Resource Investors: Why You Can Expect Sunnier Days Ahead
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
During the current commodity supercycle, there have been occasions—too many to count—when investor psyche has been damaged by reports about slowing U.S. growth, a hard landing in China or a debt crisis in Europe. Yet just behind the gloom, significant and positive trends are taking hold, causing the storms to start dissipating.
I often say that government policies are precursors to change, which is why we follow the monetary and fiscal actions closely as they can have a significant impact on asset prices. You have to go back about 16 months when Brazil kicked off the latest global easing cycle by cutting interest rates by 50 basis points. Since then many developing countries such as the Philippines, China and Colombia, as well as developed nations of Japan, the European Central Bank, the U.S. and the U.K. have joined forces in a world-wide synchronized stimulation of the economy.
Last summer, Mario Draghi indicated that the ECB would do “whatever it takes” to save the euro. In the fall, the Federal Reserve agreed to buy $85 billion a month in Treasuries and mortgages, amounting to $1 trillion a year. And just recently, Japan announced that, in addition to pumping $1.1 trillion into the markets through 2013, the central bank will keep an open-ended approach to buying assets through 2014.
Historically, central banks’ policy actions occur after there’s been some economic deterioration. Several months later, the stimulative measures work their way through the global economy.
This has been the case with China, which has been showing remarkable improvement in its export-oriented HSBC Purchasing Managers Index. The PMI is a measure of health of companies in China, as it includes output, new orders, employment and prices across numerous sectors.
This month, the Flash PMI came in at 51.9, beating market consensus, which was at 51.7. The PMI stands at a two-year high, as you can see in the chart below.
A few months ago, when China’s improving PMI was just beginning to attract attention, I talked with Peter Gibson and Randy Cass from Canada’s Business News Network, who were skeptical of the data because of the slowdown in Europe, China’s largest trading partner. I indicated that although Europe’s deceleration negatively affected China, there were other underlying positive factors taking place. In addition to the continuous stimulus program happening in the countries, China’s new leadership had been solidified. I believed that these dynamics would help PMI accelerate and exports to pick up.
PMIs are leading indicators for global resources stocks, which have lagged over the past year. In 2012, the Morgan Stanley Commodity Related Index only increased 1.4 percent. However, this year, the index is off to an incredible start, rising more than 8 percent in only four weeks.
Stocks across a number of cyclical areas of the market have benefited from this global improvement, including industrial companies such as trucking, rail and airlines. Take a look below at a classic cyclical measure of the market, the Dow Jones Transportation Average, or Dow Jones Transports. The index, an average of 20 transportation companies in the U.S., reached an all-time high this week.
In addition to the synchronized stimulus driving resources, we are entering the time of year that has historically been good for energy equities. Looking at two decades of seasonal patterns of companies in the S&P 500 Energy Index, the next six months have historically been the best of the year. While energy stocks typically decline in January, they have seen positive results in February, March, April and May. July has historically been the best month for energy stocks, climbing more than 3 percent on a median return basis.
It seems clear that there are a number of investors who have gained confidence in the global economy and are seeking to capture the growth opportunities taking place around the world. With the European crisis comfortably in the rear view mirror and global central banks taking the position that they will continue their easing policies, investors have taken their foot off the brake and have begun to accelerate.
As we’ve been consistently communicating in presentations lately, we see more sunshine and less stormy weather ahead. Take advantage of these momentous and seasonal shifts and make sure you have an appropriate allocation to equities poised to benefit, such as global natural resources stocks. As a benchmark for investors, the energy and materials sectors make up 15 percent of the S&P 500 Index.
A caveat to these sunnier days is the U.S. debt ceiling issue. In managing expectations going forward, we likely will see volatility not unlike the ups and downs of the last four years. However, every dip has historically been a buying opportunity. With many investors now considering equities today, future dips are likely to be opportunities to buy as well.
- The major market indices all finished higher this week. The Dow Jones Industrial Average rose 1.80 percent. The S&P 500 Stock Index increased 1.14 percent, while the Nasdaq Composite gained 0.48 percent. The Russell 2000 small capitalization index closed the week with a 1.39 percent gain.
- The Hang Seng Composite Index fell 0.54 percent; Taiwan fell 0.78 percent, while the KOSPI fell 2.07 percent.
- The 10-year Treasury bond yield rose 11 basis points this week, to 1.95 percent.
Domestic Equity Market
The market ended higher for the fourth week in a row as the market grinds higher, even in the face of some disappointing earnings results. The Apple earnings announcement and trading was the key event of the week. Apple disappointed and the stock suffered falling 12 percent this week. When a high-profile stock like Apple disappoints and the market shrugs it off and moves higher the market is in full-blown bull mode. The market was strong across the board except for technology which was dragged down by Apple’s results.
