Saturday, September 20, 2014

Stocks Rally Following Janet Yellen’s Conference and Scotland's Historic Referendum

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

Interest rates can’t stay zero forever, but for now it’s more of the same.

Was Chairwoman Yelen's message really dovish? Some investors aren't so sure.

The Federal Reserve’s bond-buying program, enacted to spur growth, will indeed be winding down next month, as expected. But record-low interest rates will stay as they are for a “considerable time,” Fed Reserve Chairwoman Janet Yellen insisted during her Wednesday press conference.

It was “game on” for the stock market following Yellen’s speech. The Dow Jones Industrial Average closed at a new record high of 17,156, while the S&P 500 Index rose two points to close at 2,001, and the Nasdaq nine points to end at 4,562.

This news gives stocks reason to rally for a “considerable time,” or at least until the Fed gives us a more concrete timeframe for a rate hike.

The S&P 500 Index Reacts to Fed Chairwoman Janet Yellen's Press Conference
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With interest rates very likely to rise sometime next year and at an indeterminate pace, you should consider being diversified with short-term bonds, as they’re less volatile to rate changes. Our Near-Term Tax Free Fund (NEARX), which invests in such bonds, recently received the coveted five-star rating from Morningstar for the three-year performance period.
John Derrick - U.S. Global Investors

This week in an interview with Marc Lichtenfield’s Oxford Club Radio, U.S. Global Investors Director of Research John Derrick highlighted some of the fundamentals of NEARX:

“Our average maturity’s around 2.75 years, so under three years right now… The overall fund structure is pretty conservative. [NEARX] really doesn’t move around that much. It’s a steady grinder.”

Rolling with the Punches

Chairwoman Yellen stated that the decision to raise rates was “highly conditional” and dependent on the Federal Open Market Committee’s (FOMC) assessment of the economy, which appears right now to be showing moderate or, in some sectors such as housing, faltering growth. Inflation has also fallen short of expectations.

But as always, we see opportunity.

The producer price index (PPI) numbers, released Monday by the U.S. Bureau of Labor Statistics (BLS), reveal that demand for goods such as gasoline and food dropped 0.3 percent while demand for services rose 0.3 percent, resulting in an unchanged final demand of 0.0 percent.

Producer Price Index (PPI) Remains Unchanged, Pointing to Slow Inflation
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Meanwhile, the consumer price index (CPI), which measures the cost of living, unexpectedly decreased 0.2 percent in August, the first time it’s done so since April of last year. The all-items index, however, has risen at a rate of 1.7 percent over the last 12 months.

U.S. Consumer Price Index Falls for First Time in Over a Year
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U.S. housing starts had a disappointing downturn last month, the Commerce Department reported, tumbling 14.4 percent to a seasonally-adjusted annual rate of 956,000 units. This decline is even lower than the projected -4.9 percent. Building permits fell 5.6 percent, below the -1.6 percent economists estimated.

Despite a decline in starts and permits from July, homebuilders’ confidence in the market soared to 59.0, according to the National Association of Home Builders/Wells Fargo builder sentiment index. This is the highest such reading since November 2005, before the housing bubble collapsed.

We might see stronger growth in the housing market very soon, as U.S. fixed mortgage rates had their biggest weekly jump of the year, following the increase in 10-year Treasury yields on the heels of Yellen’s press conference. This might help light a fire under hesitant homebuyers and encourage them to act. According to the Mortgage Bankers Association’s (MBA) weekly survey, mortgage applications rose 7.9 percent from a week earlier.     

Average U.S. Fixed Mortgage Rates See Biggest Weekly Jump For 2014
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Through the 12 months ended August 2014, the annual U.S. inflation rate is 1.7 percent, below many economists’ and Fed policymakers’ hopeful estimate of 2 percent.

Although lower-than-expected inflation might lead to less pain at the pump and checkout aisle, it can also sometimes lead to a sluggish economy. Debt financing becomes challenging. And as counterintuitive as it might seem, when prices are down, people tend to sit on their money and wait for even better prices to come along. 

Rising prices, on the other hand, often prompt spending. For this reason, a little inflation is welcomed by some companies and their employees. Profits and wages can both increase, which stimulates borrowing and spending. The jump in mortgage rates is a perfect example.

