There’s nothing like a little fear and loathing for putting a shine on gold prices. Indeed, concern over everything from the U.S. economy heading into recession to the possibility of sovereign debt default in Europe has been cited as the force behind gold’s meteoric price rise, reaching a record $1,917.90 per ounce on August 23. Just one day later, gold experienced its biggest one-day drop in 18 months, with prices off about 5% at $1,763 at mid-day. The reason most commonly cited for the price decline is a collective sigh of relief as the aforementioned fears appear to be somewhat alleviated--at least for now along with probability of QE3 seeing less likely.
Traditionally, gold has been viewed as the “safe haven investment;” the place to (presumably) put your money because you’re quite certain that “Financial Armageddon” is just around the corner. The fact, however, is that while fear may spark gold’s rise, when financial calamity finally strikes, it’s usually a reason to sell, hence the old adage “buy the rumor sell the fact”. Additionally, when financial calamity hits, the owners of gold, like central banks around the globe as well as large fund managers need to sell assets to cover depreciating assets and pay liabilities and this drives gold prices lower.
Gold truly is a “buy the rumor, sell the fact” commodity. Consider what happened in 2008. During the first half of the year, gold rallied to more than $1,000 an ounce on fears of a pending crisis. When the crisis hit in the second half of the year, however, gold prices actually went down, trading below $720 an ounce.
Now, with gold having made a run at $2,000 an ounce, there just doesn’t seem to be a compelling reason for it to stay at such lofty levels. Even news of fighting in the Libyan capital of Tripoli, as rebels appeared to close in on Moammar Gadhafi--a significant geopolitical development--did not keep gold prices at their recent highs. This is all the more reason to expect that gold prices may have topped. As I see it, there are more reasons for gold to continue to drop than for it to reverse course and rally significantly again. First the reasons that gold will likely sell off:
The doom that everyone has feared actually hits, whether it’s another Euro-Zone debt debacle or fresh evidence that the U.S. economy is about to go into a tailspin. As I stated, fear bolsters the rally, but when the bad news comes into fruition, investors sell and gold drops.
The threat of doom subsides. Stocks begin to trend higher, interest rates raise a touch and gold eases under its own weight. Once again, investors sell.
The only reason that gold could keep rallying is a new perception of impending doom. I don’t believe this would work for the return of an old fear, because investors tend to shrug these things off as “Oh, that old worry is coming up again?” There would have to be a new fear factor in the market to create any significant upside potential for gold from here and one that was unlikely to materialize in the near term but create fear that it could.
Looking at the three scenarios--disaster strikes for real (sell), fear of disaster fades (sell), fear of a new disaster rattles the market (buy)--I think the shine is off gold.
Thursday, August 25, 2011
Thursday, August 11, 2011
Signs Point Away from Treasuries…But Not Because of S&P Rating
August 10, 2011 will go down in financial history. On this day, the S&P’s dividend yield at the close was 2.17%, which was above the yield on 10-year Treasuries of 2.14%. This was only the fourth such occurrence since 1958, with 1962 and 2008 providing the only other modern-day examples. More interesting to note is what it could potentially signal.
Although the sample size is quite small, based on the three previous occurrences when the S&P dividend yield was above that of Treasures, the average return on S&Ps 12 months later was 18.5%. Even 2008, in the midst of a financial market meltdown and with equity dividend yields being quickly reduced, produced a positive return of 23.5%.
The obvious question now is will history repeat itself?
To be clear, there could be more downside in the market because no one can time a bottom very well, especially when investors are panicking and irrational behavior prevails in the short-term. But a decline in confidence is very different from a decline in financial worthiness. Fundamentals do matter, and they are not as bad as the recent market activity would indicate. In fact, if the fundamentals worsen, it appears this scenario has been priced in. Even if we do enter a recession, most of the damage to the market probably has been done already because the average market decline from peak to trough is about 25%.
No one knows for sure if history will be repeated, but the fundamentals are much more favorable now than during the last S&P dividend yield occurrence in 2008. Today, there is no liquidity crisis, as there was three years ago. Corporations are flush with cash. Corporate profits are at record levels, and more than 70% of earnings reports in Q2 2011 beat estimates. Additionally the broad economic data is still positive, admittedly slow, but positive none the less. We are adding about 150k jobs per month on average and GDP at the last look was +1.3%. These are slow but positive numbers that against the back drop of the recent equity markets moves seem to have a disconnect.
