There's No Place Like America

 

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

A conference with CEOs from around the globe this week brought me to Europe—the center of Western Civilization, the cradle of democracy, innovation and creativity, and the crux of today’s debt crisis. In Siena, I came across a medieval reminder of the effects of good and bad government inside the Palazzo Pubblico among the beautifully painted frescoes.

One mural, “The Allegory of Good Government,” personifies the virtues of justice, peace, virtue and wisdom, emphasizing the importance of a stable government. Two more frescos flank this painting, one depicting the effects of good government and another showing the effects of bad government.

Surrounded by historic beauty, it’s sad to see the disillusioned faces on the streets of Europe. If a picture is worth a thousand words, the one below might be more monumental than that. Business Insider featured this chart showing the rising unemployment rate among the youth throughout Europe. Since the 2009 global crisis through April 2012, youth unemployment has skyrocketed in Spain, Greece, Portugal, Italy and Ireland.

Ian McAvity recently shared some words of wisdom related to Europe’s colossal challenges: “When times get tough, economic nationalism and protectionism tends to rise because it is always easier to blame someone else for self-inflicted problems.”

The contrast of historic beauty against tragedy is one for Shakespeare. Back in the U.S., I am thankful for the entrepreneurial heart that beats throughout America. As the election grows closer, I’m confident it’ll beat louder to persuade the U.S. government to pursue thoughtful policies that embody essential American principles.

One should not underestimate what it means to be American; you don’t find a feeling quite like it outside the nation. In fact, emerging countries such as Singapore and China are now striving to replicate what my friend Alexander Green calls “American exceptionalism.”

He says the U.S. is the world’s economic superpower today not only because of geography, but, more importantly, the fact that entrepreneurs were free to innovate and create. Alex writes, “America cultivates, celebrates and rewards the habits that make men and women successful. It promises that anyone with ambition and grit can move up the economic ladder, that everyone has a chance to better his or her lot, regardless of circumstances.”

This feeling of empowerment has created a national group of well-informed and very engaged individuals. On the Organisation for Economic Cooperation and Development (OECD) “Your Better Life Index” based on 11 diverse measures of well-being, the U.S. is highly ranked. Each element measures a feeling of satisfaction with life, including health, education, environment, personal security, life satisfaction, and work-life balance. Here are a few of the highlights from OECD’s summary of the U.S.:

 

• The average income in the U.S. is nearly $38,000 a year, considerably more than the OECD average income of about $22,000.
• Almost 90 percent of adults in the U.S. have a high-school degree (or equivalent); the OECD average is 74 percent.
• Americans have a strong sense of community, as 92 percent know someone they could rely on in a time of need. The OECD average is 91 percent.
• Voter turnout was significantly higher than the world average: 90 percent of those registered participate in the U.S. political process, compared to 73 percent for the rest of the world.
• American households spend an average of only 20 percent of net disposable income on rent/home loans, gas, electricity, water, furnishings or repairs. The OECD average is 22 percent.

 

While a 2 percent difference in household spending isn’t striking, pennies add up. In a Deutsche Bank survey of how much a variety of goods cost around the world, the research firm found that New York “was found to be significantly cheaper than other major financial hubs even after accounting for taxes and other additional charges.”

According to its study, if I wanted to buy Apple’s iPhone in Europe, it would’ve cost me $845; filling a car with a liter of petrol would cost over $1 more than it does in the U.S. A pair of Levis is nearly double the price than the same pair in New York City. On multiple measures, New York City offers more for your money compared to Paris, Sao Paolo or Tokyo.

Nonetheless, consumers on the other side of the world willingly line up to purchase American-made goods, even at a premium price.
 
Affordability is partially why 60 million international tourists choose to immerse themselves in American culture each year. While Canada and Mexico make up the majority of these visitors, tourists from Brazil and China have been visiting in record numbers, according to data from the U.S. International Trade Administration. In 2011, visitors from Brazil increased 26 percent to 1.5 million people. About 1 million Chinese visited the U.S. in 2011, which was an increase of 36 percent over the previous year.

