Good Day,
Friday’s market sessions in precious metals started off on a tamer note, following the best gains in gold in three weeks. Explanations follow. The recapture of the $1045 area is noteworthy, although analysts we polled during the wee hours overseas are trying to define the move as everything from a ‘one-hit wonder’ to the ‘re-ignition of what we saw during most of October.’
The Bloomberg weekly survey foresees weaker gold prices come next week – not by a large margin (57% bearish)- but still focusing on a potential comeback by the US currency, the early signs of which became visible this past Monday. Demand for the yellow metal once again slipped away in India, following signs of life during the earlier part of the week when values came close to $1025 per ounce. The country recorded its sixth straight month of declining gold imports, despite a decent gain during September – in anticipation of festival-related sales.
New York spot dealings opened with a $2.60 loss in gold bullion, which was quoted at $1043.20 bid, as against a euro-dollar seen at $1.4798 and the USD index steady-to-higher, at 76.05, with little in the way of fresh news thus far this morning. Oil prices gave back about 50 cents of their whopper-sized Thursday gains, slipping to $79.32 per barrel. Risk traders took a latte break this morning, and this gave the dollar a moment to try to re-group.
Hawkish statements from Japan and a drop in German retail sales which undermined the euro gave them a couple of reasons to reevaluate the ‘appetite thing’ this morning. We will see what US consumer spending data ushers in for the day, later on. The FOMC meets next week. You can bet that the most minute details of that meeting’s language will come under a bunch of market analysts’ microscopes.
Silver dropped 14 cents on the open, quoted at $16.53 while platinum turned quite lower, losing $21 an ounce, to start the day at $1321. Palladium eased by $2 to $324 per troy ounce. Rhodium was flat at $1800 an ounce. The noble metals complex may still receive some support from sunnier news by automakers (at least over in Europe for now) and by potential hikes in energy costs down in South Africa.
South African state-owned utility Eskom has asked for tariff increases on electricity to help fund its expansion. A decision on the three 45 percent tariff increases that Eskom has asked for will be taken early next year. Mines had shut down for five days in January of last year after Eskom suffered a near-collapse of the power grid owing to a sharp shortfall in supply, denting the production of various commodities, including platinum, palladium, and rhodium.
The GDP data offered a Great Day to Play for speculative funds that had been blindsided by Monday’s turn in the dollar and other markets. Oil rose a whopping 3.3% and more during the day, gold spiked as high as $1049.10 and the dollar fell 0.50 on the index to just under the 76-mark. The correlation that is once again building between equities and gold is unmistakable, albeit worrisome as well, from a historical and portfolio strategy perspective.
Once again, the aggressiveness with which momentum funds threw large wads of cash at these markets was impressive, but it also showed how fickle the temperament out there really is, and how dime-tight-radius turns can buffet the markets with the release of each and every individual economic news item. More signs that bubbles are still in formation, and that the gambling addiction is hard to break.
On the face of it, the GDP data was dollar-bullish. Every argument can be made that given such notable economic growth rates, the time is fast-approaching for interest rate hikes by the Fed. The spec funds, however, were probably looking at something in the data. Possibly the fact that if one removes stimuli and other artifices from the GDP number, growth was -at best-flat. That the US economy is becoming addicted to the stimulus bottle, is a clear and present danger.
On that note, they said in fundland, let the dollar-carry stock and commodity party roll on. At least for another day, or perhaps another week. Regardless of the oil or gold markets’ fundamentals, regardless of currency intervention warnings from worried central bankers, and so on. Or, at least until the stock market senses that the statistical mirrors are bouncing around flat economic smoke that is coloured a neutral shade of gray. At which point, asset liquidations begin anew, and the Roubini scenario cited in yesterday’s comment (and the Morgan Stanley take that follows) unfolds.
Marketwatch’s Laura Mandaro captured the essence of this week’s gyrations in many a market and neatly bottled it in the following piece on risk. Appetite or aversion, it is all about Evel Knievel and Chicken Little out there, writes Laura:
"The boomerang effect that hit markets this week, driving deep sell-offs in stocks and commodities followed by swift rebounds, showed broad shifts in sentiment about fear and risk still dominate a year after the financial crisis peaked.
