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The Asian Giant Stampeding into Gold

July 5th, 2013

by Frank Holmes

of U.S. Global Investors

Last week, I discussed how traders were stampeding out of gold as a result of rising interest rates and the threat of evaporating monetary fluid that was lubricating markets. Hovering around $1,200 at the beginning of July, the gold price has completely disconnected from the precious metal’s fundamentals, in my opinion. Prices have fallen too far out of fear, but the drivers for gold are still in place.

My friend and highly respected analyst, Gregory Weldon, highlighted an important point about rising rates in the U.S. The coupon on the nation’s $13.22 trillion debt averages 1.88 percent with an average maturity of 5.4 years. As interest rates rise, debt will be rolled over at a higher rate, making the burden even greater than it already is. This suggests a likely tipping point for Treasuries. Will the Federal Reserve suppress yields at that “line in the sand?”

Domestic Equity Market - U.S. Global Investors

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In this environment, gold should remain attractive. However, as the West flees the precious metal, another set of gold buyers has come forward with the aim to preserve wealth. Take a look at the chart below which shows total gold production compared to the gold deliveries on the COMEX and the Shanghai Gold Exchange. In May, gold imports into the Asian giant rose to the second-highest level ever. While mining production is around 1,134 tons so far this year, gold delivery on the Shanghai Gold Exchange is 918 tons. This is strikingly in contrast to the gold delivery on the COMEX, which stands at only 103 tons year-to-date as of the end of May.

Domestic Equity Market - U.S. Global Investors

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In fact, this year’s demand is so significant that the physical gold delivered on the Shanghai Gold Exchange through May is almost all of the official gold reserves in China! As George Topping of Stifel Nicolaus puts it, “Annualizing 2013 year-to-date figures, China’s imports would be equivalent to 50 percent of [world] mine production.”

China may be devouring even more of the supply in the future if the price of gold remains subdued. I’ve been talking with several gold company executives, who tell me they are seeing squeezed margins because of lower grade finds, as well as governments raising taxes or increasing royalty rates.

The top priority for these miners today is cost control, focusing their efforts on viable projects that have all-in costs of less than $1,000 per ounce of gold. If spending is too expensive, exploration is cut and production is halted.

This is an extremely conservative amount, as some gold mining projects in certain countries come in significantly higher. The CEO of Gold Fields recently indicated that the average all-in cost in Africa is $1,500!

This is a similar phenomenon to the supply of natural gas recently. When there were huge discoveries in the commodity, companies immediately halted drilling. There’s a notable difference in drilling gas versus mining gold, though: The natural gas cycle is shorter and measured in months, so there can be a relatively quick recovery in supply. When gold companies cut production, the restart cycle can take decades.

To me, these supply and demand drivers point to a sustained higher gold price.

Index Summary

  • Major market indices finished higher this week. The Dow Jones Industrial Average gained 1.52 percent. The S&P 500 Stock Index moved higher by 1.59 percent, while the Nasdaq Composite gained 2.24 percent. The Russell 2000 small capitalization index rose 2.86 percent this week.
  • The Hang Seng Composite fell 0.39 percent; Taiwan fell 0.75 percent, while the KOSPI declined 1.61 percent.
  • The 10-year Treasury bond yield climbed 24 basis points this week to 10.05 percent.

Domestic Equity Market

The S&P 500 finished higher by 1.59 percent in a holiday-shortened week that ended with an upside surprise for the monthly non-farm payroll numbers, which came in at 195,000 new jobs versus consensus estimate of 165,000 new jobs in June. Cyclical sectors generally performed better than defensive sectors, led by consumer discretionary. Utilities suffered another loss as the yield on 10-year U.S. government bonds hit a 52-week high of 2.73 percent on Friday.

Domestic Equity Market - U.S. Global Investors

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Strengths

  • The consumer discretion sector led the S&P 500 this week, as cable and media companies outperformed once again, driven by continued takeover speculation.
  • The S&P Automobiles and Components gained 4.29 percent this week after strong June car sales data showed U.S. car and light truck sales were 15.9 million on a seasonally adjusted annualized basis. This is 11 percent higher year-over-year, and the highest such print since November 2007. Ford gained 7.95 percent and Goodyear Tire gained 3.67 percent.
  • Cablevision Systems was the best performer in the S&P 500 again this week up 14.27 percent following a gain of 12.43 percent last week, as the company continues to be discussed as an M&A target.