As the rising middle class in emerging markets gain more disposable income, they desire the same financial and social mobility that Americans take for granted. For that mobility, each visitor spends about $4,000 on travel, clothes, food and attractions.

Invest in America

In his article, Alex Green describes the traits that a typical American embodies: “an optimistic attitude, a can-do spirit, and an enthusiastic endorsement of the pursuit of happiness through individual initiative and self-reliance.”

Investors aren’t endorsing U.S. equities today. With all the positive aspects mentioned above, today’s low participation in the U.S. stock market is perplexing. Here are two more reasons to invest today: 1) About 620 companies in the S&P 1500 Index are growing their revenues at more than 10 percent; and 2) 428 stocks in the index have an annualized dividend yield higher than the 10-year Treasury.

Happy Memorial Day!

Whatever you happen to be doing this weekend—shopping the sales, sightseeing in the city or barbequing in your backyard—take time to honor the men and women who died serving our country. We owe the freedom of our “Better Life” we lead today to the men and women who selflessly gave their lives fighting for America.

 

Index Summary

• The major market indices were higher this week. The Dow Jones Industrial Average rose 0.69 percent. The S&P 500 Stock Index increased 1.74 percent, while the Nasdaq Composite posted a gain of 2.11 percent.
• Barra Growth outperformed Barra Value as Barra Growth rose 1.93 percent while the Barra Value index increased 1.53 percent. The Russell 2000 closed the week with a gain of 2.57 percent.
• The Hang Seng Composite posted a loss of 0.81 percent; Taiwan dropped 1.11 percent, while the KOSPI rose 2.34 percent.
• The 10-year Treasury bond yield rose modestly to 1.74 percent, rising 2 basis points for the week.

 

Domestic Equity Market

The S&P 500 Index bounced back this week, rising 1.74 percent. The materials, consumer discretionary and industrials sectors led the way, all rising by more than 2 percent. The defensive areas that have recently outperformed were the laggards this week as telecommunication services, health care and utilities all rose less than one percent.

Strengths

• The materials sector was led by strong broad based gains in the chemical sector. Standout performers in Sherwin-Williams, Eastman Chemical and FMC Corp. While company-specific news was a driver, the larger positive trend in chemicals was the declining feedstock cost as oil moves lower and natural gas prices remained depressed.
• Within the consumer discretionary sector, online travel companies and homebuilders stand out. Expedia and Tripadvisor were among the best performers on optimism regarding Europe. Home builders Pulte Group and Lennar were strong on the back of better-than-expected new home sales data.  
• The best individual stock performer this week was Cooper Industries which rose 27.5 percent as it agreed to be acquired by Eaton Corp.

Weaknesses

• All S&P 500 sectors were higher this week but the relative laggard was telecommunication services which saw AT&T and Verizon post small declines after recent outperformance.  
• At the industry level, computer storage and peripherals was the worst performer as NetApp fell by more than 13 percent on disappointing sales outlook.
• Dell was the worst performer in the S&P 500 this week, falling by more than 15 percent on disappointing quarterly results.

Opportunity

• As mentioned last week, airlines and gold stocks continued their positive trajectory and were among the best performers again this week. European concerns and lower oil prices were the primary drivers.

Threat

• The U.S. remains a bright spot in the global economy and external shocks from Europe or Asia can’t be ruled out.

 

The Economy and Bond Market

 

Treasury yields were little changed as mixed economic data here in the U.S. and lots of back and forth speculation in Europe led to an overall muted reaction. New home sales were a bright spot and as can be seen in the chart below, have been steadily trending high since last summer. A similar pattern is taking place in the existing home market and real market recovery appears to be underway.

Strengths

• The University of Michigan Confidence Index hit the highest level since October 2007, citing lower gasoline prices.
• April new home sales rose 3.3 percent, beating expectations.
• Existing home sales grew 3.4 percent in April and the median priced jumped 7.6 percent.

