Greetings from Istanbul!

With the U.S. government focused on sequestration squabbles, I wanted to make sure you didn’t miss my recent Frank Talk post that featured the wise advice from Terry Savage. You can read it below, followed by investing insights from my stay in Istanbul.

As I travel around Turkey, I am reminded how vital good government policies are to the health of a nation. Following a decade of fiscally responsible actions, Turkey is the picture of a growing prosperity. Perhaps America’s elected officials could take a tip from this vibrant country overseas.

Terry Savage Tells Washington to Stop Scaring America!

Investors are facing a political March Madness that will likely end in a disappointing deadlock if Congress doesn’t “start talking about a serious deal that includes the entire budget,” writes my friend Terry Savage in a recent email. The U.S. government is continually at an impasse over a spending cut of only $85 billion. Few would doubt that the figure is enormous; however, it is “just 2 percent of our $3.6 trillion in annual Federal spending. Every American family with a job has just taken a 2 percent cut—as payroll taxes rose in January. We survived—and Congress can too,” she writes.

Terry and I have known each other for years. She is financially savvy, dynamic, and incredibly versant on personal finance, the markets and the economy. She is also the author of The Savage Truth on Money, which was named one of the ten best money books of the year on Amazon.

Her email, and the subsequent article published in the Chicago Sun-Times, hits the nail on the head for the no-win situation that Americans have been feeling for quite some time.

According to recent data from the Pew Research Center, trust in government has sunk to a historic low: Over the last seven years, only 3 out of 10 Americans said they trust Washington to do the right thing always or most of the time.

The opinion holds across partisan lines, although more Democrats than Republicans say they trust government most of the time. Historically, the party in control of the White House receives a stronger conviction from its supporters, yet “partisan differences in trust in government have been much wider during the Bush and Obama administrations than during previous administrations,” says Pew Research.

This sense of distrust doesn’t appear to be getting through to Washington. “As reality sets in that there might be some limits to our ability to borrow and spend, Washington is insulting the American people with stories of impending collapse of government services because they need to cut 2 percent from their increased spending,” says Terry.

As Americans, you can voice your opinion by sending a message to your representative; as investors, you can manage your expectations and anticipate the volatility that will likely occur as politicians keep up their “March Madness.”

A New Chapter for Turkey?

Istanbul has been in the midst of a fantastic transformation from an impoverished population to one of affluence. Popping up among the beautiful Ottoman mosques, Byzantine churches, palaces and bazaars are ultra-contemporary art sculptures, shopping malls and lush landscaping. This blend of ancient with modern fits well with the young, vibrant and culturally diverse crowd that hangs out in the local cafes, shops and galleries.

My tacit knowledge of Turkey’s new-found prosperity and wealth supports the explicit knowledge I’ve learned from analysts’ reports.

Investment managers like me aren’t the only ones showing increased interest in Turkey. Secretary of State John Kerry visited Turkey this week during his first overseas trip as America’s top diplomat.

German Chancellor Angela Merkel, the powerhouse figure of the European Union, was also in Ankara recently to meet with President Abdullah Gul and Prime Minister Recep Tayyip Erdogan. The topic of their discussion is not new, but suggests a “new chapter” for Turkey. These leaders are picking up the conversation started years ago regarding Turkey entering the European Union.

Tim Steinle, portfolio manager of the Eastern European Fund (EUROX), says that unlike Greece, which fudged its numbers to join the EU, Turkey was held to a higher standard. But it doggedly pursued its aspiration, and in the process of implementing the EU accession chapters, such as the Right of Establishment & Freedom to Provide Services, Company Law, Financial Services, Information Society & Media, Statistics, Financial Control, and Science & Research, had modernized its economy, maki ng it competitive with those of Western Europe. In addition, open trade with the EU allowed it to build a diversified export economy.

Turkey’s admittance to the EU had stalled over Cyprus, but more recently, France and Germany seem to be warming to the idea. Under newly elected President Francois Hollande, France is opening another chapter to the accession, and Angela Merkel’s visit to Turkey is signaling a shift in Berlin’s position on Turkey’s membership.

