Commodities Snapshot (Bespoke)

Thursday, April 18th, 2013

by Bespoke Investment Group.

Below we provide our trading range charts for ten of the most widely followed commodities.  For each chart, the green shading represents between two standard deviations above and below the commodity’s 50-day moving average.  Moves to the top of or above the green zone are considered overbought, while moves to the bottom of or below the green zone are considered oversold.

We’ve seen an absolute bloodbath in the precious metals recently.  As you can see below, gold and silver have both “fallen off a cliff” over the past few trading days in what has been a remarkable move.  Platinum and copper are both oversold as well, but to a much lesser extent.

Oil has also been hit hard this week, and it’s as oversold now as it has been in nearly a year.

One commodity that has bucked the recent move lower is natural gas.  As shown, natural gas is actually remains in a very nice uptrend and at the top of its trading range.  In recent years, it had been gold and oil going higher while natural gas couldn’t buy an up day.  Now the complete opposite is occurring.

Copyright © Bespoke Investment Group

Tags: Commodities, Commodity, Commodity Market
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Extraordinary Strains (Hussman)

Sunday, July 22nd, 2012

by John Hussman, Hussman Funds

Just weeks after the enthusiasm over Europe’s plan to plan for the possibility of using the European Stability Mechanism to bail out Spanish banks, the subtle technicality – that direct bailouts would make all of Europe’s citizens subordinate to even the unsecured bondholders of Spain’s banks – has predictably deflated that enthusiasm. On the growing recognition that addressing Spain’s banking problem will mean taking those banks into receivership, wiping out unsecured debt (much of which unfortunately was sold to unknowing Spanish savers as secure “savings” vehicles), and having the Spanish government sort out the damage, Spanish 10-year debt plunged to new lows last week (see chart below), and Spanish yields hit fresh Euro-crisis highs. At the same time, interest rates in Germany, Finland, Holland, Denmark and Switzerland all moved to negative levels looking 2-5 years out. The world is paying these governments to lend money to them, because the only way to acquire other default-free, non-commodity assets is to hire armored trucks and secure vaults to take delivery of physical currency. This set of conditions is not normal or sustainable, and indicates extreme credit market strains in Europe.

The Euro also hit a fresh 2-year low last week at 1.21, just a shade above its 2010 crisis low of 1.20. Likewise, the yield on 10-year U.S. Treasury bonds dropped to 1.45%, matching the historic low it reached a few weeks ago. Yields were higher even in the depths of the Great Depression, when the S&P 500 was trading at less than 2 times the pre-Depression level of earnings, the Shiller P/E on 10-year normalized earnings was less than 5, and the S&P 500 was yielding 16%. As a side note, many analysts seem almost woozy at the “incredible value” that supposedly exists in stocks because the 2.3% yield on the S&P 500 exceeds the 1.45% yield on 10-year Treasuries. It’s worth pointing out that prior to the point that inflation took off after 1960, the yield on the S&P 500 exceeded the yield on Treasury bonds in fully 93% of the data.

Keep in mind that once you subtract out the necessary compensation for default risk (which is rapidly increasing in Spain, for example), interest rates represent the value that the economy places on time. Long-term interest rates have plunged to record lows, and real interest rates are negative after inflation. What interest rates are telling you; what the Federal Reserve is telling you; what the equilibrium created by lenders and borrowers is telling you – is that time is economically worthless and that economic malaise will extend for years.

This does not reflect a well-functioning economy. To the contrary, if you look across history and across nations, strong prospects for sustained economic growth are typically accompanied by high real interest rates, because the demand for capital is robust and good ideas have to compete for funding. Interest rates are an indication of both the demand for loans and the incentive to save. It is not “stimulative” to depress interest rates in an environment where households, businesses and governments are desperately trying to reduce debt. That policy may insult the value of time enough to deter people from saving, and to reduce the immediate penalty for assuming even larger amounts of debt (as the U.S. government continues to do), but it should be clear that these actions move the economy further from a sustainable equilibrium, not closer to it.

I do expect that it will be possible to navigate the coming years well, but it will not be by locking in negligible yields and depressed risk premiums in the futile hope that one plus one will end up being something other than two. Prospective returns vary a great deal over the course of the market cycle, and the strategy of varying risk exposure in proportion to the prospective compensation for that risk will be essential.

On the economic front, as we expected based on leading economic evidence, new orders and order backlogs have dropped abruptly in recent reports. These indices are short-leading indicators of production, which is likely to show a striking decline beginning in the July data. Note carefully whether any positive surprises are in May and June data, because these reports will still be mixed. I continue to expect negative employment changes in the coming months, though as I’ve noted before, we may only find this out later on revisions rather than the initial prints in real-time. In any event, I am convinced that we will ultimately learn that the U.S. economy, slightly trailing the global economy, entered a new recession in June.

While July components are still coming in, the chart below shows the most recent condition of coincident U.S. economic data, reflecting a variety of Fed surveys and Purchasing Managers surveys.

The key question – in view of extreme credit market strains in Europe, and accelerating economic deterioration in the U.S. – is why the S&P 500 continues to trade within a few percent of its April bull market high. The answer is simple: investors are scared to death of missing the widely anticipated market advance that they expect to follow a widely anticipated third round of quantitative easing. Good economic news may be a relief for investors, but bad economic news in this context is just as much of a relief because it brings forward the anticipated delivery date of the sugar. The follow-up question, however, is that if more QE is widely anticipated, and a market advance is widely anticipated to result, isn’t that the precise definition of an event that is already priced into the market?

If you look at the Federal Reserve’s own research on quantitative easing – large scale asset purchases (LSAPs) – nearly every paper emphasizes the “portfolio balance” effect. Put simply, as the Fed removes longer-term Treasury securities from the menu of portfolio choices available to investors, it forces investors to consider alternative securities, raising their prices and lowering their yields – with a particular impact in driving down the risk premiums of risky securities. Indeed, as we’ve noted, QE has generally been effective in helping stocks to recover the peak-to-trough loss that they have suffered in the prior 6-month period (though the most recent LSAPs in the UK and Europe have been failures in that regard).

