Striking Portfolio Balance with Gold Stocks

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

It wasn’t a pretty week for gold prices. The eurozone’s epic endeavor to conquer its sovereign debt issues forced some institutional investors to liquidate profitable gold positions to meet a rising need for liquidity.

In addition, falling confidence in the euro and other global currencies pushed investors tumbling toward the relative safety of the U.S. dollar. As we outlined for you last week, the key phrase is “relative safety” because we know that it could only take a slight breeze to blow the dollar’s house down.

Back on August 22, I wrote that gold was due for a correction and that it would be a non-event to see a 10 percent drop in gold. I wrote, “This would actually be a healthy development for markets by shaking out the short-term speculators.”

This morning’s gold price of $1,590 is about 15 percent from the high, which is a little greater than predicted, but a non-event just the same. I believe the long-term story remains on solid ground.

In a report this week, Credit Suisse reiterated the bull market for gold is not over, saying, “We do not believe the key fundamental drivers of the [gold] bull market have dissipated. While there are risks, in our opinion gold is getting close to attractive levels for new longs to be initiated.”

Gold Stocks vs. the Federal Budget

This chart, which we’ve highlighted several times, shows the size of the surplus or deficit in the federal budget. When the federal government is spending more than it takes in, gold and gold stocks tend to outperform the broader market. It’s important to point out that it’s the political policies, not political parties, that drive this phenomenon. During the 1990s, when President Clinton was in office, there was a budget surplus and investors could earn more on Treasury bills (about 3 percent) than the inflationary rate (about 2 percent). This gave investors little incentive to embrace commodities such as gold, and prices hovered around $250 an ounce.

Since 2001, increased regulation in all aspects of life, negative real interest rates, welfare and entitlement expansion funded with increased deficit spending have created an imbalance in America’s economic system. It’s this disequilibrium between fiscal and monetary policies that drives gold to outperform in a country’s currency. The Federal Reserve capped interest rates near zero back in 2008 and the federal budget deficit ballooned to $1.4 trillion. In fact, both the deficit as a percentage of GDP (negative 11 percent) and federal government debt as a percentage of GDP (nearly 65 percent) are at the highest levels since 1950. This has helped fuel gold’s rise through $1,000 and $1,500 an ounce.

Striking Portfolio Balance with Gold Stocks

Gold stocks have historically ranked among some of the most volatile asset classes. Over any given one-year period, it is a non-event for gold stocks to move plus or minus 38 percent. This DNA of volatility is about three times that of gold bullion, which carries an annual volatility around 13 percent.

Despite this volatility, our research shows that investors can use gold stocks to enhance returns without adding risk to the portfolio.

In 1989, Wharton School finance professor Jeffrey Jaffe completed an academic study that illustrated the effects of portfolio diversification into gold stocks. Jaffe’s original study covered the period from September 1971, just after President Nixon ended convertibility between gold and the dollar, to June 1987.

During Jaffe’s study period, the average monthly return for the S&P 500 was 0.89 percent. Gold stocks, as measured by the Toronto Stock Exchange Gold and Precious Minerals Total Return Index, converted to U.S. dollars, performed considerably better, returning an average monthly return of 1.42 percent.

On the risk side, gold stocks had greater volatility (measured by standard deviation) than the S&P 500. But Jaffe found that, because of their low correlation to U.S. stocks, adding a small percentage of gold-related assets to a diversified portfolio slightly reduced overall risk.

Here is an updated version of Jaffe’s results.

To find an optimal portfolio allocation between gold stocks and the S&P 500, the efficient frontier plots different portfolios, ranging from a 100 percent allocation to U.S. stocks (the S&P 500) and no allocation to gold stocks, and gradually increases the share of gold stocks while decreasing the allocation to U.S. equities.

Assuming an investor rebalanced annually, our research found that a portfolio holding an 85 percent allocation to the S&P 500 and a 15 percent allocation to gold equities* had essentially the same volatility as the S&P 500 (horizontal axis) but delivered a higher return (vertical axis). In other words, the addition of a small allocation to gold stocks increased portfolio returns with no increase in the portfolio’s volatility.