Now, enter the Fed’s latest announcement meant to assure the market in the wake of the S&P U.S. debt downgrade. The Fed took the unprecedented step of signaling future action and putting a date on it. In the past, the Fed has said it will keep interest rates exceptionally low for an extended period of time. Earlier this week, it said rates will be kept at these low, accommodative levels until at least mid-2013.
Reading the Fed’s tea leaves we arrive at two very interesting conclusions. First of all, the Fed has, in essence, thumbed its nose at S&P and its debt downgrade. Normally a reduction in credit worthiness drives up rates because investors have to be enticed to buy debt that, supposedly, is more risky. Bernanke and Company, however, have essentially told S&P: “You think rates are going up? Guess again. We’re keeping them low for two years.” No silly downgrade is going to raise rates, not on Bernanke’s watch—unless, of course, economic fundamentals deem such a move appropriate.
Further, the Fed is stating very clearly that investors will get nothing—nada, zero—in interest on short-term fixed income investments for two years, so look for something else. As investors look for other opportunities the obvious place will be stocks and the market appears to agree.
Although the sample size is quite small, based on the three previous occurrences when the S&P dividend yield was above that of Treasures, the average return on S&Ps 12 months later was 18.5%. Even 2008, in the midst of a financial market meltdown and with equity dividend yields being quickly reduced, produced a positive return of 23.5%.
The obvious question now is will history repeat itself?
To be clear, there could be more downside in the market because no one can time a bottom very well, especially when investors are panicking and irrational behavior prevails in the short-term. But a decline in confidence is very different from a decline in financial worthiness. Fundamentals do matter, and they are not as bad as the recent market activity would indicate. In fact, if the fundamentals worsen, it appears this scenario has been priced in. Even if we do enter a recession, most of the damage to the market probably has been done already because the average market decline from peak to trough is about 25%.
No one knows for sure if history will be repeated, but the fundamentals are much more favorable now than during the last S&P dividend yield occurrence in 2008. Today, there is no liquidity crisis, as there was three years ago. Corporations are flush with cash. Corporate profits are at record levels, and more than 70% of earnings reports in Q2 2011 beat estimates. Additionally the broad economic data is still positive, admittedly slow, but positive none the less. We are adding about 150k jobs per month on average and GDP at the last look was +1.3%. These are slow but positive numbers that against the back drop of the recent equity markets moves seem to have a disconnect.
Now, enter the Fed’s latest announcement meant to assure the market in the wake of the S&P U.S. debt downgrade. The Fed took the unprecedented step of signaling future action and putting a date on it. In the past, the Fed has said it will keep interest rates exceptionally low for an extended period of time. Earlier this week, it said rates will be kept at these low, accommodative levels until at least mid-2013.
Reading the Fed’s tea leaves we arrive at two very interesting conclusions. First of all, the Fed has, in essence, thumbed its nose at S&P and its debt downgrade. Normally a reduction in credit worthiness drives up rates because investors have to be enticed to buy debt that, supposedly, is more risky. Bernanke and Company, however, have essentially told S&P: “You think rates are going up? Guess again. We’re keeping them low for two years.” No silly downgrade is going to raise rates, not on Bernanke’s watch—unless, of course, economic fundamentals deem such a move appropriate.
Further, the Fed is stating very clearly that investors will get nothing—nada, zero—in interest on short-term fixed income investments for two years, so look for something else. As investors look for other opportunities the obvious place will be stocks and the market appears to agree.
Monday, August 8, 2011
Worth Less, but Not Worthless
Markets were sent tumbling yet again, with the Dow closing down 5.5% and the Nasdaq and S&P losing more than 7%, on Monday. The latest gunshot to spook the investor herd was Standard & Poor’s downgrade of the U.S. debt rating from AAA to AA+.
The rationale for the downgrade, essentially, was the inability of Washington lawmakers to get along and come up with a debt reduction plan that the rating agency deemed acceptable. No matter how much political dissention there is, however, squabbling on Capitol Hill should have nothing to do with the U.S. credit rating. To think otherwise would be like a bank raising the interest rate on a home mortgage simply because a couple doesn’t eat dinner together most nights or argues over who left the cap off the toothpaste. It’s all about the ability to pay, which is not an issue for U.S. debt.
The irony of it is, in the wake of the downgrade, U.S. Treasuries remained the safe haven, which meant the government’s borrowing costs did not go up. In fact, they went down. Unfortunately equities, the unintended victim, were trounced substantially because investors sold first and asked questions later.
Investors had already been running scared because of worries from European debt to whether a slowing U.S. economy will slip back into recession. The real reason for their panic, I would argue, has very little to do with debt levels in Greece or Italy, or whether GDP in the U.S. will drop into negative territory. It’s all about 2008.
