange derivatives classification.
Indeed, central banks all over the world continue to add to their gold reserves. If the metal were as valueless as a pet rock, as one op-ed recently claimed, why would they bother to do this? A couple of weeks ago, China disclosed the amount of gold its central bank holds for the first time in six years. Global markets reacted negatively that the country increased its reserves “only” 57 percent. But the World Gold Council (WGC) saw this as positive news:
We believe the People’s Bank of China’s confirmation of its revised gold holdings is supportive for the gold market. It reiterates how China, along with other central banks, views gold as a key resource asset as it continues to seek diversification away from the U.S. dollar.
As I’ve said before, China is the 800-pound commodities gorilla. This has largely been the case since 2000.
Half a Trillion Dollars a Year in Commodities
Between 2002 and 2012, China was growing fast at an average annual pace of around 10 percent. The country was responsible for nearly all of the net increase in global metals consumption between 2000 and 2014, according to the World Bank. Over the same time period, its share of metals consumption tripled, eventually reaching an astounding 47 percent.
The year 2014 was a standout for Chinese commodity imports. Compelled by low prices, the country, which accounted for 12 percent of worldwide imports, brought in record volumes of crude oil, iron ore, copper and other raw materials.
Because China is a trading partner with practically every other country, and because it imports over $500 billion a year in commodities, its importance in global trade cannot be stressed enough. BBVA Research writes that “any reduction in its level of [purchasing] activity places significant downward pressure on the prices of [commodities], such as oil or copper.”
And yet we’re seeing that reduction now. For the past five months, China’s purchasing managers’ index (PMI) has remained below the neutral 50 mark, indicating that its manufacturing sector has been in contraction mode for the better part of this year so far.
It’s important to keep in mind that China is still the number one importer of many key materials, including coal, iron ore and crude oil. The country’s import growth of these commodities continues to rise, but at a slower pace than in years past.
This isn’t necessarily the case with gold, however.
Demand Still Higher Than the Five-Year Average
According to the WGC, the decline in Chinese gold demand has been overstated.
Although China’s jewelry demand in the first quarter of 2015 was down from the record level the previous year, it was 27 percent higher than its five-year average. And consumer demand—jewelry plus bar and coins—in the first quarter was the fourth best on record, surpassed only by the surge in demand triggered by the price fall in 2013.
The WGC also points out that gold has a low correlation with and different demand drivers than commodities. Whereas commodities, as expressed by the Bloomberg Commodities Index, have returned to 2001 levels, gold is still up significantly for the period shown in the chart below.
As many of you know, I call gold’s drivers the Fear Trade and the Love Trade. Last week I had the pleasure to describe these drivers to Mike Gleason of Money Metals Exchange.
The Fear Trade, dominant in the psyche of North America, involves money supply growth and real interest rates. Whenever the U.S. has negative real interest rates, gold starts to rise in dollar terms, and whenever we have positive real rates of return, it starts to decline. If you go back to 2011, we had negative real interest rates off 3 percent on a 10-year government bond, and the average gold price that year was around $1,500 per ounce. But now that rates are positive 2 percent, the metal’s been depressed.
The Love Trade includes the purchase of the precious metal due to cultural affinity and rising GDP per capital in Asia and the Middle East. This includes gift giving of bullion and gold jewelry in anticipation of upcoming festivals such as Diwali, Christmas and the Chinese New Year. Historically, the Love Trade has begun to pick up around this time of the year.
Gold is a long-term investment with long-standing tradition. This remains true even now that prices have declined. As always, I recommend a 10 percent weighting: 5 percent in gold stocks, 5 percent in bullion or jewelry, then rebalance every year.
