The Ins and Outs of Physically Backed Commodity ETFs

Wednesday, March 17th, 2010

This article is a guest contribution by Tom Lydon, ETFTrends.com.

Commodity exchange traded funds (ETFs) have attracted a rabid investor following in a relatively short period of time. To play in the commodity sandbox before ETFs came along, you needed risk tolerance and capital. Today, you just need desire.

Last week, we discussed physically backed ETFs, which are just as the name implies: each share is backed by a physical product. Right now, physically backed ETFs only give exposure to precious metals. You won’t find an ETF backed by barrels of oil or livestock. [4 Types of Commodity ETFs.]

Physically backed ETFs have a special appeal to smaller investors who either lack the space for storage, or the inclination to hunt down and pay for storage themselves. In ETFs backed by physical metals, all you need to do is show up and buy a share. The rest is taken care of for you. [Contango and What You Can Do About It.]

These ETFs tend to correlate more closely to the spot price than commodity funds that hold equities or futures. The taxes are a bit different, too: profits in bullion-based ETFs are taxed at 28% (but consult your personal tax professional for specific advice). [ETFs and Taxes: What You Should Know.]

Physically backed commodity ETFs also enjoy the other benefits of ETFs, including cost-efficiency, tax efficiency and transparency (the bullion holdings in these funds are subject to regular audits and the results are posted on the ETF provider’s website).

For more stories about commodity ETFs, visit our commodity ETFs category.

• SPDR Gold Trust (NYSEArca: GLD)
• ETFS Physical Platinum (NYSEArca: PPLT)
• iShare COMEX Gold Trust (NYSEArca: IAU)
• ETFS Physical Palladium (NYSEArca: PALL)
• iShares Silver Trust (NYSEArca: SLV)
• ETFS Silver Shares (NYSEArca: SIVR)
• ETFS Gold Shares (NYSEArca: SGOL)

Tags: Audits, Bullion, Comex Gold Trust, Commodity Etfs, Commodity Exchange, Commodity Funds, Commodity Gold, Cost Efficiency, ETF, Exchange Traded Funds, Gold, Gold Shares, Inclination, Ins And Outs, Ishare, Palladium, Personal Tax, Physical Metals, precious metals, Risk Tolerance, Sandbox, Tax Efficiency
Posted in Markets | No Comments »

Confessions of a Bull.

Tuesday, March 9th, 2010

This article is a guest contribution from John Thomas, madhedgefundtrader.biz, via ZeroHedge.com

Confessions of a Bull. Barton Biggs, founder of mega hedge fund Traxis Partners, spent an hour outlining his current investment strategy with me. Barton is a man of strong opinions, backed with intensive research, which he communicates with his characteristic gravel voice. I spent the better part of the eighties debating every pebble of the investment landscape with Barton. As I recall, “what to do about Japan?” was the topic of the day, and I was bullish.

Today, Barton can say with “real certainty” that large cap multinational equities are the cheapest they have been in 30 years using sophisticated models that analyze price/sales, price/free cash flow, price/earnings, and a whole host of other metrics. Looking just at price/book ratios, these stocks have been this cheap only three times in the last 120 years.

Big cap technology stocks, like Microsoft (MSFT), Intel (INTC), Cisco (CSCO), and Oracle (ORCL) are at the top of his list. Other multinationals with plenty of emerging market exposure are attractive, such as Caterpillar (CAT). The easy way in here is to simply buy the S&P 100 ETF (OEF). The market is now at a 15-16 multiple, discounting S&P 500 earnings for 2010 at $75/share. A stronger than expected economy will take that figure as high as $90/share, which the market is not expecting at all.

Microsoft Corpora - MSFT	29.63		+0.00
Intel Corporation - INTC	22.24		+0.00
Cisco Systems, In - CSCO	26.26		+0.00
Oracle Corporatio - ORCL	25.47		+0.00
Caterpillar, Inc. - CAT	60.22		+0.00
iShares S&P 100 - OEF	53.58		+0.00

The grizzled old Wall Street Veteran sees the US as half way through an economic recovery, and the main benchmark indexes could surprise to the upside, as they have such heavy big cap weightings. He would avoid domestic companies, such as those in real estate, as the environment for stocks generally is poor. He foresees a “new normal” of a lot of volatility in stocks for the next 4-5 years. Longer term he sees US GDP growth downshifting from the heady 3.8% annual growth rate of the last decade to only 2.5 % in this one. But big cap multinationals should be able to bring in a reliable 5%-6% annual return on top of inflation.

Looking at the world as a whole, Barton thinks Asia is the place to be. A mammoth bubble may be developing in China (FXI), but it is at least 3-5 years off, and there will be plenty of money to be made until then. India (PIN) is another big pick because it is ten years behind China, and has yet to experience its big growth spurt. South Korea (EWY), Thailand (THD), Taiwan (EWT), H-shares in Hong Kong (EWH), and Turkey (TUR) are also lining up in Barton’s sites. Looking at a 1%-1.5% growth rate, things look grim for Europe, with the possible exceptions of Poland (PLND) and Russia (RSX). Traxis is short Brazil (EWZ), because it has already had a great run, and because the country still faces some severe social problems.

IShares Trust ISh - FXI	41.62		+0.00
BMO CHINA EQUITY - ZCH.TO	14.72		+0.00
ISHARES CHINA IND - XCH.TO	20.28		+0.00
TAO.TO - TAO.TO	0.00		+0.00
PowerShares Excha - PIN	22.39		+0.00
ISHARES S&P CNX N - XID.TO	20.63		+0.00
BMO INDIA EQUITY - ZID.TO	14.49		+0.00
iShares Trust (Ba - EWY	49.43		+0.00
iShares Trust iSh - THD	46.42		+0.00
iShares Trust (Ba - EWT	12.54		+0.00
iShares Trust (Ba - EWH	16.35		+0.00
iShares Trust iSh - TUR	55.15		+0.00
Market Vectors Po - PLND	25.74		+0.00
Market Vectors Ru - RSX	33.86		+0.00
iShares Trust (Ba - EWZ	73.57		+0.00

Commodities had their run last year, and won’t do much from here, but they aren’t going to crash either. He sees oil (USO) grinding up because the cost of new sources is becoming astronomically high. Barton avoids gold because it has no yield or PE, and would rather not be associated with the crazies that inhabit that space. Bonds (TBF) will be deflation driven for the next year, but are definitely not for your “Rip Van Winkle” investor, as they represent poor value for money. Real estate is dead money. To hear my interview with Barton at length on Hedge Fund Radio, please click at http://www.madhedgefundtrader.biz/Barton_Biggs.html

For more iconoclastic and out of consensus analysis, you can always visit me at www.madhedgefundtrader.com , where the conventional wisdom is mercilessly flailed and tortured daily.

Source: Zerohedge.com, March 9, 2010.

Tags: Barton Biggs, Cap Technology, Caterpillar Cat, China, Cisco Csco, Commodities, Downshifting, Emerging Markets, ETF, Free Cash Flow, GDP Growth, Gravel Voice, India, Intc, Intensive Research, Investment Landscape, Last Decade, Market Exposure, Msft, oil, Oracle Orcl, Price Earnings, Sophisticated Models, Street Veteran, Technology Stocks, Traxis Partners
Posted in Emerging Markets, India, Markets | No Comments »

Gold bullion – advancing in all currencies

Thursday, March 4th, 2010

The gold price is not only making headway in US dollar terms, but also in most major (and minor) currencies as illustrated by the table and graph below. Bullion veterans will recognise this phenomenon as a manifestation of solid investment demand (and a vote of no confidence in fiat paper per se).

The picture and the numbers tell the full story.

Source: Plexus Asset Management (based on data from I-Net Bridge).

Source: Plexus Asset Management (based on data from I-Net Bridge).

Illustrating the message even more vividly is the chart below of gold expressed in a basket of emerging-market currencies by dividing the dollar bullion price by the Wisdom Tree Dreyfus Emerging Currency ETF (CEW). Also note that the chart has again climbed back to above its 50-day moving average line.

Source: StockCharts.com

I remain bullish on gold in the medium term, especially as I believe the vast money printing by central banks could set off strong inflation pressures down the road. I will not be surprised to see bullion remaining in a secular uptrend for some time to come. Add bullion to your portfolios but, given the notorious volatility of the metal, only do so on pullbacks.

Tags: Bullion Price, Central Banks, Dollar Terms, Dreyfus, Emerging Market, ETF, Gold, Gold Bullion, Gold Price, Headway, Inflation Pressures, Investment Demand, Line Advertisement, Line Source, Medium Term, Minor Currencies, Money Printing, Pullbacks, Solid Investment, Story Source, Uptrend, Vote Of No Confidence, Wisdom Tree
Posted in Markets | No Comments »

IMF Gold Sales v. the Alchemy of Gold Futures – What’s the Impact on Gold Prices?

Thursday, February 18th, 2010

This article is a guest contribution by J.S. Kim, of SmartKnowledgeU™.

The recently announced IMF sale of 191.3 tonnes of their gold reserves, though it caused an immediate sharp knee-jerk reaction in gold futures markets, will have a negligible effect on the long-term price of gold. Here’s why.

In December, 2009 the commercial bullion banks that serve as agents for the leading Western Central Banks were net short 303,791 contracts of gold. Each COMEX gold futures contract represents 100 troy ounces, so the Commercials were net short 30,379,100 troy ounces of gold. With the average price of gold $1,134.72 per troy ounce in December 2009, this net short commercial position represented $34.47 billion worth of gold. There are 32,150.74533 troy ounces in one metric tonne. So 30,379,100 troy ounces/ 32,150.74533 troy ounces = 944.90 metric tonnes of gold. Since gold contracts are supposed to be good for physical delivery, the commercial bullion banks that were short nearly 38% of annual world production of gold this past December should have had 944.90 physical metric tonnes of gold in their vaults to back up their short position at that time. In reality, this situation never exists.

The amount of physical gold that the COMEX delivers on a daily basis is negligible compared to the massive historical short positions that have existed for decades. For example, during a two-week span across January and February, COMEX arranged for the physical delivery of 543,500 troy ounces of gold with their contracted warehouse depositories, a figure that represents an average of just 38,786 troy ounces of gold per day. At this rate of daily delivery, it would take the COMEX more than two years to deliver all the gold represented by the current net commercial short position should the holders of long contracts ask for settlement in physical delivery.

Through the use of futures markets, the Commodities Futures Trading Commission (CFTC) has granted bankers a mechanism to perform alchemy and turn paper into gold on the COMEX by allowing them to establish obscene short positions that represent 25% to nearly 40% of annual gold production at times while simultaneously allowing them to renege on their fiduciary responsibility to actually physically possess the gold represented by their short positions. In other words, the CFTC has allowed gold to operate under the principles of the fractional reserve banking system on the COMEX futures markets. As I stated above, the net short position of the commercials in gold represented more than 30 million troy ounces yet for the past few months they almost never exceeded delivery of 0.2% of their short position on a daily basis. Many people would refute this argument by stating that COMEX only delivered a minute fraction of physical gold represented by this obscene short position because no institution asked for substantial physical delivery of their long contracts. While it is true that less than 1% of most commodity futures contracts are ever settled by physical delivery, futures markets should not exist to serve the purpose of distorting the underlying reality of supply-demand fundamentals of the actual physical commodity. With gold and silver, this has been the case for decades.

However, the real question should be, “If I asked for physical delivery of an amount of gold that I should be able to receive, would I receive it?” Why? If you were India, China or the United Arab Emirates and you wanted to buy 200 tonnes of gold at the price established in futures markets, but you knew that there was no possible situation whereby 200 tonnes of gold would ever be delivered to you via the futures markets, what would you do? Would you buy 200 tonnes of gold in the futures markets only to know that you would suffer a default of this delivery and likely be forced to pay a much higher price in the open market in the future or would you try to arrange to buy 200 tonnes of gold NOW from the IMF or another Central Bank? Of course, you would choose the latter tactic. The fact that gold cannot be printed out of thin air is the essential quality that makes gold as a form of money much more sound than the Euro, the dollar, the Yen or any other form of fiat currency.

However, tens of billions of dollars of gold exist only in digital form on the COMEX and the CFTC has allowed bullion banks to indeed achieve alchemy with gold (and silver) in the futures markets. By allowing these mechanisms to persist that have absolutely zero to do with physical supply and demand of gold and silver, bullion banks can suppress the price of paper gold and paper silver in futures markets. But in the end, they will never be able to perpetually suppress the price of real physical gold and real physical silver. There will come a time when the prices for real physical gold and real physical silver completely sever the already tenuous umbilical cord they maintain to the suppressed prices of gold and silver established by the agent bullion banks of the US Federal Reserve and the Bank of England in futures markets.

As of February 17, the CME warehouse report stated that their depository warehouses contained 1,645,000 troy ounces of registered gold and 8,292,887 troy ounces of eligible gold. Only two of their depository warehouse have significant amounts of physical gold worth mentioning, HSBC, with 4,311,493 ounces of eligible gold and 266,677 troy ounces of registered gold; and Scotia Mocatta with 3,826,013 ounces of eligible gold and 936,855 troy ounces of registered gold. What does “registered” and “eligible” gold mean? As in everything bankers do, these terms are meant to confuse the average person. Central Bankers have used the same tactics to obscure their true holdings of gold reserves by alternately labeling their gold reserves as Bullion Reserve, Custodial Gold Bullion Reserve, and Deep Storage Gold, without granting any transparency to the definitions of their gold stores whenever they arbitrarily reclassify them with different names.

“Registered” gold is gold that has been assigned ownership and cannot be sold to another party while “eligible” gold is gold awaiting registration or delivery. In other words, a large portion of “eligible” gold may not be eligible at all. Furthermore, there are many questions regarding the “registered” gold that these depository warehouses hold as to whether multiple claims exist upon this “registered” gold. Many may say that questioning the validity of “registered” gold is non-justified paranoia, but the historical deceit of bankers justifies our skepticism, not our trust, in them. Just as multiple claims exist upon every single dollar, Euro, pound and yen that shows up in your savings or checking deposit bank passbook, I still believe that the gold listed as “registered” gold may have multiple owners as well (When it comes to the money in your bank savings and checking accounts, you may have the only claim on the digital representation of the cash money that exists in your bank savings and checking accounts, but that digital representation, since it has not yet been printed in cash, is an abstract concept that exists only in your mind and not in real life).

Though “registered” gold represents gold that has already been assigned to someone, unless that physical gold is in your hands, this does not preclude the fact that bankers may have assigned this “registered” gold to “multiple” owners no matter what they claim. Remember if one reads the fine print of the prospectuses of the GLD and SLV paper ETFs, it seems very likely that multiple claims exist on the physical gold and silver that back both the GLD and SLV even though the vast majority of buyers of these ETFs believe otherwise.

Last week’s Commitment of Traders report indicated that commercial bullion banks were still net short 21,342,700 troy ounces of gold. Given the definitions of “registered” and “eligible” gold, and the amounts of registered and eligible gold that exist in COMEX depository warehouses, it is obvious that bullion banks short gold with zero intention of ever physically delivering well over 90% of the gold ounces they short, even though market mechanisms require them to have the physical capacity and means to do so. Thus, if China, India or any number of Sovereign Wealth Funds wanted to buy another 1000 tonnes of gold, it would be physically impossible for them to even partially fulfill this desire. The 663.83 metric tonnes of gold that are currently represented by the physical offset of the current net short positions of the commercials that is supposed to be physically sitting in the vaults of depository warehouses contracted out by COMEX simply is not there. Furthermore, what is “eligible” for delivery may not even be eligible, and multiple claims may exist on both “eligible” and “registered” gold that exists in the contracted depository warehouses.

In the end, the announced IMF sale of 191.3 tonnes of their gold reserves, though it caused an immediate sharp knee-jerk reaction in gold futures markets, will have a negligible effect on the long-term price of gold. The IMF stated that “it would stagger the sales in order not to affect the markets too much”. However, since sovereign state buyers of gold can not get anywhere near the tonnage of gold they desire from the futures markets, the reality is that the IMF could probably dump all 191.3 tonnes on the market in one month and it would be instantly absorbed by China, India and Middle Eastern sovereign funds before any other Central Banks that also wants in on the sale could get their hands on any of it.

More than a year ago, I wrote an article describing the beginning of a disconnect between gold futures markets in Asia with those in London and New York, as well as the disconnect between physical gold and silver prices with the spot prices established in the futures markets in London. Eventually, due to the fraudulent nature of the gold and silver futures markets that have nothing to do with the physical supply and demand of the underlying commodities and everything to do with the desire of the US Federal Reserve and the Bank of England to suppress gold and silver prices, I believe that this disconnect will widen until there is an eventual total disconnect between the AM and PM London Price Fixes for gold and silver and the actual prices demanded by bullion dealers for real physical gold and real physical silver.

About the author: JS Kim is the Managing Director & Chief Investment Strategist for SmartKnowledgeU™, a fiercely independent wealth consultancy company with zero affiliations with the commercial investment and banking industry. Our independence allows us to critically analyze macroeconomic conditions with a completely unbiased eye, a crucial factor in a market where government intervention into free markets is heavily influenced by their friendly relationships with the investment and banking sector.

Tags: Bullion Banks, Central Banks, Comex Gold Futures, Commercial Position, Commodities Futures Trading, Commodities Futures Trading Commission, Daily Basis, Emerging Markets, ETF, Futures Commodities, Futures Contract, Futures Markets, Futures Trading Commission, Gold, Gold Prices, Gold Reserves, Imf Gold Sales, India, Knee Jerk Reaction, Metric Tonne, Metric Tonnes, Physical Delivery, physical gold, Price Of Gold, Troy Ounce, Troy Ounces
Posted in Emerging Markets, India, Markets | No Comments »

Michael Belkin’s Model Points Up for Stocks

Tuesday, February 2nd, 2010

Kate Welling of welling@weedon has just conducted another of her top-class interviews with Michael Belkin. Belkin is the author of The Belkin Report that I used to read regularly, but have had difficulty in obtaining over the past two years or so. He has a huge reputation among institutional investors and got his calls right more often than not when I still had access to his material.

Friend Barry Ritholtz (The Big Picture) provides some insight into Belkin’s latest thinking with the following excerpts from Welling’s report:

“Where my views are probably different to what some of the higher profile names are currently saying is that I’m not pointing to the equity market now as the source of a bubble or of malinvestment, in Austrian terms.

