How to Keep Calm and Invest On
US Global Investors
By Frank Holmes
March 9, 2013
How to Keep Calm and Invest On
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
The Dow Jones Industrial Average is making record highs, knocking the 2007 peak off its pedestal, but investors aren’t celebrating.
Since the Dow hit its March 2009 low, many sage market players followed the stimulative monetary and fiscal policies, ignored the noise of pundits predicting doom and gloom, and invested heavily in equities. Only in retrospect can their bold calls be recognized as wise.
I often look to social sciences and psychology to help investors understand the importance of the collective genius. In one of my favorite books, The Wisdom of Crowds, James Surowiecki points to statistics scientist Norman L. Johnson’s maze experiment as one of many illustrations of intelligent group decisions.
Johnson sent groups of people one-by-one through a maze, recorded their paths and timed the results. Do participants take a left or a right? How many steps does it take to make it through?
Then, he calculated how many total steps each individual took to reach the end of the maze. The average ended up to be 12.8 steps, but the group collectively did much better, taking only nine steps. More importantly, “there was no way to get through the maze in fewer than nine steps, so the group had discovered the optimal solution,” wrote Surowiecki.
Time and time again, Surowiecki found evidence of collective decisions to be superior to individual results, whether researchers asked people how many jelly beans are in a jar or how much an ox weighs. The “collective guess was very accurate, and was better than the vast majority of individual guesses.”
This collective wisdom theory was also used to predict the winner of elections. Nate Silver of The New York Times’ FiveThirtyEight blog analyzes data on state and national polls along with economic information, including GDP, jobs and inflation. His interests in playing poker and writing about baseball made him adept at studying statistical means, odds and probabilities, and his prediction model results are phenomenal. During the 2008 presidential election, Silver correctly predicted 49 out of 50 states correctly. And in last fall’s election, he correctly forecasted the electoral outcome in all 50 states.
Surowiecki notes that the wisdom of crowds is not a natural idea to many of his readers. Rather, it is counterintuitive because people are wrongly led to believe that “well-informed will be outweighed by the poorly informed, and the group’s decision will be worse than that of even the average individual.”
I believe Americans feel that investing in the stock market today is counterintuitive because of unemployment statistics, dysfunction in Washington and ongoing negative news about the U.S. economy. When discussing the Dow’s all-time high, The New York Times indicated that investors aren’t pouring Champagne like they would have in past years. “The stock market’s volatility has scared retail investors for several years. A total of $556 billion has been taken out of mutual funds focused on American stocks since October 2007, according to the Investment Company Institute. That is an enormous pot of money that largely missed out on the market’s recovery,” says The Times.
Take a visual look at what investors may be feeling. On our new infographic below, using data collected by zerohedge.com, you can see some of the reasons investors have thrown in the towel. It costs about a dollar more for each gallon of gas. Over six million more Americans are unemployed, fewer people are in the labor force and almost 50 million are using food stamps. Consumer confidence is vastly different today than it was back then.
The U.S. financial situation is also vastly different. The economy is growing much slower, the size of the balance sheet is ballooning and debt has skyrocketed. It’s no wonder that gold was about $750 per ounce back in 2007; now, it’s double that.
But it cannot be disputed that the Dow doubled from its 2009 low.
The market noise of today will not be going away. However, investors can gain confidence in the following wisdom of the crowd. As famous investor Benjamin Graham said, "The individual investor should act consistently as an investor and not as a speculator.” Keep calm and invest on.
- The major market indices finished higher this week. The Dow Jones Industrial Average rose 2.18 percent. The S&P 500 Stock Index gained 2.17 percent, while the Nasdaq Composite rose 2.35 percent. The Russell 2000 small capitalization index gained 3.04 percent this week.
- The Hang Seng Composite rose 0.65 percent; Taiwan advanced 0.63 percent and the KOSPI fell 1.01 percent.
- The 10-year Treasury bond yield fell 20 basis points this week, to 2.04 percent.
Domestic Equity Market
The S&P 500 powered ahead this week bolstered by improving economic data. Cyclical sectors led the way with gains of more than 2 percent. Financials were also strong on the back of the Federal Reserve’s stress test that boosted investors’ confidence.