Weaknesses

• Durable goods orders in April were weak, with “core” capital goods orders falling 1.9 percent, the third decline in four months.
• HSBC’s flash Purchasing Managers’ Index (PMI) for China fell to 48.7 in May and disappointed hopes for a rebound.
• Markit’s eurozone PMI told a similar story as this indicator fell to the lowest level in nearly three years.

Opportunity

• Bonds continue to grind higher and appear to be forecasting benign inflation and slow growth.
• The Federal Reserve appears willing to increase monetary accommodation if necessary, which would be a boost to the bond market.

Threat

• China’s economy is slowing faster than expected and government policy makers appear comfortable with this dynamic.
• Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty. 

 

Gold Market

 

For the week, spot gold closed at $1,573.03 down $19.96 per ounce, or 1.3 percent.  Gold stocks, as measured by the NYSE Arca Gold Miners Index, surged 7.88 percent. The U.S. Trade-Weighted Dollar Index gained 1.37 percent for the week.

Strengths

• Gold stocks strongly outperformed gold bullion this week.  As we have highlighted in the past there has been a significant disconnect between the price of gold and equity share prices.  The latest Canaccord Genuity Junior Mining Weekly highlights that one year ago, bullion was making new highs week-over-week with the price of gold rising up to $1,508 per ounce.  Based on Canaccord’s in-situ gold database, the market was valuing gold held by non-producers at about $129 per ounce.  One year later, while the price of gold is trading higher at $1,590 (5.4 percent higher than one year ago); the average in-situ value per ounce has dropped to $62 (52 percent lower than one year ago).  The junior miners have been put in the penalty box as capital markets have temporarily shut off the financing lifeline to these companies.
• With the S&P 500 now giving up more than half its gains for the year, much of the surge in gold stock buying over the past week came from generalist funds that may be diversifying in an uncertain market.  Another factor driving this buying may have been insider buying at the gold mining companies, which has recently soared according to the Market Ink Report.  The Market Ink Report notes that the stars may indeed be aligning for gold stocks as the eurozone faces the prospect of a full-blown banking crisis potentially taking hold over the next few weeks.  That would force the European Central Bank to provide further monetary easing.
• Despite gold being down this week it did get a lift in value as the International Monetary Fund (IMF) reported that central bank buying in gold was still proceeding at a brisk pace in April.  Turkey raised its reserves by 29.7 tons and Ukraine, Mexico and Kazakhstan also increased their holdings.  The Philippines, whose purchases actually date back to March but were slow in being reported to the IMF, reported gold purchases amounting to 32 tons of bullion--the biggest volume since Mexico bought around 78 tons a little over a year ago.

Weaknesses

• Feedback from the recent Bank of American Merrill Lynch 29th Global Metals, Mining and Steel conference in Miami showed there was very little interest in attending a gold company presentation, which could in itself, be interpreted as a buy signal.  Michael Jalonen, of BofAML noted he came to the conference with high hopes for news flow on capex reduction and a focus on capital returns but ultimately left feeling a little disappointed.    
• Before a mining company has even applied for a permit for the Pebble Project Assessment in Alaska, the EPA stepped in and released its own report.  The EPA issued a heavy three-volume report on the possible impact of mining projects on the Bristol Bay watershed system but the agency insisted, “the draft study in no way prejudges future consideration of proposed mining activities.”  The U.S. Corps of Engineers is the primary permitting authority for dredging and filing permits for mining projects.  However, Senate Energy and Resources Committee Member Lisa Murkowski, R-Alaska, and others noted the EPA is determined to wrestle the mining permitting authority for itself, using the power it believes was granted by the Clean Water Act. 
• Indian retail gold demand has been poor as the rupee has fallen significantly in value due to inflation and this has made gold more expensive in local currency terms.

