Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Gold – Not Yet Manic. Since the last bull market in gold, the size and scope of daily trading has grown considerably from 3.5 billion dollars to the present 38 billion (2/3 options and contracts; 1/3 physical metals). A ten-fold increase in volume needs to be set in context next to the 12-fold increase in global monetary aggregates and the doubling of world population since the ’70s. Don’t forget that new supplies of gold have been in decline for a decade, dropping 4-7% per year, even as demand is on the rise. In preview, gold has room to appreciate significantly from current levels.
Each bull market of the past 100 years has shared similar characteristics. We’ve often explored the distinct periods within a growth trend, and parsed this out by investor psychology and degree of confidence. We’ve said that there are three distinct phases from beginning to end, beginning with the maverick investor and ending with the masses chasing a momentum trend. We observed one more sign this week of being on the cusp of the third and most explosive growth phase. (You won’t want to sit this one out.)
In the early 1970s, it was a common Wall Street view to see gold as a fringe asset, determined by rational minds in the ’30s to be irrelevant to “modern” investment portfolio allocation. However, by the mid 1970s, as the price dynamics argued annoyingly for a full-fledged bull market, many on Wall Street changed from being dismissive to confidently cautious; cautioning that it had in fact already moved too high in price to be of interest to serious-minded investors. Resistance to the idea was common. (Owning gold is unsettling for a crowd whose job security is determined by “good times.” As Joseph Schumpeter has said, “The modern mind dislikes gold because it blurts out unpleasant truths.”) Once this stonewalling had finally been worn out by the repeated requests of clients seeking to purchase metals against the advice of their brokers, real money began to migrate to the asset class (real world inflation was being felt up and down the socio-economic ladder), and Wall Street no longer had an excuse to be out – they had to be in.
Between ’76 and ’78, analysts began to wrap their minds around the metals market, favoring gold stocks over physical metals (you can look at a balance sheet and even go out and meet the management of the company instead of analyzing warehouse inventories, bar weights, and serial numbers). Analysts first observed that well-run gold companies had earnings that were leveraged to the rising price of the commodity. Earnings growth expectations defined the initial (albeit late) Wall Street infatuation with gold. (We have yet to see this during the current bull market because everyone assumes the price is going lower from this point, not higher, and thus the imagination has not yet been set free – or feverishly on fire.)
Once the imagination was unrestricted by past prejudice and the Wall Street crowd was making a little money in the gold trade, valuations (at that even later stage) shifted and became more aggressive by relating a company’s value to its in-ground ounces. What was the value of a company that had a bazillion ounces available to it, even if it was just a nominal producer today? For anyone that had missed buying the metal at $125.00 an ounce, you could still buy a company with in-ground ounces at that older and more attractive price. You can count reserves; you can even stretch that method and count inferred resources to yield an even higher valuation for the company – or justification for a higher share price.
Fast forward to this week’s Barron’s magazine. David Steinberg, as asset manager out of Illinois, shared in an interview that buying gold companies was a way of buying gold under the current market price. Sounds attractive. It is even partially true. Importantly, it is the first such observation we’ve seen in the mainstream media. We are sure it won’t be the last. The trickle of public interest in the U.S. will become a flood. Conservative metrics will once again become aggressive.
The migration of money has always followed this general pattern from maverick investor to mass mania. We are still far from the point of mania, and the final push higher by momentum investors. However, as we frequently discuss a myriad of issues spanning economics to geopolitics we are closer by the day to a cusp event marking the departure of the middle stage of this bull market taking us into the final stretch.
2. Quick Fixations. It still amazes me how many folks out there subscribe to the notion that there exists some “push button” solution to our economic problems – well, at least the folks on most financial talk shows seem to – I won’t mention names. Whether it’s inflation, economic growth, or job issues, the conceptual attitude in constant repetition is that we are capable, unlike anyone else, of a fast and easy fix – like pressing the reset – as we do with video games and computers. That button has typically been at the Fed’s disposal in the form of money printing, and it has abused the privilege for years.