“If not the stock market, where are you pointing?

“At the bond market. Specifically, since the March 20, 2009 turning point in the equities market, if you look at the AMG weekly data on inflows into ETFs and mutual funds, bond fund flows have been positive every week and have averaged $4 billion a week. There hasn’t been a single down-week. But meanwhile, for equity funds, there’s been a completely different pattern. They’ve been down two weeks, up one week, then down, up four weeks, down five weeks - and the average inflow is only $500 million a week.

“Just barely positive?

“Yes, at last count only $24 billion had gone into all kinds of equity funds over this entire recovery rally, versus $178 billion into bond funds. I’ve been looking at this for quite a while and sort of scratching my head and wondering what was going on. But finally it just occurred to me. They’re buying bonds. It’s rather obvious. I think what has happened is that the public in previous cycles bought emerging-market funds or internet stocks or whatever, when the Fed would lower interest rates to an artificially low level, thereby penalizing people on their savings. So right now, for instance, I have friends who inherited a lot of money and I’m an informal advisor to them, not a paid advisor. They keep asking me, what do I do now? They were investing in CDs, which were parceled out to a lot of different banks on which they were making 2, 3, 4%. But now they’re maturing and the banks are offering, like, nothing. So they are asking, what do we do, what do we do? They need the yield; they need income; they don’t want to lose the nominal principal. What to do? What to do?”

“Belkin’s time series regression analysis is not only data driven, but he is also aware of historical predecessors. I find his argument that bonds are at greater risk than stocks to be very counter-intuitive, contrary - and compelling,” added Ritholtz.

Source: Barry Ritholz, The Big Picture, February 1, 2010.

Tags: Barry Ritholtz The Big Picture, Bond Fund, Bond Funds, Bond Market, Class Interviews, Emerging Market Funds, Equity Funds, ETF, Friend Barry, Fund Flows, Funds Bond, Inflow, Institutional Investors, Internet Stocks, Michael Belkin, Model Points, Mutual Funds, Profile Names, Stock Market, Turning Point, Weedon
Posted in Markets | No Comments »

Gold Market Highlights

Monday, February 1st, 2010

Gold Market
For the week, spot gold closed at $1,081.28 per ounce, down $11.92, or 1.09 percent. Gold equities, as measured by the Philadelphia Gold & Silver Index (XAU), fell 6.83 percent for the week. The U.S. Trade-Weighted Dollar Index (DXY) climbed 1.52 percent.
Strengths

• Investment demand for gold continued to be robust. The World Gold Council said investors bought 30 metric tons via exchange-traded funds in the fourth quarter of 2009, contributing to an overall total of 1,762 metric tons of ETF holdings for the year.
• The China Gold Association said China’s gold output jumped 11.3 percent to a record of 314 metric tons in 2009, securing its position as the world’s largest gold producer for the third straight year.
• India started the year on a positive note by importing 35 to 40 metric tons of gold during the first 27 days of January, up from 9.8 metric tons last January. Stable prices have given 2010 a good start to gold demand, the Bombay Bullion Association said.

Weaknesses

• Gold was negatively impacted during the week by offloading of positions based on sluggish global cues.
• President Obama’s spending freeze for several federal departments, and the Commerce Department’s announcement that the U.S. economy grew at a 5.7 annual rate in the fourth quarter of 2009, were also supportive in a market environment where sovereign risk and financial imbalances are key concerns.
• The Office of Fair Trading is conducting a probing investigation on several companies in the “cash for gold” industry after complaints from customers show they were not offered fair values for their mailed-in jewelry.

Opportunities

• Research from Cormark Securities shows that global gold production peaked in 2001 at 2,600 metric tons. World output has been steadily declining from that point because of lower grades and higher capital costs that are making it uneconomic for producers to bring new gold onto the market.
• A bullion analyst in Beijing said the high price of gold is not deterring investors from the yellow metal as it does in India and the Middle East. Global investors Jim Rogers and Marc Faber have said that falling Chinese equity markets present good gold-buying opportunities.
• The U.S. Federal Deposit Insurance Corporation is planning to securitize more than $36 billion in assets from failed banks, and auction them off in a bond offering to help cushion the ailing mortgage backed security market.

Threats

• Bank of America-Merrill Lynch analysts believe that policy risk and government intervention remain the largest two risks to the economic outlook in 2010.
• Economist Nouriel Roubini said he is pessimistic on the eurozone and that Spain poses a serious threat because of its fiscal imbalance. Spain is the region’s fourth largest economy with the unemployment rate of 19 percent, double the EU average. Rising sovereign risk may cause a flight of capital into the refuge of the U.S. dollar.
• The World Bank said commodity growth will be restricted for the next two years as a result of a low-growth economic environment. It has forecast global GDP growth of 2.7 percent this year, followed by 3.1 percent in 2011.

Tags: China, China Gold, Commodities, Cormark Securities, Dxy, Emerging Markets, ETF, Global Gold, Gold, Gold Demand, Gold Equities, Gold Industry, Gold Market, Gold Output, Gold Producer, Gold Production, India, Investment Demand, New Gold, Philadelphia Gold, Price Of Gold, Silver Index Xau, Sovereign Risk, Spot Gold, Stable Prices, World Gold Council
Posted in Emerging Markets, India, Markets | No Comments »

Global Stock Markets: Performance Round-up

Sunday, January 31st, 2010

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

Click here or on the table below for a larger image.

The nascent stock market correction gained momentum over the past week on the back of growing concerns about sovereign debt issues, the sustainability of the global economic recovery and Chinese policy tightening. The MSCI World Index and the MSCI Emerging Markets Index declined by 2.6% and 3.1% respectively during the past week, taking the losses for January to 4.2% and 5.6%. Among mature markets, the Scandinavian bourses and Belgium bucked the trend, whereas Russia, Venezuela and Chile returned positive numbers among developing markets.

Top-performing indices this week were Estonia (+11.4%), Lithuania (+8.2%), Bangladesh (+5.7%), Slovakia (+3.5%) and Ukraine (+3.3%). At the bottom end of the performance rankings, countries included Luxembourg (-4.8%), South Korea (-4.7%), China (-4.5%), Japan (-3.7%) and Austria (-3.4%).

Notwithstanding the huge rally since the March lows, only the Chile Stock Market General Index - again a solid performer as a result of a positive assessment of Sebastian Pinera’s election victory - has been able to reclaim its 2007 pre-crisis peak and is now trading 8.8% higher.

As far as the US indices are concerned, Wall Street closed on a weak note, reversing gains of earlier in the week to record a third consecutive down-week. All ten economic sectors (as measured by the SPDR exchange-traded funds [ETFs]) closed lower, with the defensive sectors outperforming the cyclical ones.

The major moving-average levels for the benchmark indices are also given in the table above, with most trading below their 50-day moving averages. With the exception of the Chinese Shanghai Composite Index, all the indices are still trading above the key 200-day moving averages.

Of the 99 stock markets I keep on my radar screen, 40% recorded gains, 55% showed losses and 5% remained unchanged. The performance map below tells the past week’s rather bearish story.

Emerginvest world markets heat map

Source: Emerginvest (Click here to access a complete list of global stock market movements.)

Tags: Austria 3, China, Chinese Policy, Debt Issues, Economic Sectors, Election Victory, Emerging Markets, ETF, Exchange Traded Funds, Global Stock Markets, Mature Markets, Moving Averages, Msci Emerging Markets, Msci Emerging Markets Index, Msci World Index, Performance Rankings, Radar Screen, Sebastian Pinera, Shanghai Composite Index, Showe, Sovereign Debt, Spdr, Stock Market Correction
Posted in Markets | No Comments »

Marc Faber 2010 Outlook: Go For Gold, Oil & Agriculture, But Watch Out For PIIGS & U.S. Equities

Wednesday, January 20th, 2010

Here is the summary and my thoughts on a trio of Dr. Marc Faber’s latest interview where he discussed his 2010 outlook on China bubble, sovereign default risk, stocks and commodities.

Faber is most famous for advising his clients to get out of the stock market one week before the October 1987 crash. News just broke that Faber, a famed contrarian investor often known as Dr. Doom, has joined Sprott Inc. SII-T as director and member of the money management firm’s audit committee.

Euro Death By PIIGS

Faber believes the countries most likely to blow up are the “PIIGS”: Portugal, Ireland, Italy, Greece, and Spain. One or more of them will likely default in the next couple of years, which could mean the death of Euro.

Debt Interest Costs to Triple

According to Faber, the U.S. annual interest costs, currently around 12% of the government’s tax revenue, will soar to 35% of tax revenue within five years. This will force the government to cut spending (an unlikely scenario), and/or frantically print more money

U.S. & Japan - Default in 5 to 10 Years

Excessive money printing and debasing of the Dollar would most likely result in the United States defaulting on its debt within 5 -10 years Japan could face the same fate as well. (See more U.S. debt crisis charts from Faber here.)

Note: Jim Rogers sees U.K as in danger of an implosion as well.

U.S. Stocks - Correction Coming

After noting in his January 2010 newsletter that he was bullish on U.S. stocks, Faber changed his mind after participating in Barron’s round-table discussion. Faber says the overly bullish consensus worries him.

He now believes a correction in U.S. stocks could come much sooner than most expect as momentum players could “pull the trigger relatively quickly.” Faber is now looking at a 5%-10% rate of return for global investors.

Bonds

Bonds could be in for a rebound near term, but longer term, investors should look for exit opportunities in Treasuries.

Note: Jim Rogers also sees the U.S. government bond as overpriced and “in a bubble”.

Asia

Asia is likely to have longer term favorable growth. Faber favors India and Japan. In a December 2009 interview with Economic Times, Faber liked Japan as a contrarian play for 2010.

China Bubble

Faber indicated it is difficult to pinpoint a day when China will implode. But he does not think it will happen right away. However, when it does happen, investors can expect a hit on commodities and emerging markets.

Gold

Gold is going through a correction phase and probably will test the lows of $1,050 or $1,100 levels, but is still a long term buy through exploration companies and physical gold holdings.

Crude Oil

Prices may come off somewhat. Marginal cost of finding oil is around $70. Longer term, prices are expected to continue rising as demand increases from the developing world.

Agriculture Commodities

In the short term, Faber likes wheat as it is “very, very cheap”. But he advises against buying the wheat ETFs because they’re “very expensive” due to the rollover costs. Instead, he suggests play it through companies with farm land and plantations or potash companies.

China Bubble? Views from Rogers & Mobius

“China Bubble” has been in the media headline a lot lately; whereas in fact, the liquidity bubble created by the central banks’ loose money policy could easily trump China as the biggest bubble in the world most likely to burst first.

Investment guru Jim Rogers, while acknowledging Shanghai and Hong Kong property is in bubble during a Bloomberg interview today, debunked James Chanos yesterday, as quoted by China Daily, saying:

“It is absurd to say China is in a bubble when the stock market is 50 to 60 percent below its all-time high….After 300 years of decline everything is coming together for China in the 21st century”

Meanwhile, Dr. Mark Mobius, who oversees $34 billion of developing-nation assets at Templeton Asset Management Ltd., said Jan. 7 the bubble in China’s property market isn’t about to burst, and that

“The Chinese will act rationally and they’re not going to kill the market…There’s still a lot of savings in China. Prices are high but I don’t see a crash.”

My Take on The China Bubble

As stated in my article - China Is No Dubai or Enron.

“Overinvestment and overbuilding is sometimes a prerequisite of an anticipated mass urban migration such as the one China is destined to experience.”

Beijing is taking measures to prevent a bubble-burst predicament ahead of the U.S. and most of the industrialized countries. Unlike Dubai or Enron, the country is in a better position, with tremendous resource at its disposal that could power through a bubble or two.

Moreover, whether there is a bubble to burst in China is still a matter of great debate among market pundits, as cited here.

My Thoughts on U.S. Equities

The CBOE Volatility Index (VIX) of S&P 500 options fear gauge has crashed more than 63% over the last 12 months and down 18% this month alone, retreating to pre-Lehman levels. Though the VIX index roared 6.14% to 18.66 today, it has trended consistently lower since late 2008. This is causing a great deal of consternation among some investors that the higher investor complacency level is a signal that equity prices are peaking.

The equity market, particularly tech and financials, is quite vulnerable as the current valuation suggests a high earnings expectation, which will most likely disappoint this year in the context of a still hazy global recovery picture, and weak consumer spending. The earnings release and outlook from Citigroup, Inc. (C) & JP Morgan Chase (JPM) and IBM Corp. (IBM), etc. this week do not seem to have suggested otherwise.

So, it is quite sufficient to say when complacency and speculation has returned en masse, commodities and emerging markets will likely to be better bets than U.S. stocks and bonds.

And as the famous Wall Street adage goes, “VIX low, time to go”.

Video Source: Yahoo TechTicker

Tags: Bullish Consensus, China, Commodities, Contrarian Investor, Debt Crisis, Debt Interest, Default Risk, Dr Doom, Dr Marc Faber, Emerging Markets, ETF, Euro Debt, Global Investors, Gold, Implosion, India, Interest Costs, Ireland Italy, Italy Greece, Jim Rogers, Money Management Firm, Money Printing, oil, Rate Of Return, Risk Stocks, Stocks And Commodities, Term Investors
Posted in Emerging Markets, India, Markets | No Comments »

2010 Investment Strategies: Six Areas To Buy, 11 Areas To Sell

Monday, January 18th, 2010

This week I am really delighted to be able to give you a condensed version of Gary Shilling’s latest INSIGHT newsletter for your Outside the Box. Each month I really look forward to getting Gary’s latest thoughts on the economy and investing. Last year in his forecast issue he suggested 13 investment ideas, all of which were profitable by the end of the year. It is not unusual for Gary to give us over 75 charts and tables in his monthly letters along with his commentary, which makes his thinking unusually clear and accessible. Gary was among the first to point out the problems with the subprime market and predict the housing and credit crises. His track record in this decade has been quite good. I want to thank Gary and his associate Fred Rossi for allowing us to view this smaller version of his latest letter.

If you are interested in his letter, his web site is down being re-designed, but you can write for more information at insight@agaryshilling.com. If you want to subscribe (for $275), you can call 888-346-7444. Tell them that you read about it in Outside the Box and you will get the full 2010 forecast with price targets, but an extra issue with his 2011 forecast (of course, that one will not come out until the end of the year. Gary is good but not that good!) I trust you are enjoying your week. And enjoy this week’s Outside the Box….

John Mauldin, Editor

Outside the Box

2010 Investment Strategies: Six Areas To Buy, 11 Areas To Sell

(excerpted from the January 2010 edition of A. Gary Shilling’s INSIGHT)

Our investment strategies for 2010 follow from our forecast of continued economic weakness and deflation, as discussed earlier in this report and in previous Insights, especially our Dec. 2009 edition. We see the 2010 investment climate dominated by weak economic growth here and abroad, led by U.S. consumer retrenchment. More government fiscal stimulus and continuing Fed policy ease are likely in this setting. So is low inflation or deflation.

INVESTMENTS TO BUY

1. Buy Treasury Bonds. Long-term Insight readers know we started recommending long Treasury bonds back in 1981 when we forecast secular and huge declines in inflation and interest rates. So we declared back then that “we’re entering the bond rally of a lifetime.” The yield on 30-year Treasurys was 14.7% and our eventual target was 3%. Last year, yields blew through 3% to reach 2.6% at year’s end, so in our Jan. 2009 Insight we declared “mission accomplished” and removed Treasury bonds from our recommended list.

But then Treasurys sold off, pushing the yield on the 30-year bond to 4.7% at the end of 2009. So we’ve reactivated the strategy with our forecast of a return in yields to 3.0% or lower. Treasurys will continue to be a safe haven in a troubled world and benefit from deflation as well as their three sterling features. They are the best credits in the world. They are highly liquid. And they generally can’t be called by the Treasury, and calls limit price appreciation when interest rates fall.

A decline in yields from 4.7% at present to 3.0% may not sound like much, but the bond price would appreciate over 34%. If it occurs over two years, then two years’ worth of interest is collected, and the total return on the 30-year Treasury would be 44%. On a 30-year zero-coupon Treasury, which pays no interest but is issued at a discount, the total return would be about 64% — most attractive! Recall that in 2008 when 30-year Treasurys rallied from 4.5% to 2.7%, their total return for the year was 42%..

Treasury bonds way outperformed equities in the 1980s and 1990s in what was the longest and strongest stock bull market on record. The superiority of Treasurys has been even more so since then. Chart 1, our all-time favorite graph, shows the results from investing $100 in a 25-year zero-coupon Treasury bond at its yield high (and price low) in October 1981, and rolling it into another 25-year Treasury annually to maintain that 25year maturity. In November 2009, that $100 was worth $16,972 with a compound annual return of 20.1%. In contrast, $100 invested in the S&P 500 at its low in July 1982 was worth $2,099 in November for an 11.8% annual return including dividend reinvestment. So Treasurys outperformed stocks by 8.1 times!

Doubters

Many believe Treasury yields are headed up, not down. They think that all the bank reserves created by the Fed that have not generated bank loans will do so, flooding the economy with money and then create excess demand and inflation. They also think the continual heavy issuance of Treasurys to fund the nonstop federal deficits will push up yields. In contrast, we don’t foresee the rapid economic growth needed to induce chastened banks to lend and cautious creditworthy borrowers to borrow. And if we’re wrong, it will take at least several years to eat up global excess capacity during which the ever-inflation-wary Fed will no doubt remove the excess bank reserves, as Fed officials have already indicated.

We do expect large federal deficits for many years, in part because of pressure on government to create jobs and restrain unemployment in a slow growth economy. But those deficits will increasingly be funded by U.S. consumers as their saving spree continues. Although stock market bulls salivate over the prospect that increased saving will mean more equity purchases, we believe most of the money will continue to reduce the immense debt consumers have accumulated in recent decades.

Repaying debt will be attractive to many Americans in 2010 and beyond as they shun many investments after their huge losses in stocks throughout this decade and their shocking setbacks in real estate. A number will want to be less leveraged as slower economic growth makes employment less stable and unemployment more likely. Chastened lenders, pressed by regulators, will be pushing individuals to lower their leverage by repaying debt.