|Fund||One-Year||Five-Year||Ten-Year||Gross Expense Ratio||Expense Cap (or) Expense Ratio After Waivers|
|Gold and Precious Metals Fund||-28.42%||-15.80%||1.62%||1.97%||1.90%|
|Market Vectors Gold Miners ETF||-32.35%||-18.76%||n/a||0.53%||0.53%|
Expense ratios as stated in the most recent prospectus. The expense cap is a voluntary limit on total fund operating expenses (exclusive of any acquired fund fees and expenses, performance fees, extraordinary expenses, taxes, brokerage commissions and interest) that U.S. Global Investors, Inc. can modify or terminate at any time, which may lower a fund’s yield or return. Performance data quoted above is historical. Past performance is no guarantee of future results. Results reflect the reinvestment of dividends and other earnings. For a portion of periods, the fund had expense limitations, without which returns would have been lower. Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance does not include the effect of any direct fees described in the fund’s prospectus (e.g., short-term trading fees of 0.05%) which, if applicable, would lower your total returns. Performance quoted for periods of one year or less is cumulative and not annualized. Obtain performance data current to the most recent month-end at www.usfunds.com or 1-800-US-FUNDS.
For information regarding the investment objectives, strategies, liquidity, risks, expenses and fees of the Market Vectors Gold Miners ETF, please refer to that fund's prospectus.
- The major market indices finished down this week. The Dow Jones Industrial Average fell 1.79 percent. The S&P 500 Stock Index fell 1.25 percent, while the Nasdaq Composite fell 1.65 percent. The Russell 2000 small capitalization index fell 2.57 percent this week.
- The Hang Seng Composite rose 0.06 percent this week; while Taiwan fell 2.57 percent and the KOSPI lost 0.98 percent.
- The 10-year Treasury bond yield fell 2 basis points to 2.2 percent.
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Is Gold Due for a Rally?
Domestic Equity Market
- Utilities was the best performing and only positive sector in the S&P 500 Index this week as the yield on 10-year government notes fell. The S&P 500 Utilities Sector Index rose 0.89 percent this week.
- Factory orders in the United States rose by 1.8 percent from May to June, right in line with expectations.
- German factory orders came in much stronger than expected on a month-over-month basis for June.
- Energy stocks got hit hard again this week as oil prices continue to test lows. The S&P 500 Energy Sector Index fell 3.48 percent this week.
- German industrial production for the month of June contracted sharply by 1.4 percent. The street expected a slight expansion.
- Retail sales in the eurozone contracted for the month of June by much more than expected. The negative data release highlights the struggle to recover in the eurozone.
- The German manufacturing PMI came in higher than expected at 51.8 percent, well above the 50 mark that signals expansion.
- The eurozone aggregate PMI was particularly strong for the month of July. While the PMI came in at 52.4 percent, the street expected a reading of 52.2 percent.
- Analysts are expecting consumer confidence to have risen for the month of August. The University of Michigan Consumer Sentiment Index will be released next week and is expected to rise to 93.6 from 93.1 in July.
- Inflation expectations are falling sharply as indicated by the decline in the breakeven inflation rate on 5-year inflation indexed Treasury notes. Resurfacing disinflationary pressures are a very negative sign for the economy.
- The U.S. ISM manufacturing PMI declined for the month of July, falling to 52.7 from 53.5 percent in June. This could negatively impact industrials and other manufacturing-oriented plays.
- With crude prices testing their lows, energy stocks are in for a rough ride over the near future.
The Economy and Bond Market
U.S. stocks slid this week while European stocks rose and Asian shares were mixed. Global data were mildly disappointing overall, though a solid U.S. monthly employment report was seen as increasing the likelihood that the U.S. Federal Reserve will raise interest rates in September. The yield on the 10-year U.S. Treasury note ended the week at 2.17 percent, while the yield on Germany's 10-year bund came in at 0.66 percent. Oil prices extended a sharp six-week slide, with U.S. West Texas Intermediate and international Brent crude oil falling to around $44 and $49 per barrel, respectively.
- The July employment report revealed nonfarm payroll growth of 215,000 with net positive revisions of 14,000 over the last two months, coming in relatively in line with expectations. Hiring is now averaging 235,000 over the last three months and 213,000 over the last half year. The unemployment rate held steady at 5.3 percent, as did the labor force participation rate at 62.6 percent.
- The ISM non-manufacturing composite expanded to 60.3 in July from 56.0 in June, above the expected 56.2. This represents the highest level of the index since August 2008.
