Time for More Investment Risk?

Wednesday, August 8th, 2012

“An improvement in the global economic outlook is the key fundamental reason to take on more risk in an investment portfolio,” said BCA Research in a recent commentary. “The U.S. payroll report was positive relative to expectations, but rather weak in absolute terms. Moreover, last week’s Fed and ECB meetings did little to lift our optimism. Several indicators continue to suggest it is too early to add to pro-cyclical currency trades.

• For example, the global leading economic indicator is still pointing down. More importantly, with no new stimulus measures announced this week, it is difficult to see the global LEIs inflect upwards.
• In addition, gold is a real-time monetary indicator and the peak in March 2008 correctly warned that deflation risks were escalating. Gold’s recovery in early 2009 (ahead of the bottom in equities) then accurately indicated that reflationary policies were finally gaining traction. Gold prices slipped back below $1,600/oz following this week’s Fed and ECB meetings. This suggests that major central banks are still behind the curve.  As in early 2009, a sustained rally in gold will signal that the forces of reflation are starting to win out.
• Finally, an uptrend in Chinese stocks and an acceleration in Chinese money supply growth will be bullish signs for Chinese growth and the commodity complex.”

BCA concludes that “it will take further proof that the global economy is stabilizing before augmenting a pro-cyclical currency investment stance.”

Source: BCA Research, August 7, 2012.

Tags: Absolute Terms, Central Banks, Chinese Growth, Chinese Money, Chinese Stocks, Currency Investment, Currency Trades, ECB, Fundamental Reason, Global Economic Outlook, Global Economy, Gold Prices, Investment Portfolio, Investment Risk, Leading Economic Indicator, Monetary Indicator, Money Supply Growth, Payroll Report, Reflation, Uptrend
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Where’s the Beef for Gold Equities?

Sunday, April 15th, 2012

Where’s the Beef for Gold Equities?

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

Gold bulls have plenty of room to graze in the stockyard these days as the investing herd migrated to other assets during the market’s steep climb in 2012. For the fourth time in the past year, gold bears outnumbered the bulls in Bloomberg’s weekly Gold Bull/Bear Sentiment Survey. In fact, the bears had the bulls outnumbered by almost 2-to-1.

Today’s growing sloth of gold bears is a “buy” signal for contrarian investors like us at U.S. Global. Research from the gold team at Canaccord Genuity found that gold rallied about 10 percent on average during the month following each of these sentiment “cross-overs.” This historical increase means that gold could potentially rally to the “high $1,700’s per ounce,” which Canaccord believes “would breathe some new life into the gold equities.”

After a year of neglect from investors who favored bullion, gold equities need resuscitation. Going back to April of last year, gold stocks have been undervalued compared to bullion. I discussed this disconnect back in June 2011 (Will Gold Equity Investors Strike Gold?) and again in August (Valuation Gap Makes Gold Miners Attractive, but All Miners Aren’t Created Equal).

This trend has been accelerating recently: At the end of March, the spread between the NYSE Arca Gold Miners Index and gold bullion was at the same extreme level it was during the 2008 credit crisis despite a much rosier global economic outlook. Going back the full decade of gold’s bull run, this is quite a rare event.

It hasn’t been a complete drought for gold equity investors though, as there have been occasional spurts of relief over the past year. From the beginning of 2011 through the middle of the year, the S&P/TSX Global Gold Index declined by 14 percent. The index then quickly reversed course upward during the market’s volatile period last fall. Now, the index has been declining for four months now, dropping 28 percent, while gold bullion has only fallen 9 percent over that same time period, says Canaccord.

Believe it or not, the four-month selloff is a bullish sign for gold stocks. If you expand your time horizon, you’ll see each dip has been a turning point for gold stocks. Canaccord says that, “sector weakness (less than one year) in the gold equities over the last six years has typically ended with “V” shaped corrections to the upside.” Gold investors must be quick to “buy on the dips” since these sharp V-shaped corrections have been frequent.

The Stampede to Buy Undervalued Gold Miners

If you plan on shopping for bargains in the gold miner department, you’re going to have to fight a crowd. Numerous global investors have been pounding the table for gold stocks, including Dr. Marc Faber who said “gold shares have become extremely oversold and could rebound in the next few days” in his April market commentary and Global Portfolio Strategist Don Coxe, who reiterated that gold equities are undervalued compared to the precious metal on his weekly conference call today.
Another big buyer has been the miners themselves. Mergers and acquisitions in the mining sector have been at an all-time high over the past two years. Large gold miners such as Barrick, Goldcorp and Kinross have been taking advantage of these cheap valuations by snatching up small miners with proven deposits.

And they’ve been willing to pay a premium too. According to Desjardins Capital Markets, over 2010 and 2011, a total of 26 mergers and acquisitions have taken place to the tune of more than $30 billion. In this time period, the buyout or purchasing premium has averaged more than 40 percent.

Desjardins says the M&A trend in the gold sector should continue, given “growing cash hoards and a lack of new discoveries” of the precious metal. As one example of this ongoing worldwide trend, Bloomberg News reported today that, “Chinese gold producers are vying for domestic and overseas mining resources,” with two companies competing for two different gold mining companies located in the eastern province of Shandong.

Big miners have historically purchased the known assets of their rivals as a way to increase reserves rather than deal with the heartache and headache of drilling core samples and filling out permit applications. Large-scale gold production is a complex and costly process involving digging, transporting, crushing and chemically treating massive quantities of rock to get at small amounts of gold. In fact, a commercially viable deposit could contain just a tiny fraction of an ounce of gold for every ton of mined rock. If you’re curious about this phenomenon and want to learn more, check out my book The Goldwatcher: Demystifying Gold Investing where I go into greater detail.

