Fed relaxed on inflation not on the economy. The latest comments by Yellen suggest that the Fed is ready to keep interest rates low for longer to get productivity growth going, even at the cost of higher inflation. We believe real interest rates will become more negative as inflation expectations rise. Such an environment is likely to increase investors’ hunt for yield.Last Friday, Janet Yellen said the Fed may need to run a “high-pressure economy” – tighter labour market, higher consumption and investment – to reverse damage from the financial crisis, even at the cost of higher inflation. However, the economy is not yet overheating. The US economy has been adding 193k jobs per month on average so far this year without the unemployment rate edging lower and core PCE inflation rocketing higher. In our view, Yellen is not yet satisfied with the current level of employment and sees more room before it reaches its theoretical “maximum” level. Hence, she could slow the trajectory of interest rates as long as unemployment rate stagnates and inflation remains close to 2% (+/- 1pp).
Furthermore, the FOMC (Federal Open Market Committee) seems increasingly convinced of the existence of a “new normal” paradigm which requires lower benchmark rates than in the past. Fed’s Vice President Stanley Fischer stated that “gradual increases in the federal funds rate will likely be sufficient to get monetary policy to a neutral stance over the next few years.” Historically, the tightening cycles of the Fed resulted in an average of 380bps increase of the effective Fed Funds rate. Now, considering the shadow rate – a metric used to equate quantitative easing (QE) to an equivalent federal funds rate that is not bounded at 0% – the Fed already tightened its base rate by 337 bps since the end of the QE programme in November 2014, well before inflation started to pick up, and implies continued caution in raising rates.
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There will be two labour reports before the December meeting, and we believe that the FOMC will search for an acceleration of labour and inflation trends. We expect high volatility in the following months but the current state of the economy does not support a massive sell-off in fixed income as the FED tightens. Additionally, rising inflation breakeven rates will make real interest rates even more negative, and ultimately increase investors’ search for yield.
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Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
More mistakes from the Fed… The Fed should act now to raise rates, or risk being further behind the curve.
Essentially, the Fed has a dual mandate… to maintain full employment and price stability. Wage growth sits at the intersection of these objectives. Currently wage pressure is growing, alongside inflationary forces, and loose monetary settings could see this trend accelerate, leaving the Fed further behind the curve. The Fed needs to act now to raise rates in order to temper the ‘medium term inflationary’ pressures that are already building.
Is the Fed really ‘data dependent’?
What the FOMC will do vs. what they should are very different things. There always seems to be ‘another’ concern that keeps the Fed on hold. Earlier in 2016 it was the strong US dollar and market volatility. Now it’s soft jobs numbers and the possibility of Britain leaving the EU. Aside from last month’s soft employment numbers, the recovery remains on track in the US – consumption and lending indicators are robust – and not near any emergency levels, as interest rate settings would currently indicate.
While the Fed claims data dependence, the short answer is no, it isn’t. We believe that the Fed is ‘market dependent’ and attempting to manage market expectations is a dangerous game in economics. Uncertainty exists and central banks are on the front lines of the war against volatility. Yet the Fed’s reticence to do what it ‘should’ risks causing more volatility. Extreme asset market volatility has moderated but policy uncertainty threatens the fragility of current market sentiment. The longer the Fed delays, the higher the volatility is likely to become.
Mistakes are being made
Fed Chair Yellen continues to stress the need for a gradual increase in interest rates. Six months between rate hikes is certainly a very gradual pace. But with another policy mistake (not raising rates in June) imminent, it’s unlikely that conditions are ever going to be perfect for the Fed to raise rates. And if conditions were perfect, the level of rates should probably be hundreds of basis points higher already.
Hawkish tone to prompt USD strength
With the market fully discounting a rate hike at this week’s Fed meeting, the risk is skewed for an upside move for the US Dollar (USD). Investors are not positioned for a bullish move for the USD, with futures market net long speculative at the lowest level since mid-2014. While we expect that the Fed will keep rate settings unchanged, we believe the more hawkish tone for Yellen’s press conference will drive USD strength in the near term.