America’s economic problems have arguably taken as many as four decades (or more) to reach this critical stage (since abandoning the gold standard in the early ’70s). The corrective process therefore will not take minutes, days, or even months, but rather years to complete. Growth in decades past was artificially produced through massive accumulation of debt (currently $54T contractual debt, and growing), which we now, in the aftermath of the fallout, cannot afford to service (similar to the PIIGS). Fed easy-money policy was the cause of our trouble, and pathetically it is also accepted and heralded as the solution. Systematically, our reliance on money printing is yielding a no-win situation for productive assets while simultaneously creating a boon for anything tangible and limited in supply.
However, the commodities bull – after at least 10 years in the making – is still believed to be transient in nature and unworthy of investor consideration, at least in size. The Fed, remarkably, after all that has transpired, still maintains its own credibility and the faith of creditors/investors at large. Okay, end of rant. What is clear though, and what we have been trying to communicate, is that the Fed-induced recovery is coming unhinged; hopefully taking the quick-fix (more-debt) mentality with it – we can only hope.
U.S. Economic data released this week was not reflective of a modest, let alone normal, recovery in the making. New Home Sales were thought to be decent, but have been hovering in the same vicinity for over a year now. 323K homes were said to have been sold vs. 300K expected. I say “said to have been sold” because the index really measures intent to buy and not actual contracts signed. The Richmond Fed declined by 6 in May vs. a gain of 10 in April. Durable goods orders fell 3.6% in April, with previous month’s figures being revised up (to 4.4% gain in March). Again, “channel stuffing” has been prevalent. Inventories, for the most part, have been growing for 16 consecutive months to some of the highest levels on record (since 1992 when the data was first introduced). Obviously, working down these inventories will come at the expense of current orders.
Home prices, on average, continued to decline around the country in March, leading to lower-than-expected mortgage applications and weak pending home sales (down 26.5% YOY). Personal income for April came in as expected (0.4%), but previous month’s data was revised down to 0.4% from 0.5%. Spending data was weaker, coming in lower than expected (0.4% vs. 0.5%). Previous month’s data was also revised lower. GDP was flat in the first quarter, with a 1.8% increase, falling short of expectations of 2.2%. Inflation data for the week (PCE and GDP deflator) came in flat or as expected, as recent declines in commodity prices rendered this data irrelevant. University of Michigan confidence levels came in better than expected and higher than April by 2 points, due to lower prices at the pump – for now. Jobless claims rose again after a brief decline last week, remaining above the 400K level.
Overseas, there was more of the same, and it may not be worth commenting on. However, it can be said that ECB leaders and member countries seem to be coming to the realization that lending to already bankrupt nations (the PIIGS) may not be a great idea after all – starting with Greece. Fitch cut Greece’s debt rating to B+ and S&P lowered Italy’s economic growth forecasts, placing its large debt burden under the microscope. China has offered financial assistance by offering to buy some of the €440B bond issuance (mostly backing Portugal) in auctions to be held next month – which helped buoy the euro against the dollar in midweek trading.
Markets have been mixed to some degree, caught between a weakening economy and the loose possibility of continued QE. However temporary it might be, underlying breadth in the marketplace has been weak, with the majority of NYSE stocks decisively beneath their 50-day moving averages. The Dow, on the other hand, still rests above its 50-day, confirming a mild reduction in risk appetite among investors. Treasuries have gained in the last handful of months, probably due to the same “risk off” mentality, in addition to the usual “deflation” concerns. The 30-year treasury yield has dropped nearly 54 basis points since the high in February (similar to the German 30-year Bund). As for the metals, they continue to be strong, as investors are running out of viable investment alternative within the context of growing inflation/credit crises both here and abroad.
Given the economic backdrop, we soon expect the Fed to methodically withdraw from its plans to discontinue QE. After all, it is the driver of economic progress (if we can call it that) as we know it today. Consequently, the markets may reverse their current trajectory to some degree, reverting back to levels seen a few months ago, only to be faced with a familiar inescapable reality – inflation. No doubt, further attempts (i.e., margin requirement manipulations) will be made to tame various commodities, but eventually, the powers that be will not be able to hold back the tide.
Have a great weekend!
VP Investment Management
President and CEO