Between September 1971 and November 2011, the S&P 500 averaged a 9.69 percent annual return. A 15 percent allocation to gold equities and an 85 percent allocation to U.S. stocks, with annual rebalancing to maintain the allocations, would have yielded, on average, an additional 0.82 percent per year.

How much is 0.82 percent per year?

Let’s use a hypothetical $100 investment as an illustration. A $100 investment in gold stocks in 1971 would have grown to nearly $5,100 at the end of November 2011, while the same amount in the S&P 500 Index would be worth about $4,800.

But look what happens when you combine the two. Assuming the same average annual returns since 1971 and annual rebalancing over 40 years, a hypothetical $100 investment in a portfolio with 15 percent gold stocks would be worth about $6,600. That is 37 percent greater than the $4,800 for the portfolio solely invested in the S&P 500, while adding virtually zero risk.

U.S. Global Investors consistently suggests allocating up to 10 percent gold in a portfolio, so we also looked at returns for investors at that level. In dollar terms, a hypothetical $100 investment in the 90-10 portfolio would grow to $6,022 over the ensuing 40 years (assuming annual rebalancing), compared to $4,820 for the portfolio solely invested in the S&P 500.

And when you look at the efficient frontier in the chart, a portfolio with a 10 percent weighting of gold stocks and a 90 percent allocation to the S&P 500 has also historically increased return with no additional volatility.

More than two decades and many ups and downs have passed since Jaffe published his study, but our follow-up research shows that the relationship among gold, outsized returns and volatility has remained consistent through the past four decades.

If you haven’t already completed your annual portfolio rebalancing, this may be an opportune time recalibrate your portfolio with gold stocks.

*Time series for Toronto Gold & Precious Minerals Index is a composite of this index’s returns from 1970 to 2000.  Thereafter, the S&P/TSX Gold Index is used.  Both series are analyzed based on their returns achieved in US dollar terms.

 

Index Summary

• The major market indices were lower this week. The Dow Jones Industrial Average lost 2.61 percent. The S&P 500 Index decreased 2.83 percent, while the Nasdaq Composite was lower by 3.46 percent.
• Barra Growth underperformed Barra Value as Barra Value finished 2.53 percent lower while Barra Growth lost 3.10 percent. The Russell 2000 closed the week with a loss of 3.13 percent.
• The Hang Seng Composite finished lower by 1.73 percent, Taiwan fell 1.57 percent, and the KOSPI lost 1.86 percent.
• The 10-year Treasury bond yield closed 21 basis points lower at 1.85 percent.

 

Domestic Equity Market

 

The domestic stock market as measured by the S&P 500 Index was lower this week by 2.83 percent. All ten sectors of the index declined. The best-performing sector for the week was utilities which declined 0.21 percent. Other top-three sectors were health care and consumer staples. Energy was the worst performer, down 4.88 percent. Other bottom-three performers were technology and financials.

Within the utilities sector the best-performing stock was PG&E Corp., up 4.55 percent. Other top-five performers were AGL Resources, Inc., XCEL Energy, Inc., Northeast Utilities and NiSource, Inc.

Strengths

• The construction materials group was the best-performing group for the week, up 16 percent, led by the group’s single member, Vulcan Materials Co. This week rival Martin Marietta Materials, Inc. began a $4.8 billion hostile bid for Vulcan.
• The airlines group was the second-best-performing group, up 3 percent on strength in its single member, Southwest Airlines Co. In a media interview this week the CEO said Southwest is focused on eliminating waste and inefficiencies in its operation to bring down costs and re-widen the cost advantage it has against larger rivals. Upgrading the company’s airplane fleet is a key part of the strategy to lower costs.
• The residential real estate investment trusts (REITs) group outperformed, gaining 2 percent. A major brokerage firm published a positive industry report on the apartment REITs, reiterating its view that fundamental factors will continue to drive apartment rents higher.