- July U.S. light vehicle sales improved 5.3 percent year-over-year, above the estimate of 4.7 percent, for a seasonally adjusted annualized rate (SAAR) of 17.5 million. Despite persistent concern among investors that the U.S. cycle is peaking, auto sales continue to chug higher and are now up 4.6 percent year-to-date in 2015.
- The ISM manufacturing index inched down to 52.7 in July, from 53.5 in June. This was below the expected 53.5.
- The combination of weak demand and brimming supply continues to be a headwind for the commodity complex. Global export prices are closely linked to commodity prices, while CPI goods inflation in the advanced economies is highly correlated with world export prices. The renewed downtrend in commodity prices means that another mini-wave of deflation will likely wash over consumer goods prices in the advanced economies.
- The U.S. trade deficit widened 7.1 percent to $43.8 billion in June. Exports were flat, while imports rose 1.2 percent, with the strong U.S. dollar and weak overseas demand hurting exports and boosting imports. This has weighed on U.S. manufacturers and created an obstacle to faster U.S. growth.
- Fed data about both banks' willingness to lend as well as consumers and businesses willingness to borrow, continue to improve. Indeed, following second quarter earnings results, banks cited strong loan growth. They also cited limited upward pressure on costs, courtesy of considerable financial sector labor market slack. That bodes well for profit margins, over and above any lift from the imminent upward movement in interest rates.
- State and local governments are increasingly turning to green bonds, which are a growing source of funding for clean transportation and sustainable water and waste management, as they look to raise funds and reduce reliance on fossil fuels. U.S. municipalities have sold $1.3 billion this year through June 30. If the rate of issuance continues at the same pace through the end of the year, total 2015 issuance of muni green bonds will be about $2.64 billion.
- The U.S. dollar should outperform other major world currencies as the Fed starts its rate hiking cycle.
- This week’s stronger than expected payroll report adds more weight to the data prompting the Fed to begin raising rates before the end of the year. However, the short-end of the yield curve is still not priced for such an outcome. As we approach the first rate hike, the yield curve will likely move from a “bear steepening” phase to a “bear flattening” phase. This is because when rate liftoff is thought to be far off, the yield curve tends to steepen on days when Treasury yields increase. This tends to reverse as liftoff draws nearer and the short-end of the curve becomes more volatile.
- The NFIB survey, which will be released Tuesday, painted a cautious tone last month and a repeat performance would be worrisome.
- Retail sales have been disappointing, with the prior reading coming in at -0.3 percent. July data will be released Thursday and any further slowing would cast doubt over consumer discretionary sector strength.
For the week, spot gold closed at $1,093.44 down $2.38 per ounce, or 0.22 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost 2.65 percent. The U.S. Trade-Weighted Dollar Index rose 0.32 percent for the week.
|Aug -3||U.S. ISM Manufacturing||53.5||52.7||53.5|
|Aug -5||U.S. ADP Employment Change||215K||185K||237K|
|Aug -6||U.S. Initial Jobless Claims||272K||270K||267K|
|Aug -7||U.S. Change in Nonfarm Payrolls||225K||215K||223K|
|Aug -11||Germany ZEW Survey Current Situation||64.2||--||63.9|
|Aug -11||Germany ZEW Survey Expectations||31.9||--||29.7|
|Aug -12||China Retail Sales YoY||10.60%||--||10.60%|
|Aug -13||Germany CPI YoY||0.20%||--||0.20%|
|Aug -13||U.S. Initial Jobless Claims||270K||--||270K|
|Aug -14||Eurozone CPI Core YoY||1.00%||--||1.00%|
|Aug -14||U.S. PPI Final Demand YoY||-0.90%||--||-0.70%|
- India’s gold imports shot up by about 61 percent to 155 tons in the April-May period due to weak prices globally and the easing of restrictions by the Reserve Bank.
- Sales of gold coins and minted bars jumped 65 percent in July from the previous month at Australia’s Perth Mint. South Korea is on course to buy a record amount of gold in 2015. In contrast to the weak demand in top gold buyers like China and India, South Koreans are on target to buy 1 trillion won ($860 million) in bullion for the first time this year, based on first-half sales. South Korea accounted for just 17 tons of gold demand in 2014 and would account for 23 tons by year end if buying keeps pace.
