Saturday 23 July 2011

The eurozone crisis will end in panic - here's why

 


It's make or break time for the eurozone.

Again.

Stop yawning at the back there. Seriously, this time it's really important. The International Monetary Fund (IMF) says so. And our own chancellor, George Osborne, is warning the Europeans to "get a grip".

Even Barack Obama has been on the phone to Angela Merkel. Although given that the US is on the verge of defaulting on its debt too, she might have told him to clean up his own backyard before complaining about the state of hers.

Anyway, apparently the French and the Germans have agreed on a solution to the crisis. We'll find out all about it later today after Europe's leaders have all had their latest chinwag in Brussels.

But whatever their cunning plan happens to be, I can tell you now that it's not going to work…

 


There is no palatable solution to this crisis

"We have found solutions to previous crises and we'll find a solution now as well", said French foreign minister Alain Juppé, according to the FT.

Well, now, that's not really true, is it Alain? The reason this crisis has erupted is because you didn't find solutions to the previous ones. If you had, then we wouldn't still be rattling on about the eurozone nearly two years after Greece first blew up.

All the previous 'solutions' were fudges, and whatever comes out of the meeting today is almost certain to be a fudge too. Depending on the precise nature of the fudge, the market may cheerfully lap it up for now, or it might see through it right away and sell off heavily.

But whatever happens, this crisis is not going to end today. In fact, I think this will end in a panic: what the pundits like to call a 'disorderly' resolution, rather than an 'orderly' one.

As I've said before, this isn't because I have some blind pathological hatred of the European project, though I'm not a fan of it either. It's because all of the solutions that would draw a convincing line under this mess are unpalatable to at least one or more powerful parties involved.

There are three basic solutions. The first is 'extend and pretend'. You sweep everything under the carpet, and hope that, given enough time, Greece gets its act together. This is what everyone has been trying to do. It has failed miserably. Greece isn't going to be able to repay its debts, regardless of how much extra time it gets.

Despite that, this is what today's fudge will probably consist of, whether it's about buying bonds with the European Financial Stability Facility (EFSF), or a 'voluntary rollover' of Greek debt, or even a 'bank tax' designed to help fund a new Greek bail-out.

The big problem with this option is that it doesn't really provide a solution for the 'too big to fail' countries, like Spain and Italy. There simply isn't enough money in the eurozone to stand behind all that debt, which is why the fear is spreading.

The second solution is for the European Central Bank to print money and buy the debt of any country that's struggling: quantitative easing euro-style. Or you can issue joint eurozone bonds, backed by the full faith and credit of every country in the eurozone.

What would this mean? It would mean a much weaker euro. It would mean rich countries – let's call them Germany – would pay a tax in the form of either inflation (in the QE option) or higher borrowing costs (in the joint bond option) in order to repay Greece's debts. Markets would no doubt rebound, but in the long run this would also send the gold price soaring.

This would also inevitably require closer political integration. Because this is the equivalent of giving Greece a free pass to spend what it wants. No one would be happy about that. So you'd need to have some sort of central body actively dictating economic policy.

But it's hard to see how that would work. There were already economic 'rules' on debt in place that European countries (including us) are meant to stick to. They haven't of course. And what sort of sanctions can you threaten a country like Greece with? You can't toss them out of the euro, because that's what you're trying to avoid in the first place.

The logical conclusion is that you have to have a central European policy-setting and tax-collecting body with serious enforcement powers that supersede sovereign governments and their citizens. That's going to be a hard sell to the voters, to say the least.

Why not throw Greece out?

So what's the third option? Well, you evict Greece, and maybe some of the other countries too. You make sure everyone who needs to know, knows that it's going to happen. You prop up the banks that need to be propped up, and you throw Greece to the wolves. The other problem countries get the message, redouble their efforts to reform their economies, and the euro survives, stronger than ever before.

This might seem the most sensible route. After all, some of these countries should never have been in the euro in the first place. But there's a problem here too, which again comes down to politics.

