The S&P credit agency sent shockwaves through the global financial system on Monday when it issued a warning on U.S. debt and changed its outlook on the U.S. sovereign credit rating from “stable” to “negative.” This sent markets lower and the prices of commodities such as oil rocketing back above $110 per barrel and both gold and silver to new highs.

 

It should be clear the S&P announcement was just a warning, not a lowering of the U.S. debt rating, which was affirmed at AAA (the highest level possible). The fears quickly subsided and U.S. markets hit fresh three-year highs. Essentially there’s only a one-third chance of a downgrade and anyone who’s ever listened to the weather man knows that a 33 percent chance of rain means you probably don’t need your umbrella.

 

However, the warning validates what we already know: The U.S. needs a plan to address its debt and budget issues…and fast. Due to the fact that future fiscal austerity measures will likely act as a drag on the economy, we also think this opens the door for a third round of quantitative easing (QE3) heading into next year so we’ll have to keep an eye on Bernanke and the Federal Reserve’s next move.

 

These factors will likely produce downward pressure on the U.S. dollar and upward pressure on commodity prices. This is why we emphatically believe the bull cycle for gold still has a long way to run. (Read: The Bedrock of the Gold Bull Rally).

 

One of the things we recently pointed out was the effect money supply growth can have on gold. Last week, one of my fellow presenters at the Denver Gold Group’s European Gold Forum was Dr. Martin Murenbeeld from Dundee Wealth who put the notion of a “gold bubble” in context with the following chart.

 

 

If you compare the current bull cycle for gold against gold’s run from the 1970s and 1980s, you can see that today’s run has been slow and steady. It’s also missing the sharp spikes typical of a bubble.

 

Also, a key difference in this gradual move higher is the growing affluence of the developing world. There people have traditionally turned to gold as a store of wealth and we are seeing that in unprecedented numbers in countries such as China and India.

 

Dr. Murenbeeld also presented this fascinating chart showing how much gold would need to increase in order to cover the amount of money that has been printed since gold was revalued at $35 in 1934.

 

 

Using that as the cover ratio, gold would need to climb all the way to $3,675 an ounce to cover all paper currency and coins. If you use a broader—and more common—measure of money (M2), gold would need to rise all the way to $7,931 in order to cover the outstanding amount of U.S. money supply.

 

With gold pushing through the $1,500 level and silver above $46, many investors are questioning whether we’ll see a pullback. Going back over the past ten years of data, you can see that gold’s current move over the past 60 trading days is within its normal band of volatility, up about 7 percent over that time period.

 

 

Silver, however, has traveled into extreme territory. Over the past 60 trading days, silver prices have jumped over 58 percent and now register nearly a 4 standard deviation move on our rolling oscillators (see chart). Based on mean reversion principles, odds favor a correction in silver prices over the next few months.

 

We should be clear: If a correction occurs, this would not mean the rally is over. It would just be a healthy bull market correction and reflect the normal volatility inherent with these types of investments. Investors must anticipate this volatility before participating in these markets.

 

This volatility also brings along opportunity. We believe we’re only halfway through a 20-year bull cycle for commodities and investors can use these pullbacks as an opportunity to “back up the truck” and load up for the long-haul.

 

Director of Research John Derrick contributed to this commentary.

 

 

Index Summary

 

·         The major market indices were higher this week. The Dow Jones Industrial Index gained 1.33 percent. The S&P 500 Stock Index rose 1.34 percent, while the Nasdaq Composite increased 2.01 percent.

·         Barra Value underperformed Barra Growth as Barra Value finished 0.75 percent higher while Barra Growth gained 1.92 percent. The Russell 2000 closed the week with a gain of 1.28 percent.

·         The Hang Seng Composite Index finished higher by 0.79 percent; Taiwan gained 2.75 percent, and the KOSPI increased 2.71 percent.

·         The 10-year Treasury bond yield closed 1 basis point lower at 3.40 percent.