Opportunities

• Ray Dalio was interviewed by Barron’s recently.  Dalio is one of the most successful hedge fund managers in the world, overseeing $120 billion in assets.  Dalio was asked if he is still a fan of gold.  Dalio noted it could be a bumpy ride temporarily because Europeans will have to sell gold in order to raise funds because they are squeezed but recommended that most people should have in the vicinity of 10 percent of their assets in gold, not only because he thinks it will be a good investment longer term, but because he thinks it is a very effective diversifier against the other 90 percent.  He also explained that he is viewing gold as an alternative currency.  “The big issue is debtor-developed countries, the U.S., Europe and Japan, all have a lot of debt and will have to print money or they will have credit problems.  I don’t want to have all of my money in those currencies.” 
• Technical studies by Institutional Advisors show that the Philadelphia Stock Exchange Gold and Silver Index (XAU)/Gold Ratio has hit an extreme reading of less than 25 and such lows have only been seen around the important lows of September-October 2008, October-November 1948, the double bottom of March and October 1942 and June 1924.  Their work indicates these types of readings have historically marked turning points in the relative performance of gold versus the gold stocks and the current readings support stronger gold stock prices.
• Chris Wood, in his latest Fear and Greed report, said that gold has been acting like a risky asset lately, and it is only a matter of time before it resumes its safe haven status.  In the near term, so long as there are investors who own gold on leverage via ETFs or futures, there is always the risk of gold correcting further in a classic deleveraging trade.  But in the long run, gold is the only real hedge against both deflation and hyperinflation.  The ongoing experiment in unorthodox monetary policy from Western central banks will not end well.  While rising energy costs have hurt gold companies’ profit markets, CLSA says that with U.S. crude oil inventories rising, rising gold and falling oil prices are “a perfect ‘combo’ for gold-mining shares.”

Threats

• Don Coxe noted there is essentially a backroom political ban on investing in companies deemed impure by environmental NGOs and this is unfairly depressing the prices of some of the leading gold mining stocks, and hurting pension funds.  Coxe says pension funds are succumbing to political pressure, resulting in “more and more corporate pension funds…being impaled on their own funding swords due to inadequate investment returns.”  Coxe suggests that commodity stocks are “victims of a new form of persecution from two groups--those with contempt for capitalism, along with those who resent what mining and oil and gas companies do for a living.”
• To stop the development of several new mines that are being contemplated in Minnesota, a couple of NGOs recently went on the offensive to highlight that sulfide mining presents many more risks to their environment than traditional iron ore mining that has taken place in their state and the citizens need a broad conversation about this issue.
• The Canadian mining industry is seeing a couple of headline risks this week with the Teamsters strike, which shut down Canadian Pacific Railway freight lines early Wednesday with no end in sight.  This leaves mining and other resource companies in Canada faced with supply and fuel disruptions.  Also, forest fires in Canada have surfaced as a problem as some power lines to the mines have been damaged while other areas are shutting in to make sure air quality underground is free of smoke.

 

Energy and Natural Resources Market

Strengths

• Global mining equities recovered from last week’s sell off with an average gain of 6.5 percent in the NYSE Arca Gold BUGS (HUI) and S&P/TSX Metals & Mining indices.
• The global LNG market has tightened considerably since Japan’s nuclear industry was shut down in 2011 after a serious nuclear power accident.  Japan’s LNG imports grew 14.9 percent to 6.91 million tons in April from a year earlier according to the finance ministry.

Weaknesses

• Natural gas futures closed lower this week after a 6-week rally.  Weekly inventory data from the Department of Energy knocked down prompt futures by about 18 cents per mmbtu from the prior week to close under $2.58 per mmbtu. 
• Steel output in China declined in April from a record as buyers sought to defer imports of raw materials such as iron ore and coking coal, Bloomberg reported. China’s crude-steel production declined 1.6 percent to 60.57 million metric tons after soaring to a record 61.58 million tons in March, the World Steel Association said.