- The discretion sector led the way this week with strength in internet retailers such as Netflix, Priceline.com, Expedia and Amazon. Netflix rose an amazing 71 percent this week after the company unexpectedly reported a profit, and gained more customers than expected. Unsurprisingly, Netflix was the best performing stock in the S&P 500 this week.
- Financials were also strong this week in what was also a broad-based rally. AIG, Bank of America and State Street Corp. were among the best performers. The market appears to be a believer in the economic recovery story and it is being reflected in economically sensitive areas.
- Advanced Micro Devices was the second-best performer in the S&P 500 this week rising 15.8 percent. The company reported earnings that beat expectations, and while the company still has hurdles to overcome the worst may be behind it.
- The technology sector was the worst performer as Apple’s guidance for next quarter disappointed. The company faces increasing margin headwinds and stiff competition, and without an obvious new product that will move the needle, the stock sold off.
- Other notable decliners this week included Joy Global, McCormick, Hasbro and Cliffs Natural.
- Coach was the worst performer in the S&P 500 this week losing 17.1 percent. The company reported earnings on Wednesday which missed analysts’ estimates. The company was also more cautious in its second-half outlook, seeing single-digit sales growth and flat North American comps.
- The focus will remain on earnings next week, with Caterpillar, Pfizer, Amazon and Qualcomm, just to name a few, all set to report next week.
- The dysfunctional political process brings little hope for the U.S. to regain its AAA credit rating and more credit downgrades are possible if Washington remains acrimonious.
The Economy and Bond Market
Treasury bond yields rose this week with most of the move coming on Thursday and Friday. Economic news was modestly positive but the bigger news story of the week was the larger than expected LTRO repayment to the European Central Bank (ECB). The ECB said banks will pay back $184 billion next week versus expectations for $99 billion. This was viewed as a sign of strength and that banks didn’t need the extra funds. New home sales for December were weaker than expected at 369,000 units (annualized), but judging by the chart below the prospects appear very good. As can be seen in the chart, prospective home buyer activity has picked up considerably and historically new home sales track this trend fairly closely, but obviously have some catching up to do.
- The HSBC Flash Manufacturing PMI for China continued to strengthen and reached the highest level in two years.
- Initial jobless claims fell to 330,000 which is a five year low.
- Mortgage applications rose 12.9 percent last week to their highest level in nearly years.
- New home sales fell 7.3 percent in December in a somewhat surprising development.
- Existing home sales also fell 1 percent in December.
- Brazilian consumer confidence fell for the fourth month in a row. This is somewhat surprising as Brazil should be a good read on the global economic recovery.
- The debt ceiling debate appears to be pushed into May, allowing the market to focus on economic fundamentals.
- While some Fed members expressed concerns over continued quantitative easing, the Fed still remains committed to an extremely accommodative policy until the economy improves.
- Globally central banks are increasing their stimulative policies, as Japan’s recently elected prime minister vowed to take on deflation and deflating the Yen.
- Earnings season will dominate the news flow again this week. Focus will be on the outlooks for 2013.
For the week, spot gold closed at $1,684.30, up $25.30 per ounce, or 1.50 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost 1.89 percent. The U.S. Trade-Weighted Dollar Index gained 0.37 percent for the week.
- Klondex Mines Ltd., a Northern Nevada gold exploration and development company, announced the discovery of a new gold mineralization at its flagship Fire Creek project. The discovery, located approximately 540 feet west of the Main Zone, intersected 123.9 grams per ton gold over five feet. Paul Huet, CEO of Klondex, commented “We are very excited by this new discovery at Fire Creek. A discovery of this nature demonstrates that Fire Creek remains under-explored and that ongoing exploration could lead to other zones providing potential growth for Klondex.”
- The Russian central bank will continue to buy gold as it seeks to diversify its foreign reserves away from paper assets which it views as risky, First Deputy Chairman Alexei Ulyukayev said Thursday at the Davos conference.
- Demand for physical gold has been unusually high for this time of the year. The Standard Bank Gold Physical Flow Index signaled demand climbed to the highest since November. Purchases typically pick up at the end of year coinciding with religious festivals in India.
- Total assets of the Federal Reserve’s balance sheet broke through $3 trillion, hitting new highs. Money printing is in full swing and has started to have material impact on bank reserves, and dramatically expand the monetary base.
- Gold capped the biggest decline in almost two weeks after a drop in U.S. jobless claims signaled an improving outlook for economic growth and curbed demand for the precious metal as a haven asset.