If Greece is chucked out, or allowed to leave the euro, it puts the whole project of closer political union under threat. Because if you establish a mechanism by which one country leaves, then others can do the same thing.

The fact is, lots of people don't like the idea of being part of a United States of Europe. After all, any time they allow citizens to vote on it, they have to insist on at least two referendums before the voters make the 'right' choice. If you show the voters an exit door from the euro, then that strengthens the 'no' camp in every member country.

So the real fear among the 'elites' is not a 'Lehman' moment. It's the worry that if you kick Greece out, every other euro member will want to follow.

What does this mean for you?

This is the very definition of being caught between a rock and a hard place. There are no good options here. That's why I suspect the choice will be made for politicians in the end. Because a genuine crisis will erupt, and something will have to be done.

What should you do? I'd build up a watch list of stocks you'd like to buy for a start, particularly in the eurozone. When a panic comes, it's handy to know exactly what you want to 'buy on the dips' so that you can take advantage.

I'd stick with gold – it might be due a correction, but this turmoil could also send it much higher in the long run. And I'd stick with our usual defensive stocks: they're best placed to cope with all this.

 


Market update


The FTSE 100 built on Tuesday's rally yesterday, as investors seemed cautiously optimistic that the US would reach a deal to extend its debt ceiling. The index climbed a further 1.1% to close at 5,853.

Banks were again among the top performers. Barclays was the day's highest climber, rising 5.2%. Lloyds gained 4.1%, RBS added 3.1% and HSBC was 2% higher.

Retailers were among the few fallers, however. Sainsbury lost 0.9%, Marks & Spencer fell 0.5% and Wm Morrison was 0.3% lower.

Biggest faller of the day was commodities giant Glencore, which lost 1.3%.

In Europe yesterday, the Paris CAC 40 rose 60 points to 3,754, and the German Xetra Dax was 29 points higher at 7,221.

In the US, the Dow Jones Industrial Average and the S&P 500 each slipped 0.1% to 12,571 and 1,325 respectively, and the Nasdaq Composite was 0.4% lower at 2,814.

Overnight in Asia, Japan's Nikkei 225 gained five points to 10,010, and the broader Topix index was flat at 860. China's Shanghai Composite lost 1% to 2,765, and the CSI 300 fell 1.1% to 3,059.

Brent spot was trading at $117.87 early today, and in New York, crude oil was at $98.49. Spot gold was trading at $1,598 an ounce, silver was at $39.53 and platinum was at $1,773.

In the forex markets this morning, sterling was trading against the US dollar at 1.6162 and against the euro at 1.1344. The dollar was trading at 0.7019 against the euro and 78.77 against the Japanese yen.

And in the UK, retailing group Kingfisher, which owns the B&Q and Screwfix brands in the UK, plus Castorama and Brico Depot in France, reported a drop in like-for-like sales of 0.5% for the first half of the year. Performance was worst in the UK, where B&Q's like-for-like sales fell 6.7%. In France, sales were up 3.7%.



 

Thursday 7 July 2011

Stagflation All The Way

Super-Cycle:  We believe western economies are about 60% of the way through an 18 year bear stock market. This began in March 2000. The crash of 2008 was part of this overall down cycle – the final 40% leg of this bear market will lead to significantly higher inflation along with a commodities bull run through to about 2018. As inflation rises, living standards will be eroded, interest rates will rise, the stock market will drift laterally or down and probably ending in 2018 at a lower level than in 2011, but inflation adjusted this level will be down some 40% from today’s levels. We also expect a mini-stock market crash in the next six months – down by about 25%, but this will just be a correction in an overall lacklustre bear market leading to a low somewhere in 2018. We’ll expand on this in our next Newsletter mid July – because it is critical to describe this in depth – as context to property investment and other asset purchases. Investor often shift out of the stock market into property and commodities (oil, gold, coal, metals, food) as a hedge against inflation. And in our view, for the next 7 years, it will be “inflation all the way” – corresponding to disappointing GDP growth in western developed nations. So called “stagflation” before the end of the bear market in 2018.