Weaknesses

  • Utilities suffered another loss on the week as the yield on 10-year U.S. government bonds hit a 52-week high of 1.63 percent on Friday following a stronger-than-expected non-farm payrolls report.
  • The consumer staples sector also fell behind the market with Mead Johnson down 12.50 percent for the week after the company guided for lower pricing in its China operations.
  • The S&P Homebuilding Index dropped 4.13 percent this week with the rise in interest rates threatening the recovery in the housing sector.

Opportunity

  • The current macro environment remains positive as economic data remains robust enough to give investors confidence in an economic recovery, but not too strong as to force the Federal Reserve to change course in the near term.
  • Money flows are likely to find their way into domestic U.S. equities, and out of bonds and emerging markets, which should help the market find a floor.

Threat

  • A market consolidation could continue in the near term, as macro concerns could dominate for the next couple of weeks while the market waits for earnings.
  • Higher interest rates are a threat for the whole economy, the Fed must walk a fine line, and the possibility for policy error is potentially large.

The Economy and Bond Market

U.S. Treasuries fell significantly this week, sending the 10-year note yields to the highest level in almost two years. This comes after the stronger-than-forecast employment report fueled speculation that the American economy is growing fast enough for the Fed to begin tapering its asset purchases as early as September. On Friday, treasuries had the biggest intraday losses since August 2011 as the Labor Department’s non-farm payroll (NFP) report shows the economy added 195,000 jobs in June. This beat analysts’ forecast of 165,000 jobs. Moreover, the Labor Department’s revisions to the prior two months’ NFP reports added a total of 70,000 jobs to the employment count in April and May.

Consumer Confidence Index

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Strengths

  • Orders placed with U.S. factories rose 2.1 percent in May, reflecting stronger vehicle sales and gains in residential construction. The gain in bookings followed a revised 1.3 percent advance the prior month.
  • The U.S. ISM manufacturing index rose to 50.9 from 49.0 in June, beating analysts’ forecast of 50.5.
  • Portuguese bonds pared a seventh-weekly decline after Prime Minister Passos Coelho held meetings with the opposition to shore up support for the government. Portugal’s 10-year yield dropped 15 basis points to 7.12 percent.

Weaknesses

  • Treasuries lost 3.2 percent in May and June, their worst two-month performance since the first two months of 2009 when they lost 3.6 percent, Bank of America Merrill Lynch indexes show.
  • The unemployment rate for June remained at 7.6 percent compared with the Bloomberg News survey of economists forecast of 7.5 percent.
  • The trade deficit in the U.S. unexpectedly widened in May as imports climbed to the second-highest level on record, while exports stagnated, reflecting slack global growth.

Opportunity

  • European Central Bank President Mario Draghi and Bank of England Governor Mark Carney both signaled Thursday that they will keep borrowing costs at record lows for an extended period.
  • China will resume trading of Chinese government bond futures for the first time in 18 years to provide investors with a hedging tool and also to help boost the fixed-income market.
  • The stronger-than-expected June employment data should not have elicited such a big rates sell-off, according Nomura. The note to clients considers the rise in yield as another tactical buying opportunity into the summer months ahead.

Threat

  • Inflation in emerging markets such as Brazil, Turkey and India is getting the attention of policy makers and may be an early indicator for the rest of the world.
  • Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
  • The recent bond market sell off may be a “shot across the bow” as the markets reassess the changing macro dynamics.

Gold Market

For the week, spot gold closed at $1,222.89, down $11.68 per ounce, or 0.95 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, declined 4.7 percent. The U.S. Trade-Weighted Dollar Index rose 1.50 percent for the week.

