When Goldman says sell, everyone knows they really mean buy. However, when less specialized banks in the art of Kermit rapage, such as Bank of America, come out with a report saying that now is a good time to hunker down, they may just actually mean that.
From BofA’s Ethan Harris:
In the spring, the risks to growth seemed to be fading. The economy was weathering the fiscal shock. Politicians decided to delay battles over the budget and the debt ceiling, passing a continuing resolution to fund the budget through September and postponing the debt ceiling drop-dead date to some time in the fall. Meanwhile, financial markets in Europe had settled down, the European economy showed signs of improvement, and commodity prices were stable. In their June directive the FOMC made it official: “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.”
Unfortunately, we seem to be entering another of those periods of elevated risk.
Interest rate shock: The Fed’s tapering talk has caused about a 100 bp rise in longer term interest rates. Clearly this puts economists on high alert for signs of weakness in interest-sensitive sectors such as autos, housing, and capital goods investment. On the one hand, auto loan rates have moved up very little and while auto sales dipped slightly in July, they appear to be on a steady upward track. On the other hand, both housing and capital goods demand are looking a bit shaky. In July new home sales plunged by 13.4% and core capital goods orders dropped 3.3%. These are very volatile series, but they are not the only sign of weakness. Our GDP tracking model now shows a modest decline in equipment investment in 3Q. Meanwhile, the housing data have shifted from steady strength to mixed: the homebuilder survey hit a new cyclical high in July, but the pace of housing starts has flattened out in recent months and mortgage applications for both refinancing and purchasing have been slipping since May.
Fiscal brinkmanship: With Congress on vacation things are quiet in Washington. That ends on September 9th when they are back in session. There will be a partial shutdown of the government if they can’t pass a continuing resolution by the end of the month or can’t raise the debt ceiling some time in October. In our view, investor, consumer and business confidence have become relatively immune to threats of shutdown. However, we think an actual shutdown, lasting more than a couple days, could cause a significant risk-off trade in the markets and could curb some hiring and investment plans.
Geopolitical: The civil war in Syria is now starting to impact the oil and equity markets. During the Arab Spring in 2011, oil prices rose about $20 bbl (Chart 1). This acted like a tax on consumer budgets. One way to gauge this impact is to look at the extra inflation caused by higher energy prices: by the spring of 2011, higher energy prices were adding 1.8 pp to year-over-year CPI inflation. That is a fairly big “tax” considering that wage and salary income was only growing at about 4% at the time (Chart 2). That price pressure presumably contributed to the growth “soft patch” during that spring and summer.
Hoping for the best, preparing for the worst
We are least concerned about the Fed. Some commentators seem to think a steady Fed exit is a done deal. We strongly disagree: the last thing the Fed wants is a big risk-off trade in the markets that aborts the pickup in economy growth. Tapering in September was already problematic given that both growth and inflation are coming in below the Fed’s forecasts. Rising risks offer yet another reason for waiting. Indeed, we believe the whole exit path is slowly extending.
We expect the budget battles to produce a lot of negative headlines but last-minute deals, with minor fiscal austerity (at most) and no sustained government shutdown. While many fiscal conservatives would welcome a shutdown, we think the leadership of the House is reluctant to go down that route. Public opinion polls suggest that many Americans want smaller government, but do not like shutdowns and will punish the party they deem most responsible. Moreover, incumbents take the blame for any market/economic disruption. President Obama cannot run for re-election, while the whole House must run next fall.
In the Spring, Congress passed both a continuing resolution and a debt ceiling increase without any additional budget cuts. In a recent conference call with House Republicans, Speaker Boehner argued against using the threat of a government shutdown to stop the implementation of the Affordable Care Act and suggested passing a continuing resolution to continue funding into November. While there are many possible scenarios, we now assume a series of short-term extensions as our base case.
Geopolitical risk is a much tougher call, but our forecast assumes only a temporary rise in oil prices. Syria is a relatively small oil producer, with production averaging about 350,000 bbl/d before the civil war. That compares to 1.6 million bbl/d for Libya before its war. Our commodities team has developed a number of scenarios. In their base case, a combination of an air strike on Syria, political tensions, and a variety of other small supply disruptions causes Brent prices to spike to $120-130/bbl.
This would match the run-up in prices during the Arab Spring, but we think the effects would be less pronounced for several reasons. First, the price increase will likely be short lived and hence not fully passed through to consumers. Second, over time US energy prices are getting a bit less sensitive to global developments. The recent $10 increase in oil prices is not enough to change our call. As a rough rule of thumb, a sustained $10 bbl rise in prices that works its way broadly into energy prices slices GDP growth by about 0.3 pp over the following four quarters. If prices rise further on a sustained basis, however, we will be cutting our US and global growth forecasts.
Tapering talk has created two other risks. First, it has put considerable pressure on emerging markets. Since the start of the year we have trimmed our 2013 GDP forecast for EM from 5.3% to 4.7%. So far the blow back to the US economy and markets looks small. Tapering talk has also slowed the healing of household and business balance sheets. Mortgage refinancing has plunged about two-thirds from its peak in early May and this will likely stop the drop in the household debt service ratio. On a similar note, fewer companies are able to term out their debt and refinance at low rates. This balance sheet improvement has been one of the big—often ignored—collateral benefits of QE.
When in doubt, wait
In our view, reduced downside risks have been a key part of the move toward tapering. At the July meeting FOMC members were already talking about increased downside risks. At the September meeting they will face a choice of pushing ahead with tapering or waiting for clarity: is the economy really accelerating and is the recent risk flare serious or not? While the decision remains a close call, we see an even stronger case for waiting.
There has been much confusion in the past several months relating to the US debt ceiling, and specifically the fact that total debt subject to the limit has been at just $25 million away from the full limit since late May.
As we explained first in January 2011, there is nothing sinister about this. Any time the Treasury hits its physical debt cap, it activates its available “emergency measures” which include such money releasing options as disinvesting the Civil Service Fund, Suspending reinvestment in the G-Fund, Selling securities from the Exchange Stabilization Fund, and others, which cumulatively free up around $300-$350 billion. In essence the “emergency measures” act like a revolving credit facility that is slowly but surely being drawn down. Add to that sporadic cash creation over the past few months from cash inflows from the GSEs and one can see why the US has been able to be in breach of the debt ceiling for as long as it has. And why it still has just under two months of capacity.
The chart below shows how much emergency capacity the US has currently when adding all the emergency benefits, and how much it will have over the next three months. Of note is the period between October 15 and November 1, when first the “revolver” cash balance dips below $50 billion, and then hits $0 by November 1. Either way, there better be a debt deal by mid-October, or late October at the very latest, or the summer of 2011 debt ceiling fiasco will seem like a walk in the park in comparison to what’s coming.
For all other debt-ceiling related questions, we present Goldman’s take.
Treasury Secretary Jack Lew informed Congress on August 26 that the Treasury would exhaust its borrowing capacity by the “middle of October.” Specifically, this is when the Treasury has determined that it will have used the last of the “extraordinary measures” it has been employing to temporarily lower debt held in internal trust funds in order to make room under the debt limit for marketable Treasury issuance. Once those accounting strategies are no longer available, the Treasury will be left to rely on incoming tax receipts and the cash balance on hand to finance any disbursements.
The Treasury projects its cash balance to be roughly $50bn in mid-October when it exhausts its borrowing authority. This is a greater level of detail than the Treasury has provided ahead of previous debt limit deadlines. Prior announcements never stated the precise cash level the Treasury expected to have around the deadline, and thus left some uncertainty about whether payments scheduled to be made in the days following the deadline were truly at risk. For example, the Treasury announced in 2011 that it expected to exhaust its borrowing authority by August 2 of that year. Deficits turned out to be slightly lower than anticipated in the weeks leading up to the deadline, leaving the Treasury with $54bn in cash on hand at the deadline, which could have allowed the Treasury to operate without additional borrowing for at least another week.
We had previously projected that Congress would need to raise the debt limit before November 1, give or take a week or two. However, although the deadline we projected differs from the Treasury’s “middle of October”, it is the definition of the deadline that differs rather than our view of projected Treasury cash flows. Our latest projection implies that the Treasury’s total financing capacity–i.e., the headroom under the debt limit plus the cash balance–will drop below $50bn in mid-October, similar to the Treasury’s projection (Exhibit 1). Based on the pattern of daily receipts and outlays that we project (we base these on prior years’ patterns scaled to current levels and adjusted for calendar differences), we expect that the roughly $50bn cash balance that the Treasury will have in mid-October will gradually shrink over the following two weeks. The Treasury would probably be able scheduled payments in late October with the cash we expect it to still have on hand, but it would be unable to make all of the payments scheduled for November 1.
To avoid disruptions to the Treasury market, Congress will probably need to raise the deadline by mid-October, as the Treasury states. Since the Treasury plans its securities issuance with the expectation of a sizeable cash cushion–the cash balance has averaged around $60bn over the last couple of years–it should be expected that the debt limit, net of extraordinary measures, would be reached before the point that the Treasury is unable to pay its obligations as they come due. The upshot is that Treasury’s regularly scheduled auctions could be scaled back or delayed if Congress doesn’t raise the debt limit by Treasury’s stated deadline, even though scheduled payments might not be immediately at risk.
The Treasury is scheduled to hold auctions of 3- and 10-year notes and 30-year bonds the week of October 6 that are scheduled to settle October 15. The Treasury’s projection that it will exhaust its “extraordinary measures” by mid-October seems reasonable if one assumes that Treasury auctions continue on schedule in amounts similar to what is implied by the Treasury’s most recent issuance projections. Assuming those projections are accurate, the Treasury might not be able to conduct those auctions as planned without a high degree of confidence that the limit would be raised by the time the securities settle on October 15.
This would be highly unusual but not unprecedented. A Government Accountability Office (GAO) report lists 17 Treasury auctions between 1995 and 2006 that for which the announcement date was delayed; in 11 of those cases the auction itself was delayed. Most of these involved short delays to bill auctions, but during the 1995 debt limit debate the Treasury postponed 3-year and 10-year auctions for roughly one week.
The announced deadline probably shifts attention further toward the debt limit and away from the debate over extending government spending authority. Current spending authority expires at the end of the fiscal year on September 30. While that issue could still be dealt with separately from the debt limit, a mid-October deadline increases the likelihood that they will be rolled up into one debate given their proximity on the calendar (perhaps involving a short extension of spending authority to more closely line up the deadlines). The practical consequences of this are not that great, however. Republican leaders have not appeared enthusiastic about strategies to block the renewal of spending authority unless changes to the Affordable Care Act (also known as “Obamacare”) are made, and had already appeared to be more focused on negotiating around the debt limit even before the Treasury’s announcement.
The detail the Treasury has provided regarding its cash balance may also lead some lawmakers to believe they have more time to raise the limit than they really do. As noted earlier, the Treasury’s mid-October deadline is analogous to the August 2 deadline from 2011. The Treasury still had a significant cash balance it could use to make scheduled payments, but due to normal scheduled Treasury issuance it had exhausted its capacity to borrow under the limit. In the 2011 episode, lawmakers had little doubt that they needed to raise the debt limit by the deadline. This was, among other things, due to the perceived risk that the Treasury could miss an important scheduled payment, which seemed quite possible without knowledge of how much cash the Treasury expected to have on hand. If lawmakers feel confident that payments scheduled for the days following the mid-October deadline are likely to be made on schedule, they may feel less pressure to enact an increase by that point and could conceivably wait until later in the month. (Complicating matters further, Congress is scheduled to be on recess October 14-19.) Given this risk, it seems likely to us that the Treasury will make clear to Congress in upcoming communications that while it may have some remaining cash on hand to pay obligations after the mid-October deadline, waiting until late October would nevertheless be disruptive and should be avoided.
Today’s AM fix was USD 1,392.75, EUR 1,051.85 and GBP 899.19 per ounce.
Yesterday’s AM fix was USD 1,406.25, EUR 1,059.96 and GBP 906.79 per ounce.
Gold fell $8.60 or 0.61% yesterday, closing at $1,407.10/oz. Silver fell $0.44 or 1.81%, closing at $23.85. Platinum fell $11.61 or 0.8% to $1,518.99/oz, while palladium was down $8.78 or 1.2% to $734.22/oz.
Gold is set for its second consecutive higher monthly close which is bullish from a momentum and technical perspective. Gold is nearly 5% higher for the month in dollars and euros, 2.5% in pounds and 12% in rupees after the rupee collapsed in August.
Gold quickly fell from $1,407/oz to $1,395/oz at 0800 London time despite no data of note and little corresponding movement in oil and stock markets. Profit taking and an increase in risk appetite may have contributed to the falls after the U.K. parliament voted to reject military action against Syria and fears over oil supply disruptions in the Middle East eased.