 

Strategy to Inflate: As western national governments look to reduce their sovereign debt mountains, they will view inflation as the best way forward (possible the only way forward) to try and reduce this mountain in real terms. It’s politically more acceptable to have inflation at 5% and wage increases at 2% - thereby reducing disposable incomes by 3% a year and the debt mountain than having inflation at 0%, telling people they need to have wage reductions of -3% and having the debt mountain stay the same size. This we believe is one of the fundamental reasons why the Bank of England has “let” inflation rise to 4-5% without raising interest rates. At least they will argue that there is some form of GDP growth, albeit this might only be in the 1-2% range. And with this growth, tax receipts should keep rising. But please realise that inflation will lead to slow growth and declining living standards while it rages away.

 

Option to Print Money: The big lever of printed money has not worked very effectively in the UK – and the Bank of England’s must be looking over the pond with horror at what is happening in the USA and think, there is no way they want to follow them down this road of escalating debt mountains, higher taxes, drifting to default and declining currency value – all leading to even higher inflation and eroded living standards. The other problem with printing money is it declines the value of national currencies – on the one hand this leads to lower import costs as import prices rise, hence stimulating domestic manufacturing. However, if your manufacturing efficiency is poor and the declining currency value upsets your foreign investors who then shy away from buying your new debt, then you can get into a real pickle. This is the way the USA has been heading for many years now with a massive acceleration in the last 3 years – it’s only so much the international investor can take and when the Fed stops printing money in 8 days time, we think interest rates in the USA will have to rise – and these will depress the economy. China is now only investing 25% of it’s foreign reserve into new dollars – it is divesting away from the dollar. Frankly, we think the Fed’s strategy will end in disaster – a US crash later this year (see Special Report 382).

 

Middle Ground: There is a middle ground and the Bank of England seems to have found it, for right or wrong, namely:

 

1   GDP growth 1-2% (attempted recovery)

2   Bank of England interest rates on hold at 0.5%

3   Mortgage Rates at 5-6% meaning the banks make gigantic profits to rebalance their damaged books

4   Inflation controlled in the range 4-5% - being used to reduce disposable income by stealth (rather than ask for wage reductions and higher taxes)

5   Stop printing money and target slow steady growth and re-balancing from public to private sector employment

6   Allow Sterling to float and settle in the middle area

7   Keep Credit Agencies happy with plans for deficit reduction

 

Stagflation: This what we describe as good old fashioned “Stagflation” – a stagnant overall economy, with fairly high inflation and reducing living standards for most people. It’s probably the best we can hope for. The reason we describe this central scenario is that it directly links to the property market and your investment strategies – and the market for rental supply and demand. We will explain.

 

Low Lending: Bank lending remains low as demand is low and banks remain reluctant to risk lending to sub-prime borrowers. Deposits are high, interest rates on mortgages are very high (relative to BoE rates, a massive 5% above-premium) and the banks would rather hoard their cash ,mountains because of new regulations dictating higher collateral, and a pessimistic view of recovery hopes – they don’t want to get burnt again if the property market dips and personal home defaults start up again.

 

Buy-to-Let Growth:  Meanwhile, the buy-to-let sector has shown a bit of a resurgence – partly because of increased rental demand and rental prices, and partly because banks have done analysis to prove that buy-to-let investors are generally lower risk than individual home owners as far as credit rating is concerned. Buy-to-let investors rarely default – analysis from the 2007-2011 period shows.

 

Landlord Misery: Meanwhile increasing tenant powers, increasing regulations, increasing energy, council tax and hassles have driven many buy-to-let investors out of the business. Its a tough task with many stresses so there are not enough buy-to-let investors to feed the growing buy-to-let sector in southern England and some parts of the north, Wales and Scotland. So rents continue to rise – particularly in London – at well above inflation. Rents are rising at about 8% per annum (against inflation in range 4-5%. Meanwhile property prices remain stagnant in most areas – and hence yields are rising.