Strengths

  • New data shows physical demand for the yellow metal remains as robust as ever in China. Net Chinese gold imports jumped 40 percent in May from the month before. Analysts at Stifel Nicolaus noted that China has already imported about 20 million ounces of gold in 2013, compared to 26.7 million in all of 2012 and 13.8 million in all of 2011. If these import numbers hold up through the year, they would equal to 50 percent of global mine production. Or as Paolo Lostritto of National Bank Financial puts it, the Chinese buying exceeds the total GLD ETF liquidation.
  • Mineweb reports a South African physical platinum ETF holdings race to 500,000 ounces just 10 weeks after its launch. Holdings of Absa Capital’s platinum-backed exchange-traded fund have risen to account for about a quarter of all global platinum ETF reserves. The ETF is now the second-largest physical platinum ETF after New York-based ETFS Physical Platinum Shares, which holds 611,847 ounces of metal and took two years since inception to hit the half-a-million ounce mark. The South African fund has seen strong interest since launch, indicating very healthy appetite for physical investment in South Africa, according to Mitsubishi analyst Jonathan Butler. The unprecedented interest also highlights the appetite for physical precious metals by South African pension funds and other investment funds in emerging markets, which are constrained to invest in their local mark ets and are unable to benefit from purchases of oversold physical metals in the New York or London markets.
  • Dundee Precious Metals has started work at its Tsumeb smelter in Namibia to eliminate the sulphur dioxide emissions and at the same time create a viable byproduct, sulphuric acid, which could be sold to other mines operating in Namibia. The acid plant will turn a problem into increased revenues for Dundee. Discussions are already underway for possible off-take agreements with local mines.

Weaknesses

  • Gold Fields Ltd. Chief Executive Officer Nick Holland was quoted saying bullion must rise to $1,500 an ounce for the gold mining industry to be sustainable. “The industry is not sustainable at $1,230 an ounce, which is where the gold price is at the moment,” Holland said today in a telephone interview. “There’s going to be significant rationalizing in the gold industry,” Holland added. The comments come as analysts began commenting on the possibility of mine closures as gold producers can’t keep mines running while losing money.
  • Jefferies published a very critical report this week stating gold is a commodity whose price can rise or fall, and an argument could be made that gold equities should trade at valuation discounts just like any other resource equities. The reports highlights rising costs, rising political risks and a stagnant commodity price, as reasons why dissatisfied investors have been exiting the market, bringing about selling that could beget selling and send the gold price lower.
  • In the past 10 years, 55 gold and silver companies analyzed by BMO Capital Markets have increased their net debt, or debt minus cash, from less than $2 billion to a record of $21 billion. Low interest rates made debt a more attractive option as companies embarked on enormous capital expenditure projects, and a massive industry consolidation drive. Barrick Gold Corp. and Kinross Gold Corp. are trading as if they’ve lost their investment-grade ratings despite Moody’s rating them grade Baa2 and Baa3 respectively. The result is that of miners scrambling to cut costs, as the higher yields threaten to add to the already increasing costs of future borrowing.

Opportunities

Wage inflation Moderating

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  • Market Anthropology published the chart above in a report titled “The Case for Buying Precious Metals.” The report highlights the four reasons why they turned bullish on gold: First, the downside momentum went from gradual decline to waterfall cascade, signaling the overreaction caused by the media. Second, on purely technical terms the sector has extended beyond historical extremes. Third, they don’t have a favorable opinion for the U.S. dollar or for rising yields. Lastly, what they call “anecdotal evidence” of prominent bulls capitulating on the sector inevitably links gold with the banks low in 2009. The report brings attention to multiple valid comparisons between the sector and the desperate selling of 2009, and concludes that, as “outlandish as it seems right now – perhaps [gold’s] best days are yet to come.”
  • Despite the Labor Department’s statement that nonfarm payrolls swelled by 195,000 jobs in June, and its upward revision of job gains for May and April, Gregory Weldon offered a word of caution, as it “specifically applies to the “strength” of today's U.S. macro-data.” According to Weldon, reading beyond the headlines one could find the following data: Full-time jobs decreased by 240,000, while part-time jobs increased by 360,000, meaning full-time employment actually decreased in June. Furthermore, 253,000 people left the labor force in June, meaning more people dropped out, than found jobs. Similarly, the number moving from Employed to Unemployed was larger than the number of people who moved from Unemployed to Employed: 79,000 vs. 153,000. Weldon accurately concludes the so called ‘strength’ of U.S. macro-data is nowhere nearly as robust as the headlines suggest.
  • UBS has officially started storing gold for clients at a vault in Singapore, as Asian investors chase after the yellow metal notwithstanding the drop in prices. The Singaporean government has done its part by removing a 7 percent sales tax from investment-grade precious metals last year. McKinsey & Co. estimates millionaires in Asia outside Japan will create $7 trillion in new wealth by 2016, adding pressure to the unprecedented physical demand in Asia.