With the signals there for a bounce and stocks undervalued, what’s stopping investors from buying gold equities? One reason could be margin pressure. Rising energy costs, reduced supply and currency swings can quickly erase a gold company’s margin. It takes a great deal of diesel fuel to run the shovels and dump trucks that haul ore to the mill for processing and rising energy costs can affect the profitability of a mine substantially. These variables are the project’s cash costs, or how much capital must be spent to pull an ounce of gold out of the ground.

From the first quarter of 2008 through the third quarter of 2011, the global average cash cost has been rising for miners at a rate of about 8 percent year-over-year. Desjardins says costs will “likely remain under pressure, especially on the energy and labor fronts.”

However, as Desjardins points out, at the level that gold is at now, “most producers will be generating significant cash flow and earnings,” using this cash to fund takeovers, build out development pipelines and pay higher dividends.
Another barrier for investors could be perceived volatility. On Bloomberg Radio, I explained to host Kathleen Hays how gold’s 12-month rolling volatility is very different from the way it’s perceived. While the normal volatility for the S&P 500 Index is up or down 19 percent over a 12-month period, it’s only 13 percent for gold bullion.

My friend and CIBC analyst, Barry Cooper heard my Bloomberg interview and emailed me the chart below showing how the TSX Global Gold Index ETF/Gold Price Ratio has historically been negatively correlated with gold’s volatility. Two times over the past four years, when gold price volatility was falling, it was generally associated with rising valuations of the TSX Global Gold Index ETF. Today it’s a different story: Gold’s volatility and value are both going down. According to Barry, “either we are in a totally new regime for gold shares or something has to give.”

The cold shoulder from investors has also given way to a promising trend in the gold space—growing dividend payouts. We believe this is one can’t-miss trend. We’ve been paying close attention to this as it has developed over the past few years, because through monthly or quarterly dividends, investors can receive income while they wait for share prices to appreciate. To capture the income potential, we’ve adjusted the portfolios of USERX and UNWPX to hold some of these dividend-payers. Many of these holdings pay a monthly dividend that is higher than the two-year government note, have rich balance sheets and receive royalties from all over the world on their gold mines.

We encourage investors to think contrarian: Eat up all you can while the pasture is wide open, because as the chart above shows, when gold equities reverse, it happens quickly.

Tags: Bullion Gold, Chief Investment Officer, Contrarian Investors, Credit Crisis, Equity Investors, Extreme Level, Frank Holmes, Global Economic Outlook, Global Gold, Gold Bullion, Gold Bulls, Gold Equities, Gold Equity, Gold Index, Gold Miners, gold stocks, Gold Team, Nyse Arca, Strike Gold, U S Global Investors, Volatile Period
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Chinese Gold Imports From Hong Kong Rise Nearly 13 Fold – PBOC Likely Buying Dip Again

Wednesday, April 11th, 2012

From GoldCore

Chinese Gold Imports From Hong Kong Rise Nearly 13 Fold – PBOC Likely Buying Dip Again

Gold’s London AM fix this morning was USD 1,654.00, EUR 1,261.63, and GBP 1,040.25 per ounce. Yesterday’s AM fix was USD 1,643.75, EUR 1,255.92 and GBP 1,037.72 per ounce.

Silver is trading at $31.66/oz, €24.08/oz and £19.87/oz. Platinum is trading at $1,591.50/oz, palladium at $636.30/oz and rhodium at $1,350/oz.

Cross Currency Table – (Bloomberg)

Gold climbed $17.70 or 1.2% in New York yesterday and closed at $1,659.00/oz. Gold gradually ticked lower in Asian trading prior to tentative gains in Europe and is now trading around $1,655/oz.

Gold’s 1.2% gain yesterday was the largest since March 26 and its four sessions of gains is the longest winning streak in two months.

XAU/CNY (Renminbi or Yuan) Monthly Chart – Bloomberg

A positive sign for gold was that US COMEX futures volume was the strongest in a week and gold rose despite a sharp 1.5% drop in the S&P 500 and other equity indices and a large fall in crude oil and grains.

Gold appears to be catching a breather today and is taking a break after the four sessions of consecutive gains driven by safe haven flows on a cloudy global economic outlook.

Gold’s proven safe haven attributes were clearly seen again yesterday as the sharp bout of risk off in international markets saw gold again have an inverse correlation with riskier equity and commodity markets.

SHANGHAI SE A SHARE INDEX – 2002- Today

Markets continue to digest the very poor US employment number which has led investors to again question the rose tinted view of the US economic ‘recovery’.

The Fed’s beige book will be released at 18.00 GMT.  Investors will also watch the European government debt market, after Italian and Spanish debt was met with decreased demand due to shaky euro zone economies and renewed contagion concerns.

Chinese Gold Imports From Hong Kong Rise Nearly 13 Fold – PBOC Likely Buying Dip Again

Chinese gold demand remains very strong as seen in the importation of 40 metric tonnes or nearly 40,000 kilos of gold bullion from Hong Kong alone in February.

Hong Kong’s gold exports to China in February were nearly 13 times higher than the 3,115 kilograms in the same month last year, the data shows.

Shipments were 72,617 kilograms in the first two months, compared with 10,564 kilograms a year ago or nearly a seven fold increase from the record levels seen last year.

China’s appetite for gold remains strong and Chinese demand alone is likely to put a floor under the gold market.

Reuters Global Gold Forum

Mainland China bought 39,668 kilograms (39.668 metric tons), up from 32,948 kilograms in January, according to export data from the Census and Statistics Department of the Hong Kong government.

Demand has picked up again after the Lunar New Year and demand has climbed in China as rising incomes and concerns about inflation lead to store of value buying.

There is also a concern about the Chinese stock market which has gone sideways since 2001 (see chart) and increasing concerns that various property markets in China look like bubbles ready to burst.

Consumer demand for gold beat India for the first time in almost three years in the fourth quarter and China may replace India as the biggest buyer annually this year.

The massive gold purchases may signal the People’s Bank of China is continuing to secretly accumulate gold reserves.

