A Chinese sage once suggested it was good to live in interesting times, advice often mangled in translation. Readers should thank their ancestors for providing them for the current opportunity. Do not waste it, gentle readers.
Some of the US time series have been updated. The leading indicator shown below is still rising, a good sign, but the pace is slowing and de-accelerating. This is not a surprise as a recent Raff Report considered capacity utilisation, which is rapidly closing in on the long-term average and several time series for durable goods orders are close to or at a cyclical peak
It is not all bad news with new orders for nonferrous metals still very strong and spiking higher, most likely because of a strong recovery in new orders for motor vehicles and parts (see below). It seems that households have delayed buying new vehicles that are now seen as necessity. Although not shown in this Raff Report, orders for nonferrous metals have risen when LME prices are falling, implying a rise in orders in terms of volumes/tonnes of metal.
A graph showing durable goods orders over the long-term, since January 1969, is shown next. The writer believes that when New Orders for Manufacturing Durables are shown in real and nominal terms that the trend in real terms is symptomatic not only of the US, but also of most of Europe with Spain suffering dreadfully. The GFC, as bad as it was, masked a much greater problem for western economies. The year 2002 signaled the start of a structural change in global manufacturing. It was impossible for many goods manufacturers in North America and Europe to adapt to the dynamic quickly and as a result legions of workers in Europe and America are replaced by workers in China, India and other low cost emerging economies.
This structural change in terms of manufacturing means that there has to be a drop in the contribution to global manufacturing in some countries. In the case of the US, it seems that this change in dynamics is going to show up in orders for durable goods in real terms peaking at lower levels. This will also ensure that some elements of durable goods like machinery orders appear to have already peaked. The Raff Report sees this as a structural change, not a cyclical change. There is not a lot of debate on this matter, probably because nobody has a plan to remedy the situation.
Here is the picture of orders for vehicles and parts that have risen back to pre-GFC levels.
A high level of unemployment is a recipe for social unrest. This is evident in a number of European countries with migrants as minority groups under attack from those unemployed that consider themselves nationals by birth and hereditary right.
The cost to maintain social cohesion through payments by way of social services is set to soar. There is a limit to bailouts from central banks and the IMF. By necessity the printing of money or so-called quantitative easing will continue. The piper has to be paid. Government spending is accounting for an increasingly higher proportion of GDP; funnily enough debt usually has to be repaid by printing more money, borrowing more or as in the case of Greece, slashing costs. The latter is generally unpalatable although the Irish have had to adapt to hard knocks.
Perhaps a reversal in bond yields might be triggered by governments need for cash. We should all ponder Australia borrowing a $100M per day and when the Government will have to raise returns on its domestic paper that it issues to attract investors.
Members of the Government constantly tell us, that the strong Australian economy and one, which is a fantastic one to do business, is the reason foreign capital is deployed here to develop resource projects. Of course it has nothing to do with the fact that Australia is blessed with commodities, which other countries want and need?
Markets are pre-occupied with daily events and the attempts of hedge funds within investment banks to generate turnover seem to have no bounds. Private investors should be aware that hedge funds have a mandate to take short positions in markets so that they are not always on a loosing streak when markets fall.
Gold might be under-performing in the short-term but the underlying fundamentals for the yellow metal have not changed. Global capital costs and operating costs are rising apace and central banks will ensure that in the medium- to longer-term fiat currencies will depreciate against gold and other metals. The Raff Report still expects to see gold sharply higher by year-end.
The market seems polarized between the proponents for deflation and those proposing a move into an inflationary environment. It seems that deflation is carrying the day, which is not a positive for gold. But the bond market will eventually reverse and interest rates and prices will rise and gold will come back into vogue as a hedge against inflation.
The Raff Report has been very positive on the price of gold and is surprised by a weaker gold price that may reflect the notion that the bond markets are signaling a strongly deflationary recession. If this were so and holders of gold say in ETF funds were selling, then this would surely show up in recent trading. It would appear that a lower gold price over recent days has sparked an increase in demand for gold bullion. Although it is noteworthy that there has been little increase in gold held over the past couple of years, at least in volume terms, but not of course in terms of value the amount held have risen sharply. Some investors have obviously profited greatly.
