The world watched in awe as American swimmer Michael Phelps became the most decorated Olympian of all time. I’ve read he’s been training in the pool for an average of 6 hours a day, 6 days per week, which equates to about 30,000 hours since age 13 and about 10,000 calories burned during a training day. It’s inspiring to see the incredible results of his tremendous sacrifice and commitment.

Investing in global markets requires the same sort of stamina, especially at times like this week, when the month’s reading on the manufacturing industry was not encouraging. The J.P. Morgan Global Manufacturing PMI of 48.4 for July was the lowest since June 2009.

However, I believe there are encouraging pockets of strength to energize and inspire investors.

For example, we’re coming up on the anniversary of the first stimulus move that kicked off the global easing cycle. On August 31, 2011, Brazil unexpectedly cut rates by 50 basis points, and since then, ISI says 228 stimulative monetary and fiscal policy moves have been initiated across several countries, including the Philippines, China, France, and Colombia.

In June and July alone, there were nearly 70 moves—the most since the world began this massive easing.

Generally, by the time central banks make a fiscal or monetary easing move, economic deterioration has already occurred. Even with these moves, it still takes several months for the stimulative measures to take effect and work their way through.

But while the world wades in the shallow end of the pool waiting for the economy to warm up, Asia has taken a deep dive into the energy space as they’ve recently announced acquisitions of Canadian resources companies.

In my presentations, I’ve discussed how resources companies have significantly underperformed their underlying commodities. During 2009 and most of 2010, the performance between oil and the S&P 500 Oil & Gas Exploration and Production Index was closely correlated. By the middle of 2011, oil and oil stocks started to separate, with crude continuing to rise while stocks deteriorated. Even with the recent drop in oil prices, oil stocks have continued to lag.

I’ve also discussed the strikingly similar trend occurring between gold and gold stocks. There’s been a spectacular pop in gold stocks recently, but it hasn’t been enough to catch up to gold’s performance.

The disparities mean that the cheapest resources are not found in the ground—they’re listed, and it’s been confirmed by recent energy company acquisitions.

Chinese oil company CNOOC put in a bid of $15 billion to purchase Canada’s Nexen. This was at a 61 percent premium to Nexen’s share price on July 20, according to Bloomberg. As you can see below, not only did the takeout announcement close the gap, now the company is outperforming the price of oil.

If CNOOC’s deal is approved, the state-run oil giant gets even bigger, gaining access to significant energy stores in several areas of the world, including Canada, the Gulf of Mexico, Colombia and West Africa, as shown below.

With a rapidly growing middle class and rising urbanization, Chinese leaders know they need to fill their country’s tremendous energy demands and are continually finding innovative ways to keep their country powered. CNOOC’s acquisition is one way China continues to acquire not only the resources needed to power the country, but also the technological innovations that come from countries with free markets and lower barriers to entry. According to The New York Times, China “has been garnering advanced production technologies to better draw oil and gas from nontraditional areas like deepwater fields and hardened rock formations.”

The other announcement came from Malaysia’s state-owned and natural-gas giant Petronas, which will purchase Canada’s Progress Energy Resources Corp. Petronas is one of the largest producers and shippers of supercooled LNG fuel in the world. According to the Vancouver Sun, the company is “anxious to increase its market share in Asia, where analysts expect demand to surge 75 percent by the end of the decade.”

After Petronas’ original bid was announced, Progress increased 74 percent—a record gain for the company, says Bloomberg. As shown below, Progress now dramatically outperforms the underlying commodity.

Ready to be a Buyer like Asia?
If you’re contrarian investor, there may be an additional reason to jump into the market today. According to research from J.P. Morgan, institutional investors have become extremely negative, as hedge funds “essentially short the market,” meaning that their expectation is that stocks will fall. 

J.P. Morgan looked at the rolling 21-day beta of macro fund returns compared to the S&P 500 Index returns and found that the ratio is at an extreme level of -0.26. Research shows that the last two times the ratio fell this low—in September 2010 and February 2012—stocks rallied. In 2010, the S&P 500 climbed 26 percent in five months; in 2012, stocks rose 8 percent in two months.