Still, once risk premiums are already deeply depressed (we estimate the likely 10-year prospective total nominal return for the S&P 500 to be only 4.8% annually), once stocks are trading near their bull market highs, and once Treasury debt already sports the lowest yield in history, should investors really expect much of a portfolio-balance effect from further attempts at QE? Frankly, I doubt it, but in the eventuality of a third round of QE, we’ll focus on our own measures of market action – not on any blind faith in the Fed.

The more troubling issue is that Fed papers on the effectiveness of QE focus almost singularly on the effect of QE on interest rates and risk premiums in the financial markets, with the notable absence of any analysis of the resulting effect on the real economy. This is like showing that squirting gas into an engine will make the engine run faster, without any concern for the fact that there is no transmission that connects the engine to the wheels. In a nutshell, the problem with QE is the lack of any material transmission mechanism from monetary interventions to real economic activity. This is a problem that the Fed should have recognized years ago, because there is strong and consistent historical evidence that real economic activity has very weak “elasticity” with respect to financial market fluctuations, particularly in equity values. Invariably, a 1% change in the value of the stock market is associated with a change of just 0.03-0.05% in GDP, and even that change is transitory. What the Fed has been doing is little but bubble-blowing, while at the same time driving the global financial system further from equilibrium rather than toward it.

Unfortunately, I expect these efforts to continue, but I also expect that it will be useless in averting an unfolding global recession. If the Fed was to initiate a third round of QE near present levels, it would likely be disappointing in the sense that it would fail to reverse economic weakness and at the same time would fail to drive equity prices higher than they already are, or interest rates materially lower than they already are. This would damage confidence in the Federal Reserve and force it to resort to language about monetary policy working with “long and variable lags.” Moreover, at a 1.45% yield and an 8-year duration on a 10-year bond, any interest rate increase of more than about 18 basis points a year will now produce a negative total return for the Federal Reserve over the period that the bonds are held, which comes at public expense (reducing the amount of interest that the Fed would otherwise turn over to the Treasury). As a result, talk is presently much cheaper than action. It seems likely that another round of QE will await obvious economic weakness and a significant spike in risk premiums – probably best measured by the depth of the drawdown in the S&P 500 from its most recent 6-month peak. Still, given that the rationale for much higher risk premiums is very real, it’s not clear that QE will have durable effects on stocks even in that event.

In short, a broad array of observable evidence suggests extraordinary strains in Europe, and abrupt though expected deterioration in U.S. economic activity. The Federal Reserve certainly has policy options, but those options have no material transmission mechanism to the real economy. We’ve always viewed the Federal Reserve as having an important and legitimate role in providing liquidity to the banking system in the event of heavy withdrawals; creating new reserves in return for high-quality, default-free securities backed by the full faith and credit of the U.S. government. This remains an important role, but the Fed’s actions have gone far beyond this role into areas that distort financial markets without transmission to economic activity. That’s just a reality we have to accept, and we’ll respond to further interventions with particular attention to trend-following measures of market action.

Here and now, we remain defensive in the face of accelerating strains the global economy – new highs in Spanish yields, negative interest rates across more stable European countries, new lows in the Euro and U.S. Treasury yields, collapsing new orders and backlogs, a sudden plunge in the employment component of the Philly Fed index, collapsing M2 velocity, and other factors. Due to some modest interest-rate considerations, our estimates of prospective return/risk have improved negligibly from the most negative 0.5% of historical observations, and are now among the most negative 0.8% of historical data. This rare extreme keeps us on red alert for now.

Market Climate

As noted above, accelerating strains are evident both in the global economy – particularly Europe – and in the U.S. economy. Stock valuations remain stretched on the basis of normalized earnings. Profit margins are nearly 70% above their historical norms at present, but these margins reflect very high deficit spending and very weak savings rates – something that can be related to corporate profit margins through accounting identities. Unless one anticipates continued deficits indefinitely, either revenues will revert closer to the level of labor compensation, or less likely, labor compensation will increase toward the level of revenues, but in any event the gap will tend to narrow. This may not be an immediate outcome, but stocks are instruments with an effective duration of over 40 years (mathematically, the duration of stocks is essentially equal to the price-dividend ratio, regardless of growth rates or repurchases). The very long-term stream of cash flows matters enormously in asset valuation.

One of the immediate issues I have with stocks here is the “exhaustion syndrome” (see Goat Rodeo) that has re-emerged in recent weeks. Examining the rare past instances of this syndrome, in 1961, 1987, 2000, and early-2008 among others, the key feature is a breakdown in measures of market action from an overvalued, overbought extreme, followed by a recovery rally toward the prior high and accompanied by earnings yields below their level of 6-months earlier. Normally, the recovery carries the market back to the prior “line” of support that surrounds the peak. The emergence of this exhaustion syndrome may seem benign or unimportant, but it has historically been an important precursor of major market declines. Given what are already significant challenges for both the economy and for the prospective return/risk tradeoff in stocks, my concerns about the potential for deep market losses remain elevated.

