Valuation Gap Makes Gold Miners Attractive But All Miners Aren’t Created Equal

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

Goldwatchers were reminded gold’s volatility works in both directions this week, with prices falling more than $100 an ounce in just one day. We forecasted the selloff last week, explaining a 10 percent correction would be a non-event. Once again the CME Group hiked the exchange’s margin requirements for gold investment to shake out overleveraged speculation. This is a positive for long-term investors.

One market trend that seems to be attracting more and more attention is the large performance gap between gold bullion and gold stocks. The price of gold bullion has increased roughly 28 percent in 2011, while the S&P/TSX Gold Index was down 1 percent as of Monday. This shouldn’t come as news for subscribers to these weekly alerts; we first discussed this opportunity back on June 17: Will Gold Equity Investors Strike Gold?

A report this week from BMO Capital Markets offered one reason behind the performance gap, “The rate of change in the gold price has been high over the past decade, perhaps too high for investors to gain confidence in that price as sustainable for an equity investment decision.” BMO says it was hard to imagine gold prices could sustain a $1,000 an ounce levels five years ago, but “now it’s hard to see the gold price falling to that level.”

Using the implied value of a defined group of global gold stocks, it calculated the internal rate of return to measure how gold stocks have underperformed compared to the yellow metal. Over a period of nearly 20 years, BMO’s group of global gold stocks has never been this inexpensive. Only twice—during the Tech bubble in 2000 and the financial crisis of 2008—has the internal rate of return compared so closely with the price of gold bullion.

RBC Capital Markets also sees potential in unpopular, undervalued gold equities and urged readers to take “a fresh look” at gold companies in a report this week. RBC says gold companies currently have margins that are at record highs and it believes margins could be approximately $1,200 an ounce for the next 12 to 24 months. This is substantially higher than the 10-year average of $320 an ounce. Comparatively, many current projects were economically sound at $700-$1,000 per ounce gold prices, creating $300-500 an ounce margins.

Right now, BMO calculates the total cost to produce an ounce of gold at roughly $900 an ounce, while the company can turn around and sell that ounce for upwards of $1,400. This puts margins near 40 percent, roughly twice what they were in 2007 and four times higher than in 2000.

Increased profit margins put more money in gold company coffers and this is reflected in the unprecedented amount of free cash flow (FCF), RBC says. The firm says the industry has reached an inflection point with a “substantial wave of free cash flow” coming over the next 1 to 2 years.

You can see this incredible increase in Tier 1 producers, such as Barrick, Goldcorp, Kinross and Newmont Mining. Looking at their trailing 12 months of free cash flow over 10 years, FCF never rose above $2 billion. However, following the trend in gold prices, FCF among these Tier 1 companies stair-stepped up to $4 billion.

Looking forward over the next few years, RBC estimates that if the price of gold remains at $1,850, FCF should stair-step even further, reaching nearly $12,000 by the end of December 2013. BMO estimates the global gold companies will accumulate net cash of $120 billion by 2015 if gold prices remain elevated.

Rising FCF is especially relevant to shareholders, as it allows the gold company to use that money to invest in projects that should enhance shareholder value. This could include pursuing new projects, making acquisitions, reducing debt or paying dividends. Many gold companies are opting for the latter and increasing dividends but these increases haven’t kept up with the pace of rising earnings. The average payout ratio was roughly 20 percent in 2008 but currently sits around 10 percent in 2011.

BMO says, “A dividend policy linked to the financial performance of the company offers investors additional leverage to the gold price. The provision of a meaningful and sustained dividend has the potential to broaden investor appeal and to instill fiscal responsibility for management.” I’ve often echoed similar sentiments.

BMO says gold stocks are currently trading at historically cheap levels, which the company sees as an opportunity investors can take advantage of. RBC attempts to quantify that opportunity by saying “if gold prices remain elevated and/or investors accept a higher long-term gold price, we could see 25-50 percent upside in equities.”

How to Pick Gold Miners

With gold miners, in general, so attractively valued relative to the gold bullion price, the question becomes: Which stocks are the most compelling and have the best leverage to robust precious metals prices?

First, an investor could begin the process through elimination. FINRA highlighted some of the key warning signs when analyzing gold stocks, such as claims of being a “buyout target,” or speculative claims about reserve growth, and grandiose predictions of exponential growth, to name a few. FINRA says investors should be wary of “free lunch” programs that claim profits in gold are “easy,” and we agree.