Oil prices are still heading for the largest monthly gain in a year, with Brent up more than 6% in August after unrest cut output in Libya by around 1 million barrels per day and production fell in Iraq, Nigeria and elsewhere.
The U.S. seems likely to proceed with a strike against Syria even after U.K. lawmakers rejected action which should support prices. The yellow metal reached $1,433.83/oz on August 28th, its highest since mid May on concerns that the U.S. will go to war with Syria.
Gold’s recent gains are primarily due to very strong physical demand globally and increasing supply issues, particularly in the LBMA gold bullion market. Syria and the increasing geopolitical uncertainty in the Middle East are creating real oil price and inflation risk which has contributed to the increased bullion buying in recent days.
As ever it is important to focus on the medium and long term drivers of the gold market:
The medium market themes guiding the market currently are as follows:
Late summer, autumn and early New Year are the seasonally strong periods for the gold market due to robust physical demand internationally.
This is the case especially in Asia for weddings and festivals and into year end and for Chinese New Year when China stocks up on gold. Gold and silver often see periods of weakness in the summer doldrum months of May, June and July.
This week will see the end of August trading and September is, along with November, one of the strongest months to own gold. This is seen in the charts showing gold’s monthly performance over different time frames – 1975 to 2011, 2000 to 2011 and our Bloomberg Gold Seasonality table from 2003 to 2013 (10 years is the maximum that can be used).
Thackray’s 2011 Investor’s Guide notes that the optimal period to own gold bullion is from July 12 to October 9. During the past 25 periods, gold bullion has outperformed the S&P 500 Index by 4.7%.
Futures market positioning as seen on the COMEX is now very bullish.
Short positions held by hedge funds in the gold and silver markets remain very high and the stage is now set for a significant short squeeze which should propel prices higher in the coming months. Arguably we are in the early stages of this short squeeze.
Hedge funds have consistently been caught wrong footed at market bottoms for gold and silver in recent years and high short positions have been seen near market bottoms, prior to rallies in gold and silver.
Conversely, the smart speculative money, bullion banks such as JP Morgan have reduced their short positions and are now long in quite a significant way and positioned to profit from higher prices in the coming weeks and months.
Federal Reserve “Tapering”
The Federal Reserve has been suggesting for months, indeed years, that they would return to more normal monetary policies by reducing bond buying programmes and gradually increasing interest rates.
‘Talk is cheap’, ‘actions speak louder than words’ and it is always best to watch what central banks do rather than what they say.
Near zero interest rates and bond buying are set to continue for the foreseeable future.
Precious metals will only be threatened if there is a sustained period of rising interest rates which lead to positive real interest rates. This is not going to happen anytime soon as it would lead to an economic recession and possibly a severe Depression.
Chinese demand for physical bullion continues to be very high and continues to support prices and will likely again contribute to higher prices in the coming months. China gold purchases surged 54% to 706.4 metric tons in the first half of 2013 from the first half of 2012 – a year of record demand in China.
Demand surged 87% for bars and 44% for jewelry. China’s gold demand should hit a record 1,000 tonnes this year and will almost certainly overtake India, the world’s largest saver in gold.
The People’s Bank of China is almost certainly continuing to quietly accumulate gold bullion reserves. As was the case previously, they will not announce their gold bullion purchases to the market in order to ensure they accumulate sizeable reserves at more competitive prices. They also do not wish to create a run on the dollar – thereby devaluing their sizeable foreign exchange reserves.
Expect an announcement from the PBOC, sometime in 2013 or 2104, that they have doubled or even trebled their reserves to over 2,000 or 3,000 tonnes.
Indian demand has fallen somewhat due to recent tariffs but will remain robust and should be as high as 1,000 tonnes this year.
Gold Forward Offered Rates (GOFO)
Gold forward offered rates (GOFO) or the cost to borrow gold remains negative. Negative gold borrowing costs is likely due to a lack of supply of large 400 ounce bars as mints, refineries and jewellers internationally and especially in Asia are scrambling to secure supply.
Gold is in backwardation. Meaning that gold for future delivery is trading at a discount to physical market prices – a rare situation that has occurred only after the Lehman Brothers collapse and near the bottom of the gold market in 1999. Spot prices or prices for delivery now are higher than prices for future contracts at later dates. This is very unusual and means that buyers are willing to pay a premium for physical. It also strongly suggests that there is tightness in the physical market.
Eurozone Debt Crisis
The Eurozone debt crisis is far from over and will rear its ugly head again – probably as soon as the German elections are over. Politicians and bankers have managed to delay the inevitable day of reckoning by piling even more debt onto the backs of already struggling tax payers thereby compounding the problem and making it much worse in the long term.
Greece, Spain, Portugal, Italy, Ireland, now Cyprus and even France remain vulnerable.
In Japan, the national debt has topped the ¥1 quadrillion mark. A policy of money printing pursued for a decade has failed abysmally and now politicians look set to pursue currency debasement in an even more aggressive manner – with attendant consequences.
The U.K. is one of the most indebted countries in the industrialised world – the national debt continues to rise rapidly and is now at more than 1.2 trillion pounds ($1.8 trillion) and total (private and public) debt to GDP in the U.K. remains over 500%.
The U.S. government is once again on the brink of defaulting. At the start of the ‘credit crisis’ six years ago, U.S. federal debt was just $8.9 trillion. Today, U.S. federal debt stands at $16.738 trillion – 88% higher and increasing rapidly. This does not include the $70 trillion to $100 trillion in unfunded liabilities for social security, medicare and medicaid.
Long Term Fundamentals
The long term case for precious metals is based on the four primary drivers – the ‘MGSM’ drivers that we have long focussed on.
Macroeconomic risk is high as there is a serious risk of recessions in major industrial nations with much negative data emanating from the debt laden Eurozone, U.K., Japan, China and U.S.
Geopolitical risk remain elevated – particularly in the Middle East. This is seen in the serious developments in Syria and increasing tensions between Iran and Israel. There is the real risk of conflict and consequent affect on oil prices and global economy. There are also simmering tensions between the U.S. and its western allies and Russia and China.
Systemic risk remains high as few of the problems in the banking and financial system have been addressed and there is a real risk of another ‘Lehman Brothers’ moment and seizing up of the global financial system. The massive risk from the unregulated “shadow banking system” continues to be underappreciated.
Monetary risk or currency risk remains high as the policy response of the Federal Reserve, the ECB, the Bank of England and the majority of central banks to the risks mentioned above continues to be to be ultra loose monetary policies, zero interest rate policies (ZIRP), negative interest rate policies (NIRP), deposition confiscation or “bail-ins”, the printing and electronic creation of a tsunami of money and the debasement of currencies.
Should the macroeconomic, systemic and geopolitical risks increase even further in the coming months, as seems likely, than the central banks response will likely again be more cheap money policies and further currency debasement which risks currency wars deepening.
Absolutely nothing has changed regarding the fundamentals driving the gold market. We are confident that gold, and indeed silver, are still in long term secular bull markets likely of a 15 to 20 year duration.
Owning physical gold coins and/or bars in your possession and owning physical gold and silver in allocated accounts will continue to protect and grow wealth in the coming years.
Via Citi FX Technicals,
Following the multi-year surge in Gold the recent fall took us 14% below the 55 month moving average. That is exactly what happened in 1976 during Gold’s correction after a multi-year move higher.
Once that moving average was regained on a monthly close basis the uptrend re-established itself and Gold rallied for the next 3 years. (included in that period was the “supply shock” driven move higher in crude)
The rally in the Equity market after the 1973-1974 “crash” peaked 4 weeks after that corrective low was placed in Gold.
SO FAR the trend peak in the stock market (DJIA and S&P) has taken place 5 weeks after the corrective low was posted in Gold.
After that peak in late 1976 the Equity market entered into an 18 month long 27% correction.
The pivotal breakdown level on Gold was at $1,522-1,527 and should now be pivotal resistance in this rally.
Gold broke below this level during the week of 08 April 2013. It is unlikely that it is a coincidence that that precipitous fall took place in the same week that the S&P 500 regained its 2007 highs.
So, do not be surprised that IF , as we expect Gold heads higher to re-test this $1,522-1,527 area in the weeks/months ahead that the S&P is re-testing the break out point of 1,576 again…
We still retain a view that we can see a “low to high” percentage move in this bull market similar to what we saw in the bull market of 1970-1980.
If we extract the final leg of that move in December 1979-Jan 1980 which was totally driven by the USSR invasion of Afghanistan almost doubling the price of Gold over 5 weeks then we end up with a target of around $3,500 over the next 3 years or so.
The charts below are compelling in that respect, but before we look at them we will indulge in some pontification.
We are at a point of change of leadership at the Fed with two primary candidates being mentioned. (Janet Yellen and Larry Summers). We are NOT going to opine on who it should be but rather make observations about why we think it is going to be one rather than the other.
When President Obama spoke on the Charlie Rose show about Chairman Bernanke’s tenure it was obvious that it was coming to an end. The question to ask was why? If we (He) was happy with the path being followed, why not just ask Ben to stay on. (We also firmly believed that if asked Ben would have stayed). It is therefore not a stretch to believe that the President was less than convinced about the “efficacy” of QE. Reasons for this could well have been (supposition on our part):
- Sub-par economic growth of 1.7-2.0% and very low nominal growth given the low level of inflation
- A falling unemployment rate… yes (7.6% at the time)… but not of the magnitude and quality that we associate with an economic recovery (Lowest participation rate since 1979 flattering the rate; underemployment at the time (U6) at 14.3%; the majority of jobs being created are part time jobs with the 55-69 year old age group the primary demographicbeneficiary)
- Housing recovering but very gradually compared to previous cycles and a view in a lot of circles that a significant chunk of demand was private equity buying distressed assets
- An Equity market rallying about 140%+ (The rich get richer, the gap gets wider)
- Banks et all benefiting from never ending cheap money and being encouraged to misallocate capital in financial assets that are being made almost risk free by the Bernanke, ever expanding, “QE to infinity” put
- Provides a benefit to the marginal borrower while “crucifying” the whole savings base
- Continued QE created a back stop to allow congress to push harder on budget cut and debt limit negotiations (Play hardball)
Let us say that some or all of that was true. Would the President really want to appoint somebody who to a very large extent would be likely to follow the same “prescription” (Yellen)? Why? If you wanted to continue that policy then would you not do that with the “guy” who engineered it and took us through the crisis (Bernanke)? Or do you feel that your financial “Churchill”…the man to fight the war is no longer the direction you want to go. We firmly believe that “change is afoot” and that change goes by the name of Larry Summers.
Why is that important?
Nothing suggests that Summers is a “hawk”. However, there are suggestions that he questions the “mix” of policy. It looks like he would be much more likely to try and “draw a line” under this unorthodox monetary policy experiment by bringing QE to a conclusion. This will not be a “shock and awe” change but rather a gradual wind down of purchases and eventually the Fed balance sheet through the maturity schedule.(We believe this could happen irrespective of the economic backdrop)
What would this mean?
If, as we believe, we have some potentially significant headwinds coming in markets and the economy then this is going to “throw the ball” right back into the “arms of Congress”. (Is Larry Summers the 21st century’s Paul Volcker?) If the independent Fed is no longer prepared to expand monetary policy “ad infinitum” to support the economy and the economy is slowing what will Congress have no choice but to do???? Stimulate again through fiscal policy. This will mean deficits once again widening and the debt limit rising. It will be a shift back not to tight but to “less loose” monetary policy and looser fiscal policy (This will also likely benefit the USD)
That is why the chart below remains one of our favourites.
Gold and the US Debt Limit
It is no coincidence in our mind that these two have expanded together over the last 10-12 years
As we continue to spend more than we earn and shift that liability to the next generation Gold has shown itself to be a very effective hedge against that policy. The recent “squeeze in Gold” has sent it significant below this “stairway to hell” chart (Debt limit) which has continued higher. As we said earlier, we do not believe that this fall in Gold will be sustainable and expect new highs in the trend eventually. As we also said above , we have retained a long term target of about $3500 for some time on this Gold price based on a comparison of this period and that seen in the 1970’s
As we headed towards the last Presidential election there was a considered view in the markets that by the end of President Obama’s 2nd term the debt limit could be as high as $22 trillion. Then we got the sequester, a more rosy economic outlook, tapering talk and all this has been forgotten. For how long?
The market dynamics above combined with the change of leadership at the Fed may well be “resurrecting that thought”. If so our 2nd favourite Gold chart comes into play.
Gold and the US debt limit (Again): So what would a debt limit of $22 trillion over the next 2-3 years suggest for the Gold price?
How about $3,500
We firmly believe that the Gold correction has “run its course” and that much higher levels will be seen in the years ahead.Courtesy: Zerohedge
The recent release by the Bureau of Economic Analysis, of the 2nd estimate of the 2nd Quarter of 2013’s GDP – gross domestic product, was really somewhat mixed below the headline story despite a sharp increase in economic growth from the original estimate of 1.7% to 2.5%. Econoday always provides good coverage of major economic points which is primarily focused on the headline numbers as they are reported. Their analysis of the latest GDP report provides a good basis for a debate of this good news/bad news story.