Investors often have the impression that the market simply collapses once a bull market peak is set, but this isn’t typical. What is typical is exactly the sort of exhaustion pattern we’ve observed since April. To illustrate this, the chart below presents market behavior around several market peaks that were also followed by an exhaustion syndrome as we observe today. The bull market peaks are aligned at 1.0. The remaining scale is set as a fraction of that peak. Time is measured in trading days before and after the bull market peak. Note that after a quick initial decline from the bull market peak, it’s typical for the market to recover much of the lost ground before the downside progress continues, in some cases producing the “exhaustion syndrome” that we presently observe. Exhaustion syndromes can go on for several weeks, but have historically been very dangerous advances to trade, because more often than not, there is a bear market just behind them. This was not the case in three instances: the July 1998 instance – followed by a decline of only 18%, the July 1999 instance – down only 12% over the next several months, and of course the instance in late January of this year, which occurred at about 1326 on the S&P 500 and still hasn’t yet resolved into losses beyond the weakness we saw in May. It’s possible that the market outcome will be benign in this case, and that the market will go on to set further bull market highs. We have no intention of taking that improbable gamble in the face of present headwinds.

Strategic Growth and Strategic International continue to be fully hedged, with a staggered-strike option position in Strategic Growth (which raises the strike prices of the put side of our hedge). We presently estimate the time-decay or “theta” of the staggered-strike position at about 0.25% of assets monthly – which we are willing to accept based on the extremely negative outcomes that are typical of the current climate, and the expectation that we will not remain in this position for a long time. Strategic Dividend Value is hedged at about 50% of the value of its stock holdings, and Strategic Total Return continues to carry a duration of just over one year, with about 10% of assets in precious metals shares and a few percent of assets in utility shares and foreign currencies.

Copyright © Hussman Funds

Tags: 10 Year Treasury, Armored Trucks, Bondholders, Commodity, European Stability, Great Depression, Hussman, Hussman Funds, John Hussman, Lows, Receivership, Shiller, Spanish Banks, Spanish Government, Strains, Technicality, Time Interest, U S Treasury, U S Treasury Bonds, Unsecured Debt, Vaults
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Oversold Stocks Piling Up (Bespoke)

Thursday, May 10th, 2012

by Bespoke Investment Group

May 9, 2012

Although the S&P 500 is down less than 5% from its bull market highs, the percentage of stocks that are oversold is really starting to pile up.  Using a boundary of one standard deviation above or below the 50-day moving average as the threshold for being overbought or oversold, 49.4% of the stocks in the S&P 500 are now considered oversold, while just 19.0% of the stocks in the index are overbought.  The chart below shows the daily percentage of S&P 500 stocks that are overbought and oversold.  As shown in the chart, the current level of 49.4% is the highest percentage of oversold stocks in the index since 10/3/11.

Tags: Amp, Bollinger Bands, Bounces, Bull Market, Commodity, Dead Cat, Downward Path, ETFs, European Elections, Futures Market, Hallmarks, Intermediate Term, Investment Group, Market Futures, Moving Average, Nbsp, Next Level, Oversold Stocks, Rebound, Relative Strength, Rubber Band, Selloffs, Standard Deviation, Sunday Evening, Swoons, Threshold, Trough
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Commodity Snapshot (Bespoke)

Wednesday, April 25th, 2012

Below is an updated look at our trading range charts for ten of the most widely followed commodities.  For each chart, the green shading represents between two standard deviations above and below the 50-day moving average.  Moves to the top of or above the green shading are considered overbought, while moves to the bottom or below the green shading are considered oversold.

There are no commodities in rally mode right now, and oil is the only one that’s still holding onto a slight uptrend.  From the precious metals to wheat to orange juice to coffee, everything is currently at the bottom of its trading range.  Are we due for a reversal soon?

Tags: coffee, Commodities, Commodity, Orange Juice, precious metals, Rally Mode, Range Charts, Shading, Snapshot, Standard Deviations, Uptrend, Wheat
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Emerging Markets Radar (April 9, 2012)

Sunday, April 8th, 2012

Emerging Markets Radar (April 9, 2012)

Strengths

• The Hungarian PMI surged above expectations in March to 56.8, the strongest reading in the last thirteen months, reflecting the positive impact of the opening of the brand new Daimler AG plant. The Czech manufacturing PMI has also improved.
• Brazil’s consumer prices rose 0.21 percent in March from February, the government’s statistics agency said in a report distributed in Rio de Janeiro today. Economists surveyed by Bloomberg had expected inflation of 0.37 percent, according to the median forecast of 50 analysts.
• Chilean consumer prices rose 0.2 percent in March from the previous month, less than analysts’ forecast, bringing annual inflation back within the central bank’s target range for the first time in four months.
• China official March PMI was 53.1 versus the estimate of 50.8, rising 2.1 from February; new orders were up 4.1 points at 55.1 percent. Nevertheless, due to seasonality, March’s PMI is usually 3 points better than February’s, therefore, the market is cautious about the better-than-expected PMI for last month. PMI above 50 indicates industrial activities are expanding.
• China’s March non-manufacturing PMI was 58 versus 48.4 in February, indicating consumer consumption may be resilient.
• Philippines inflation eased to 2.6 percent on a year-over-year basis in March from 2.7 percent in February. A base-year comparison suggests inflation in the country will remain subdued in April. However, inflation trends should turn up from mid-year driven by a resumed rise in oil and commodity prices and strengthening domestic demand.
• March housing transactions increased 40 percent in Beijing, and similar increases were also seen in other tier 1 and tier 2 cities. Some analysts say buyers are encouraged by the fact that the Chinese government had historically failed in curbing housing prices, but others say March sales volume is always the equivalent of combined sales of January and February in the year and March of this year didn’t see better volume than prior years.
• Indonesia’s parliament did not pass the fuel raise bill which was to remove the fuel subsidy and raise fuel prices by 33 percent.

Weaknesses

• The Russian central bank chairman said the liquidity deficit faced by the financial industry is the “new norm” this year. One of the reasons is a continued capital outflow. Russians spent $12 billion on foreign property last year, compared with $5.5 billion a year in 2007 and 2008, according to the chairman.
• Colombian policy makers meeting last month were divided over the need to raise interest rates further to keep inflation in check. Analyst Brian Lesmes, at Grupo Bancolombia in Bogota, said that though inflation and credit demand have eased, further tightening may be needed to cool household demand.
• Thailand inflation edged up to 3.4 percent year-over-year in March from 3.3 percent in February, but base-year comparison suggests inflation in the country will remain subdued in April.
• Indonesia is to discuss an export tax on coal and base metals, which is negative for local materials companies but good for global coal and base metal producers.
• Taiwan may implement a capital gains tax on stock trading profits.