Weaknesses

• The consumer electronics group was the worst-performing group for the week, down 14 percent on weakness in its single member, Harman International Industries, Inc. The company’s CEO sold 25,000 shares of stock on Friday of the prior week.

 

• The computer & electronics retail group declined 14 percent. Best Buy Co, Inc. reported third-quarter earnings below the consensus estimate as margins in the period were lowered by promotions and the cost of free shipping for online shoppers.

 

• The coal & consumable fuels group lost 11 percent, with all three group members declining. In the prior week a major brokerage firm lowered its coal industry rating to neutral from attractive, looking for a more negative demand outlook due to proposed EPS regulations of coal plant emissions, lower natural gas prices in 2012 and 2013, and lower secular demand growth.

Opportunities

• There may be an opportunity for gain in merger & acquisition (M&A) transactions in 2012.  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

 

Long-term Treasury yields ended the week sharply lower as the reprieve from the euro crisis was short lived. Ten-year Treasury yields fell decidedly below 2 percent and are at the lowest levels since early October.

Recent economic data has been mixed and global economic news flow has generally been weak. One positive outlier worth mentioning is initial jobless claims which have declined to the lowest level since 2008. Historically, initial jobless claims have been a good indicator on the overall economy, so the economy may be in better shape than many currently believe.  

 

Strengths

• Initial jobless claims fell to the lowest level since May 2008.
• Several inflation measures were reported this week for November (Consumer Price Index, Producer Price Index and import prices) and all signaled flat to declining inflation trends.
• The National Federation of Independent Business’ November small business optimism index hit a 9-month high as strength was seen in many areas.

Weaknesses

• November Industrial production fell 0.2 percent.
• November retail sales were disappointing, rising a modest 0.2 percent.
• The excitement over the European Union (EU) accord that was reached last Friday barely lasted the weekend and sentiment turned sour this week.

Opportunities

• There is quite a bit of economic data due out next week with numerous housing measures, durable goods orders and leading indicators.

Threats

• The situation in Europe remains extremely fluid and negative news is almost expected at this point. Unfortunately it is politically driven and difficult to predict outcomes and ramifications.

 

Gold Market

 

For the week, spot gold closed at $1,598.95 down $112.65 per ounce, or 6.58 percent.  Gold stocks, as measured by the NYSE Arca Golds BUGS Index, fell 9.06 percent. The U.S. Trade-Weighted Dollar Index jumped 2.07 percent for the week.

 

Strengths

• Despite tough gold markets, we continue to see strength from Asia, with the latest government statistics showing that Chinese gold imports were up 50 percent in October from September.  The most common route for Chinese imports is one through Hong Kong, which hit a new record and was 40 times higher than imports via this route a year ago. This is the fourth month of record imports into China. Chinese New Year, beginning January 23, presents a strong platform for further Chinese gold import records. 
• Peru’s newest Prime Minister Oscar Valdes decided late Thursday to lift the “state of emergency” instituted late last week in response to protests that had turned violent against the Newmont and Buenaventura Minas’ Conga project. Negotiations will be reopened Monday.  Both Buenaventura and Rio Alto Mining, with largely only Peruvian based assets, rose 4.5 and 2.9 percent, respectively.
• Despite the pull back in gold bullion, gold exchange-traded products have experienced fairly small outflows so far, and do not anticipate much to change.  With the amount of gold held equaling the holdings of the French central bank, the amount of gold is up nearly 20 percent for the year. The recent price correction touched almost a 17 percent drop from the highs set in September 2011 and by the end of the week gold seemed to have found a floor. 