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnold joined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
Gold Seesaws Between Dovish Fed and Upbeat Jobs Report
Commodity ETP Weekly – Gold Seesaws Between Dovish Fed and Upbeat Jobs Report
Positive inflows into Gold ETPs resume after dovish comments by Fed Chair Yellen helped gold post its highest (16.1%) quarterly rise in 30 years. However the positive beat in payrolls might see a reversal in trend.
Declining US crude oil production helps reverse four consecutive weeks of outflows as investors plough into WTI crude oil ETPs.
Fall in production in world’s largest copper mining producer help revive inflows into copper ETPs.
Dovish comments by Fed chair Yellen help revive positive inflows into gold ETPs. Gold prices caught a fresh bid after a more cautious policy trajectory was inferred from Fed chair Yellen’s comments early in the week boosting inflows into gold ETPs by $96.7mn. Furthermore the Fed Chair remained unsure of the durability of the recent spike in inflation reinforcing a more gradual rate normalization path in the US. However we believe the positive beat in payrolls data provides evidence of economic resilience that could allow the Federal Reserve to raise interest rates more often than projected, thereby avoiding a policy error. Silver ETPs also benefited in Gold’s slipstream recording inflows for the 6th consecutive week worth $9.2mn.
Energy ETPs attract strong inflows, led by WTI crude oil. After four consecutive weeks of outflows, WTI crude oil ETPs received positive inflows worth $19.9mn. This is reflective of declining US crude oil production for the fourth month in a row. We expect this decline to continue since drilling activity has been lacklustre with 30% active oil rigs idled over the past 14 weeks. On the other hand oil production by OPEC has risen by 100,000 barrels per day in March owing to Iran and Iraq. The pre-condition laid out by Saudi Arabia to freeze output subject to Iran and other major producers following suit is casting doubts on the ability of these nations to reach an agreement at the next Doha meeting scheduled on April 17. We expect oil prices to trade a volatile range on the back of acrimonious decision making over the capping of oil production limits by OPEC though declining US oil production may help alleviate sharp price drops.
Copper ETPs attract $10.2mn of inflows amid declining production in Chile. According to data from Chile’s (the world’s largest copper mining producer) National Statistics Institute (INE), about 450,000 tons of copper were produced in February, marking a 7% decline in production for the first two months of the year.
Coffee ETPs garner $5.7mn inflows on the back of dry weather conditions. The probability of a deficit in the coffee crop is becoming increasingly likely due to the ongoing dry conditions in Vietnam, Columbia and parts of Brazil. Interestingly the recent appreciation of the producer’s currencies against the US dollar is providing some relief to the pricing pressure faced in the international market however there is no assurance of how long this could last.
Key events to watch this week. Purchasing Managers’ Indices (PMI) for the US, China and UK this week will offer further signs of a slowdown in the services sector. After setting the stage for a more gradual rate normalization path by Fed chair Yellen, investors will focus on the minutes of the March meeting on Wednesday for clues on the timing of the next rate rise. While Thursday sees the unveiling of the minutes of the ECBs March meeting.
Video Presentation
Aneeka Gupta, Research Analyst at ETF Securities provides an analysis of last week’s performance, flow and trading activity in commodity exchange traded products and a look at the week ahead.
For more information contact
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
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Gold and Precious Metals – Golds Breakout Continues in February
March 14, 2016
by Joe Foster, Portfolio Manager and Strategist
With more than 30 years of gold industry experience, Foster began his gold career as a boots on the ground geologist, evaluating mining exploration and development projects. Foster is Portfolio Manager and Strategist for the Gold and Precious Metals strategy.
Golds Breakout Continues in February
For the month ended February 29, 2016
Gold’s Bear Market is Over
We are willing to declare the gold bear market over. Is this the beginning of a new bull? Time will tell.
Since the Federal Reserve (the ”Fed”) raised the targeted federal funds rate on December 16, a number of changes have occurred in the markets that lead us to believe that one of the longest and deepest bear markets in the history of gold and gold equities may be over.