This wasn’t the only time Turkey reformed its policies. In 2001, the country experienced its own devastating financial crisis, and as a result of that experience (with which the rest of the world can now sympathize), the government adopted tough, but important financial and fiscal reforms. These reforms helped the country rebound, and its strong banking regulations kept banks well capitalized compared to the U.S. and Europe.

In the charts below, you can see the result of the government’s determination. From 2010 through 2012, Turkey’s GDP exceeded that of Europe, the Middle East and Africa (EMEA), as well as the rest of the world. Through 2015, GDP is also expected to be greater than EMEA’s GDP as well as overall world GDP. Simply stated, Turkey “remains superior in the region,” says Wood & Co.

Turkey’s manufacturing sector, in areas such as the automotive industry, white goods that include refrigerators and washing machines, and glass makers, has also been growing in strength.

For nearly two years, Turkey’s purchasing managers’ index (PMI) has been significantly stronger than Europe’s and “outstrips global averages,” says Wood & Co. Although the PMIs around the world fell rapidly in mid-2011, Turkey’s manufacturing hasn’t fallen below the expansion number of 50 as often, and as significantly, as Europe. According to Wood, Turkey’s PMI also recovered, “signaling growth ahead.”

Turkey’s latest manufacturing PMI number of 53.5 in February was slightly lower than its January figure of 54.0, but manufacturing remains solid and in expansion territory. Businesses are reporting an increase in new orders, new products and new clients and “new business from abroad increased at the fastest pace since January 2012,” says HSBC.

With Turkey exhibiting positive demographics, strong consumer demand and an open, competitive economy, the country is at a figurative, as well as literal, crossroad between Europe and Asia. The European Energy commissioner Gunther Oettinger annoyed Germany when he suggested that the EU needed Turkey more than Turkey needed the EU: “I would like to bet that one day in the next decade a German chancellor and his or her counterpart in Paris will have to crawl to Ankara on their knees to beg the Turks, ‘Friends, come to us.’”

However, Spiegel Online reports Erdogan hinted that the emerging economy may consider joining the Shanghai Cooperation Organization instead. “The economic powers of the world are shifting from west to east, and Turkey is one of these growth economies,” remarked the prime minister.

My visit to Istanbul was thrilling, and I’m equally excited about the investment prospects for Turkey, as well as the entire emerging Europe area. U.S. Global’s Eastern European Fund (EUROX) is a unique way to gain access to this area, as a significant percentage of its holdings are located in Turkey. Read more about the fund here.

Tim Steinle contributed to this commentary.

Index Summary

• The major market indices generally finished higher this week. The Dow Jones Industrial Average rose 0.64 percent. The S&P 500 Stock Index gained 0.17 percent, while the Nasdaq Composite rose 0.25 percent. The Russell 2000 small capitalization index was the exception, closing the week with a 0.16 percent loss.
• The Hang Seng Composite rose 0.68 percent; Taiwan advanced 0.21 percent and the KOSPI gained 0.38 percent.
• The 10-year Treasury bond yield fell 12 basis points this week, to 1.84 percent.

Domestic Equity Market

The S&P 500 rose modestly this week bolstered by the Federal Reserve Chairman Ben Bernanke’s comments on his commitment to continuing the current quantitative easing (QE) program. The Fed’s commitment came into question last week as the market reacted to Fed minutes from the January 29-30 meeting that indicated policymakers were concerned with the risks surrounding the current QE program and the possibility that is could be curtailed as soon as March.

Strengths

• Defensive areas generally outperformed again this week as the telecom sector led the way. The big heavyweights in the sector, Verizon and AT&T, saw steady appreciation throughout the week.
• The consumer discretionary sector was also strong this week. The home improvement retailers Lowe’s and Home Depot both reported earnings this week and investors were enamored with a strong report from Home Depot; the stock rose by more than 5 percent this week.
• Dollar Tree was the best performer in the S&P 500 this week rising 10.1 percent. The company reported earnings that were more or less in line with expectations but it appears the street was braced for worse news and the stock rallied.