- Billionaire hedge fund manager John Paulson, one of the world’s most influential gold investors, said that the metal is now at an appropriate price level, following last week’s rout that dragged prices to five-year lows. Paulson has retained a 10 million share stake, now worth about $1 billion, in the SPDR Gold Shares Trust, which tracks the price of gold.
- The week started with money managers staying net-short on gold for a second week. Gold finished the week with a seventh consecutive weekly decline, marking its worst run in 11 years in reaction to the U.S. payrolls report that provided strong supporting evidence for the Federal Reserve to raise interest rates. Additionally, Morgan Stanley said investment buying for gold will keep dropping through 2018, however, these forecast are typically predicated on expectations that other investments will be rising in value.
- The two biggest unions in South Africa’s gold industry rejected a pay-increase proposal by the country’s largest producers. This could put further pressure on these companies’ margins.
- Platinum traded near a six-year low and palladium reached the lowest since 2012 on speculation that supplies are ample amid slowing demand from China.
- While the dislocation between demand for physical gold and the price of paper gold has made headlines recently, something happened at the CME recently that may be the most important development yet. Back in 2013 the gold held in the newest Comex vault plunged by nearly 2 million ounces in six months. This sent the gold coverage ratio soaring from under 20 to 112. This means that the paper claims on physical gold available for delivery was 112 times greater than the physical gold that could be delivered at any given moment by the exchange. The latest Comex gold vault depository update, covered by ZeroHedge, revealed that the gold coverage ratio reached a whopping 124, an all-time record high. After this story broke, J.P. Morgan moved gold from its available account into the registered category, boosting registered ounces by 78 percent.
- Gold’s tumble to the lowest level since 2010 promises to prolong an M&A boom that’s seen transactions at a three-year high as weaker prices slash asset valuations. Deals valued at $9.6 billion were proposed or completed in the six months to June 30, up 7 percent on the previous half. In addition, Zijin Mining Group, the world’s biggest gold producer by market value, said it will press ahead with mine acquisitions to improve its portfolio quality.
- Klondex Mines provided an update on its recent drill results. The drilling extended the four known mineralized veins by a collective 426.7 meters laterally and 182.8 meters vertically in the West Zone. Additionally, new parallel mineralized structures were intercepted 152.4 meters west of the Karen vein or 167.6 meters west of the underground workings. These results continue to demonstrate that the project is significantly under drilled. Klondex is up 51 percent year-to-date, while the GDM Index is down 27 percent.
- Hedge fund losses from the commodity slump are sparking investor exodus. Cargill, the world’s largest grain trader, decided to liquidate its hedge fund following diminishing investor demand last month. Additionally, the amount of money under management by hedge funds specializing in commodities stands at $24 billion, 15 percent below the peak three years ago.
- According to Mohammed El-Erian, the situation in gold is unlikely to change soon but it need not be terminal. A shift would probably require a broader normalization of financial markets, including a reduction in the direct and indirect role of central banks in determining asset prices and their correlations. Basically, El-Erian is saying that investing is rigged and will continue to be until central banks stop manipulating the markets. Only then will gold and other assets normalize to their true market value.
- Goldman Sachs reiterated a forecast that gold prices may drop below $1,000 per ounce.
Energy and Natural Resources Market
- Construction materials led all natural resource sub-sectors this week on the back of very strong earnings reports, particularly for aggregate and cement stocks. The S&P 500 Construction Materials Index gained 5.2 percent on the week.
- Container and packaging stocks were among the leaders for natural resources this week. The S&P 500 Containers & Packing Index gained 4.61 percent
- The Bloomberg Dry Ships Index outperformed this week, gaining 1.2 percent despite concerns over China’s economic growth.
- The Alerian MLP Index fell by nearly 10 percent this week as the Federal Reserve weighs an impending interest rate hike next month. This negatively impacts both bonds and high dividend-paying stocks.
