Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Gold – Potential Energy Today and Kinetic Energy Tomorrow: What happened last year and what do we expect to see this year – more of the same?
A year ago this very month, I was on a panel discussion in the Bahamas when asked to identify the asset class I was most interested in for the coming year, and what was likely to be the most profitable trade. Little did I know that milk would be the commodities winner by a wide margin (+24%). I had suggested that silver (to the chagrin of our silver bulls, all still in the family) would not be the 2011 winner, although the hare did lead the pack initially. I preferred gold. It was and is, very simply, the best credit when credit quality is in question.
As the year unfolded, credit issue after credit issue surfaced, with the problems seemingly localized in Europe (until the mid-summer downgrade of US debt by S&P). The concern over a deflationary contagion was on and off as quickly as the next memo released from some European head of state or the Eurocrats in Brussels. Sovereign insolvency dominated the discussion. How to prevent default and a domino effect across a globe tightly interconnected by trade, finance, and counter party dependencies riddled the best minds all year long.
We wish we had better news, but the existing leadership has yet to develop structural solutions to these deeply structural flaws within the global economy. Simply stated, after all the official jawboning, mountains of debt remain and revenue increases are stuck between a lack of political will and a sputtering economy. Truth be told, the global economy is very close to slipping into a desperate spot. Strangely encouraging, however, is that the market’s response in 2008 was founded upon 100% confidence in government methods and strategies; this time around, skepticism abounds, and the market knows that little in the way of resources remains to bail out institutions, let alone whole countries – unless those resources are created out of thin air (inflation/monetization). Individuals are gradually growing up and seeing they have to be responsible for themselves and their own financial security.
So, to the point, what direction will gold go in 2012? We see the year ahead as volatile for gold and all asset classes, as investors try to divine the way forward in light of political change here and abroad. In the final analysis, we look for a low-side target of $2,100, and a high side target of $2,500 for gold. Dips should be contained by the 65-week moving average (as we have recently seen price support at $1,534-40, which is the current level of the 65-week average). There is always an outside chance of prices going lower on the basis of CME rule changes (remember 2011), but at current levels there is no justification for an increase in margin requirements, as speculation in the metals is quiet – very quiet. These prospective year-end numbers for 2012 represent a 10-30% gain over the recent high, and a more considerable gain from current levels. The gold/silver ratio will likely contract 10-15 points, giving silver better prospects for outperformance in 2012.
Year-end tax loss selling is finished, hedge fund liquidations to meet redemptions have tapered off, MF Global’s client position liquidations (some of which were metals-related) are behind us – but are we out of the woods? Not quite. The technical repairs we need to see before moving forward to higher prices will likely entail a sideways grind in price. Let me illustrate how constructive these periods can be by referring to the following numbers. Note that the high growth seasons (in green) are followed by a move down or sideways before prices reassert to the upside. Twelve to twenty-four months can elapse between old highs and the setting of new highs. Patience is required to succeed, and, as this bull market has already proved, it is often rewarded handsomely.
Before year-end, and near the lows of the market, we added to portfolio positions. These additions had remained as unfilled allocations up to that point. For new accounts, this action entailed adding to positions that had been modestly allocated given our concerns over price stability during the final quarter of 2011.
We think the worst is behind us. We are likely to regain old territory quickly this spring, and then battle toward new highs in the fall. In part, our confidence in the metals is supported by the presidential election, during which nothing policy-related is likely to be accomplished. The focus will be on campaigning, not governing – and that just as the credit crisis reaches our shore, leaving our leaders behind the curve and with only desperate measures to employ. If we are wrong, and the metals markets grind sideways even longer than anticipated, it will be worth practicing patience. What follows will feel like being shot from a cannon. Potential energy will quickly become kinetic.
2. Failed Expectations – Again: Today’s jobs report was preceded by the usual hype and was followed by the usual disappointment. This has been the pattern in the majority of economic releases over the last few months – and one that seems very resistant to change. At first glance, the jobs report looked healthy, but doubt was cast on the veracity of the data. Non-farm payrolls posted an increase of 200,000 jobs for December, of which 42,000 were due to “seasonal adjustments” that will be gone next month. Favorable adjustments, reducing the labor pool, also contributed to gains in the unemployment rate, which fell from 8.7% to 8.5%. Still, factoring out the “fixings,” these were some of the better numbers seen this year. Stocks were unimpressed, putting a halt to what was a decent streak of “new year’s” gains – while bonds rallied from previous losses (See the box scores at right).
The US ISM manufacturing, factory orders, vehicle sales, and claims (jobs) data all had better-than-expected results, and improved from November. Of course, this is in stark contrast to data discussed in last week’s commentary, in which December regional manufacturing data was lacking. Some are beginning to blame election year “chicanery” for such wild swings. While gaming the system may be occurring to some extent, we continue to believe the volatility has more to do with record low (and going lower) mortgage rates. Apparently, Banks are not afraid of earning less while credit risk increases (globally) – all due to the Bernanke “put” in the marketplace.
Obama may also see an opportunity to capitalize on the mortgage trend. After asking Congress for an additional $1.2 trillion in spending capital (without cuts, of course), Obama may have prematurely leaked his intentions regarding the use of the funds – among other things, a $1 trillion refinancing scheme for US homeowners. Adding to the legitimacy of the claim, Bank of America’s stock leapt more than 6% on the news, gains it has largely maintained thus far.
Earnings season has started with a whimper. Alcoa disappointed. Inflation is taking its toll on the organization, as we have surmised here before. In the face of rising costs, Alcoa is permanently closing 12% of its smelting operations to streamline production. Alcoa share price has lost about half its value since May 2011.
In Europe, the fix to the situation remains elusive. Italian, Spanish, and French Bond and Stock markets are eroding in unison, while the German markets appear stable – for the moment. Spain’s introduction of austerity measures may have triggered the slide. As a result, the ECB was active in monetizing Italian and Spanish debt once again, but managed only to slow the decline. In Asia, Chinese lawmakers are drawing up plans to stimulate consumption on their home turf, while rumors are flying that its central bank will relax reserve requirements in the face of a “global slowdown.” This is in contrast to mainstream media cheerleading just last week regarding improved manufacturing in the region.
With the stage set for lower corporate earnings, it will be interesting to see how the current administration and the Fed handle the election year. It’s our opinion that, if damage is done to the stock market, further QE – whether covert or public – will be forthcoming. As we have said before, the metals are not entirely dependent on further QE to advance, but it sure wouldn’t hurt in the short run.
Best regards,
David McAlvany
President and CEO
MWM LLLP
David Burgess
VP Investment Management
MWM LLLP