Reuters report that there are suspicions that the number could include purchases from the public sector, as the market was largely quiet during a post-Lunar New Year holiday slump in February. “On the public level, China’s central bank will continue to accumulate gold, which is easier than liberalising their capital account and currency,” said Friesen of SocGen, adding that building gold reserves would help China’s push to turn the renminbi into a global currency.

Accommodative monetary policy will remain an incentive for private investors to buy into gold, he added.

The nation last made its reserves known more than two years ago, stating them to be 1,054 tons.

The PBOC’s gold reserves remain small compared to those of the Federal Reserve and many European nations.  Their gold reserves remain tiny when compared to their massive foreign exchange reserves of $3.2 Trillion.

It is important to note that in past years, Hong Kong gold imports have accounted for about half of China’s total gold imports. China itself doesn’t publish gold import data and the very high and increasing demand from Hong Kong is only a component of overall Chinese demand.

The per capita consumption of 1.3 billion people continues to increase from a near zero base meaning that this is indeed a paradigm shift and not a blip or ‘flash in the pan’.

It means that gold will likely see record nominal highs – possibly before the end of the year.

Prudent western buyers wishing to protect and grow wealth will again buy gold on the dip as the Chinese are doing.

For breaking news and commentary on financial markets and gold, follow us on Twitter.

OTHER NEWS
(Bloomberg) — China’s Feb. Gold Imports From Hong Kong 39,668 Kilograms
Hong Kong government announced Feb. gold exports data on its website.

(Bloomberg) — Russia’s FinEx Plus Plans Gold Exchange Traded Product This Year
Asset Management Co. FinEx Plus LLC plans to start a gold exchange traded product in Moscow and expand that to other commodities this year.

FinEx is in negotiations with the Micex-RTS exchange in Moscow to list the gold product, said Evgeny Kovalishin, general director. FinEx is partly owned by Andrei Vavilov, Russia’s former first deputy finance minister, according to Kovalishin.

(Bloomberg) — Raw Materials Group Sees Gold Averaging $1,775 an Ounce in 2012
Gold will average $1,775 an ounce this year, 13 percent more than in 2011, Raw Materials Group said in a statement today.

Silver will drop 6.3 percent to an average of $33 an ounce, platinum 1.1 percent less at $1,700 an ounce and palladium 2.9 percent lower at $710 an ounce, RMG said.

NEWS
Gold pauses after 4-day rally; investors turn cautious – Reuters

Gold futures retreat in electronic trading – MarketWatch

European stocks stage tentative recovery – Financial Times

Sovereign bonds ‘most overvalued asset’ – Financial Times

COMMENTARY
Was That The Bottom In Gold? – MarketWatch

Price Manipulation in the Gold and Silver Market – RT

JPM’s TV Appearance – Silverseek

Spain’s crisis exposes limits of ECB help – Financial Times

Economist’s Bishop On Concerns Re Paper Currencies and Gold – MSNBC

Tags: Beige Book, Bloomberg, Comex, Commodity Markets, Contagion, Currency Table, Debt Market, Economic Recovery, Euro Zone, European Government, Global Economic Outlook, Gold Imports, Government Debt, Index 2002, International Markets, Inverse Correlation, Longest Winning Streak, Rhodium, Safe Haven, Share Index
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Cyclical Outlook: Navigating the Hurricane of Global Deleveraging (PIMCO)

Friday, March 16th, 2012

by Saumil H. Parikh, PIMCO

• We expect the eurozone economy to experience a recession in 2012 on the back of continuing pro-cyclical fiscal austerity measures.
• We expect 2012 to be the year in which the residential construction sector begins to gradually contribute to U.S. economic growth after a long and painful five-year hiatus.
• Major emerging market economies are struggling with domestic over-investment, rising income inequalities and inflation risks. Therefore, PIMCO expects major emerging market economies to be less of a global engine of growth in 2012-13.

The global economy finds itself sailing through calmer waters and clearer skies this quarter. Most financial asset prices have improved substantially in recent months. Liquidity conditions across markets have eased. Forced balance sheet deleveraging has slowed, and as a result, global economic growth has found a footing of sorts compared to last quarter.

The recent improvement in liquidity conditions and financial asset prices in Europe on the back of two Long-Term Repo Operations (LTROs) carried out by the European Central Bank (ECB) in early December and early March is of great importance to the evolving nature of PIMCO’s cyclical economic outlook. These operations have succeeded in providing highly at-risk European financial institutions with nearly a trillion euros in much needed financing to meet accelerating deposit flight, pay bond redemptions, secure longer-term funding and address asset-liability mismatches. Additionally, they have also driven positive spillover effects for certain sovereign bond markets (in particular Italy and Spain). In turn, this has slowed down the vicious European deleveraging feedback loop that was threatening the global economic outlook coming into 2012.

But the critical question for the year ahead is whether the ECB has done enough to halt and reverse deleveraging and change the course of the eurozone and global economic outlook on a sustainable basis? That is, is the global economy in the eye of the hurricane or has the hurricane passed over completely?

At PIMCO, we recognize the dynamics of economic and balance sheet healing but remain concerned that, in some key areas, they have not yet reached critical mass. This is particularly the case in Europe, where ECB liquidity provisions are necessary, but insufficient to deal with the twin underlying problems of too little growth and too much debt.

Eurozone’s Challenges Continue

In our view, it is still too early to give the all clear sign for the eurozone outlook. The fundamental problem facing the eurozone remains one of uneven competitiveness, currency rigidity and the lack of a coordinated vision shared between monetary and fiscal policy institutions.

We expect the eurozone economy to experience a recession in 2012 on the back of continuing pro-cyclical fiscal austerity measures, which will make eurozone sovereign risk indicators cyclically worse before they are given a chance to get secularly better.

This raises the specter of more downgrades, further destruction of demand for eurozone debt and the need to further deleverage balance sheets in the coming months and quarters. Spain has already raised its hand, demanding permission to run higher fiscal deficits than promised just a few months ago. The situation in Greece remains critical, and, along with Portugal, highlights the inadequacy of liquidity provisions to cure real solvency problems once debt dynamics move beyond the point of no return.