Research from geologist Robert Sibthorpe shows that only one in 2,000 (0.05 percent) companies would ever find 1 million ounces of gold, and that only a third of those would be able to turn that find into production. In addition, research from Barry Cooper at CIBC shows that these discoveries are becoming even more difficult. There were 51 gold/copper porphyry discoveries of +3 million ounces during the 1990s, but only 24 of such discoveries occurred during the 2000s.

In order to find the diamonds in the rough, I use what I call “The Five M’s” for mining stocks. I discussed this process thoroughly in The Goldwatcher: Demystifying Gold Investing, an investor’s guidebook to gold investing I co-authored with John Katz a couple of years ago.

The Five M’s are: Market cap, Management, Money, Minerals and Mine life cycle.

1) Market Cap

Market cap is simply the number of shares outstanding multiplied by the stock price. The gold sector is broken down into three sectors by market cap: Seniors (market caps >$10 billion), intermediates (between $2 and $10 billion) and juniors (<$2 billion).

If a gold company has 10 million shares outstanding at $1 per share, the company is valued at $10 million. The question any investor should ask is, “Is this company really worth $10 million?” If the market pays $25 per ounce of gold in the ground, the company should be valued at $25 million (1 million ounces in reserves X $25 an ounce). If the company’s market cap is only $10 million, it may look undervalued. Accordingly, if the company’s market cap is $50 million, it may appear to be overvalued.

For larger gold companies, an investor can measure a company’s market cap against its production level, reserve assets, geographic location and/or other metrics to establish relative valuation. For junior mining companies—an area of focus for our World Precious Minerals Fund (UNWPX)—we look for balance sheets with ample cash for exploration and development of prospective reserves, but we resist paying more than two times cash per share.

2) Management

Essentially, management of mining companies must have both explicit and tacit knowledge to be successful. Explicit knowledge is academic. How many PhDs or masters in geology/engineering does company management have?

Tacit knowledge is more personal in nature and much more difficult to obtain. It is acquired over time through first-hand observation, experience and practice. How many years have they worked in the industry? Has management ever successfully completed a project with similar geopolitical/environmental constraints?

Success in the mining sector, especially the juniors, relies on the ability to raise capital and communicate with investors. Often the heads of junior companies are geologists or engineers who have no relationships in the brokerage business. This lack of relationships impedes their ability to generate market support. Historically, companies with the highest number of retail shareholders have the highest price-to-book ratios and carry higher valuations than peers.

Some of the most successful company builders in the gold-mining industry are what I call the “financial engineers” – people who have the relationships and understand the capital markets and who know how to hire the best geological and engineering teams. We tend to have more confidence investing in them.

3) Money

Mining is an expensive business. Often, companies burn through substantial amounts of capital before generating their first $1 in cash flow. A gold exploration company has to deliver reserves per share to have a chance at another round of financing. It has to convince the capital markets that it is an attractive investment on a per-share basis.

We call this the “burn rate”—how long will the company’s current cash levels last before it has to return for additional financing. If a junior exploration company has $15 million in cash reserves and is spending $3 million a month, it has five months to deliver enough reserves per share to convince capital markets it is worth the risk.

This calculation can be done quickly. Exploration reserves are generally valued at one-third the reserve values of a producing mine—if producing reserves are valued at $150 an ounce, exploration reserves would be $50 per ounce.

The gold-equities market is generally efficient at judging reserves per share, so if the exploration company doesn’t come up with the results necessary to get an evaluation—find gold for less than $50 an ounce—investors quickly lose confidence. There is an old rule when it comes to exploration companies: don’t pay more than two times cash per share if there are no proven assets in the ground.

4) Minerals

Compared to the rest of the mining sector, gold companies have the highest industry valuations based on price to earnings, price to cash flow, price to enterprise value and price to reserves per share.

Companies operating mines that produce gold as well as industrial metals tend to have lower valuation multiples. For example, the current price-to-earnings ratio for Freeport-McMoRan (FCX), is 8x-times forward earnings. This is considerably lower than Yamana (20x), Goldcorp (21x) and Agnico-Eagle (36x). Investors can use the low relative valuations of copper/gold producers to increase their margin of safety in anticipation of an upward move in gold prices.

