Ian Nar­ine

Last week was in­deed a crazy week. In the re­cent past, news such as the Cyprus col­lapse/bailout was sim­ply shrugged off as glob­al mar­kets pushed high­er. In fact, while Eu­rope was deal­ing with their most re­cent is­sue and Japan was em­bark­ing on their lat­est plan to get out of their 20-year de­fla­tion­ary spi­ral, the bench­mark US stock mar­ket in­dex the S&P 500 pushed on to new all time highs.

Then came the events of last week. The bomb­ing in Boston and the sub­se­quent dra­ma sur­round­ing the iden­ti­fi­ca­tion and cap­ture of the sus­pects clear­ly roiled the mar­kets push­ing it low­er for the day. That is an iso­lat­ed in­ci­dent and, on its own, should be shrugged off just as eas­i­ly. How­ev­er, there seems to be much deep­er un­der­cur­rents that in­vestors should take note of and be aware.

Back in Feb­ru­ary, the yield on the ten-year US trea­sury bond was ris­ing in­to the 2.1 per cent re­gion. Last week the yield went to 1.67 per cent, which was the low­est lev­el since mid-De­cem­ber 2012. The bomb­ing in Boston as a one or two day event can­not ac­count for yields falling in­to what can be termed as "per­pet­u­al cri­sis" ter­ri­to­ry.

You should ap­pre­ci­ate that much of the com­men­tary be­hind the ral­ly in the US stock mar­ket dur­ing 2013 has been about "the great ro­ta­tion" or the move­ment of mon­ey out of bonds and in­to stocks. Is the ro­ta­tion slow­ing down?

The ar­gu­ment was that bond yields were as low as they were ever go­ing to go and there is no val­ue to be had from in­vest­ing in bonds and so mon­ey was flow­ing out of bonds in­to stocks caus­ing stock prices to rise.

My com­men­tary on this ear­li­er in the year was to ex­pect a fair amount of volatil­i­ty in bond yields as there is as yet no clear path to eco­nom­ic growth, which is the ba­sis up­on which bond yields should rise on a fun­da­men­tal ba­sis.

With bond yields once again falling (which means that bond prices are ris­ing) con­se­quent­ly or co­in­ci­den­tal­ly the US stock mar­ket al­so had its worst week in five months. US eco­nom­ic da­ta con­tin­ues to be mixed with var­i­ous in­di­ca­tors as­so­ci­at­ed with the jobs mar­ket, hous­ing, man­u­fac­tur­ing and growth ex­pec­ta­tions all show­ing some mea­sure of in­con­sis­ten­cy with a skew to­wards the down­side.

The truth is that da­ta is hard­ly ever uni­form and point­ing de­cid­ed­ly in a par­tic­u­lar di­rec­tion. It is the in­ter­pre­ta­tion of da­ta as mixed and var­ied as it is that gives rise to the dif­fer­ing opin­ions on where the stock mar­ket is head­ing. These are the opin­ions that are then put to work in the stock mar­ket and gives rise to in­vest­ment out­comes of ei­ther prof­it or loss.

Mag­i­cal as­set

One of the ma­jor talk­ing points from last week was the per­for­mance of the gold mar­ket and by ex­ten­sion the com­modi­ties mar­ket. Gold had its worse two week run since 2008. On Mon­day last the price of gold fell pre­cip­i­tous­ly and while it re­cov­ered to­wards the end of the week to close over US$1,400 an ounce it was at one time down close to 11 per cent.

Over the past decade gold tend­ed to be the mag­ic in­vest­ment as­set. It is sup­posed to be a store of val­ue in times of cri­sis, it is sup­posed to be the store of val­ue to pro­tect against in­fla­tion, it is sup­posed to go up when com­mod­i­ty prices rise (eco­nom­ic pros­per­i­ty) and it is sup­posed to go up when the cen­tral banks around the world en­gage in at­tempts to in­crease the mon­ey sup­ply via quan­ti­ta­tive eas­ing.

Be­fore go­ing fur­ther in­to this dis­cus­sion, note that while falling gold prices have tak­en the head­lines, there is lit­tle at­ten­tion to the fact that com­modi­ties, such as cop­per and oil, are al­so head­ing down.

The news flow points to low­er than ex­pect­ed growth in Chi­na dur­ing the first quar­ter of 2013 and the In­ter­na­tion­al Mon­e­tary Fund al­so re­duc­ing the glob­al growth fore­cast for 2013 dur­ing the course of last week. In ad­di­tion, in­vestors should note a slow down in the pace of earn­ings growth for com­pa­nies re­port­ing earn­ings in the US. All of this in­di­cates re­duced de­mand and so there is a fun­da­men­tal ba­sis for the fall in com­modi­ties.

In ad­di­tion, quan­ti­ta­tive eas­ing in Japan, cou­pled with con­tin­ued weak­ness and in­sta­bil­i­ty in the Eu­ro area, means the US dol­lar is ap­pre­ci­at­ing against the ma­jor world cur­ren­cies. His­tor­i­cal­ly, there has been an in­verse cor­re­la­tion be­tween a ris­ing US dol­lar and com­mod­i­ty prices.