Weaknesses

• The financials sector was the worst performer, but losses were modest as the sector gave back some recent gains.
• The technology sector also underperformed as sector heavyweight Apple fell 4.5 percent on disappointment surrounding the company’s annual meeting this week. It was expected that the company would make an announcement regarding capital allocation and possibly returning cash to shareholders, but no such announcement was made and the market was disappointed.
• First Solar was the worst performer in the S&P 500 this week losing 25 percent. The company reported fourth-quarter earnings and issued disappointing first-quarter earnings and revenue guidance and delayed making full year 2013 forecasts until the company’s analyst day on April 9.

Opportunity

• After selling off last week after a strong start to the year and following that up this week with Italian elections that create considerable uncertainty for Europe, the markets resilience is commendable and likely bodes well for the near future.

Threat

• A market consolidation wouldn’t be a surprise after a strong start to the year.

The Economy and Bond Market

Treasury bond yields fell this week as Federal Reserve Chairman Ben Bernanke reaffirmed the Fed’s commitment to the current quantitative easing program. The Fed’s commitment to the program came into question last week due to mixed views from Fed officials, which came to light after release of the minutes to the past meeting. This week, the Treasury auctioned $99 billion in 2-, 5- and 7-year notes with yields of 0.26 percent, 0.78 percent and 1.26 percent, respectively. On a year-over-year basis the consumer price index is up 1.6 percent through January. Investors who bought those bonds appear likely to experience negative “real” returns (inflation adjusted) over the life of the bonds. For investors who can take on some additional risk, there may be better yielding alternatives. For example, the Tax Free Fund (USUTX) and Near-Term Tax Free Fund (NEARX) had a higher 30-day SEC yield on a tax-equivalent basis based on a 35 percent tax rate as of December 31, 2012. For the funds’ annualized returns, click here.

Strengths

• The ISM Manufacturing Index rose to 54.2 in February, hitting the highest level since June 2011 in a somewhat surprising show of strength.
• Consumer confidence jumped in February, shaking off the decline the month before. While still at a low level on an absolute basis, the quick bounce back is encouraging. Improved outlook for jobs and improving business conditions were cited as drivers.
• Fed Chairman Bernanke reaffirmed the Fed’s commitment to continued QE.

Weaknesses

• China’s Manufacturing PMI for February unexpectedly fell to 50.1. The Chinese government also announced rules to reign in home price appreciation, which will likely slow activity in the housing market.
• Durable goods orders fell 5.2 percent in January. The caveat is that the decline was driven by volatile aircraft orders, implying that the underlying trend is better than the headline.
• Construction spending unexpectedly fell by 2.1 percent in January.

Opportunity

• The Fed still remains committed to an extremely accommodative policy until the economy improves.
• Key global central bankers are still in easing mode such as the European Central Bank, Bank of England and the Bank of Japan.
• Treasuries benefitted from political turmoil in Italy this week, which looks likely to continue for at least a few weeks.

Threat

• The economy appears to be gaining momentum, the risk for bondholders is that this trend continues, and bonds selloff.
• Inflation in some corners of the globe is getting the attention of policy makers and may be an early indicator for the rest of the world.

Gold Market

For the week, spot gold closed at $1,575.23, down $6.17 per ounce, or 0.39 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost 2.14 percent. The U.S. Trade-Weighted Dollar Index gained 1.02 percent for the week.

Strengths

• Ivan Glasenberg, CEO of Glencore, was very critical of his mining peers when he spoke at the BMO Capital Markets Conference last Monday. His remarks on excessive mine building, production and resource growth irrespective of cost, which negatively impacted returns to shareholders over the past several years, echoed the calls for management discipline by investors. Glasenberg called for its peers to stop the development of new mines in order to prolong higher prices for commodities and return more cash to shareholders.
• The China Gold Association has reported domestic demand for gold at 832 tons in 2012, up nearly 10 percent year-over-year. Over the same year China’s gold mines produced a record 403 tons, a 46 percent increase in output over the last 5 years. The China Gold Association highlights that despite the rapid increase in production from local mines, demand for the metal is growing at a faster pace, thus increasing demand for gold imports.
• The World Gold Council, along with the major gold producers, is working on developing a new definition for reporting the cost to produce an ounce of gold. Currently they are testing investor acceptance of an “all-in cash costs” per ounce rather than the so called “cash costs” developed in the 1990s. This is a step forward towards more transparent reporting and a big effort to win back investor confidence, but the currently proposed method seems to fall short of expectations.