The future solvency of eurozone sovereigns can only be improved via the realization of much higher nominal growth and the reduction in sovereign borrowing costs which will require a lender of last resort. Rates need to drop to a level low enough to make debt burdens sustainable even at economic growth rates below the eurozone’s full potential. Neither of these solvency improving options are being offered to the troubled eurozone economies today.

As a result of our expectations for a eurozone recession, rising political risks across important countries and also the lack of critical solvency conditions, we believe the deleveraging feedback loop in Europe will remain in place and will continue to be the defining central feature of the global cyclical economic outlook. Like we said in December, as goes the eurozone deleveraging, so goes the global economy over the next six to 12 months.

U.S. Economic Growth Prospects

While the struggling eurozone economy will likely prevent the U.S. from achieving above-trend growth, some sectors of the U.S. economy have genuinely improved and are re-emerging from secular lows. This is clear in automobile output and more generally in manufacturing. One important inflection point in the story of U.S. deleveraging is the flattening out and reversal of the negative contribution of residential construction to overall economic growth. We expect 2012 to be the year in which the residential construction sector begins to gradually contribute to U.S. economic growth after a long and painful five-year hiatus. While we don’t expect the total contribution from this sector to be large (῀0.3%-0.4%), it does set the stage for a potential multi-year recovery in residential construction that we expect will eventually see a return to balance between household formation rates and new construction. This will add jobs and create income for many American workers that have endured a long depression in the sector. This is great news.

Another positive for the U.S. economy in 2012 is the nascent revival of availability of consumer credit. In recent months, this has become most clearly evident in the areas of student loans and also automobile financing. The latter was a critical component in the recovery of automobile sales to a 15 million annualized sales rate in February 2012 (a level of activity not seen in the sector since March of 2008) according to the U.S. Department of Commerce.
An important question, however, is whether this recovery in consumer credit availability will filter deep enough and wide enough in the household sector to allow for a sustained and continued drop in the U.S. household savings rate, which will be needed to sustain cyclical U.S. economic growth in the face of a weakening outlook for fiscal stimulus and exports. The potential certainly exists and will be strengthened significantly if current improvements in employment and income can be sustained into 2013.

Emerging Market Slowdown

Europe and the emerging markets are very important destinations for U.S. exports. Brazil, Russia, India, China and Mexico, in total, are the largest market for U.S. exports, followed by Canada, followed closely by Europe. While we believe Europe is almost certainly going to encounter a recession in 2012, recent evidence from the major emerging market countries suggests that there is a significant cyclical slowdown underway there as well, especially in China, Brazil and India.
Our cyclical outlook for the major emerging markets is for growth to settle at the sector’s full potential, with risks of under-shooting due to policies designed to opportunistically contain inflation. Emerging market economies have played an outsized role in the global economic recovery since 2008.

Because of much better initial conditions, and also greater policy effectiveness, fiscal and monetary stimulation of major emerging market economies provided important external demand for both U.S. and European commodity and capital goods exports during fragile periods of post-crisis growth. But, we expect this external demand source to wane during 2012.

Major emerging market economies are struggling with domestic over-investment, rising income inequalities and inflation risks. Therefore, PIMCO expects major emerging market economies to be less of a global engine of growth in 2012-13.

Potential Grey Swans

Finally, there are three grey swans on the cyclical horizon.

The U.S. elections in November will be critical in determining the shape of U.S. fiscal policy going into 2013 and beyond. As is well known by now, the U.S. economy faces a “fiscal cliff” in January of next year, when tax stimulus and government spending worth approximately 3.5% of GDP are scheduled to be cut. Even if the new president and incoming congress are able to avoid the debilitating fiscal contraction in 2013, the risk remains that as we approach the “fiscal cliff,” political theatrics and uncertainty regarding the outcome will hinder confidence and animal spirits as they did before the debt ceiling debate of 2011.

There are also presidential elections in France, a country that is key to resolving the European debt crisis. We will be following developments there closely, with particular focus on their potential impact on the French policy stance, Franco-

German collaboration and the outlook for Europe.

It is the third swan that disturbs us most. The quietly rising tensions in the Middle East between Israel and Iran must be addressed by global leaders in a unified manner before long. The existence of known unknowns is exerting unwelcome pressure on oil prices at a time when the global economy is only beginning to stabilize and grow out of vicious secular deleveraging process. Any global complacency on this front will quickly embed itself in oil prices, which in turn will render our best cyclical forecasts useless during a time in which visibility is already poor on all points across the horizon.

While we are sailing through calmer seas and clearer skies this quarter, the horizon in most directions remains grey and visibility remains very poor. A sustainable resolution to the eurozone sovereign crisis, continued gains in U.S. employment and consumption and a peaceful resolution to Middle East tensions are all necessary before we can declare secular smooth sailing ahead.

Tags: Asset Liability, Asset Prices, Austerity Measures, Bond Markets, Brazil, Canadian Market, Construction Sector, Critical Question, Emerging Market Economies, Feedback Loop, Financial Asset, Fiscal Austerity, Global Economic Growth, Global Economic Outlook, Global Economy, Income Inequalities, Inflation Risks, Liquidity Conditions, Outlo, Parikh, PIMCO, Russia, Spillover Effects
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China: Hard, Long, or Soft Landing? (Chanos, Pettis, and O’Neill)

Sunday, February 5th, 2012

February 6, 2012 – Hedge fund billionaire Jim Chanos, Finance Professor Michael Pettis, and Goldman’s Jim O’Neill weigh in with equally interesting but different views on whether or not China will experience a hard, long, and or soft economic landing.