 

Domestic Equity Market

 

The figure below shows the performance of each sector in the S&P 500 Index for this holiday-shortened week. Eight sectors increased and two decreased. The best-performing sector for the week was technology which rose 2.99 percent. Other top-three sectors were materials and energy. Telecom services was the worst performer, down 0.67 percent. Other bottom-three performers were financials and consumer staples.

 

Within the technology sector, the best-performing stock was F5 Networks which rose 12.86 percent. Other top-five performers were JDS Uniphase, Apple, Qualcomm and Western Digital.

 

 

·         The consumer electronics group was the best performer for the week, rising 7 percent, led by its single member, Harman International Industries. The company announced that it had been chosen to supply branded audio solutions for certain automotive applications for Geely Motors of China, BYD Motors of China, and for a joint venture formed by BYD Motors of China and Daimler, AG.

·         The diversified metals & mining group was the second-best performer, up 7 percent, led by its single member, Freeport McMoRan Copper & Gold. The company reported quarterly earnings which handily exceeded the consensus estimate. Also, the price of copper and the price of gold increased during the week.

·         The computer hardware group outperformed, gaining 6 percent. Apple, the largest member of the group, reported quarterly earnings and revenue above the consensus estimates.

 

 

·         The motorcycle manufacturer group was the worst performer, down 6 percent on weakness in the group’s single member, Harley Davidson. The company reported quarterly earnings above the consensus estimate, but its U.S. sales declined 0.5 percent year-over-year.

·         The diversified support service group underperformed, losing 5 percent on weakness in the stock of its largest member, Iron Mountain. The stock had risen strongly over the last month since an activist shareholder laid out proposals to drive operational improvement. On Tuesday the firm laid out its strategic plan for enhancing shareholder value. The stock sold off after the plan was announced, so it appears that the projected improvements may have already been priced into the stock.

·         The diversified banks group lost 4 percent. All three members of the group (Wells Fargo, U.S. Bancorp, and Comerica) sold off after reporting earning this week. In general, banks are being challenged by slow revenue growth.

 

 

·         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.

 

 

·         Should investors’ expectations for an improving economy not come to fruition on a reasonable time frame, it could be a threat to stock prices.

·         Quantitative easing currently being implemented by the Federal Reserve might result in unintended consequences.

·         The nuclear disaster in Japan creates uncertainly, which is not good for stock.prices.

 

The Economy and Bond Market

 

Treasury bonds rallied sharply for the second week in a row sending yields lower across the maturity spectrum. The bond market was responding to weaker economic data but also to news that S&P placed the U.S.’s sovereign AAA credit rating on negative watch with a one-in-three potential of a downgrade in two years if the deficit issues are not adequately addressed. The chart below plots the U.S. 5-year credit default swap (CDS) spread (cost for protection against default in basis points) which spiked on the news early in the week but, as can be seen in the graph, is still within the recent range for this series. The bond market is well aware of the issues facing the country and this news is not really shocking. It validates the current debate in Washington over how to take debt-reducing action in the near future.

 

 

·         Leading economic indicators rose 0.4 percent in March, rising more than expected and a sign that continued economic expansion is likely.

·         March housing starts rose 7.2 percent and building permits rose 11.2 percent. Housing starts and permits bounced from very low levels but the numbers are still encouraging.

·         March home resales rose 3.7 percent and prices rose 2.2 percent in a sign housing activity may be picking up.

 

 

·         S&P placed the U.S. on negative credit watch, which shines a spotlight on the urgency of addressing the country’s debt situation.

·         Initial jobless claims fell to 403,000 but still remain above the 400,000 level.

·         Greek 2-year bond yields rose above 20 percent this week as default appears inevitable.

 

 

·         In an interesting twist, higher oil prices may actually act as a deflationary force if they materially slow the global economic growth.

 

 

·         Budget cuts and austerity measures in Europe and the U.S. are necessary “evils” but will likely be a considerable drag on global growth.

 

Gold Market

 

For the week, spot gold closed at $1,504.13, up $17.43 per ounce, or 1.17 percent for the week. Gold equities, as measured by the Philadelphia Gold & Silver Index, rose 3.24 percent. The U.S. Trade-Weighted Dollar Index slid 0.97 percent for the week.