Opportunities

• Citigroup Inc. raised South African equities to overweight, the equivalent of a buy, on expected strong earnings growth and companies’ expansion into Africa’s fast-growing frontier markets, the bank said.
• In the last decade, Indonesia has restored stable economic growth and, therefore, has improved its wealth. With opportunities to build vast infrastructures and industrial complex, foreign direct investments (FDI) now are returning to the country. The increasing FDI has driven up demand for industrial estate and building materials, such as cements.

Threats

• Brazil’s tax agency said on Wednesday that intra-company commodities exports and imports by multinational traders must be settled using international prices. The country’s Federal tax authority said the measures are aimed at ending “price manipulation” of inter-company imports and exports that allow multi-national companies to evade local taxes.
• Peru is renegotiating with Mexico to cut natural gas shipments after allocating gas reserves to its domestic industry, a Peruvian government official said. Approximately half of the shipments will be cut, the president of state oil contracting agency Perupetro said this week.
• The Chinese economy is still in the process of a soft landing, but the policy response may fall behind the curve. In 2012, corporate revenue growth is predicted to be much slower than 2011, with gross margins also expected to be lower due to weaker demand and a rise in input costs.

Tags: Beijing, Brazil, China, China Official, Chinese Government, Commodities, Commodity, Commodity Prices, Consumer Consumption, Daimler Ag, Economists, Emerging Markets, Four Months, inflation, Philippines, Pmi, Radar, Rio De Janeiro, Russia, Sales Volume, Seasonality, Statistics Agency, Target Range, Thirteen Months, Tier 2
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Commodity Snapshot (Bespoke)

Thursday, April 5th, 2012

Tags: April, Commodities, Commodity, Copper, Copyright, Corn, Gold, Gold And Silver, Gold Silver, Green Zone, Investment Group, Natural Gas, Orange Juice, Range Charts, Shading, Silver Platinum, Snapshot, Standard Deviations, Trading Ranges, Wheat
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3 Trends to Watch for Global Investors

Thursday, April 5th, 2012

Bloomberg announced over the weekend that China’s manufacturing grew at the fastest pace in a year. We follow the government’s Purchasing Managers’ Index (PMI) closely, as we believe it is a better indicator of China’s domestic demand than the HSBC PMI. Whereas HSBC PMI surveys 400 small and mid-sized companies, which are typically export-oriented, the government’s PMI surveys 820 mostly large, state-owned enterprises across 20 industries.
Though manufacturing activity exceeded analysts’ estimates, some China bears focused on the fact that the March 2012 number is lower than the average during the third month from 2005 through 2011. What’s important for investors to consider is that the trend is your friend: It is the fourth month in a row where the PMI landed above the three-month PMI, and shows the economy is on the right path.

Below are three additional constructive trends we see in China.

1. China Returns Poised to Revert to the Mean

Over the past few years, Chinese stocks have lagged compared to their emerging market peers. However, the Periodic Table of Emerging Markets perfectly illustrates how last year’s loser can be this year’s winner. Historically, every emerging country has experienced wide price fluctuations from year to year. Over time, though, each country tends to revert to the mean.

In the visual below, we highlighted China’s performance pattern over the past 10 years. Chinese stocks landed in the top half four out of 10 years—2002, 2003, 2006 and 2007. In 2003, China climbed an astounding 163 percent; in 2007, it was the top emerging market again, returning nearly 60 percent.
Since then, the country has fallen to the bottom half of the chart. If you apply the principle of mean reversion, history appears to favor China landing in the top half during this Year of the Dragon.

See the original Periodic Table of Emerging Markets here.

2. Liquidity Cycle Could Benefit Stocks

Yet China leaders won’t leave its success to pure luck. If the Dragon doesn’t breathe fire into markets, it may be a shot of liquidity injected by policy easing that could drive stock prices higher. Macroeconomic theory states that when a country’s money supply exceeds economic growth, the excess liquidity tends to drive up asset prices, including stocks.

BCA Research documented this trend in China over the past eight years. The research firm compared the difference between the change in money supply growth and nominal GDP growth and Chinese stock prices. In both instances when the change in excess liquidity fell to a low, so did stocks. Conversely, the rise of money supply growth compared to GDP growth “coincided with major rallies” for China’s stock market, according to BCA.

Today, it appears that the change in excess liquidity is just beginning to bounce off another low, as are stocks, indicating another potential inflection point.

3. Incentive to Maintain Growth

BCA hedges China’s possible stock advancement in the short-term if signs of economic improvement continue because they “reduce the odds of aggressive policy easing.” A few weeks ago, I discussed how investors seemed to overlook China’s focused macro policy strategy, with its actions deliberate and purposeful. This year, the government has extra incentive to sustain meaningful growth as it transitions to a new leadership by the end of the year. As President Hu Jintao and Premier Wen Jiabao depart, Xi Jinping and Li Keqiang are expected to take over.

Looking at historical GDP growth per year since 1978, Deutsche Bank finds there’s precedence for this idea. During the fifth year of the leadership transition cycle, “high or stable” GDP growth was maintained, with the exception being the Asian Financial Crisis in 1997.

These trends will be covered in my upcoming webcast on China with CLSA’s Andy Rothman. Join us as we discuss what investors should expect from China in terms of long-term GDP growth, fixed asset investment, exports and the housing market.

