September 18, 2009 Edition, Volume III
Inside Signature Update
- The Next Bubble … Gold!
- The Current Account Deficit
- Yield Curves are a Little Like Tea Leaves
The Next Bubble … Gold?
The price of gold rose to over $1,020 in late trading Wednesday as the US dollar continued to sink amid fears over inflation. Many now expect the next ‘bubble’ to be in precious metals with gold leading the way, just as oil did last year, real estate before that, and tech stocks before that. Bubbles can be a great place to be when you’re on the rise, but as we’ve seen all too clearly, they can be devastating when they burst. In this case, the rise in the gold prices is more of a reflection of the weak US dollar and concerns over inflation than anything else and it is likely not sustainable.
In 2008 we saw oil prices heat up and then supercharge as speculative forces captured the markets; then prices crashed. In recent months we’ve seen and heard more from ‘gold bugs’ than at any time since the late 1970’s and early 1980’s. You may recall that this was when gold topped $1,000 an ounce before falling by more than 65%. ‘Gold bugs’ are those proponents of owning gold as a tradable commodity just in case calamity strikes and currencies are no longer of any value. While they offer an interesting argument and make some good points, their presence increases just before gold prices start to rise; about the same time speculation begins to take shape. Just as we experienced in the oil markets in 2008, if gold and other precious metals become the purview of market speculation, and they already have, gold could be in for a wild ride.
That’s the good news. The bad news is that most proponents of precious metals ownership recommend that one take possession of the commodity and that makes it far less liquid than may be prudent for most investors. It’s far easier to purchase tangible gold or silver than to sell it, as most buyers want to make sure they’re securing a pure product. Sometimes this requires an assayer’s stamp or certificate and at the very least, this takes time and often adds expense to the transaction.
The markup on precious metals when taken physically (coins, bullion, etc) is significant unless purchased in large quantities (hundreds of ounces), which also means that the discount at which it may be sold can also be steep. Lack of liquidity and steep discounting of an asset with high price volatility can be a recipe for disaster when markets shift – and they ultimately will.
Investors choosing to step into the commodities game may be better served by purchasing gold based mutual funds or ETF’s than the physical commodity itself. The run up in pricing for these commodities may now be too high to make sense for most as investing into a possible bubble is speculation rather than investing and should never be entered into with resources that ought not to put at risk.
(This is not a solicitation to buy or sell any investment of any kind. Consult with your financial advisor before buying or selling any investment or financial instrument. The purchase of commodities in any form may involve a high degree of risk. Past performance is no indication of future gains.)
The Current Account Deficit and the US Dollar
The US dollar has continued its decline in recent weeks and has reached the point at which some foreign central banks have once again begun to openly discuss an alternative to the dollar as a global currency. Were it not for the fact that there are many trillions of dollars held by foreign investors and central banks, the debate may be credible, but in light of the dominance of the dollar in international trading and the dependence so many foreign governments have on their dollar denominated holdings, the discussion is more amusing than important.
In the short run, the US dollar’s decline actually strengthens the economy as US goods and services become more affordable to overseas markets. In the long run it can lead to inflation and weak economic bargaining power.
The current account deficit, the measure of the balance of foreign trade, has declined (improved) to $98.5 billion from over $104 billion in recent months, and while the impact is helpful, the cause reflects lower US demand for imports owning to the weak economy. The Fed indirectly influences the value of the dollar and the current account deficit by controlling the money supply and setting interest rates. When the US economy can bear higher rates, the dollar will improve. In the mean time we’ll have to suffer threats from the BRIC nations (Brazil, Russia, India and China), some Middle Eastern countries (Saudi Arabia, Iran, The UAE),and a few Central and South American dictatorships (Cuba and Venezuela) as a weak US dollar puts pressure on their economies.
The leaders of some of these same economies rattled their sabers with bravado when the price of oil was higher and their coffers were filled with hundreds of billions in stronger US dollars. Some touted their disdain for the US and vowed to use their resources to challenge our economic superiority. With the price of oil in the $72 range - 50% lower than less than a year ago - their clamors are no less caustic, but their rhetoric has changed. Ironically, their appetite for US treasury debt has increased and their dependence on the well being of our economy has increased. I think Keynes would write this off to ‘animal spirits’.