Threats

  • The link between Fed monetary easing and the growth of the money stock delinked after 2008 when the Fed began to pay interest on excess reserves. The interest rate induced the banks to maintain excess reserves at the Fed instead of lending. The result is money stock growth of just 1.5 percent a year from 2008 to 2012. Thus, it is not surprising that inflation has remained so moderate, and that quantitative easing has done so little to increase real economic activity. However, when businesses and households increase their demand for loans, and commercial banks meet that demand with new lending, the resulting growth will become a source of unwanted inflation.
  • An anticipated write-down of $4.5 billion to $5.5 billion on Barrick Gold’s Pascua-Lama project would eliminate the company’s $3.9 billion in retained earnings. That is not all; Analyst Greg Barnes of TD Securities estimates Barrick’s write-downs could total $10 billion. The company’s carrying value of its assets assumes future revenues at a gold price of $1,700 an ounce, far above the current level. Additionally, Barrick calculates its gold reserves at $1,500 an ounce. The implication, not only for Barrick, but for other miners too, is that any impairment testing at a current gold price would likely result in necessary write-downs.
  • The Reserve Bank of India attack on gold imports has become so desperate that bank officials have taken to urging the populace, at each and every available occasion, to desist from buying gold. The bank has suggested reducing gold imports would automatically reduce the current account deficit in the country, at the same time stifling all lines of credit for gold purchases. In our opinion, the bank’s efforts will continue to be futile; in April and May the import of precious metals stood at $15.88 billion. Furthermore press reports are stating the obsession to bring gold into India has reached unprecedented levels with authorities acknowledging the smuggling from Dubai is rampant.

Energy and Natural Resources Market

Attractive Valuations for Industrial Miners

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Strengths

  • Rallying to the highest level in 14 months, the prompt-month crude oil contract rose $1.64 to settle at $101.89 per barrel on Friday. This comes as fears of supply disruptions in the Middle East and the biggest stockpile decline this year provided support to the market. Egypt’s military announced Wednesday that Mohamed Mursi is no longer president, leading to concerns over supply through the Suez Canal. The market found additional support behind the Energy Information Administration (EIA) inventory report that showed oil stockpiles declined by 10.3 million barrels, more than four times analysts’ estimates of 2.25 million barrels.
  • Latest data shows the trend for strong U.S. car sales continued in June. U.S. car and light truck sales were 15.9 million on a seasonally adjusted annualized basis, 11 percent higher year-over-year. This is the highest such print since November 2007, before the recession began. This is positive for palladium demand, which is the dominant PGM in U.S. car catalyst; as is the trend towards larger vehicles.

Weaknesses

  • Rallying to the highest level in 14 months, the prompt-month crude oil contract rose $1.64 to settle at $101.89 per barrel on Friday. This comes as fears of supply disruptions in the Middle East and the biggest stockpile decline this year provided support to the market. Egypt’s military announced Wednesday that Mohamed Mursi is no longer president, leading to concerns over supply through the Suez Canal. The market found additional support behind the Energy Information Administration (EIA) inventory report that showed oil stockpiles declined by 10.3 million barrels, more than four times analysts’ estimates of 2.25 million barrels.
  • Latest data shows the trend for strong U.S. car sales continued in June. U.S. car and light truck sales were 15.9 million on a seasonally adjusted annualized basis, 11 percent higher year-over-year. This is the highest such print since November 2007, before the recession began. This is positive for palladium demand, which is the dominant PGM in U.S. car catalyst; as is the trend towards larger vehicles.