The da­ta seems to sug­gest we are de­cel­er­at­ing once again and the pat­tern of 2010, 2011 and 2012 is be­ing re­peat­ed. On each oc­ca­sion, there was a stock mar­ket ral­ly at the be­gin­ning of the year on the back of height­ened op­ti­mism that the worst was be­hind, on­ly to then see a marked soft­en­ing of eco­nom­ic con­di­tions, along with the odd cri­sis in April to Au­gust, fol­lowed by con­cert­ed cen­tral bank ac­tion to­wards the end of the year that sparked a ral­ly and gen­er­at­ed op­ti­mism in­to the next year.

Pat­terns

We should be on the look out to see if the pat­tern is go­ing to re­peat through the en­tire year. The cen­tral is­sue, though, is that each time there was in­ter­ven­tion in the mar­kets, the im­pact of the in­ter­ven­tion has been pro­gres­sive­ly mut­ed, re­quir­ing a big­ger stim­u­lus to get a re­sult.

Now back to gold, which has be­come al­most a cult favourite amongst in­vestors. A more than a decade-long run with year-on-year growth, each year is a very al­lur­ing prospect for an in­vestor. sad­dled with the ex­treme volatil­i­ty of the fi­nan­cial mar­kets.

Gold is the safe haven as­set and I have writ­ten ex­ten­sive­ly about this in the past. I al­so re­cent­ly point­ed out that it has run its course and to be wary.

The cau­tion comes from two ar­eas. There are so many per­mu­ta­tions as­so­ci­at­ed with the fi­nan­cial mar­kets, I am not here to make a clear causal re­la­tion­ship be­tween the fac­tors I am about to men­tion and a falling gold price, how­ev­er, even if it is a ca­su­al re­la­tion­ship, it does spark some in­ter­est­ing con­sid­er­a­tions.

The first point to note is that while quan­ti­ta­tive eas­ing was sup­posed to bring about some lev­el of in­fla­tion, the cur­rent da­ta shows that con­sumer prices are ac­tu­al­ly falling in the US. Fur­ther in­fla­tion ex­pec­ta­tions are al­so falling as ev­i­denced by the pric­ing of var­i­ous US Trea­sury prod­ucts that are sup­posed to pro­tect against in­fla­tion.

One of the key rea­sons for the sup­port giv­en by cen­tral banks to the glob­al econ­o­my, es­pe­cial­ly the US Fed­er­al Re­serve was to fight de­fla­tion. It is de­fla­tion that has cap­tured the Japan­ese econ­o­my for more than 20 years, and the point be­hind quan­ti­ta­tive eas­ing was to pro­vide liq­uid­i­ty to the fi­nan­cial sys­tem to, in the first in­stance, sup­port as­set prices and then as as­set prices pushed high­er, the ex­pec­ta­tion is that this would flow over in­to the re­al econ­o­my, which would en­gi­neer a lev­el of de­mand and so catal­yse eco­nom­ic growth.

As in­di­cat­ed above, the ef­fects of this pol­i­cy is mut­ed as the in­fla­tion is stuck at the lev­el of as­set prices, par­tic­u­lar­ly in the form of stocks. If there is no con­sis­tent pass through, then de­fla­tion sets in, which, as strange as it may sound, could mean that long bond yields can stay at these lev­els or fall fur­ther.

For an event such as this to oc­cur, the first point of con­tact is a fall in com­mod­i­ty prices, in­clu­sive of gold. It is there­fore some­thing worth watch­ing.

On the oth­er hand, this is not the first time that gold has fall­en as it did dur­ing its im­pres­sive run. In March 2008, gold hit its then peak cross­ing US$1,000 an ounce. That peak co­in­cid­ed with the fall of Bear Sterns. At that time, de­spite the cri­sis, gold fell around 16 per cent. Sim­i­lar moves were ex­pe­ri­enced lat­er in 2008 when there were oth­er "liq­uid­i­ty events" at play.

Just last year be­tween late Feb­ru­ary in­to May, gold was down 14 per cent. Note the cor­re­la­tion to the cur­rent year, a point al­ready dis­cussed above.

The point is that in­vestors should be alert to the ques­tions posed in or­der to seek out the an­swers. Is the gold price move­ment of re­cent weeks giv­ing an ear­ly warn­ing sign of de­fla­tion, is it point­ing to an­oth­er liq­uid­i­ty event that will re­quire cen­tral bank in­ter­ven­tion (or was that event sim­ply Cyprus?) or is all of this just co­in­ci­dence and what we are ex­pe­ri­enc­ing is sim­ply the end of a very long and pros­per­ous bull mar­ket in gold and it is time to switch to oth­er as­set class­es?

Ian Nar­ine is a bro­ker reg­is­tered with the Se­cu­ri­ties and Ex­change Com­mis­sion.

Cor­po­rate fraud loves com­pa­ny

35%: Com­pa­nies where the top four ex­ec­u­tives were ap­point­ed by the cur­rent CEO are about 35 per cent more like­ly to en­gage in fraud–and about 20 per cent less like­ly to get caught–than firms in which none of the top four are the present CEO's hires, re­ports a team led by Vikra­ma­ditya S Khan­na of the Uni­ver­si­ty of Michi­gan Law School. It takes team­work to com­mit fraud and keep it hid­den, the re­searchers sug­gest.

(Source: The Uni­ver­si­ty of Michi­gan.)

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