When I was in Singapore at the Asia Mining Congress last week, I was fortunate to be among a group of sharp and intelligent experts across the financial and mining industries. A China bull presenting an excellent case for the country was Jing Ulrich, JP Morgan’s managing director and chairman of China equities and commodities group. She’s the Oprah Winfrey of the investment world, as for the past three years, Forbes Magazine has ranked her among the 50 Most Powerful Women in Business.

Ulrich expressed similar views toward China and its political will in a recent “Hands-On China Report” following her attendance at the China Development Forum in Beijing. She said that the government ministers emphasized their commitment to rebalancing the economy toward consumption. While “fundamentals are currently sound, the nation must modify its ‘imbalanced, uncoordinated and unsustainable’ course of development,” says Ulrich. What investors should remember is that the government had the financial resources to effect this change and considered it important to maintain sustainable growth.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The Purchasing Manager’s Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The Hang Seng China Enterprises Index is a capitalization-weighted index comprised of state-owned Chinese companies (H-Shares) listed on the Hong Kong Stock Exchange and included in HSMLCI index (Hang Seng Mainland Composite Index).

Tags: China, Chinese Stocks, Commodities, Commodity, Dragon, Economy, Emerging Market, Emerging Markets, Estimates, Global Investors, Gold, History China, India, liquidity, Loser, Mining, Pace, Periodic Table, Pmi, Price Fluctuations, Principle, Purchasing Managers Index, State Owned Enterprises, Surveys, Year Of The Dragon
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Drilling into Fuel Prices (Templeton)

Wednesday, April 4th, 2012

by Franklin Templeton Investments

Gasoline, deodorant, dishwashing, liquid, eye glasses, crayons….What does this list of seemingly random items have in common? They are all made from refined crude oil.¹ So even if you don’t feel pain at the gas pump, you probably rely on more products made with or from crude oil than you’d think. And of course even non-oil based products are generally shipped via fuel-consuming transport vehicles, so you’re bound to feel the pinch in the form of fuel surcharges or price hikes sooner or later.

But Beyond Bulls & Bears has never taken a fatalistic view. If volatility can present buying opportunities, surely there’s a possible silver lining to headline-making oil price heights. And so we turn to Fred Fromm, portfolio manager for Franklin Natural Resources Fund and part of the team that manages Franklin Gold and Precious Metals Fund, aka the guy with the inside scoop on all things oil, gold, and even those other less-talked-about commodities.

Fromm in brief:

• U.S. demand for gasoline is actually down, but demand outside the U.S. is strong.
• Geopolitical issues, namely in Iran and Syria, are being factored into oil pricing, but major disruptions may not occur.
• If China’s growth rate could continue indefinitely, its too-strong growth would likely strain commodity supply.
• Supply-demand balance looks tight enough to support gold, but demand can fall quickly and should be closely watched.
• Fromm opts for geographic diversification to avoid the risk of having too many investments in a country with a high degree of political risk.

Oil prices tend to follow a seasonal rise in the summer, but the recent run-up, much like the recent odd weather, has been outside the expected norm. The price of a barrel of crude oil has risen above $100 this year, and the U.S. national average for a gallon of gas rose to $3.867 in mid-March, up more than 30% over last year.¹ All this, and the traditional North American summer driving season hasn’t even started yet. Fromm explains the dance of supply and demand, as he sees it.

“We’re actually seeing U.S. demand down year-over-year for gasoline, but demand outside the U.S. has remained strong. Exports out of the United States have now reached a level we haven’t seen for several decades; we’ve actually become a net exporter of fuel.¹ Of course, we still import quite a bit of crude oil, but demand in Latin America, for instance, is quite robust and they don’t have a lot of refining capacity coming on line there. China’s demand has also remained quite strong, even though there’s a lot of concern about slowing economic growth. In February, China set a monthly record for oil imports.² One of the other factors is supply. Non-OPEC supply continues to disappoint, meaning it’s coming in lower than most people had expected it. And, as a result, that helps keep the supply side fairly tight as well.

And then, of course, there are geopolitical tensions: what’s going on with Iran and the potential for a significant disruption to fuel supply, and also the issues in Syria, which are ongoing. I don’t think we’re going to have a significant disruption, but there is some probability that a disruption could occur. I think that’s being factored into crude oil prices.”

Impact of Chinese Demand

As Fromm mentioned, the impact of Chinese demand is important for the oil market. China is the world’s second-largest consumer of oil, behind the United States,³ and is also a large consumer of other natural resources. That consumption has been an economic driver for suppliers, but it’s also been a source of concern for those who fear China’s consumption will drive up prices and leave the rest of the world with expensive table scraps. Regardless, China’s GDP is anticipated to slow a bit this year from last year’s pace of 9.2%. In Fromm’s view, that’s not necessarily a bad thing, because he does believe commodity supplies would be strained if China sustained its recent high level of demand.

“I think one of the most important things to think about is that China had to slow: as I see it, there’s no way it could continue at the pace that it was growing, indefinitely. The world just does not have enough commodities to supply that level of growth. We do see some risk areas that have been growing quite rapidly, like steel production, which is a factor in iron ore consumption and where China represents a large part of world demand. That is an area, where, even if you see a little bit of slowing, it could have a bigger impact. And it’s one of the reasons why in the fund we tend to focus more on energy, because we believe it’s a more durable commodity in terms of global demand, longer term.

Our main job, as we see it, is to identify the areas that we think are going to be the strongest in terms of the supply-demand balance and then identify the companies that we think are positioned to benefit from that environment. So what we’re trying to do is figure out which commodities we think will be best supported by the environment that we see, and then stay away from those that might suffer from a slower environment.”

A Look at Gold

Gold is another commodity that’s been capturing headlines, perceived as a “safe-haven” asset class by many investors. Gold made a record run in the wake of the 2008-2009 financial crisis. What does Fromm, think of gold? And what is his strategy?