“Final sales of domestic product showed a revised gain of 1.9 percent versus the advance estimate of 1.3 percent. This series increased 0.2 percent in the first quarter. Final sales to domestic producers (which exclude net exports) was nudged down to 1.9 percent versus the initial estimate of 2.0 percent. This followed a 0.5 percent gain in the first quarter.”
While the revised gain in final sales was a positive for the current report it is the longer term trend of real final sales of domestic product has declined sharply as of late and is mired at levels that is normally consistent with recessionary economic periods.
“The upward revision to GDP growth was mainly due to a sharp upward revision to net exports. Also, there were improvements to inventories and nonresidential structures investment. Government purchases were modestly weaker. Other components were little changed.”
The outsized increase in exports is somewhat of an anomaly that is consistent with recent survey reports. It is likely that the level of exports will be adjusted in upcoming reports. The real concern was the weak demand for imports which suggests further internal weakness of domestic consumption. Finally, residential construction came in extremely weak which casts further concerns over the durability and sustainability of housing as an economy underpinning. The chart below shows the changes from the 1st to the 2nd estimate of GDP which shows the entire gain coming primarily from the increase in exports.
“Turning to comparisons to the first quarter, the increase in real GDP in the second quarter primarily reflected positive contributions from personal consumption expenditures, exports, private inventory investment, nonresidential fixed investment, and residential fixed investment that were partly offset by a negative contribution from federal government spending. Imports, which are a subtraction in the calculation of GDP, increased.”
The problem is that the trend of growth in the underlying components of the GDP report are deteriorating, most importantly of which is personal consumption expenditures. Personal consumption currently makes up in excess of 68% of the economic calculation so it is more than concerning to see the deterioration in the annualized growth rates. While private investment picked up in the 2nd quarter it is primarily a function of businesses investing in productivity increases to keep employment, and wages, at a minimum as end demand remains weak. While there were positive contributions in the latest report from the underlying components; the negative trends in the data is more predictive of future outcomes.
“Overall, GDP growth for the second quarter was better than earlier believed. Compared to past recoveries, the latest growth rates are not inspiring but the upward revision may add to Fed debate to gradually start to taper asset purchases.”
While GDP growth did come in stronger than previously estimated it is, once again, most important to review the overall trend of growth rather than focusing on a single data point. As I showed in our previous report on GDP, which immediately followed the massive revisions by the BEA to the historical data, the economy has already appeared to have peaked for the current economic cycle. The 6-panel chart below shows the long term annualized growth trends of personal incomes, consumer spending, industrial production, employment and the personal savings rate as compared to GDP.
The assumption is that the stronger economic growth in the second quarter will clear the way for the Federal Reserve to begin reducing their ongoing bond buying/liquidity injection scheme in the months ahead. This could likely prove to be a mistake as there is scant evidence of an economy that is currently improving. With an economy that is currently built on roughly 70% personal consumption (68.3% after latest revisions to the economic data to be exact) it is hard to see where economic growth is going to come from when incomes remain under attack by slow economic growth and high unemployment. Savings rates are being depleted as debt levels increase to maintain the current living standard as cost pressures are passed down from producers. The lack of demand for imports, as stated above, is likely bearing testimony in this regard.
The reality is that the economic data trends are clearly weak and, unfortunately, seems to be getting weaker. It is not uncommon, as inventories become depleted or incremental demand is built-up, that pops in activity will occur. However, those “pops” have tended to be short lived in recent years with the economy rolling from one “soft patch” to the next. While the Federal Reserve continues to state that negative drags to economic growth are fading, and that the economy is showing signs of accelerating, the actual data suggests otherwise. The recent spike in interest rates, which is a drag on economic growth and activity, combined with a reduction in the liquidity support from the Federal Reserve, could turn out to more restrictive on the economy, and the markets, than is currently believed.
Courtesy: Lance Roberts
What we are witnessing here is the disintegration of the so-called economic recovery. A great deal of effort by the FED to print, pump and prime the market seems to be losing steam. The tide has now changed as the broader stock markets decline, the precious metals have decoupled moving higher making significant gains.
The once great U.S. Economy is nothing more than a Grand Paper Facade. The housing market is not being kept alive by Mom & Pop home buyers, but rather from a mixture of wealthy individuals, Hedge Funds and Wall Street who are buying up real estate with cash. Real Estate Speculators are the most fickle of the bunch.
If we look at the chart below, we can see that the majority of home purchases have been using cash:
I think the myth of cash buyers being a small part of the market fed into the meme that the housing market was “organically” going up on the underlying power of the economy. In reality, the market has been bubbling up because hot money is voraciously fighting over itself to eat up whatever inventory is available.
The above chart clearly shows that investor money is really driving the bulk of the housing market. The low rates promoted by the Fed were cast under the umbrella of helping out regular families but in reality, they have turned into the next hot money play for banks, hedge funds, and Wall Street. The fact that 60 percent of all purchases in 2013 are being driven by the cash crowd is crazy (a 200 percent increase from the 20 percent pre-crash levels).
Furthermore, it looks like the housing market is starting to turn south as new home sales missed big time:
And lastly, we know we are getting into serious bubble territory when the largest Wall Street Firms are unloading some of their real estate exposure by the selling of RENTAL BACKED SECURITIES.
The last time there was a great divergence (to the benefit of housing), Wall Street spawned an entire Residential Mortgage-Backed Securities industry where Paulson, Goldman willing sellers would package mortgages, often-times synthetically, slice them up in tranches of assorted riskiness, and sell them to willing idiots yield-starved buyers. As everyone knows, that particular securitization bubble ended with the bankruptcy of Lehman, the bailout of AIG and the near collapse of the financial system. As it turns out,the answer to our original question was “a few hours” because securitizations are back, baby, and this time they are scarier and riskier than ever.
Blackstone – America’s largest landlord – is now actively selling its housing exposure, whether with the assistance of Goldman’s Fab Tourre, Paulson’s Paolo Pellegrini, or… Deutsche Bank’s own Greg Lippmann.
So, now that it looks like we have reached the TOP of the housing-rental market, the big players are getting out by packaging garbage and selling it to poor unworthy slobs. Not only are these big players selling at the top, they will more than likely be shorting these RBS- Rental Backed Securities all way down to the bottom.
Funny how markets never seem to learn from past mistakes.
A few months ago, I wrote about the great Dow Jones Divergence after QE3 when the broader stock markets rose to new highs, while the precious metals were taken out to the woodshed and beaten senselessly.
Well, it looks as if the trend has changed as gold and silver have seemingly decoupled from the broader stock markets:
Since Aug. 6th, the price of gold and silver have moved up higher while the Dow Jones lost 700 points (chart above from 8/27). As we can see the SLV is outperforming the GLD. This is normally the case when we see the beginning stages of a new precious metals up-leg.
While the precious metals have fallen in Thursday trading, nothing goes up in a straight line. Furthermore, the action in the markets reconfirms this inverse precious metals – Dow Jones correlation.
There still seems to be many precious metals investors concerned with the so-called “Supply & Demand Forces” in silver. Some may think that a slowing economy is bad for silver industrial demand. While that may have been true in the past, we are heading into a future in which orthodox forecasts become increasingly worthless. This will be a time when typical supply and demand analysis will be thrown out the window.
Gold and Silver are now in the beginning stages of reclaiming their “Monetary Status.” This can be easily seen by the two side-by-side charts below:
Without going to StockCharts.com and comparing charts, which chart belongs to gold and which to silver? Almost identical… aye? These are sections of gold & silver divided by the Dow Jones Average. The low point on both charts was in Nov. 2012 when the ratio of the DOW to gold & silver bottomed (Dow-Gold = 7/1, Dow-Silver = 375/1).
The top was reached in July 2013 when the Dow-Gold ratio hit 12.5/1 and the Dow-Silver ratio was a staggering 800/1. Today, the ratios have fallen considerably as it only takes 10.5 ounces of gold to buy the Dow and 610 ounces of silver.
As for the answer…. the gold chart is on the left and silver on the right.
There is still a great deal of optimism coming from MSM as well as some of the precious metals analysts that the U.S. can return to the heydays of the past and become a strong manufacturing economy once again.
I am really surprised that a few of the well-known gold bugs believe that once the U.S. Dollar is backed by gold or etc, we will see one of the greatest economic expansions in U.S. history. I hate to break the bad news… but those days are over for good.
U.S. energy consumption peaked in 2007, and has been falling ever since.
There are several trends that can been seen from the chart above. First, energy consumption in the transportation, residential and commercial sectors peaked during 2007-2008. Second, energy consumption in the great U.S. manufacturing sector first peaked in 1979 (shown by industrial consumption line) and then again in 1997. Third, the second peak in industrial energy consumption (1997) was the final nail in the coffin for the U.S. manufacturing industry as it was sent overseas to make way for the bubble service economy.
The reason why we cannot return to a manufacturing industry as we had in the past is due to the fact that we don’t have the cheap and available energy to do so. Of course we can transition back to a more local and smaller mode of manufacturing in the states, but it will be a fraction of its former self.
The U.S. economy has been nothing more than a series of bubbles ever since it transitioned out of manufacturing and into a service economy. We now are at the very last and largest bubble in history — the U.S. Treasury Bubble.
There is no way of telling exactly when the U.S. Treasury Bubble will burst, however fundamentals are now pointing back in favor of the precious metals. Currently we are seeing a decoupling as the prices of gold and silver are heading in the opposite direction of the broader stock markets.
Lastly, it looks as if the bullion banks are now situated to be on the “Bullish Side” of the big move up in the precious metals. With war on the horizon in Syria and the continued disintegration of the U.S. economy… things are about to get very interesting in the gold and silver markets.
I had alerted yesterday regarding the sharp price rise in Gold futures and the heavy selling which came in as an after-effect and caused the hefty premiums on gold buying to disappear. In fact, gold is on a discount in the Indian bullion markets. The article Record High Gold Prices on Rupee Bashing Triggers Physical Selling in India surprised many who read with disbelief. Also an earlier article – Could this be the Peak for Gold Prices in India and Bottom for the Rupee?
Here is an article from the Business Standard that now confirms the same.
From Business Standard–
The falling rupee has rapidly changed sentiment in the gold market from a massive premium a few weeks earlier to a healthy discount now.
Gold was trading at a Rs 800-900 for 10g premium a few weeks before, due to the shortage of supply from the import control measures of the Reserve Bank of India. With the rupee hitting a record low of 68.80 against the dollar, the price of gold set a new high record of Rs 33,265 per 10g on Wednesday. This resulted in buyers turning sellers. Now, spot gold is being quoted at a discount of Rs 300 per 10g of import cost and Rs 1,000 per 10g of the price for near- month delivery on the Multi Commodity Exchange (MCX). “Everybody has become a seller; there is no buyer. The price rise of five per cent in just one session has persuaded investors to offload gold without any interested buyers,” said Bhargav Vaidya, an analyst with B N Vaidya & Associates.
While gold moved up marginally in global markets to touch $1,425 an ounce, high fluctuations in the value of the rupee has made the price highly volatile. Jewellers fear fresh purchases might mean a huge loss in case the rupee appreciates or the gold price falls in the global market, with its immediate repercussion in the home market.
“We are committed to take our own ornaments back from customers and pay them cash after deducting the making charges. But we have kept coins and bars’ purchase on hold, albeit temporarily,” said Samir Sagar, director, Manubhai Jewellers. “Gold above jewellers’ average daily requirement has to be sold in the open market. Today, no one is interested in its purchase. They are asking customers to hold on for a day or two. We have seen very high rise and fall in gold prices in the past. But volatility of today’s kind was never seen. Hence, it is better to avoid purchase at this level.”
To discourage customers from offloading their gold holdings, Tribhovandas Bhimji Zaveri (TBZ) is deducting three per cent from the value of the bullion in cash buys. “Instead of paying cash, we prefer to sell ornaments to customers who wish to offload Gold coins and bars to us. For those who insist on cash, we pay with a three per cent deduction from the prevailing price,” said a sales executive at TBZ.
Umedmal Tilokchand Zaveri, a jewellery retailer at Zaveri Bazaar, purchases gold coins and bars at a discount of Rs 300 at current prices and only at company’s discretion. Kumar Jain, owner of UTZ and spokesperson of Bombay Bullion Association, said customers seek a selling price in the spot market commensurate with prices on the MCX. “Since, gold futures prices are higher than spot gold prices, it impossible to pay that to customers,” a jeweller said.
Today’s AM fix was USD 1,406.25, EUR 1,059.96 and GBP 906.79 per ounce.