Yield Curves are a Little Like Tea Leaves
The current slope of the yield curve - reflecting short term debt or credit as less costly than that of longer duration - suggests that we will continue to enjoy a strengthening of our economy and an improvement in the equities markets, but it does not suggest a meaningful strengthening of the dollar in the foreseeable future. Brian Wesbury, Chief Economist at First Trust, suggests the slope of the yield curve confirms his belief that the US equities market is currently undervalued by some 40%. While 40% seems very optimistic (Wesbury is a self-proclaimed optimist), I’m confident that his expectations for continued market improvement are accurate, though perhaps a little overstated. We expect GDP growth of 3-4% for the second half of 2009 with continued gains in 2010. While this may not support a 40% improvement in stock values, it certainly suggests an ongoing bull market recovery for the next 12 – 24 months.
The following chart shows selected treasury yield curves of the last two years, and together they tell a story.
Inside Signature Update
- The Next Bubble … Gold!
- The Current Account Deficit
- Yield Curves are a Little Like Tea Leaves
The Next Bubble … Gold?
The price of gold rose to over $1,020 in late trading Wednesday as the US dollar continued to sink amid fears over inflation. Many now expect the next ‘bubble’ to be in precious metals with gold leading the way, just as oil did last year, real estate before that, and tech stocks before that. Bubbles can be a great place to be when you’re on the rise, but as we’ve seen all too clearly, they can be devastating when they burst. In this case, the rise in the gold prices is more of a reflection of the weak US dollar and concerns over inflation than anything else and it is likely not sustainable.
In 2008 we saw oil prices heat up and then supercharge as speculative forces captured the markets; then prices crashed. In recent months we’ve seen and heard more from ‘gold bugs’ than at any time since the late 1970’s and early 1980’s. You may recall that this was when gold topped $1,000 an ounce before falling by more than 65%. ‘Gold bugs’ are those proponents of owning gold as a tradable commodity just in case calamity strikes and currencies are no longer of any value. While they offer an interesting argument and make some good points, their presence increases just before gold prices start to rise; about the same time speculation begins to take shape. Just as we experienced in the oil markets in 2008, if gold and other precious metals become the purview of market speculation, and they already have, gold could be in for a wild ride.
That’s the good news. The bad news is that most proponents of precious metals ownership recommend that one take possession of the commodity and that makes it far less liquid than may be prudent for most investors. It’s far easier to purchase tangible gold or silver than to sell it, as most buyers want to make sure they’re securing a pure product. Sometimes this requires an assayer’s stamp or certificate and at the very least, this takes time and often adds expense to the transaction.
The markup on precious metals when taken physically (coins, bullion, etc) is significant unless purchased in large quantities (hundreds of ounces), which also means that the discount at which it may be sold can also be steep. Lack of liquidity and steep discounting of an asset with high price volatility can be a recipe for disaster when markets shift – and they ultimately will.
Investors choosing to step into the commodities game may be better served by purchasing gold based mutual funds or ETF’s than the physical commodity itself. The run up in pricing for these commodities may now be too high to make sense for most as investing into a possible bubble is speculation rather than investing and should never be entered into with resources that ought not to put at risk.
(This is not a solicitation to buy or sell any investment of any kind. Consult with your financial advisor before buying or selling any investment or financial instrument. The purchase of commodities in any form may involve a high degree of risk. Past performance is no indication of future gains.)
The Current Account Deficit and the US Dollar
The US dollar has continued its decline in recent weeks and has reached the point at which some foreign central banks have once again begun to openly discuss an alternative to the dollar as a global currency. Were it not for the fact that there are many trillions of dollars held by foreign investors and central banks, the debate may be credible, but in light of the dominance of the dollar in international trading and the dependence so many foreign governments have on their dollar denominated holdings, the discussion is more amusing than important.
In the short run, the US dollar’s decline actually strengthens the economy as US goods and services become more affordable to overseas markets. In the long run it can lead to inflation and weak economic bargaining power.
The current account deficit, the measure of the balance of foreign trade, has declined (improved) to $98.5 billion from over $104 billion in recent months, and while the impact is helpful, the cause reflects lower US demand for imports owning to the weak economy. The Fed indirectly influences the value of the dollar and the current account deficit by controlling the money supply and setting interest rates. When the US economy can bear higher rates, the dollar will improve. In the mean time we’ll have to suffer threats from the BRIC nations (Brazil, Russia, India and China), some Middle Eastern countries (Saudi Arabia, Iran, The UAE),and a few Central and South American dictatorships (Cuba and Venezuela) as a weak US dollar puts pressure on their economies.