Weaknesses

• The BMO Capital Markets Conference held this week in Florida evidenced a subdued interest in the gold mining sector. Senior producers are expected to be prudent with capital spending; juniors are continuing to see a hold on project financing, and the M&A space appears to have many deals close to materializing, but very few are actually doing it. Some attention has shifted to the copper space as industrials have been outperforming the mining sector as of lately.
• Excessive share dilution among gold producers is one of the explanations for underperformance that our team has been consistently mentioning over the last year. As producers dilute their share structures, cash flows and income are divided among a larger pool of shareholders, leaving each shareholder with a smaller portion of the gain. Louis James at Casey Research has published facts that add color to this theme; since 2003 gold producers have more than doubled their outstanding shares while the S&P 500 members of more than 10 years, have only increased their outstanding shares by 7 percent over the same time period.
• The Mongolian government has taken a strong stance towards Rio Tinto and the massive Oyu Tolgoi copper project. The central government accuses Rio Tinto and its partners of failing to pay taxes and overspending on the project (the government owns a 20 percent stake). Rio Tinto in the mean time has vowed to stand its ground and has accused the Mongolian government of using the project as a means of swaying public opinion ahead of this year’s presidential election. Rio Tinto has opted to defer its first copper sales coming from the mine until the issue has been resolved.

Opportunities

• CLSA’s Laurence Balanco notes on his latest Derivatives Report how large sell-offs in gold over the past two weeks have accelerated below the lower boundary of the October 2012 peak and resulted in a $1,520 - $1,550 support zone. Furthermore, he reports the Bloomberg Commodity Sentiment Gold Bullish reading reached the 30 percent mark, which according to his research signs a buying opportunity. Since 2004 there have been 13 previous observations where the reading has reached 30 percent; the 12-month return immediately following the reading has been positive for all 13 occasions, with an average return of 21 percent.
• In a recent interview, Mike Niehuser, founder of Beacon Rock Research, spoke about the macroeconomic fundamentals signaling a higher gold price. A significant decrease in the velocity of money (read: spending fear) has left Bernanke’s massive Treasury purchases alone to sustain nominal output. In his opinion, once inflation starts picking up, velocity will increase too fast and inflation will become a real problem, leading to higher prices of real assets, mainly gold.
• On March 1, 2012 Federal Reserve Chairman Bernanke made comments to U.S. Congress that suggested future quantitative easing from the Fed was unlikely. Exactly one year later it is clear further easing was, and continues to be, necessary. On the same note, James Rickards, author of the best-seller Currency Wars, mentioned during the Gold Stock Analyst conference last Sunday that the Fed’s balance sheet will likely reach $4 trillion by year end and $5 trillion by the end of 2014. In his opinion, the Fed will not be able to materially change its easing program until then. What this means for gold, is that assuming a 40 percent gold-backed standard, an ounce of gold should be priced between $6,000 and $7,000 just to cover currency in circulation and demand deposits.

Threats

• Rickards’ theory of $6,000 gold has a lot of merit, but according to him there is strong political will to avoid it; at least in the near-term. His main argument for gold trading at current levels has to do with China’s steady accumulation of gold. A big part of China’s accumulation of U.S. dollars is being speedily exchanged for gold reserves, as it anticipates a long period of U.S. dollar devaluation. He argues it is in the best interest of the U.S. to maintain gold prices at current levels and allow China to increase its gold reserves for the time being, for a rapid devaluation of the U.S. dollar, or rapid appreciation of gold in U.S. dollar terms would lead to retaliation from China, and in a worst-case scenario to a full out war.
• During the week ended February 27, money managers took a record $4.23 billion from commodity funds according to EPFR Global. Most of the withdrawals were made from gold and precious metals funds; an all-time high of $4.03 billion. As negative as this is for commodity and mining stocks, record setting money outflows traditionally coincide with a market bottom.
• According to Goldman Sachs’ latest Precious Metals Research, most of the price decline in gold over the past months can be explained by a gradual increase in U.S. real rates supported by stronger economic data and the perception that QE3 could end earlier than anticipated. However, the fall of bullion prices over the last two weeks has far exceeded any changes in real U.S. interest rates, leading analysts to believe the lower market risk premium has waned investors’ conviction in holding long gold positions. Goldman Sachs warns that a continued waning of conviction in gold could lead to a faster and larger drop in bullion prices than they anticipate.