Opportunities

  • According to analysts at Macquarie, the latest round of monthly manufacturing purchasing managers’ indices (PMIs), published on Monday, were mixed once more, but overall the mix was better than a month ago. These point tentatively to the prospect of a modest upturn in demand for metals and bulk commodities in the coming months. PMIs in the U.S. and Japan, which rank first and third, respectively, in the world output league, increased sharply. European PMIs, while still weak, were at least moving in the right direction, with the exception of Germany. China’s PMI did drop, as anticipated, but the headline number still posted a plus-50 point reading, signalling expansion of output. Selected subindices also suggest stocks of both raw materials and finished goods continue to be reduced, while pricing pressures remain subdued.
  • Grain imports by China, the biggest consumer, are on course to surpass last year as a slump in global prices encourages purchases even as farmers across the country prepare to increase harvests for a tenth straight year. Inbound shipments of wheat, corn and rice are projected to rise, while domestic corn and rice output expands and wheat remains in line with last year, according to estimates from state and private forecasters in China and the U.S. China will buy 4 million metric tons of wheat in the year that began June 1, the most in nine years, while corn imports will rise 67 percent to 5 million tons, the U.S. Department of Agriculture said on July 3.
  • With TransCanada’s Keystone XL pipeline dominating environmental debate in the United States, efforts by America's struggling coal industry to boost coal exports to Asia have flown largely under the public's radar. Freight trains almost two kilometers long are already hauling coal from Montana and Wyoming to the Pacific Northwest, where it's then shipped to energy-hungry Asian nations that have few qualms about burning the maligned fossil fuel. The $40 billion U.S. coal industry is hoping to ship even more coal to Asia depending on the fate of three more coal export terminals proposed for Oregon and Washington State. The industry has been reeling in the face of a steep decline in domestic coal consumption, caused by both an abundance of cheaper natural gas and increasingly strict federal environmental regulations. But exporting American coal overseas is an undertaking with the potential to result in a greater increase in global greenhouse gas emissions than Alberta's oil sands and the Keystone XL pipeline.
  • The U.S. Energy Department on Tuesday laid out plans to offer up to $8 billion in loan assistance for fossil fuel projects that reduce greenhouse gas emissions, as the Obama administration pushes ahead to use its authority to address climate change. The draft proposal opens the door for a wide range of technologies to receive federal backing, from innovative oil and gas drilling projects to projects that capture and store carbon released from coal plants. Since the U.S. gets about 80 percent of its energy from coal and other fossil fuels, Energy Secretary Ernest Moniz said these traditional sources could not be ignored.

Threats

  • The June results of Macquarie’s proprietary China steel sector survey show conditions remained challenging over the last month. Both the steel mills and traders report a contraction in orders, and although the steel traders have seen continued declines in inventory, the mills are starting to report a rise in stocks. Raw material destocking at the mills has continued, but there are signs that this is now coming to an end.
  • The U.S. Dollar index gained 1.5 percent on the week and hit a 52-week high Friday as stronger jobs data lent support to the Fed’s tapering of its quantitative easing program.