Another concern for Treasury bonds is that continued huge federal deficits and the required Treasury financing will erode confidence in these issues by Americans and foreigners, as noted earlier. This seems unlikely, especially before the end of this year. Also, as U.S. consumers save more and curb spending on domestic products and imports, the trade and current account deficits will continue to shrink. Earlier federal deficits were financed by foreigners as they recycled back to the U.S. the dollars gained from their trade and current account surpluses. The growing U.S. current account deficit measured the increasing gap between domestic saving and investment, or, in effect, and the need for foreigners to not only finance government deficits but also make up for declining U.S. consumer saving.

But now, the current account and trade deficits are shrinking, and further declines will accrue in future years if, as we forecast, exports grow faster than imports. So foreigners will have smaller American current account deficits to finance. At the same time, much more of federal deficits will be financed by rising U.S. consumer saving.

Advertisement, story continues below

With 3-month treasury bills yielding 0.046%, we’ve moved out on the yield curve for what is essentially cash positions in some cases. Sure, 5-year obligations are much more volatile than 3-month bills and do have risk of loss if interest rates rise. But we think the direction is down in that part of the interest rate curve, and 2.6% returns vs. 0.046% seem enough to offset the risks.

2. Buy Income-Producing Securities. This includes high-quality corporate and municipal bonds as well as stocks of utilities, consumer product companies, health care firms and others that pay meaningful dividends that are likely to rise. Master Limited Partnerships are also possibilities, but only if their underlying businesses are secure enough to continue significant income flows to limited partners and stockholders. Banks used to pay significant dividends but slashed them when their earnings collapsed. Nevertheless, their deleveraging and reversion to safer but less growth-oriented businesses will probably pressure them to again pay attractive dividends.

Utilities lagged behind the stock market last year, but at the end of November, the dividend yield on utilities averaged 4.5% compared to 2% for the S&P 500 index. That low return compares with 3%, which used to be the floor (Chart 2). Payout ratios recently have been essentially meaningless with the collapse in corporate earnings, but low, 31% in the third quarter of 2009. Under pressure from stockholders, dividend yields are likely to return to 3% or more. The current high level of corporate cash will also encourage dividend paying.. Also, the S&P utility sector has returned 53%, including dividends, since 2000 while the total return on the S&P 500 index has been a minus 11%.

With stocks likely to be weak this year, dividend yields may constitute 100% or more of total returns. Note, however, that although the prices of utility and other defensive stocks sometimes rise in bear markets associated with recessions, that’s not always the case. That was clearly true in 2008 when virtually every stock sector went down. Utility and other dividend-paying stocks and ETFs based on them, however, can be hedged against general stock market declines.

3. Buy Consumer Staples and Foods. Items like laundry detergent, bread and toothpaste are basic essentials of life that are purchased in good times and bad. In fact, as we’ve seen lately, consumers are buying more of their calories in supermarkets and they economize by eating at home rather than in restaurants. Note, however, that they are downgrading from national brands to cheaper house brands, and likely will continue to do so as a weak economy and high unemployment persist. Among retailers, the winners may continue to be discounters. Producers of national brands will need to continue to adapt to consumer downgrading by emphasizing cheaper “value” products.

4. Buy Small Luxuries. This is an investment concept we developed years ago. Consumers, especially when they’re hard pressed, tend to buy the very best of what they can afford, even if it’s within a low-priced category. We first noticed this tendency years ago, before apartheid ended in South Africa. We read that urban blacks there often carried the elegant, slim and expensive umbrellas typical of investment bankers in London. They couldn’t afford cars or maybe even taxi fares, but did achieve status and satisfaction with fine umbrellas. We also learned of a currently unemployed man who enjoyed the status of morning coffee at 7-Eleven six days a week. By reusing his cup and the one he takes home to his wife, he gets a 32-cent discount per $1.37 serving and saves $655 a year on this small luxury.

Companies are adapting to small luxury modes in various ways. Some are offering the same products with lower cost and selling prices. Coach is cutting ladies handbag prices and working with suppliers to reduce costs. Neiman Marcus is pressing suppliers for lower-cost versions of designer styles.

Others are putting their prestigious names on different products. C.F. Martin reintroduced its stripped down 1930s guitar for under $1,000. Average prices were in the $2,000 to $3,000 range and its top of the line guitar sells for $100,000. California winemakers are emphasizing cheaper wines as sales of those over $25 per bottle slump. Consumers are retrenching and dining out less at upscale restaurants where fine wines are sold. Tiffany sales of products over $50,000 are weak, but high-quality small items continue to sell well–always in its trademark blue box. Procter & Gamble has not cut prices on its top of the line products that sell at premiums but carry high-quality images. Consumers still splurge on such small luxuries as Gillette’s five-blade Fusion razor and Olay’s Pro-X moisturizer. But P&G has introduced cheaper “value” versions of Tide and other products to compete with the growing consumer interest in lower-cost national and house brands.

5. Buy The Dollar. Dumping on the dollar was the favorite sport of investors and the financial media until very recently. The financial meltdown in 2008 drove investors to the dollar as the global safe haven, but in early 2009 that status faded as fears of financial collapse melted. Buck-busters cited the record low short-term interest rates, with the fed funds target rate at 0-0.25%, even lower than in Japan. This made the greenback the preferred funding currency for the carry trade in which it is borrowed and then sold for other higher yielding currencies with rising interest rates. The falling dollar against those currencies enhances the profitability of those trades. Buck dumpers also emphasized the tremendous amount of dollars being pumped out by the Fed and the Treasury 70 in their attempt to revitalize the economy 68 and the Fed’s clearly-stated commitment to keep short-term interest rates low for an extended period.

Despite all its drawbacks, however, the dollar remains the world’s reserve currency and safe haven, regardless of suggestions by the Chinese and others that the dollar should eventually be replaced by a global currency. This status for the buck appears to be reemerging and will grow if we’re right and hopes for a rapid economic recovery are dashed. Furthermore, almost everyone was on the dump-the-dollar side of the boat, a situation similar to early in 2008 that preceded the dollar’s jump starting in mid-year (Chart 3). History suggests that when that happens, the winds often shift and all those folks will get tossed into the water as the boat sails in the reverse direction.

We favor selling British sterling since the U.K. economy remains in deep trouble, with even higher external debt than in the U.S.– a ratio to GDP of 404% in 2008 compared to 95% in this country, which has caused bond rating agencies to threaten a downgrade of U.K. government debt. Also, the troubled British financial sector accounts for 21% of total jobs compared with 14% in the U.S. The U.K. was almost alone among advanced countries in suffering a falling economy in the third quarter of last year.

The euro is vulnerable, in our view, because the eurozone has a one-size-fits-all monetary policy but its economies vary in strength from Germany and the Low Countries at the top to Portugal, Italy, Spain, Greece and Ireland at the bottom. Those lands can’t use independent monetary policies to stimulate their economies since that’s the providence of the European Central Bank. So they need to resort to fiscal stimuli and increasing government borrowing to finance the resulting deficits. A number have suffered sovereign debt rating downgrades, which increase their borrowing costs, and more are likely. This could spark renewed threats that one or more countries will withdraw from the eurozone and go back to using drachmas, draculas or whatever as their currencies. That probably won’t happen as the ECB will do all it can to prevent dissolution, but serious discussion of the likelihood could depress the euro considerably against the dollar.

These concerns are not new for us. Just as the euro was being launched 10 years ago, we wrote in our Dec. 1998 Insight that with a common currency, individual countries would be forced to rely on fiscal policy to deal with local business conditions and “the limit on fiscal stimulus will be default risks. Government bond investors and rating agencies will become the policemen and will blow the whistle…. It’s even possible that economic differentials among countries may be so great that the common currency doesn’t hold together, especially in the next European recession when unemployment leaps….”

Commodity-driven currencies like the Canadian, Australian and New Zealand dollars are also likely to weaken against the greenback as commodity prices fall. The Japanese economy remains weak and back in deflation, but the yen’s involvement I the carry trade makes it a tricky currency for investment.

6. Buy Eurodollar Futures. In most markets, traders want to be where the action is, where liquidity is the greatest even though that’s where competition is the strongest. Years ago, a jeweler in New York City complained to us about how fierce the competition was in his location. His shop was on 47th Street between Fifth and Sixth Avenues, the heart of the jewelry district. We asked why he didn’t move to a less competitive area. He shrugged and said, “This is where the action is.” In the case of short-term credit instruments used in futures trading, eurodollars are where the action is.

Our interest is in eurodollar futures contracts. Eurodollar futures are a way for companies and banks to lock in an interest rate today, for money it intends to borrow or lend in the future, and for investors to bet on the future direction of short-term interest rates. Each Eurodollar futures contract has a notional or “face value” of $1 million, though the leverage used in futures allows one contract to be traded with a margin of about $1,000. Trading in Eurodollar futures is extensive, and the market for them tends to be very liquid. The prices of Eurodollars are quite responsive to Fed policy, inflation, and economic indicators. It’s ironic that eurodollar futures markets dominate trading, not those for Treasury bills or federal funds on which eurodollars are essentially based.

Eurodollar futures prices are determined by the market’s forecast of the 3-month US$ LIBOR interest rate expected to prevail on the settlement date. Eurodollar futures contracts extend out for 40 quarters or 10 years, so they can be used to bet on interest rate movements many quarters ahead.

Long positions in eurodollar futures have been one of our most successful investments in recent years. Earlier, the futures market did not price in the full extent of the Fed-engineered decline in short-term interest rates. With our forecast of the financial crisis and the worst recession since the 1930s, however, we believed that the Fed would ease dramatically. So we reasoned that eurodollar futures prices would rise as they reflected the Fed’s action. So far, they have.

Now the futures market assumes that the Fed will raise its target rate in the course of this year, so the LIBOR rate on which eurodollar futures settle will increase by 1.22 percentage points between January and December. We, however, believe that a weak economy will keep the Fed on hold throughout this year, so the interest rate implied by the December 2010 contract will fall by 1.22 percentage points. That would result in a $3,050 profit on a $1 million futures contract. That’s a mere 0.3% gain. This is hardly worth the investment without leverage. But with only a $1,000 margin requirement on the futures contract, well, you do the math.

INVESTMENTS TO SELL OR AVOID We hope these six investment strategies for 2010 that involve buying or being long securities are useful. But given our forecast that, at best, the U.S. and global economies will be sluggish this year, it won’t be a surprise that we have a longer list of strategies that involve selling or avoiding various sectors. In fact, there are 11, or nearly twice as many. 7. Sell U.S. Stocks in General. The S&P 500 index in late December was selling at 19 times top-down Wall Street strategists’ operating earnings estimate of $60.59 per share for this year, as noted earlier. That’s an historically high P/E to start with that makes stocks vulnerable going into the year. Even more so because it assumes a steep economic recovery in 2010. And even more so if our forecast of continuing recession or sluggish recovery at best proves out. Our $50 estimate of operating earnings, down 11% from estimates for 2009, puts the S&P 500 index P/E at a nosebleed 22.5 level, as noted earlier. Selling stock indices short, either through futures contracts or ETFs, strikes us as a prudent idea. Index shorts can also hedge long positions in utilities or other long strategies we discussed earlier. Be well aware that our forecast of a declining U.S. stock market is critical to many other strategies we’ll discuss later that involve selling or avoiding equity sectors here and abroad. We believe they all will perform worse than the stock market overall, but if we’re wrong and the stock market leaps this year, we’ll probably also be wrong on many of these other strategies. 8. Sell Homebuilder and Selected Related Stocks. Homebuilder stocks rebounded sharply from their March 2009 lows, along with stocks in general, but peaked in September with a slight downward trend since then. This may be beginning to reflect our forecast of another 10% decline in house prices (Chart 4). Excess inventories of houses for sale, the mortal enemy of prices, remain huge. And inventories may rise, even with housing starts at very low levels, as people foreclosed out of their houses double up with family and friends. Also, a quarter of homeowners with mortgages are under water, 40% of those who took out mortgages in 2006. Increasing numbers of these people are convinced that they’ll never regain positive home equity and are abandoning their abodes in favor of renting other houses at lower monthly costs. Still, the subsequent foreclosures on their mortgages will keep them from qualifying for a government-guaranteed mortgage for three to five years and will stay on their credit records for seven years. Despite leaping mortgage delinquencies, federally-mandated but mostly unsuccessful mortgage modification programs are keeping many houses, especially middle- and higher-priced homes, from being foreclosed and sold–temporarily. Furthermore, the investment tax credit for new and some existing home buyers, which was extended beyond November 2009, is scheduled to expire in April. The overhang of aging new single-family homes available for sale is huge (Chart 5 ). Also note that new residential mortgages are almost entirely dependent on guarantees from government entities such as Fannie Mae, Freddie Mac and the FHA, and they are tightening their credit standards. Low mortgage rates are a plus, but are only meaningful to those who qualify for loans as lending standards tighten. Most now need to meet the old conservative standards of 20% down, good credit, full documentation of income and assets, etc. And lower borrowing rates don’t help underwater homeowners either refinance or buy other houses. Furthermore, rates on large “jumbo” mortgages remain high. Finally, lower house prices don’t induce buyers who expect the downward trend to continue and hold out for even-lower prices. 9. Sell Selected Big-Ticket Consumer Discretionary Equities–for two powerful reasons. First, as consumers persist in their saving spree they’ll continue to curtail spending on expensive postponeable items. Second, as widespread price declines persist, they will be anticipated. Prospective buyers will wait for lower prices. As a result, excess inventories and unused capacity will mount, forcing prices lower. That will confirm prospective buyers’ suspicions so they’ll wait for still-lower prices in a self-feeding downward spiral. Deflationary expectations are clearly at work in the vehicle market. The cash-for-clunkers program generated one-time sales as buyers viewed it as just one more rebate inducement in a never-ending stream. But who would dare announce to a friend that he paid the full sticker price for any car? Of course, deflationary expectations don’t work for small, inexpensive items. Suppose you know for sure that toothpaste will be cheaper next month. If you run out, you won’t brush your teeth with Ajax while waiting for lower prices before buying a tube. Even the rich, normally immune to recessions, are cutting back and downgrading. Note the weak sales at Tiffanys, Nordstrom and Saks Fifth Avenue and the poor auction results for Sotheby’s and Christie’s. A Merrill Lynch study found that the number of people in the world with $1 million or more in investable assets fell from 10.1 million in 2007 to 8.6 million in 2008. Those assets dropped from $40.7 trillion to $32.8 trillion. Their equity holdings fell in step with the S&P 500, about 40%, and their real estate also dropped in value. Ever since the data series began in 1967, the share of income of the top 20% has trended up while all other shares fell. Note that these are shares, not income levels–which have grown on balance for all quintiles. Studies have found considerable rotation in and out of the various quintiles, with many of those in the top bracket in a given year absent from it in earlier and later years. Still, the drop in purchasing power for many middle-income people in the last year in addition to the collapse in their homes’ values has created considerable anger at those at the top. The equities of most producers of big-ticket consumer discretionary goods and services collapsed in the 2007-2009 bear market, reflecting consumers’ buying strike, but have recovered somewhat since March. With our conviction that American consumers have reached a watershed and switched from a quarter century borrowing-and-spending binge to a decade or longer saving spree, we are very suspicious of the sustainability of any rebound in stocks of producers of major consumer discretionary products such as cruise lines and airlines. 10. Sell Banks and Other Financial Institutions. During the financial free-for-all days, large banks moved well beyond traditional spread lending–taking deposits and then lending them with interest rate spreads to cover their costs, loan risks and reasonable profits. They hyped their leverage–and their risk–as they set up off-balance sheet vehicles, engaged in proprietary trading and in the origination of and investment in derivatives. Regulators stood by under the theory that free markets would discipline excessive risk-taking. Both the big banks and the regulators, however, knew or should have known that those institutions were too big to fail and could take the financial system down with them. So those financial institutions were really playing a game of, heads we win, tails we get bailed out. And fail they did, and bailed out they have been. Many investors seem to believe that’s the end of the unpleasantness and now it’s back to business as usual. The recent big trading profits by some financial institutions certainly point in that direction as did the stock rebounds until recently. We doubt it, though. The financial sector expanded its leverage over about three decades and its deleveraging will probably consume most or all of the next decade. Big risk-taking CEOs like Ken Lewis at Bank of America are being forced out, sending a clear message to the senior officers who remain. Stringent, probably excessive regulation is replacing the laissez faire model. Higher capital requirements and other limits on risk-taking will curb bank profitability. So will the limits on executive pay aimed at reducing the incentive to take big risks. Weak Loan Demand Furthermore, with slow economic growth, consumer zeal to save and repay debts, and weak capital spending this year, loan demand will likely be weak. In addition, the present steep yield curve makes borrowing cheap deposits and lending long-term at higher interest rates very profitable. But it will probably flatten as the year progresses and long rates fall. Banks, of course, can increase fees on checking and other accounts, but are limited by competition from money market funds and other alternatives. Also, banks’ costs of borrowing in the bond market is well off its highs relative to Treasurys, but still elevated compared to pre-crisis years. The spread now runs over three percentage points compared to about one in pre-crisis days. Much of the cheap debt banks acquired from private markets in earlier years and the government more recently will mature in the next several years and need to be replaced at much higher costs. The maturities for U.S. banks have dropped from 7.8 to 3.2 years in the past five years. Regional and community banks are also likely to be unattractive investments this year. Ironically, in the go-go days, many of them were unwilling to virtually abandon their underwriting standards to compete with nonblank residential mortgage lenders. So they lent to the commercial real estate market instead. That’s proving to be a jump from the frying pan into the fire, as discussed earlier, and is shown by weak demand, falling prices and rising delinquencies. Regional banks have more than their share of the $1.7 trillion in outstanding commercial real estate owned by all banks. These loans constitute 35% of regional banks; total loans, up from 25% in 2000. Due to bad commercial as well as residential real estate loans, smaller banks are dropping like flies, 140 so far this year (Chart 6 ). Individually, they aren’t too big to fail, but collectively they are since they are the primary financers of smaller businesses. Those businesses don’t have access to commercial paper and other credit market vehicles and must rely on their local banks for loans–or on the personal credit cards of their owners. 11. Sell Consumer Lenders’ Stocks. Consumer lenders’ stocks have also rebounded sharply from their March 2009 lows. We were wrong on our strategy of selling them last year, but believe it will work in 2010. Consumer lenders had their hey day during the long consumer borrowing-and-spending spree. Consumers were trained–and we use that word deliberately–to believe they deserved instant material gratification. Buy now, put it on the plastic card and pay later– much later–became the norm. And creditworthiness was no problem for credit card issuers and other consumer lenders. They sliced and diced consumers’ financial statuses, used sophisticated models to determine payment risks and charged fees and interest rates to fit any risk category. But their models and analyses inherently assumed that the borrowing-and-spending binge, as well as the ability to repay, would last indefinitely. But then consumers suddenly switched to a saving spree and started to pay down credit card and other debts. Also, heavy layoffs, leaping unemployment and collapsing house prices and inadequate consumer incomes spiked credit card delinquencies. Congress last year restricted credit card fees and interest charges. Also, consumers went on a buyers strike a year ago and cut back on their use of credit, debit and charge cards. Recent developments are virtually all negative for the credit card business now and for years to come. The cottage industry to help these people deal with their huge credit card debts is exploding in size. As noted earlier, charge cards and debit cards are replacing credit cards as consumers realize they can’t trust themselves to restrain debt and need to pay off monthly or accumulate the money in a bank account before spending it. Layaway plans are replacing the buy now-pay later approach. With the switch from a quarter century consumer borrowing-and-spending binge to a long run saving spree, the credit card business has moved from a growth industry to a laggard.