Weaknesses

• Gold was likely a source of liquidity to meet redemptions for hedge funds that anticipate large redemptions due to poor equity market performance and suffered somewhat from European banks, such as France’s Credit Agricole decision to scale back its commodity trading and finance business in a move to cut risk. As proprietary trading for the banks was ended by new regulations, many of the trading desks have been scuttled in Europe.
• With gold taking a hit this week, the reins were also pulled in on gold stocks. Senior gold stocks declined roughly 9 percent but junior gold producers decreased, on average, about 6 percent, perhaps reflecting cheaper valuations. Gold exploration and development companies fared the worst, with a fall of about 11 percent. 
• The decision to rule Rio Tinto as the winner in the arbitration with Ivanhoe Mines left Ivanhoe’s shares down almost 22 percent this past Tuesday.  Rio Tinto is no longer subject to a standstill agreement with the company which therefore means that Rio is protected against having its 49 percent holdings diluted should Ivanhoe issue additional shares. When questioned whether or not Rio would continue taking Ivanhoe out completely, Rio stated that it, “may seek opportunities to increase its shareholding in Ivanhoe to a majority position but currently has no intention of making a full takeover bid for Ivanhoe’s shares.” 

Opportunities

• Due to the Royal Canadian Mint’s (RCM) overwhelming success of its new Canadian Gold Reserves’ Exchange Traded Receipts (ETRs), the RCM is now considering marketing silver ETRs. With each ETR representing actual ownership in the physical precious metal, investors helped to raise C$600 million in three weeks for the gold ETR initial public offering, killing initial expectations of raising C$250 million. So far, U.S. customers are the largest buyers of the gold ETR. 
• Merger and acquisition activity remains hot in the gold space with the latest bid coming from Luxor Capital Group, a major hedge fund, for Crocodile Gold.  Luxor said it would buy up to 215.5 million Crocodile Gold shares for C$0.56 a share, representing a 60 percent premium over the previous day’s close.  Currently, Luxor owns 10 percent.  Crocodile Gold shares were up almost 39 percent the day of this announcement. 
• India reportedly has been considering freeing gold doré imports, which up until this point, has only been undertaken by India’s central bank. India’s commerce ministry is currently debating a proposal which would ultimately bring down jewelry prices. The country’s Finance Bill 2011 had stipulated that doré, with up to 80 percent gold content, could be imported through designated agencies, under strict conditions and a complex tax structure; freeing the import restrictions would encourage more to come into the country. The Centre for Monitoring Indian Economy has forecasted that the country’s consumption of the precious metal will surge 50 percent to 1,200 tons a year by 2020.  

Threats

• Oxford Policy Management reported in a new research document that Botswana, the Democratic Republic of Congo and Zambia are currently most vulnerable to “resource curse.” The study looked at nearly 100 “mineral-dependent” countries and explained “the paradoxical situation in which resource-rich countries suffer from stagnant growth or even economic contraction, as well as institutional problems such as corruption and weak public service delivery.” Other countries in this category included Bolivia, Burkina Faso, Ghana, Guyana and Mauritania, where many companies are currently mining. 
• The FTSE International announced this week that it had increased the free-float requirement for U.K. incorporated companies seeking inclusion in the benchmark U.K. equity indices to 25 percent from 15 percent, subject to take effect January 2012.  Although this announcement is potentially positive from a liquidity and corporate standpoint, it does potentially threaten the stocks until compliance is met.  Eurasian Natural Resources, Fresnillo and ENRC are a few companies that may have trouble meeting this new requirement. 
• Absa Capital’s latest quarterly economic outlook reported that mining and manufacturing would remain a drag on South Africa’s growth for 2012. Gina Schoeman, a leading South African economist, pointed out that the two sectors had been a material drag on the country’s growth performance during the second and third quarters of 2011. Growth domestic product was negatively affected in the third quarter by a 17.4 percent quarter-over-quarter contraction in mining, while an 8.8 percent contraction in manufacturing in the second quarter affected the second-quarter GDP number. 