The leaders of some of these same economies rattled their sabers with bravado when the price of oil was higher and their coffers were filled with hundreds of billions in stronger US dollars. Some touted their disdain for the US and vowed to use their resources to challenge our economic superiority. With the price of oil in the $72 range - 50% lower than less than a year ago - their clamors are no less caustic, but their rhetoric has changed. Ironically, their appetite for US treasury debt has increased and their dependence on the well being of our economy has increased. I think Keynes would write this off to ‘animal spirits’.
Yield Curves are a Little Like Tea Leaves
The current slope of the yield curve - reflecting short term debt or credit as less costly than that of longer duration - suggests that we will continue to enjoy a strengthening of our economy and an improvement in the equities markets, but it does not suggest a meaningful strengthening of the dollar in the foreseeable future. Brian Wesbury, Chief Economist at First Trust, suggests the slope of the yield curve confirms his belief that the US equities market is currently undervalued by some 40%. While 40% seems very optimistic (Wesbury is a self-proclaimed optimist), I’m confident that his expectations for continued market improvement are accurate, though perhaps a little overstated. We expect GDP growth of 3-4% for the second half of 2009 with continued gains in 2010. While this may not support a 40% improvement in stock values, it certainly suggests an ongoing bull market recovery for the next 12 – 24 months.
The following chart shows selected treasury yield curves of the last two years, and together they tell a story.
Notice the 9/16/2009 trend line; the near term treasury debt yields little while the 30 year maturity yields more than 4% - this positive sloping curve suggests a normally functioning credit market, though at very low rates. In contrast, the 10/15/2007 trend line – this was when the DOW was over 14,000 - showed a flat yield curve with little additional benefit to owning longer maturities versus those of shorter duration. This was due in part to the perceived benefit of owning stocks over bonds; we now understand that this was also beginning to reflect concerns in the credit and housing markets.
Now look at the 9/8/2008 curve; though it has a positive slope, it reflects a high cost for short term borrowing when compared to longer term commitments – this was the case when the credit markets began to seize and the Federal Reserve and US Treasury were forced to take unprecedented action. The 1/8/2008 curve, in contrast, represents the beginnings of the credit debacle well before it became obvious to the markets. Short term borrowing was expensive and became less so as durations extended to the two to five year range, before shifting higher with ten year maturities and beyond.
This inverted curve was evidenced slightly in the 10/15/2007 trend line when expectations for the stock markets were still high, but its appearance was discounted by most economists.
In retrospect, we recognize that 8 out of the last 10 recessions were preceded by flat or inverted yield curves such as those we saw in October 2007 and early 2008. Likewise, a positively sloping yield curve, similar to those we’ve experienced throughout 2009, foretells a bull market in stocks. Like tea leaves to a fortune teller, the treasury yield curve offers important texture to other economic data and events and ought not to be overlooked. Over time it has become one of the more consistent indicators of equity market trends and the current yield curve suggests Wesbury may be more right than many of us dare hope.
As I said a few weeks ago… this is just starting.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
Now look at the 9/8/2008 curve; though it has a positive slope, it reflects a high cost for short term borrowing when compared to longer term commitments – this was the case when the credit markets began to seize and the Federal Reserve and US Treasury were forced to take unprecedented action. The 1/8/2008 curve, in contrast, represents the beginnings of the credit debacle well before it became obvious to the markets. Short term borrowing was expensive and became less so as durations extended to the two to five year range, before shifting higher with ten year maturities and beyond.
This inverted curve was evidenced slightly in the 10/15/2007 trend line when expectations for the stock markets were still high, but its appearance was discounted by most economists.
In retrospect, we recognize that 8 out of the last 10 recessions were preceded by flat or inverted yield curves such as those we saw in October 2007 and early 2008. Likewise, a positively sloping yield curve, similar to those we’ve experienced throughout 2009, foretells a bull market in stocks. Like tea leaves to a fortune teller, the treasury yield curve offers important texture to other economic data and events and ought not to be overlooked. Over time it has become one of the more consistent indicators of equity market trends and the current yield curve suggests Wesbury may be more right than many of us dare hope.
As I said a few weeks ago… this is just starting.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
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