12. Sell Many Low and Old Tech Capital Equipment Producers. Low and old tech producers will remain depressed in a world of chronic excess capacity. When operating rates are low, producers don’t need more capacity and worry that revenues, prices and profits won’t be adequate to justify even existing capacity. And note that the volatility of the producers of equipment is much greater than that of the users. Auto sales declined by over 47% from their peak in July 2005, but orders for machine tools, automatic transfer lines and other equipment fell much more as auto assemblers and parts makers almost froze orders. Recall as well how the recession-sired excess capacity in airlines has caused massive cancellations and postponements of orders for Boeing’s Dreamliner.

Earlier, we discussed our statistical models that explained capital spending. They show that in accounting for the year-over-year change in the equipment and software or in equipment and software plus nonresidential structures components of GDP, thelevel of operating rates is far and away the most important explanatory variable, even more so for the year-over-year change in operating rates. This indicates that even if capacity utilization is growing rapidly, if it remains at low levels as at present, the growth in capital spending will be subdued.

Other variables, such as the year-over-year changes in cash flow, profits and interest costs, were statistically significant in our models, but much less effective in explaining the change in capital spending. These findings are important because many believe that the negative gap between capital expenditures and internal funds is sure to generate a capital spending surge. But our models, based on history, say that with huge excess capacity, that cash flow won’t burn holes in corporate pockets. And our models don’t quantify and add in the extra corporate caution spawned by today’s recessionary climate and financial crises.

Besides the depressing effects of excess capacity, low and old tech companies suffer from ongoing problems. Foreign competition continues to grow as their technology is transferred to China and other cheap production locales. Some suffer rising cost pressures due to lack of productivity gains. High-cost unionized labor forces are sometimes a problem. And many sell into saturated, slow growth markets.

13. If You Plan to Sell Your House, Second Home or Investment Houses Any Time Soon, Do So Yesterday. This strategy has worked for the last two years and will continue to do so if we’re correct and house prices nationwide fall another 10%. Sure, prices have been weakest in states like Florida, Arizona, Nevada and California where the biggest bubbles preceded the collapses. But almost every area of the country has experienced price declines (Chart 7 ).

Many owners have tried to wait out the bear market in housing, a technique that worked in earlier years when any price declines were small and short-lived. But huge excess inventories, a flood of distressed sales after mortgage modification attempts are over, depressed incomes and rising unemployment will probably keep sellers plentiful, buyers reluctant and prices falling throughout 2010 and perhaps beyond. In past regional house price collapses, it’s taken homeowners a year-and-a-half to give up and throw their houses on the market for whatever they will bring. After the final bottom is reached, house prices will likely mirror inflation, or in future years, deflation as they have historically.

14. Sell Junk Bonds. During the dark days of the financial crisis, the yields on junk bonds leaped to 19.3 percentage points over Treasurys as investors worried about complete financial collapse and widespread defaults among low-grade issues. Triple-C rated bonds, the lowest junk tier, sold at 42.6 cents on the dollar at the beginning of last year.

But the bailout of the big banks and easing of the financial crisis allayed investor fears and junk spreads narrowed. Institutional investors piled in, followed by individual investors, many of whom sought alternatives to low returns on bank deposits and money market funds. So the spread has dropped to 4.6 percentage points, much closer to where it was before the crisis began. Last year, junk bonds returned over 50%, much more than the 25% gain on the S&P 500 index.

Nevertheless, we believe this rally is way overdone. Default rates on junk bonds normally peak late in recessions or in the year after it ends. Also, the default rate may reach or exceed the previous peak in 2002 if the economy remains weak, suggesting major declines in junk bond prices. Furthermore, the value of bonds after default is likely to go lower if the recession drags on, as we forecast. Slow revenue and cash flow growth will make it difficult if not impossible for a number of financially weak and weakening firms to service their bonds and other debts.

15. Sell Commercial Real Estate. As discussed earlier, excess capacity and big refinancing requirements in coming years will continue to plague hotels, malls, warehouses and office buildings. Moody’s/REAL Commercial Property Price Index was down 44% last October from its October 2007 peak. Retailers closed 8,300 stores last year, more than the previous peak of 6,900 in 2001. Businesses will continue to cut costs this year, not only by holding down employment and therefore the need for office space, but also by moving in the partitions to fit the remaining people in less space, as mentioned earlier.

Increasing use of telecommuting will also reduce need for office buildings. And more teleconferencing will cut hotel-utilizing business trips, especially after intensified airport security in reaction to the recent terrorist incident in Detroit on Christmas Day. At the same time, frugal consumers will restrain discretionary travel and the hotel and motel use involved. Weak consumer spending will keep mall and warehouse space under pressure.

Some believe that commercial real estate woes may exceed the residential collapse, and they may be right. Commercial tends to be less leveraged but if refinancing isn’t available, it may note make much difference how leveraged it is. Also, distressed commercial real estate owners definitely don’t have the political sympathy and bailout prospects enjoyed by troubled homeowners. The Fed has set high standards for bailout loans on commercial real estate. Commercial real estate REITs rebounded last year along with the overall stock market (Chart 8 ), but strike us as vulnerable. These leaps combined with plummeting real estate prices have pushed REIT prices to a 25% premium over their net asset values.

16. Sell Most Commodities. Commodity prices rebounded last year and benefited from cheap and available money. Some live in their own worlds. Petroleum is not only influenced by fundamental supply-demand conditions, but also by OPEC decisions. Natural gas prices in the U.S. weakened last year with the recession, but also because of new production technology that unlocked abundant shale gas. The prices of agriculture commodities, including honey, are highly dependent on weather.

In any event, we believe that economic supply and demand will rule most industrial commodity prices this year and result in weakness due to sluggish global business conditions. Also, investors put a record $50 billion into commodities in 2008 but then retreated last year after prices nosedived. They learned the hard way that commodities aren’t an asset class but speculations, and may be cautious this year. And the strengthening dollar should depress the prices of the many commodities traded worldwide in dollar terms. We look for falling commodity prices this year. Also, we believe that many commodity-producing companies and their suppliers of equipment and supplies will be unattractive investments as weak demand, excess capacity and soft prices persist. The same is true for economies such as Persian Gulf sheikdoms that depend heavily on petroleum, as witnessed by the financial collapse of Dubai.

17. Sell Developing Country Stocks and Bonds. As late as the end of 2007, most forecasters believed in decoupling. Even if the U.S. economy suffers a setback, they said, the rest of the world, especially developing countries like China and India, would continue to flourish. Indeed, the strength of those economies could even aid the U.S. as they bought more American exports.

We disagreed. We did a study two years ago that found that China was not yet developed sufficiently to have enough people with discretionary spending to support the economy domestically. She remained export-led, with most of those exports going directly or indirectly to U.S. consumers. So, with our forecast of a major retrenchment by U.S. consumers, we predicted big trouble for China. Our analysis revealed that in China, it takes about $5,000 per capita to have meaningful discretionary spending power. About 110 million Chinese had that much or more, but they constituted only 8% of the population. In India, that class was a mere 5% of the population. In contrast, it takes $26,000 per capita in the U.S. to have discretionary spending power and 80% of Americans have at least that much.

Well, as they say, the rest is history. The Chinese and most other developing Asian countries nosedived as U.S. consumers retrenched. But in the wake of China’s huge $585 billion stimulus program last year, massive imports of industrial materials like iron ore and copper, jumps in construction of cement, steel and power plants and other industrial capacity, and a pick up in economic growth, many forecasters again believe in decoupling.

We continue to disagree. Sure, some countries such as Brazil were not hurt too severely by the global recession, at least so far. Still, most developing economies depend on exports for growth, and the U.S. consumer has been the biggest buyer of those exports and far and away the globe’s biggest spenders. As the American consumer saving spree continues to shrink the U.S. trade and current account deficits (Chart 9), those developing economies will be subdued.

China’s economy looks like a house of cards. Her most recent fiscal stimulus not only went into industrial capacity-building but also bank lending-spawned stock market and real estate speculation. But what will utilize that capacity and justify those speculations? The usual outlet, exports, is curtailed by retrenching U.S. consumers. And, as noted, China is not far enough down the road to industrialization for local consumers to fill the gap.

We doubt that the rebounds in emerging market stocks and bonds correctly forecast robust, decoupled economic growth that is sustainable. While the S&P 500 now trades at 20 times earnings over the last 12 months, normally cheaper emerging markets are more expensive. Recently, the Shanghai Composite Index sported a 32 P/E while South Korea’s was at 35 and Indonesia’s was at 29. And note that the 65% jump in emerging market stocks in 2009 only offset two-thirds of the 54% drop in 2008.

Furthermore, as was made clear by the universal weakness in security markets in 2008, bond and stock markets around the world are highly correlated. With globalization, the days are gone when a globe-trotting sleuth can discover gems in the remote reaches of Asia or Latin America. The similarity of bond and stock performance is even greater when adjusted for risk. Emerging market stocks and bonds may climb more in bull markets, but have greater falls when the bear arrives, as we believe he is about to. There’s no such thing as free lunch.

Disclaimer

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Tags: Buy Sell, Canada, China, Commodities, Crises, Decade, Economic Growth, Economic Weakness, Economy, Emerging Markets, ETF, Fed Policy, Fiscal Stimulus, Forecast Issue, Gary Shilling, India, Insight Newsletter, Investing, Investment Climate, Investment Ideas, Investment Strategies, John Mauldin, Price Targets, Retrenchment, Subprime Market
Posted in Emerging Markets, India, Markets, Oil and Gas | No Comments »

Words from the (Investment) Wise (January 17, 2009)

Sunday, January 17th, 2010

“Words from the Wise” this week comes to you in a somewhat shorter format as I do not have access to all my normal research resources while spending a few days with the gnomes in Geneva (also see my post “Blogging gone AWOL - to Switzerland“). Although the commentary is not as comprehensive as usual, a full dose of excerpts from interesting news items and quotes from market commentators is included.

With investors’ hopes of an economic recovery that might have gotten ahead of reality, the Dow Jones Industrial Index experienced its largest one-day drop (-0.9%) of the year in a sell-off on Friday - unnerved by China starting to rein in liquidity and cautious earnings guidance - causing the benchmark US indices to register a fourth down-week over an eight-week period. Not surprisingly, the CBOE Volatility (VIX) Index, also referred to as the “fear gauge” of US stocks, gained 1.2% over the week.

Providing “entertainment” of a dubious kind and reminding one of the 1933 Pecora Commission, the Financial Crisis Inquiry Commission on Wednesday started interrogating four of Wall Street’s top executives in Washington and promised to use wide-ranging powers to establish the causes of the financial crisis and pursue any wrongdoing.

Meanwhile, Christina Romer, who heads the president’s Council of Economic Advisers, said (via MoneyNews) the payment of big year-end bonuses for bailed-out financial institutions would be “ridiculous” and “offensive” and “is going to offend the American people. It offends me”.

Similarly, according to The Canadian Press, President Barack Obama said with reference to his proposed plans to impose a levy on big financial institutions to recoup some of the costs of the financial crisis: “If the big financial firms can afford massive bonuses, they can afford to pay back the American people.”

Source: Steve Sack, Comics.com

The past week’s performance of the major asset classes is summarized in the chart below - a set of numbers indicating a degree of risk aversion has crept back into financial markets. Steps by the People’s Bank of China to tighten liquidity by increasing the bank reserve requirement ratio and raising inter-bank interest rates negatively impacted oil and other commodities, causing the first decline in five weeks.

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The MSCI World Index and the MSCI Emerging Markets Index declined by 0.2% and 0.6% respectively during the past week. Among mature markets, Japan (+1.7%) bucked the trend and added a seventh consecutive week of gains - coinciding with a weaker yen over the period. (Also see my post “What to expect from Japan’s new finance minister“.) Among emerging countries, Russia (+7.2%) performed solidly, while China (+0.9%) also eked out a gain after having to balance adverse monetary developments in that country with impressive trade data early in the week.

Notwithstanding the huge rally since the March lows, only the Chile Stock Market General Index - again a solid performer on the expectation of a positive election result - has been able to reclaim its 2007 pre-crisis peak and is now trading 8.1% higher. Mexico could be the next country to eliminate the bear market losses.

As far as the US indices are concerned, Wall Street managed to hit 16-month highs on Monday and then again on Thursday, but reversed course on Friday as traders closed positions before the Martin Luther King long weekend, pulling indices into the red.

Seven of the ten economic sectors (as measured by the SPDR exchange-traded funds [ETFs]) closed lower for the week, with the defensive sectors outperforming the cyclical ones. Health Care (+1.4%), Consumer Staples (+0.8%) and Utilities (+0.6%) returned gains, whereas all the other sectors were under the water. Small caps, in particular, led the way down on Friday.

Click here or on the table below for a larger image.

Top performers among stock markets this week were Estonia (+15.6%), Venezuela (+9.6%), Lithuania (+8.7%), Kazakhstan (+7.2%) and Kenya (+5.7%). At the bottom end of the performance rankings, countries included Greece (-7.9%), Jamaica (-6.7%), Cyprus (-6.5%), Luxembourg (-4.9%) and Portugal (-1.2%). “Greece on Thursday announced an ambitious three-year plan to curb its runaway budget deficit but failed to convince skeptical markets that its targets for growth and fiscal reform were feasible,” reported the Financial Times.

Of the 96 stock markets I keep on my radar screen, 53% recorded gains (last week 79%), 41% (15%) showed losses and 6% (6%) remained unchanged. The performance map below tells the past week’s rather bullish story

Emerginvest world markets heat map

Source: Emerginvest (Click here to access a complete list of global stock market movements.)

John Nyaradi (Wall Street Sector Selector) reports that as far as ETFs are concerned the winners for the week included iShares MSCI Japan (EWJ) (+4.8%), Claymore/Delta Global Shipping (SEA) (+3.6%), Vanguard Extended Duration Treasury (EDV) (+3.3%) and iShares MSCI Austria (EWO) (+2.7%).

At the bottom end of the performance rankings, ETFs included Claymore/MAC Global Solar Energy (TAN) (-8.7%), PowerShares WilderHill Clean Energy (PBW) (-7.2%), Claymore/AlphaShares China Real Estate (TAO) (-6.6%) and United States Oil (USO) (-5.7%).

Referring to the modern robber barons, or “banksters”, and Obama’s proposed bank tax to recoup bailout costs, the quote du jour this week comes from long-timer Richard Russell, writer of the Dow Theory Letters. He said: “Obama is fighting two wars, the war in Afghanistan and the war in Iraq. Now he’s got a third war going, the war on Wall Street. He’s joining the populist fury over Wall Street and its bonuses. It’s ‘payback time’, and Obama proposes a $90 billion tax on Wall Street’s banks.

“The Prez utters the words the crowd loves to hear, ‘We want our money back, and we’re going to get it.’ Obama’s words dovetails with Democrats’ worries that they would be blamed for the recession and the debts. Blame it on Wall Street, and get even with those greedy devils; maybe tax the greedy devils out of existence or at least tax their stinkin’ bonuses away. As Obama’s assistant Rahm Emanuel put it, ‘Its a shame to let a good crisis go to waste.’

“The $90 billion Obama will extract from Wall Street won’t even begin to shrink the monster deficit the Fed has run up. Let the next administration (probably Republicans) deal with that problem.”

How the lie of the land has changed! The Financial Times yesterday headlined an article: “Obama is right to clobber Wall Street”.

Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. As to be expected with the banking shenanigans moving to center stage, “banks” commanded poll position.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town when not traveling) are given in the table below. With the exception of the Shanghai Composite Index (discussed above), the indices in the table are all trading above their 50-day moving averages, with all the indices also comfortably above their respective key 200-day moving averages.

As far as the S&P 500 Index is concerned, an upward sloping trend line extends from the August lows. A break below this line’s support level of 1,080 (and the December low of 1,092) could signal a deeper pullback.

Click here or on the table below for a larger image.

Last week I discussed a long-term chart of the S&P 500. Let’s now also consider monthly data, going back to 1998, for the 10-year Treasury Note. As shown below, the MACD oscillator provided a sell signal about seven months ago and Treasuries are still classified as being in a primary bear market.

Source: StockCharts.com

This raises the question of when rising long-term rates start ruining the equity party. “For me, a sustained move above 4% by ten-year Treasuries will be equivalent to a yellow caution light for equity investors. Above 5%, stock markets could be in dangerous territory, as we saw in the last cycle,” commented David Fuller (Fullermoney). ”I will continue to view US Treasury 10-year yields as a lead indicator. Currently, they are still in a ’sweet spot’. However, when they move higher I will monitor stock market indices, particularly for Wall Street, even more closely for signs of fatigue in the form of inconsistencies, not least a loss of upward momentum.”

Looking beyond the low-growth economies of mature countries, Jeremy Grantham of GMO said (via Fortune): “I think there is a nascent bubble in emerging markets. Over the next three to five years, emerging markets are likely to sell at a handsome premium P/E because of the respect for their higher GDP growth.”