5) Mine Lifecycle

There are many delays and disappointments during the development and operation of a gold mine. Input costs can rise out of control (such as what happened in 2008 when oil hit $140 per barrel), labor workers can strike, and political/environmental policy shifts such as higher taxes or stricter environmental regulations can shrink margins.

During the exploration and development phase, the price of a gold stock often follows a course that ends up looking like a double-humped camel (see graphic). First there’s euphoria over exploration results that are better than expected. The stock price rises as investors race to buy shares. Then reality sets in – this gold discovery is still years away from being an actual producing mine. At this point, there’s a huge correction in the stock price.

Assuming the company continues down the path to development, its share price drifts sideways until around six months before the first ounce of gold is expected to be produced. At this point, the stock begins a strong new leg up when a more sophisticated set of shareholders come into the market. Eventually the price drops off and then levels as the speculative money moves on to the next hot opportunity and the company transitions from explorer to producer.

U.S. Global’s Expertise

Clearly, the task of picking which gold miners to invest in isn’t easy. We actively travel to mining projects in places such as Colombia, Panama and West Africa to “kick the tires” and ask tough questions of management. This is the value that our investment team at U.S. Global Investors provides for our shareholders and how we seek to generate alpha.

 

Index Summary

 

• The major market indices were higher this week. The Dow Jones Industrial Average gained 4.32 percent. The S&P 500 Stock Index advanced 4.74 percent, while the Nasdaq Composite rose 5.89 percent.
• Barra Growth outperformed Bara Value as Barra Value finished 4.13 percent higher while Barra Growth increased 5.30 percent. The Russell 2000 closed the week with a gain of 6.15 percent.
• The Hang Seng Composite Index finished higher by 0.03 percent, Taiwan rose 1.39 percent, and the KOSPI gained 1.95 percent.
• The 10-year Treasury bond yield closed 12 basis points higher at 2.19 percent.

 

Domestic Equity Market

 

The domestic stock market was higher this week with the S&P 500 Index gaining 4.74 percent. The figure below shows the performance of each sector in the index for the week. All ten sectors increased. The best-performing sector for the week was technology which increased 6.19 percent. Other top-three sectors were consumer discretionary and industrials. Utilities was the worst performer, up 2.05 percent. Other bottom-three performers were consumer staples and telecom services.

Within the technology sector the best-performing stock was JDS Uniphase, which rose 13.26 percent. Other top-five performers were Flir Systems, F5 Networks, Jabil Circuit and Harris Corp.

 

Strengths

• The construction materials group was the best-performing group for the week, up 17 percent, led by its single member, Vulcan Materials. Short interest in the stock as a percent of the float at August 15 was 19.7 percent, so perhaps short-covering may have played a part in the strength.
• The healthcare technology group outperformed, rising 16 percent on the strength of its single member, Cerner Corp. A brokerage firm upgraded the stock on August 19 to “Outperform” from “Neutral.”
• The specialty stores group rose 13 percent. Group member Tiffany & Co. reported second quarter earnings and revenue which handily beat the consensus estimates, and it raised its full-year earnings outlook.

Weaknesses

• The industrial real estate investment trust (REIT) group was the worst-performing group, down 6 percent, led by its single member, ProLogis. The weakness might be related to investor concern that a soft patch in the economy could impact real estate values.
• The brewers group also underperformed, losing 0.47 percent, led by its single member Molson Coors Brewing. The company this week announced three new executive appointments to its international beer business. The company said it is committed to accelerating its expansion into new markets. Beer demand in North America and the U.K. has been sluggish.
• The paper packaging group underperformed, gaining 0.87 percent. Group member Sealed Air Corp. was down 2 percent for the week. A major brokerage firm noted that third quarter protective packaging demand could be sluggish (down 1 to 2 percent), and that year-to-date flexible packaging volumes are down low single digits.

Opportunities

• There may be an opportunity for gain in merger & acquisition (M&A) transactions in 2011. Corporate liquidity is high, thereby providing the means to pursue acquisitions.

Threats

• A mid-cycle slowdown in the domestic economy would be negative for stocks.
• An escalation in concerns over sovereign debt obligations in Europe would be negative for stocks.