As the U.S. Ends Quantitative Easing (QE), China and Europe Begin

With low inflation also comes the risk of dipping into deflation territory, which China is now facing. The country’s own PPI declined 1.2 percent in August, continuing a 30-month downtrend, while its CPI rose only 0.2 percent from July. Its purchasing managers index (PMI) also dropped last month, as did imports and manufacturing jobs. 

To counteract this slowdown, China’s central bank injected $81 billion to five state-owned banks. So far the market seems to have liked the stimulus measure, as stocks in both the Hang Seng Index and Shanghai Composite Index have rallied, tracking positive stock performance on Wall Street. Only time will tell if the world’s second-largest economy is in a permanent recovery mode, but we’re optimistic.

Like the People’s Bank of China, many central banks around the world continue or are implementing easing policies. The European Central Bank (ECB), for instance, will be buying close to $1.3 trillion in bonds to provide fresh capital to the Union’s depressed banking system. All of this global stimulation activity is good for global financial markets and specifically U.S. equities. We’ll be exploring this very topic in our October 2 webcast, “One World Market, Many Central Banks: How Will Your Investments Be Impacted?”

Scots Vote “Nay” in Historical Referendum

Speaking of one world market, it collectively breathed a sigh of relief Thursday when Scotland voted to stay in its long-term relationship with the United Kingdom. As a Canadian, I’m familiar with separatist movements. In Scotland, as it is with Quebec, there seems to be a disconnect between wanting to break up the government in order to obtain more government. At a time when there’s so much uncertainty in the world, when members of the eurozone are in the doldrums, when China is trying to jumpstart its economy, when Russia is rattling its saber and ISIS is spreading as quickly as the Ebola virus, the last thing we needed was a major restructuring of one of the globe’s most stable and reliable countries.

Once the votes were counted, stocks in London rose and the pound bounced up a quarter of a percent.

Below you can see the current gross domestic product (GDP) growth forecasts for the U.S., eurozone, U.K. and China. Had Scotland voted “yes” in the referendum, it’s possible that the increased uncertainty might have stalled growth among these powers and altered economists’ predictions.

Real GDP Growth Forecasts
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Granted, every people has the right to declare its independence for the right reasons. If that were not the case, America might today be in the same family as Scotland. University of Bath professor Chris Martin said it best when he wrote: “The desire for independence seems to be driven by romantic views of a separate Scottish identity and culture rather than by cold economic logic.”

Indeed, it’s important to realize that the U.S., E.U. and China—the world’s three greatest economic powers—all rely on one another and help drive the rest of the globe.

China's Major Trading Partners - The EU Surpasses the U.S. as China's Biggest Trading Partner

Even many Scots were apprehensive of the economic implications of leaving the U.K. and, by proxy, the E.U. According to the gold trading firm BullionVault, approximately 40 percent more Scots bought gold in September compared to last year, most likely as a hedge against an uncertain economic future.

Once again, who says gold isn’t currency?

Gold Market

For the week, spot gold closed at $1,216.98 down $12.76 per ounce, or -1.04 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, fell 5.44 percent. The U.S. Trade-Weighted Dollar Index rose 0.63 percent for the week.

DateEventSurveyActualPrior
Sept 16 US PPI Final Demand YoY 1.8% 1.7% 1.7%
Sept 17 Eurozone CPI Core YoY 0.9% 0.9% 0.9%
Sept 17 US CPI YoY 1.9% 1.7% 2.0%
Sept 17 FOMC Rate Decision 0.25% 0.25% 0.25%
Sept 22 HSBC China Manufacturing PMI 50.0 -- 50.2
Sept 24 US New Home Sales 430K -- 412K
Sept 25 US Initial Jobless Claims 300K -- 280K
Sept 25 US Durable Goods Orders -17.8% -- 22.6%
Sept 26 GDP Annualized QoQ 4.6% -- 4.2%