To which money man Bill Gross, head honcho of Pimco, added (according to Fortune): “If you’re looking for growth, you should venture outside the US. Brazil, China and other Asia equities are the cherry on top of the melting sundae. It’s not only their internal economies; they’re in better shape from the standpoint of reserves and balances. Ten years ago Brazil was a basket case and beggar. Now it has hundreds of billions of dollar reserves.”

Back to the US stock markets, John Hussman (Hussman Funds) is treading carefully with the current stock market make-up, saying: “There’s no denying that the beliefs of investors have been far more important, in the intermediate term, than economic realities, which are revealed more slowly and sporadically. Yet despite the high level of bullishness here, the market has gained only a few percent beyond its September highs. Most of what we are seeing now is a tendency to make marginal new highs, back off slightly, and then recover that ground enough to register another marginal new high.

“As I’ve noted frequently, when market conditions are characterized by unfavorable valuations, overbought conditions, over-bullish sentiment, and upward yield pressures, the market’s tendency is exactly that - to make continued marginal new highs for some period of time, followed by abrupt and often steep losses virtually out of nowhere.”

As we embark on the earnings season, the S&P 500 as a whole is expected to grow by 62.1% in Q4 2009 versus Q4 2008. As shown in the graph below, courtesy of Bespoke, the bulk of the growth is expected to come from the Materials and Financial sectors - the only two sectors with Q4 growth expectations that are higher than the S&P 500. Technology and Consumer Discretionary are the other two sectors expected to see growth. On the other hand, “Energy and Industrials are both expected to see earnings decline by more than 20% in the fourth quarter, while Telecom is not far behind at -19.2%. Health Care, Consumer Staples, and Utilities are all expected to see a drop of about 5%,” said Bespoke.

Source: Bespoke, January 12, 2010.

I do not have much to add to my conclusion of last week and repeat it: “It goes without saying that the strong rally since March is bound to be followed by a correction at some stage. But rather than pre-empting (and more often than not getting it wrong as a result of short-term noise), I will be guided by the longer-term charts and the yield curve to identify a major top. Meanwhile, I am watching valuations carefully, and specifically how the Q4 earnings reports stack up. (See my post “Earnings into focus“.)

“Although I am treading with caution after the 74% rally in the mature markets and 108% in emerging markets, I am not ignoring good old stock-picking, and specifically those companies with strong balance sheets that will be growing their dividends over time with a reasonable degree of certainty.”

For more discussion on the economy and financial markets, see my recent posts “Lessons from Bernstein, Rosenberg and Farrell“, “El Erian: Markets not facing reality of slow economy“, “Mark Mobius on emerging market valuations“, “Earnings into focus“, “Picture du Jour: Dow rally in perspective“, “Wealthtrack - making money in 2010 in stocks, bonds and foreign markets“, “Doug Casey: ‘Stock market set to crash’” and “Picture du Jour: Weak hands are heavily long the greenback“. (And do make a point of listening to Donald Coxe’s webcast of January 15, which can be accessed from the sidebar of the Investment Postcards site.)

Twitter and Facebook
I regularly post short comments (maximum 140 characters) on topical economic and market issues, web links and graphs on Twitter. For those readers not doing so already, you can follow my “tweets” by clicking here. You may also consider joining me as a friend on Facebook.

Economy
“Global business sentiment has remained largely unchanged since the summer, consistent with a global economic recovery that is holding its own but is not gaining significant traction. Confidence is generally stronger in South America and among business services firms and weakest in North America and among those that work in real estate,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. Businesses are most upbeat when responding to broad questions about current conditions and expectations through mid-2010, but remain cautious when responding to specific questions about sales, pricing, inventories and hiring.

Source: Moody’s Economy.com

Meanwhile, sovereign debt default looms, according to George Magnus, senior economic adviser at UBS Investment Bank. He said (as reported by the Financial Times): “Concerted fiscal restraint could trigger another recession, but the lack of it could end up in bigger default risks. Even Japan, now into its third ageing decade, may be vulnerable, while some eurozone countries, though sheltered from currency turbulence, may yet falter in their deflation commitments and compromise the integrity of the single currency as we know it. The UK still lacks a credible debt management strategy, and the US cannot take investor goodwill for granted.”

Interestingly, the Financial Times says mounting fears about government debt has now caused the cost of insuring against the risk of debt default by European nations to exceed that for top investment-grade companies for the first time. “It now costs investors more to protect themselves against the combined risk of default of 15 developed European nations, including Germany, France and the UK, than it does for the collective risk of Europe’s top 125 investment-grade companies, according to indices compiled by data provider Markit.”

A snapshot of the week’s US economic reports is provided below. (Click on the dates to see Northern Trust’s assessment of the various data releases.)

Friday, January 15
• Inflation - “Don’t worry, be happy”, for now
• December industrial production - mixed news from the nation’s factories

Thursday, January 14
• December retail sales - mixed news, focus on details necessary
• Ballooning Treasury deficits - it takes both outlays and receipts to tango
• Total continuing claims matter the most

Wednesday, January 13
• Recent Fed rhetoric and highlights from the Beige Book

Tuesday, January 12
• Trade deficit widens in November, volume of trade maintains upward trend

Monday, January 11
• Inflation expectations approach pre-crisis range

The latest Beige Book, published on Wednesday in preparation of the next Federal Open Market Committee (FOMC) meeting on January 26-27, indicates a modestly improving economy.

Regarding the benign CPI numbers, Asha Bangalore (Northern Trust) said: “The Fed continues to be a sweet spot with regard to inflation and can continue to focus on economic growth for several more months. Although the Fed has begun examining the ways in which inflation emerges at the December Federal Open Market Committee (FOMC) meeting, the more vigorous debate and concern about inflation is topic for several months ahead.”

“The Federal Reserve is unlikely to raise interest rates before next year,” Richard Clarida, global strategic adviser for money manager Pimco, told Bloomberg (via MoneyNews). “The Fed has never hiked until they have seen a sustained decline in unemployment. By the Fed’s own forecast, that is at least a year away. I don’t think the Fed’s going to do anything with rates until 2011 or perhaps very late in 2010.”

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, January 15, 2010.

Click the links below for three research reports from Wells Fargo Securities:

• Weekly Economics & Financial Commentary (January 15, 2010)
• Global Chartbook (January 2010)
• Monthly Economic Outlook (January 2010)

US economic data reports for the coming week include the following:

Tuesday, January 19
• Net long-term TIC flows

Wednesday, January 20
• Building permits
• Housing starts
• Core PPI
• PPI

Thursday, January 21
• Jobless claims
• Leading indicators
• Philadelphia Fed

Markets
The performance chart for various financial markets usually obtained from the Wall Street Journal Online is unfortunately not available this week.

Final words
Morris King “Mo” Udall, American politician (1922-1998) said: “If you can find something everyone agrees on, it’s wrong.” (Hat tip: David Fuller.) Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist readers of Investment Postcards in guarding against popular (and often wrong) market views.

That’s the way it looks from an icy cold Geneva (from where I will be making my way back to Cape Town on Monday).

Source: RJ Matson, Comics.com

CNN Money: Four pros - investing in the next decade
“The coming 10 years won’t necessarily resemble the past 10. Fortune enlisted four investing sages - Rob Arnott, Jeremy Grantham, Bill Gross and Jeremy Siegel - who lay out the opportunities and pitfalls.”

Click here for the full article.

Source: CNN Money, January 14, 2010.

Richard Russell (Dow Theory Letters): Pondering a deflation scenario
“I’ve been pondering over the following strange situation. The Dow is actually lower today than it was ten years ago. What does this really mean? To me, it means that the market over the last ten years has been discounting ‘no growth’ ahead. When you take an unbiased look at the picture, compared with gold almost everything today is cheaper than it was a few years ago. Since gold is the universal immutable standard around which everything else (including the dollar) fluctuates, this means that the price of literally everything has been going DOWN against the standard which is gold.

“This is deflationary. Of course you can say that a loaf of bread costs more now than it did a year ago, and this is inflationary. True, it’s inflationary in terms of dollars, but the dollar is lower in terms of gold. So in terms of gold, everything is deflating.

“This deflationary trend is continuing, and what’s more it’s continuing against a veritable ocean of central-bank created currencies. Subscribers know that I believe this bear market will end, as most others have, with stocks selling at extreme great values - dividends high, price/earnings low. And you ask, ‘How can this possibly occur?’

“This is the question I’ve asked myself. And the answer I come with is that stocks will be hit by brutal world deflation. That’s what the miserable performance of the Dow is telling me. That’s what the poor performance of everything else against gold is telling me. I’m not talking about the performance over recent months, but their performance over the years.

“Yes, I know that the conventional wisdom is that we’re heading for all-out inflation. This forecast is based on the thesis that the only way to handle America’s deadly multi-trillion debts is to inflate them out of existence. But suppose the Fed is unable to engineer inflation? Look how hard they’ve been trying over the last year to restart inflation. And what’s happened to housing, the chief object of the Fed’s inflation target? Housing prices have gone nowhere, well maybe they’re less weak then they were six months ago. But inflation in home prices? It’s just not happening.

“And now political pressure is on the Fed to cut back on stimulus, money-creation and at the same time raise interest rates. This, if it happens, will definitely be deflationary, and it will hit housing and the economy.

“Ever since World War II the Fed has been on the inflation path. Leverage, rising debt, speculation, and higher prices have been the ‘law’ of the land. Now, I believe we have hit the inflection point; we are just entering the huge deflationary spiral that will unwind six decades of leverage and inflation.

“In the big picture what I see is that China and Asia will become (they already are) phenomenal producers. The developed nations will not be able to compete with them. The result will be a crushing decline in the price of manufactured goods, which, in turn, will impact on all goods including foodstuffs and services and medical services. In a vain effort to compete with China, India and Asia, currencies will be devalued across the board.

“Currencies will sink in the face of competitive devaluations (think Venezuela), and whatever can go bankrupt will go bankrupt. Debt will become a dirty word again, as it was during the 1930s (if you can’t pay for it with cash, live without it).

“The one item that will withstand this crushing force of deflation will be gold, whereas most items have been sinking against gold. If the deflation that I foresee arrives, items will be plunging in price against the standard - gold. This will be the great deflation that nobody foresees and nobody understands and nobody has protected themselves against.

“When you’re willing to agree that gold, not the dollar, is the universal immutable standard, you can see that the forces of deflation are taking over.

“For the sake of argument, let’s just say that I am correct. Then as the great deflation envelopes the land, all things (merchandise, stocks, currencies) will sink against gold. So gold then becomes the single item that is not declining, because gold is the standard, and the standard can’t go down against the standard. In that case, everyone will opt for the safety of gold. Gold will be seen as the final and ultimate protection against deflation.

“Question - Russell, let me play the devil’s advocate. Suppose you are dead wrong, and suddenly all the money that the central banks have injected into the system ‘catches on’. Then what?

“Answer - In that case gold surges higher. It goes higher because the amount of fiat currency being produced is far greater than the available amount of gold. The sheer amount of new currencies overwhelms the relatively fixed amount of gold.

“Question - Then, Russell, you’re saying that gold is the place to be whether inflation or deflation materializes.

“Answer - Yes, that’s the way I see it. Gold will be ‘the last man standing’, as it is now in Venezuela and Zimbabwe.”

Source: Richard Russell, Dow Theory Letters, January 14, 2010.

George Magnus (Financial Times): Sovereign default risks loom large
“The sustainability of sovereign debt hangs heavily over bond markets, and the prospects for economic and financial stability.

“Since 2007, OECD government deficits have risen by 7 per cent of GDP to just over 8 per cent, and debt, excluding contingent liabilities, has risen by about 25 per cent of GDP to just over 100 per cent.

“The biggest increases have occurred in Iceland, Ireland, the US, Japan, the UK, and Spain. There is no peacetime precedent for the current speed and scale of public debt accumulation and it is difficult to assess the social tolerance for high debt levels, and for the pain of protracted fiscal restraint. In several EU member states, the threshold has already been breached. The spectre of sovereign default, therefore, has returned to the rich world.

“Default does not have to mean outright debt repudiation. It can mean some type of moratorium on interest payments, and the restructuring of loan terms. Richer nations are assumed to be above such measures, but not in extreme circumstances. The US abrogated the gold clause in government and private contracts in 1934, and in 1971, it abandoned the gold standard altogether.

“Default can also occur via inflation, currency debasement, the imposition of capital controls, and the imposition of special taxes that break private contracts. Seen in this light, a few countries in eastern and western Europe may already be technically at risk of default.

“At the moment, higher spreads on sovereign bonds and credit default swap rates do not provide convincing evidence of an imminent default crisis, per se. Japan’s public debt has already risen above 200 per cent of GDP, but the government can borrow for 10 years at 1.4 per cent, while Australia’s government debt is about 25 per cent of GDP, but it pays over 5.5 per cent. Other rich countries with varying debt ratios all pay roughly 3.5-4 per cent. However, the status quo is not sustainable.

“Concerted fiscal restraint could trigger another recession, but the lack of it could end up in bigger default risks. Even Japan, now into its third ageing decade, may be vulnerable, while some eurozone countries, though sheltered from currency turbulence, may yet falter in their deflation commitments and compromise the integrity of the single currency as we know it.

“The UK still lacks a credible debt management strategy, and the US cannot take investor goodwill for granted.”

Click here for the full article.

Source: George Magnus, Financial Times, January 13, 2010.

CNBC: Bullard on US interest rates
“The greenback extended declines partly because of comments from St Louis Federal Reserve Bank president, James Bullard, that interest rates may remain low for quite some time. In an exclusive interview with Cheng Lei, Bullard says that maintaining low interest rates is all data dependant.”

Click here for a BusinessWeek article.

Source: CNBC, January 12, 2010.

MoneyNews: Pimco’s Clarida - Fed unlikely to hike rates this year
“The Federal Reserve is unlikely to raise interest rates before next year, says Richard Clarida, global strategic adviser for money manager Pimco.

“‘The Fed has never hiked until they have seen a sustained decline in unemployment,’ now 10 percent, he told Bloomberg.

“‘By the Fed’s own forecast, that is at least a year away.’ And thus, so is a rate hike, Clarida says.

“‘I don’t think the Fed’s going to do anything with rates until 2011 or perhaps very late in 2010.’

“In addition to improvement in the labor market, the Fed would want to see durable sources of demand in the economy before it raises rates, Clarida says.

“‘We had very modest growth in the third quarter (2.2 percent) and perhaps somewhat stronger growth in fourth quarter,’ he said.

“‘But all that is being driven by an inventory rebound and some temporary fiscal stimulus. The Fed’s going to want to see some durable demand from consumers, exports and investment.’

“It’s too soon to say the consumer sector has stabilized, Clarida says.

“‘If you believe as I do that the household sector in the next five years will be deleveraging, that means there will be more (trouble) to come.’”

Source: Dan Weil, MoneyNews, January 11, 2010.

Reuters: White House plans more to trim joblessness
“President Barack Obama plans more economic stimulus measures to bring down the high US unemployment rate, while cutting the bulging budget is a longer-term challenge, a top White House economic aide said on Sunday.

“‘We are … talking about actions right now to jump-start job creation,’ White House Council of Economic Advisers Chairwoman Christina Romer said on CNN’s State of the Union.

“‘You don’t get your budget deficit under control at a 10 percent unemployment rate,’ she said.

“Beating back unemployment will be a key yardstick by which US voters will measure Obama’s success in November congressional elections and will go a long way to determining his own long-term political future.

“Also troubling to many is a budget deficit that has ballooned from spending aimed at cushioning workers and businesses through the worst recession in decades.

“‘We have to do something,’ Romer said. ‘There are more targeted actions that we think absolutely will help.’

“Obama will focus is on getting the US fiscal house in order over the longer run, she said.

“Congress is considering proposals to help labor markets that include a $155 billion jobs package that has already cleared the House of Representatives.”

Source: Mark Felsenthal, Reuters, January 10, 2010.

Asha Bangalore (Northern Trust): Recent Fed rhetoric and highlights of Beige Book
“In speeches late yesterday [Tuesday], Fed Presidents Plosser and Fisher of Philadelphia and Dallas, respectively, were of the opinion that unemployment rate is most likely to trend higher than the December jobless rate of 10.0%. However, both of these non-voting hawkish members of the FOMC expressed concerns about inflation.

“Plosser was of the opinion that the Fed needs to be pre-emptive such that inflationary expectations remain anchored and an inflationary situation is avoided. He also noted that there is ‘extraordinary uncertainty about the prospects for inflation over the next two to five years.’

“President Fisher’s speech focused on lawmakers in Washington attempting to reduce the power and independence of the Fed.

“This morning [Wednesday], President Evans of Chicago, also a non-voting member of the FOMC, presented the Chicago Fed’s forecast for the economy in 2010. He reiterated that restrictive bank credit and cautious households and businesses are restraining the pace of recovery but indicated that these ‘headwinds’ would fade in the latter half of 2010.

“The next FOMC meeting is on January 26 and 27, with four new regional Fed Presidents as voting members - Presidents Bullard of St. Louis, Sandra Pinalto of Cleveland, Rosengren of Boston and Hoenig of Kansas City. President Hoenig is the most hawkish of these new voting members, with President Bullard painted as a hawk, while President Pinalto is seen as a centrist and President Rosengren is classified as a dove.

“The latest Beige Book, published today in preparation for the FOMC Meeting, indicates a modestly improving economy. Ten Districts indicated improving conditions compared with the last Beige Book reporting increased activity in eight Districts. Mixed conditions were reported for the Districts of Philadelphia and Richmond.

“The Beige Book assessment of consumer spending in the holiday season is consistent with the tally of chain store sales reports which indicated gains in retail sales from a year ago but below the levels seen in 2007.

“The labor market information in the Beige Book confirms the grim details of the December employment report published last week.

“Price and wage pressures were not problematic.

“The housing market was depicted as recovering from the lows of early-2009, with low mortgage rates and home buyer tax credit program lifting sales. The non-residential real estate sector remains a source of serious concern in nearly all Districts.