Yesterday’s AM fix was USD 1,425.50, EUR 1,066.03 and GBP 919.91 per ounce.
Gold rose $0.20 or 0.014% yesterday, closing at $1,415.70/oz. Silver ceded some its previous gains and closed down $0.17 or 0.7%, closing at $24.29. Platinum gained $9.45/oz to $1,531.20.
Gold fell from a three month high, its first fall in six days on profit taking after the likelihood of U.S. military strikes on Syria, at least in the short term, diminished. Prices rallied to $1,433.83 yesterday, the highest since May 14, partly due to concern about military action and the risk that it may lead to a deeper, more protracted Middle Eastern war.
Geopolitical risk, emanating from the Middle East in particular, has been underestimated for some time. Since the alleged chemical weapons attack on August 21, oil has risen sharply and gold has received a safe haven bid.
Gold and oil began rising in afterhours trading on the day of the incident and since then gold is up 3.9% and oil is up 5.5% (see chart). From $103.52 per barrel to $109.25 per barrel (NYMEX crude) and from $1,355/oz to $1,408/oz today.
Gold and oil are often correlated particularly when there are sharp movements up in oil prices as was seen in the 1970s and in the period from January 2002 to July 2008 when NYMEX crude oil prices rose from less than $20 a barrel to over $140 a barrel.
An escalation of the crisis in the Middle East and the real possibility that Iran and Israel could become embroiled in the conflict means that there is again the possibility of oil rising to new record highs, with an attendant rise in gold prices.
NYMEX Crude Oil – Generic 1st ‘CL’ Future – (Bloomberg)
There are also growing concerns that the recent poor U.S. economic data and geopolitical uncertainty will lead to the Federal Reserve not slowing stimulus or ‘tapering.’ A continuation of cheap money policies will be bullish for gold.
Another positive factor for the gold market is the very delicate situation regarding peak gold and supply from South Africa.
In what could be described as a provocative move, gold mining companies in South Africa are considering locking out workers. The aggressive move is being considered if labor unions fail to accept a revised pay offer.
The four unions in the gold industry have until 12 p.m. local time today to accept an offer from the chamber, which represents gold mining companies, to increase the wages of some categories of workers by 6.5%. Workers in the automotive, construction and aviation industries are already on strike to demand pay increases in excess of the considerable inflation rate of 6.3% in July.
The chance of a South African gold strike is ‘highly likely’ said Solidarity Union General Secretary Gideon du Plessis, in a speech in Johannesburg.
Respected Citigroup strategist Tom Fitzpatrick said in a telephone interview from New York with Bloomberg that gold and silver should surge in the coming years as the precious metals continue to benefit from the easy monetary policies adopted by central banks.
Fitzpatrick, who has a good track record, said that gold has put in a low for the year and will rise to about $1,500-$1,525/oz this year. A gain of over 6.3% from today’s prices.
He said that silver is in a strong uptrend and will likely outperform gold as the gold silver ratio will drop from its current level at 58.1.
Separately, in an interview with King World News’ Eric King, Fitzpatrick elaborated on why he believes gold could reach $US3,500:
“So we believe we are back into that track where gold is the hard currency of choice, and we expect for this trend to accelerate going forward. We still believe that in the next couple of years we will be looking at a gold price of around $US3,500.“
“As the gold/silver ratio plummets near 30, this would also suggest a silver price above $US100.”
Gold appears to have bottomed in June and is rising due primarily to strong physical demand for jewelry, coins and bars globally.
Gold is heading for a second monthly gain which is very important technically and from a momentum perspective.
When I talk to friends and family, one of the most common concerns they tell me about is their frustration over the current economic recovery—with the slow pace of job creation and the relatively high number of unemployed keeping a tight lid on wages.
According to Sentier Research, the current median income in June of 2013 was $52,100. This represents a drop of 4.4% from June of 2009, when the recession officially ended, and 6.1% below the December 2007 median income, prior to the Great Recession. (Source: “Household Income on the Fourth Anniversary of the Economic Recovery: June 2009 to June 2013,” Sentier Research LLC web site, August 21, 2013.)
While we’ve seen job creation pick up over the past couple years, it is still not enough to increase wages. While the economic recovery will produce approximately two million new positions this year, job creation has been primarily in the low-wage-paying sectors.
Plus, with the massive disturbance that the recession caused, the economic recovery is significantly different than anything we’ve seen before, causing job creation to increase while wages stagnate.
I believe the bubble we experienced over the past decade was artificially inflated—and this is why the recession ultimately burst. The reason people feel uncertain about this economic recovery is that they expect the job creation will resume at the pace we saw a decade ago—and that’s just not going to happen anytime soon.
This is a new economy, and I think the structural situation is significantly different than in the past. There is still much uncertainty, especially with new healthcare rules and regulations, which are creating impediments to job creation.
Because the economic recovery has been so slow, this has left people with no choice but to take any position and remain willing to jump at a moment’s notice when a better job pops up. What this means for job creation is that there are millions of people who are willing to work for less money, which is causing a ceiling in the level of net income.
Looking at it through the basic principles of supply and demand, there’s far too great a supply of labor. Because job creation has been slow during this economic recovery, there is still an abundance of workers in most fields. And when supply is in abundance, we all know that means demand isn’t up.
Talk that the nation’s wealth has been rebuilt is referring to asset prices, not income. Both the housing market and the stock market have strongly rebounded, but the economic recovery has not led to enough job creation; this is why we’re not seeing an increase in wages.
Most people don’t have a majority of their wealth in the stock market. Because of the uncertainty in the economic recovery, many people have barely any excess capital to invest.
So, what’s the solution? More needs to be done by the federal government to alleviate concerns by business owners when it comes to hiring people. We need more job creation to help boost the economic recovery, and that comes from small- and medium-sized businesses.
If you are a small-business owner, would you really think about hiring 10 more employees ahead of so much uncertainty regarding changes to health care and new regulations? I know I would be very tentative.
The goal should be to increase the growth rate of the economic recovery, yet the federal government is hammering small businesses with costly rules that are hard to interpret, causing significant hesitation when it comes to job creation instead.
As an investor, I would suggest that you focus on wage growth. We need to see higher wages in addition to job creation for the economic recovery to really start improving significantly.
Courtesy: Investment Contrarians
According to the information just released by the Royal Canadian Mint, sales of Gold & Silver Maples are beating all records. Not only are Canadian Maple sales surpassing its own previous records, Gold Maple Leaf sales actually out performed U.S. Gold Eagles during the second quarter of 2013.
The Royal Canadian Mint just published its Q2 2013 Fiscal Report showing that it sold 403,000 oz of Gold Maples in the 13 week period ending on June 29th, 2013 compared to 165,000 during the same period last year. Furthermore, Silver Maple Leaf sales increased to 6.4 million Q2 2013 compared to 4 million in Q2 2012.
Here we can see that Silver Maple sales have increased 60% y.o.y (year over year) while Gold Maples are up a staggering 144%. As mentioned above, what is even more surprising is that Gold Maples have surpassed Gold Eagles during this time period.
The U.S. Mint sold 336,500 oz in Gold Eagles during the second quarter of 2013, whereas the Royal Canadian Mint recorded 403,000 in sales. Gold Maple sales were 20% higher than Gold Eagles during Q2 2013.
Canadian Maple Leaf sales year to date are on track to beat both 2012 and 2011 records. In the first 6 months of the year, Gold Maple sales were 664,000 oz compared to 302,000 oz in 1H 2012 and 502,100, 1H 2011. Silver Maples increased to 12.1 million up from 8 million, 1H 2012 and 11.4 million in 1H 2011.
Even though Silver Maple sales (+53%) are up considerably since last year, Gold Maples (+123%) have increased the most in percentage terms. Furthermore, total Gold Maple sales in 2012 were only 883,048 oz, while 2011?s record was 1,150,285 oz. If the present trend continues, we may see 1.2-1.3 million oz of Gold Maple sales for 2013.
Additionally, Silver Maple sales are on track to reach 24 million oz in 2013 which will beat the sales of 18.1 million in 2012 and possibly the 2011 record of 23.1 million.
Together, Silver Maple and Silver Eagle sales will hit between 68-71 million oz in 2013. This is an amazing figure as it represents 9% of total world silver production of 787 million ounces in 2012. Also, we must remember this 9% investment demand is just from these two Official Mints.
If we consider the sales of additional commemorative silver coins as well as sales from the other official mints, total figures for 2013 will more than likely top 2011?s total of 118.2 million oz (2013 World Silver Survey) by at least 10 million oz.
Even though sales of official gold and silver coins have picked up dramatically, this is only a preview of the huge demand to come in the future as the public wakes up to the GREAT PRECIOUS METAL TRANSFER OF WEALTH.
Still confused what that fateful FOMC day just three weeks away from today may bring, in the aftermath of a Jackson Hole symposium which was mostly focused on the adverse side effects of Quantitative Easing and the proper sequencing of unwinding the Fed’s nearly $4 trillion balance sheet? Here is the explanation straight from the firm whose chief economist has dinners with none other than the Fed shadow Chairman, Bull Dudley, on a frequent basis. To wit: “First, we expect Fed officials to adjust the “mix of instruments” somewhat away from QE towards forward guidance at the September meeting, which appears to be an appropriate strategy in light of these results. Second, we expect that the FOMC will focus most if not all of the tapering on Treasury purchases rather than (current coupon) MBS purchases, consistent with the evidence that the latter are more effective in lowering mortgage rates and easing financial conditions.”
So: $10-15 billion reduction in TSY monetization announced in September, enacted in October, and a seismic shift in FOMC communication away from actual intervention to promises of such, aka forward guidance. Judging by the recent track record of “forward guidance” so far, the global market volatility exhibited so far may well be just a walk in the park compared to what is coming.
Full Goldman note:
While the Jackson Hole conference was less eventful than in previous years?in light of the lack of a keynote address from a member of the FOMC leadership?a number of interesting academic studies were presented. In particular, a paper by Arvind Krishnamurthy and Annette Vissing-Jorgensen (or “KVJ” for short)?presented by Krishnamurthy at the conference?argues that QE has more narrow effects on asset prices than Fed officials have typically proposed. First, KVJ present evidence that MBS purchases have been more effective than Treasury purchases in lowering mortgage rates and, thus, supporting the economy. The reason is that they find only limited evidence for a broad “duration removal effect,” through which taking out duration risk from the Treasury market boosts other, riskier, asset prices. Instead, they argue that Treasury purchases work mainly through a scarcity effect that pushes down Treasury yields but leave riskier asset prices largely unchanged. Purchases of MBS?which lower private borrowing costs more directly?are therefore a more direct and more effective way to boost the economy. Second, KVJ argue that within mortgages, purchases of newly issued (current coupon) MBS have been more effective in lowering mortgage rates than higher coupon MBS purchases. The basic intuition for this is that purchases of current coupon MBS are more effective in encouraging new MBS issuance. KVJ’s main vehicle for establishing these results is an event study that looks at the response of different asset prices to the Fed’s announcement of its unconventional policy steps.
The main shortcoming of such an event study?as stressed by the discussant of the KVJ paper at the Jackson Hole conference, Anil Kashyap of the University of Chicago?is that it is hard to control for the influence of other factors. In particular, the event studies do not control properly for the role of expectations. Also, the event studies focus on one-day changes, making it difficult to explore the persistence of the effects.
In the remainder of today’s comment we therefore provide additional evidence on this issue. Specifically, we extend our previous analysis and model jointly the effects of forward guidance, Treasury purchases and MBS purchases (both current and higher coupon) on mortgage rates, and financial conditions more broadly. We proceed in three steps.
First, we create a proxy of the FOMC’s forward guidance and the effects of its Treasury purchases on long-term rates. Following our previous work, we decompose the change in 10-year Treasury yields observed around FOMC decision announcements into the change in the rate expectations path (a proxy for forward guidance) and the change in the Treasury term premium (a proxy for the effects of Treasury purchases). We do so using the Board staff’s statistical approach (the so-called “Kim-Wright” model). To increase the chance that we only capture the effects of Fed policy on rates, we focus on the change in the Treasury term structure during the 1-hour window surrounding FOMC announcements. We then map the observed change in 2-year, 5-year and 10-year Treasury yields into a change in the term premium using a (daily) regression of the historical Kim-Wright term premium estimate on the structure of the yield curve. Our intra-day data goes back to 2001.
Second, we construct a proxy for the Fed’s mortgage purchases, distinguishing between current coupon and higher coupon MBS.
Specifically, we use the daily change in option adjusted spreads (OAS) on conventional 30-year MBS on FOMC decision announcement days. We define the current coupon spread as the OAS for a coupon that prices at par (i.e., at $100) and the higher coupon spread as the OAS for a coupon that prices at a 4% premium (i.e., at $104). While using daily, rather than intra-day, data might lead us to include influences other than the FOMC meeting, we believe that this is a reasonable simplification because we observe that MBS price changes around FOMC announcements drive most of the variation in daily changes in MBS spreads on those days over the last couple of years (when data are available).