These changes include:
• Waning conviction in the market regarding further Fed rate increases.
• The U.S. dollar’s rise appears to have stalled.
• Volatility and weakness in U.S. stock markets.
• Strong gold prices despite seasonal weakness in Chinese demand.
• Strong gold prices as oil and commodities have sunk to new lows.
• Tremendous inflows to gold bullion exchange traded products (ETPs) and gold futures.
• Technical breakout from an established downtrend.
Gold advanced $120.57 (10.8%) to $1,238.74 per ounce in February and is up $177.32 (16.7%) for the year [as of 2/29/16].
Growing Concerns About Global Financial Risks
Economic headwinds have escalated, from local occurrences in Asia and Europe to global concerns that now include the United States. The Institute for Supply Management’s (”ISM”) Non-Manufacturing Index fell more than expected in January and was weak in February as well. The U.S. has been in a manufacturing recession and the ISM reports suggest that the services sector, which makes up the bulk of the economy, is beginning to weaken.
Negative Interest Rates May Increase Gold’s Appeal
Worries about systemic financial risk have also escalated due to many European countries and the Bank of Japan employing negative interest rates on certain reserves. There are now trillions of dollars’ worth of sovereign bonds that trade at negative yields. Fed Chair Janet Yellen said recently that the Fed is evaluating whether negative rates are an option for monetary policy in the U.S. Meanwhile the president of the European Central Bank (”ECB”) has said the ECB is looking at expanding its stimulus. The Governor of the Bank of Japan (”BOJ”) stated last summer, ”If we judge that existing measures in the tool kit are not enough to achieve the goal, what we have to do is to devise new tools, rather than give up the goal.” If negative rates work their way into commercial deposits, it might undermine money market funds, pension funds, and the insurance and banking industries.
Negative rates may also increase gold’s appeal, as gold effectively has a better yield at 0% than negative rate accounts. The Wall Street Journal reports that in the month after the BOJ’s negative rate announcement, sales of personal safes rose as much as 250% in some stores. What we believe markets are telling central bankers in 2016 is that radical monetary policies have not produced positive results and that further financial engineering risks bringing down the financial system. So far this year, because of these concerns, gold has supplanted the U.S. dollar as the preferred safe haven investment.
South Africa Stands Out Among Gold Shares
Gold stocks are showing the leverage we expect in a positive gold market. The NYSE Gold Miners Index (GDMNTR) gained 36.1% in February while the Market Vectors Junior Gold Miners Index (MVGDXJTR) advanced 35.0%. While nearly all gold stocks have seen handsome returns this year, the South Africans have seen additional gains as a currency play, with some more than doubling this year in the wake of the collapse of the rand. We continue to see the geopolitical, operating, and other risks in South Africa as impediments to prudent investing. In addition, many of the highly levered (high cost and/or high debt) but lower quality companies have outperformed. It is not uncommon for short covering and momentum investing to propel low quality stocks in the early phase of a strong market.
What to Expect from Gold Miners in 2016
The junior gold stocks have lagged the larger producers, as evidenced by the 6.6% year-to-date underperformance of the MVGDXJTR relative to the GDMNTR. The performances of some of the mid-tier stocks have lagged as well. This lag is typical in the early phase of a newly rising market as investment flows start with the large companies. We expect the mid-tiers and smaller companies to outperform if gold continues higher.
By analyzing companies’ fourth quarter reporting, 2016 guidance, and our meetings at the Bank of Montreal (BMO) Global Metals and Mining Conference, we have a better idea of what to expect in 2016 from gold mining companies. We have commented frequently about efforts to help reduce costs across the industry. It looks like the cost cycle is nearing its low point, as some companies are expecting further declines in 2016 and others are guiding to slightly increase. It is now common for companies to carry all-in mining costs of less than $1,000 per ounce. Large companies that were the perennial leaders 20 years ago are reasserting their roles. Newmont, Barrick, AngloGold, and Newcrest are the super majors that fell out of favor as they became bloated bureaucratic behemoths in the bull market. After several years under new managements, they are in the process of downsizing to become leaner, more efficient and more profitable companies. Barrick is targeting all-in mining costs below $700 per ounce by 2020. At the same time, company reports indicate that Barrick expects production to decline from 6.1 million ounces (before asset sales) in 2015 to 4.5 million ounces in 2020. Barrick also intends to reduce its net debt to zero. We think these are lofty goals, but if successful, they would solidify Barrick’s leadership and potentially reset the bar for the industry.