 

Higher Yields As Demand Rises: So the message is, as long as you can handle the hassle and are good at managing properties, buying high yielding rental property in good southern England areas with rising rental demand is probably a pretty good strategy – even with the threat of property price drops ever present. It’s a risk because property prices can fall sharply if another recession begins, but ultimately, a lot more rental property will be require in London in future years because so many 20-40 year olds have given up aspiring to own a property because of:

 

1   high student loans (average £30,000)

2   high wedding costs (average £20,000

3   increasing student fees

4   inflation and tax eroding disposable income

5   high deposits (25% of £150,000 – £37,500)

6   rental being only slightly more expensive than servicing a mortgage without any risks

7   young people would rather holiday, have fun, enjoy life and travel these days

8   money from the bank of mum and dad to help with deposits dried up after the 2008

financial meltdown and reduced pension with jobs losses

 

More Rental Less Home Ownership: All of these factors are unlikely to change any time soon. In London, the property market is supported by gigantic financial inflows from wealthy immigrants and investors. In the provinces, this is not the case, so areas far from London will be more affected by the factors mentioned above.  Hence one can see that property prices should remain broadly the same in northern areas as rental prices rise as the younger population increases. Buy-to-let properties will be held by only a more select group of wealthy people, in the 45 year plus age group. These buy-to-let investors will probably grow old with these properties as time moves on. Some of the 20-40 year olds will possible get to buy property in the early 40s, but many will remain in rented accommodation – similar to Germany. The argument that everyone should have a right to own a property will fade away as people are more worried about their jobs, having enough money for food, holidays, a car and retirement. This sounds rather bleak – in a way it is – particularly for low growth areas well away from London. Times are likely to get worse through inflation lowering disposable incomes by stealth.

 

Civil Disorder Threat: The big threat is that riots and major public disturbances will break out – like in Greece, leading to credit rating agencies downgrading the UK credit from its AAA rating. This would lead to even higher interest rates as Sterling crashed, and another deep recession. The best the UK can hope for is that the public sector jobs cuts work, tax cuts lead to higher private sector investment and growth and jobs, and the population stays engaged in working through the monstrous debts the Labour party left behind in their 13 years of profligate spending. In a way, we are all paying back the debts caused by wastage of money during this period.

 

Back to Peak Oil Stagnation: One of the reasons why we do not see things improving rapidly if at all is that we are now more of less past Peak Oil (or at least Peak Cheap Oil). This is the point of maximum global oil production. The end of cheap oil was 2003 when prices rose above $25/bbl and this corresponds with the decline in the living standards we have seen since then in most western nations. Debts rose rapidly as oil escalated to $147/bbl in July 2008 before the financial meltdown – as unsustainably high oil prices hit the global economies – another oil price shock.  We have updated our model of global oil supply and consumption through to 2015 and it looks like a very tight market will remain until then as China, India, Brazil and other developing nations increase their consumption whilst the western nations get squeezed. So the fundamental economic situation to stimulate a string recovery in UK, Europe and the USA is simply not there – period. Strong recovery could only come with oil prices at ~$50/bbl. Any oil prices over $100/bbl should lead to Stagflation as we are seeing. The only stock and shares that would normally increase in this situation would be oil, gas and mining stocks.

 

High Oil Price Leads to Stagflation: We’ll expand on this theme in our next special report, though we thought we should mention this because – as we forecast high oil prices to remain (unless a severe recession starts again), then inflation will continue to be a big problem – hence it will be “stagflation all the way”.