Opportunities

• The shale gas boom in the U.S. has led to a big drop in the country’s carbon emissions, as power generators switch from coal to cheap gas.  According to the International Energy Agency, U.S. energy-related emissions of carbon dioxide, the main greenhouse gas fell by 450 million tons over the past five years.
• The Financial Times reported that China is moving to accelerate investment in major infrastructure projects. The official China Securities Journal said that the government was stepping up approvals for infrastructure projects. “Some projects that were to have started in the second half of the year are being shifted to the first half, with the allocation of central government funding being brought forward,” the newspaper quoted a “related person” as saying. “There is a clear acceleration of the allocation of investment from the government budget this year compared with the last two years,” it said.
• Xstrata expects copper demand in China to recover in the second half of 2012 as it takes steps to boost its economy, Bloomberg reports. “The commentary from China that they’re going to look to re-stimulate the economy in some areas is positive,” Bloomberg reported citing Charlie Sartain, CEO of the company’s copper unit. Demand for white goods and household appliances, as well as continuing year-over-year growth in China’s power generation sector, will benefit from China’s stimulus efforts, Sartain said. “We see those parts of the economy in China as still pretty robust,” he said. “This decade we are going to see generally tight conditions in the copper market” he said, adding that higher costs related to new sources of production will help to keep copper prices at historically elevated levels in the future.

Threats

• U.S. manufacturers have attacked JP Morgan Chase’s plans to launch an exchange traded fund backed by physical copper, arguing that the ETF would drive up the cost of the metal and be detrimental to the global economy.
• China stainless steel demand growth this year will probably be the slowest since 2001, said Lu Ping, assistant general manager of Baosteel Stainless Steel. Demand in China may only rise 3 percent to 5 percent to about 10 million metric tons as a result of the slowdown in economic growth, Lu said. Output of stainless steel in China is likely to grow 3 percent to 5 percent to 12 million to 12.5 million tons.

 

Emerging Markets

Strengths

• The State Council, China’s cabinet, on Wednesday called for more economic policies to encourage growth. The new policies are expected to include support for big infrastructure projects, tax cuts for businesses, more loans for small and medium-sized enterprises, and programs to boost domestic consumptions.
• Chinese infrastructure companies rallied after the market heard the government plans to hasten approval of infrastructure construction projects to improve the economy.
• Russian equities earnings yield is at the highest level it has been since 2008 after the recent selloff.

Weaknesses

• The HSBC China flash PMI dropped to 48.7 in May from 49.3 in previous month, a consecutive seventh month below 50, indicating that industrial activities are contracting. Particularly worrisome is the new export order index that dropped to 47.8 from 50.2 in April, indicating strongly that export businesses are declining.
• The big four banks’ new loan growth was at RMB 30 billion as of May 20, versus a quota of RMB 250 to 280 billion, and  their deposits fell RMB 270 billion as of May 20 versus the end of April. Mid- and long-term corporate loans remained weak, and retail loans also showed signs of sluggish growth, further signals that may force the central bank to cut interest rate and reduce the bank reserve ratio.
• The faster-than-anticipated sell off of the Brazilian real has exposed several economic vulnerabilities and has triggered government and a corporate debt sell off.

Opportunities

• The Russian central bank is ready to enlarge its balance sheet to protect the banking system if needed in a “Russian equivalent of QE.”
• Thailand is most involved in exporting to the low income Association of Southeast Asian Nations (ASEAN) economies of Laos, Vietnam, Myanmar and Cambodia. As these countries grow at an exponential rate, Thai companies stand to benefit the most in exporting manufactured goods and exploring natural resources, according UBS research.
• The end of the presidency of France's Nicolas Sarkozy, a staunch opponent of Turkey’s EU membership, has revived hopes for the country’s accession to the bloc, after little progress since the EU opened entry talks with Turkey in 2005.

Threats

• China’s premier Wen Jiabo warned at a State Council meeting this week that global growth has deteriorated and pressure has increased on domestic growth. There is a need to accelerate railway and other infrastructure projects. The State Information Office is forecasting that second-quarter GDP growth could fall to 7.5 percent.
• The threat of nationalization in Latin America is not isolated to Argentina, according to Business Monitor International.  Actions by the Argentine authorities to reverse its trade deficit with Brazil have also seen retaliations from the Brazilian authorities, who introduced tighter restrictions on perishable imports. Should the trade spat escalate, more Brazilian companies are likely to suffer.
• The uncertainty surrounding the Greek political situation raises the risk that the country’s exit from the eurozone could happen as early as this year and that it could be disorderly.

 

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