“On the financial side, weak demand for all loans, excluding residential mortgages, a deterioration of credit quality, increased loan delinquencies and defaults were noted. Against this backdrop, it is certain the Fed will hold the monetary policy stance unchanged. The minutes of the December FOMC meeting included differences in opinion about the Fed’s mortgage purchase program and prospects about inflation. The latest information does little to clarify these muddy waters. The nature of the incoming data after a deep recession and a financial crisis is bound to be mixed and present differences in the evaluation of the status of a recovering economy. Criticisms about the Fed’s handling of crises in the past suggest that the Fed is likely to err on the side of being cautious with an emphasis on economic growth.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 13, 2010.

Paul Kasriel (Northern Trust): Ballooning Treasury deficits - it takes both outlays and receipts to tango
“On Wednesday, the US Treasury reported a record cumulative deficit over the 12 months ended December 2009 of $1.472 trillion. Although the editorial board of the Wall Street Journal surely will rail against exploding federal spending, it will probably fail to mention another key driver of ballooning federal deficits - collapsing federal receipts.

“Yes, as shown below, the year-over-year growth in 12-month cumulative federal government outlays remains in double digits, which it entered in October 2008. But notice that the growth rate in federal outlays is slowing. It peaked at 19.2% in July 2009. As of December 2009, the year-over-year growth in 12-month cumulative federal outlays had slowed to 11.8% - the slowest since December 2008’s 12.8% growth. But look at what has been happening to the year-over-year rate of contraction in 12-month cumulative total federal receipts. In the 12 months ended December 2009 vs. the 12 months ended December 2008, total federal receipts contracted by 17.1%, a slightly slower rate of contraction than the 17.6% rate of contraction in the 12 months ended November.

“Of course, receipts are contracting. The US economy has only recently emerged from its longest and deepest recession in the post-war era in which both corporate profits and wage/salary income collapsed. Moreover, personal income taxes were cut by both the Bush (Jr.) and Obama administrations, something the editorial board of the Wall Street Journal presumably approved of.

“In sum, although high growth in federal spending is contributing mightily to our record federal deficit, the rate of growth in that spending is slowing. What often is forgotten is that the rate of contraction in federal receipts has accelerated.”

Source: Paul Kasriel, Northern Trust - Daily Global Commentary, January 14, 2010.

Asha Bangalore (Northern Trust): US trade deficit widens
“The trade deficit of the US economy widened to $36.4 billion in November from a revised $33.9 billion in the previous month. The inflation adjusted trade deficit of good in the October-November months nearly matches the average of the third quarter of 2009. The trade deficit is predicted to post a smaller deficit in the fourth quarter and help to lift overall GDP.

“Following the recession when world trade shrunk significantly, the volume of exports and imports now show a noticeable upward trend. In November, exports of goods and services rose only 0.9% to $138.2 billion, the highest since in the past year. Imports of goods and services increased 2.6% in November to nearly $175 billion, also the highest in the past year.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 12, 2010.

Clusterstock: Shipping into US unexpectedly jumped in December
“Shipping into the US climbed from November to December, defying typical seasonal trends and perhaps demonstrating growing demand in the US

“‘December was a surprisingly good month that put a promising end to 2009,’ the research company Panjiva said in a report issued today.

“Specifically:

“There was a 3% increase in the number of global manufacturers shipping to the US market.

“There was a 2% increase in the number of US companies receiving waterborne shipments from global manufacturers.

“Traditionally, these numbers decline from November to December (-5% in 2009 and -1% in 2008).

“You can expect that the good news will continue, although it may be more confusing than clarifying. For the first quarter, the year-over-year comparisons will likely look very good. But that will largely be a result of the global trade free fall in 2009. A better comparison is probably against 2008 or 2007.”

Source: John Carney and Kamelia Angelova, Clusterstock - Business Insider, January 12, 2010.

Asha Bangalore (Northern Trust): Industrial production - mixed news from the nation’s factories
“The Industrial Production Index rose 0.6% in December after a similar increase in November. However, the reasons for the gain were different. The December increase in production reflects a 5.9% jump in activity at utilities due to inclement weather, while the November gain was largely due to a 0.9% increase in factory production. In December factory production slipped 0.1%. “A mixed performance is seen in factory data for December. Production of consumer goods (+0.6%) and business equipment (+0.9%) increased but construction supplies fell 2.0%. Industrial production has risen 4.7% from the cycle low in June 2009.

“Production at factories has risen 4.5% from the cycle low in June 2009, while on a year-to-year basis, factory production dropped 1.9% in December. The decelerating pace of decline of factory production is noteworthy. The operating rate of the factory sector (68.9%) is still close to the historical low of 65.1%, which implies that businesses have room to meet a growth in demand without undertaking an expansion of capacity. There is nothing in this report that points to an inflationary threat and it is not likely to be seen for several more months.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 15, 2010.

Asha Bangalore (Northern Trust): Retail sales - mixed news
“Retail sales fell 0.3% in December, after an upwardly revised estimate for November (1.8% increase vs. 1.3% in the previous estimate). At first blush, the headline for December looks weak and contradicts the chain store sales reports published last week. These details should help to sort out the report.

“First, unit auto sales increased in December (11.2 million vs. 10.9 million in November) vs. the decline (-0.8%) reported in the retail sales report. Unit auto sales matter for consumer spending in the GDP report for the fourth quarter. But, the fourth quarter average for unit auto sales fell at an annual rate of 20.4% after a nearly 108% jump in the third quarter due to the cash for clunkers program. Therefore, unit auto sales will be a negative for fourth quarter consumer spending. Second, the upbeat chain store sales information published last week were comparisons from a year ago. Retail sales from a year ago presented in today’s report also show strong gains (see chart 4). The 2009 sales numbers look rosy compared with the 2008 weak holiday sales numbers. Third, on a quarterly basis, retail sales excluding autos or excluding auto and gas are stronger in the fourth quarter compared with the third quarter (see table below). Fourth, the level of retail sales excluding gasoline ($318.44 billion) in December compared with the fourth quarter average ($318.2 billion) is virtually flat, implying the absence of an arithmetical advantage.

“The main take away is that consumers are spending but gains are essentially lackluster when the details are sorted out.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 14, 2010.

Asha Bangalore (Northern Trust): Inflation - “Don’t worry, be happy,” for now
“If there is good cheer to go around, it is from inflation, for now. The Consumer Price Index (CPI) edged up 0.1% in December, putting the year-to-year change at 2.7%. The large jump after a string of declines in the eight months ended October 2009 is primarily due to higher energy prices. The energy price index moved up 0.2% in December, but was up 18.2% from a year ago. Food prices rose 0.2%, which translates into a 0.5% drop in food prices in all of 2009.

“Excluding food and energy, the core CPI, inched up 0.1% in December, with the year-to-year increase at 1.8%, matching the gain seen in 2008. The cycle low for the year-to-year increase of the core CPI is a 1.4% gain posted in August 2009. The main reason for the significantly contained core CPI is the decelerating trend of the shelter index (the single-largest component of the core CPI). The 0.3% year-to-year gain of the shelter index in December is smallest increase since record keeping began in 1953 for this price index.

“The Fed continues to be a sweet spot with regard to inflation and can continue to focus on economic growth for several more months. Although the Fed has begun examining the ways in which inflation emerges at the December FOMC meeting, the more vigorous debate and concern about inflation is topic for several months ahead.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 15, 2010.

Reuters: Fannie, Freddie re-defaults reach 34 pct
“More than a third of US residential loans modified by Fannie Mae and Freddie Mac early last year were in arrears again after six months, though the default rate has improved, according to the regulator of the two largest mortgage finance companies.

“About 34 percent of homeowners with loans guaranteed by the companies modified in the first quarter of 2009 were at least 60 days delinquent, the Federal Housing Finance Agency said in a quarterly report on Friday.

“That compares with 39 percent of mortgages going bad after the companies agreed to ease terms of the loans in the last quarter of 2008, the report said.

“The re-default measures cover loans modified before the start of President Barack Obama’s Home Affordable Modification Program that gives lenders a standard blueprint to ease terms of loans for troubled borrowers.”

Source: Al Yoon, Reuters, January 8, 2010.

Financial Times: US commercial property attracts new wave of money
“The beleaguered US commercial real estate sector has been attracting a new wave of money from sources including foreign banks, US private equity firms, and a leading Chinese sovereign wealth fund.

“Market participants warn that the activity represents ‘bottom-feeding’ by opportunistic investors whose strategies could be derailed by rising interest rates. Also, sums are tiny compared with the debts that need refinancing. Nevertheless, the growing interest from investors is a sign of stabilisation, making it less likely that worsening commercial real estate conditions will sink banks and choke off a US recovery.

“‘We believe the real story is that capital is ready to buy, even though it may not be so visible today,” said Bob Steers, co-chairman of Cohen & Steers, a real estate investment firm.

“Recently, state-owned China Investment Corporation has enlisted Cohen & Steers, Angelo Gordon and Morgan Stanley to identify commercial real estate opportunities, people familiar with the matter say.

“A public sign of such activity came on Friday when Colony Capital won a Federal Deposit Insurance Corporation auction for $1bn of commercial property loans formerly held by failed banks in states hit hard by the real estate downturn.

“The deal valued the loans at 44 cents on the dollar and was structured so the FDIC contributes $136m and holds 60 per cent of the equity, while Colony, a Los Angeles investment firm, puts in $90m for the remaining 40 per cent.

“Tom Barrack, Colony founder, called the investment ‘an implicit bet that rates stay low’ and warned: ‘If rates go up, everyone will be crushed.’”

Source: Henny Sender, Financial Times, January 10, 2010.

MoneyNews: Boskin: US economic data is almost criminal
“Former White House economist Michael Boskin says American investors no longer place much credibility in the economic and fiscal statistics being reported by the US government, and are ‘increasingly inclined to disbelieve them’.

“Boskin, the one-time economic adviser to President George H.W. Bush, says that solid, reliable information is needed by investors, because ‘as a society, and as individuals, we need to make difficult, even wrenching choices, often with grave consequences’.

“To base those decisions on misleading, biased, or manufactured numbers, is not just wrong, ‘but dangerous’, he wrote in The Wall Street Journal.

“But, due to the obvious fudging of numbers involved in the government’s health care insurance industry reform effort, most Americans now believe the health-care legislation will actually raise their insurance costs, rather than reduce them, and increase the federal budget deficit, rather than contain it.

“That’s not the only area where cynicism over official statistics is growing.

“‘Most Americans are highly skeptical of the claims of climate extremists,’ writes Boskin, now a professor of economics at Stanford University and a senior fellow at the Hoover Institution.

“And because of the spin over ‘jobs created and saved’ by the stimulus, they have a ‘more realistic reaction to the extraordinary deterioration in our public finances than do the president and Congress,’ Boskin adds.

“Squandering their credibility with these numbers games will only make it more difficult for America’s elected leaders to garner support for difficult decisions from a public increasingly inclined to disbelieve them, writes Boskin.”

Source: Gene Koprowski, MoneyNews, January 14, 2010.

Financial Times: FDIC chief blames Fed for crisis
“The Federal Reserve was blamed by a fellow regulator for contributing to the financial crisis on Thursday as the central bank and one of its former chairmen fought back against congressional moves to curb its powers.

“In unusually pointed criticism, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, told the Financial Crisis Inquiry Commission that ‘much of the crisis may have been prevented’ had the Fed dealt with subprime mortgages seven years before it did.

“In New York, Paul Volcker, former Fed chairman and now White House economic adviser, was making the case for the defence.

“He said there was ‘a compelling case that central banks should have a strong voice and authority in regulation and supervisory matters’.

“Both Ms Bair and Mr Volcker carry weight on Capitol Hill, where the Fed has drawn blame for aspects of the crisis.

“Mr Volcker told the Economics Club of New York he was ‘particularly disturbed’ about moves to take away the Fed’s regulatory function.

“Chris Dodd, Senate banking committee chairman, has proposed consolidating bank supervision into a single regulator.

“The Fed published a paper on Thursday, which had been sent to Mr Dodd on Wednesday, arguing that its financial stability and monetary policy roles were complemented by supervising bank holding companies.

“Mr Volcker said: ‘What seems to me beyond dispute, given recent events, is that monetary policy and the structure and condition of the banking and financial system are irretrievably intertwined.’”

Source: Tom Braithwaite, Financial Times, January 14, 2010.

Bloomberg: Federal Reserve seeks to protect US bailout secrets
“The Federal Reserve asked a US appeals court to block a ruling that for the first time would force the central bank to reveal secret identities of financial firms that might have collapsed without the largest government bailout in US history.

“The US Court of Appeals in Manhattan will decide whether the Fed must release records of the unprecedented $2 trillion US loan program launched after the 2008 collapse of Lehman Brothers Holdings Inc. In August, a federal judge ordered that the information be released, responding to a request by Bloomberg LP, the parent of Bloomberg News.

“‘This case is about the identity of the borrower,’ said Matthew Collette, a lawyer for the government, in oral arguments today. ‘This is the equivalent of saying ‘I want all the loan applications that were submitted.”

“Bloomberg argues that the public has the right to know basic information about the ‘unprecedented and highly controversial use’ of public money. Banks and the Fed warn that bailed-out lenders may be hurt if the documents are made public, causing a run or a sell-off by investors. Disclosure may hamstring the Fed’s ability to deal with another crisis, they also argued. The lower court agreed with Bloomberg.

“”The question is at what point does the government get so involved in the life of the institution that the public has a right to know?’ said Charles Davis, executive director of the National Freedom of Information Coalition at the University of Missouri in Columbia. Davis isn’t involved in the lawsuit.

“The ruling by the three-judge appeals panel may not come for months and is unlikely to be the final word. The loser may seek a rehearing or appeal to the full appeals court and eventually petition the US Supreme Court, said Anne Weismann, chief lawyer for Citizens for Responsibility and Ethics, a Washington advocacy group that supports Bloomberg’s lawsuit.

“New York-based Bloomberg, majority-owned by Mayor Michael Bloomberg, sued in November 2008 after the Fed refused to name the firms it lent to or disclose the amounts or assets used as collateral under its lending programs. Most were put in place in response to the deepest financial crisis since the Great Depression.”

Source: David Glovin and Thom Weidlich, Bloomberg, January 11, 2010.

Financial Times: Wall Street titans face the flak
“Four of Wall Street’s top executives offered some contrition and a defence of their actions on Wednesday, as the head of the Financial Crisis Inquiry Commission promised to use wide-ranging powers to establish the causes of the financial crisis and pursue any wrongdoing.

“Lloyd Blankfeinof Goldman Sachs, Jamie Dimon, chief executive of JPMorgan Chase, John Mack of Morgan Stanley and Brian Moynihan of Bank of America maintained a united front as the Financial Crisis Inquiry Commission, headed by Phil Angelides, probed the bail-out of AIG, risk management and executive compensation.

“Mr Blankfein, whose bank has become a lightning rod for public anger at Wall Street, bore the brunt of the panel’s questions. He mounted a robust defence after being asked whether part of his business was akin to selling a car with faulty brakes and then buying an insurance policy. But he added: ‘Anyone who says I wouldn’t change a thing, I think, is crazy.’

“The Goldman boss said that he and his rivals had been insufficiently sceptical of loose credit standards.

“‘We rationalised [it] because a firm’s interest in preserving and growing its market share, as a competitor, is sometime blinding - especially when exuberance is at its peak.’

“Mr Angelides, a former California treasurer appointed head of the panel by Congress last year, told the witnesses on the first day of public hearings: ‘We’re after the truth … the hard facts … we’ll use our subpoena power as needed. And if we find wrongdoing, we’ll refer it to the proper authorities.’

“Bonuses are drawing increasing political fire on Capitol Hill as the banks prepare to announce billions of dollars in pay-outs over the next few days.

“‘Clearly Wall Street has to be a lot more attuned to what’s going on in the economy,’ said Mr Mack. But he said that compensation had to allow the banks to compete for staff. ‘I have to run a company.’

“As part of a plan to quell anger and ensure that any government bail-out losses are recouped, the Obama administration is planning to impose a levy on banks.

“Mr Dimon told reporters: ‘Using tax policy to punish people is a bad idea.’ He added that the banks should not be paying for losses caused by car companies and other industries.

“Mr Dimon acknowledged that ‘certain subprime mortgages  …  weren’t great products. I think there were some unscrupulous mortgage salesmen and mortgage brokers. And, you know, some people mis-sold.’

“Mr Dimon and Mr Moynihan agreed that banks should not be considered ‘too big to fail’.

“Mr Obama will on Thursday announce a new levy on banks to try to recoup some of the stimulus funding they received.”

Source: Tom Braithwaite and Francesco Guerrera, Financial Times, January 13, 2010.

The Wall Street Journal: Goldman Sachs CEO singled out
“The Wall Street Journal’s Jerry Seib joins the News Hub from Washington, where he says Goldman Sachs CEO Lloyd Blankfein became a target at a hearing before the Financial Crisis Inquiry Commission.”

Source: The Wall Street Journal, January 13, 2010.

MoneyNews: Romer - big bonuses to bankers are offensive, ridiculous
“A White House economic adviser says big year-end bonuses for bailed-out financial institutions would be ‘ridiculous’ and ‘offensive’.

“Christina Romer says the Bush administration’s $700 billion bailout was necessary to avoid a collapse of the financial system.

“Now that banks are returning to profitability as a result of government help, Romer says that paying out billions of dollars in bonuses ‘does seem really ridiculous’.

“Romer, who heads the president’s Council of Economic Advisers, say that kind of big payout ‘is going to offend the American people. It offends me.’”

Source: MoneyNews, January 11, 2010.

Financial Times: Obama vows to recover crisis cash
“Barack Obama slammed ‘obscene’ bank bonuses on Thursday, as the US president formally revealed plans to impose a levy on big financial institutions to recoup some of the costs of the financial crisis.

“‘We want our money back and we’re going to get it,’ Mr Obama said, pledging to ‘recover every single dime the American people are owed’ for the troubled asset relief programme bail-out fund.

“Appearing keen to pick a political fight with the big banks, Mr Obama faulted them for trying to ‘return to business as usual’ with ‘risky bets to reap quick rewards’ and compensation practices that did not reflect the state of the nation.

“‘I’d urge you to cover the costs of the rescue not by sticking it to your shareholders or your customers or your citizens but by rolling back bonuses,’ he said. Aides said the levy would recover at least $90bn from 50 of the largest institutions, including US subsidiaries of foreign banks and insurance companies as well as US banks.