Third, we use our proxies for forward guidance, Treasury purchases and MBS to explore their effects on the primary mortgage rate and financial conditions (measured by the GSFCI). In particular, we run regressions of changes in the primary mortgage rate/the GSFCI on our measures of guidance, Treasury purchases and MBS purchases. We use daily data back to 2001 (when the intra-day Treasury data are first available) and run separate regressions for different time horizons (after one to twenty days after the policy event).
Exhibit 1 shows our results for the primary mortgage rate. Specifically, the exhibit shows the cumulative effect of a 100 basis point increase in each of our Fed policy proxies on the primary mortgage rate after 1 to 15 days. First, we find that forward guidance (proxied with changes in rate expectations) has larger and more persistent effects on the primary mortgage rate than Treasury purchases (proxied with changes in the Treasury term premium). Second, changes in current coupon mortgage spreads (our proxy for current coupon MBS purchases) have larger effects on the primary mortgage rate than changes in the Treasury term premium (Treasury QE). Finally, our proxy for higher coupon MBS purchases (changes in higher coupon OAS) has negligible effects on the primary mortgage rate. Statistical tests (not shown) indicate that the effects of guidance and current coupon MBS purchases remain statistically significant even after 15 days, while the effects of changes in the Treasury term premium become insignificant after 10 days, and the effects of changes to higher coupon mortgage spreads are statistically never distinguishable from zero.
Exhibit 1: The Effect of Forward Guidance and Purchases on Primary Mortgage Rates…
Exhibit 2 shows that a broadly similar pattern is observed for our financial conditions index (GSFCI). Guidance, in particular, is highly effective in affecting financial conditions, followed by current coupon MBS purchases and Treasury purchases.
Exhibit 2: …and Financial Conditions
Our analysis is subject to a number of important caveats. First, it has been challenged whether the Kim-Wright model can distinguish accurately between changes in the rate expectations path and term premium at the zero lower bound. Attributing too much of the change in yields to the term premium?and too little to changes in rate expectations?could bias our results toward finding that signaling (per basis point) is more effective in easing financial conditions. Likewise, our analysis does not allow for an interaction between guidance and the effects of purchases, a channel we have found to be empirically relevant in past research. Second, our mortgage OAS variables are subject to a number of issues, including OAS model dependency and an arbitrary choice of what constitutes current coupon and higher coupon securities. Finally, all of our variables are proxies for the Fed’s actions, not direct measures. Ideally, we would have liked to explore directly the effects of the per-dollar purchases of Treasury and MBS purchases on private borrowing rates. This approach, however, is practically infeasible due to data limitations (asset purchase announcements were not broken down by current/higher coupon MBS) and expectational effects (asset purchases were typically anticipated prior to announcement).
Despite these caveats, our results are consistent with KVJ’s findings?and Fed officials’ evolving views over the last couple of years?that assign a more important role to forward guidance and (current coupon) MBS purchases than Treasury purchases. Moreover, these findings are consistent with our expectations for Fed policy in coming months. First, we expect Fed officials to adjust the “mix of instruments” somewhat away from QE towards forward guidance at the September meeting, which appears to be an appropriate strategy in light of these results. Second, we expect that the FOMC will focus most if not all of the tapering on Treasury purchases rather than (current coupon) MBS purchases, consistent with the evidence that the latter are more effective in lowering mortgage rates and easing financial conditions.
Thailand has fallen back into recession, Mexico’s economy is shrinking again, Russia is growing at just 1.2% – the pace of the slowly recovering West. Brazil’s growth was less than 1% last year, while the country that many have their eyes on is India, which is struggling with a pace of growth that is more reminiscent of the pre-1980s era than the rapid expansion of the past decade.
Of course not all emerging economies are in the same boat. For instance, the Philippines has grown faster than expected in the second quarter, by 7.5% from a year earlier. But, there are a number, especially the large emerging economies, which are slowing. And that raises the question as to whether the emerging market growth story is over, with investors pulling at least some of their money out from these countries.
Economic growth in the past decade was supported by a commodity boom and a lot of US consumption that turned out to be based on cheap but ultimately unsustainable debt. As the so-called commodity super-cycle moderates and the US consumer buys at a more moderate level, growth will slow around the world.
It’s not necessarily the end of the emerging market growth story though. Countries across Asia now have their own middle class consumers after a period of rapid growth in incomes.
And, put into perspective, emerging economies are still forecast to grow by 5% or more by the International Monetary Fund in the next couple of years, barring a crisis. Growth may have slowed from the heady days of 7%-plus growth, which was more than double America’s in the late 1990s and 2000s, but it’s still a decent clip.
One of the reasons for the slowdown is that developing countries now have less room to “catch up” than before. For the first time ever, emerging economies now account for more than half of the world’s GDP, according to the IMF. So, countries like China, India, Russia and others produce more of the world’s output than rich countries like the US, UK, Germany. It implies that these developing nations have caught up to some extent and growth will slow unless they innovate like the richer countries.
After all, it has been two decades since the early 1990s when China, India and the former Soviet Union opened up and integrated with the world economy. This propelled the world into a phase of greater globalization where terms like off-shoring came into vogue and trade surged – exports of goods almost doubled from 16% of world GDP to nearly 30% by the late 2000s. Foreign investment and money also poured into cheaper and fast-growing emerging economies as they opened up.
Developing countries could have done a lot more to strengthen their economies during the good times. But, it’s often during the bad times that there is an impetus for reform, including supporting industrialization and the middle classes. The protests across the world from Brazil to the Middle East have some of their roots in what hadn’t been done by their governments during the boom times.
Take India – a country very much in the spotlight as its currency has fallen at the fastest pace since the 1991 balance of payments crisis.
Two key indicators as to whether India has improved the foundations for its economy are how much it produces and sells overseas. Industry makes up only about a quarter of GDP and hasn’t increased since the 1990s. India has also barely increased its exports, accounting for just over 1% of global markets. When compared to China, which accounts for 11% of global exports, or Indonesia where industry accounts for nearly half of GDP, India has lagged in its industrialization and penetration of global markets.
During the good times, India’s long-standing impediments to growth – a low average level of educational attainment and poor infrastructure that impede manufacturing – weren’t addressed. Growth is now at its slowest pace in a decade at about 5%, and that isn’t enough to significantly lift average annual incomes of only $1,500, which is a fraction of the average $10,000 for emerging economies.
More worryingly, according to Morgan Stanley, Indian companies have borrowed too much. They estimate that one in four companies can’t cover its interest payments. This is all adding to the worries over the large current account deficit and draining confidence from its currency as investors fret about the ability of the Indian government to manage when the era of cheap money ends. I wrote about this when the rupee began its plunge a few weeks ago.
This year could see the world economy expanding at the slowest pace since the 2008 crisis. There’s no financial crisis this time, but for countries like India, there could be one brewing if the economy continues on its downward trajectory.
As Warren Buffett remarked about the vulnerable banks during the 2008 financial crisis: “After all, you only find out who is swimming naked when the tide goes out.”
India will hope that it’s not one of them.
Courtesy: Linda Yueh
It was Richard Nixon’s treasury secretary John Conally who famously told the rest of the world to go pound sand when it complained about US monetary policy and Nixon’s default on the Bretton Woods gold clause. Conally’s audience at the time were European finance ministers who were told “it’s our currency, but your problem”. The major monetary and economic upheavals of the 1970s promptly ensued thereafter. As Conally would find out, this turned out to be a rather sizable problem for the US as well.
We already noted yesterday that the protests of submerging country representatives against the central bank policies of developed nations only received a cursory hearing at Jackson Hole. Following Christine Lagarde’s admonition that central banks should ‘coordinate their policies’ to avoid precipitating another crisis, Atlanta Fed president Dennis Lockhart proceeded to present his version of Conally’s famous saying, by pointing out that:
“You have to remember that we are a legal creature of Congress and that we only have a mandate to concern ourselves with the interest of the United States,” Dennis Lockhart, president of the Atlanta Fed, told Bloomberg Television’s Michael McKee. “Other countries simply have to take that as a reality and adjust to us if that’s something important for their economies.”
Lockhart was later seconded by James Bullard of the St. Louis Fed. In other words, India, Mexico, Brazil, etc., can go pound sand this time around.
As Joan McCullough of East Shore Partners has pointed out in a piece written for John Mauldin, this would actually represent quite a departure from US policy since the 1990s. In light of the experiences of the 1970s, it has been standard operating procedure to rush to the aid of crisis-stricken foreign economies that got into trouble, which often happened because they tied their currencies to the US dollar.
As Mrs. McCullough points out, the US aided Mexico in the 1994 crisis, and Asian economies such as South Korea in 1997/1998, with the administration often circumventing a recalcitrant Congress in the process (e.g. the secretive ESF was employed in the Mexico crisis, forwarding $20 billion to it after Congress said no to $40 billion in loan guarantees).
She concludes that obviously, the idea that US monetary policy has always been of the ‘every man for himself‘ type is a blatant denial of reality. However, this time, with its ‘QE’ and ‘ZIRP’ policy, the Fed has painted itself into a corner it is very difficult to get out of. The ‘exit’ that will probably be attempted by September (unless economic data published until then continue to be as terrible as the most recent releases, most of which appeared to be screaming ‘recession dead ahead’), is likely to have grave repercussion for financial markets everywhere, considering that even talking about ‘QE tapering’ has pushed a number of emerging economies to the brink of crisis, or as was the case in India, has given them the final shove over the precipice.
Several other authors, inter alia the always interesting David Zervos of Jefferies, have also provided contributions to Mr. Mauldin’ publication, which is entitled ‘Exit, Schmexit’. It can be downloaded here (pdf). Mr. Zervos had one comment that we want to repeat here, as it fits well with our remarks about ‘central bank communications’ strategies in yesterday’s post about the alleged need for ‘central bank shamans’. Zervos on the Fed’s ‘taper’ plans:
“There is no doubt these folks are trying to delicately pop a fixed-income leverage bubble. They are deathly afraid of a souped-up version of the 1994 rout! They know that balance sheet expansion comes with the parasitic side effect of excessive private sector leverage. And as of now they feel the potential costs of further expansion are beginning to outweigh the benefits. The economy is recovering; QE has been working like a charm; but it’s time to nip the side effects in the bud. That’s the current Committee view!
As a consequence, there is a campaign underway by the FOMC to somehow convince us all that “soothing language” will be better than QE injections. That, of course, is like trying to tell Charlie Sheen that a warm cozy snuggle by the fireplace with a good book will be better than an eight ball. The market is not stupid, and neither is Charlie — both will freak out when u try to take their drugs away! And to be sure, we are 130bps into this freak-out session on 10yr rates. The bubble has been popped. And the question we should all be asking ourselves is, will the Fed lose control of the situation? My answer to that (for now) is NO! But I must say, there is quite a bit more room for a policy mistake than at any other time in the past few years.”
We should mention at this juncture that we believe that the ‘policy mistake’ has of course already been made: it consisted of the decision to print money with gay abandon in the first place. Prices all over the economy have been distorted, hampering and falsifying economic calculation. Is there a bubble in fixed income? You bet there is. The junk bond market has grown to a monstrous $2 trillion in size, with huge amounts of dubious debt issued at ridiculously low interest rates in recent years. The junk bond market has doubled in size in just seven years.
“It took three decades for the amount of speculative-grade debt to reach $1 trillion. It took about seven years to reach $2 trillion as investors sought relief from the financial repression brought on by near-zero interest rates.
The market for dollar-denominated junk-rated debt has expanded more than eightfold since the end of 1997 from $243 billion, according to Morgan Stanley. That compares with a quadrupling of the investment-grade market to $4.2 trillion as tracked by the Bank of America Merrill Lynch U.S. Corporate Index.
While Federal Reserve policies have pushed investors toward riskier investments to generate high yields, allowing even the neediest companies that might otherwise default to access capital markets,concern is rising that missed payments may soar when benchmark rates begin to increase. Martin Feldstein, a past president of the National Bureau of Economic Research, said last week that low rates should be allowed to rise because they’re driving investors into risky behavior.
“The growth in the market, and volume of supply is less important than quality of issuance,” Adam Richmond, a credit strategist at Morgan Stanley in New York, said in a telephone interview. “When we see a heavy volume of lower-quality deals, that’s when you need to worry a little bit.”
What Mr. Richmond fails to realize is that there is a direct connection between the volume of issuance and the quality and creditworthiness of borrowers. Often securities that look reasonably ‘safe’ at the height of a bubble turn out to be anything but when the bubble bursts. As we have pointed out at the end of May, even the government of Rwanda was able for the first time ever to place a large bond issue, at a ridiculously low interest rate to boot. Demand for the security was brisk – it was almost ten times oversubscribed. The buyers of this deal are by now already stuck with large losses after the recent rout in EM currencies and bonds. It is a good bet that the bonds issued by Rwanda have gone ‘bidless’.