Sources for full interview video:

Jim Chanos on Bloomberg.com – China’s Banking System is ‘Extremely Fragile” (November 23, 2012)
http://www.bloomberg.com/video/81455126/

Michael Pettis on BNN.ca – The Achilles Heel of China – February 2, 2012
http://watch.bnn.ca/the-street/february-2012/the-street-february-2-2012/

Jim O’Neill on Bloomberg.com – Goldman’s O’Neill on Global Economic Outlook, Jan. 17, 2012
http://www.bloomberg.com/video/84388896/

For future reference, our (iPad compatible) player with AdvisorAnalyst.com video dispatches will be permanently on our video page which you can navigate to by clicking on the VIDEO link in the menu at the top of this page, or on the link in the Latest Stories box below.

Tags: Achilles Heel, Banking System, Bloomberg, Bnn Ca, China, Compatible Player, Dispatches, February 2, Finance Professor, Global Economic Outlook, Goldman, Hedge Fund Billionaire, Jim Chanos, Michael Pettis, Nbsp, O Neill, Professor Michael, Video Link
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Known Unknowns (PIMCO)

Monday, November 14th, 2011

Known Unknowns

by Neel Kashkari, Chief Equity Strategist, PIMCO

• ​ We believe investment managers can analyze numerous data sources and apply lessons learned from past economic cycles to make reasonable assessments about the global economic outlook.
• We also believe managers can make reasonable judgments about asset classes over the long term and, through rigorous bottom-up research, develop an edge regarding the outlook for individual companies.
• However, the market as a whole is much better at aggregating all the information that could affect any of the thousands of companies in the stock market than any investor could possibly be. Hence predictions of where the stock market will close on a given date are likely to be wrong.

People love bold predictions. More precisely: People love people who make bold predictions that are eventually proven correct. We tend to put such soothsayers on pedestals and anoint them heroes. And why shouldn’t we? They were able to see important outcomes that the rest of us missed.
Consider two notable examples:

• In 1969 quarterback Joe Namath boldly guaranteed his underdog New York Jets would beat the Baltimore Colts to win the Super Bowl. An audacious prediction, when Namath successfully led his team to beat the Colts he ensured his place in sports history.
• In 1961 President Kennedy called for the nation to land a man on the moon and return him safely to Earth by the end of the decade. At the time an American hadn’t even orbited the Earth, let alone made it to the moon. Considering today it takes almost a decade just to design a new rocket, Kennedy’s call to action from virtually a blank sheet of paper was truly a “moon shot.”

But our memories tend to be skewed: we remember the heroes but often forget the bold predictions that fell flat. For example:

• What was the name of the pastor who predicted the world would end on May 21, 2011? I can’t remember either. I’m sure I would remember had the world actually ended. (Well, maybe not, but you get my point.)
• In December 2007 sell-side equity strategist Abby Joseph Cohen predicted the S&P 500 would climb from 1,463 to reach 1,675 by the end of 2008. Given the brewing financial crisis, this was a bold call. In fact, the crisis dramatically worsened and the S&P 500 ended 2008 at 903. As the U.S. crisis recedes into memory, people have moved on.

Turning on business television, one can hear bold predictions almost daily: Where will interest rates be in the future or what actions will policymakers take to solve the European debt crisis? Every January many strategists predict the level of the stock market at year-end. It’s an annual tradition.

But with so many bold predictions routinely made on every side of virtually every economic issue, it can be hard to determine which predictions to take seriously. How does one make sense of the noise?

I believe two questions are essential to assessing predictions:

First, is the prediction “knowable?” Joe Namath was certainly able to influence the outcome of the Super Bowl. His prediction should have carried more weight than that of the average football commentator. We should pay more attention to those with special insights into knowable topics.

Second, does the person making the prediction have any downside if wrong? While President Kennedy is rightly lauded for setting the country on a path that transformed America’s standing in the world, presidents frequently make such bold calls, and the majority of them expire unfulfilled and unnoticed. For example, in 1983 President Reagan called for development of a missile shield to defend America against a nuclear attack from the Soviet Union; “Star Wars” never came to pass. In 2003 President Bush called for hydrogen cars to be commercially viable by 2020; seven years later President Obama cancelled their funding. There is little downside to Presidents setting ambitious goals – and they might improve their place in history if one of them works out.

In a society where we hoist the heroes but forget the mistakes, incentives are strongly skewed toward making as many bold predictions as possible, because at least a few are bound to hit. We should pay more attention to those who actually have something to lose if they are wrong.

So let’s analyze both questions in the context of predicting markets:

We at PIMCO believe certain investment topics are knowable and some are not knowable. To borrow a phrase from former Defense Secretary Donald Rumsfeld, there are Known Knowns and Known Unknowns. I will leave Unknown Unknowns for a future piece.
Known Knowns:

• Global economic outlook. We believe investment managers can analyze numerous data sources on global economic activity and apply lessons learned from past economic cycles to make reasonable assessments for what the future is likely to hold. This is complicated by changing global dynamics and sometimes unpredictable politics. But a robust economic framework can yield real benefits for investors.
• Relative value among asset classes. Looking at the current prices of securities, such as P/E multiples, dividend yields and expected earnings growth for stocks, and spreads and yields for bonds, in the context of the current economic environment, managers can make reasonable judgments about the overall expected return from asset classes over the long term. From this perspective, managers can determine which asset classes they believe will provide the best risk-adjusted returns over time. Stress testing these assumptions against a range of economic environments is important.
• Outlook for an individual security, be it a stock or bond. Through rigorous bottom-up research, analyzing financial statements, meeting with management, speaking with suppliers, customers and competitors, we believe managers can develop an edge regarding the outlook for individual companies. We will often research a stock only to uncover no special view; we let a lot of pitches go by before we find a stock we like in which we believe we have found an edge.
• However, innovation, business expansions and turnarounds take time. While investment managers may have confidence in a company’s growth plans, whether that expansion takes one quarter or one year to bear fruit can be hard to know. Hence, taking advantage of fundamental research often requires lengthy holding periods. We generally expect to hold stocks for three to five years.