 

The Economy and Bond Market

 

The yield on the ten-year U.S. Treasury Note increased 12 basis points this week to end the week at a yield of 2.19 percent.

The Mortgage Bankers Association Purchase Index, which measures the volume of applications to purchase single family U.S. homes, fell 5.7 percent to 157.90 in the week ended August 19 from the prior week, the lowest index level since December 1996. The chart below of that index illustrates the weakness in the housing market despite near-record-low mortgage rates.

 

Strengths

• July durable goods orders increased 4.0 percent from June levels, above the consensus 2.0 percent forecast and the best report since March.
• The Federal Housing Finance Agency reported that its house price purchase index for June increased 0.9 percent from the prior month, above the 0.2 percent consensus.
• The Chicago Federal Reserve national activity index improved to minus 0.06 in July from minus 0.38 a month earlier, and it was better than the consensus estimate of minus 0.48.

Weaknesses

• Initial jobless claims in the U.S. rose by 5,000 to 417,000 in the week ended August 20, above the 405,000 consensus.
• Sales of new homes in July fell 0.7 percent month-over-month to an annual pace of 298,000, the lowest level in five months and below the 310,000 consensus.
• Real gross domestic product for the second quarter was revised down to 1.0 percent from the prior 1.3 percent estimate.
• The home mortgage delinquency rate was 8.44 percent in the second quarter, an increase of 12 basis points from 8.32 percent in the first quarter. This was the second consecutive quarterly increase.
• The University Of Michigan Survey Of Consumer Confidence Sentiment fell from 63.7 in July to 55.7 in August, the lowest level since November 2008.

Opportunities

• With the economy weak and concerns brewing about an additional financial crisis, the Federal Reserve will remain accommodative for some time and bonds appear well supported in the current environment.

Threats

• There is a crisis of confidence in world leaders at the moment and the potential for another financial crisis is rising.

 

Gold Market

 

For the week, spot gold closed at $1,827.95, down $24.15 per ounce, or 1.30 percent. The U.S. Trade-Weighted Dollar Index fell 0.38 percent for the week.

 

Strengths

• This week we saw gold reach another all-time high of $1,911.46 a troy ounce, set in late trading on Monday. Throughout the week, however, we witnessed considerable movement of the precious metal’s price. The funds performed relatively well during such a volatile week. Considerable weight in the seniors continued to work in the funds’ favor, despite juniors and venture stage companies not seeing significant investment interest. We also witnessed strength in gold equities’ performance this week, which is contrary to their generally weak performance relative to the bullion.
• The World Gold Council said in a report Thursday that gold ETFs added nearly 52 metric tons of bullion in the second quarter, reversing the outflows from the first quarter. ETFs listed around the world that invest in gold hold more than $1 trillion in total assets as investors continue to move into metals ETFs to hedge against inflation and seek shelter from sovereign debt uncertainty.
• The World Gold Council recently highlighted that current gold price levels are being supported by central banks; they have been continuing to accumulate positions in gold over the last six months. In February and March, the Bank of Mexico accumulated almost 94 tons of gold, representing the largest accumulation of gold by a central bank in over a decade. The second-largest growth in the precious metal’s accumulation was made by South Korea in June. With the exception of the Philippines, every central bank has reported increased reserve holdings over the last six months. Kazakhstan’s Central Bank has plans to add to its gold reserves by exercising its right to buy the Central Asian state’s entire bullion output, according to Mineweb.

Weaknesses

• The performance divergence between the junior and venture stage mining companies relative to their senior peers has not seen such spreads since the 2008 credit crisis.
• Gold suffered its largest two-day absolute fall in more than three decades, dropping $160 per ounce between Tuesday and Wednesday in a move that highlighted the dangers of an asset viewed as a haven. Spot gold prices fell to a session low of $1,750.55 per troy ounce from $1,911.46 a troy ounce. The previous, largest two-day absolute drop was in January 1980.
• Late Wednesday, CME Group, the operator of New York’s Comex exchange, increased gold margin requirements by 27 percent, following a 22 percent increase two weeks ago. The margin increase came as gold futures fell more than $100 during the day, in one of the steepest falls ever. The Shanghai Gold Exchange (SGE) raised trading margins on three gold spot-deferred contracts to 12 percent from 11 percent from August 26 to limit trading risks following recent wild price swings. It also widened daily trading limits for those contracts to 9 percent, up from 7. This is the second time the SGE has raised collateral requirements on gold forward contracts this year, as international gold prices hit a series of new highs over the past few weeks. Interestingly, Central Banks’ purchases more than quadrupled for this same period.