Emerging Markets

Strengths

Emerging Markets Selloff: Buying Opportunity

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  • Poland's purchasing managers' index (PMI) rose to 49.3 in June, up from 48.0 in May. This is the second-highest result in the current cycle of 15 readings below the 50 mark. The bigger picture is that growth in manufacturing is still bordering on contraction, but June’s PMI reading suggests it might swing into growth in the third quarter. As seen in the chart above, HSBC believes the economy has bottomed in the first half of 2013 and a gradual, though slow, recovery will follow. In addition, Poland’s central bank cut borrowing costs to a record low, cutting by 2.25 percentage points since November. The central bank indicated that the cycle of interest rate reductions was over, and the European Union’s largest eastern economy is poised to recover.
  • Mexico has approved a 10 billion peso ($772 million) credit program for the nation’s homebuilders as Homex, Urbi and Geo, the three biggest players, seek to restructure their debt after a shift in government policy depleted their cash. Despite the modest size of the financing program, which equals to just 18 percent of the 55 billion pesos of debt owed by the three biggest homebuilders, the program’s approval is a sign that President Enrique Pena Nieto enjoys sufficient parliamentary support to have his “Mexico Plan” bills passed by the legislature.
  • China’s State Council issued a statement to stabilize growth after the interbank liquidity crunch in June. The statement said China is not tightening, but not easing either. Rather, it said for the People’s Bank of China (PBOC) to use quantitative tools to maintain an appropriate level of money supply in the open market. The statement came after the government realized a transparent and gradual approach in its monetary policy should be used to avoid market disruption. The government also provided clarity on the first-time home buyer policy where supportive lending will be continued, as opposed to recent reports that said the government was going to tighten mortgage lending. The statement also mentioned specifically that the monetary policy will support advanced manufacturing, strategic emerging industries, IT, labor intensive industries, services and environmental protection industries.
  • China’s overnight interbank rate dropped to 3.38 percent from the recent peak of 11.7 percent last week, after the PBOC injected liquidity and the State Council provided clarity for its monetary and fiscal policies. In spite of intensified GDP growth downgrade by brokerage firms after interbank liquidity turmoil a week ago, a State Information Center report believes that second-half GDP growth can achieve 7.6 percent.
  • China raised the natural gas wellhead price by 15 percent for existing volume and 20 percent for incremental volume. The policy will help exploration and production companies invest more on upstream projects and increase gas supply. It also will be positive to the downstream gas distributors in the long-term due to increased pipeline supply.
  • China’s passenger vehicle sales were up 12 percent year-over-year, according to the preliminary data reported by the China Auto Market. For the first half of this year, auto sales went up 20 percent.
  • Macau gaming revenue was up 21.1 percent in June, versus market expectation of 20 percent. The gaming sector is probably the most profitable business in the greater China region.
  • Investment approvals in the Philippines went up 103 percent in the first quarter of this year, which will help improve infrastructure services in the country. Broad money supply (M3) expanded 16.3 percent in May due to large credit growth to the private sector.
  • Thailand’s headline inflation was up 2.25 percent, lower than the market forecast of 2.39 percent.
  • Indonesia’s May trade deficit narrowed to $0.6 billion, in line with market consensus. Increases in fuel price last month will help reduce trade deficit going forward.
  • Korea’s consumer price index (CPI) inflation remains at 1.0 percent in June, benefiting falling prices of agricultural goods. Korean trade surplus remained over $5.5 billion, despite weaker exports which was down 0.9 percent in June, slower than the market expectation.

Weaknesses

  • Rosneft, Russia’s largest oil producer, announced the acquisition of gas producer Itera for $2.9 billion. Bloomberg reports that the most accurate analyst covering the stock said Itera was priced expensively, compared with the current multiples of Rosneft. This would make it difficult to justify the acquisition with the argument that the company’s reserves could be further monetized via a boost in production. The move, rather than motivated by economic rationale or potential synergies, appears driven by Rosneft’s challenging of Gazprom, the world’s biggest gas producer, and an effort to increase its leverage to receive favorable treatment from the government.
  • Brazil is the only BRIC (Brazil, Russia, India, and China) economy where state-controlled companies do not earn the most investment banking fees. However, that may end soon as loans made by government-owned banks rose to 49 percent of the total 2.49 trillion Brazilian reais outstanding. Government-controlled banks are leveraging their relationship with the administration to gain investment banking market share, as President Rousseff relied on boosting credit as a means of reigniting economic growth. Sell-side analysts appear to agree that public banks are showing little risk aversion as they enjoy government support, bolstering a dual credit system similar to China’s that has been widely criticized recently.
  • China’s official PMI weakened to 50.1 in June, versus 50.8 in May. The fall in headline PMI was driven mainly by weaker new orders and production sub-indices, each falling 1.4 and 1.3 percentage points respectively. PMI readings above 50 indicate the economy is in expansionary territory.
  • Hong Kong’s May retail sales went up 12.8 percent versus market consensus of 19.4 percent. The slower growth is an indication that the tightening housing market policy in Hong Kong and slower activities in China have affected consumption.
  • Indonesia’s inflation went up 1.3 percent month-over-month, and was up 5.9 percent year-over-year, higher than 5.47 percent in May. The market expects inflation will go up further in the following months due to an increase in fuel price. Also the market expects the Indonesian central bank to raise interest rates in the face of increasing inflation expectation. Indonesian exports continued to contract in May, down 4.5 percent, though better than market forecast of negative 8.8 percent, and down 8.7 percent the month earlier. Imports also declined, contracting 2.2 percent. Capital goods imports fell 16.7 percent, confirming a slowdown in investment activities.
  • Korean exports retreated to -0.9 percent, slower than market consensus. The declines came mostly from falling exports in LCD, petroleum and steel products. Exports to Japan contracted for the fifth month, down 16.6 percent since yen depreciation.
  • Dedicated emerging markets equity funds reported outflows for the fifth consecutive week; emerging markets funds saw outflows of $5.62 billion for week ending June 26, 2013. The outflows are driven by Federal Reserve tapering fears and China’s interbank crunch.