- Financials were the best performing sector this week rising by 3.39 percent as investors cheered on the news of the relatively strong showing of the largest banks in the country passing the Fed’s annual stress test. Citigroup was one of the biggest beneficiaries rising 10.85 percent.
- Consumer discretion was also strong this week, rising by more than 3 percent. The housing stocks bounced back this week with DR Horton and Lennar both rising about 7 percent.
- Best Buy was the best performer in the consumer discretion sector as well as the S&P 500 this week rising 17.54 percent. The company reported earnings last Friday that beat fourth-quarter estimates and the stock followed through by rising every day this week.
- Every sector in the S&P 500 rose by at least 1 percent this week, so weaknesses are relative.
- Intuitive Surgical fell 7 percent this week following last week’s announcement of an FDA probe into the firm’s da Vinci surgery system.
- J.C. Penney was the worst performer in the S&P 500 this week falling 14.58 percent. The company’s continued troubled turnaround has prompted sells from strategic holders, a lawsuit with Macy’s and analysts’ downgrades that were just too much this week.
- The market continues to climb a wall of worry and is shrugging off any bad news. It may be a sign that investors’ confidence has returned and will propel the market higher.
- A market consolidation wouldn’t be a surprise after a strong start to the year.
Treasury bond yields rose sharply this week as better than expected employment on both Thursday and Friday drove yields higher. The weekly initial jobless claims continued to trend lower and the four week average hit the lowest level since March 2008. The unemployment report released on Friday showed better than expected payroll growth and the unemployment rate fell to 7.7 percent from 7.9 percent.
- Nonfarm payrolls increased 236,000 in February, well ahead of expectations and appear to confirm the strength seen in other areas of the economy.
- The ISM’s nonmanufacturing index hit the highest level in a year in February and the new orders component also reached a new one-year high, which bodes well for the next few months.
- Household net worth in the fourth quarter of 2012 hit the highest level since the financial crisis. This is a key milestone in repairing investors’ confidence.
- The European Central Bank (ECB) lowered the eurozone economic forecast for 2013. The ECB is expecting a contraction of 0.1 to 0.9 percent. Despite this forecast, the ECB did not change monetary policy at this week’s meeting.
- German industrial orders fell 1.9 percent in January.
- France’s jobless rate hit 10.6 percent, the highest level since 1999.
- The Fed still remains committed to an extremely accommodative policy.
- Key global central bankers are still in easing mode such as the ECB, Bank of England and the Bank of Japan.
- 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 are getting the attention of policy makers and may be an early indicator for the rest of the world.
For the week, spot gold closed at $1,578.80, up $2.57 per ounce, or 0.16 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost 0.33 percent. The U.S. Trade-Weighted Dollar Index gained 0.47 percent for the week.
- Despite reports of lower than expected shopping over the Chinese New Year, the Chinese government has reported sales of gold bars for investment purposes rose twofold, as compared to last year. Monitored establishments reported sales of gold, silver, and jewelry pieces were up 38.1 percent this season. Even fears of China slowing down cannot dwindle Chinese craving for gold.
- The South Korean Central Bank added 20 metric tons of gold to its international reserves in the month of February arguing a need to diversify its holdings. The transaction value of just over $1 billion is not massive by global standards; however it symbolizes a 24 percent increase in the countries gold reserves. Furthermore, including this recent transaction gold reserves account for only 1.5 percent of the country’s total reserves, thus leaving plenty of room for further “diversification” purchases.
- Fed Chairman Ben Bernanke gave a speech last Friday night in which he reiterated his commitment to QE III, and added that the program’s main purpose is to “prompt a return to the productive risk-taking” essential for economic growth. David Rosenberg of Gluskin Sheff noted on his March 7 “Breakfast with Dave” newsletter that the Fed Chairman is clearly telling investors that being in cash is a money-losing strategy, and that he has the power to maintain this “financial repression” for a long time. To be clear, “financial repression” means a sustained period of negative interest rates even with inflation expectations on the rebound; in such a scenario it is difficult not to make a case for gold as the most effective inflation-hedge.