Opportunities

• Despite the correction, investors noted that gold remains the second-best-performing commodity so far this year, up 24.6 percent since January. Silver is the best-performing commodity, up nearly 30 percent since the beginning of the year.
• Net central bank buying, renewed investment demand for gold and record levels of inflows into Southeast Asia are providing positive fundamental drivers for gold. Coupled with ongoing eurozone debt crisis, concerns over the U.S. debt and the prospect of another round of Quantitative Easing (QE-3), there is a continuing sound market for continuing strength in gold.
• RBC analysts believe investment upside opportunities lie within the gold stocks. Although gold stock performance is lagging presently, RBC analysts believe that the disconnect can be attributed to concerns over rising operating and capital costs, a shift out of equities in general and doubts over the sustainability of a higher gold price over the long term. They believe gold equities are poised to outperform the gold price as investors take advantage of growing free cash flow that they forecast to be generated over the next 12 to 24 months.

Threats

• Doug Silver, founder of International Royalty Corp. and portfolio manager for Red Kite Management, recently advised that the “mining ‘supercycle’ has stalled.” He highlighted that mining companies are now contending with a global debt crisis, smaller areas available for exploration, and competition with Chinese mining investment, as more metal goes into the Shanghai Exchange and less metal goes to the London Metals Exchange. He also made the connection between the world’s top consumers pulling back on their consumption in the wake of the global economic crisis and the fact that U.S. jobs are moving overseas because domestic companies have no incentive to invest in America, both contributing to an overall decrease in living standards, reducing metals consumption in the long term. He further commented that major western mining companies are concentrating on mega mines with long mine life and multi-billion-dollar capex budgets, which leaves very little available capital for mid-tiers and juniors.
• Greece has been forced to activate an obscure emergency fund, the Emergency Liquidity Assistance program, for its banks because they are running short of collateral that is acceptable to the European Central Bank. Greece’s bailout faltering has been in the news lately and this appears to the last stand for Greek banks, according to the London Telegraph. The ongoing debate of the eurozone’s economic crisis continues.
• South Africa’s state-owned power utility, Eskom Holdings SOC Ltd., may raise power costs by 60 percent over the next three years, raising the average electricity tariff to about 75-80 cents per kilowatt by 2016. This could potentially create downward pressure on margins for all South African businesses.

 

Energy and Natural Resources Market

 

Strengths

• The Global Resources Fund performed relatively well for the week, despite overall global economic uncertainty and volatile market activity. Exposure to precious metals helped the fund, while maintaining little exposure to negatively-performing sectors limited downside risk. The fund continues to benefit from exposure to the food and agriculture sector.
• Refining margins continue to remain very strong, with the spread between Brent Oil and West Texas Intermediate (WTI) remaining consistent, by about $30. This has been contributing to the strong performance of the oil and gas refining sector. The fund has also benefited from exposure to the refiners.
• Corn rose to a 10-week high in Chicago and soybeans gained as worsening crop conditions in the U.S., the top global exporter, raised concern that supply may be smaller than estimated. The Department of Agriculture said Monday that conditions deteriorated last week for the U.S. corn and soybean crops. Corn for December delivery has already climbed 6 cents. Only 57 percent of the corn in the top 18 producing states was in good or excellent condition as of August 21, down from 60 percent a week earlier and 70 percent a year earlier, according to Bloomberg.
• According to Bloomberg, U.S. wheat shipments to Egypt, Iraq, Japan and Saudi Arabia surged in the first half of this year, driven by political turmoil and natural disasters, to wrap up the best export season since 1992-1993. A drought led Russia to cut off its exports from August until last month, giving the U.S. an opening. Low rainfall in Iraq and Saudi Arabia’s move to save water by reducing domestic production drove demand as well. Exports to Japan jumped because of a weather-shortened harvest in 2010 and possible food hoarding after the March earthquake and tsunami.
• Deutsche Bank highlighted that copper demand exceeded supply by 80,000 tons in May which brought the shortage to 146,000 tons for the first five months of this year, compared with 162,000 tons in the same period last year, according to the International Copper Study Group.
• The Energy Department said the nation’s oil supplies dropped by 2.2 million barrels last week, which helped to keep the price higher. Oil rose Wednesday following news of strong U.S. manufacturing activity. Benchmark West Texas crude rose 75 cents to $86.19 a barrel in New York, while Brent crude was up $1.34 at $110.65 per barrel in London that day.