Investors remember all too well the great flush that occurred in the midst of the financial crisis, when huge companies that had been thought to be rock solid--Bear Stearns and Lehman Brothers, to name two--suddenly went out of business. Asset values evaporated, and investors feared a return of the Great Depression.
Now as fears ripple through the market, investors vow not to be caught flatfooted again. “I’m not going to let that happen to me” is the mantra as they head for the hills, taking their cash with them.
The good news is this is not 2008. Not even close. The economy is still growing. GDP for Q2 2011 was up 1.3%. Although that’s hardly strong growth, it’s a far cry from a negative reading of -6.8% for Q4 2008. Yes, employment is soft, but we are adding jobs, even in the midst of government layoffs. Just a few years ago, the monthly job reports were showing losses of 500,000 jobs.
Demand is weak as consumers deleverage, while the government, which can account for 20-30% of GDP, has cut its spending by mandate. This could set the stage for a soft economy to go into recession, but don’t look for things to fall off a cliff.
The simple fact is we’re two years into an economic recovery and we’ve hit a soft patch, which is to be expected. We’ll either start growing from here, or slip into a recession again. Only time--and economic data--will tell. In the meantime, assets are worth less, but they are not worthless. This is far more important than a clever play on words. It is a statement of fact that this is not 2008 all over again. We are in an economic slowdown/recession, not a crisis. No big corporations are about to implode and go out of business.
Although these are painful times to be an investor, when fear grips the market with increased volatility, but there really is no reason to panic. The economy may be wounded, but it’s been on the mend and, for the moment, there is no reason to believe the patient needs to be in intensive care. And if you are looking for the right medicine to make you feel better then look no further then the dividend yield on the S&P 500 which is yielding about as much as the US 10 year treasury. Historically when that has happened in the past equities have had a very nice rally.
The rationale for the downgrade, essentially, was the inability of Washington lawmakers to get along and come up with a debt reduction plan that the rating agency deemed acceptable. No matter how much political dissention there is, however, squabbling on Capitol Hill should have nothing to do with the U.S. credit rating. To think otherwise would be like a bank raising the interest rate on a home mortgage simply because a couple doesn’t eat dinner together most nights or argues over who left the cap off the toothpaste. It’s all about the ability to pay, which is not an issue for U.S. debt.
The irony of it is, in the wake of the downgrade, U.S. Treasuries remained the safe haven, which meant the government’s borrowing costs did not go up. In fact, they went down. Unfortunately equities, the unintended victim, were trounced substantially because investors sold first and asked questions later.
Investors had already been running scared because of worries from European debt to whether a slowing U.S. economy will slip back into recession. The real reason for their panic, I would argue, has very little to do with debt levels in Greece or Italy, or whether GDP in the U.S. will drop into negative territory. It’s all about 2008.
Investors remember all too well the great flush that occurred in the midst of the financial crisis, when huge companies that had been thought to be rock solid--Bear Stearns and Lehman Brothers, to name two--suddenly went out of business. Asset values evaporated, and investors feared a return of the Great Depression.
Now as fears ripple through the market, investors vow not to be caught flatfooted again. “I’m not going to let that happen to me” is the mantra as they head for the hills, taking their cash with them.
The good news is this is not 2008. Not even close. The economy is still growing. GDP for Q2 2011 was up 1.3%. Although that’s hardly strong growth, it’s a far cry from a negative reading of -6.8% for Q4 2008. Yes, employment is soft, but we are adding jobs, even in the midst of government layoffs. Just a few years ago, the monthly job reports were showing losses of 500,000 jobs.
Demand is weak as consumers deleverage, while the government, which can account for 20-30% of GDP, has cut its spending by mandate. This could set the stage for a soft economy to go into recession, but don’t look for things to fall off a cliff.
The simple fact is we’re two years into an economic recovery and we’ve hit a soft patch, which is to be expected. We’ll either start growing from here, or slip into a recession again. Only time--and economic data--will tell. In the meantime, assets are worth less, but they are not worthless. This is far more important than a clever play on words. It is a statement of fact that this is not 2008 all over again. We are in an economic slowdown/recession, not a crisis. No big corporations are about to implode and go out of business.
Although these are painful times to be an investor, when fear grips the market with increased volatility, but there really is no reason to panic. The economy may be wounded, but it’s been on the mend and, for the moment, there is no reason to believe the patient needs to be in intensive care. And if you are looking for the right medicine to make you feel better then look no further then the dividend yield on the S&P 500 which is yielding about as much as the US 10 year treasury. Historically when that has happened in the past equities have had a very nice rally.
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