Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Bonds and Gold Strange Bedfellows in 2010

2010-07-30T10:07:31-04:00

Montreal, Canada

Can deflation and inflation assets co-exist? Can both assets rally in unison, despite harboring completely divergent asset class outcomes in wildly different economic environments?

Since the onset of the credit crisis three years ago, more often than not, gold prices and Treasury bonds have rallied simultaneously; brief periods showed negative correlations, including July 2008 through November 2008 and throughout most of 2009, which followed a crash in bond yields after hitting their lowest levels since the Eisenhower administration in December of 2008.

After seven months of trading in 2010, gold prices and U.S. benchmark ten-year Treasury bonds have exhibited a higher correlation than historical behavior would suggest. That's bizarre market action because gold acts as a traditional inflation hedge while bonds are regarded as primary winners amid accelerated disinflation (e.g. 1990s) and deflation (e.g. 2008, 1930s). It's almost like cats and dogs enjoying each other's company when we all know they don't get along.

Through July, gold and bonds have rallied together in five out of seven months with January and July the only disconnect. Both asset classes also rank as one of the few investments to rise in a tough market this year; Treasury bonds have gained 6% this year as measured by the Vanguard Total Bond Fund and gold prices are up about 7%.

Perhaps a greater explanation for this largely positive correlation in 2010 lies in the growing fear that we're entering outright deflation again. Gold is a store of value in uncertain economic times – including price deflation. It's simply not true that gold must decline as nominal and real prices fall in value.

Consumer prices remain in positive territory in the United States but just barely with June CPI up 1.1% year-over-year. But in Europe, a few countries are now experiencing negative inflation or deflation, including Ireland and Spain. This is consistent with the resultant effects of housing deflation in these countries and, increasingly, it appears to be spreading to the United States.

Bubbles in housing, however, remain in Canada, Australia and parts of China.

Gold, which now commands the attention as a surrogate currency in the age of rapidly rising government deficits and weakening fiat currencies, is showing its metal (no pun intended) as a store of value as governments flood the system with debt obligations. It's also noteworthy to mention that broader monetary aggregates in the West and Japan have literally fallen off a cliff this year – again, a deflationary event suggesting central banks are losing the war on credit growth and rising inflation.

Gold, contrary to popular wisdom, is rising in a deflationary environment just as it did in 2008.

High quality bonds and gold are the new anomaly this year. Both assets should harbor a strong negative correlation but, instead, appear to be running together. I suspect this odd relationship will continue until the bond vigilantes attack Treasury, at which time I expect gold prices to head off to the next solar system or, what I would term, the "meteoric phase." That'll mark the endgame of the "flight-to-safety" trade in T-bonds and the nadir of the secular bull market in gold.

Bonds Versus Stocks: 2010 to 2020

2010-07-29T09:44:51-04:00

Montreal, Canada

What would you rather own over the next ten years: Stocks or bonds?

A dividend yield of 4% per annum, or 48% compounded, from now until 2020 looks mighty appealing compared to staid bonds after a massive 30-year bull market.

Unless we face a long and drawn-out Great Depression II, then stocks should easily outpace bonds over the next ten years. Combined with dividends, which are pretty attractive on some of the largest global multinationals -- stocks offer better inflation-adjusted returns and far greater value.

But let's be clear about the current state of the American economy. This is not the time to be lunging after aggressive capital gains or even stodgy blue-chip stocks paying fat dividends. For my U.S. managed accounts, I've recently purchased Coke (KO), Johnson & Johnson (JNJ), Statoil ADR (STO) and Reynolds American (RAI). Cash remains high at 30%.

I'm buying blue-chips lately but continue to keep my powder dry because we'll experience more market dislocations this fall and in 2011 as uncertainty grips financial markets.

Economists and most analysts have failed to appreciate the state of this economic recovery and continue to compare this growth cycle to previous recoveries since WW II; that is the wrong way to analyze this post-2008 growth cycle because it remains deeply fragmented and impaired by a sluggish job market, contracting or tepid bank credit and a free fall in the U.S. money-supply as measured by M2. Let's not forget this Great Recession was triggered by a credit crash.

This is not your typical expansion because, unlike previous post-WW II recoveries, this one isn't being accompanied by bank credit growth; in the absence of bank lending or loan demand, it's pretty hard to build a bullish case for a highly leveraged economy that's still in the process of winding down debt, building savings and consuming less goods and services. It's also running out of gas lately because government stimulus is just about exhausted.