At this juncture it is worthy to consider the World Gold Council (WGC) report for May 2012. Assuming that the WGC can measure the supply and demand for gold with a fair degree of accuracy then recent trends are noteworthy. These trends are shown in the following tables that have been cut and pasted from the WGC web site.
Industrial demand for gold in 1Q12 was well down on a year ago and demand for gold bars fell 18% on a year ago. This seems surprising because demand for gold by ETF funds soared from an outflow of 62.1 tonnes for 1Q11 to an increase of 51.4 tonnes in 1Q12; in other words there was a turnaround of 113.5 tonnes or 3.65M ounces. ETFs are gold backed and on the ETF Securities’ web site you can see the serial numbers of each gold bar held. 1Q12 demand for gold medals and coins was up 7% on a year but otherwise there was no other joy.
Some of Henry’s readers might have seen a recent segment on gold shown on CNBC. This was an interesting segment because it took viewers from the deepest gold mine in South Africa to the largest western jewellery manufacturer in the United States. It also took viewers into HSBC’s gold bullion vault in London at a secret location; a very impressive sight with pallets of gold bars stacked to the ceiling. HSBC is a custodian for the likes of ETF Securities. The guy from HSBC in charge of this side of the business, perhaps not surprisingly, had a very positive view of gold. Why was this?
The answer is simply that the mine supply of gold falls far short of total demand. The WGC estimated that world mine supply of gold in 1Q12 was 678.8 tonnes. The other major source of gold is recycled gold or scrap that added another 391.5 tonnes to supply. Mine supply only just covered jewellery and industrial demand of 627.5 tonnes; to this figure is added investment demand of 389.3 tonnes and demand from the official sector of 80.8 tonnes.
It is impossible to forecast what the price of gold has to be to attract sufficient scrap gold to balance supply with demand. The view from HSBC is that the current situation is unsustainable in the long term. The Raff Report certainly agrees with this but of course the timing for a choke point to develop and put a rocket under the price of gold is impossible to predict.
Keen watchers of gold equities and gold price will know that until recently gold equities have dreadfully under-performed gold bullion. The main reason for this is because the lofty price earnings ratios (PERs) that North American gold companies used to trade on; high teens and sometimes higher, have contracted to more sensible levels. However, as things stand today, gold stocks and indeed most mining stocks are trading on historically low PERs.
Pundits in the financial like to compare earnings yields with bond yields. An earnings yield for a listed company is simply the inverse of the PER. Bill Matlock is a regular contributor to the Kitco Metals web site and provides regular updates concerning the current valuation metrics for a large number of mining companies. For instance the large gold producers were recently trading on an average PER of 10X for 2013, and an average cash flow ratio (CFR) of 7.5X for 2013. Corresponding multiples for mid-cap and small gold miners were PER 11.6X and CFR 7.5X and PER 7.7X and CFR 5.5X respectively. The major miners like BHP were trading on an average PER of 7X and a CFR of 5.4X.
Taking the inverse of these PERs, the earnings yield ranges between 8.62% for mid-cap gold stocks to 14.3% for major miners that includes BHP and Rio. With bond yields still rising and yields still falling in key world markets and heading well below 1.5% (recently negative in Germany if only for a day, meaning investors were paying the Bundesbank to look after their cash), the gap between earnings yields and bond yields continues to grow. The Raff Report does not have a database on these metrics but the difference makes equities very cheap relative to bonds. And it’s not just mining stocks that are cheap as industrial shares are likewise cheap.
Something major is about to happen within global financial markets. If the European problem gets a band-aid and there is a defined pathway to reform and recovery then global equity markets will stage a significant rally. At some point in time there will be a blood letting in the bond markets when prices fall and yields rise.
A fantastic opportunity is developing for investors with cash to make above average returns from equities. These chances might only happen half a dozen times in a lifetime. One thing is for sure, and that is there are huge amounts of cash currently being withheld from equity markets. This is painfully obvious in the difficulty small miners and explorers are having in raising new funds. As a result all eyes are on Chinese sources of capital. But even this source will dry up if China re-routes capital to stimulate domestic demand
As always It is all about timing, timing is everything, but once again we should recall those famous words of Winston Churchill at the Yalta Conference which went something like this: “it is always wise to look ahead, but difficult to look further than you can see”.