- The China Securities Regulatory Commission (CSRC) has finished drawing up regulations that will enable gold-backed exchange traded funds to be listed on domestic stock exchanges. It seems possible that a launch could attract a substantial initial inflow of capital (into the mutual fund sector).
- On January 24, Bob Hoye wrote on Pivotal Events about gold appeal from a relative strength perspective (RSI). When the RSI gets to the high 70s the rally is close to peaking. In September the RSI soared to 84 and in late December fell to 28. The view is that any measurement below 30 is considered as the signal to begin accumulating.
- On January 23, a piece titled “The End of Gold Cash Costs as We Know Them?” by Geoff Candy was published on Mineweb. The article discusses plans by Goldcorp and Yamana to adopt new cost performance measures known as “all-in sustaining cash costs.” This measure more fully defines total costs associated with producing gold; it includes by-product cash costs, sustaining capital, selling general and administrative expenses, and exploration expense.
- Gold’s bull market is over, according to Rene Hochreiter, Allan Hochreiter’s CEO, the top forecaster in the London Bullion Market Association’s 2012 poll. The fading of so-called fear trades is set to diminish the appeal for gold, said Tom Kendall, Credit Suisse’s head of precious-metals research, and the most accurate precious-metals forecaster in the past eight quarters tracked by Bloomberg.
- India, the world’s largest buyer of bullion, raised taxes on gold and platinum imports to 6 percent from 4 percent. The move is set to reduce a record current-account deficit and may reduce gold demand in Asia’s third-largest economy. However, the appetite for gold is so ingrained in India this tax won’t have a dramatic impact.
Energy and Natural Resources Market
- Commodity-hungry China showed more signs of a strengthening economy this week with the HSBC flash PMI for January rising further to 51.9 in January from 51.5 in December which suggests growth momentum continues to improve in the first quarter.
- Energy stocks led the S&P 500 to multi-year highs this week with a gain of nearly 2.5 percent as crude oil gained about 50 cents on the week to finish at $96 per barrel for WTI.
- Palladium closed the week at a 15-month high price of $740 per ounce on continued mine disruptions in South Africa.
- Bloomberg reported that Vale has suspended construction at its Rio Colorado potash project in Argentina. The Rio Colorado project was expected to represent approximately 4.3 million tons of annual production at full run-rates, with our forecasts assuming production starting up in 2016. Capex was estimated at $5.9 billion with approximately $1.6 billion already invested. Wednesday's news follows previous reports that Vale had officially postponed its $3 billion potash project in Saskatchwan, Canada (Kronau) and separately was looking for potential investment partners in the Rio Colorado project.
- This week saw the release of December’s global crude steel and pig iron production data by Worldsteel. The data show continued weakness in ex-China output at the end of 2012, rounding off what was a difficult year for the global industry. 2012 saw global steel output rise 1.2 percent year-over-year, although after stripping out the reported 3.1 percent growth in Chinese output, ex-China production fell 0.4 percent, with most of the weakness coming in the second half of the year.
- CNBC.com wrote that the slowdown in the world's largest economies last year, particularly in China, led to warnings that the end of the commodities super-cycle was near, as prices of key resources plummeted. However, a flood of government stimulus unveiled in recent months has reversed that trend, prompting one expert to say the commodities bull run that began in 2002, is here to stay. "(The super cycle) is still intact. The combination of the economic recovery, especially with China powering ahead, and continuing support from central banks…It's going to be a good year for commodities," Eugen Weinberg, global head of commodities research at Commerzbank told CNBC on Friday, pointing to the Bank of Japan's commitment to open-ended easing this week.
- According to a new study by IHS, in the United States alone, the direct, indirect and induced effects of the surge in nonconventional oil and gas extraction have already added 1.7 million jobs (with 3 million expected by 2020) and $62 billion to federal and state government coffers in 2012 (with $111 billion expected by 2020). For the first time in many decades, a number of large global chemicals companies have announced plans to build or expand facilities in North America for exports—capital expenditures totaling around $95 billion in the next decade, focused primarily on ethylene production.
- The Russian central bank will continue to buy gold as it seeks to diversify its foreign reserves away from paper assets it views as risky, First Deputy Chairman Alexei Ulyukayev said on Thursday. The bank has also been a bullion buyer and the share of gold in its reserves is approaching a medium-term target of 10 percent.
- The global copper market faces a surplus of the metal that may push down prices toward the end of the year, according to Codelco CEO Thomas Keller. “Maybe there will be a certain element of downward pressure, albeit very slight, toward the end of the year when there will be a small surplus,” Keller said.
- Bloomberg news reported that Barclays commodity traders believe iron ore will almost erase the past two months’ rally and fall 19 percent in the second quarter as weather stops disrupting supply and Chinese restocking ends.