Known Unknowns:

• The level of the stock market on a particular date in the future. Stocks receive cash flows last in the capital structure, so any new information that can affect instruments senior to equities can also affect equities: Political events. Economic events. Interest rate moves. Industry dynamics. Management changes. Product innovation, etc.
• Equity prices are continuously updating to reflect the constant stream of new information that could affect the stock. As described above, we believe we can get to know individual companies well through deep fundamental analysis. But the market as a whole is much better at aggregating all the information that could affect any of the thousands of companies in the stock market than any investor could possibly be.
• Think of an individual trying to compete against a supercomputer that is composed of an almost infinite number of microprocessors working in parallel crunching vast amounts of data as it pours in. The computer isn’t perfect and may not have wisdom, but it has a huge advantage over the analyst. In the short-term, equity markets contain the bulk of available information that should affect stocks.
• As a result, predicting where the Dow will close on a given date is like trying to predict where ocean waves will splash against the Newport Beach pier at a given moment in time. While oceanographers can tell us the general time and average level of high and low tide, they know the natural dynamism of the sea limits their precision to forecasting trends and averages rather than point estimates. We believe the same is true for forecasting the stock market as a whole.

To understand the second question, the downside of being wrong, it is important to consider who is making the prediction. One common group of predictors work for broker-dealers, generating investment ideas hoping investment managers will find their ideas interesting and reward them by trading with their firms. They are incentivized to offer as many ideas as possible. Some are bound to be thought-provoking, and there is little downside if their predictions are wrong: They aren’t actually investing based on their views.

In contrast, investment managers are seeking to generate attractive returns for their clients. Managers make decisions based on their outlook for securities and if they are wrong, there is downside: Clients may not perform as well as they hoped. While PIMCO has sought to generate strong performance for our clients over our 40-year history, we aren’t perfect, and we work hard to get as many of our calls right as possible.

Most of the commentators predicting the level of the Dow at year-end are sell-side analysts rather than investment managers. This makes sense: There is little downside for being wrong most of the time. The interesting question for the investment managers who do partake in such fortune-telling is do they actually utilize their own predictions? Most equity investment managers are managing portfolios that are required to be fully invested in equities at all times. If they believe the Dow will close at 13,000 on December 31, can they actually take advantage of that view since they don’t have idle cash to put to work? And if they can’t use their own predictions, why are they making them in the first place?

If we’re right – and neither PIMCO, nor anyone else, can accurately predict the level of the stock market at a certain date in one week, one month or one year – why do so many sell-side analysts (and a few investment managers) make such predictions? And why do we pay any attention?

I will answer my question with a question: Why do millions of people watch professional wrestling, “The Real Housewives” or “Jersey Shore?” It makes for entertaining television.

My hope from this piece is not that you stop watching business television. I certainly watch regularly and I also participate, sharing PIMCO’s views. I think it is a unique medium in which to follow markets and quickly hear a variety of perspectives on important topics.

My hope is that it becomes a little easier to distinguish thoughtful commentators discussing knowable economic topics from entertainers throwing darts.

In conclusion, I will leave you with my very own bold prediction. I am utterly unqualified to make it. I have no information edge nor can I possibly influence the outcome. In addition, there is absolutely no downside to my being wrong. Are you ready for it? “The Cleveland Browns will win the Super Bowl.” You heard it here first. (Note: I didn’t specify in which year.)

Copyright © PIMCO

Tags: Asset Classes, Baltimore Colts, Blank Sheet Of Paper, Bold Predictions, Data Sources, Economic Cycles, Global Economic Outlook, Individual Companies, Investment Managers, Joe Namath, Known Unknowns, Man On The Moon, Moon Shot, New Rocket, New York Jets, Pedestals, President Kennedy, Soothsayers, Sports History, Stock Market, Strategist
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Citi Downgrades Global Growth And Expects EFSF ‘Grand Plan’ Disappointment

Thursday, September 29th, 2011

Citi’s Economics team downgraded global growth expectations once again, expecting 3.0% this year (versus 4.0% last year) with more aggressive downgrades next year to only 2.9% (from 3.2% expectations last month and 3.7% two months ago). Growth revisions were downgraded for every major global economy as expectations move with Goldman’s coincidentally-timed discussion of stagnation (also tonight) with advanced economies cut more than developed though Eastern Europe saw the most significant reductions. They note that ‘the recent pace of GDP forecast downgrades is among the greatest of the last ten years’ and extends the recent run of lower forecasts to four months-in-a-row. In a secondary note, Willem Buiter and team also pour cold water on market expectations for the EFSF pointing out, as we have done for a few weeks now at every suggestion, that all the different options have their shortcomings and are unlikely to be implemented quickly.

From Citi’s September 2011 Global Economic Outlook and Strategy:

Global growth prospects continue to deteriorate quickly, both for advanced economies and emerging markets.

 

This month, we are again cutting our 2011-12 GDP growth forecasts for many countries, including the Euro Area, UK, Japan, US and Canada, with a modest downgrade for China and sharper cuts for Eastern Europe, Singapore, Hong Kong and South Africa.

 

 

We expect early sovereign debt restructuring in the Euro Area, and for the Euro Area overall to slip back into recession in coming quarters. The following table outlines progress so far on the initial increase:

 

 

Against this backdrop, Citi’s Macro Strategy team are cautious on risk
assets and bullish core fixed income. Citi equity strategists believe
that markets are oversold, but that stock prices are unlikely to move
convincingly higher until there are clearer signs of stability in
economic activity and profits growth. Citi rate strategists expect lower
yields and flatter curves in core EMU markets and the UK. Citi FX
strategists expect the USD and JPY to gain.