“Gold is probably the most difficult to predict among all of the commodities for various reasons, so we don’t try to come up with a specific commodity price for gold. We use ranges and try to establish a level where we feel its price is well supported. And then we look to see what the gold-based- equities are reflecting, because that’s where we invest. We do not invest in gold bullion itself. The demand side still looks fairly robust around the world, even though we do have to watch that closely because investment demand has become a much bigger portion and that’s something that, as we know, can go away pretty quickly.

But I think the supply side and what’s going on there is more important. It continues to struggle to grow, and what we are seeing right now is that costs are rising significantly, especially for new projects. And what that could mean in the future is that there could be less investment. We’re also seeing a lack of exploration from some of the major mining companies, which could impact supply longer term. So as long as demand stays fairly healthy, and the supply side continues to struggle, we think the supply-demand balance should remain tight enough to support the commodity.

I also think that, as important as how the commodity itself is priced, is what the commodity-based stocks are reflecting, and the equities have significantly underperformed the metal itself over the past year or year and a half. And because of that, in our view, the equities are looking more attractive now. So what we are trying to do is to determine if the metal will be supported at a level that will still make the equities attractive, and we do believe at this time that looks to be the case.”

Geopolitical Risks

Both oil and gold are markets that can be subject to geopolitical risk, which in turn can create price volatility. Vetting each individual company is always a very important part of the investment process, but political unpredictability can add a layer of additional challenges. For Fromm, it boils down to thorough fundamental research and due diligence, which often includes management meetings and site visits in far-flung locales.

“We have analysts going to small countries in Africa.  I’ve been to the interior in China visiting single gold mines. And this is a very important part of the research process. But I think what’s very critical is a company’s management and their ability to find their way through the political landscape in the various countries. And so, therefore, we put a high degree of importance on management’s ability, their experience and track record to not only explore new areas but also deliver on projects.  One of the areas where we are seeing costs really go up is the process of actually bringing production on line at these various mines.

The other factor is diversifying. You obviously don’t want to put all your eggs in one basket and be in too many investments in one country that has a high degree of political risk. You are always going to have some political risk; we even have it here in the United States. But in certain countries it is elevated, and we will attempt to manage that risk through diversification and also through position size. So we will strive to have smaller positions in names that we believe have a higher degree of geopolitical risk.”

Fromm’s philosophy fits with Sir John Templeton’s thoughts on the subject. “No matter how careful you are, you can neither predict nor control the future…so you diversify—by industry, by risk, and by country.”

What are the Risks?

All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.

Franklin Natural Resources Fund: Investing in a fund concentrating in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector. The fund may also invest in foreign stocks, which involve exposure to currency volatility and political and economic uncertainty. The fund’s holdings in smaller companies involve special risks associated with smaller revenues and market share, and more limited product lines. The prices of such securities can be volatile, particularly over the short term. These and other risks are described more fully in Franklin Natural Resources Fund’s prospectus.

Franklin Gold and Precious Metals Fund: Investing in a non-diversified fund involves the risk of greater price fluctuation than a more diversified portfolio. Also, the fund concentrates in the precious metals sector which involves fluctuations in the price of gold and other precious metals and increased susceptibility to adverse economic and regulatory developments affecting the sector. In addition, the fund is subject to the risks of currency fluctuation and political uncertainty associated with foreign investing. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. The fund may also invest in smaller companies, which can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies. These and other risks are described more fully in Franklin Gold and Precious Metals Fund’s prospectus.

² Source: People’s Republic of China, General Administration of Customs.

³ Source: CIA World Fact Book 2010 – 2011.

Tags: China, Commodities, Commodity, Commodity Supply, Demand Balance, Eye Glasses, Franklin Templeton Investments, Fromm, Fuel Prices, Fuel Surcharges, Gallon Of Gas, Geographic Diversification, Geopolitical Issues, Gold, Liquid Eye, Mid March, Mining, Natural Resources Fund, Oil Price, Political Risk, Precious Metals Fund, Price Hikes, Price Of A Barrel Of Crude Oil, Seasonal Rise, Transport Vehicles
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The Fed’s Con Appears To Be Working But The Curtain Is Rising On The Third Act

Wednesday, April 4th, 2012

 
Courtesy of Lee Adler of the Wall Street Examiner

In today’s conomic news, the mainstream media focused on the disappointment surrounding the FOMC Minutes, the massaged and sanitized fairy tale about what the participants said at last month’s FOMC confab. The market was shocked! SHOCKED! that most of the members saw no need for additional QE, unless things got worse. I had concluded that a couple of months ago based on the fact that every time QE speculation arose, not only did stocks rally, but so did energy and other commodity prices. The commodity vigilantes, I thought, would tie the Fed’s hands. That and the fact that the conomic data was coming in relatively perky, at least in terms of the headline data, made it highly unlikely that the Fed would do any more money printing.

But here’s the thing. The minutes are fake. They are fabricated, false, phony, and sterilized garbage, designed for public consumption. To put it bluntly, they’re propaganda. They are what the Fed and Wall Street casino owners want you to think. They are a blatant attempt to manipulate the behavior of market participants through the use of clever turns of phrase. The Fed wants the market to go higher, but it doesn’t want commodities to go with it, so its story line is that the conomy is healthy enough to continue growing without more QE. That gives traders reason to continue buying stocks, and no reason to buy commodities, which everyone “knows” go up when the Fed prints, in spite of Bernanke’s denials. And besides, commodities are up for other reasons, not anything Ben did, according to Ben.

That’s what these “minutes” are about, self justification and market manipulation. We won’t know the real story until February 2018 when the Fed will release the transcripts of this year’s FOMC meetings. Why do they hold them back for at least 5 years? Because the Fed thinks that you can’t handle the truth. The problem is that you can and they just don’t want you to know what it is, because if you did, you’d be able to make informed investment decisions. The decisions the Fed wants you to make are to buy stocks, bay and hold Treasuries, and sell commodities. They tailored the minutes accordingly, so that the headlines would elicit the desired response. They think that they’re Pavlov, and we’re the dogs.