- Renewable energy stocks lagged the benchmark this week in response to weakening technology stocks as well as negative earnings reports. The NASDAQ Clean Energy Index fell 5.8 percent during the week.
- Copper and other base metals stocks pulled back this week as investors continue to fear a slowdown in China’s growth. The S&P/TSX Capped Diversified Metals and Mining Index fell 4.4 percent.
- The Department of Energy is set to release its Short-Term Crude Outlook next Tuesday. The report will highlight U.S. production trends and consumer demand growth.
- Exxon Mobil Corp, the world's largest publicly traded oil company, said this week that it signed two agreements to drill on 48,000 acres in Texas' Permian Basin. The transaction suggests that the stagnant merger and acquisitions market is beginning to heat up.
- China’s industrial production and fixed-asset investment numbers will be released next week. Depending on the data, sentiment could recover if numbers improve or even hold steady.
- Crude oil fell to its lowest level since March this week and could fall further given high inventory numbers along with resilient U.S. production. Production remains elevated despite a lower rig count and softer prices.
- Concerns over China’s slowing growth rate remain elevated. Commodities and related stocks should be cautiously monitored.
- The Federal Reserve has all but said for certain that it plans to raise rates this year. As more investors consider this to be true, precious metals stocks will continue to see pullbacks.
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- Chinese stocks outperformed this week as markets remain considerably volatile and the index continues to climb back from its sharp fall a few weeks ago. The Shanghai Stock Exchange Composite Index rose 2.20 percent this week.
- Russian equities rallied this week on little to no country specific news. The MICEX Index rose 1.28 percent this week.
- The Czech economy is booming. Industrial output in the emerging European economy grew at 8.1 percent year-over-year for the month of June, sharply surpassing analyst forecasts. Furthermore, retail sales grew at an impressive 11.1 percent year-over-year in June. The Prague Stock Exchange Index rose slightly by 0.18 percent this week.
- Greek markets opened on Monday and came crumbling down. Banks were hit the hardest, with the FTSE/Athex Banks Index falling 58.09 percent this week. The broader Athens Stock Exchange General Index fell 15.2 percent this week.
- Turkish equities underperformed this week as markets are assigning a higher probability to a snap election in November. The Borsa Istanbul 100 Index fell 1.86 percent this week.
- The Russian ruble continued its decline this week as Brent crude oil prices headed lower. The ruble fell 3.93 percent against the dollar this week.
- The Turkish lira has been depreciating for some time now which has historically benefitted Turkey’s current account. With a three-quarter lag, the current account as a percentage of GDP moves closely with the real effective exchange rate in Turkey. Given the recent decline in the real exchange rate over the last few months, the current account should move closer to a surplus through the rest of 2015. Additionally, Turkey’s manufacturing PMI broke above 50 for the month of July, signaling expansion in the sector.
- Polish and Czech manufacturing PMIs came in exceptionally strong for the month of July. With each economy’s PMI well above 50, economic activity should continue to improve.
- Beijing’s victory in its bid for the 2022 Winter Olympics should reinforce the secular theme of rising sports participation among increasingly health conscious middle class Chinese. With per capita spending on sportswear a mere fraction of developed countries, active apparel boasts highest visibility of growth within consumer spending categories in China in the aftermath of recent stock market gyration. Leading local sports brand innovators and cost efficient textile manufacturers are likely to be major beneficiaries of this trend.
- Russia’s manufacturing purchasing managers’ index (PMI) headed lower this week, signaling further signs of trouble for the struggling economy. Furthermore, Brent crude’s continued decline is creating serious headwinds for the country.
- Commodities remain severely depressed and are dragging down the emerging markets most closely linked to the resources space.
- Macau’s July casino revenue came in line with market expectations at 34.5 percent year-over-year decline, a slight improvement from June’s 36.2 percent contraction but far from a trend reversal. Unabated anticorruption campaign in China and renewed volatility in the A-Share market should reinforce the ongoing retrenchment of risk appetite in games of chance for the mainland middle class, and the ongoing bear market rebound in Macau casino stocks may not be sustainable.
(c) US Global Investors