What this feeding frenzy for the bonds of extremely dubious issuers tells us is that almost anyone was able to raise money over the past year at what have been the lowest rates for ‘junk’ in all of history. Issuance of products like ‘PIK’ bonds has soared as well. These ‘payment in kind’ bonds are essentially a pure Ponzi scheme, in which the borrower has the choice to service the debt by issuing more bonds instead of paying cash.
High yield bond ETF JNK – beginning to look a tad wobbly – via StockCharts – click to enlarge.
Numerous large bubbles in financial assets have formed due to the extremely lax monetary policy of recent years. That always happens when there is monetary pumping on such a colossal scale. It seems to us that there is no way to let the air out of these bubbles gently, therefore it seems actually likely that any attempt at ‘QE tapering’ will soon be followed by ‘full speed ahead’ again. Meanwhile, the crises in a number of emerging countries show that the bubbles are already fraying at the edges. Eventually, the problems will migrate from the periphery to the center, which is also why Messrs. Lockhart and Bullard are not quite credible with their ‘every man for himself’ assertions. We rarely agree with Mrs. Lagarde, but she had a point when she noted:
“IMF Managing Director Christine Lagarde warned that financial market reverberations “may well feed back to where they began.”
Courtesy: Pater Tenebrarum
It’s funny: nearly five years ago, when we first started, and said that the world is doomed to an endless cycle of bubble, financial crisis and currency collapse as long as the Fed is around, most people laughed: after all they had very serious reputations aligned with a broken and terminally disintegrating economic lie. With time some came to agree with our viewpoint, but most of the very serious people continued to laugh. Fast forward to last night when we read, in that very bastion of very serious opinions, the Financial Times, the following sentence: “The world is doomed to an endless cycle of bubble, financial crisis and currency collapse.” By the way, the last phrase can be written in a simpler way: hyperinflation.
So ok then: we are happy to take that as an indirect, partial apology by some very serious people. Partial, because the piece’s author, Robin Harding, doesn’t explicitly come out and state that this cycle of boom and bust is a direct function of ever encroaching central-planning being handed over to a few economists with zero real world experience, whose actions result in ever more devastating blow ups once the boom cycle shifts to bust. Instead, it is their admission that this is what the world has come to. But, being economists, they naturally fail to see that it is all due to them. Instead, just like pervasive market halt, flash crashes, and everything else that now dominates a broken New Normal, this cycle which eventually culminates with currency collapse, or said otherwise, hyperinflation.
The FT’s read on the paradox of modern finance and central banking is surprisingly accurate: in fact, it is almost as if it comes not from the FT but from a textbook on Austrian economics, or a Zero Hedge article:
All [the central bankers’] discussion of the international financial system was marked by a fatalist acceptance of the status quo. Despite the success of unconventional monetary policy and recent big upgrades to financial regulation, we still have no way to tackle imbalances in the global economy, and that means new crises in the future.
Indeed, the problem is becoming worse. Since the collapse in 1971 of the old fixed exchange rate system of Bretton Woods, the world has become used to the “trilemma” of international finance: the impossibility of having free capital flows, fixed exchange rates and an independent monetary policy all at the same time. Most countries have plumped for control over their own monetary policy and a floating exchange rate.
The rest of the article is also like reading early Zero Hedge. Or middle. Or late: in a world of instantaneous fungibility and global capital flows, the Fed is in charge of hot money everywhere, which incidentally is why it is the Emerging Markets that are getting destroyed (first, for now) as the global Fed-funded carry trade slowly but surely unwinds.
Yet all the debate was about how individual countries can damp the impact of capital flowing in and out. Prof Rey’s own conclusion was that it is hopeless to expect the Fed to set policy with other countries in mind (which would be illegal). She recommended targeted capital controls, tough bank regulation, and domestic policy to cool off credit booms.
In practice, this will never work well. It requires every country in the world to react with discipline to constantly changing capital flows. It is like saying we can cure the common cold if only everyone in the world would wash their hands hourly and never leave the house. Even if it did work, the necessary volatility of policy would still impose painful economic costs on the countries acting this way.
The shocking lucidity continues:
The flaws in the international financial system are old and profound, and they defeat any effort to work around them. Chief among them is the lack of a mechanism to force any country with a current account surplus to reduce it. Huge imbalances – such as the Chinese surplus that sent a flood of capital into the US and helped create the financial crisis – can therefore develop and persist.
Even the conclusion is straight out of a Zero Hedge article:
The flaws in the international financial system are old and profound, and they defeat any effort to work around them. Chief among them is the lack of a mechanism to force any country with a current account surplus to reduce it. Huge imbalances – such as the Chinese surplus that sent a flood of capital into the US and helped create the financial crisis – can therefore develop and persist.
Indeed, running a surplus is wise because there is no international central bank to rely on if investors decide they want to pull capital out of your country. There is the International Monetary Fund – but Asian countries tried that in 1997, and the experience was so delightful they have been piling up foreign exchange reserves ever since to avoid a repeat.
A reliable backstop is impossible when the international system relies on a national currency – the US dollar – as its reserve asset. Only the Fed makes dollars. In a crisis, there are never enough of them – a shortage that will only get worse as the world economy grows relative to the US – even if the problem for emerging markets right now is too many of them.
The answer is what John Maynard Keynes proposed in the 1930s: an international reserve asset, rules for pricing national currencies against it, and penalties for countries that run a persistent surplus. After the financial crisis there was a flood of proposals along these lines from the UN, from the economist Joseph Stiglitz, and even from the governor of the People’s Bank of China. None has gone anywhere.
Oh it will go somewhere… as soon as Bernanke leads the US to its own final “currency collapse”, resulting in an inevitable shift in the reserve currency status as we have shown many times before, and as has happened in history so many times. Because no reserve currency is forever.
And finally, on that other topic, gold and systemic stability, here is what the FT has to say:
A stable international financial system has eluded the world since the end of the gold standard.
What else is there to say.
No really: when the FT becomes ZH, maybe everything that should be said, has been said?
The aftermath of the biggest crash in the Indian rupee in history is becoming clear: business are scrambling to refine budgets, import and export activity is disappearing as there is zero clarity what the actual transaction prices net of FX are, purchases of hard assets are exploding as people are desperate to protect what little purchasing power they have left, capital controls are being instituted virtually everywhere, and the overall economy – at least that part that is reliant on foreign trade flows – is grinding to a halt. In fact, it got so bad, that moments ago the 1 month USDINR forward hit a ridiculous 70.
However, what is scariest is that so far the Indian Central Bank, the (RBI) Reserve Bank of India has failed to reassure markets that it has anything up its sleeve. At least until moments ago, when the RBI finally announced its first band aid solution in the form of this: “RBI introduces Forex Swap Window for Public Sector Oil Marketing Companies”
On the basis of assessment of current market conditions, Reserve Bank of India has decided to open a forex swap window to meet the entire daily dollar requirements of three public sector oil marketing companies (Indian Oil Corp., Hindustan Petroleum Corp. and Bharat Petroleum Corp). Under the swap facility, Reserve Bank will undertake sell/buy USD-INR forex swaps for fixed tenor with the oil marketing companies through a designated bank. The swap facility gets operationalized with immediate effect and will remain in place until further notice.
Translation: instead of doing a shotgun liquidity injection targeting everyone (ala Fed, ECB, BOE and BOJ), and be sure the USD shortage is everywhere not just at these three oil companies – the RBI will instead proceed with surgical USD liquidity injections based on its perceived importance of the dollar recipients. In this case, the companies most exposed to the vagaries of the petrodollar system, because last we checked a barrel of Brent can be bought only for USD, not for INR.
However, what is more troubling is that while the RBI may have just bailed out its critical oil industry, if only for a few days or weeks, it means everyone else is left hung out to dry and the exodus of all INR positions into USD will only accelerate to a point where the USDINR may surge well over 70 when it reopens for trading, leading to an ever deteriorating currency collapse toxic loop (and one which most likely will inevitably result with the RBI leasing out its several hundreds tons of gold to those in greater need for physical).
Which also means that the only winners are those who bought gold, or rather smuggled it thanks to numerous capital controls, as only their purchasing power has been preserved: gold in rupee terms is at an all time high.
For everyone else: please keep reading Krugman.
If SocGen is right in its just released oil price forecast in a “Syrian war world”, then the global economy is about to undergo an apoplectic shock the likes of which have not been seen since the summer of 2008, when Lehman brothers had to be taken under to generate the deflationary shock sending crude from $130 to $30 in the matter of days. The French bank’s forecast in a nutshell: “Base case scenario: $125 for Brent. We believe that in the coming days, Brent could gain another $5-10, surging to $120-$125, either in anticipation of the attack or in reaction to the headlines that an attack had started. In our base case, we assume an attack begins in the next week. Upside scenario: $150 for Brent If the regional spill over results in a significant supply disruption in Iraq or elsewhere (from 0.5 – 2.0 Mb/d), Brent could spike briefly to $150.” And if indeed 2008 is coming back with a vengeance, the next question is who will be this year’s unlucky Lehman Brothers?
In recent days, the US has been leading a drive to use military action to punish Syria for the alleged use of chemical weapons last week. The severity and tone of the threats and rhetoric has been getting stronger, not just from the US, but from close allies such as the UK and France. As a result, the oil markets have begun to price in the risk of military action. Today, front-month ICE Brent gained over $4 to $115.30, while NYMEX WTI was up over $3 to $109.50 (more on the oil market impact below).
We believe that such an attack is likely within the next week, but not before the weekend. The talk from the US and others has been so tough that, at this point, the option not to attack does not exist any longer. The US would be seen as very weak for not keeping its word and doing what it said, and this has very important ramifications for other countries and problems in the region, including the Iranian nuclear issue. Like Syria, there are also red lines for Iran.
Our geopolitical analysis indicates that the question is not whether there will be a military action against Syria. The questions are “who?”, “what?”, and “when”? The coalition being assembled reportedly includes the US, the UK, France, Germany, Turkey, Canada, Saudi Arabia, Qatar, and Jordan. A range of options prepared by the Pentagon months ago has been under consideration. At one end of the spectrum is a relatively short period of surgical cruise missile strikes directed at military targets, not directly related to the chemical weapons complex in Syria (such targets could be dangerous to civilians). In the middle is a lengthier air campaign targeted at eliminating the Syrian Air Force. At the other end of the spectrum is the establishment of a no-fly zone designed to protect rebel forces and civilians. This open-ended strategy is similar to the one used two years ago in Libya, where the no-fly zone was liberally interpreted by NATO to allow attacks on government ground forces, also to protect rebel forces and civilians.
Fed by leaks from the US officials to various media outlets in the last two days, the current reporting is that President Obama has all but decided on a short two-day surgical cruise missile attack aimed at punishing Syrian and deterring further use – and also proving to others that the US keeps its promises. This makes a lot of sense, and also keeps the US and its allies out of the broader civil war, where the most effective opposition fighters are hard-line Islamists that the US does not want to support.
In addition, having perhaps learned some lessons from Iraq, Afghanistan, and Libya, the US wants to avoid entanglement in a civil war where the “what comes next if Assad falls” question does not have an easy answer. Having said all that, it is also possible that the leaks by US officials are part of a disinformation campaign. The military and intelligence community may want Assad to believe in a short surgical cruise missile attack, when in fact one of the more severe options is being planned.
The US and key allies have made clear that they will act without the approval of the UN Security Council, in a “coalition of the willing”, because they expect Syria’s ally Russia to veto a UNSC resolution. However, to win approval in the court of world opinion, the US-led coalition may want to present their evidence at the UN and try to get a UNSC resolution to a vote, despite the expected Russian veto (China may well abstain). In addition to making final preparations for an attack, the political aspects will take a few days, which is why we believe the attack will not come before the weekend.
Why are prices going up? What is the oil market worried about? It’s not Syrian crude production or exports. As shown on the left-hand chart above, in the two years since the Arab Spring and the Syrian unrest began, Syrian output has fallen from 350 kb/d to 50 kb/d. It is not a factor. The concern is that an attack on Syria will reverberate through the region, increasing the spill over into other countries and possibly resulting in a larger supply disruption elsewhere.
Our big worry is Iraq. The Sunni vs. Shiite conflict in Syria has a direct parallel in Iraq, and the violence in Iraq has reached levels not seen since 2008. For oil, the northern pipeline carrying Kirkuk grade to Ceyhan, Turkey in the Med has been repeatedly attacked for the last 2-3 months, reducing exports from 350 kb/d to unde 200 kb/d (on average). Our concern is that the oil-directed attacks move south and potentially disrupt the 2 Mb/d of Basrah grade exported through the Basrah port complex on the Persian Gulf. There are signs that the non-oil violence (bombings, etc) may be moving south, and oil-directed attacks may follow. Iran, who is Syria’s only state ally in the region (Hezbollah and Russia are Syria’s other allies), may choose to stir up such attacks, in order to hurt the economies of the Western countries by causing an oil price spike.