Weaknesses

• The fund also did not have any exposure to the construction and materials group, which experienced positive gains for the week.
• Deutsche Bank recently published an article stating that output from Chile’s Escondida mine dropped 14 percent in the first half from the previous year to 452 kilotons due to declining ore grade and labor issues. BHP Billiton’s Escondida mine, the world’s biggest copper mine, experienced striking issues the last few months. Chile is the world’s largest copper producer, accounting for one-third of global supply.
• Aluminum, zinc and nickel continue their weak performance relative to other metals. The ongoing global sovereign uncertainty, lower GDP forecasts for the U.S., bleak consumer sentiment, a potential world-wide recession and overall global negative sentiment are all contributing factors.

Opportunities

• Independent oil analyst Andrew Lipow said refineries along the East Coast will likely decide whether to shut down production ahead of Hurricane Irene, which could disrupt gasoline shipments and hit refineries in New Jersey and Pennsylvania. Once stopped, refineries usually need 10 to 21 days to get back up and running at full capacity. That means gasoline supplies could drop and prices rise, he said.
• According to Forbes, the government reported that orders for long-lasting, durable goods like autos and aircraft increased 4 percent in July, the biggest increase since March. Manufacturing is a major driver of economic growth, and more manufacturing boosts energy demand.
• The Financial Times highlighted that the U.S. ethanol industry, now the top domestic corn user, has not been slowed by high corn prices, with output up 4 percent from a year ago.

Threats

• Again, with no clarity on the issue of the global sovereign debt, there is a risk that we will continue to experience volatile market activity. Already-established negative trends may continue among commodities and sectors.
• Dan Greenhaus, Chief Global Strategist for BTIG LLC, reported that investors are likely disappointed by the lack of any policy specifics from Chairman Bernanke’s speech Friday. He highlighted that Bernanke said that the debt ceiling debate damaged the credibility of the United States and suggested more such debates are likely to do further damage. Bernanke emphasized that without significant policy changes, the finances of the federal government will inevitably spiral out of control, risking severe economic financial damage. He did not present a Quantitative Easing 3 outline, which contributes to the nation’s remaining uncertainty for the future.

 

Emerging Markets

 

Strengths

• Overall, the Global Emerging Markets Fund performed well considering the worldwide uncertainty and negative sentiment among the global sovereign debt issues. The fund’s exposure to the information technology, telecom and energy sectors continued to produce positive gains, coupled with the fund’s weighting in Peruvian, Chinese and Polish stocks, which contributed positively to the fund.
• Chile, the world’s biggest copper producer, is poised to shrug off a global economic slowdown and generate growth of more than 5 percent next year.
• Standard & Poor’s upgraded the Czech Republic's credit rating by two notches to AA in late August, citing the government’s commitment to its fiscal consolidation program and the prudently managed and balanced economy. The upgrade came on the heels of the parliament committee’s decision to green-light a pension overhaul plan, according to RGE Monitor.
• Many Chinese companies have reported sales and earnings exceeding analysts’ expectations for the first half of the year. Particularly, banks and consumer goods and services are seeing growth in sales and resilient earnings momentum, in spite of the fact that China retains the policy of monetary tightening. Industrial and Commerce Bank of China (ICBC) reported net interest margin expansion of 4 basis points to 2.62 percent on 24 percent growth year-over-year in loans to small business, and steady demand deposits. Meanwhile, asset quality has improved and Local Government Financing Vehicle loans with cash flow coverage of less than 70 percent declined 74 percent half-over-half, bumping up the tier-1 capital adequacy rate by 16 basis points quarter-over-quarter to 9.82 percent. Belle International, a women’s shoes retailer, reported first half net earnings up 25 percent.
• The People’s Bank of China (PBOC) didn’t raise interest rates over the weekend as the market had expected, confirming that China may slow tightening when the global economy is in difficulty.