Strengths

  • China officially opened the Shanghai Free Gold Exchange on Thursday. By giving foreign investors direct access to its gold market for the first time, China is seeking to obtain more influence over prices while simultaneously boosting the global use of its currency, the yuan. In addition to the deregulation of the gold market in Shanghai, Hong Kong’s Chinese Gold and Silver Exchange Society was given permission to set up a precious metals vault in Shenzhen this week. The continued deregulation of the gold market by the world’s largest consumer is a huge boost to the precious metal.
  • China is planning on boosting its gold reserves. The country’s reserves, a mere 1.1 percent of total reserves, have plenty of room to grow if when compared to nations such as the United States and Germany, which hold roughly 70 percent of their reserves as gold. The increase in gold demand from Chinese central bank purchases should place upward pressure on gold prices.
  • In the first eight months of this year, Shanghai imported $15.98 billion of gold, a staggering indicator of demand in China. Furthermore, last Thursday, two tonnes of gold was imported into Shanghai, indicating that gold imports into the city are not slowing down.

Weaknesses

  • Gold traders have become the most bearish in three months, according to a survey from Bloomberg. The poor market sentiment is the result of the Federal Reserve lifting its median estimate for the Federal Funds rate by the end of 2015.
  • Despite historically being the best month for gold, September has shown nothing but declining gold prices. The typical increase in demand from India due to the festival season appears to be overshadowed by the extraordinary strength of the U.S. dollar and its negative effect on gold prices.
  • The ratio between gold prices and global equities, as measured by the MSCI ACWI, has declined to its lowest level since September 2008. The low point is due to the unusual headwinds for gold as of late and the continued strength of equities. It will be interesting to see if the strength in equities continues in the near future.

Opportunities

  • Despite overall market sentiment favoring equities, George Soros has decided to bet on gold. Soros increased his bearish position in equities by 605 percent last quarter. The world famous investor did double down his position on gold mining ETFs, while also adding many gold companies.
  • Klondex Mines remains significantly undervalued relative to its peers. Despite its higher profit margins and similar revenue production, the company’s enterprise value is much lower than that of its peers. This undervaluation creates a significant opportunity for those seeking to take advantage of cheap and high-quality gold companies. In addition to the company’s superior margins, Klondex recently identified a third mineralized structure at its Fire Creek mine, with grades exceeding one ounce per tonne.  A new resource estimate for Fire Creek will certainly add to the company’s resource base at year end. The success of Klondex has been noticed by some, as it is to be officially included in the S&P/TSX SmallCap Index, which will serve to boost demand for the stock.

Klondex Mines Looks Attractive Against Peers in Second Quarter
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  • Teranga Gold reported that the first ore obtained from Masato confirms high-grade mineralization, a sign of the project’s increasing profitability. Furthermore, insiders at Teranga Gold, including the company’s chairman, recently purchased more than 600,000 shares. Insider buying typically foreshadows an expected increase in stock prices.  Teranga was also added to the Market Vectors Junior Gold Miners Index as of close on Friday.

Threats

  • The recent record performance of the S&P 500 is painting an incomplete picture of current market conditions. Roughly 47 percent and 40 percent of stocks in the Nasdaq Composite (CCMP) Index and the Russell 2000 Index, respectively, are experiencing a bear market. The divergence between large-cap and small-cap stocks points out significant threats in the market, painting a much darker picture for future performance.
  • Deutsche Bank notes that, due to the recent poor performance of gold, households in India will begin to move toward financial investments and away from physical investments. The bank sees the attractiveness of financial savings through bank deposits, mutual funds and insurance increasing in the future.
  • Higher bond yields and the continued strength of the dollar, continue to create headwinds for gold. Although the dollar is in store for a reversal soon, higher yields could persist as investors continue to consider the coming rate rises.

September 19, 2014 (U. S. Global Investors)

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The Original
Vulture Speculator

Trading gold, silver and mining shares since 1980 with a focus on taking advantage of volatility extremes, Gene Arensberg analyses the markets through a basket of technical and fundamental indicators and shares his findings from time to time here at Got Gold Report. Mr. Arensberg has been quoted in the Wall Street Journal, Dow Jones MarketWatch, USA Today and dozens of other news organizations.

"I've been a huge fan of Gene and his amazing work for years..."

Brien Lundin, CEO, Jefferson Financial, Host of the annual New Orleans Investment Conference and Publisher of Gold Newsletter


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