Base case scenario: $125 for Brent
We believe that in the coming days, Brent could gain another $5-10, surging to $120-$125, either in anticipation of the attack or in reaction to the headlines that an attack had started. In our base case, we assume an attack begins in the next week. If it takes longer, and there are no signals that an attack is imminent, the oil price uplift from the entire Syrian situation will start to fade. Our base case scenario does not include any actual supply disruptions resulting from the US-led attack on Syria.
Upside scenario: $150 for Brent
If the regional spill over results in a significant supply disruption in Iraq or elsewhere (from 0.5 – 2.0 Mb/d), Brent could spike briefly to $150. In this case, the focus will turn to Saudi spare capacity, shown on the right-hand chart above. Saudi spare capacity is 1.7 Mb/d (total capacity at 11.5 Mb/d), but will likely go up to 2.0 Mb/d or higher, as output eases after the summer. The Saudis could handle most likely scenarios, but the markets will look at the shrinking spare capacity that remains after any disruption is made up, and that would be bullish.
Price surges and spikes won’t last
There are several factors or mechanisms that would limit the duration of any price increase. First, there would be a negative impact on GDP growth and on oil demand, with demand destruction visible quickly, within a couple of months. Second, the Saudis would use their spare capacity to pump more oil to make up for any disruption and also cool off prices, to bolster GDP and oil demand. Third, depending on the price and the severity of any actual disruption, the IEA countries could release their considerable strategic oil reserves. Their goals would be identical to the Saudis – to make up for any disruption and also to help cool off prices. The IEA countries would be particularly concerned with protecting the fragile economic recovery, which has only recently been gathering momentum in a sustainable fashion. [ZH: what recovery?]Courtesy: Zerohedge
Today’s AM fix was USD 1,425.50, EUR 1,066.03 and GBP 919.91 per ounce.
Yesterday’s AM fix was USD 1,411.00, EUR 1,057.80 and GBP 909.38 per ounce.
Gold rose $13.10 or 0.95% yesterday, closing at $1,415.50/oz. Silver rose another $0.16 or 0.66%, closing at $24.46. Platinum fell $20.25/oz to $1,521.75 and palladium edged down 0.1% to $743.22/oz.
Gold and silver are higher in all currencies today. The rupee sharp falls continue and it fell the most in 20 years overnight and gold reached new record highs in the rupee.
Safe haven demand has returned due to concerns that military action against Syria could lead to a war in the already very unstable Middle East which could result in much higher oil prices and impact the already fragile global economy.
Gold in USD – 5 Years (Bloomberg)
Geopolitical risk, which has been vastly underestimated for months, has returned with a vengeance. Markets have seen increased volatility and risk aversion as the US, the UK and France press ahead with plans for a 48 hour cruise missile attack on selected targets in Syria this week.
Gold and silver have risen 4% and 7.5% in the 5 trading days since the drums of war began.
Oil prices rose sharply yesterday with NYMEX crude rising 2.9% and Brent crude rising 3.3%. This was the sharpest daily rise this year and led to a six-month high of $114.35 a barrel. NYMEX crude has risen 6% since last Thursday.
Share prices tumbled globally in volatile trading on Tuesday as momentum built for military action. Stocks in Asia also saw some losses. Falls in Europe have continued again this morning.
The FTSE All-world share index dropped 1.4% to close at its lowest since early July. The S&P 500 was down 1.42% and the Nasdaq by 2%.
It is noteworthy that one of the largest moves in stock, bond, commodity and all markets today is the sharp fall in British gilts which has seen 10 year yields rise sharply from 2.59% to 2.8%, the higest level since August 2011.
Western officials said sea launched cruise missiles would be used to attack Syria. Syria vowed yesterday to use “all means available” to counter a U.S. led assault on the country.
Russia and China have repeatedly used their Security Council vetoes to block UN action against Syria.
NYMEX Crude Oil – (Bloomberg)
Yesterday, they warned strongly against a U.S. led strike on Syria in response to the alleged use of chemical weapons, arguing it would be dangerous, irresponsible and could have “catastrophic consequences”.
Mohammad-Javad Zarif, the Iranian foreign minister, urged western countries to avoid “hasty decision making” about Syria, warning military action could worsen the situation.
The greatest risk is that an already threatened and embattled Iran decides to attempt to aid one its few allies Syria by closing the Strait of Hormuz.
Much of the oil that the Western world consumes still comes from the Middle East and most of it is still shipped through the very narrow Strait of Hormuz. More than 20% of the world’s petroleum, and about 35% of the petroleum traded by sea, passes through the strait making it a highly important strategic location for international trade.
The shipping lane is only two miles wide in each direction with a two mile buffer zone in between and is therefore a potential choking point. The narrowness of the lane makes it easy for Iran to block it. Iran is on the recorded stating that if attacked, it will block the strategic shipping lane.
Astute investor,Jim Rogers has warned overnight in an interview with Tara Joseph of Reuters that oil and gold will go “much, much higher” due to “market panic” regarding Syria and the coming “end of free money”:
Jim Rogers: Well, Tara, I own oil, I own gold, I own things like that and if there is going to be a war, and it sounds like America is desperate to have a war, they’re gonna go much, much higher. Stocks are gonna go down, some of the markets that I’m sure are already going down, commodities are gonna go up. I mean, yeah, some of the things I own all make a lot of money. It’s, I’m not particularly keen on war, I assure you, but it sounds like they want it.
Tara Joseph: Is your main concern about supply chain disruptions for oil? Is that where we’ll see the biggest moves?
Jim Rogers: Well, that’s where we’ll see huge moves but the problem with war, Tara, is — and I’m not the first to know this — no matter how well the plans are made, strange things happen in war and who knows what unintended consequences will come. But I do know that throughout history whenever you had war, things like food prices have gone up a lot, energy prices have gone up a lot, copper price, lead prices: you know, all of these things go up a lot whenever there’s been a war in the past.
TJ: Meanwhile, moving farther to the Far East, we’re seeing of a mini crisis around Asia. The Fed stimulus unwinding really affecting confidence in India and Indonesia in particular. Do you think this is a short-term blip or do you think these countries face very rough waters ahead?
Jim Rogers: Of course they face rough waters ahead, Tara. You know, India and Indonesia – Turkey too, which is part of Asia – all of them have huge balance of trade deficits, which they’ve been able to finance with all this artificial free money that’s been floating around. Now, the artificial sea of liquidity is going to end some day and when it ends, all the people depending on this free money and this sea of liquidity are gonna suffer. Whether its this week or this year or next year, they’re all going to suffer.
TJ: We’re already, though, Jim seeing sort of the unwinding of what happens when there’s fears of that stimulus coming out. What’s next for these countries? Where does it go from here?
Jim Rogers: Tara, we, we haven’t seen much of anything yet. I mean, normally, in bear markets things go down 40% to 80% and people give up. They throw the shares out the window and they say, “I never want to invest again as long as I live.” Sure, we’ve seen some declines. Have we seen panic, have we seen terror? Absolutely not. Not in any markets yet.
TJ: Are you expecting panic? We’ve seen mini crises do you see more panic?
Jim Rogers: Yes, of course. When, when, when this artificial sea of liquidity ends we’re gonna see panic in a lot of markets, including in the US, including in West developed markets.
I mean, Tara, this is the first time in recorded history that all major central banks have been flooding the market with artificial money printing at the same time. They’ve all been trying to debase their currencies at the same time.
This has never happened in recorded history. When this ends its gonna be a huge mess.
The interview can be watched here.
Western powers told the Syrian opposition to expect a strike against President Bashar al-Assad’s forces within days, according to sources who attended a meeting between envoys and the Syrian National Coalition in Istanbul. The possibility of Western military action in Syria hit shares worldwide yesterday, while boosting demand for safe-haven assets such as the yen, gold and silver, while also helping oil prices rise sharply. Gold prices in India surged sharply to hit a new record high with MCX gold futures for Oct delivery on the Multi Commodity Exchange trading at rupees 34,725 per 10 grams Wednesday as the rupee again slumped to a new record by over 5% to 69.80(Sep futures) per U.S. dollar. MCX Silver for Sep delivery shot up to 59,580 rupees at the time of writing. Gold prices in India are at over 98,440 rupees per ounce, on Wednesday, and past the earlier record rupee high of 97,129/oz seen on November 26, 2012. Nymex gold futures on Tuesday reached as high as $1,424 an ounce. While Comex gold futures are up by just over $250 at $1433, from the lows of $1182 seen in June, gold prices on the MCX in India are up by 9,525 rupees at 34,725 per 10 grams (a price equivalent to over $2000) from a low of 25,200 rupees in June. This massive rise in gold prices has been triggered in Indian markets solely on the back of the incessant rupee bashing. Gross domestic product that expanded at the slowest pace in a decade, inflation that’s among the fastest in the world and an unprecedented current-account deficit have created an economic trilemma for India which has prompted global funds to pull some $10.1 billion from the country since May 21. The passing of a landmark food program bill couldn’t have come at more inappropriate time,
Most traders and investors in gold have turned towards the bullion markets to either sell their gold bullion, coins or jewelry and book profits after gold prices hit an all time new record, or to pawn gold to pay for margin calls on their leveraged rupee (currency) or stock market positions. Traders and investors are reported to have lost heavily after getting caught on the wrong side of the already battered rupee. The rupee collapse also had a cascading effect on the Indian stock markets, where traders and investors had been bottom fishing ever since the Nifty hit a low of 5500. The NSE Nifty Index hit a low of 5108 today. Traders rushed to sell gold and cash in on the huge gains, but most of these seem to have been triggered due to large and urgent margin calls to maintain trade positions incurring hefty losses.
Globally, gold prices climbed to a three-month high in London, heading for a bull market, as speculation about an attack against Syria within days spurred demand for precious metals as a haven. Silver rose to four-month high. Assets in the SPDR Gold Trust reached the highest since Aug. 1, gaining 0.1% to 921.03 metric tons, according to the fund’s website. Holdings rose for a second week in the five days to Aug. 23.
Emerging market currencies such as the Turkish lira and the Indian rupee bore the brunt of the capital flight as doubts over the Syrian situation added to pressure from investors’ positioning for an end to the supply of cheap dollars from the US Federal Reserve’s monetary stimulus.
It is just impossible to put any realistic value to the rupee any more. The rupee plummeted the most in two decades to a record as a surge in oil prices, based on the imminent possibility of a U.S.-led strike on Syria, threatened to worsen the current account and push the economy toward its biggest crisis since 1991. Stocks and bonds plunged further. The U.S., France and the U.K. are considering limited military action against Syria after concluding the regime used chemical weapons against civilians, fanning concern unrest will disrupt Middle East oil supplies. This tension has worsened the rupee rout that’s seen global funds pull $8.7 billion from local debt since end-May on bets the Federal Reserve will pare stimulus. An 8.9% jump in Brent crude this month is set to boost costs for India, which imports almost 80% of its oil consumption. The rupee has lost 13.1% this quarter and 19.5% this year to date, headed for the worst annual loss since a balance of payments crisis in 1991 forced the nation to pawn gold to pay for imports. The collapsing rupee pushes up prices of goods, adding to inflation on top of meager urban salary hikes and an economy growing at its slowest in a decade. Indian economy will be witnessing a tighter slowdown when only recently in the past one quarter has it been so pronounced.
India’s budget and current account deficits are responsible for the rupee’s slide. The Indian government on Tuesday, passed a landmark bill through the lower house of parliament yesterday that expands the world’s biggest food program, which involves spending about 1.25 trillion rupees ($18.3 billion) in subsidies each year, potentially worsening the fiscal gap. India’s petroleum imports averaged $14.2 billion in the first seven months, compared with $13.9 billion a year earlier. Indian stocks may fall further as the nation’s external deficits and the capital flight from emerging markets threatens the currencies of developing nations, according to Goldman Sachs Group Inc. Foreign investors sold nearly $1 billion of Indian shares in the eight sessions through Tuesday – a worrisome prospect given stocks had been the country’s one sturdy source of capital inflows, although net purchases so far this year still total $12 billion. The rupee has failed to rebound despite a slew of measures by policymakers, including extraordinary measures by the Reserve Bank of India to drain liquidity unveiled last month and action to curb gold imports and cut on India’s oil import bill. In bond markets, foreign investors have sold more heavily, with outflows reaching $4.5 billion so far this year. In its latest initiative, the government late on Tuesday proposed setting up a task force to look into currency swap agreements, a measure analysts said could bring some relief if carried out in time by reducing market demand for dollars or other major currencies.