Admittedly, I have not yet read the minutes (I will for this weekend’s Fed Report), but I have read the news headlines. Those headlines are what the Fed-Wall Street-Media-Industrial Complex wants you to think, so you really don’t need to read the minutes. Rest assured that the Fed got the propaganda it wanted. The market reaction it wanted it hasn’t yet gotten, yet, but the Fed is betting that it will, and therein lies the rub. The Fed doesn’t always get what it wants. If traders decide to sell the Dow off 200 points in response to this news, then the next morning, the Fed’s ventriloquist dummy, Jon Hilsenrath, will float another QE3 trial balloon in the Wall Street Urinal.

So we’ll just have to see how traders respond. As for what the Fed really thinks, sorry, that will have to wait 6 years.

Meanwhile, the other datapoint the conomists focused on today was February Factory Orders. This is an item based on a Census Bureau monthly survey of a tiny sampling of US manufacturers that extrapolates that sample into a total dollar estimate of new orders and other metrics. The Bureau reports both the seasonally adjusted result and the actual result, also known as not seasonally adjusted. The only number the pundits and media pay attention to is the seasonally adjusted, fictional number. That’s just wrong, but that’s the way it is. It gives us the opportunity to look at the actual data and know what’s really going on, rather than the smoothed fiction that the Wall Street mouthpieces present on a silver platter as if it’s the grail.

The headline number for February was a 1.3% month to month increase, seasonally smoothed. That was a miss. The conomic consensus was for a gain of 1.5%. But this is a minor item in the conomic firmament–durable goods orders out the week before are more important–and the pundits managed to spin it as bullish anyway. The bullishness is wild and universal, nary a contrarian to be found in the pages of the Murdoch, Bloomberg tout sheets.

The headline number isn’t always wrong or misleading, and as it turns out, the actual, not seasonally adjusted gain in February was impressive, up 4.7% from January and up 10.6% over February 2011, both in real terms adjusted by CPI inflation. The 4.7% monthly gain compared with a decline of 0.7% in February 2011. Over the prior 10 years, monthly changes in February ranged from last year’s -0.7% to a high of +4.9% in February 2004. Any way you slice it this was a good number. Did the warm weather in February have anything to do with that? Certainly, but it’s impossible to say how much. If it pulled demand forward from March and April, we’ll see that in the next month or two.

I thought it would be interesting to overlay the ISM’s not seasonally adjusted New Orders Index on the chart of new factory orders. I am using the factory orders not seasonally adjusted data, but adjusted for inflation in order to see the real change in unit volume over time. The ISMsurvey should lead the Factory Orders. The ISM data is for March. It turns out that the correlation with the between the ISM New Orders Index, and the 12 month rate of change in the Commerce Department’s New Factory Orders data is pretty close. Lately, however, the ISM data suggests greater weakness than has been showing up in the government data. Who’s right? I don’t know, but as with the ISM and the 50 line on its chart, an annual change in factory orders of more than 1 to 2%, tends to correlate with an ongoing uptrend in stocks. It will be time to start worrying when the growth rate closes in on zero. That has correlated with a topping process in stocks.

Real Factory Orders NSA Chart- Click to enlarge

Manufacturing activity lags stock prices. By the time new factory orders go negative, stocks will have already gone through their first leg down.  Consumers and businesses take their cues from the stock market, and the stock market takes its cues from the Fed.

Everybody thinks that Dr. Bernankenstein’s monster alphabet soup experiments, and Henry Paulson’s TARP saved the world from conomic collapse. The fact is that they caused, or at least exacerbated the conomic collapse. Take the manufacturing orders data as an example of how that unfolded.

Fed, Stocks, and Factory Orders Chart- Click to enlarge

The manufacturing conomy was doing just fine until Bernanke stopped feeding the Primary Dealers and actually starved them out early in 2008. He did that by paying for his crazy alphabet soup programs with cash from the Fed’s System Open Market Account. In selling and redeeming Treasuries from the SOMA he radically shrank the cash levels in Primary Dealer accounts, rendering them  unable to maintain orderly markets. The dealers are, after all, not just market makers in Treasuries. They run all the markets, stocks, bonds, commodities, futures, options, everything. They are the big mahoffs of all the markets, and Ben is their banker and bagman.

So manufacturing  was doing just fine in 2007 and 2008 until stocks broke down. Stocks broke because of the combination of the Fed starving out the Primary Dealers in late 2007 and the first half of 2008, followed by Henry Paulson’s bravura panic performance before House and Senate committees, convincing Congress to fund the $700 billion TARP. Bernanke was best supporting actor at those hearings.

Faced with the testimony of the two dynamite strapped suicide extortionists, Congress caved, and the Treasury raised that money in a few short weeks in September and October 2008. That forced the dealers (and others) to absorb $100-200 billion a week of new Treasury supply at a time when the Fed had already cut their balls off. They were in no position to absorb anything.  The Fed had taken their manhood and all their cash.

In order to perform their function as Primary Dealers and absorb that part of the new Treasury supply not purchased by others, the dealers had no choice but to liquidate stocks. Because most economic units, both individual consumers and businesses, base their purchase decisions on the stock market, when it cratered that was their signal to consumers and business to be scared, be very scared, and hunker down in fear in their mental bunkers.

Manufacturing orders were still very strong in June 2008. They didn’t collapse until after Bernanke and Paulson triggered the panic.  In October 2008, they collapsed on the heels of  the Bernanke-Paulson Panic.