Confirmation that the U.S. economy returned to growth in the third quarter "provided investors with a reason to breathe easier, after several sessions in which they fretted about weaker growth," wrote Andrew Wilkinson, a senior market analyst at Interactive Brokers Group, in emailed comments.
"The data caused the risk pendulum to reach its maximum extent," he said. Stocks on Thursday came close to clawing their way back to closing levels touched the previous Friday, with the Dow Jones Industrial Average adding 200 points for its best day in about three months.
Oil futures topped $80 a barrel during the session for the first time since Friday, while gold futures broke a five-session losing streak to end above $1,047 an ounce, the contract’s highest close since Friday. The U.S. dollar, one of the few bright spots over the last week, made its first drop in six sessions as measured by the U.S. dollar index.
The U.S. government’s estimate that the economy expanded at a 3.5% annual pace in the third quarter pulled investors into what analysts are now calling the "risk-on trade," propelling stocks and commodities to double-digit gains this year. The ‘risk-on trade’ is also referred to as the ‘reflation trade,’ reflecting the resurgence in ‘risk appetite.’
Also referred to as the "reflation trade" or a resurgence in "risk appetite," this trend refers to frequently in-sync purchases of commodities, stocks and currencies from nations that sell directly to China, such as Brazil or Australia. As the Federal Reserve has kept interest rates near 0%, driving down yields on the U.S. dollar, investors have been borrowing the greenback to buy these other assets.
"We had caution breaking out in the markets over the last few days," said David Watt, senior currency strategist at RBC Capital Markets in Toronto. "People had made a lot of money out of these risk-long profits," and nervousness ahead of Thursday’s report on gross domestic product gave them a reason to cash out. When it came roughly in line with expectations, "it was enough to suggest the global economic rally is still in place," added Watt.
In the sessions leading up to Thursday, investors had fled, oil, copper and emerging-markets assets, which had been on a tear since March. The few winners had been the U.S. dollar and Treasurys, also among the isolated bright spots last year. Few analysts, except the most ardent gold bugs, were talking about a return of crisis conditions that roiled the global economy in 2008.
Most instead cited a variety of factors — from talk of major central banks inching toward rate hikes to some disappointing economic reports that put Thursday’s GDP report in question — as catalysts for investors to take some profits. On Monday, the U.S. dollar fell to a fresh 14-month low against the euro, which rose to $1.5062, or higher than the key $1.50 level. Also Monday, the S&P 500 Index topped 1,091, or 64% off March lows and near the closely watched 1,100. The benchmark closed well off that level.
The Netherlands’ ING financial group, again on Monday, announced a sweeping plan to break itself apart. The move, which ING said stemmed from pressure from the European Commission’s antitrust enforcers, brought into sharp relief the possibility that financial institutions in the United States and Europe face a significant shake-up to their structure. In the subsequent days, disappointing readings on consumer sentiment and durable goods, as well as trimmed forecasts for Thursday’s GDP report, continued to pull investors into safe-haven assets. The dollar benefited from and magnified that trend, seeing some strength after months of declines.
As investors took hope from massive stimulus packages in the United States, China and elsewhere, the dollar suffered. It’s fallen about 15% from early March. Those declines have accelerated since early September. That dollar decline has helped drive up the value of hard assets like metals and beef up export earnings for U.S. companies, a boon for their stocks. Then, for the first part of this week, the dollar gained, sending stocks and other so-called risk assets reeling.
"A lot of this rally had been short dollar and long commodities," said Bart Melek, global commodities strategist at BMO Capital Markets in Toronto. Earlier this week, he said, "people unwound some of their riskier trades and went into the dollar."
It is all in the timing and in the pushing of the envelope. Thursday was a classic example of both. There is probably more of that to come. Desperate times (engendered by last year’s bloodletting in fund performance) call for… aggressive speculation. The world is awash in cash and liquidity. It has to go somewhere, regardless of conditions in the particular market being targeted. That such a casino-like environment is not sustainable, goes without saying. Keep a timer on it, nothing more required.
What fundamental conditions do you know of – for example in oil- that have changed dramatically since last December, when oil fell to $30 a barrel, from its $147 pinnacle? We can, still, only call all of this fund-related activity as, premature…speculation. But, let’s see what Morgan Stanley has to say about the matter of bubbles and appetites, and such:
"The global stock market rally, which resembles the bull run between 2003 and 2007, will end as government spending slows after so-called easy money boosted asset prices, according to Morgan Stanley.
