ASK ANY CENTRAL BANKER WHAT THEY THINK OF GOLD, AND THEY WILL DISMISS IT AS A "STORE OF VALUE" OR VALID "CURRENCY" - however...................WATCH WHAT THEY DO, NOT WHAT THEY SAY !!!
We have discussed many times how increasing deficits and monetary stimulus will also inflate the value of gold relative to other currencies which are more easily diluted by politicians eager to please constituents. The following two charts show clearly how the major Central Banks, the US Fed, ECB, PBOC, BOJ, and SNB have built their balance sheets by printing money and purchasing securities of all types. This process has kept interest rates artificially low and inflated the price of stocks, bonds and most asset classes, with gold participating the least (so far). The bankers are well aware that they are diluting their respective currencies as they try to encourage inflation, which is of course directly opposite from their originally stated mission to control inflation. However, Central Banks are smart enough to know that the clearly demonstrated antidote to paper currency "debasement" is ownership of the currency that has protected purchasing power over the very long term, namely gold.
The chart below, on the left shows how balance sheets of the five major Central Banks have grown since 2009, in the aftermath of the Great Recession. The acceleration of money creation was first justified as a method to avoid a worldwide deflationary collapse, but, though theoretically independent of political influence, the bankers to this day have not had the political will to pull back the stimulus and shrink their respective balance sheets. Note from the chart below that the U.S.Fed stopped printing money a couple of years ago, but the other Central Banks took up the slack. We all know that the US Fed has announced their intention to shrink their balance sheet at a very modest pace, starting in the current quarter. However far that process goes in the U.S., and even if the ECB follows suit within the next six to nine months, we have no doubt that China and Japan will more than take up the slack.
The chart below, on the right, shows how the Central Banks, at precisely the same time that they are diluting their currencies with the newly created money which has been used to purchase stocks and bonds, have been relentlessly accumulating gold bullion. As a percentage of foreign exchange reserves, gold still represents only about 9.5% of their total, up from a low of about 8.5%, down from a high since 2000 of about 12.5%. By no means, therefore, are the Central Banks over weighted with gold bullion. It is worth noting that one of the most aggressive purchasers, relative to the size of their economy, has been Russia, whose holdings have quadrupled in the last ten years to 1,556 tons at the end of June. Also interesting is that China, the largest producer of gold in the world, 400 tons out of about 3,000 worldwide tons, purchases all their domestically mined gold within undisclosed governmental agencies. They announced in 2016, for the first time in about six years, that their ownership over those six years had increased about 60% to 1800 tons. Only modest additional purchases have been announced since then, and many observers believe that there are 5,000 tons or more within various Chinese agencies, far more than officially disclosed.
It is crystal clear that Central Bankers, though unwilling to acknowledge gold as a "currency", allocate assets in a far different manner.
Here are the most important bullet points from the just released Fed Beige Book (key parts are underlined!):
"Reports from all 12 Federal Reserve Districts indicated that economic activity increased in September through early October, with the pace of growth split between modest and moderate."
"Employment growth was modest on balance, with most Districts reporting flat to moderate increases. Labor markets were widely described as tight. Many Districts noted that employers were having difficulty finding qualified workers, particularly in construction, transportation, skilled manufacturing, and some health care and service positions. These shortages were also restraining business growth. Firms in several Districts reported that scarcity of labor, particularly related to construction, would be exacerbated by hurricane recovery efforts."
"Despite widespread labor tightness, the majority of Districts reported only modest to moderate wage pressures. However, some Districts reported stronger wage pressures in certain sectors, including transportation and construction. Growing use of sign-on bonuses, overtime, and other nonwage efforts to attract and retain workers were also reported."
"Price pressures remained modest since the previous report. Several Districts noted increased manufacturing input costs, but in most cases these weren't passed through to selling prices. Retail prices generally increased slightly. Transportation, energy, and construction materials prices increased more rapidly, with some Districts citing effects from hurricanes."
"Retailers indicated that prices for goods remained steady, though one contact in the hardware industry said that paint prices had recently gone up 5 percent. Several manufacturing contacts reported price increases. A packaging firm recently raised prices 10 percent; they also reported an 8 percent to 10 percent increase in material costs over the year, although they said that materials prices remained well below levels from a few years ago. A chemical manufacturer said customers accepted a price increase more easily than expected. A manufacturer of frozen fish said it had reduced discounts."
"Retail spending rose slowly, while vehicle sales and tourism increased in most Districts."
"Manufacturing activity and nonfinancial services expanded modestly to moderately in most Districts."
"Residential construction continued to increase, and growth in commercial construction was up slightly on balance. Low home inventory levels continued to constrain residential sales in many areas, while nonresidential real estate activity increased slightly overall."
"Loan demand was generally stable to modestly higher."
Bottom Line
First, there is continued jobs market tightness.
Second, the descriptions of "modest" and/or "moderate" economic growth seems to support the view of a +2% type of Real GDP growth rate.