I still like Treasury bonds for two reasons. Firstly, everyone I know hates them, which makes me believe bonds are still largely a contrarian bet even though investors have dumped record amounts of cash into bond funds since 2009. In the late 1990s, investors raced into stock funds and that party kept on going until March 2000. The same can happen in bonds. We're only in the second year of bulging bond fund inflows.

Secondly, it's hard to argue with the rising forces of deflation or, at the very least, accelerated disinflation since May. The economy just doesn't have the juice it needs to build a sustainable growth path and, at this point, government stimulus is over.

However, bonds are in the 8th or 9th inning of their historical bull market. At some point, banks will start lending and that's when inflation will burst. Bonds will rank as one of the best shorts in history. Anyone holding bonds must watch them like a hawk.

Bonds still have one last hurrah – unless you're expecting an economic boom in 2011. I'm certainly not. And if that's true, then Obama is a one-term President and bond yields are heading to 2% or lower.

Big Brother and Austerity Don’t Jive

2010-07-28T11:28:14-04:00

Montreal, Canada

Big Brother is going to choke taxpayers this decade. He's broke, and looking for income any way he can find it. He'll also attempt confiscation of your wealth and declare this directive as a "political imperative" amid socioeconomic chaos. This is already happening in parts of Latin America (Argentina, Venezuela) and I suppose it's also going to occur someday in Europe as governments boost tax rates to supplement stagnant revenues.

And unless the United States gets its finances under control, it'll happen here, too.

Since its inception more than 13 years ago, the Sovereign Society has urged members to move a portion of their assets offshore. That window of diversification is vital in the age of violent capital markets, rising taxation and growing uncertainty as government attacks big business.

Of course, these days there isn't a tax incentive to deploy assets overseas – unless within the auspices of an offshore variable annuity. The reason we move some wealth offshore is for "peace of mind."

For most individuals, having some personal wealth stashed overseas makes good sense. It's also a privilege that I believe is drawing to an end as some sort of financial exchange controls or restriction on the movement of capital lies ahead as government finances deteriorate further amid growing austerity in the West. We are living beyond our means and we need to cut down on consumption; but the government will struggle in this quest and instead, will probably turn to taxation to fund its coffers.

I recall a presentation made by Isle of Man Assurance managing director and personal friend, Colin Bowen, several years ago at one of our conferences abroad. Colin urged delegates to get some money out of their respective domiciles because foreign exchange controls were a growing possibility. He reminded investors that Britain in the mid-1970s was basically bankrupt and required IMF financial assistance. He also stunned the audience warning that FX controls could happen again as they did in Britain. At one point in the early 1970s, the British were not allowed to leave the country with more than £25 pounds.

It's still legal to open a foreign bank account. Don't wait much longer.

Gold Pullback Underway, Correction in FX Terms

2010-07-27T11:00:43-04:00

Montreal, Canada

The summer is typically a bad time to ride most commodities – including gold. Some of the most violent declines in world markets have occurred from May to August combined with massive market dislocations ranging from the Asian credit crisis, Russian GKO default, the NASDAQ blow-up, Enron scandal and, most recently, the global credit crisis.

When markets are thinly traded, bad things usually happen. This is one of the reasons why I remain cautious on stocks even though the Dow Industrials and the Dow Transports surpassed important near-term resistance levels yesterday; the move was accompanied by a meager 4.1 billion shares – a pathetically weak showing in a rising market. All along, stocks have attracted low trading volumes, also a bearish sign.

Back to the point about gold: Since hitting an all-time high in June at $1,266 an ounce, the August contract has declined a cumulative 6.2% as of this morning. That's not a big pullback by any means; but when expressed in foreign currency terms, this ranks as a correction. The EUR, which has rallied from 1.22 on June 30 (low of 1.1875 in late June) to 1.30 now, has risen a cumulative 15% against gold this month after hitting new lows for months.

The U.S. dollar and gold, however, are now buddies since the emergence of the Greek sovereign debt crisis because traders have flocked into gold as a means to hedge against the EUR – until this month. The dollar has also been a safe-haven recipient from nervous money. Yet we now see a major divergence in the relationship between gold and the EUR whereby on any given day the European single currency rallies, gold prices usually decline. I fear the EUR is now heading higher as it strives for 1.325 and possibly, beyond.

But after August, I expect the European debt crisis to re-emerge and show its ugly head. It's inconsistent to have a strong EUR accompanied by rising austerity measures in most eurozone countries coupled by rising unemployment and softening GDP growth. The EUR is still not out of the woods.