 

Energy and Natural Resources Market

 

Strengths

• The Brazilian fertilizer agency ANDA released November 2011 fertilizer data showing potash demand of 493,000 tons in November and total potash tonnage year-to-date of 7.04 million tons, up 24 percent year-over-year. Total Brazilian fertilizer imports were flat versus November 2010 with domestic consumption up 2 percent.
• In another sign of rising gold demand in emerging economies, China’s gold imports from Hong Kong surged 51 percent to a record in October as investors sought to hedge against turmoil in the financial markets and took advantage of the price gap between the two places. Mainland China bought 86,299 kg (86.3 metric tons) from Hong Kong in October, up from 56,977 kgs in September, according to the Census and Statistics Department of the Hong Kong government.
• Copper imports by China advanced 18 percent to 452,022 metric tons from 383,507 tons in October, the highest level in 20 months as stronger local prices than in London prompted traders to increase buying. Iron ore imports by China rebounded 29 percent in November from an eight-month low as some steelmakers replenished their stockpiles after prices fell. The country imported 64.2 million metric tons of iron ore last month, General Customs said. This is the highest since January, and compares with 49.94 million

Weaknesses

• Most commodity prices fell this week as global growth concerns, coupled with unresolved eurozone issues following last week’s EU summit, continue to rattle investors. Commodity-related equities fell about 6 percent this week.
• Crude oil (West Texas Intermediate) fell 6 percent last week to close near $93.50 per barrel as weekly Department of Energy data indicated rising inventories.
• Macquarie Research reported that preliminary Indian iron ore export volumes for November totaled 5.14 million tons, down 36 percent year-over-year. Total export volumes are down by 22.4 million tons year-over-year in the first 11 months of this year and are set to total only about 80 million tons in 2011, 15 million tons below initial expectations and 33 percent below recent peak levels in 2009.
• U.S. aluminum orders continued to weaken in November as buyers apparently destock towards the end of the year. Total orders (ex-cansheet) fell 3.4 percent month-over-month in November, according to the U.S. Aluminum Association's monthly survey. 

Opportunities

• JP Morgan highlighted that the International Energy Agency (IEA) medium-term coal report says that coal demand is set to increase by 600 kilotons per day over the next five years, driven by forecast growth from China and India. This compares well, under the circumstances, to the last decade’s 700 kilotons daily growth. The agency added that the increase in demand could put upward pressure on costs and prices as infrastructure maxes out. Interestingly, the study points to different scenarios for Chinese imports that vary between a bull case of 180 million tons by 2016 and a bear (for imports) at just 39 million tons depending on the success of domestic investment in mine and rail infrastructure.
• China’s Coal Transport and Distribution Association reported thermal and coking coal imports to increase by 13 percent in 2012. Chinese customers may push for more overseas purchases in the next year as they face the cheapest foreign supplies in three years relative to domestic costs. Chinese benchmark thermal coal traded $22 higher than supplies from Newcastle as of December 4. This is the widest difference since July 2008.
• Roubini Global Economics (RGE) highlighted that today the world’s largest consumers of potash are China (16 percent), followed by the United States, Brazil and India, with the world’s largest importers being consistent with the exception of the United States.  RGE has also forecasted that global potash demand will rise 11 percent to 58.3 million tons this year. While demand grew from India and China at an annual rate double the world average at 8 percent between 1993 and 2008, Indian production is set to grow as well in order to maintain the country’s position as the second-largest producer of sugar, rice, wheat, fruits and vegetables. RGE also highlighted that Brazil is slated to be the top potash consumer by 2020, despite having its own reserves. The seasonality in Brazil is such that there is an all-year demand for fertilizer. Ov erall, RGE believes potash investments in the medium- to long-term look positive, with short-term macroeconomic head winds such as heightened volatility. 