These signs the market is sending out make it an especially attractive time to “mine” for investment opportunity. In July, we began to see energy stocks and oil get recharged, as the energy sector in the S&P 500 was the second best performer, increasing 4.17 percent and crude oil rose 3.68 percent. Unlike the start of an Olympic race, in investing, there isn’t a signal sounded to let you know when to dive off the starting block into the markets. Just make sure your portfolio is poised to participate in the race for resources.

 

Index Summary

• The major market indices were higher this week. The Dow Jones Industrial Average rose 0.16 percent. The S&P 500 Stock Index rose 0.36 percent, while the Nasdaq Composite advanced 0.33 percent.

• Barra Value outperformed Barra Growth as Barra Value rose 0.41 percent while the Barra Growth index appreciated 0.33 percent for the week. The Russell 2000 closed the week with a loss of 0.94 percent.

• The Hang Seng Composite rose 2.03 percent; Taiwan rose 1.31 percent, while the KOSPI added 1.07 percent.

• The 10-year Treasury bond yield rose 1 basis point for the week, to 1.56 percent.

 

Domestic Equity Market

The S&P 500 Index rose 0.36 percent this week as the equity market shrugged off initially disappointing news from both the Federal Reserve and European Central Bank (ECB). The market rallied strongly on Friday to erase losses from earlier in the week. It appears the market also negatively reacted to the news that Knight Capital lost $440 million in a mini “flash crash” for the firm caused by a software glitch. By Friday, the company was able to secure short-term financing to continue trading and this appeared to be a relief to the market.

 

 

• The technology sector was the best performer this week rising 1.52 percent driven by a stealth rally in Apple which rose by more than 4 percent this week, along with healthy performances from Teradata, Microchip Technologies and Cisco. 

• The financial sector was once again near the top of the performance charts with solid performances from the insurance companies as Metlife, Lincoln National, Prudential and Allstate all reported earnings this week that were well received by the market.

• Frontier Communications was the best performer in the S&P 500 this week, rising by 18 percent on better than expected second quarter results and an improving outlook.

 

 

• The healthcare sector lagged as managed care companies and healthcare distributors sold off sharply on disappointing quarterly results. Within the managed care industry group, Humana dropped more than 11 percent and in the distribution space, Cardinal Health fell by more than 7 percent.

• Utilities also underperformed this week, bucking a recent positive trend for the sector.

• Abercrombie & Fitch was the worst performer in the S&P 500 this week. The stock hit a three-year low as the company slashed its full-year earnings outlook by almost a third.

 

 

• The market shifted its focus from earnings to central bank policy last week and that shift will likely dominate the price action for the next several weeks.

 

 

• While policy makers in Europe have made strides to stabilize the economic situation, many risks remain and the situation remains very fluid.

• The head of the ECB, Mario Draghi, stated that the ECB will do whatever it takes to save the euro. However, it appears all is not under his control and policy makers in Germany may not allow for the policies the central bank believes the economy needs.

 

The Economy and Bond Market

Treasury yields were little changed this week as a tug of war continues between global central bankers and economic data. This week was all about the Fed and ECB announcements, which came in with a bang last week but went out with a whimper this week.  Neither central bank took action and, once again, tried to reassure the markets with words not action. Global economic data remains weak as can be seen in the JPM Global PMI chart below, which indicates a global contraction in manufacturing. Tempering this news was a better than expected employment report on Friday, potentially causing policy action indecision from the Fed.

 

 

• July nonfarm payrolls grew 163,000 vs. the 100,000 that was expected and was the best showing since February.

• Retail sales posted surprising strength in July as same-store sales rose 4.4 percent.

• Consumer confidence unexpectedly bounced back in July, showing greater optimism about short-term business and employment prospects.

 

 

• ISM’s July manufacturing index remained in contraction territory for the second month in a row.

• The Fed failed to take any action this week after it was widely viewed that the Fed planted those seeds in a widely disseminated story last week. 

• The ECB also failed to follow through with any action and possibly lost some credibility with investors. The market has become used to a lot of talk from European officials but when the head of the Central Bank promises to do whatever it takes to save the euro and then is unable to articulate exactly what that entails, it raises credibility issues.

 

 

• The Fed and ECB are still talking about additional monetary stimulus and it may happen in the near future. Interest rates are likely to remain very low for the foreseeable future.

 

 

• Europe remains a wildcard with the markets shifting focus on a weekly basis.

• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.

Gold Market

For the week, spot gold closed at $1,603.48 down $19.42 per ounce, or 1.20 percent.  Gold stocks, as measured by the NYSE Arca Gold Miners Index, fell 1.04 percent. The U.S. Trade-Weighted Dollar Index slid 0.48 percent for the week.

 

 

• Central bank buying of gold continues to be a strong theme.  This week the Bank of Korea, which has the world’s seventh biggest foreign exchange reserves, announced it had purchased 16 metric tons of gold last month, increasing reserves to 70.4 tons. Central banks and the International Monetary Fund (IMF) are the largest bullion owners with 29,500 tons at the end of last year, or 17 percent of all mined metal, World Gold Council data shows.  Central banks have been net buyers for two straight years, the Council said.  Purchases this year will probably exceed the 456 tons added in 2011, the Council estimates.

• Although gold was down for the week we think the price action was positive.  Gold was down somewhat when the strong ADP jobs number came out on Wednesday morning, and then gold initially declined further after Federal Reserve Chairman Ben Bernanke held off on announcing new stimulus measures.  The selloff did not last long before buyers came back in and scooped up the metal.  The simplistic trade of shorting gold on no new Bernanke announcement for another round of quantitative easing has become quite crowded.

• Although global gold mine production has fallen -2.9 percent year-to-date and has registered year-over-year declines for eight months running may sound like bad news, and it has been for certain gold producers, this is certainly a positive for those companies that have maintained or grown their production.  Despite the 11 years of consecutively higher gold prices, gold production has been flat and this should bode well for higher prices in the future.

 

 

• Kinross Gold replaced CEO Tye Burt this week.  This is the second senior gold company CEO to have been removed by their boards in the past month.  The replacement CEO is J. Paul Rollinson, a long-time associate of Mr. Burt. Mr. Rollinson is also a former investment banker, with a geology and engineering background.  In general, analysts lamented that they would have preferred a high profile manager with a proven track record of operating and/or building mines and/or turning companies around.

• Standard & Poor’s has downgraded Barrick Gold from “A-” to “BBB+” with a negative outlook.  The rating agency’s negative outlook on Barrick “reflects our view that the execution risks surrounding Pascua-Lama could potentially stretch the company’s credit measures and free operation cash flow generation beyond the levels we have assumed within our base case scenario.”

• The Indian market is still seeing no relief as the rupee remains weak, the arrival of the monsoon season has been disappointing and the multi-state electric grid collapse last week caused widespread blackouts across the region, obviously curtailing near-term economic activity.

 

 

• Nick Holland, CEO of Goldfields Ltd., recently addressed the Melbourne Mining Club and covered a 35-page presentation surveying all the things that gold miners have been getting wrong over the last decade and offering a few ways to solve some of them.   Nick Holland pointed out that one theme has run through the presentations of large gold producers at investor conferences over the last 15 years is that production is going to increase and this will result in the company increasing its earnings.  Nick notes that if the gold industry had actually met all its production promises over the last five years, then it would not have dropped output on a compound annual basis by 2 percent between 2006 and 2011.  Unfortunately gold miners have not met their production promises and investors have become skeptical.

• Nick also highlighted that gold miners need to think differently about costs.  “Who are we trying to kid?  We don’t kid the investors because they know how much cash we really generate after everything is accounted for.  The sell-side also understands this.  The only people we’re kidding are governments and communities, who, not surprisingly, say, okay, you’re making super profits, please pay up.  And before we know it we have windfall taxes, higher royalties and so on.  We’ve got to change the lens through which we and the world view this industry, and start talking about what it really costs to produce an ounce of gold.  I don’t care if we call it NCE or something else, but to talk about cash costs only is not telling the full story.”  We view this type of examination of the industry as a strong positive for management to take full notice of a nd start delivering on what the investor is expecting from gold mining companies.

• Bank of America Merrill Lynch noted that while the Federal Open Market Committee (FOMC) did not take any easing action at its current meeting, under its forecast, the economic data should weaken enough by the September 13 FOMC meeting to convince most Fed officials to support more QE and extend the forward guidance then.  But the call on further Fed easing remains very dependent on the path of incoming data.  We think only a small portion of recent gold buyers entered with the expectation of a Fed move this week but it is more likely a greater number are looking toward the Jackson Hole meeting at the end of August, and then the September FOMC meeting as key entry points into the gold market.