The Fed finally figured it out in February 2009, and it started a radical program of pumping hundreds of billions into the accounts of the Primary Dealers with QE1. The stock market and manufacturing orders rebounded almost immediately. When the Fed experimented with withholding funds in mid 2010, stocks plunged and manufacturing activity stalled. Double dip fears exploded and the Fed resumed pumping cash into dealer accounts.

Flash forward to today and the Fed is again on hold, although its MBS replacement purchase program helps to keep the dealers liquid. The effect of that program on dealer accounts is not reflected in the SOMA, but it does send cash to dealer accounts. The effects of the program on stock prices are clear.

The issue now is when will the Fed make its next catastrophic blunder. Just by tapping the brakes on the SOMA, it is creating conditions for another swoon. It is trying to hold back commodity prices while getting the benefit of conomic growth. The problem is that that growth is a second order bubble effect of the rising stock market. If they don’t feed the market, they won’t get their conomic growth. If they do feed the market, commodity prices will explode upward, and that will eventually put a stake in the heart of growth. For now, manufacturing activity is on a growth track. On the surface it appears that the Fed’s propaganda and manipulation is working, but in truth Bernanke has laid the groundwork for the Fed’s next blunder, panic move,  and massive dislocation.

Copyright © 2012 The Wall Street Examiner. All Rights Reserved. This article may be reposted with attribution and a prominent link to the source The Wall Street Examiner.

Tags: Bernanke, Blatant Attempt, Buying Stocks, Casino Owners, China, Commodities, Commodity, Commodity Prices, Conomy, Denials, Fairy Tale, Fomc Meetings, Fomc Minutes, Lee Adler, Mainstream Media, Market Manipulation, Market Participants, Money Printing, Public Consumption, Qe, Self Justification, Street Casino
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Does China Hold the Winning Ticket?

Sunday, April 1st, 2012

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

The odds of winning tonight’s Mega Millions jackpot are 1 in 175,711,536. This remote chance hasn’t stopped people from lining up to buy a ticket, as the “what-if-I-win” idea seems so thrilling.

Some bears may think the odds of China being the winner among emerging markets in 2012 are also remote. Over the past few years, Chinese stocks have lagged compared to its emerging market peers. However, the Periodic Table of Emerging Marketsperfectly illustrates: last year’s loser can be this year’s winner. Historically, every emerging country has experienced wide price fluctuations from year to year. Over time, though, each country tends to revert to the mean.

In the visual below, we highlighted China’s performance pattern over the past 10 years. Chinese stocks landed in the top half four out of 10 years—2002, 2003, 2006 and 2007. In 2003, China climbed an astounding 163 percent; in 2007, it was the top emerging market again, returning nearly 60 percent.

Since then, the country has fallen to the bottom half of the chart. If you apply the principle of mean reversion, history appears to favor China landing on top during this Year of the Dragon.

See the original Periodic Table of Emerging Markets here.

Unlike the lottery system, China won’t leave its success to pure luck. If the Dragon doesn’t breathe fire into markets, it may be a shot of liquidity injected by policy easing that could drive stock prices higher. Macroeconomic theory states that when a country’s money supply exceeds economic growth, the excess liquidity tends to drive up asset prices, including stocks.

BCA Research documented this trend in China over the past eight years. The research firm compared the difference between the change in money supply growth and nominal GDP growth and Chinese stock prices. In both instances when the change in excess liquidity fell to a low, so did stocks. Conversely, the rise of money supply growth compared to GDP growth “coincided with major rallies” for China’s stock market, according to BCA.

Today, it appears that the change in excess liquidity is just beginning to bounce off another low, as are stocks, indicating another potential inflection point.

BCA hedges China’s possible stock advancement in the short-term if signs of economic improvement continue because they “reduce the odds of aggressive policy easing.” A few weeks ago, I discussed how investors seemed to overlook China’s focused macro policy strategy, with its actions deliberate and purposeful. This year, the government has extra incentive to sustain meaningful growth as it transitions to a new leadership by the end of the year. As President Hu Jintao and Premier Wen Jiabao depart, Xi Jinping and Li Keqiang are expected to take over.

Looking at historical GDP growth per year since 1978, Deutsche Bank finds there’s precedence for this idea. During the fifth year of the leadership transition cycle, “high or stable” GDP growth was maintained, with the exception being the Asian Financial Crisis in 1997.

When I was in Singapore at the Asia Mining Congress this week, I was fortunate to be among a group of sharp and intelligent experts across the financial and mining industries. One China bull presenting an excellent case for the country was Jing Ulrich, JP Morgan’s managing director and chairman of China equities and commodities group. She’s the Oprah Winfrey of the investment world, as for the past three years, Forbes Magazine has ranked her among the 50 Most Powerful Women in Business.

Ulrich expressed similar views toward China and its political will in a recent “Hands-On China Report” following her attendance at the China Development Forum in Beijing. She said that the government ministers emphasized their commitment to rebalancing the economy toward consumption. While “fundamentals are currently sound, the nation must modify its ‘imbalanced, uncoordinated and unsustainable’ course of development,” says Ulrich. Importantly, the government had the financial resources to effect this change and considered it important to maintain sustainable growth, writes Ulrich.

The ups and downs of this road toward a consumption-led economy are topics I’ll cover in next week’s webcast on China. I will be joined by CLSA’s Andy Rothman. Together, we’ll discuss what investors should expect from China in terms of long-term GDP growth, fixed asset investment, exports and the housing market. Be sure to sign up now.

Copyright © U.S. Global Investors

Tags: Asset Prices, Chief Investment Officer, China, Chinese Stock, Chinese Stocks, Commodities, Commodity, Emerging Market, Emerging Markets, Excess Liquidity, Frank Holmes, Gold, India, Lottery System, Macroeconomic Theory, Mega Millions, Mining, Money Supply Growth, Nominal Gdp Growth, Periodic Table, Price Fluctuations, Ris, Stock Prices, Theory States, U S Global Investors, Year Of The Dragon
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