“Treasury secretary Tim Geithner told the Financial Times that the US would urge other countries to adopt a similar principle of recouping bailout costs from the financial sector. ‘We are going to see if we can encourage policymakers in other important financial centres to do something similar,’ he said.”

Source: Krishna Guha, Financial Times, January 14, 2010.

Financial Times: Banks braced for Basel battle
“Banks are gearing up to fight a proposal by global regulators to sharply increase capital requirements for institutions that bring in outside investors to fund subsidiaries, saying it will cripple their ability to expand in emerging markets.

“Bank executives fear the provision would create huge holes in the capital stocks of a wide range of UK, European and Japanese financial institutions, at a time when they are already under pressure to increase their regulatory capital.

“Analysts described the proposal as one of the most ‘draconian’ and ‘potentially devastating’ parts of a package of measures put forward in December by the Basel committee, which sets global standards that are implemented by local regulators.

“Credit Suisse analysts calculate the rule would substantially reduce the estimated equity buffers that banks hold against potential losses.

“They estimate the so-called equity tier one capital ratio, a key measure of balance sheet strength which excludes hybrid capital such as preference shares, would be cut by 0.7 percentage points from the current 9.6 per cent.

“In essence, the Basel committee wants to force banks to stop counting minority-owned stakes as part of their equity capital but insists they continue to recognise the entire potential losses of any subsidiary.

“Regulators are essentially saying that banks are on the hook for all the losses of their subsidiaries, but that equity owned by minority investors in a particular subsidiary would not be available to absorb group losses elsewhere in the world.

“Banking analysts at Citi and Evolution have concluded that HSBC, BNP Paribas, Credit Agricole and Natixis would be particularly hard hit. The banks either did not respond or declined to comment.”

Source: Brooke Masters and Patrick Jenkins, Financial Times, January 12, 2010.

The Wall Street Journal: Beware of bond bubble
“Bond traders are leery of a possible growing bond bubble. If the bubble bursts, people’s retirement savings may be in jeopardy, SmartMoney’s Russell Pearlman reports.”

Source: The Wall Street Journal, January 12, 2010.

Financial Times: Rate rise fears spark rush to issue bonds
“Businesses and governments have rushed to raise tens of billions of dollars from bond markets in a frenetic round of new year fundraising amid fears that interest rates are set to jump.

“A flurry of issuers, including Virgin Media, BMW and Manchester United football club, turned to the capital markets on Monday aiming to raise more than $20bn.

“Poland and Mexico were among a number of governments that also tapped international investors.

“So far this month more than $75bn has been raised, more than two-thirds of this by financial institutions trying to repair their balance sheets in the wake of the economic crisis.

“Last week, the US corporate bond market had its second busiest day on record.

“Wayne Hiley, of Barclays Capital, said a recent rally in the corporate bond markets had lowered the interest rate premium to government bonds that businesses pay. ‘There are issuers who are saying ‘let’s take advantage of this’ even if they hadn’t planned to come to the market until later on,’ he said.

“Companies usually aim to sell bonds early in the year when investors have fresh funds and before many companies enter a ‘purdah’ period ahead of earnings announcements.

“However, the current round of capital raising is particularly intense. Some companies believe a recovery in economic growth this year will lead to central banks raising interest rates, pushing up the cost of borrowing.

“Other companies, fearing market turbulence as the authorities begin to unwind last year’s emergency monetary and fiscal measures to prop up the economy - which have included buying bonds - are borrowing as much as they can while demand for debt remains strong.”

Source: Jennifer Hughes and Aline van Duyn, Financial Times, January 11, 2010.

Financial Times: Sovereign bonds seen as riskier than corporates
“The cost of insuring against the risk of debt default by European nations is now higher than for top investment-grade companies for the first time, as mounting government debt prompts fears over the health of many leading economies.

“It now costs investors more to protect themselves against the combined risk of default of 15 developed European nations, including Germany, France and the UK, than it does for the collective risk of Europe’s top 125 investment-grade companies, according to indices compiled by data provider Markit.

“Markit’s iTraxx Europe index of 125 companies is trading at 63 basis points, or a cost of $63,000 to insure $10m of debt over five years. This compares with 71.5bp, or $71,500, for Markit’s SovX index of 15 European industrialised nations.

“Fears over sovereign risk have risen sharply in the past few months as investors have become increasingly alarmed over rising budget deficits and record levels of government bond issuance needed to pay off public debt.

“By contrast, hopes of a recovery have helped support corporate credit markets. Since September, the SovX index has jumped 20bp, while the iTraxx Europe index has narrowed 30bp.

“Bankers are even warning that big economies, such as the US and the UK, could lose their top-notch triple A status because of the deterioration in public finances.”

Source: David Oakley, Financial Times, January 12, 2010.

MoneyNews: Gross - German, Brazil bonds better than Treasuries
“Bill Gross, who manages the world’s biggest bond fund for Pimco, expects German and Brazilian bonds to outperform US Treasuries.

“In the US, the budget deficit, which totaled $1.4 trillion last year, will push up Treasury yields faster than German government bonds, Gross said.

“And while the US will likely endure huge deficits for years, Germany has a constitutional amendment requiring a balanced budget by 2016.

“‘(It) is the most fiscally conservative, has half the deficit of the United States, potentially has a low inflation rate, and they yield about the same,’ Gross told Bloomberg, comparing US and German 10-year government bonds.

“The 10-year US Treasury now yields about 45 basis points more than the equivalent 10-year bund.

“Brazilian bonds, which make up 2 percent of Gross’ Pimco Total Return Fund, also are attractive, he says.

“‘Brazil has the highest real interest rates in the world,’ he pointed out.

“Brazil’s 10-year government bond yields 11.22 percent.”

Source: Dan Weil, MoneyNews, January 14, 2010.

Bespoke: Strategists get stock happy
“Each week Bloomberg asks Wall Street strategists (the same ones polled for their year-end S&P 500 price targets) for their recommended portfolio allocations to stocks, bonds, and cash. Currently, the consensus recommended stock allocation is 60.5%. As shown in the chart below, this number has spiked significantly in recent weeks. Throughout the financial crisis, strategists lowered their recommended stock allocations pretty much every week. They missed the bottom, however, as the market turned before their consensus hit bottom. During the week of the Lehman collapse, strategists were recommending that investors have 56.6% of their portfolio in stocks.

“Add this as another indicator that is currently back to its pre-Lehman levels, while the S&P 500 is still has about 9% to go.

“The current reading of 60.6% is up quite a bit from its level at the market lows. This doesn’t yet suggest that strategists are too bullish, however, as their average recommendation during the ‘03-’07 bull market was about 64%.”

Source: Bespoke, January 14, 2010.

Bespoke: And you thought the rally in equities was impressive
“Even though the S&P 500 has rallied more than 60% off its March 2009 lows, the index is still well below the 1,251.70 level it closed at on the Friday before Lehman’s bankruptcy filing. While the rally has been quite impressive, it pales in comparison to the gains we’ve seen in the corporate bond market. As of last week, the spread between Baa rated corporate bonds and 30-year US Treasuries had narrowed to its lowest levels since July 2007! Yes, you read that right - July 2007. Back then, the S&P 500 was trading above 1,500.”

Source: Bespoke, January 11, 2010.

Bespoke: Estimated Q4 S&P 500 and sector earnings growth
“S&P 500 earnings are currently expected to grow by 62.1% in Q4 ‘09 versus Q4 ‘08. In the first chart below, we highlight how this growth estimate has changed since the start of the fourth quarter. As shown, estimates are essentially right where they were at the start of Q4, but there was a lot of movement in the estimate throughout the quarter. From October to the end of November, the growth estimate rose on a weekly basis all the way up to 75.7%. Since peaking, however, estimates headed lower by quite a bit until finally bumping up from 60% to 62.1% in the last week. As we enter earnings season, it’s probably a good thing for the bulls that expectations have come down a little.

“While the S&P 500 as a whole is expected to grow by 62.1% in the fourth quarter, the bulk of this growth is expected to come from the Materials and Financial sectors. As shown below, these are the only two sectors with Q4 growth expectations that are higher than the S&P 500. And more sectors are still expected to see a decline in earnings than a rise. Energy and Industrials are both expected to see earnings decline by more than 20% in the fourth quarter, while Telecom is not far behind at -19.2%. Health Care, Consumer Staples and Utilities are all expected to see a drop of about 5%. Technology and Consumer Discretionary are the other two sectors expected to see growth.”

Source: Bespoke, January 12, 2010.

John Authers (Financial Times): Too soon for complacency
“Markets have set themselves up for some bad news to send them spinning. On Tuesday, the bad news broke.

“Markets move on the interaction of news with flows of greed and fear among investors. When fear is lowest, the danger of a fall is greatest.

“This week the CBOE Vix Index, measuring volatility in US stocks, hit its lowest level since May 2008, when a lull after the Bear Stearns rescue gave way to an implosion.

“Another great contrarian indicator is the survey of sentiment by the American Association of Individual Investors. Last week, this showed the lowest proportion of self-described “bears” since February 2007 - when volatility first started to spike as investors at last began to grasp the severity of the subprime mortgage crisis in the US.

“Bearishness in this survey hit an all-time high in March last year when the current rally first started, showing how much money can be made by betting against extremes of sentiment.

“Even bulls should concede that this optimism looks overdone. Stock market valuations enshrine very strong earnings growth for this year, while there are numerous possibilities of macroeconomic shocks around the world.

“Tuesday, China tightened monetary policy, in a necessary action which displeased the market, while the European Commission condemned Greece for falsifying data, in a broadside that raised fears once more that Greece could default without being bailed out by fellow eurozone members.

“Meanwhile, Alcoa, the aluminium producer, revealed disappointing results to launch the US earnings season for the fourth quarter of last year.

“If not exactly the sum of all fears, this combination of bad news showed that it is too soon for complacency. There are real risks in many different places and the chance of a sharp correction looks high. In that context, Tuesday’s falls for stock markets around the world look surprisingly muted.”

Source: John Authers, Financial Times, January 12, 2010.

Bespoke: Volatility at lowest level since May 2008 - should you care?
“Now that the VIX index is at its lowest levels since May 2008, and down nearly 80% from its record high in late 2008, there is a growing concern among some investors that there is not enough fear in the marketplace. As the chart below indicates, the current level of 17.55 is lower than the long-term average of 20.3 since 1990. However, during the mid-nineties and the middle part of this decade, which were both good periods for equity investors, the VIX not only traded at and below current levels, but it also remained at those levels for several years.

“While the VIX’s decline over the last year indicates that investors are not as fearful as they were a year ago, can you blame them for not being so? Things haven’t quite returned to normal, but they are a lot closer now than they were then.”

Source: Bespoke, January 12, 2010.

CNBC: Kass’ correction
“The man who called the bottom now calls for a correction, with Douglas Kass of Seabreeze Partners.”

Source: CNBC, January 13, 2010.

David Fuller (Fullermoney): Treasuries above 5% could harm equities
“The main risk to economic recovery will surface when long-dated interest rates back up, presumably as quantitative easing (QE) is phased out. However, every seasoned financial observer, including those at the Fed and US Treasury, will be aware of this risk. Therefore, will they blur the date at which QE supposedly ends? Will they extend it? Might they agree to no more than a partial phase-out, retaining the freedom to squeeze ‘bond vigilantes’ if rates rise too quickly?

“My guess in response to these questions is, yes, one way or another. After all, the Fed has always been active in government bond markets and it will not want to leave yields looking exposed, like ducks in a shooting gallery. Whether the Fed and US Treasury can prevent rates from rising too quickly, possibly later this year, remains to be seen.

“I will take my cue from the chart action, with particular interest in how higher yields affect stock markets. For me, a sustained move above 4% by US 10-year Treasuries will be equivalent to a yellow caution light for equity investors. Above 5%, stock markets could be in dangerous territory, as we saw in the last cycle.

“However every forecast for a precise repetition of a previous cycle assumes that all other factors remain equal, which of course, is never the case. Therefore stock markets, which remain mostly in consistent uptrends today, could weaken sooner or later relative to long-term rates.

“Consequently I will continue to view US Treasury 10-year yields as a lead indicator. Currently, they are still in a ’sweet spot’. However when they move higher I will monitor stock market indices, particularly for Wall Street, even more closely for signs of fatigue in the form of inconsistencies, not least a loss of upward momentum.

“Lastly, an eventual break in 10-year yields to the downside below 3%, which I do not expect, could also be bearish for equities by signalling weaker GDP growth and rising deflationary pressures.”

Source: David Fuller, Fullermoney, January 11, 2010.

Bespoke: The smaller the better
“The average S&P 500 stock is up 3.50% so far in 2010. We broke the index into 10 deciles (10 groups of 50 stocks) based on market cap and calculated the average YTD percent change of the stocks in each decile to see how a company’s size has impacted performance so far this year. As shown below, the 50 biggest stocks in the S&P 500 are up an average of 2.4% year to date. The 50 smallest stock in the index are up an average of 6.5%. In general, the bigger the stock, the smaller the gain so far in 2010.”

Source: Bespoke, January 14, 2010.

MoneyNews: Goldman - big banks, Latin America are best buys for 2010
“A recent report from Goldman Sachs’ shows the investment bank forecasting that big banks with consumer exposure and commodities will be among the best bets for 2010.

“Goldman says that corporate profits will grow, especially in tech, business travel, office supplies and advertising - and that excess corporate cash will drive more mergers and acquisitions, bigger dividends and more stock buybacks.

“Tech growth will be built on the move towards cloud computing and a corporate level refresh of personal computers and servers.

“E-commerce will also continue to grow, taking advantage of its strength to draw business away from traditional competitors.

“Commodity prices will rise as demand outpaces supply, and inflation on key agricultural and protein commodities will boost the agricultural and supermarket industries, but damage internationally underexposed restaurant companies because increased foreign demand won’t benefit their bottom lines.

“Market-oriented Latin American nations and China are best positioned for what Goldman describes as the “post-crisis economy” and will outpace slow US recovery.

“As a supplier of natural resources, Latin America is becoming the go-to destination for new commodities consuming behemoths, particularly China.

“Obamacare, Goldman claims, is less important than the fundamentals for health care, where financial engineering increasingly generates med-tech earnings per share.

“Brazil’s economy will not need additional stimulus in 2010, although some measures introduced in 2009 could become permanent.”

Source: Julie Crawshaw, MoneyNews, January 12, 2010.

BCA Research: Interest rate differentials are likely to weigh against the US dollar
“The upturn in the global economy, a renewed widening of the US current account deficit and a Federal Reserve that keeps interest rates near zero will spell trouble for the US basic balance and keep the dollar under downward pressure.

“During 2002-2008, there was a marked divergence between the widening US current account deficit and falling real yields, which weighed on the dollar. The current account represents the US’s need for foreign capital. Meanwhile, real interest rates help to attract the required inflows. As these two variables moved in opposite directions, i.e. the current account widened and real rates fell, the dollar suffered as a consequence. Then, the Great Recession narrowed the US current account deficit and the deflationary pressures lifted real interest rates. This combination helped support the dollar in late 2008 and into early 2009. But with the deflationary impulse receding, real interest rates are falling again. As the US current account begins to widen and diverge with real interest rates, the dollar will face renewed downward pressure.

“Bottom line: Low real interest rates and a renewed cyclical widening of the US current account deficit should push the dollar lower in the coming months. This dynamic will be in place at least until the Fed begins to normalize interest rates, i.e. for most of 2010.”

Source: BCA Research, January 12, 2010.

CNBC: Implications of a strengthening yuan
“Beijing will probably appreciate the yuan by about 3-3.5% in 2010, predicts Tony Raza, director of asset allocation at UOB Asset Management. He outlines the implications this yuan appreciation will bring.”

Source: CNBC, January 11, 2010.

Bespoke: Commodity prices and the consumer
“Since the start of 2010, the rally in commodities has been a boon for companies and investors in the Energy and Materials sectors. Consumers, on the other hand, are increasingly feeling the impact on their wallets. In the chart below we have calculated the cumulative daily price change of the major food and energy commodities in the CRB index (Corn, Soy, Wheat, Cattle, Hogs, Oil and Natural Gas) since the beginning of 2008. We then multiplied the changes by the annual per capita consumption of each item. When the line is in positive territory, commodity prices are acting as a tax on consumers, while readings in negative territory are indicative of a windfall for consumers. Although this method may oversimplify the actual costs, it provides a good idea of how changes in commodity prices have impacted consumers’ wallets over the last 24 months.

“As shown in the chart, the rally in commodities in 2008 was especially painful on consumers. During the Summer of 2008, commodity prices were acting as a $4.77 per capita daily tax on US consumers versus the start of the year. When the credit crisis escalated, commodities tanked, thus erasing the entire tax (and then some) on consumers. By the time commodity prices bottomed in early 2009, US consumers were now benefitting from nearly a $5 daily windfall due to the decline. Since commodity prices bottomed early last year, however, that windfall has been slowly dwindling away. While US consumers are still benefitting from lower commodity prices compared to the start of 2008, the windfall is less than 30% of what it was nearly a year ago.”

Source: Bespoke, January 11, 2010.

MoneyNews: Pickens - forget the wind, go with natural gas
“Famed Texas billionaire T. Boone Pickens is dramatically changing his position on alternative energy.

“Pickens spent most of the last two years, and $62 million of his oil investing fortune, on an advertising campaign in which he sought to persuade Americans to adopt his plan for wind-based energy.

“The scheme called for a massive expansion of wind energy to displace natural gas, leaving natural gas for use in vehicles, thus displacing foreign oil.

“‘No American with a television set could escape Mr. Pickens’s argument last year. But somehow, a mass conversion to natural gas cars failed to ensue,’ a recent report in The New York Times stated.

“But, now Pickens is changing his pitch.

“Pickens said Wednesday he has cut in half an order for General Electric Co. wind turbines and plans to use the rest in other areas instead of Texas, where he once planned a massive wind farm, the Associated Press reported.

“Pickens, who heads the hedge fund BP Capital Management LP in Dallas, purchased 333 turbines from GE, which was about half his initial order of about 687 turbines.

“Pickens scrapped his plan for a 1,000-megawatt wind farm in West Texas last summer because of technical problems in getting power from the site to transmission facilities.

“Pickens now is spending millions more on a new campaign, with the first advertisements scheduled to be broadcast Thursday on cable stations across the country.