 

Property As A Hedge Against Inflation: For the smart investors, consider that your savings will erode over time by ~2-3% a year. Stocks and shares are likely to remain depressed and risky with lowering dividends. Cash in banks could also be risky if banks fold. And investment in property would lead to reducing debt levels in real terms over time. So as a hedge against inflation, property is probably better than most people think. Even if property prices do not keep pace with inflation, over time, your equity would rise and debt levels reduce – and if you have a high rental yield, you could still do quite well in the long run. This is why so many wealthy people put their money into property, as a hedge against inflation. If you could purchase property at ~25% below market value with cash, you do particularly well. This is one of the reasons why the rich get richer, and middle income people stay the same or get poorer.

 

Central Location Close To Jobs: So our overall steer is, if you are looking to invest in property, buy-to-let is still a good option but only in UK areas with growing micro-economies and large private sectors like central London and Aberdeen. You have to make sure you buy high yielding property at a good price in areas close to rail, tube, bus, roads, retail and leisure facilities with many high paid jobs close by. A well presented property should then attract a good low risk tenant at a good rental price.  Specific examples:

 

FW: Five reasons to buy gold and silver stocks now

 

 

  • Recommended article: Is this the start of the next bear market?
  • Yesterday's close: FTSE 100 down 0.4% to 6,002... Gold up 0.87% to $1,528.90/oz... £/$ - 1.6004


We're back in the buy zone, folks, for gold, silver and the mining stocks.

It might be another week or three before we hit rock bottom. Then again we might already have seen it.

But I'm confident we're in the zone.

A number of boxes on my check-list have been ticked.

For those that like a flutter, it's 'dipping your toe in' time.

Here are five reasons you should be buying in now...


 


1. It's early July

I don't know why it happens – I can offer suggestions – but I don't really know why it is that July and August repeatedly prove to be the best time of year to buy precious metals and precious metals stocks.

The simple strategy of accumulating over the summer and off-loading early the following year keeps on working.

This first chart shows gold (black line) and the CDNX (the composite of the Toronto and Toronto Venture Stock Exchanges – blue line), which I use as a proxy for junior miners. The vertical red lines mark the month of July.

image

As you can see, with gold (the black line) a low for the year repeatedly comes in the July-August time frame. The strategy of buying gold in the summer and off-loading early the following year has worked every year since 2001, with the exception of 2007-08.

Our juniors proxy, the CDNX (the blue line), is not as consistent as gold. But if the low doesn't come in the July-August time frame, it comes the following October. If not one, then the other. It's remarkably consistent in that regard. Again the year that broke the rules was 2008.

2. The COT Report looks bullish for silver

The COT report shows the commitments of the futures traders on the Chicago futures exchanges. Broadly speaking, the fewer open positions (open interest), the more bullish the set-up, because the more potential buyers there are still to come into the market.

In a strong uptrend the open interest will expand – the new buyers are stronger than new sellers. A rising trend with declining open interest suggests that the market is being pushed higher more because short sellers are exiting positions than because new buyers are establishing positions. That's a sign that a move is tiring.

In general, I have found the COT report to be a better identifier of lows than of tops. And the open interest in silver hasn't been this low since late 2008, when silver was trading below $10. In other words, to me it looks as though buyer demand for silver can only go up.

Back in the spring, when silver had its mega correction, I said the most bullish setup would be for $33 to hold. It has held. It's been repeatedly re-tested and it has held. Not only has it held, but the weak hands have now been flushed out, as evidenced by the COT open interest. So there is a lot of room for new buyers to come into the market.

A lot of people sold silver at $50. But were they clever enough to buy back in at $33? If not, there could be a scramble.

I am also extremely impressed by the way the gold-silver ratio has stayed below the key 45 level. Silver has stayed strong relative to gold.

We have had a run over the last two days, so some caution is recommended. But I am feeling very bullish about silver in the intermediate term. I expect a retest of $50 before year-end – or perhaps even sooner than that.

3. We've almost reached our friend the 144-day moving average again


Since the bust of 2008, the 144-day moving average – which shows the average price over the previous 144 days – has been the best gold indicator I have found. (Hats off to the trader Michael Hampton who first alerted me to it).