Tell Me Something I Don't Know About The Shiller Cape Ratio
Regular readers of my diary know I sometimes post things that replicate the theme of the "Tell Me Something I Don't Know" segment on MSNBC's "Hardball With Chris Matthews."
Respectfully, there was not an iota of empirical evidence to support their claims -- just a bunch of confident opinions expressed by generally bullish market participants.
Of course, we will never know the answer to the question of what has been discounted without the benefit of hindsight (neither case can really be proven) -- but here is one observation to consider that suggests Secretarary Mnuchin may be right.
Let's first start off with the fact that 2016 S&P EPS were flat while the S&P Index rose by +10% -- this valuation expansion is something few remember today.
The Russell Index ^RUT (seemingly most impacted by tax reform since they pay higher taxes than components of the S&P) rose for twelve days in a row following the Trump election -- for a gain of close to +13%.
The cumulative gains from the Russell since the Presidential election exceeds +25%.
But, during that timeframe (November, 2016 to October, 2017) , the 2017 EPS estimates for the Russell Index have steadily declined from about $50/share to only $46/share.
I would say this provides some evidence that a successful delivery of tax reform is priced into the markets.
Regular readers of my diary know I sometimes post things that replicate the theme of the "Tell Me Something I Don't Know" segment on MSNBC's "Hardball With Chris Matthews."
So... "Tell me something I don't know, Dougie."
OK, here it goes:
By Friday's close the S&P Index will have travelled 242 days without a three percent drawdown -- that's the longest streak in history.
Based on my Twitter feed, the price chart (and technical positioning), my emails and other comments - the new stock du jour and fav trading stock is expected by many, to become Amgen (AMGN) .
The stock was recommended by two people I admire, Carter Worth last night on Fast Money and earlier in the week by our own Bobby Lang -- on technical grounds.
While I understand the reason for their strong views, for a host of reasons -- not the least of which is the sudden consensus interest (and the implication that trading is as simple and easy as observing the chart) as well as the recent stock advance -- I took a very contrary (at least relative to the recent price action) short trading rental on the early morning strength.
Though the shares may very well move higher in a market where many worship at the altar of price momentum -- I am shorting the "breakout" because of these factors as well:
* As the shares have rallied, there has been no apparent change in the fundamentals at Amgen (that I am aware of).
* Amgen and other pharma/biotech face an Administration that wants drug prices to be lower and not higher.
* There is a near consensus notion that breakouts are to be bought (which has paid off handsomely in recent months) -- but this phenomenon could be coming to an end in a corrective market phase. (At least, if that corrective phase ever comes!)
I have a tight stop on this small "anti break-out" short.
Amid ever-expanding stock prices and investor optimism coupled with my perception of a near "give up" stage for so many in the bearish crowd, I am making one of my infrequent and foolish Ludacris Forecasts today -- that the market will decline.
Yes, you heard me right -- the market could drop today.
I've shorted more SPDR S&P 500 (SPY) , Amazon (AMZN) , Apple (AAPL) and Facebook FB on the higher opening and added iShares U.S. Real Estate ETF (IYR) as a short.
Position: Short SPY large, AMZN small, FB small, AAPL small, IYR small
For those still long Radian Group (RDN) , the better-than-expected bottom line recorded by MGIC Investment Corp. (MTG) (lower-than-anticipated losses) should buoy Radian's shares.
I and Mark Hanson have been harping on the issue of affordability thwarting the continued recovery in housing over the last six to nine months.
The Lindsey Group's Peter Boockvar comments on the latest housing data:
September housing starts totaled 1.127mm annualized, 50k less than expected and down from 1.183mm in August (revised up by 3k). There was a 40k m/o/m start drop for single family homes to 829k and that is a 4 month low. Multi family starts fell by 16k to 298k and that is a one year low. Looking forward, single family permits rose by 19k after falling by 12k in August while there was a sharp drop in multi family permits of 76k (but is very volatile month to month).
Bottom line, as seen in the chart single family starts remain 19% below its 25 year average and just can't really break out. We need the supply there is no question but whether it's the rising cost of labor, lots, raw materials (lumber prices at a 13 year high) and permitting, the builders just can't deliver enough. Multi family starts in response to huge demand for rentals has kept pace with its long term average but has rolled over the past few months just when evidence of more notable supply was coming on stream. If sustained, this will of course keep rental prices elevated and the lack of single family housing supply will do as well in this category. Housing inflation for those looking to buy and rent is a problem for many first time households right now. In the last measure at the end of Q2, the housing affordability index for 1st time buyers touched its lowest level since Q4 '08.