Source: Citi

Tags: Buiter, Canadian Market, Downgrades, Economics Team, Efsf, Gdp Forecast, GDP Growth, Global Economic Outlook, Global Economy, Global Growth, Gold, Growth Expectations, Growth Forecasts, Growth Prospects, Initial Increase, Market Expectations, Outlook, Singapore Hong Kong, Sovereign Debt Restructuring, Stock Prices, Strategists, Strategy Team, Table Outlines
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Global Economy: Bracing for Impact (Craig Alexander)

Sunday, September 18th, 2011

September 15, 2011 (11 minutes)

This online video features Craig Alexander, Senior Vice President and Chief Economist, TD Bank Group in conversation with MaryAnn Matthews.

This summer once again has showed us that there is no such thing as decoupling in economies or financial markets. Craig discusses the Euro zone sovereign debt crisis and the lack luster growth in the US economy and what it will mean for Canada and the financial markets.

During this interview, Craig Alexander addresses the following questions/topics:

• What are the factors that have prompted you to downgrade the global economic outlook?
• What is the likely endgame in the Euro zone sovereign debt crisis?
• Can President Obama’s Jobs Bill help the US economy and what will it mean for Canada?
• What will this mean for financial markets?

Click here or on image below to view:

Tags: Addresses, Alexander, Bank Group, Canadian Market, Chief Economist, Craig Alexander, Debt Crisis, Decoupling, Endgame, Euro Zone, Financial Markets, Global Economic Outlook, Global Economy, Jobs, Lack Luster, Maryann, Obama, Online Video, Outlook, Senior Vice President, Sovereign Debt
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Gold Market Diary (August 30, 2010)

Saturday, August 28th, 2010

Gold Market

For the week, spot gold closed at $1,238.01 per ounce, up $10.13, or 8.3 percent, for the week. Gold equities, as measured by the Philadelphia Gold & Silver Index, rose 3.4 percent. The U.S. Trade-Weighted Dollar Index was essentially flat.

Strengths

• The World Gold Council released it Gold Demand Trends publication for the second quarter of 2010 and highlighted the massive growth in investment demand, including a 414 percent jump in gold ETFs compared to the same period last year. Gold demand also rose 36 percent higher than the same period as last year.
• The gold price was propelled to a seven-week high due to a U.S. government report that showed weaker-than-expected data in orders for durable goods and a record low pace sales of new homes.
• India’s consumption of gold rose 94 percent in the first half of 2010 compared to the same period last year. The total demand for gold jewelry in the country in the first half of 2010 increased 67 percent compared to the same period last year.

Weaknesses

• “The world may well have lost its optimism over the global economic outlook, but the two key drivers for the price of gold—anticipation of higher inflation and lack of risk appetite—are little more than shifting sands,” according to Renaissance Asset Management.
• Investors withdrew $33 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute. If that pace continues, more money will be pulled out of mutual funds in 2010 than any year since the 1980s, with the exception of 2008, when the global crisis peaked.
• It was hoped the numerous festivals in India at the end of August would revive gold buying in India, but the high price appears to have trimmed volumes and caused consumers to opt for cheaper imitation gold.

Opportunities

• Van Eck Associates forecasts a new record gold price as of $1,400 as we move through the fall of 2010 and into 2011.
• Amid the likelihood of a hung Parliament, Australia’s Association of Mining and Exploration Companies is pushing for the government to remove all uncertainty and scrap a planned mining tax. The AMEC points out that Australia’s reputation has been damaged, and that dropping the tax would “announce to the world that Australia’s doors are open for business again.”
• An analyst at the Gold Forecaster stated that “gold will not enter a bear market by falling as equity markets are to do today. It is not an item whose demand will fall away.”

Threats

• U.S. Representative Ron Paul plans to introduce a new bill next year that would allow for an audit of U.S. gold reserves.
• Many real estate experts now believe that home ownership will never again yield rewards like those enjoyed in the second half of the 20th century.
• Dean Baker, co-director of the Center for Economic and Policy Research, estimates that it will take two decades to recover the $6 trillion of the housing wealth lost since 2005.

Tags: Dollar Index, Domestic Stock Market, ETF, ETFs, Festivals In India, Global Crisis, Global Economic Outlook, Gold, Gold Demand Trends, Gold Equities, Gold Jewelry, Gold Market, Gold Price, Imitation Gold, India, Investment Company Institute, Investment Demand, Market Diary, Philadelphia Gold, Risk Appetite, Silver, Silver Index, Spot Gold, Van Eck Associates, World Gold Council
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2010 Economic Outlook: From Exit to Exit

Tuesday, December 22nd, 2009

This post is a guest contribution by Joachim Fels* of Morgan Stanley.

This year was all about the exit from the Great Recession – and, as we had expected at the start of the year, it worked courtesy of massive global policy stimulus. Next year will be all about the exit from super-expansionary monetary policy – we expect the major central banks to start exiting around mid-2010. Yes, they will likely be cautious, gradual and transparent. However, the prospect and process of withdrawal may have unintended consequences: we think government bond markets will be the first victim. While we believe that the exit will be the dominant macro theme next year, we identify five important economic themes in our global economic outlook that, in our view, will be highly relevant for investors in 2010.

A tale of two worlds: We forecast 4% global GDP growth in 2010, up only marginally from three months ago (see the previous Global Forecast Snapshots: ‘Up’ Without ‘Swing’, September 10, 2009).  True, if this turns out to be about right, it would be a fairly decent outcome, especially compared to the widespread doom and gloom earlier this year. However, it falls short of the close to 5% growth rate in the five years prior to the Great Recession, and it will be the product of unprecedented monetary and fiscal stimulus, which poses substantial longer-term risks on various fronts. Moreover, our 4% global GDP growth forecast masks two very different stories. One is a still fairly tepid recovery for the advanced economies – the ‘triple B’ recovery we discuss below. The other is a much more positive outlook for emerging markets, where we forecast output to grow by 6.5% in 2010 (China 10%, India 8%, Russia 5.3%, Brazil 4.8%), up from 1.6% this year. A rebalancing towards domestic demand-led growth in EM is well underway. Moreover, as our China economist Qing Wang has been pointing out for a while now, the official statistics are likely to vastly underestimate the level and growth rate of consumer spending in China. In short, we think that the theme of EM growth outperformance has staying power and has even been bolstered by the crisis.