- According to media reports Farc rebels in Colombia blew up two southern oil pipelines, including the Transandino pipeline (a 48,000 barrels-per-day pipeline from Putumayo to the Pacific Coast) after a two month cease-fire ended on January 20 with no extension.
- Flash HSBC China PMI was 51.9 in January, better than the expected 51.7 and improved from December’s reading of 51.4. All sub-indices improved again, except new orders were down 20 basis points from December, at 52.7 versus 52.9. A PMI above 50 indicates industrial activities are expanding.
- According to People’s Bank of China (PBOC), total outstanding real estate related loans were RMB12.1 trillion at the end of 2012, up 13 percent year-over-year. Loans to developers outstanding were RMB3.9 trillion, up 11 percent year-over-year. Personal mortgage loans outstanding were RMB 8.2 trillion, up 14 percent year-over-year.
- Chinese solar names were strong last week due to government subsidies and increased solar power targets for the year. More supportive policies are said to be in the pipeline.
- Hong Kong exports went up 14.4 percent in December, versus the estimate of 9.4 percent.
- Countries such as Peru, Colombia and Mexico, where demographics skew younger, and the middle class is expanding, have proven a very good opportunity for credit growth. “The population in Latin America is very young and is entering a credit accumulation stage,” said Wendy Hannam, executive vice-president of Latin America for Scotiabank.
- Recent headline news in China had filled with government officials selling luxury properties across the country even at a huge discount. Those sales were said to be motivated to either hide their wealth or to avoid having to report publicly as China’s new leadership has determined to clean up corruption.
- The Philippines’ imports were lackluster in November by rising only 2.2 percent, indicating slower production for domestic demand.
- CLSA coal analysts lowered the coal price for 2013 due to improved rail transportation capacity in China, driving down the coal price. This is negative for coal stocks in Indonesia and China.
- Korea’s fourth-quarter GDP growth was 1.5 percent, below consensus forecast of 1.8 percent. Weak export markets and a depreciating Japanese Yen are threats to Korean businesses and GDP growth.
- Thailand’s December exports were up 13.45 percent out of the low base the same month last year, but the market was expecting 21.5 percent.
- Singapore’s December industrial production was down 0.6 percent compared to being up 2.9 percent in November, but contracted at a slower pace than the market consensus of -4.8 percent.
- Industrial production in Russia surprised on the downside, slowing down to 1.4 percent year-over-year in December from 1.9 percent year-over-year in November.
- The cost of high crime and violence in Latin America is staggering. In Brazil alone, people pay an extra $13 billion to gain a sense of security, while in Uruguay economic activity suffers a negative impact of more than 3.0 percent of gross domestic product. This is according to a series of studies commissioned by the Inter-American Development Bank (IDB) in an attempt to quantify the cost of crime and violence in Latin America and the Caribbean.
- The chart above shows HSBC China Manufacturing PMI is reaching a two-year high above 50 expansionary levels. The improving PMI confirms China’s economic growth recovery in the fourth quarter last year, and points to growth momentum into this year.
- Strengthening of domestic demand in Mexico and Turkey may keep supporting GDP growth and even temper lower external demand.
- Favorable developments in Iraqi Kurdistan -- lack of Baghdad reprisal after the entry of oil majors into KRG, the oil and gas export agreement with Turkey, and progressing infrastructure projects -- bode well for the exploration companies operating in the region.
- John Kerry, who has been nominated for U.S. Secretary of State, said at his senate confirmation hearing on Thursday that he hoped Washington could make progress in the Western Hemisphere with improved relations with Venezuela, Bolivia and Ecuador, much like the success the United States had with Colombia. He stated, "Colombia is a model for the region. It is an example to the rest of Latin America about what awaits them if we can convince people to make better decisions."
- The number of H-share companies in share placement increased last week causing selling pressures among peers. After H-share stocks rallied 27.5 percent since early September last year, share placements are clearly a short-term price risk.
- “Squeezing the Last Drops” is the title of the 159-page outlook report by the Deutsche Bank’s emerging markets fixed-income research team. Bond yields have compressed, and it is not a question of whether, but rather when the “Great Rotation” from fixed income into equities will begin.
- Uncertainty regarding electricity supply in Brazil may have a negative consequence on investment decisions and makes the growth forecast for 2013 vulnerable to disappointment.
- The current rally in Latin American currencies has exporters in the region calling for fiscal and monetary policy action. Exporters fear the appreciation will erase their competitive edge at a time of slowing demand for exports by Europe and the U.S. In Peru, Colombia and Chile, the dollars are flowing in as investors seek the higher returns emerging markets offer.
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