My good buddy Peter Boockvar, chief market analyst with The Lindsey Group, discusses sentiment, interest rates, economic data and Xi this morning:
Sentiment remained extreme in the weekly Investors Intelligence data but a hair less so. Bulls totaled 60% vs 60.4% last week (7 month high) while Bears rose .1 pt to 15.2% from last week's lowest level since May 2015. Off a 7 month high, the spread between narrowed to 44.8% from 45.3%. II classifies a Bull level at 60+ as being in the "danger zone" and as stated before, we've seen this year the market plateau and consolidate when it's in this zone and then resumes the rally when the frothy sentiment wears off a bit when Bulls get around 50. It's clear what stocks have celebrated this year, and that is the global growth rebound and hopes for US tax cuts, along with a year of still massive QE from the ECB and BoJ. Fed rate hikes, QT and the end of ECB QE I guess will matter more next year.
Speaking of rates, the US 2 yr yield continues higher and is now touching 1.56-1.57%, up another 2 bps. It closed Friday at 1.50%, 1.38% at the end of Q2, 1.19% at the start of the year and was .80% one year ago. As the 10 yr yield is higher by 3 bps, the spread is wider by 1 bp at 76 bps. The 5s/30s is also unchanged at 84 bps with the 5 yr yield at 1.99%, the highest since March. Not that we needed much of a reminder that the Fed is hiking again most likely in December but the WSJ interview with voting member Patrick Harker said "Mr. Harker noted that high prices for equities and other assets could be an argument for a continued, steady pace of rate increases." Harker then said "That's why I would like to prudently move up to the neutral rate as quickly as possible."
As this trend up continues, as central bank tightening progresses, getting the P/E multiple right will be just as important or more so as figuring out how earnings handle this change in monetary policy. Here is an example, let's assume tax cuts pass and growth remains intact and the S&P prints $150 per share in 2018 as many hope for. That means for every 1 turn in the P/E ratio equates to 150 S&P points. Thus, if instead of paying 17x those earnings the market decides it should be 15x because of a tightening of liquidity, that is 300 S&P points lower on the same set of earnings. And vice versa of course if we miraculously get multiple expansion in the face of monetary tightening which I find highly unlikely.
The MBA said mortgage applications to buy a home rose 4.2% w/o/w and 8.7% y/o/y which is nice to see and comes ahead of September housing starts today. The index level is a touch above the average seen this year. We all know the opportunities and issues with the housing market so I'm not going to repeat them all again here. As for refi's, they rose 3% w/o/w after 4 straight weeks of declines and remain down 36% y/o/y.
There was a modest increase of $11.5b of net buying of US notes and bonds in August. It brings the year to date total to $58.3b after net selling of $325b in 2016. Again, net selling was seen from central banks but was offset by a rise in private foreign buying. China increased their holdings of US Treasuries by $34.5b while Japan sold $11.4b worth. Saudi Arabia was also a net seller continuing that trend of less petro dollars sloshing around. Bottom line, follow the reserves because that has been the key driver of fund flows into and out of US Treasuries. Yes, from the private side yield differentials and yield grabs, offset by the cost of FX hedging matters but central bank holding changes has been the main factor in driving flows.
The UK unemployment rate held at the lowest level since 1975 at 4.3% for the 3 months ended August but the number of those employed rose less than expected at 94k vs the estimate of 148k. The more timely September jobless figure saw a slight rise of 1.7k and August was revised to a decline of .2k vs the original print of -2.8k. As for wages, they remain stuck below the rate of inflation which touched 3% in September vs 2.9% in August. August wage growth ex bonus' rose just 2.1% vs 2.2% in July. Instead of sitting there with interest rates basically at zero with fingers crossed that wages rise to offset the inflation, the BoE is finally realizing they can better control the inflation part of the real wage equation, as they should. The pound is little changed but the 10 yr Gilt yield is rising by 4 bps but only after dropping by 10 bps over the past 3 trading days. The 2 yr Gilt yield is up by 4 bps after losing that amount yesterday on the belief that inflation might have peaked. The FTSE 100 is up by 1/3 of a percent. The BoE will hike by 25 bps on November 2nd but that only takes back the emergency cut last summer. The y/o/y CPI growth rate last summer was less than 1%.
In response to 3 hours of talk from President Xi Jinping in China at the Party Congress, the Shanghai comp rallied by .3% while the H shares in Hong Kong was higher by almost .5%. The yuan is little changed and the 10 yr yield fell 1 bp over the highest level since December 2014. Xi acknowledged the "very bright" prospects for China but "the challenges are very severe." He threw some bones to those looking for a further opening in the economy and liberalization of its financial system ("We should endeavor to develop an economy with more effective market mechanisms, dynamic micro entities, and sound macro regulation") but at the same time reasserted the power of the Party and the State in overseeing the economy. In fact on the latter, he said he wants to make China a "great modern socialist country...with Chinese characteristics." With respect the bubble in China that is their property market, he used a line he said before that homes should be used for living, not speculating. Even so, the Shanghai property stocks rallied by .4%. Bottom line, there were no real surprises in this 3 hour speech but there should be no question as to who's in charge.
My thoughts remain the same -- among other things, upside to estimates no longer exists and my AGN position remains small. Nevertheless, AGN's valuation is quite reasonable and I would be a buyer at current levels were it not for the fact that I am bearish on the markets.