- Hedge fund billionaire John Paulson has seen the value of his gold fund drop 26 percent this year on what analysts largely attribute to a hefty levered bet on gold. In a letter addressed to his investors Mr. Paulson stated he continues to believe in the long term outlook for gold thanks to credit expansion in the U.S., continued monetary easing around the world, and significantly discounted gold equities.
- Declines in ETF gold holdings have continued to decrease thanks to liquidations and rotation to more cyclical assets. The month of February saw a decline of 3.4 million ounces in ETF holdings, the largest on record. The largest factor contributing to the decline is the growing sentiment that monetary tightening could occur earlier than expected. Yet, according to Russ Koesterich, BlackRock’s global Chief Investment Strategist, this is an attractive point of entry for many investors given speculative positioning in gold futures is now at 2008-end levels.
- According to the Financial Post of Canada, up until this week the nearly 700 TSX Venture mining companies combined have raised only $110 million this year. Capital has flown out of the sector leaving some juniors with market values below the cash on their balance sheet. A light at the end of the tunnel may still shine for those juniors with good assets; during a recent interview at the Prospectors and Developers Annual Conference (PDAC) with Mark Bristow, Randgold’s CEO, he acknowledged exploration companies are struggling to access capital and stated Randgold is currently looking for opportunities to sign joint ventures with exploration companies.
- The gold price has gone sideways for the past two years with Operation Twist recycling maturing short-term securities into longer dated bonds to lower long-term interest rates without expanding the Fed’s balance sheet. Since the policy shift to purchase $85 billion worth of bonds per month, gold has not seen any traction towards higher prices with new all-time highs being attained in the broader market indexes as investors chase performance.
- Investor sentiment towards gold stocks, as tracked by StockCharts.com, the Gold Miners Bullish Percent Index has plummeted to just 3.33 percent. From a contrarian viewpoint now may be one of the best times in the past two years to add gold stocks to your portfolio with pessimism at an extreme as certain investment funds are liquidating their gold stocks at the bottom.
- Bain & Capital has published a recent study in which it forecasts a “super abundance of capital” between now and the year 2020. The rationale is that financial assets are close to reaching a ratio of 10:1 when compared to global GDP. The result will be a world with too much capital chasing too few goods, which will inevitably lead to an increase in the frequency, intensity, size and longevity of asset bubbles. Central Banks will be in a position where they will have to continue easing just to keep assets moving up in price, proof of which is the recent statement by the Fed assuring investors it is not planning an exit strategy for its treasury holdings. Investors will slowly but surely begin to feel the effects of inflation and will flock to hard assets and inflation hedges.
- China’s mining giants continue growing larger and have recently received consent from the Chinese government to beat the $19.6 billion in mergers they participated in last year. The government is assisting these firms in providing capital at very attractive rates in return for these companies looking for merger and acquisition candidates in natural resource sectors. This move should bode well for junior precious metal explorers and producers currently trading at very cheap valuations as China seeks to increase its gold reserve holdings, currently at 2 percent, compared to 20 percent in the 1990s.
- Central banks around the world have moderated the pace of monetary intervention as their foreign reserves grew almost 7 percent over the last 12 months. The concept of moderating the easing has found some investors willing to believe the real economy can continue to grow without further intervention. However, as some countries pledge to tame their currency and interest rate interventions, other countries have given assurance their easing will not stop. It is a growth war rather than a currency war in their view, which justifies unlimited intervention. Mark Carney, future governor of the Bank of England was quoted saying the books “aren’t maxed out.”
- Impala Platinum Holdings of South Africa has been notified by the Zimbabwean government that it must cede 51 percent ownership of the company’s local unit to the nation without any compensation. The so called Indigenization laws passed in 2011 dictate all foreign or white owned companies must surrender a controlling stake in their business to the government or to black Zimbabweans. There are numerous South African and global mining companies currently operating in Zimbabwe, and could, at any point, face a similar expropriation.
- The stock market is back to mid 2007 levels. Not only has the Dow broken through its previous peak, current earning per share (EPS) have also matched 2007 levels, as have price to earnings multiples. Most importantly, according to David Rosenberg of Gluskin Sheff in the fourth quarter of 2012 the S&P EPS growth turned negative for the first time since the third quarter of 2007.What some conservative investors see as a strong sell signal appears not to resonate among the investment world. Investors have continued to pile on to the U.S. equity market with a great deal of determination at the cost of gold and gold backed equities.