Threats

• The China Non-Ferrous Industrial Association (CNIA) met with 10 major domestic aluminum smelters to discuss business strategy in light of current low aluminum prices and the losses of some producers. Macquarie Research reported that the overall outcome from the meeting appears bearish for the Shanghai Futures Exchange price, with no agreement reached on an alliance to idle capacity, a confirmation the SRB will not buy excess metal, and the prospect of CNIA pushing the Natural Resources Defense Council for preferential power rates (thereby reducing cost support).
• In its latest monthly report, the IEA also reduced its 2012 demand forecast by 200,000 barrels per day to 90.3 million barrels per day, representing a growth rate of 1.4 percent year-over-year. OPEC’s latest monthly report released this week also reduced its 2012 demand estimate by 140,000 barrels per day to 88.87 million barrels per day, equating to global oil demand growth of 1.1 percent, slightly lower than that of the IEA.
• The western Corn Belt has now been threatened, as the severe drought that has gripped Texas, Oklahoma and Kansas for the past year has spread north into eastern Nebraska, northwestern Iowa, and southern Minnesota. Barclay’s Capital reported that while some improvement is expected in southern Minnesota over the winter, the drought is expected to persist in that part of the state as well as in northwestern Iowa at least through the end of the most recent forecast period ending February 29. Soil cores being taken in parts of Iowa are coming back dry while field agronomists have reported that the soil is dry to depths of five feet in northwestern Iowa, which is now experiencing severe drought, according to the U.S. Drought Monitor. Parts of the state are as much as nine inches behind in precipitation. Soil in southern Minnesota is just as dry.
• Deutsche Bank believes that a hazard for the commodities complex would be a further appreciation in the U.S. dollar, as historically this has tended to push commodity index returns lower.  The dollar has been on a relatively steady strengthening path since hitting 1.42 in late October. The U.S. dollar strength may be linked to increasing concerns towards funding issues in Europe, as the first quarter of 2012 will mark the peak of the funding schedule for the euro area and specifically Italy and Spain.  Despite opposed announcements from the European Central Bank (ECB) last week, the likelihood of a rate cut in Europe in early 2012 is still a conceivable scenario which, once realized, would further weaken the euro.

 

Emerging Markets

 

Strengths

• With depressed market prices, the China Region Fund has been able to pick companies that trade below book value, but still expected to grow revenue more than 10 percent a year.
• Indonesia’s sovereign debt was upgraded by Fitch Ratings to BBB- from BB+ with stable outlook. “The upgrades reflect the country’s strong and resilient economic growth, low and declining public debt ratio, strengthened external liquidity and a prudent overall macro policy framework,” said Philip McNicholas, Director of Fitch’s Asia Pacific Sovereign Ratings Group.
• Also in Indonesia, the Parliament passed the Land Acquisition Bill this morning, essentially eliminating deadlock in land use for public infrastructure construction. In the past, landowners could not be forced to yield their land for public use. With the new law, once the government has gone through some legal procedures with the landowners and has paid, the land is deemed for public use. This is significant for Indonesia since the country is planning to build massive infrastructure in the next five years. 
• Gou Shuiqing, head of China’s Retirement Pension Plan, said that China has 4 trillion in plan money that can be invested in stock market.
• China and Hong Kong agree to “deepen cooperation between the Mainland and Hong Kong in financial services and product developments. The new agreement on RMB Qualified Foreign Institution Investors (RQFII) will mark the first formal channel for yuan offshore to be invested in the China’s domestic markets.
• Korea’s unemployment rate was 3.1 percent in November, unchanged from the previous month.
• JP Morgan reported that the strongest performing sector of Chinese retail in 2011 has been gold, silver and jewelry retail. The driver behind this has been the demand increase from lower-tier cities where income levels are rising the fastest and improvements in retail infrastructure have allowed for rapid store expansion.  During the third quarter alone, China was the single largest market worldwide, accounting for 28 percent of global jewelry demand, and was one of four markets to show healthy growth (Hong Kong, Japan and Russia being the other three). 
• South Africa, which has the highest unemployment rate of 61 countries tracked by Bloomberg, added 59,000 non-farm jobs in the third quarter, increasing employment by 0.7 percent.
• Protests in Moscow and other Russian cities following parliamentary elections were mostly peaceful and received more national TV coverage than usual.  Authorities were keen to avoid any violence, and kept pro-regime demonstrators away from confronting the protesters.