The European bank stress tests were a total joke and smart investors know this. European banks need capital. Amazing how most Greek banks even passed this stupid stress test – the whole system is rigged. Gold knows this. We know this. Use any intermittent weakness in the gold price to buy or accumulate more bullion this summer and fall.

Volatility the “New Normal” Since 2000

2010-07-26T10:55:38-04:00

Montreal, Canada

At the Agora Financial Symposium in Vancouver last week, I heard my colleague and friend, Karim Rahemtulla, deliver an insightful speech just ahead of Dr. Marc Faber. I spoke after Faber, and was followed by the boss, Bill Bonner, right after my presentation. Our Sovereign Society Chairman, Jack Pugley, spoke ahead of Karim – probably the best talk on the history on money and currency debasement I've ever heard.

Karim and I have always been good buddies and see eye to eye on just about everything. We dined together last Thursday night in Vancouver.

Karim believes we're in a protracted environment of market volatility and illustrated this point by handing out a document showing how we've been overwhelmed by a series of financial shocks since the bursting of the NASDAQ bubble ten years ago; in fact, over the last decade, we've suffered more global market dislocations than at any other point in market history. Go back even further to 1997 and we've got an even bigger list of crashes and crises.

Karim, who specializes in options trading, referred to the VIX, or the CBOE Volatility Index, during his presentation. The VIX is widely known as the "fear gauge," measuring 30-day price volatility on the S&P 500 Index, or the U.S. broader market. The higher the VIX trades, the higher the fear among traders; conversely, the lower the VIX, the more complacent traders become.

What caught my attention was how often the VIX has traded at extremely high levels since 2000. What's also interesting is how traders and portfolio investors can mitigate stock market risk by applying VIX hedges at market extremes or when the VIX is trading below 20.

Karim believes the VIX is a "buy" below 20 and a "sell" above 40. No-man's land for the VIX lies between 20 and 30. Right now, the VIX is trading at 23.47, or 49% below its 52-week high of 45.79 in June.

More market dislocations lie ahead as the odds of "getting it right" on behalf of Western policymakers is next to nil. One or more countries will bungle fiscal and/or monetary tightening at a time when draining excess liquidity or fiscal spending is a juggling act. Economic growth is not balanced and is slowing in the West and in parts of Asia, including China. Volatility will respond.

Watch the VIX as it declines below 20. If it falls to 15, dig in deep and buy the VIX or its retail investor equivalent, VXX. Market complacency is a dangerous habit.

Bullish of Fish Farming

2010-07-23T10:25:21-04:00

Vancouver, Canada

Over 800 delegates are here this week at the Agora Financial Symposium, a whopper of a conference with dozens of keynote speakers. I'll be speaking later this morning just ahead of Bill Bonner and right after Dr. Marc Faber. My topic: The Destruction of Credit, Part II and How to Avoid the Growing Debt Trap Engulfing the Public Sector.

British Columbia is a beautiful province. I flew to Vancouver directly from Montreal yesterday on Air Canada (A321) – about 5 ½ hours. The weather has been perfect.

The best wild salmon is right here in British Columbia. An endangered species across the world, wild salmon can still be netted in B.C. and boy, is it good! I enjoyed a terrific dinner in Vancouver last night with my old friend and colleague, Karim Rahemtulla, probably the best options trader in the business. Karim will be our M.C. this fall at Offshore Academy in Cabo San Lucas, Mexico.

The population of many fish species continues to decline. Most of the fish we consume nowadays is largely farmed and that's not the healthiest fish available. Unfortunately, man has overfished for decades, reducing or destroying populations around the world in the name of profit and over-consumption. As a result, wild salmon is now an endangered species.

Last year, I made numerous trips to Oslo, Norway. I met with several banks and brokers and learned about Norwegian fish farms – many quite profitable. I was immediately intrigued and after conducting some due diligence on the sector, realized I was too late. Fish farming stocks had already doubled or tripled off the early 2009 lows.

In Oslo, you can't get wild salmon. That's incredibly bizarre considering Norway is surrounded by the North Sea. The problem is that virtually all available fish stocks today are farmed, not wild. If you can get wild salmon, you'll pay dearly.

There's no doubt in my mind that man is rapidly wiping-out many fish species. The popularity of sushi shops over the last past decade everywhere has dramatically boosted demand while some of the most popular sushi dishes, like blue fin tuna, is heading the way of the dinosaur.

Check out Marine Harvest (MHG) in Oslo. The stock is now considerably below its 52-week high and has rallied sharply recently. Marine Harvest is the world's largest farmed salmon company. Last trade: NOK 4.89 ($0.78).