Gold Strategy Review: A Focus on Value Creation
Historically our investment strategy has tended to underperform during downturns in the gold price and outperform in positive gold markets, generating strong performance over the long term. However, based on our years of experience following the gold industry, we find our performance, and that of most actively managed funds in general, to be surprising so far this year given the rising gold price environment.
The overriding theme of our investment criteria, which has not changed, is value creation. Companies create value by taking an essentially worthless piece of property and turning it into a gold mine. This is what motivated me as a geologist in the ’80s and ’90s and it drives me now as a fund manager. So why is this investment style performing differently in 2016?
To answer that question we have undertaken a portfolio review and here are our conclusions:
• As we mentioned earlier, South African mining stocks are on fire despite the risk mentioned earlier, with some gaining more than 100% this year. In the past, we have avoided South African stocks due to geopolitical risk, union strife, difficult deep mining conditions, and an unreliable power grid.
• Highly indebted supermajors have outperformed. The market no longer seems concerned with excessive debt. We have been avoiding these stocks.
• Beaten down companies with high costs and/or no growth have outperformed. We have avoided these fundamentally flawed names.
• Mid-tiers and juniors that are creating value through growth have underperformed due to market concerns over project financing or acquisitions. These concerns began early in 2015 and gained momentum at the beginning of 2016. Some of these companies may need additional capital if gold prices average around $1,100 or less. We have been overweight in these stocks.
• We believe most of the companies that fall into the first three categories are unable to create value outside of their ongoing operations. However, until we see the market again rewarding companies that fit our investment style, we must adapt. We are not abandoning our quest for companies that create value, just toning it down. Here are the key portfolio developments that have been made as of the end of February.
Investment considerations:
• We continue to avoid South Africa due to risks. The outperformance is largely a function of a collapse in the rand, which we now believe is priced into the stocks.
• We have said that the supermajors have done a good job of paring down debt. We initiated a position in Newmont last year and we continue to view the large caps in a more positive light. With the operating improvements and financial discipline evident throughout the bear market, these large caps are again able to attract the big funds.
• We will consider more operationally levered companies if the relative valuation is compelling. However, some of these companies are in need of an acquisition to maintain production. We will continue to underweight or avoid potential acquirers until they make a transformative acquisition.
• We have adjusted our exposure to mid-tier growth names until we see the market take a more positive view. We are not avoiding these companies, as we believe they are now acquisition targets for the majors. We have increased exposure to Australian mid-tiers and juniors. There is a reemerging gold sector in Australia that doesn’t carry the same financing stigma of its global peers.
Our overall top-down allocations have not changed much. However, the strategy has more names, fewer overweights, and a few new names in the top 10. As we had indicated at yearend, we have reduced royalty companies to rotate into producing companies. The portfolio will remain more diversified until we gain the conviction to make larger bets. Also, our investment universe will expand if gold stays above the $1,200 per ounce threshold.
Finally, despite these challenges, we find all this market action very compelling. Seeing the movement in South African and other stocks reminds me of the early phase of the bull market that started in 2001.
Fed’s Rate Hike: The Straw Breaking the Camel’s Back?