- The price of natural gas gained nearly 5 percent this week to $3.62 per Mmbtu, its third weekly gain, as late winter storms increased demand for the fuel. Additionally, MDA Weather Service predicted another round of below-normal temperatures for the Eastern region of the country next week.
- The Energy Information Administration (EIA) said U.S. crude oil production reached 7 million barrels per day in February due to increase in the crude production from the Bakken oil field in North Dakota.
- The Financial Times notes that China has overtaken the U.S. as the world's largest net importer of oil. U.S. net oil imports dropped to 5.98 million barrels a day in December, the lowest since February 1992, according to figures from the EIA. In the same month, China's net oil imports surged to 6.12 million barrels a day. The U.S. has been the world's largest net importer of oil since the mid-1970s. U.S. domestic oil production is booming on the back of the oil shale revolution, reducing the need for crude oil imports.
- China’s daily crude steel output rose 1.4 percent to 2.03 million tons in late February, the China Iron & Steel Association said.
- According to copper miner Teck Resources Inc., investors continue to underestimate the true copper cost curve. TCK management believes costs are tracking 20 percent above current long term estimates of $2.50 to $2.75 per pound, and once you include sustaining capital of $0.25 per pound, you actually end up with a price closer to $3.50 per pound. As such, TCK expects additional projects to be shelved or curtailed. However copper has the best 10 year supply-demand fundamentals in their commodity universe.
- Rusal PLC , the world's largest aluminum producer, will cut annual output by around 7 percent this year, the company said Monday, paring excess global supply at a time of lackluster demand, depressed prices and rising output in China and the Persian Gulf.
- Texas is poised to more than double daily oil production by 2020, surpassing a 1972 record with surging output from the Eagle Ford shale and Permian Basin, the state’s petroleum regulator said.
- Oil production may rise to as much as 1.75 million barrels a day in 2013 from about 1.5 million barrels a day last year, Barry Smitherman, chairman of the Railroad Commission of Texas, said in an interview at the IHS CERAWeek conference in Houston today. The commission oversees oil and gas drilling and production in the state.
- By 2020, Texas’ crude output may exceed the 3.45 million barrels a day seen in 1972 if prices stay high enough to make drilling economic, he said.
- “The Eagle Ford really continues to ramp up, especially the liquids and crude portion,” Smitherman said. The Eagle Ford, which includes an area south of San Antonio, may reach 800,000 to 900,000 barrels a day by 2016, while the Permian in West Texas may reach one million barrels a day, he said
- The Los Angeles Times writes that the Mexican government has passed a reform that allows foreign investment in Pemex. The article goes on to say that this could eventually allow U.S. oil firms to drill in the region.
- According to the U.S. Department of Agriculture, China is poised to become the world’s largest wheat producer in the next 10 years.
- Following the death of Venezuelan President Hugo Chavez this week, Bloomberg reported that China is taking a look at the risks Chavez’s death poses to China’s investments in the country that total around $50 billion after 14 years of close ties with the leader that have led to contracts to build railroads, housing and power stations. One analyst at Mirae Asset Securities said “the death of Chavez could lead to oil supply uncertainties from Venezuela and could jeopardize Venezuela’s oil exports to China in the short term.”
- China’s February export was up 22 percent, exceeding the market expectation of 8.1 percent. China export is highly correlated with industrial production (IP), and therefore, the market is looking for a better February IP number to be released this weekend.
- China raised the fixed asset investment target to 18 percent growth for 2013 from 16 percent in 2012 in order to meet a GDP growth target of 7.5 percent. China also increased the fiscal budget deficit by 50 percent to Rmb1.2 trillion from last year’s 0.8 trillion.
- National Development and Reform Commission (NDRC) added 10 million kilowatts of solar power capacity to this year’s target. NDRC also said it will target expanding wind power capacity by 18 million kilowatts. The pollution reduction is clearly a policy priority in China.
- The Chilean economy expanded 6.7 percent in January benefiting both from increased commodity exports to China and growing internal demand. Exports were up 7.4 percent from a year earlier, while retail sales rose 9.5 percent over the same period. It is expected Chile will grow at the second-largest pace this year among Latin American countries; analysts estimate GDP will climb 4.8 percent for the year.