 

·         After S&P lowered its rating outlook on the U.S., the gold price surged early in the week and reached an all-time high of $1,507 per ounce Thursday on a weak jobless claims report.

·         The University of Texas Investment Management Company, which manages the endowment for the Texas teacher’s pension fund, has placed 5 percent of its assets in gold bullion.

·         What is significant about this purchase is that the buyer has taken delivery of the physical gold into its own custodial accounts versus relying on an intermediary to hold the bullion through a paper claim on its behalf. This represents a purchase of $1 billion of gold bullion and makes a strong statement about the seriousness of pension funds treating precious metals as a legitimate asset class.

 

 

·         Negotiations for higher electricity prices are nearing conclusion, as Zambia expects to agree on higher electricity prices with mining companies this year in a move that is likely to increase costs for miners within the country, a senior industry official said.

·         David Rosenberg, chief economist and strategist at Gluskin Sheff, noted debt-strapped governments are pulling in around 9.5 percent more revenue year-over-year, showing the economy may be getting stronger.

·         Conversely this increase in government revenue may be a pick-pocket effect of governments’ having raised sales taxes, unveiled high income surcharges or boosted top marginal rates. This, along with the hammering the consumer has taken from rising food and fuel costs, is absorbing a near 23 percent share of wages and salaries.

 

 

·         There is chatter in the foreign exchange market that China may do a surprise 10 percent Yuan revaluation and Greece may strike a deal to cut its bonds by 40 percent. It would appear the Chinese government has guided multinational corporations to expect a 5 percent revaluation in the near term, but 10 percent is a big number and would likely support the gold price.

·         Earlier this week the Chinese supported the Spanish bond auction. Notably, the eurozone is China’s largest trading partner and it appears they may be more concerned about keeping the euro from collapsing versus a steady decline in the dollar.

·         Gold's decade-long bull run could continue in the next four years, though at a slower pace, with positive inflation risks partially cooled by a shift towards more normal economic conditions, analysts polled by Reuters said. The median forecast of 12 analysts polled in the past two days for the average price in 2015 was $1,700 an ounce. "Gold will be underpinned by sovereign debt in the eurozone, United States and Japan, as well as the dollar weakness and further reserves diversification by central banks," said Robin Bhar, an analyst at Credit Agricole.

 

 

·         A U.S. law threatens natural treasures including Grand Canyon National Park as mining claims on public lands proliferate, an environmental group said. The 1872 Mining Law, signed by President Ulysses S. Grant, allows mining companies, including foreign-owned ones, to take about $1 billion a year in gold and other metals from public lands without paying a royalty, according to a report by the nonprofit Pew Environment Group. Non-governmental organizations have been very successful in aligning themselves with state and federal regulators that see creating new rules as a means to greater job security.

·         Nevada mining operations may soon face three tiers of regulations and legislation aimed at eliminating constitutional caps on net proceeds of mines taxation and clamping down on net proceeds tax deductions. Senate Majority Leader Steven Horsford argued that state regulators need to close mining tax loopholes as soon as possible “so the state gets every dollar it’s entitled to.”

·         Jim Rogers, a well respected commodity expert, said “Silver and gold, yes, will be a bubble someday…There’s no question in my mind that all commodities will be a huge bubble someday. But I don’t think that bubble is going to happen in 2011. I think it’s going to be more likely 2017, or 2018…you know, a few years from now. I’m not picking a year, just saying its a few years away.”

 

Energy and Natural Resources Market

 

This section is unavailable today due to technical difficulties. It will be updated on Monday.

 

Emerging Markets

 

 

·         China has announced this week that it raised the minimum income tax threshold to Rmb 3000/month from Rmb 2002/month. This change is expected to help boost consumer spending. It will also help increase purchasing power in the wake of rising food prices.

·         According to news website Hexun.com, Zhou Wangjun, a deputy director of NDRC’s pricing department, has said China’s average wages will grow 15 percent annually in the five years through 2015. Wage increases will help China to become a consumption country.