To appreciate what is going on in the markets this year, we believe investors must use a perspective that takes into account the post-credit crisis economy. We believe that the post-crisis monetary tightening cycle did not begin with the first rate increase, as it did in past cycles. Tightening began when the Fed began ”tapering” its purchase of government bonds in late 2013. Once the Fed stopped buying bonds, it talked about raising rates. Then on December 16, 2015 it finally increased rates by 25 basis points. We see this as the modern tightening cycle and it has been going on for two years. The Atlanta Fed’s Wu-Xia Shadow Federal Funds Rate model measures an overall tightening in financial conditions that occurred while rates were artificially held around the zero-bound by central banks. The Wu-Xia calculation estimates there has been a tightening that is equivalent to a 3.19% rate rise over the last two years. An economy that, in our opinion, is overburdened with regulations, taxes, uncertainties, and misallocations of capital is unable to grow without monetary stimulus. The December 16 rate increase was the straw that is seemingly breaking the camel’s back.
Three areas that we believe have underpinned the stock market have diminished as this tightening cycle has progressed:
• Companies that took on debt when corporate rates were lower to buy back stock.
• Risk averse investors who moved out of treasuries and CDs into higher risk stocks and junk bonds to generate yield.
• The sovereign wealth funds of energy producing countries who must sell stock to help support their economies.
Flows in to Gold Stock Reverse Course
As markets seem to have passed a potentially historic inflection point, it looks like the money that flowed out of gold and into stocks and corporate debt over the last five years is beginning to reverse course. When a little of this money flows into gold stocks, it can have a big impact. The market cap of the global gold industry is only $205 billion, which is roughly one third (36%) of the value of Apple. While gold stocks have performed well this year, when factoring in the higher gold price, Scotiabank figures stock valuations of the senior producers are lower now than they were a month ago. We find that the valuations of many mid-tier and junior stocks are even more compelling.
Gold Breaks Out of Technical Downtrend
Gold has broken a technical downtrend that was well established. Following gold’s crash in 2013, it traded in a declining $150 range that in December stood at $1,050 to $1,200 (see chart below). Gold has clearly broken out of this range and until we see a new technical pattern emerge, it will be difficult to discern a trend. The next major technical resistance is at $1,600, which was the support level before the crash in 2013. However, we believe reaching this level is unrealistic in 2016, barring some sort of black swan event. At some point during the first half of 2016, we expect gold to pull back and consolidate. At that point, the depth and duration of the correction will help determine whether this is a new positive trend. We believe gold will be driven by a heightened undercurrent of financial risk as a result of growing distrust of central bank policies, global economic malaise, and overall market turbulence. Layered onto this is additional uncertainty brought on by Middle Eastern turmoil and widespread discontent with political leadership as evidenced by the U.S. presidential race and the British referendum on EU membership.
Breaking the Technical Downtrend – Gold Price Per Ounce (USD)
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Därför kommer inte negativa räntor att fungera Det bästa sättet att avgöra om negativa räntor kommer att fungera som en lösning för de ekonomiska problem som världen tampas med är att se hur det har fungerat i de länder som faktiskt har infört dem. För närvarande har centralbankerna infört negativa räntor i Danmark, Euroområdet, Schweiz, Japan och Sverige. Målet att bygga ut negativa räntor är att stimulera ekonomisk tillväxt genom att uppmuntra utlåning och investeringar. Men fungerar det på lång sikt? Här är de problem vi har sett med att ingå negativ ränta territorium.
Påverkan av negativa räntor
Japan är den tredje största ekonomin i världen; Därför är det bästa exemplet vi kan få när det gäller hur priserna skulle påverka de globala marknaderna. BOJ sänkte sin styrränta till -0,1 procent den 29 januari 2016. Syftet med att införa negativa räntor var att tvinga konsumenterna att spendera pengar, vilket skulle sedan leda till inflation.
Detta i sig visar vad centralbanker verkligen kämpar mot i dagsläget: deflation. Det andra syftet att införa negativa räntor är att få banker att minska sina stora reserver. Ingetdera av dessa två mål har uppnåtts ännu.
Vi ser hur de japanska konsumenterna köper kassaskåp, vilket är goda nyheter för Shimachu, ett järnhandelsföretag som sett hur försäljningen av kassaskåp har fördubblat under det senaste året.