- China’s February import was down 15.2 percent, lower than the market expectation of down 8.5 percent.
- China lowered the target for broad money supply growth from last year’s 15.9 percent to this year’s 13 percent, which suggests a possible shift towards a more proactive fiscal policy and a more prudent monetary stance. Total social financing may continue to grow, which has the effect to increase debt durations.
- The Indonesia rupiah is stabilizing below 10,000 rupiah per U.S. dollar.
- Despite a two-day rally in the Brazilian Bovespa Index, macroeconomic news continues to be discouraging for Brazil. A surprisingly low inflation reading published on Wednesday, together with an agreement in which BTG Pactual Group will provide $1 billion in liquidity to billionaire Eike Batista’s EBX group, helped boost the Brazilian market mid week. The EBX group controls OGX Oil & Gas, MMX Mining & Minerals, and LLX Logistics, a total 5 percent weight in the Bovespa Index. On Friday however, three CPI numbers were announced significantly above analyst expectations, further reducing the country’s capacity to advance economic growth through monetary easing.
- According to the graph above, China’s residential property value is 195 percent of GDP, which is in line with the U.S. and Japan, but below the U.K. and Ireland. After the Chinese government reinforced its housing tightening policies recently, the news media and China bears cooked up China ghost town stories again. In 2010, the most sensational story was Ordos city. A report in CBS’s 60 Minutes last weekend discovered another ghost city called Zhengzhou New Community within Zhengzhou, the capital city of Henan province. The story was actually made by a local Chinese TV crew last year before the building’s power and water connections were completed. CICC analysts had visited the community at the first report, and went back again last year after the community was completed and saw that people had started moving in. Zhengzhou has a population of nearly 9 million, and the Henan province is the most populated province in China, with more than 100 million people. Both Zhengzhou and Henan are growing much faster in recent years than coastal-developed China as this area is catching up in investment and consumption. In Henan, as everywhere in China, it is undeniable that people like properties for personal use and for investment savings, but most have made a large down payment, which is less risky if prices fall. Globally and historically, unleveraged housing investments for the long term have seen value increases.
- Mexico’s President, Enrique Pena Nieto, will advance a plan to congress that recommends an end to the monopoly of state-owned Pemex in the domestic oil industry. Oil output has fallen dramatically over the last decade as the Mexican central government tapped into the company’s earnings to finance its budget and to add U.S. dollar reserves. The move is set to open the industry to more competition, restore oil production levels and reduce the tax burden on Pemex. President Pena Nieto expects a boost in foreign direct investment and economic growth.
- A wide ranging energy deal is in the works that according to Financial Times, will see state-backed Turkish firms and Western oil majors plough money into Kurdish infrastructure and oilfields, connecting them to Turkey and the world beyond. The deal would unlock the value of oil exploration companies operating in Northern Iraq. More broadly, the entire Turkish economy would benefit from greater energy independence, both through strong domestic demand and diversified export economy.
- China’s housing market tightening can hurt property stocks if local governments follow up with their own tightening measures. There are discontents in China from all walks of life towards the 20 percent capital gain tax, which eventually will cause property prices to go up when that levy is passed to the buyers.
- Following the death of Venezuelan President Hugo Chavez, a multitude of reports on the current state of the Venezuelan oil industry have surfaced. Despite being home to the largest heavy oil reserves in the world, the country is facing a pipeline capacity glut; massive delays in infrastructure spending over the past few years will weigh down the country’s ability to capitalize on oil exports. Furthermore, Vice-President Nicolas Maduro is widely expected to win the election that should follow, leaving little hope for structural changes that could reduce the country’s massive fiscal deficit, excessive inflation and precipitous productive capacity drop in its oil sector.
- An influential think tank warned that in the nearest future, president Putin will make replacements in the top echelons of Russia’s ruling class either by dismissing the government or by announcing early Duma elections. The measures would be a result of the perceived inability of the ruling elite to successfully respond to the challenges Russia is facing: growing popular dissatisfaction with corruption, the lack of growth opportunities for the country, and increased number of conflicts among various ruling clans.
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