A ‘triple-B’ recovery in G10: In contrast to our upbeat EM story, we forecast barely 2% average GDP growth in the advanced G10 economies in 2010 – a triple B recovery where the three Bs stand for bumpy, below-par and boring. On our estimates, GDP growth has averaged around 2% in the G10 in the second half of this year and won’t accelerate much from that pace next year – hence our ‘up’ without ’swing’ characterisation from three months ago remains valid. The two reasons why we think the recovery in advanced economies will be of the ‘triple B’ type are that it is likely to be creditless and jobless. Creditless recoveries – defined as a situation where banks are reluctant to lend and the non-bank private sector is unwilling to borrow – are the norm following a combination of a credit boom in the preceding cycle and a banking crisis; and creditless recoveries typically display sub-par economic growth as credit intermediation is hampered. Moreover, we expect a jobless G10 recovery, with unemployment in the US declining only marginally next year and rising further in Europe and Japan. Unemployment may well stay structurally higher over the next several years in the advanced economies as many of the unemployed either have the wrong skills or are in the wrong place in an environment where the sectoral and regional drivers of growth are shifting.

More growth differentiation within the G3: Beneath the surface of what we call a lacklustre ‘triple B’ recovery in the advanced economies lies a differentiated story for the three largest economies within this block – the US, the euro area and Japan.  We expect significant growth differentials between these countries in 2010, which may well become a topic for currency, interest rate and equity markets again. We see the US as the growth leader among this group next year, with output expanding by 2.8% in the annual average of 2010. The euro area economy looks set to grow by less than half that rate (1.2%), while Japan should hardly grow at all (0.4%) next year and is forecast to actually fall back into a technical recession in 1H10. One reason for relative US outperformance is that the creditless nature of the recovery affects the US private sector by less because banks (as opposed to capital markets) play a smaller role in financing the economy than in Europe or Japan. Another reason is that US companies have been much more aggressive in shedding labour this year than their European or Japanese counterparts, so the US labour markets looks set to recover (albeit slowly) next year, while we expect unemployment to rise further in both Europe and Japan.  Further, European and Japanese exporters should feel the pain from this year’s currency appreciation, whereas US exporters should benefit from this year’s dollar weakness.

Crawling towards the exit, but triple A liquidity cycle remains intact: As stated above, we expect the beginning of the exit from super-expansionary monetary policies and its implications to be the dominant global macro theme in 2010. We will discuss details of the likely monetary exit strategies across countries in next week’s year-end Global Monetary Analyst. Here, it suffices to say that we expect the Fed, the ECB and the PBoC to move roughly in tandem and raise interest rates from 3Q10, with the Bank of England following in 4Q. Some, like the central banks of India, Korea and Canada, are likely to move earlier, while others, such as Japan, will lag behind. Generally, given the remaining fragility in the financial sector, central banks are likely to approach the exit in a cautious, gradual and transparent manner, so any hikes will likely be telegraphed well in advance, partly through appropriate twists in the crafted language, and partly through some cautious draining of excess bank reserves. Importantly, while the end of easing and the beginning of the exit can be expected to cause wobbles in financial markets, and this is one reason why we see bonds selling off sharply next year, we point out that official rates are likely to stay well below their neutral levels (even factoring in that these themselves are likely to be lower now than they have been in the past) throughout 2010 and, probably, also in 2011. Hence, monetary policy is only expected to transition from super-expansionary to still-pretty-expansionary. This would leave what we have dubbed the ‘triple A’ liquidity cycle (ample, abundant and augmenting), which we have identified as the main driver behind this year’s asset price bonanza and economic recovery, fairly intact next year. The metrics we follow to validate or refute this view is our global excess liquidity measure depicted in the chart below, which is defined as transaction money (cash and overnight deposits) held by non-banks per unit of nominal GDP. This measure exploded this year and we would expect it to rise further, though at a much lower pace, through 2010.

Sovereign and inflation risks on the rise: Fifth, but not least, we think that sovereign risk and inflation risk will be a major theme for markets in 2010. The current issues surrounding Greece’s fiscal problems are only a taste of things to come in many other advanced (note: not emerging) economies, in our view. We note that fiscal policy looks set to remain expansionary in all major economies next year, as it arguably should be, given the ‘triple B’ recovery which still requires support. However, markets are likely to increasingly worry about longer-term fiscal sustainability, and rightly so. Importantly, the issue is not really about potential sovereign defaults in advanced economies. These are extremely unlikely, for a simple reason: most of the government debt outstanding in advanced economies is in domestic currency, and in the (unlikely) case that governments cannot fund debt service payments through new debt issuance, tax increases or asset sales,  they can instruct their central bank to print whatever is needed (call it quantitative easing). Thus, in the last analysis, sovereign risk translates into inflation risk rather than outright default risk. We expect markets to increasingly focus on these risks in the year ahead, pushing inflation premia and thus bond yields significantly higher. Put differently, the next crisis is likely to be a crisis of confidence in governments’ and central banks’ ability to shoulder the rising public sector debt burden without creating inflation.

* Joachim Fels co-heads Morgan Stanley’s Global Economics Team (with Dick Berner) and is the Firm’s Chief Global Fixed Income Economist, based in London. His research focuses on monetary policy, the global liquidity cycle, and inflation. Joachim edits The Global Monetary Analyst, a weekly Morgan Stanley Research publication.

Tags: Brazil, BRIC, BRICs, Canadian Market, Central Banks, China, Doom And Gloom, Economic Themes, Emerging Markets, Expansionary Monetary Policy, Fels, First Victim, Fiscal Stimulus, GDP Growth, Global Economic Outlook, Global Gdp, Global Policy, Government Bond Markets, India, Morgan Stanley, Official Statistics, Positive Outlook, Qing Wang, Rebalancing, Russia, Two Worlds, Unintended Consequences
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