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Energy and Natural Resources Market

Strengths

• There are some positive signs from Japan. According to the Ministry of Economy, Trade and Industry (METI), Japan’s crude imports grew 3.2 percent year-over-year to 20.03 million kiloliters in January. Also, the country’s crude steel output rose 3.5 percent month-over-month to 8,863,052 tons in the same month.
• Coal India's coal production grew 4 percent to 46 million tons in January, the Indian government said.
• Chilean copper production continued to run strongly into 2013, according to data released by the INE statistics agency. Chilean miners produced 475 kt of copper in January, an 8.6 percent expansion from a year earlier, on higher ore grades and improved productive capacity at some deposits.

Weaknesses

• Copper Stockpiles at the London Metal Exchange rose 1.5 percent to 430,725 tons, and is at the highest level since October 28, 2011.
• Higher fuel prices and further energy conservation led U.S. crude oil consumption to fall 2.08 percent to 18.56 million barrels per day last year, the Energy Information Administration (EIA) said.

Opportunities

• China plans a major overhaul of its bond market to ensure it is capable of raising around $6 trillion needed to bring around 400 million people into cities over the next 10 years. The new leadership plans to turn China into a wealthy world power with a large affluent consumer class and views urbanization as key to this goal, according to JP Morgan.
• Indonesia’s liquefied natural gas (LNG) demand is likely to increase by 45 million tons per annum by 2025, and should become one of the key drivers of LNG demand growth in Asia, as its domestic production declines and exploration efforts come up short, according to Wood Mackenzie.
• India’s coal imports are likely to be 185 million tons in the year 2016-2017, the Finance Minister said.

Threats

• Coal’s share of China’s energy consumption mix will drop from 68.4 percent currently, to 52.8 percent by 2020, according to Deutsche Bank, as the economy moves towards more clean technologies such as gas and hydro. Given China’s dominant role in production and world-seaborne markets, this would potentially have a negative impact on global coal prices.
• Australia’s 2012 Survey of Planned Capital Spending has shown the first evidence that mining capital expenditures may have peaked. Moreover, the study implies that certain commodity sectors such as gold and thermal coal are only at the initial stage of the cutback cycle.

Emerging Markets

Strengths

• The China Securities Regulatory Commission said there is no time table for resuming public offerings, Xinghua reports, citing an unidentified official with the regulator.
• China’s Power Industry Group expects Chinese power consumption to rise between 6.5 to 8.5 percent in 2013, and GDP to rise between 7.5 to 9.5 percent. Many analysts believe there will be more policies to come out from two March conferences in Beijing for wind and solar subsidies, due to severe pollution in Beijing and elsewhere in China, which made clean energy a policy a priority.
• China Internal Capital Corporation’s (CICC) property analyst Eric Zhang, believes Chinese property policy risks have largely been priced in. The current sector valuation has a 45 percent discount to the NAV, and 7.6 times 2013 estimated earning per share and one time price to book ratio, which seem very attractive.
• Macau’s February gaming revenue was up 11.5 percent, better than the market expectation.
• Thailand’s February inflation softened to 3.23 percent lower than 3.39 percent in previous months and better than expected 3.3 percent by the market. Food prices fell during the month. Also in Thailand, January exports were up 16.1 percent higher than both previous months and market expectation, which are 13.45 and 13 percent, respectively. Imports were up 41 percent; in particular gold imports were up 133 percent causing a wider trade deficit than the previous month.
• Korea’s January industrial production went up 7.3 percent year-over-year, though down 1.5 percent month-over-month and exports were down 8.6 percent, better than the estimate of down 9.2 and 10.9 percent in the previous month. The economic trend is stabilizing.
• The Philippines expanded broad money (M3 money supply) by 10.6 percent in January after a 10.6 percent rise in December, which facilitated nominal GDP growth.
• A recent survey by Frontier Strategy Group showed that a majority of its more than 200 multinational clients report Latin America is their most profitable emerging market region. On average, Frontier’s clients report 55 percent higher operating margins than in Russia, China and India. The rising middle class demand for more and better products, together with demand factors that allow for setting comfortable operating margins and the realization of economies of scale, have propelled the region into its current position.