Weaknesses

• China’s November M2 money supply grew 12.7 percent, lower than the market expectation of 12.8 percent. This was also the lowest reading since May 2001 when M2 gained 12.1 percent. November new loans were at 562.2 billion RMB.  Although this was higher than the market consensus of 550 billion, it was not large enough to improve market liquidity. China also saw foreign direct investment decrease 9.8 percent in November, indicating investors’ concern about slower growth in the country.
• China’s exports grew 13.8 percent to $174.46 billion, slower than 15.9 percent in October on a year-over-year basis. Imports gained 22.1 percent to $159.9 billion, with a shrinking trade surplus of $14.52 billion.
• Electricity consumption for November in China went up 9.9 percent year-over-year, easing 1.4 percent month-over-month, indicating slower industrial growth.
• HSBC China’s December purchasing managers’ index (PMI) was up 1.3 to 49 from 47.7 in November. Although the reading was improved, a PMI below 50 still indicates China’s economic activity is in contraction mode. 
• Philippine exports fell 14.6 percent year-over-year in October, declining for a sixth-straight month as demand for electronic products continued to sag.
• Roubini Global Economics highlighted that Brazil recently placed 73rd on the 2011 Corruption Perceptions Index, down from 69th in 2010. The most recent minister resignation was amid allegations of corruption, which also doesn’t look promising for the country’s reputation.  President Dilma Rousseff, who has displayed less tolerance for corruption than preceding presidents have, is set to formally replace a number of ministers in the new year. 
• South Africa’s inflation rose to 6.1 percent for the month of November, breaching the central bank’s target range for the first time in almost two years.  Higher fuel prices and a weaker rand were the two main drivers behind the acceleration. 
• Poland published a draft of its new copper tax bill that is to be instituted March 1, 2012.  Investors reacted negatively to the draft, with the belief that it was higher than expected.  KGHM is Poland’s sole copper producer, and was down over 11 percent on the news. The tax is to be paid monthly, and the Finance Ministry has set the maximum level of the tax at approximately $9,138 a ton. 

Opportunities

• The chart below is recreated from CLSA. It shows how Chinese stocks in Hong Kong and domestic B-shares (represented by MSCI China Index) rise and fall along with China’s M2 money supply. We anticipate the People’s Bank of China (PBOC) will be easing by creating more loans in the economy.

• Only a few days before beginning her second term in office, Argentina’s President Cristina Fernandez de Kirchner announced three major changes to her cabinet, welcoming in a new minister of agriculture, a new cabinet chief and a new finance minister. Markets reacted very positively to the new finance minister, Hernan Lorenzino, with five-year CDs dropping sharply in his first week’s appointment on hopes he will introduce more investor-friendly policies.
• In recent years, Turkey has ramped up capital spending in general and investment in machinery and equipment in particular, unlike other underinvested nations like Brazil, Mexico, Russia and South Africa that have failed to achieve higher investment ratios. Hence, the outlook for productivity gains in Turkey is superior to many other developing nations.

Threats

• According to Nouriel Roubini, a bailout would make everything work for Greece, whose GDP is expected to contract further for a fourth consecutive year to 5.7 percent year-over-year, before easing to 4.9 percent in 2012 and 2.1 percent in 2013.  RGE expects that should Greece be faced with a choice between years of austerity measures and recession, or an exit from the eurozone, that it will choose the latter.  Following an exit from the eurozone, RGE believes the country will regain competitiveness in 2013, by reissuing a national currency and allowing it to depreciate. This would allow GDP to fall by the increment of 2.1 percent that year.
• Hungarian government and local banks have reached an agreement on a five-year household foreign exchange loan aid program. The proposal provides an option to fix monthly installments for the next five years 35 percent below the current spot rate by sharing the losses between banks (two-thirds) and the state (one-third).
• The China Politburo meeting, in which economic policy direction for 2012 is set, concluded this week with the market being disappointed. Although the priority has become to support growth, followed by continuing structural change and maintaining price stability, China’s government clearly stated it won’t lift housing market curbs. With obvious down trend  in growth in GDP, exports, PMI, housing transaction and price, M2, bank deposit, new loans, the recent capital outflow added to the worries that China may face deflation risk. 

 

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