Weaknesses

• Unfortunately, the fund was negatively affected due to exposure in Thailand, India and the healthcare sector, all of which were in the bottom half of performers for the week.
• BBC News reported that Chile witnessed two days of nationwide work stoppages and street protests amid ongoing student protests to press for education reform. The unions’ demands included changes to pensions, health care and taxes, as well as constitutional reform. Violent clashes erupted after some demonstrators erected burning barricades and threw stones. Over 300 people were arrested, there was one fatality and dozens were injured.
• UBS AG, Switzerland’s largest bank, announced that 3,500 jobs, or 5.3 percent of the workforce, would be eliminated. UBS is among many of the international banks which have announced reductions in the past two months, contributing to the 60,000 job reductions this year through the first week of August.
• At $9.0 billion, the trade gap in Turkey came in narrower in July than the consensus. Trade figures showed nascent signs of improvement as export growth of 6.3 percent surpassed import growth of 1.6 percent.
• PBOC had just confirmed after market close on Friday that a new required reserve ratio (RRR) rule will be implemented in September, which will require margin deposits from acceptance, guarantee, and letter of credit to be included in the calculation of RRR. The overall impact would be Rmb 0.7 to 0.8 trillion, according to CICC. This will be another overhang for bank stock prices in the short-term.

Opportunities

• The Financial Times highlighted that there are a growing number of Brazilians with international expertise and experience who are returning to Brazil. They are helping Latin America’s largest economy deal with a shortage of managerial talent as it becomes evermore entwined in the global economy, particularly after China overtook the U.S. as its biggest trading partner in 2009. Popular sectors include banking and engineering, and the shortage of managerial talent is reflected in soaring salaries. A study by Dasein Executive Search last December found that company bosses in Sao Paulo were the world’s highest paid, with a chief executive in Brazil’s financial capital earning an average of $620,000 excluding bonuses, compared with $574,000 in New York and $550,000 in London.
• According to Bloomberg, Mexico may receive as much as $20 billion in foreign direct investment this year, 11 percent more than a prior forecast, as the second-largest Latin American economy’s low wages and proximity to the U.S. draw producers. Mexico has manufacturing costs 25 percent lower than the U.S., is producing more engineers than other countries and is signing free trade pacts with nations like Colombia, Economy Minister Bruno Ferrari said.

• China’s cement H-shares price has corrected 30 percent on average since mid-July, showing attractive valuation. Aside from broad market fears for a possible global recession, the cement price decline in July and August was to blame for the sell-off. According to CICC research, the cement price is seasonally weak in July and August, but the fourth quarter is the high season. This chart shows the supply driver for the cement price is reduced capacity in the sector, after the Chinese government ordered consolidation by closing down inefficient and environmentally harmful factories.

Amid a decline in brownfield production in West Siberia and elsewhere in Russia, greenfield production is becoming more important. The next big hope for Russian oil is in East Siberia, with output to account for 80 percent of growth and 15 percent of total output by 2018, according to Merrill Lynch estimates.

Threats

• Bloomberg reported that the cost of protecting Argentinean debt against default is rising faster than in any country except Greece as President Cristina Fernandez de Kirchner’s landslide win in a primary vote bolsters her re-election bid, reducing the chance of policy changes needed to sustain growth. Since taking office in 2007, Fernandez has seized $24 billion of private pensions, called for limits on foreigners buying land and fined researchers who say inflation is 23 percent, more than double the official rate.
• There is speculation that Mexico’s central bank will hold its benchmark interest rate at a record low as Europe’s debt crisis and the prospect of a U.S. recession restrain economic growth and inflation. Signs of economic weakness in the U.S., which buys about 80 percent of Mexico’s exports, have prompted JP Morgan Chase & Co. and Financiero Banorte SAB to cut their Mexican economic growth forecasts.
• Russian news wires reported that the government agreed on the new tax regime for the oil industry, to be introduced October 1. The unintended outcome of this proposal, according to VTB Capital, is that the entire refining segment could become loss-making in a sub-$80 per barrel of crude pricing environment.
• The expectation for August inflation in China has been that it will show an inflection point before turning downward in the fourth quarter. However, the price of pork has moved up again after weakening in the first two weeks. If inflation is at the same level as July, or higher, the PBOC may have to raise interest rates, though such action is not generally expected by the market.

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