Gold repeatedly pulls back to it during sell-offs, and it has marked an optimum entry point. The average currently sits at $1,441 and rising. Gold began the week close to it at $1,480. I daresay the twain shall meet somewhere in between at some stage over the next month. Then again, $1,480 held after the spring sell-off. It held during the weakness of the past ten days. That may be the low.

image

4. Gold stocks are cheap

Gold stocks remain cheap compared to gold. Of course, there are all sorts of reasons for gold stocks under-performing. Rising mining costs, foreign exchange fluctuations squeezing profits, and general poor sentiment towards equities are just a few. And just because they're cheap doesn't mean they can't get cheaper.

But valuations are starting to look compelling even to a cynic like me. With the horrible exception of 2008, gold stocks are as cheap relative to gold as they've been in eight years.

And if you look at the ratio between gold and the junior mining stocks, with the CDNX as proxy (see below), junior gold stocks are as cheap as they've ever been, bar a few months in 2008.

image

5. I can't find a bull out there

There are the permabulls. But that's it.

I don't use a technical measure of investor sentiment, as some do. I follow investor chat boards. I listen to interviews. I read a lot. I go to presentations. I talk to people. My reading of investor sentiment is nothing scientific, just a judgement based on what I'm seeing and hearing.

There is no elation out there. There was last autumn, but not now. There is a feeling of fatigue, wariness and cynicism. There is also a feeling that 2008 is coming again. Maybe it is. In which case, all bets are off.

But what if it isn't? In general an atmosphere of fear and loathing is a better atmosphere to buy into than one of celebration.

All in all, I think there is a strong case to be buying into precious metals and precious metals stocks for an intermediate-term trade into early next year – or for longer if that's your style.

It looks to me like we are entering the second phase of the financial crisis. When the banks were bailed out in 2008, we noted that all that was happening was that debt had been moved from the balance sheets of private corporations to those of governments. The next phase would be marked by sovereign debt default.

We are there now, whether it's southern Europe, or the US's issues with its debt ceiling. They might be able to put it off for a few more months, but it is coming. It is all incredibly bullish for gold. Sooner or later gold will pull its related stocks up, like a fierce mother with an errant child.

I have published a new Gold Report, which comes out today. I've deliberately tried to time the release to catch a summer low, so that investors have plenty of time to position themselves ahead of the normally sleepy summer months for an autumn run. We'll see if that works.


 


Market update

Click here for the latest stock market news and charts.

The FTSE 100 ended its run of gains yesterday, slipping 0.4% to close at 6,002.

Banks were again among the worst performers. Barclays was the biggest faller of the day, losing 3.8%. RBS fell 3.4%, Lloyds fell 2.1%, and Standard Chartered was 0.7% lower. But HSBC bucked the sector trend to rise 0.1%.

Highest climber of the day was government contractor Serco, which added 3.9%.

In Europe yesterday, the Paris CAC 40 fell 17 points to 3,961; and the German Xetra Dax was eight points lower at 7,431.

In the US, the Dow Jones Industrial Average gained 0.5% to 12,626, the S&P 500 added 0.1% to 1,339, and the Nasdaq Composite was 0.3% higher at 2,834.

Overnight in Asia, Japan's Nikkei 225 slipped 0.1% to 10,071, and the broader Topix index fell 0.4% to 870. In China, the Shanghai Composite lost 0.6% to 2,794, and the CSI 300 was 0.4% lower at 3,101.

Brent spot was trading at $113.97 early today, and in New York, crude oil was at $97.34. Spot gold was trading at $1,530 an ounce, silver was at $35.93 and platinum was at $1,722.

In the forex markets this morning, sterling was trading against the US dollar at 1.5983 and against the euro at 1.1175. The dollar was trading at 0.6992 against the euro and 80.95 against the Japanese yen.

And in the UK, manufacturing output rose by 1.8% in May, according to the latest figures form the Office for National Statistics - its fastest rise since March 2010. Analysts had forecast a rise of 1%. Year on year, output is up 2.8%.