 

 

• While most governments are outright buyers of gold, Vietnam’s government has a different view on gold.  The problem is nobody wants to use their local currency, the dong but instead more and more rely on gold to settle transactions.  The Vietnamese people have a huge affinity with gold, but the country’s government is taking major steps to restrict the gold market and the practice of replacing the dong with gold in transactions.  These restrictions included banning gold as a medium of exchange and issuing seven directives which are designed to reduce “goldization” the practice of replacing the dong with gold in transactions.

• David Rosenberg, of Gluskin Shelf, pointed out that U.S. investors withdrew a net $11.5 billion out of equity funds in the prior week according to the Lipper data that includes ETFs, the sharpest outflow in two years.  Taxable bond funds attracted over $3 billion and that brings the year-to-date tally to $151 billion as the secular shift in investor behavior towards income-generation continues apace. 

• Baby boomer investors looking forward to retirement have been burned by the tech bubble, the housing boom and ensuing credit crisis. Much of the shift in money flows has been to extreme risk aversion and government bonds have been the choice for the safety.  Unfortunately, the market has the uncanny ability to move in a direction that will disappoint the most investors.  It is unlikely, given the rising debt burden of governments, that the masses will be rewarded for seeking safety in bonds for the next five years. Under owned assets which are out of favor, such as gold, deserve some consideration for portfolio diversification.

 

Energy and Natural Resources Market

 

 

• Crude oil prices gained again this week to reach nearly $109 per barrel (Brent) on supply concerns in the North Sea and rising geopolitical premiums as the conflict in Syria intensifies. 

• Copper slipped 7 cents this week to $3.35 per pound but it has been one of the better-performing commodities in 2012, despite global growth slowing. The price has been supported by a combination of global inventory draw down, now back to 2009 levels and global producers struggling to meet near-term expectations.  Analysts at Nomura note that in the short term, prices appear fundamentally supported and are likely to be range bound. On average, current producers are generating cash margins of about 50 percent, yet cost inflation sees new projects have a hurdle rate closer to $3 per pound.

 

 

• U.S. natural gas prices fell back under $3 per mmbtu after the Department of Energy reported that weekly inventories of natural gas built larger than expected. 

• Rio Tinto PLC is cutting some jobs at its regional headquarters in Melbourne and will close an office in Sydney as the Anglo-Australian mining giant moves to contain costs amid falling prices for key commodities such as iron ore, two people familiar with the matter said Tuesday.

• The latest round of PMI data released on Wednesday paints a weak picture for global growth, and suggests that Asian economies are starting to feel stronger headwinds from the eurozone crisis. China and India also recorded slower manufacturing growth for July, while Japan’s PMI fell to the weakest level since last year’s tsunami.

 

 

• Reuters reported that the Ecuador government is preparing mining reforms to attract investments, according to a top mining official. The proposed new bill would delay a windfall tax until miners recover their investments and set a ceiling on mining royalties, bringing more certainty.

• The Indonesian Coal Mining Association (ICMA) estimates the country’s coal production is now likely to be flat in 2012, compared with a 10-12 percent increase previously. Coal analysts with Macquarie Capital think this highlights that the falling thermal coal price has put pressure on producers, particularly at the smaller, low-energy end of the spectrum which should ultimately tighten seaborne coal supply and provide price support for falling coal prices. 

• The Wall Street Journal reported that China has quietly increased its budget for railway investment this year by 16 percent, data from the Ministry of Railways showed. In its latest bond prospectus published on Chinabond, an official website for debt issues, the railway ministry said Monday it plans to spend 470 billion yuan ($73 billion) on infrastructure investment this year, up from the 406 billion yuan stated in a prospectus earlier this month. Spending on railway infrastructure in the second quarter slipped to 7.6 percent year-on-year, down from 8.1 percent in the first quarter, for its slowest pace in more than three years. Data from the railway ministry showed that it spent 148.7 billion yuan on infrastructure investment in the first half of 2012, down 39 percent from a year earlier.

 

 

• Reuters reported that Indian coal markets are seeing scattered defaults among end users and trade buyers in part because of a 20 percent slide in coal prices this year, though a vast majority are still honoring contracts.