Weaknesses

• The HSCI China flash PMI was 50.4 versus consensus 52.2 for February. China’s official February PMI was 50.1, lower than the estimate of 50.5, due to the effect of the Chinese New Year. The number indicates weaker recovery in a cyclical upturn economy and may, therefore, push back any attempt of monetary tightening by the central bank.
• China has announced five policies to curb housing prices overnight after market close in Hong Kong and China, which included a housing price target, purchasing restrictions, higher down payment and interest rate on second home purchases, transaction stamp duty taxes, and roll-out of property taxes to more cities. China International Capital Corporation’s (CICC) analysts say these measures are consistent with the summary from the state council meeting last week, and would not expect material impact on the primary property market where developers belong. Nevertheless, the new policy proposed a 20 percent capital gain tax on existing home sales, which will stir a huge debate and may not be welcome among the home owners.
• The People’s Bank of China (PBOC), the central bank, did not inject money into the economy this week after net withdrawal last week.
• In Hong Kong, the government doubled stamp duty to curb property speculation due to rising housing prices. The new stamp duty taxes can go as high as 8.5 percent for property valued at more than 20 million Hong Kong dollars.
• Indonesia’s February inflation was 5.3 percent, higher than consensus 4.8 percent and previous 4.6 percent. The increase was primarily caused by soaring food prices and import quota on beef and live cattle during the flood in the month.
• Brazil reported Q4 GDP growth of 0.6 percent slowing fiscal year 2012 GDP growth to 0.9 percent. Growth has slowed for two consecutive years now, and places Brazil significantly behind its major emerging market peers. The central government has lowered benchmark rates to record lows, depreciated the real, and pressured banks to extend lending without tangible success. A lack of clarity on fiscal policy guidance and exaggerated government intervention will continue to undermine investor confidence.

Opportunities

• As shown in the BCA Chart above, due to strengthening U.S. dollar and weakening yen and euro, the trade-weighted renminbi is rising. The appreciating renminbi makes imported goods cheaper and helps slow down inflation at a time when global central banks are increasing money supply.
• Canada’s Foreign Minister made a diplomatic mission to Latin America last week in an effort to boost economic and diplomatic relations with a region that has shown resiliency in a time of global recession. The visit is seen as a reinforcement of Canadian Prime Minister Stephen Harper’s “re-engagement in our hemisphere” policy; a Canadian recognition of the fact that more investment in the region is warranted as Latin American states have begun to adopt a posture of economic expansion into other dynamic economies on their Pacific Ocean side.
• Chancellor Angela Merkel of Germany arrived in Turkey this week for talks with Prime Minister Recep Tayyip Erdogan, holding out hope for new impetus in the stalled negotiations for the country to join the European Union.

Threats

• Increasing total social financing, in addition to global monetary easing in the U.S., Japan and Europe, has caused the PBOC to worry about inflation risk. The recent news had it that China may tighten money supply slightly by raising bank reserve ration for some selected banks. Today’s new housing tightening policies may cause real estimate investment and property transactions to slow, which can be directly negatively impact demand in materials and household items.
• There is a new round in the Paul Singer vs. Argentina scuffle, where the country is attempting to overturn a November 2012 ruling to pay $1.33 billion to the 2001 default holdout creditors. President Fernandez has vowed not to repay holdout investors more than the 30 cents on the dollar paid to other debt holders in two previous restructurings, regardless of the court’s verdict. If the previous ruling is upheld, Argentina will have difficulties in re-routing its debt servicing payments, as banks will avoid the risk of being deemed to be in contempt of court. Buenos Aires’ Merval Index is down 15 percent from its 2013 highest levels.
• Sectors which are perceived to be relatively free of government intervention in Brazil are standing at massive valuation premiums to the rest of the markets, which leads Deutsche Bank to be wary of the Brazilian consumer sector in particular.

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