"Such echo rallies are never as big as the original one and we will see it fading away" Ruchir Sharma, 35, who oversees $25 billion in emerging-market stocks at Morgan Stanley, said in an interview in Mumbai. "The rally will end as the effects of the stimulus begin to fade and the credit bubble caused by easy money disappears."
The MSCI Emerging Market Index, which tracks shares in developing markets, has surged 59 percent this year, set for its biggest annual advance since 1993, as governments poured in $2 trillion and central banks cut interest rates to near zero to kick-start their economies. Last year, the measure dropped 54 percent, its worst run in the gauge’s 20-year history. A new rally globally needs to be driven by new industry groups, he added, while the current advance is led by the same sectors, such as commodities, as the ones in the bull market that ended in 2007. That’s not a good sign, he said.
The emerging-market index fell 1.3 percent to 904.64 as of 5:10 p.m. in Mumbai, a four-week low, after the Standard & Poor’s 500 Index lost 2 percent to 1,042.63 yesterday, the steepest drop since Oct. 1. Sharma, the New York-based head of emerging markets, said he expects the S&P 500 to trade in a "long-term" range of 800 to 1,200 in the next couple of years. Markets globally dropped last year following the biggest financial crisis since the 1930s as the bankruptcy of Lehman Brothers Holdings Inc. and writedowns from subprime debt caused a seizure in lending.
Only 31 percent of respondents to a poll of investors and analysts who are Bloomberg subscribers in the U.S., Europe and Asia see investment opportunities, down from 35 percent in the previous survey in July. Almost 40 percent in the latest quarterly survey, the Bloomberg Global Poll, say they are still hunkering down. U.S. investors are even more cautious, with more than 50 percent saying they are in a defensive crouch.
"The doubt and the pessimism just won’t go away," said James Paulsen, who helps oversee $375 billion as chief investment strategist at Wells Capital Management in Minneapolis. "They’re still so shell-shocked by what they went through despite the improvement in the market and the economy." Sharma predicted in May 2006 that emerging markets will post further gains. The index for developing nations has risen 20 percent since then, compared with a 16 percent drop in the MSCI World Index.
The commodity-producing nations will be the hardest hit when the current rally ends, Sharma said. The Latin American markets of Brazil and Chile are the most expensive, he said, and Morgan Stanley is also "underweight" on Taiwan, Malaysia, Israel and Russia. Commodity prices are rising even as economic fundamentals are deteriorating, he added, a sign that the rally may be fizzling.
"Commodities are at the centre of this echo bubble," he said, adding that they are "in substantially overvalued territory, way above fundamentals." Inventories of oil, copper, aluminum have risen over the past few months even though demand hasn’t picked up, Sharma said, adding that the price of oil is inversely correlated to the U.S. dollar. Increasing buying of commodities as a hedge against the decline in the U.S. dollar has resulted in the commodity rally, he said.
"The greatest degree of irrationality is in commodities," Sharma said. Morgan Stanley owns a lower percentage of commodity stocks, including metals, materials, energy and industrials, compared with the benchmark index. It holds a higher percentage of financial and consumer stocks including automobiles, retailers and beer companies. Some brokerages are predicting further gains in equities. The emerging markets benchmark stock index may retest its "life high" by next year, helped by economic growth and gains in credit markets, according to JPMorgan Chase & Co.
Some markets may be hurt by the diversion of government stimulus away from the economy and into stocks and other investments. Central banks globally were hoping the funds would result in an increase in credit growth, driving the economy. That remains weak in most countries, Sharma said.
"Liquidity has found its way to the wrong assets," he said. "You can take a horse to the water but can’t force it to drink."
A pleasant weekend to everyone. Let’s see if spec funds trick or treat next week. They certainly had quite a dress-rehearsal during this one. It will also be interesting to see if FOMC members wear hawk or dove costumes to their own party. For now, that kind of costuming is what makes for other masks also being worn on The Street – the bear or bull kind.
Jon Nadler
Senior Analyst
Kitco Metals Inc.
North America
Websites: www.kitco.com and www.kitco.cn
Blog: http://www.kitco.com/ind/index.html#nadler
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