• The Argentine government is moving to exercise further control over the country's oil sector with a new initiative that will require companies to submit annual investment plans for approval. Dow Jones Newswires reported that the government is making it mandatory for oil companies to submit their yearly investment plans to Deputy Minister of Economy Axel Kicillof by September 30 of each year, according to new rules published July 27 in the Official Bulletin. The new rules are likely to further exacerbate the tension between the Argentine government and the private companies operating in the country's hydrocarbon sector.

Emerging Markets

 

 

• Chinese President Hu Jintao presided over a Central Politburo meeting on July 26. He reaffirmed maintaining stable growth as the top priority and pledged to increase the policy support for the real economy. The frequent economic meetings hosted by the president and premier in late July suggest a higher probability for more follow-up measures soon to stabilize growth.

• China’s new bank lending may be about Rmb 700 billion in July, Economic Information Daily reports, showing the gradual rising of money supply.

• The Ministry of Railway announced that it plans to spend RMB470 billion on railroads and bridges this year.

• Money supply in the Association of Southeast Asian Nations (ASEAN) countries is robust, driven by infrastructure and property, and consumer spending. Singapore total domestic banking loans shows 20.9 percent growth year-to date by the end of June, while it is 12.6 percent for Malaysia, 26.2 percent in Indonesia, 14.6 percent in Thailand, and 14.7 percent for Philippines.

• Singapore’s unemployment rate fell in the second quarter to 2 percent from 2.1 percent the previous three months.

 

 

• China’s PMI, China’s official gauge of manufacturing activities, declined by 10 basis points from 50.2 in June to 50.1 in July. It is lower than market consensus of 50.5.

• Taiwan’s second quarter GDP was down 0.16 percent, versus the estimate 0.5 percent.

• Korea’s industrial production rose 1.6 percent in June, missing expectations for a 1.8 percent increase and down from May’s 2.6 percent.

• Thailand’s exports fell 4.3 percent in June while imports rose 5 percent, further demonstrating robust domestic demand in the country. Companies that are selling to the world market are, in general, seeing sales earning growth slow down, while those that sell to domestic demand, such as telecom, utilities and property companies, are still seeing robust growth. The same happens to China and other ASEAN countries.

• Hong Kong June trade growth missed expectations. Exports were down 4 percent year-over-year and imports down 2.9 percent.

• Korea’s second quarter GDP expanded 2.4 percent, growing at the slowest pace in almost three years, below the median estimate for a 2.5 percent gain.

• China’s Xi’an city said it would limit vehicle ownership to control traffic congestion.

 

 

• The recent strong support for the European project voiced by both the ECB and the German political establishment provides significant tail risk of increased forms of monetary policy support in the coming weeks.

• After the surprise July rate cut in South Africa, the market is pricing in a 25 percent chance that the Monetary Policy Committee will follow up with a further 50 basis point cut by year end. Monetary policy is already very accommodative and the policy rate is at multi-decade lows.

• Already representing 17.5 percent of the world’s population, India is projected to surpass China to be the most populous country in the world by the year 2025. With more than 65 percent of its population below the age of 35, it is expected that in the year 2020, the average age of an Indian will be 29 years compared to 37 for China.

• The dividend yield of telecom companies in Asia, excluding Japan, is close to 5 percent on average. The dividends are sustainable due to high free cash flow yield. This compares favorably with 10-year U.S. Treasury which yields less than 2 percent.

 

 

• Investors have heard many times from the Chinese government that it is committed to secure economic growth, but the government’s actions are still behind the curve. Particularly, its inability to find a balanced property policy will affect the growth of the economy.

• High household debt burden, reduced consumer purchasing power, and a relatively weak domestic growth outlook bode ill for banking sector growth in Brazil. Existing banking sector stress is likely to grow over the coming quarters on the back of declining interest rates and deteriorating asset quality.

• The Czech central bank forecasts gross domestic product to contract 0.9 percent in 2012, as measures to curb the budget deficit damp domestic demand.  The economy relies on demand for cars, auto parts and electronics from the European Union, which buys about 80 percent of Czech exports.

Leaders and Laggards

The tables show the performance of major equity and commodity market benchmarks of our family of funds.

 

 

An investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

 

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