“His aides reckon that a stronger message, concentrating on the national security aspects of energy independence, will be quite effective after the thwarted Christmas Day airliner bombing and other, recent terrorist actions in the United States.

“Natural gas is said to be the cleanest fossil fuel, emitting fewer greenhouse gases than either coal or oil.

“Many energy experts say they think it is underutilized as a fuel, especially since new technologies recently unlocked huge reserves in shale gas fields across the country.

“Some, however, say putting in place the infrastructure for natural gas vehicles would be too costly, and battery-powered electric cars and hybrids are a much better alternative.”

Source: Gene Koprowski, MoneyNews, January 14, 2010.

Financial Times: China’s exports rise as economy picks up
“China’s exports rose in December for the first time in 14 months, providing fresh evidence of recovery in the global economy but also placing renewed pressure on Beijing to appreciate its currency.

“Following strong export figures last month from South Korea and Taiwan, China said on Sunday that its exports climbed 17.7 per cent, well ahead of the modest increase that economists had predicted. These numbers put China on track to overtake Germany as the world’s largest exporter.

“Chinese imports surged by 55.9 per cent in December, the latest indication of buoyant domestic demand in China, although the figures are also likely to increase concerns about potential inflationary pressures.

“Exports to China’s two biggest markets both rebounded last month, with sales to the US increasing 15.9 per cent and to the European Union 10.2 per cent.

“However, the year-on-year comparisons were inflated by the low base of the previous year’s figures. Economists said some of the improvement was due to restocking by companies that had run down inventories.

“‘While December’s export figures are encouraging … a recovery to pre-crisis levels appears some time away,” said Jing Ulrich, head of China equities and commodities for JPMorgan.

“Andy Rothman, CLSA’s chief China economist, said a resumption of export growth was necessary before Beijing restarted appreciation of the renminbi, suspended over a year ago in the crisis. He said Beijing was unlikely to act on one month’s figures alone. But if the export recovery continued, China’s leaders would have the political cover to resume renminbi appreciation by mid-year, with a possible rise of 3 per cent for 2010.

“‘Beijing has been waiting for three things to happen before resuming gradual appreciation: strong economic recovery in China; stability in the US and European economies; and several months of [positive] Chinese export growth, which is important to sell appreciation to the domestic audience.’

Source: Patti Waldmeir, Financial Times, January 10, 2010.

Financial Times: China raises bank reserve requirements
“China has increased the amount banks must set aside as reserves in the clearest sign yet that the central bank is trying to tighten monetary conditions amid mounting concerns of overheating and inflation as a result of the credit boom.

“The People’s Bank of China also raised interest rates modestly in the inter-bank market on Tuesday for the second time in less than a week, as it engages with commercial banks in a tug-of-war over rapid lending.

“Stock markets and commodities fell in Asia on Wednesday after the surprise decision, sparking concerns that the move could slow China’s purchases of natural resources and other imported goods from around the region.

“Economists said that Tuesday’s announcements were a warning to the banks against lending too aggressively following reports in state media that loans in the first week of 2010 reached Rmb600bn ($88bn), not far short of the monthly average last year.

“‘This is a warning across the bows of the commercial banks,’ said Tom Orlik, of Stone & McCarthy in Beijing. ‘The central bank said that the high level of bank lending needs to come to an end but that the commercial banks do not seem to be taking it seriously.’

“Reserve requirements were raised by 0.5 percentage points, while rates on one-year paper increased by 0.08 per cent and on three-month paper by 0.04 per cent.

“The moves underline the increasingly delicate task the PBoC is facing in managing the consequences of China’s credit binge, when lending more than doubled from Rmb4200bn in 2008 to above Rmb9000bn last year.”

Source: Geoff Dyer, Financial Times, January 12, 2010.

The Wall Street Journal: China’s hot money headache
“While Beijing battles its coldest winter in half a century, Chinese officials are battling a major hot money problem. Heard on the Street’s Andrew Peaple ponders the government’s efforts to restrain the flow of funds into China.”

Source: The Wall Street Journal, January 12, 2010.

Bloomberg: China’s property prices rise most in 18 months
“Rong Ren, chief executive officer of Harvest Capital Partners, talks with Bloomberg’s Bernard Lo about the implications of China’s increase in the proportion of deposits banks must set aside as reserves. Ren, speaking in Hong Kong, also discusses his strategy for investing in China’s retail malls and development projects.”

Click here for the full article.

Source: Bloomberg, January 14, 2010.

Financial Times: Greece unveils 3-year plan to curb deficit
“Greece on Thursday announced an ambitious three-year plan to curb its runaway budget deficit but failed to convince sceptical markets its targets for growth and fiscal reform were feasible.

“The stability and growth plan calls for the budget deficit to be cut from 12.7 per cent to 2.8 per cent of gross domestic product by the end of 2012.

“The economy is projected to shrink by 0.3 per cent this year before rebounding with growth of 1.5 per cent in 2011 and 1.9 per cent in 2012.

“The deficit would be reduced this year by 4 percentage points of GDP, with deep cuts made in hospital and defence spending where waste and corruption are widespread, according to officials. Revenue increases would be driven by higher excise taxes on tobacco and alcohol, an overhaul of the tax system and a crackdown on tax evasion.

“‘This plan can be achieved, we’re confident of that,’ said George Papandreou, the prime minister, after an outline was presented at a televised cabinet meeting.

“The plan is seen as Greece’s passport to borrowing almost €54bn ($78bn) on international markets to fund a swollen public debt expected to rise this year from 113 per cent to more than 120 per cent of GDP.

“But markets reacted negatively almost as soon as George Papaconstantinou, finance minister, finished his presentation at a cabinet meeting broadcast live on Greek television under the government’s policy of promoting transparency.

“The cost to insure Greek debt rose to fresh heights as investors continued to worry about the parlous state of the country’s finances. The Greek bond markets also sold off, dipping to 12-month lows.

“‘We think these forecasts are too optimistic … we doubt the government will meet its fiscal targets - the recent renewed surge in government bond yields may therefore have further to go’, said Ben May of Capital Economics in note published on Thursday.

“‘The two targets - growth and public deficit - are inconsistent and at least one won’t be achieved,’ BNP Paribas said in a note.”

Source: Kerin Hope and David Oakley, Financial Times, January 14, 2010.

Tags: Asset Classes, Barack Obama, BRIC, Canada, Cboe, China, Christina Romer, Commodities, Council Of Economic Advisers, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Index, Economic Recovery, Emerging Markets, ETF, Financial Institutions, Gnomes, Gold, India, Inquiry Commission, Interesting News, Interrogating, Market Commentators, oil, Pecora, Research Resources, S Council, Steve Sack, Top Executives
Posted in Emerging Markets, India, Markets | No Comments »

SocGen’s Investment Strategy For 2010

Wednesday, January 13th, 2010

Société Générale (SocGen), France’s second-biggest bank, has told its clients to be bullish on commodities, stay with stocks and “anything but cash” in 2010. SocGen’s Chief Strategist Alain Bokobza spoke to CNBC on Jan. 11, 2010 about the investment strategy.

Fear of Double Dip to Prevent Bond Crash

Bokobza sees an ongoing momentum for growth in the U.S. with higher employment, as well as the emerging economies.  The consensus seems to be we are heading towards a bond market crash in 2010; nevertheless, fear of a double-dip will prevent a bond market crash.

The U.S. Federal Reserve and G4 countries are expected to stay on a near-zero interest rate for much longer than expected, which makes yield curve play attractive.

Yen - The Carry Trade Currency

Bokobza expects the U.S. Federal Reserve and the ECB to announce this summer that the monetary tightening process will start at the end of 2010 or in Q1 of 2011.  At the time of the announcement, i.e., this summer, carry trade will begin to switch from Dollar to Yen.

Overall, the Dollar is expected to be fairly flat against the Euro by the end of this year; however, Yen, as the new major carry trade currency, would fall ”massively”.

SocGen’s Main Advice For 2010

With near-zero interest rates, getting out of cash and into other riskier assets such as equities or commodities should be the strategy this year.

• Anything but cash
• Stay in equities
• Expect rising M&A cycles
• No bond market crash
• Yen carry-trade
• Be a commodity bull

Refer to SocGen’s Cross Asset Research Report dated Jan. 4, 2010 from Scribd.com HERE, and below, for full commentary and recommendations.

Video Source: CNBC

Outlook 2010 (SocGen)

Tags: Alain Bokobza, Bond Market, Chief Strategist, Cnbc, Commodities, Commodity, Dollar To Yen, Double Dip, ECB, Emerging Economies, ETF, Federal Reserve, G4 Countries, Investment Strategy, Market Crash, Q1, SocGen, Societe Generale, Video Source, Yen Carry Trade, Yen Dollar, Zero Interest
Posted in Markets | No Comments »

Gold Outlook 2010: Gold Resuming its Historical Monetary Role – as the Anti-Currency

Monday, January 11th, 2010

Keynote Speech Presented by Nick Barisheff at the Empire Club’s 16th Annual Investment Outlook Luncheon

Thursday January 7, 2010

To download the PDF version of this article, click here.

Good afternoon. As always, it is a privilege to speak at the Empire Club.

Each year for the past three years, I have returned to share perceptions about the precious metals industry and specifically about gold. Generally, this forces me to step back and assess the previous year’s events and then to speculate about what they may indicate for the coming year. Choosing the seminal events this year has been more difficult than usual. Lately the pace of gold-related news has accelerated exponentially with gold’s rising price. While 2009 was an exciting year for gold, setting a new average high of $1,088, 2010 promises to be even more exciting.

In 2009 gold resumed its historical monetary role - as the anti-currency. Therefore, the influences and events that affect its price are not simple commodity supply/demand fundamentals, but the more complex global monetary issues.

To summarize some of the important key events, I thought it would help to separate them into three categories.

First, there are the obvious events-those whose implications for gold are self-evident.

Second, there are the events that require some interpretation and, finally, there are the events that we might call “incipient”. These events and stories are in their early stages of development. They may amount to nothing, or they may develop into tectonic forces that completely disrupt the gold-related financial landscape.

It is more than a year since Wall Street made some very bad bets that resulted in unprecedented losses, losses that were passed on to the American taxpayer. For their incompetence and greed, most of the company heads responsible were rewarded with generous severance packages, or with new jobs commensurate in pay and status to the ones they left behind. Even more surprising, perhaps, is that one year later many of these people continue to advise the US government’s financial policy makers. My associate, trend analyst Richard Karn, likens this particular situation to a group of chickens getting together and consulting with the foxes about a problem that is plaguing their community-the rapidly decreasing chicken population. Since the same key figures remain firmly in charge of US fiscal policy, we can assume the status quo will continue until the ship finally hits the iceberg.

So let’s start with the obvious gold events of the past year.  It was the first time in 20 years that gold purchases for investment purposes outpaced gold purchases for jewellery demand.  However, in terms of significance, central bank buying of gold this past year upstaged all other events. For the first time in over 20 years, central banks became net buyers rather than net sellers of gold. This is a watershed event.

India’s central bank purchase of over 200 tonnes of IMF gold in the fall of 2009 demonstrated that large central banks were willing to pay the market price for gold. This removed the concern that official sector sales could cut short any meaningful rally.  Although the central banks have been selling less gold each year lately, the threat of IMF sales had continued to weigh on the market.  Russia and China further dispelled this fear with the disclosure that they too have added 130 and 454 tonnes respectively.  Several smaller central banks such as those in Sri Lanka and Maritius also added to their gold reserves. Therefore, central bank buying was clearly the significant gold event of 2009 and will likely continue to be in 2010.

The next level of news events had implications that might not have been so obvious at first glance. On October 6, Robert Fisk, a veteran Middle East correspondent writing for the UK’s Independent, published an article entitled “The Demise of the Dollar.” The article described how “Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading.” Although the central banks immediately rejected these rumours, the market treated their denials as a clear admission of guilt and gold broke through year-long resistance at $1,020 an ounce into an entirely new trading range that day.

The Iranian oil bourse, which allows oil sales in several currencies except the US dollar, is another indication that this trend will continue.  In addition, the US’s greatest supporter of the petrodollar, Saudi Arabia, announced that it would no longer trade oil futures on the NYMEX. And on October 19 a related event occurred that received almost no mainstream press coverage; in fact, the only mention I could find of this story at first was at Al Jazeera Online. This was an agreement between ten member states in Central and South America and the Caribbean to use the sucre rather than the dollar for intra-regional trade. Venezuela, one of the West’s largest oil suppliers, is also a member of this new alliance.

This trend is significant to gold because, since 1973, the US has been able to accumulate huge deficits thanks to an agreement with OPEC to price oil in dollars exclusively. This system worked until the 2008 financial crisis, which many felt weakened the dollar’s inherent worth beyond repair. The petrodollar experiment, which started in 1971 with the removal of the dollar’s peg to gold and continued in 1973 when the dollar was essentially backed with oil, is coming to an end after only 36 years. However, given the weakness of other currencies and the fact that no other paper currency currently threatens to replace the US dollar, the process may take years to complete. The end of the petrodollar’s hegemony, which is inevitable in my opinion, will have significant implications for gold.

Another event whose implications may require some extrapolation was the move by the Chinese government to encourage and facilitate gold buying by the Chinese public. China watchers know the Chinese have a long-term love for gold. In fact, on December 9, Reuters announced that China had surpassed India as the world’s largest gold buyer, for the first time in recorded history.  The Chinese have also demonstrated a strong propensity for saving. With their government making no secret of its displeasure with the US dollar, and with few other safe investment options available, the Chinese public could provide the fuel to move the gold price to new highs. One ounce purchased by each of the 80 million middle-class Chinese would equate to 2,500 tonnes of gold.  It is important to remember that during the last gold bull, the Chinese public was unable to participate. This is a story that definitely bears watching.

Finally, in the third category, is the news we might compare to the first spark of a match that either extinguishes uneventfully or ignites a raging, out-of-control forest fire. Most of us in the gold industry have discovered that we ignore these flickers at our own peril. Many of the stories that started as hints or rumours a few years ago are now accepted as fact. The first of these issues we are watching is the imbalance between gold derivatives and paper proxies and the amount of physical gold in existence. This is important because despite its best efforts, Wall Street still cannot print gold.

Since almost all the gold ever mined remains in existence and gold reserves and production estimates are monitored meticulously, such discrepancies will show up faster in the relatively small gold market than they might with other commodities. As Wall Street churns out new gold investment vehicles, people are starting to do the math. If it becomes apparent that financial institutions have sold more paper gold than actually exists in physical form, then the price of paper gold and physical gold could diverge.

This year, many analysts began to apply increased scrutiny to the gold and silver ETFs. In mid-July, hedge fund giant Greenlight Capital announced they were moving assets out of the world’s largest gold ETF - SPDR Gold Shares - and into physical gold. Greenlight is an industry leader whose movements are carefully studied and often emulated. Although Greenlight’s manager, David Einhorn, claimed it was cheaper to own and store physical gold than it was to pay the ETF fees, the fact that a major, industry-leading fund would move to physical bullion set off many alarm bells.

Since ETFs do not actually purchase their assets, there is nothing prohibiting Authorized Participants from contributing baskets of borrowed gold. The amount of borrowed gold held by ETFs is a matter of speculation.  With multiple claims on the bullion, ETF investors may suffer unexpected losses under stress conditions when they need their gold the most.

So with these events of 2009 in mind, I am often asked, “How high might the price of gold go?”

Let’s look at some figures.

We know that the US must refinance at least two trillion dollars of debt in 2010. They can raise this money in one of three ways:  through the sale of bonds, through increased taxation, or through monetization by the Federal Reserve. Foreign investors showed decreasing appetite for US treasuries in 2009. Rising unemployment along with an aging population makes increased taxation a poor option. Therefore, the US Fed will be forced to monetize the ballooning debt, further eroding  confidence in the dollar as the world’s reserve currency.

This will encourage central bankers, especially those of the developing countries, to accelerate their accumulation of gold. Stephen Jen, a managing director at hedge fund BlueGold Capital and an expert on sovereign wealth funds from his days at Morgan Stanley, estimates that the percentage of gold held by the Chinese, Indian and Russian central banks is just 2.2 percent. This compares with 38 percent held by Western central banks. According to Jen, they would have to buy $115 billion dollars worth of gold at current prices to raise their bullion to just 5 percent of total reserves, and $700 billions’ worth to reach just half of Western levels.

Along with many others in the gold industry, we have noticed that fund managers are starting to buy gold as long-term insurance, which they intend to hold for several years. By one estimate, if the world’s pension funds and hedge funds moved only five percent of their assets into gold, which these days seems quite conservative, gold would trade above $5,000.  With leading wealth managers such as David Einhorn, John Paulson and Paul Tudor Jones allocating significant amounts of their portfolios to gold, the process may have already begun.

In conclusion, the events of the past year bode well for the price of gold in 2010. At the recent highs of $1,200 many thought that gold was overbought. For those who feel this way, I would like to close with some recent words from investment legend Richard Russell who said, “If gold is going parabolic, then there’s no such thing as ‘overbought’,” Almost any of the events of 2009 I have highlighted could trigger such a parabolic rise. Right now the Chinese and Indian public, the non-Western central banks, the sovereign wealth funds, the pension funds and the hedge funds of the world are all looking for ways to increase their long-term gold holdings. The pull-back from the recent highs of $1,200 seems to be over, providing an attractive entry point for investors. In 2010 we will likely see prices rise to at least $1,300 to $1,500.

It is important to understand that this isn’t a typical bull market. Unless governments around the world stop creating massive amounts of new money, the price of gold will continue to rise.

There is a famous investment axiom that states, “Now is always the most difficult time to invest.”  To that I would add, “But now is also the best time to insure the wealth we have accumulated is protected through the ownership of gold.”

Thank you.

Tags: American Taxpayer, China, Commodities, Commodity Supply, Emerging Markets, Empire Club, ETF, Financial Landscape, Gold, Gold Outlook, Good Afternoon, Greed, Incompetence, India, Investment Outlook, Keynote Speech, Monetary Issues, New Jobs, oil, Pdf Version, Precious Metals Industry, Previous Year, Seminal Events, Severance Packages, Stages Of Development, Tectonic Forces, Unprecedented Losses
Posted in Canadian Stocks, Currency, Economy, Emerging Markets, Gold, India, Markets, Outlook | No Comments »