I Schweiz är kunderna hos Alternative Bank Schweiz inte alls glada över att de tvingas betala för att pengar på sina konton, men det mest slående är att de som mer pengar på sina konton tvingas betala högre avgifter. Hur skulle detta hjälpa konsumtionen? Om något, kommer det att skada bankerna eftersom deras kundbas sinar.
I Sverige sjönk priserna i december med 1,3 procent jämfört med året innan. I Danmark har de negativa räntorna inte haft någon varaktig inverkan under en längre tid.
Det är för tidigt att bedöma effekten av negativa räntor i euroområdet på grund av Mario Draghi ordförande i ECB-förmodligen kommer att inta vårdslös inställning, vilket innebär att han kommer att skicka ned räntorna ännu längre i negativt territorium. Överväga några andra åsikter om negativa räntor i allmänhet.
Centralbankerna
Även John Maynard Keynes, den största förespråkaren för monetära stimulanser från regeringen, sade redan på 1930-talet att penningpolitiken blir mindre effektiv ju närmare du flyttar räntorna till noll. I mer modern tid har efterföljare som den amerikanska investmentbanken Morgan Stanley sagt att negativa räntor är att betrakta som ett ”farligt experiment.” Det är intressanta uttalanden, men det mest profetiska citatet kommer från en osannolik källa-Mises Institute, som undervisar i den österrikiska skolan:
“The real pity is that the busts and crackups could all have been avoided if central bankers recognized that falling prices eventually create the conditions for a normal economic revival. Deflation is not a death spiral as the Keynesians believe. In a functioning market, the public’s demand to hold money will be satisfied when their reserves of money balances are sufficient in relation to the price level, when they are once again confident of the future, and when they are willing to invest for the long term.”
Det citatet är rätt vad gäller pengarna, men vilken centralbankschef kommer vilja att ha hans eller hennes arv att förknippas med deflation? De vill inte att deras fartyg att gå ner på deras vakt. Vad de inte inser är att de kommer att hamna där då de styr sina skepp längre in i avgrunden. Så småningom kommer smarta ekonomer inse att endast centralbanker som offrade de nuvarande ekonomiska förutsättningarna för den framtida ekonomiska hälsan var de verkliga hjältarna.
Yellens chans
Den enda som fortfarande har en chans är Federal Reserves ordförande Janet Yellen. Om hon höjer räntorna i en miljö som kännetecknas av global deflation kommer det sannolikt att svida under flera år, men det kommer samtidigt att signalera att ekonomin i USA på väg att återhämta sig snabbare än resten av världen.
Sett över tiden är deflation hälsosamt och en nödvändig del av den långsiktiga ekonomiska cykeln. Problemet är att vi hade en så lång bom utan en deflationscykel, och nu är det ingen som uppleva det längre. Deflation är nödvändigt eftersom det är oundvikligt. Det kommer alltid att besegra centralbanker i slutet. Därför finns det ingen mening med att addera ännu mer skuld och framtida problem genom att försöka bekämpa den.
Centralbankerna har sänkt räntorna 637 gånger sedan finanskrisen för nästan ett decennium sedan. I början var detta mycket effektivt. Varje ytterligare ökning har varit mindre och mindre effektiv. Detta kommer inte att förändras. Om Janet Yellen inför negativa räntor, då är hon inte smartare än någon annan centralbankschef. Det har redan visat att negativa räntor misslyckas att höja inflationsförväntningarna. Negativa räntor skulle inte leda till ökad konsumtion, skulle det skicka ett meddelande till investerare att något är mycket fel med ekonomin. De skulle fungera som en skatt på banker, vilket skulle minska bankernas vinster.
Slutsats
Negativa räntor skulle skapa fler problem än de löser. Förhoppningsvis kommer Yellen lära sig av andras misstag. Hon kommer att pressas att delta i en globalt samordnad insats för att ”återuppliva den globala ekonomin.” Om hon faller för trycket kommer hon sannolikt att leda sin egen nations ekonomi djupare ner i avgrunden.