·         The China State Council met on Wednesday to discuss fine points of reforms in relation to interest rate liberalization and a natural resources tax. Also in the meeting, China’s premier Wen Jiabao announced an additional $2.8 billion will be invested to improve shantytowns as part of a social housing program.

·         China telecom carriers have increased their capital expenditures for 2011. Total capital expenditure budgets are Rmb 132.4 billion, 74.8 billion and 50 billion for China Mobile, China Unicom and China Telecom, respectively. We expect telecom, 3G and 4G equipment providers and installation service companies to greatly grow their revenue and profits again this year.

·         Both Korea and Japan financial authorities stood up to support U.S. Treasuries after S&P placed a negative outlook on the U.S. debt rating.

·         Argentina’s industrial production grew by 8.5 percent during March.

·         The Polish zloty had its strongest gain in two months after the Polish government said it would use some 14 billion euros it expects to receive from the European Union this year to buy the currency in order to reduce the need for higher interest rates.

 

 

·         Over the week, the People’s Bank of China (PBOC) has raised the bank’s required reserve rate (RRR) another 50 basis points. The RRR is now 20.5 percent for large banks in China. The RRR is not expected to impact the banks on the liquidity they need for lending since the hike is basically used to withhold the proceeds of matured PBOC notes in April. However, authorities in the PBOC have said China still has room to raise RRR further. The Asian stock markets have shrugged off the news.

·         The Korean National Assembly has passed a bill to levy a capital tax on foreign currency liabilities on banks’ balance sheets at a rate of 0.2 percent.

·         Shares of America Movil (AMX) have been under pressure following the telecom regulator’s ruling that the company had engaged in monopolistic practices and imposing a $1 billion fine on the company. Market participants expect AMX to challenge this ruling in courts and the issue may not be resolved for years to come.

·         Real labor productivity in Eastern Europe still lags that of workers in Western Europe by a significant margin, according to a report from the World Bank.

 

 

 

 

 

·         Xia Bin, a monetary advisor to the PBOC, has recently suggested that RMB could be revalued to its fair value by one move. Directionally, RMB has been appreciating faster recently.

·         An appreciating RMB is a facilitator to Chinese outbound tourism. See the chart below showing increasing outbound spending by Chinese tourists. In 2010, Chinese tourists spent $55 billion overseas. This could rise to $190 billion by 2015. We have seen tourism-related companies perform well. Macau’s March visitor arrivals from China have increased 18 percent. We expect hotels and entertainment in Macau and Hong Kong to capture a large share of the booming outbound China tourism.

 

 

·         Cuba has introduced a series of economic reforms that include elimination of various state subsidies and allowing citizens to buy and sell real estate. We believe it is likely that the country will gradually gravitate towards the Chinese economic model that will see the growth of private enterprises with a guiding hand of the state.

·         The World Bank has predicted that Polish GDP will grow by 4 percent this year and by 4.2 percent next year, making it one of Europe's growth engines. Romania is expected to lead the pack in 2012 with 4.4 percent growth. Slovakia is also expected to see strong growth at 4.3 percent in 2012. “The performance of Slovakia and Poland is set to remain solid thanks to low pre-crisis imbalances, deep integration into European production networks, EU funds, and, in the case of Poland, solid consumption,” according to the World Bank.

 

 

·         Rumor has it that some hedge funds have gathered in Hong Kong ready to short China’s real estate bubble and inflationary asset price in general, expecting that China’s flying economy will experience a hard landing. However, China’s central bank governor Zhou Xiaochun, while giving a speech at Qinghua University this week, said that short plans cannot be implemented simply because China’s capital market has a firewall to insulate speculation.

·         Market participants will nervously await the first opinion poll on April 24 in the presidential race in Peru between Keiko Fujimori and Ollanta Humala.

·         Armenia's nuclear power plant is operating the first generation Soviet reactors (built without containment vessels) well past their retirement age and lies on some of the world’s most earthquake prone terrain, according to National Geographic. The combination of design and location make the facility a danger to the entire region.

 

 

 

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