Opportunities

Emerging Markets Selloff: Buying Opportunity

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  • As shown in the graph above, the Philippines still had strong fund inflows this year after the recent sell-off due to Fed tapering concerns. The Philippines is in an early investment cycle which is driven by infrastructure and business process outsourcing (BPO). The consumption is another powerful driver for the economy due to increasing remittance from overseas Philippine workers.
  • Egypt’s military ousted President Mohamed Mursi from power on Wednesday night, suspended the constitution, and announced an early presidential election in a bid to resolve the political crisis that has polarized the nation. The appointment of an interim technocratic government has been well received by the markets, and we see the potential for the International Monetary Fund (IMF) to ease on the conditions for the disbursement of the loans, a positive for the markets. The euphoria of the trading sessions this week propelled the Egyptian Exchange up 13.64 percent as of Thursday’s close, with the exchange closed on Friday.
  • Mexico’s emergence as an automobile exporter is pushing railroads higher as they haul autos from deep in the country to the U.S. The Mexican Automobile Industry Association projects annual output will reach 4 million vehicles in 2017, a gain of more than 35 percent from last year’s record. Mexico ranked eighth in global production in 2012, up from twelfth in 2005, according to the International Organization of Motor Vehicle Manufacturers. Similarly, Ferrocarril Mexicano S.A., Mexico’s largest carrier, projects that annual auto revenue will rise at least 10 percent in each of the next three years.

Threats

  • Turkey’s inflation for the 12 months to the end of June hit 8.3 percent, up from 6.5 percent in May, significantly outpacing analysts’ expectations for a 7.6 percent rise. There is speculation as to what the central bank can do to staunch the lira’s decline, and rein in inflation without taking monetary stimulus off the table. In normal circumstances, a central bank would increase interest rates; however this could threaten the promised levels of economic expansion. For the time being, the central bank has sought to steady the lira by intervening in currency markets.
  • Chile’s IPSA Index fell after the central bank cut its economic growth forecast to 4 percent from 5 percent this year, down from a previous projection of growth ranging from 4.5 percent to 5.5 percent. Moreover, analysts in the South American nation highlighted that former President Michelle Bachelet, whose platform includes raising corporate taxes, tightening regulations and boosting government spending, won by a landslide in a primary on Monday and will be on the presidential ballot in November. The consensus is that Bachelet will increase regulation which will cut into companies’ profits, a local analyst added.
  • Trade deficits in Indonesia and Thailand threatened currency valuations, falling 5.05 percent and 2.4 percent year-to-date, respectively. The Thai baht fell 8.5 percent from its peak on April 22. Recent fund outflows from these two countries due to Fed tapering concerns added further pressure on the currencies.
  • China went into a slower GDP growth period when it transformed to a consumption-driven economy. Although China’s policy to slow down credit growth in investment is positive in the long-term, many weaknesses might be exposed over the transition time, such as lower return on invested capital, local government debt repayment, and consolidation of over-built industries.

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