As per Economywatch –
India on Tuesday approved 36 infrastructure projects, including 18 power projects, worth some $28 billion in a bid to jumpstart the economy and restore investor confidence after the rupee. On Tuesday, Chidambaram said that the rupee had “overshot its true level”, and stressed that the food security bill would not lead to the government overshooting its fiscal deficit target. “As I said in parliament, every emerging market is challenged today. So, India is also challenged, and the impact is felt both on the equity market as well as the currency market,” he said. “I think we’ll simply have to be patient, be firm, do whatever is required to be done, and the rupee will find its appropriate level. What I said a few days ago, I still maintain it. The rupee has overshot its true level, it’s undervalued. Others have confirmed it. And we have to be patient and we have to be firm and we have to do what requires to be done.”
“The message that we are sending is that the investment cycle has restarted, and we are pushing it. It is gathering pace and bottlenecks are being cleared” Finance Minister P. Chidambaram told a news conference yesterday. He said a cabinet panel had cleared 18 power projects, alone worth 830 billion rupees, reported Reuters. “It’s not out of choice, but out of compulsion that the finance minister is announcing so many things,” said G. Chokkalingam, managing director and chief investment officer of Centrum Wealth Management in Mumbai. “The trinity of the fiscal deficit, slowing growth and an unstable currency is hitting us badly. In addition to these, the government has passed the food security bill which may put fear in the mind of rating agencies.”
The Hindu Businessline reported–
The Rupee will remain bearish till world markets come to terms with the emerging post – QE era. The rupee continues to be vulnerable despite Government and central bank efforts to rein in the depreciation. Efforts have been made to attract FDI, boost infrastructure spending, ease ECB norms, control investments abroad and reduce gold imports in order to contain the high CAD (current account deficit) — and, in turn, curb sharp depreciation in the currency. If we divide the factors that are impacting the rupee into domestic and international, we can figure out that while international economic issues are a matter of concern, it is the domestic economic weakness that is contributing to its ongoing depreciation — despite several efforts to deal with these infirmities.
The ratio of total external transactions (on current and capital account) to GDP indicates the level of financial integration. In the case of India this ratio had more than doubled from just 44 per cent in 1998-99 to 112 per cent in 2008-09, thus suggesting that the Indian economy was well integrated financially with the rest of the world. Financial integration is a stronger force today than ever before. Hence, the fear of a pullback in quantitative easing (QE) by the Federal Reserve has already led to capital outflows from India and other major emerging economies.
While gold prices on the Comex are expected to rise exponentially due to several factors, I doubt if the same would be true now for gold in the Indian markets as the rupee bounce is imminent after serious and incessant bashing. And if that is true, the rupee should rise against the dollar, in turn weakening gold prices in Indian markets.
No matter where you go in the market, all anyone wants to talk about is “The Taper” (i.e. – when the Federal Reserve will start to reduce its pace of bond purchases).
Indeed, interest in the term is reaching unhealthy levels. Don’t believe me? Just ask Google (GOOG).
Google Trends data reveals that searches for “Fed taper” barely registered a blip on the radar for most of the year. But over the last 90 days – boom! They’ve exploded higher.
As I’ve said before, we do need to get off the quantitative easing sauce eventually. But we don’t need to obsess over when it’s going to happen. And we definitely shouldn’t be making investment decisions based on the latest market predictions.
Still though, investors are looking at a projected September unwinding with anxious eyes. You’d think the world was ending. Is it?
On the heels of the Federal Reserve’s annual powwow with leading economic policy makers in Jackson Hole, Wyoming, a market consensus has emerged…
As the headline for one of the most read articles at MarketWatch.com declares, “Fed seen making first taper move in September.”
Meanwhile, a Reuters blog proclaims, “Post-Jackson Hole, Fed Septaper still appears on track.”
Hard data jives with the headlines, too…
Bloomberg reports that 65% of economists recently surveyed believe that the taper will officially be announced at the September 17-18 Fed meeting.
Apparently, it’s just a matter of formality, then. Or, as San Francisco Fed President, John Williams, told Bloomberg, “If the data continues to progress as we’ve seen, then I do agree that we should edge down or taper our purchases later this year.”
The only problem? I’m convinced that the data isn’t going to cooperate. Here’s why…
The Fed has been very clear about its targets.
Inflation needs to tick above 2.5% or the unemployment rate needs to dip below 6.5% before it (finally) raises interest rates.
Regarding the former target, we’re nowhere close. “Official” inflation has been running at about 1%. And regarding the latter, the Fed expects to hit the unemployment rate target by mid-2014.
Of course, before the Fed can raise interest rates, it needs to completely end its quantitative easing efforts. So if we extrapolate backwards from the Fed’s estimates, for a September taper to make sense, the unemployment rate needs to hit 7.2% in December.
Is that even possible?
Based on the latest trends, market pundits believe so. Initial jobless claims and the unemployment rate are in a steady decline, with the latter hitting a five-year low at 7.4%.
Essentially, as long as the next unemployment report shows an improvement, the Fed should be good to go in September.
However, the less-tracked Gallup daily unemployment rate tracking survey suggests that could be wishful thinking.
It recently spiked to 8.9% – a full 1.5 percentage points higher than the government’s official unemployment reading. (Go figure. The government’s reading is the rosier one.)
As Bespoke Investment Group notes, the last three times the Gallup rate spiked, the official government rate either trended sideways or only declined modestly.
Sorry folks, but a sideways or modest decline won’t cut it. The Fed needs to see signs of a steady decline for a September – or even December – taper to be even remotely possible.
Monitor This Single Statistic
The next Bureau of Labor Statistics Employment Situation report will be released at 8:30 AM on September 6. And it’s the last unemployment report we’ll see before the Fed needs to make a taper decision at its September meeting.
Nothing like a little pressure, right?
In terms of a specific number to watch for in the report, we can use the Atlanta Fed’s Jobs Calculator to figure out how many jobs are needed each month to hit the Fed’s December unemployment rate target:
Bottom line: No doubt investors are in a rush for the taper to begin. But the Fed isn’t so anxious. They’ve pretty much admitted as much, too. St. Louis Fed President, James Bullard, recently said, “We can afford to be patient.” Indeed.
For the Fed, it all boils down to the unemployment data. And based on the latest Gallup reading, the data likely won’t be good enough for a September taper. Heck, with Bernanke set to leave his post in January, don’t be surprised if he kicks the “taper” can down the road to his successor.
Ahead of the tape,
Courtesy: Louis Basenese
At Templeton, we’ve repeatedly championed our value-driven philosophy by frequently buying at times others are most pessimistic. This is not easy to do, even for seasoned market veterans. During the past few months, emerging markets have been subject to such pessimism. These periods of short term volatility are certainly not new to us, and don’t change our long-term conviction of the potential emerging markets hold.
We feel recent declines were overdone and based largely on irrational investor panic, and have viewed the recent pullback as an opportune time to search for bargains for our portfolios. We find valuations in many emerging and frontier stocks particularly attractive right now. No doubt, emerging markets have been beaten up a bit this year. In the second quarter, the MSCI Emerging Markets Index lost 8.0% in US Dollar terms, and emerging markets recorded outflows of US$33 billion during the quarter; June alone accounted for US$22 billion of the flows.
This offset the US$32 billion in net inflows from the first quarter of 2013, resulting in a net outflow of about US$1 billion for the first half of the year. What happened? Indications in mid-May from US Federal Reserve Chairman Ben Bernanke about a moderation in the central bank’s asset purchase program caused fixed income investors who had invested in offshore bonds, particularly in emerging markets bonds, to view the high yields they were receiving in those bonds as less attractive if US interest rates were to rise. In addition, signals from the People’s Bank of China that it would not intervene in the market after a sharp spike in a key interbank lending rate in June raised concerns about the stability of the banking sector there, and further heightened investor concerns that global liquidity could dry up.
A sharp, across-the-board sell-off hit emerging market debt, currencies and equities during the second quarter. Those particular emerging market countries with high current account deficits, large foreign holdings of local bonds and exposure to China were among the worst affected. Turkey, Egypt and Brazil were particularly hard hit; their respective equity markets ended the quarter with declines. In addition, periods of social unrest in these countries also heightened investor anxiety. However, as you can see in the two charts below, despite the short-term outperformance of world markets, over the longer term emerging markets have outperformed, and we expect this trend to continue for reasons outlined further here.
Like all markets, emerging markets can at times be volatile and dominated by excessive flows and sudden sentiment shifts. Many are now dubbing the BRIC countries (a handy acronym for the grouping of Brazil, Russia, India and China) down and out, but we think there has been too much negativity there. I believe that the strong prospects for growth in many emerging markets are not currently recognized in equity valuations, which generally lag those of developed world markets. We are finding attractive valuations not only in the BRICs but particularly so in the frontier markets (a subset of emerging markets), which in some cases have single-digit price-earnings (P/E) ratios and even lower price-to-book ratios. (See charts below for emerging markets overall, and specifically, China.) But no matter what major market indexes may show, as bottom-up stock pickers, we hone in on individual opportunities, and currently see many good companies that were unjustifiably swept along in the tide of negative sentiment.
It is always necessary to take hits from time to time as we maintain our long-term focus. A case-in-point is Thailand, a country with its fair share of turbulent periods. In the mid-90s, while the country was in the midst of a massive financial crisis, I eagerly hopped on a plane to Bangkok, in search of opportunities while many investors gave up on the country. Why did I feel so positive? I certainly knew that in the short-term, Thailand was in trouble. But we did our homework, and felt that in three, four, or five years’ time, the Thai people would bounce back. And they did. Of course, it wasn’t all smooth sailing. After recovering from that crisis period, further setbacks came in 2004, when a tsunami struck the country, and in 2011, when severe flooding hit. But Thailand has been adept at battling back from adversity time and time again, and in 2012, its equity market posted one of the best performances in Asia (and even the world), with the benchmark Stock Exchange of Thailand (SET) Index returning more than 35%3.
You can see the merit of buying during these downturns and holding on for the potential recovery. Today, we believe there is great potential for Thailand, which we feel could be on the cusp of a growth spurt, with, of course, corrections along the way. I would not classify this recent bout of emerging market volatility a crisis of confidence as some would, but it marks a good time to again reiterate the value of a long-term perspective and emphasize that we base our analysis and projections not on this year or even next year, but generally five years out in time.
Being contrarian or value-driven doesn’t mean we will necessarily buy anything we can get our hands on during a market downturn. During times of extreme stress, liquidity is important. If I have a choice between a small, illiquid stock and a large liquid one, naturally I would pick the latter. When buying stocks during a bust period, it’s important that you don’t buy corpses which have fallen in price but have unhealthy fundamentals (otherwise known as “value traps”), but rather, find patients with good recovery prospects that appear undervalued.
There are a few characteristics we’ve seen in companies that often prove fatal and that we seek to avoid, including excessively high levels of debt and management who can’t cope with a difficult environment. In the case of Thailand’s big financial crisis, it was extremely important to be a good stock-picker and do your homework. By the end of 1997, out of the 480 companies trading on Thailand’s stock exchange, about 40 companies had gone belly up, and a near equal number saw trading suspended.
I believe emerging markets in general have three attractive characteristics, which haven’t changed from what I see. First, their growth rates have generally remained well in excess of those for developed markets. Overall, emerging markets are forecast to grow about five times faster than developed markets in 2013, with the IMF forecasting average GDP growth of 5.0% for emerging markets, compared to just 1.2% for developed markets4. Second, emerging markets generally have large and growing foreign exchange reserves, which are far greater than that of developed markets. Moreover, unlike developed markets, many emerging and frontier markets still appear to have ample room for fiscal and monetary stimulus. Although weak growth in developed markets could be transmitted to emerging markets, notably through declines in world trade, this influence could continue to be offset in emerging markets by higher investment spending and increased domestic demand. Third, the debt level of many emerging markets in relation to their GDP is generally much lower than that of many developed markets.
Additionally, all this fear and concern about the US central bank starting to “taper” its asset buying program does not necessarily mean it is going to start tightening rates anytime soon or that the money supply will suddenly dry up. We must remember that the various QE programs have been cumulative so that the liquidity pumped into the system has piled up and will not disappear overnight. It is only recently that banks have begun to grow their loans; previously they were using the liquidity supplied by the Fed to strengthen their balance sheets and were holding US Treasuries. In addition, even if the Fed starts to pull back as the US economy improves, other central banks are still generating liquidity, which we feel could support investor flows into emerging markets. Japan has been embarking on a massive easing program, which is greater as a percentage of their GDP than the US’ program.
While we worry about the long-term implications of inflation, if it can be avoided or offset by greater productivity gains, it could be a game-changer for many economies. Overall, I believe emerging markets will likely continue to offer good long-term prospects for patient investors. There are always risks, and unexpected shocks could occur. But I still believe in the comeback story.
Courtesy: Mark Mobius