Short Term Look at Silver

2010-07-22T09:20:10-04:00

- Dugald Malcolm, Montreal, Canada

While Eric and I currently hold a longer term bullish view for silver, I decided to take a technical look at the short term price action. I find this provides a good clue in establishing timing for points of entry to or exit from a position. Currently, silver seems to be at a turning point, the outcome of which could very well determine such a short term buy or sell signal.

The short term daily chart is showing silver as being in a Symmetrical Triangle pattern. This is a formation to which one must pay close attention as it can be an important reversal pattern. While it does not forecast in which direction price movement is going to go, it does typically point to the fact that a decisive movement is about to take place. What characterizes a decisive move is a close above or below the pattern lines by around 3% with any move to the upside accompanied by increased volume. While the chart below shows the Continuous Contract Index for silver which does not display volume, one can use the iShares Silver Trust ETF as a suitable proxy to keep an eye on volume increases.

A possible hint at possible directional movement might come in looking at the stochastic and/or the MACD. As indicated on the chart, both technical indicators are in downtrends. It could be possible that a break to the upside in price action might be preceded by a break of one or both of these two indicators from their existing trends.

Another hint comes in examining the moving averages. While the price of silver is trading below its short term 50 day moving average, strong support is found at the longer term 200 day moving average. This important level of support might prove a formidable floor from which price movement might bounce. Fortifying the significance of this level of support is the fact that it also coincides with the bottom trend line of the Symmetrical Triangle pattern.

It is crucial to point out that while this strong level of support is important in that it can possibly provide a level off which prices may bounce, it is even more significant should the levels be broken. Because of its strength any breach to the downside should be taken very seriously as it could very well represent a significant pullback in silver prices.

Small-Caps Lag Large-Caps in 2010 as Domestic Economy Falters; Emerging Market Margins Rise

2010-07-21T09:22:40-04:00

Montreal, Canada

Since May 1st, the S&P 500 Index has declined 8.2% compared to a loss of 12.7% for the Russell 2000 Index of smaller companies. And in the latest correction since the May "flash crash," small stocks have entered bear market territory, defined as a loss greater than 20% from their highs.

Increasingly, investors are moving away from riskier smaller stocks and heading into the relative safety of large-caps – many paying dividends about 50% to 100% greater than the yield on the broader market. This transition is justified since the U.S. economy is in the process of slowing while overseas markets – mainly in Asia and Latin America – are growing strongly.

Small companies rely on domestic sales much more than large-cap companies. Though the former has definitely outpaced larger stocks historically, that edge has been on the decline over the last three months as investors grow nervous and hunker down to the relative safety of big companies paying above-average dividends.

Last month I made the long-term case for owning several large-cap U.S. multinationals with an emphasis on overseas earnings. One of my favorites is Coca-Cola (NYSE-KO), trading at the same price this morning compared to twelve years ago. Coke also yields 3.4% -- or 55% more than the S&P 500 Index. Coke continues to generate most of its net margins from overseas sales, not domestic sales. That's a trend that's likely to persist for many years to come as the emerging markets become significant consumers.

Going forward, it seems, the United States will struggle as domestic consumption lags amid an environment of debt reduction and balance sheet repair; that's not the case in the emerging markets. These countries, which already experienced the tribulations of a wicked bear market in 1997-1998, are home to the world's biggest trade surpluses, foreign exchange reserves and debt-to-GDP ratios of just 40% compared to more than 80% or more in many developed economies. Multinationals are aware of this development and it's no surprise everyone is running to China and other emerging markets to land big sales.

The majority of emerging markets are fairly valued at best and at worst, not cheap. The MSCI Emerging Markets Index used to trade at a fraction compared to the MSCI World Index of major markets but that ratio has compressed significantly since 2003. Instead, I prefer to hunt after multinationals that derive the bulk of their profits from these economies, accompanied by lower multiples and attractive dividends. Coke is one example. Stocks like Coke offer a greater margin of safety than many "bubble" emerging market stocks, which pay little or no dividends.

Need a Boeing 737?

2010-07-20T09:56:18-04:00

Montreal, Canada

Asset deflation hasn't escaped commercial aircraft pricing since the credit crisis first began to unfold almost 36 months ago. Monthly lease rates for the most popular aircraft have declined as much as 22% since early 2008.

Inflation is still running wild in healthcare, tuition, medicines and several food groups, including cocoa, coffee and orange juice. But overall, the primary trend for most goods is definitely heading down, posing significant risks to the global economic outlook.

