Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. G7: Deficit Producers to the Rescue: It may not surprise anyone that the economic figures for this week continued to slide in light of the events in Japan, despite Ben Bernanke’s best efforts to tell us otherwise at the latest FOMC meeting. Inflation and higher interest rates took their toll on the economy. Food and energy figures, or “the cost of living” components in February’s data, released during the week, are surging. Import prices rose 6.9% year over year vs. 5.3% in January, and the Producer Price Index jumped again, rising 5.6% y/y vs. 3.6%.
The CPI also rose 0.5% more than the expected 0.4%. Interest rates, which have risen nearly 100 basis points since August of 2010, are beginning to take their toll on housing. Housing starts (479,000) came in 15% below expectations of 570,000, and were the lowest on record – ever. Building permits followed suit, coming in at 9.2% below expectations. Also released were the TIC flows, which saw a $32.5 billion inflow (from foreign creditors) for the month of January. When weighed against our current account balance over the same period of -$113.3 billion, foreign creditor funding still isn’t enough to keep the US from the assumption of more debt to make up the difference.
The G7 met overnight on Thursday to discuss the plight of Japan. Ministers agreed to support the selling of the yen to help Japan’s source of revenue – exports – remain alive and well. The dollar amount of the pledge was not given, only that the G7 would “cooperate as appropriate.” The yen fell (2%) sharply, while most other currencies rose commensurately.
Outside Japanese markets, volatility in stocks was the order of the day. Early morning gains around the world faded in late-day trading, as uncertainty with respect to recent events continued to be digested. Commodities, however, spared no time in advancing (about 1%, on average), holding on to most of their gains as the pendulum tipped in favor of an inflationary verdict.
Judging from the results of the trading day, we suspect that the market generally understands the financial position of the G7. Only two countries that represent the seven generate current account surpluses, Germany ($10.22 billion/qtr) and, ironically, Japan ($5.76 billion/qtr). Combined, the G7 runs a quarterly current account deficit of $142.07 billion, raising doubt as to its ability to finance its open-handed generosity. No good deed goes unpunished, as they say. Japan may well be on the mend, but inflation, already on the move, may have been given a good shove in the wrong direction.
2. A Quick Look at the Markets: Volatility. Yes, this was a week with a lot of it. US equities, commodities, and of course all international markets responded to the unknown in a predictable way: sell first, ask questions later. Uncertainty can weigh on the markets, but panic often ensues when the market stares into the void with no information to work with at all. Such was the context this week, with both a Japanese tragedy and Middle East conflagration (Libya and Bahrain, in particular).
The precious metals remained strong, even with several days of extreme pressure. Gold held above both the 50- and 100-day moving averages, finishing the week nearly forty dollars above its trading lows. Silver, which would have to correct to $31 to reach similar moving average support, shrugged off much of the pressure and finished above $35 – a mere 4% below recent peaks. We would expect further declines, but thus far have been mocked by the strength in the market. It is notable that buying remains strong in the international markets. Inflation there is not as easily excused or brushed aside as it is here.
Mining shares are being affected by a number of issues. First, there is the increase in the price of oil similar to the 2008 period (although less of a supply demand issue today and more a fear premium reflecting current events in the region). The oil price has not been at a high enough level for a long enough period of time to overturn profitability, but such circumstances can erode profits (if the price of gold is not moving up simultaneously).
There is a concern that this erosion will increase as the quarter continues. The concern is reasonable if you assume that there will be no further catalysts for gold demand. We doubt that, and see the “gold as currency” epiphany among investors taking the price much higher (nominally, and relative to oil) by year-end. Second, and more notable, was the selloff in mining shares this week in lock step with the general equity markets, a reminder that during stressful periods in the market, correlation increases. Having a hedge within the MWM portfolios mutes this kind of volatility to the desired degree.
With all the worries in the world, and a tremendous amount of global instability in the news, it is telling that the dollar continues to drift lower (now below 76 against the euro dollar index). In past periods of crisis, the gold standard of currencies was preferred as a repository of safety and liquidity. As time wears on, those perceptions are wearing out, and the dollar is seeing less safe-haven buying. Astute investors and asset managers are concluding that U.S. balance sheet risk is a real problem, and that perhaps other safe haven assets are required for that combination of security and liquidity.
The financial establishment maintains an institutional bias for protection via some sort of paper product. We are witnessing a divergence between individual investors and these institutions all over the world as individuals are reconsidering paper risks, and opting for tangibles instead.
Maybe this preference reflects an erosion of confidence in the global fiat system, or even the politicians that support it. It wouldn’t be the first revolt from the status quo in the last 90 days. Is there another revolution afoot? Is King Dollar being dethroned? The pound, the euro, and other G7 currencies face the same popular protest. Fiats will fail, or be forced out, as they always have.
Have a good weekend…
President and CEO
VP Investment Management