Falling prices can crimp corporate earnings as consumers decide to delay purchases anticipating even lower prices down the road. Consumer balance sheets remain impaired with big ticket personal asset like real estate and stocks still down about a third since their peaks in 2006 and 2007, respectively.

Boeing Co. (NYSE-BA) dominates the commercial aircraft market along with European-based Airbus, a subsidiary of EADS. I fly on Airbus products more these days because Air Canada, Swiss and Lufthansa – the Star Alliance partners I usually fly – maintain sizable fleets in the A340, A330, A321 and A320 types. Personally, my favorite plane is the Boeing 777.

As a kid, there was nothing more thrilling for me than flying a plane; if I hadn't discovered the financial markets as a hobby 22 years ago, I probably would have become a commercial airline pilot. More than just about anything else, taking-off on a big jet gets my engines going. I'm still amazed how a 100,000 pound machine can lift off the ground and climb to 37,000 feet in a matter of minutes. I'd have to say that the airplane ranks as one of the greatest discoveries by modern man; the world has literally shrunk.

Yet, despite the advancements in commercial aircraft technologies, the Boeing 707, which was introduced by Pan Am way back in 1958, doesn't fly any slower than a super modern Boeing 777 today. Amazingly, cruising speed for the biggest jets remains the same in 2010 as it did 52 years ago at about 550 miles per hour. The Concorde changed that, briefly, traveling at Mach 2.2 (more than twice the speed of sound) but was an expensive sideshow to maintain and unfortunately, drew the death-knell following the tragic Air France Concorde crash in 2001.

This week marks the biggest event in aviation as commercial and military industry officials converge at the Farnborough International Airshow in the United Kingdom. Leasing companies have the edge this year as airlines seek to finance new aircraft – mostly Asian and Middle Eastern carriers. And bargains beckon; the cost of a new Boeing 777-200 is 6% less compared to 24 months ago. Even more attractive is the 777's competitor, the Airbus A330-200, which is now 20% less compared to 2008 prices.

One thing is for sure. Though I might regret not getting my pilots' license, I certainly will never regret not owning an airline. I can't think of a business model that's worse!

Deflation Fears Dog Stocks, Commodities Since April amid Big Declines

2010-07-19T09:21:46-04:00

Montreal, Canada

Asset price deflation has gained momentum since May across a swath of risk-based assets. Investors should heed the warnings and brace for a possible shakeout in world markets this summer or fall. Broader U.S. stock indexes are at the cusp of another major decline, if important support levels fail to hold this week.

Over the past three months, the price of copper has plunged 16%, aluminum has declined 18%, lead down 21% and nickel has fallen 27%. Spot benchmark iron ore has tanked 18% in the past three weeks and 36% from its peak in April.

Steel scrap prices, however, largely viewed as a leading indicator in the commodity space, have actually rallied lately. But that's an exception within the primary trend for many industrial metals, which have peaked in this cycle.

In May, we turned cautious on raw materials as signs of a correction began to materialize in the sector. Copper prices, the Baltic Dry Index, the price of TIPS and a renewed downturn in residential housing began to flash red. Combined with the huge rally in bond prices (or sharply lower yields), investors have begun to discount the possibility of a double-dip recession in 2011. Toss in the uncertainty looming regarding the expiration of the Bush tax cuts next year and investors and businesses have one less reason to be bullish and put money to work.

Two months into the correction for commodities, we remain bearish over the short-term as indicators continue to remain dogged by declining Chinese consumption, slack industrial global capacity and a slowdown underway in China and the United States. Europe is heading into outright deflation because of austerity measures while Japan remains stuck in a deflationary abyss.

In the United States, consumer prices hit their lowest levels since 1966 in June – another measure that's suggesting price pressures are threatening the recovery and corporate earnings. Companies must show revenue growth going forward; the cost-cutting blitz since last year is now exhausted.

Stocks remain in a correction. The S&P 500 Index has rallied off its early July trough when it was down 16.5% off its January best levels.

Despite a brief rally over the last two weeks, stocks are down 12.5% from their January highs as measured by the broader market. But small-caps, which led the post-March 2009 rally, are now bleeding hard since May; the Russell 2000 Index is now down 17.7% from its January high and bordering official bear market territory this month.

If asset prices continue to slide this summer, expect the Federal Reserve to announce another wave of quantitative easing. At this stage of the recovery, it's obvious that stimulus has drawn its course and real consumption is flagging. It's also true that broader monetary aggregates (M2) are in a freefall in the United States, Europe and Japan. Central banks are losing the war against deflation.