I used this space in early July to discus investor fear as measured by the bullish stampede into the perceived safety of the U.S. 10-year Treasury Bonds. Keep in mind that during periods of panic and crisis sheep-like investors will stampede into any space that appears to be safe.
During the dark period following the September 2008 Lehman Brothers bankruptcy (the biggest in U.S. history), fearful investors could find safety in only two global asset classes, U.S. T-Bonds and the Japanese Yen.
These “doomsday trades” centre on the perception that a deflationary environment is bad for everything except for long term bonds, and that Japan’s continuing trade surpluses and high domestic savings rate make it one of the few providers of global capital which is good for the Yen.
Unfortunately investor appetite for these doomsday assets is still present as we see the 10-year bond yields moving down to their post Lehman shock lows and the Yen breaking to a fifteen year high.
As a contrarian I wonder if investors are engaging in an “error of pessimism.”
Here is a quote from the brilliant 1978 publication Cycles, What They Are, What They Mean, How to Profit by Them, by Dick A. Stoken.
When risk takers become risk averters, “consumers now postpone their purchases, while business executives either terminate their operations, or reduce debt, fire workers, and discontinue unprofitable ventures.” And, “as the demand for money lessens, long-term interest rates fall below the natural rate (adjusted for past inflation). This fall in the cost of capital to below the natural rate is now an error of pessimism.”
Sound familiar?
Stoken is suggesting that when too many become risk averters and stampede into safe places they are usually wrong.
Fortunately for investors we are getting a bullish signal from an unlikely asset class, the gold complex. You will recall that in 2008 all the global equity markets along with the price of gold and the related gold stocks were falling leading into the September 2008 Lehman crisis. During the subsequent dark weeks leading into early 2009, only the two “doomsday trades” ran up to new 52-week highs.
Clearly the gold complex was suppressed by the possibility of a no-growth deflationary scenario, because gold has a history of underperformance during recessions.
As we entered the third quarter of 2009 the deflation threat abated and the price of gold along with a handful of gold stocks rallied and broke up to new 52-week highs. This has now set up an interesting investment dilemma to resolve because we now have the two doomsday deflationary trades (U.S. T-bonds and the Yen) at or near historical highs and we have the inflationary trade (gold) also at or near historical highs.
Our chart this week is the monthly closes of gold miner Barrick Gold Corp. spanning about 10-years.
Technically, Barrick has been in a secular up trend since 2000. A secular up trend is a long term advance that can span anywhere from 12 to 20 years. The secular up trend will be interrupted by a series of shorter bull and bear markets (cycles) that span about 40 months as measured from trough to trough. A secular up trend will contain at least three of these cycles and possibly extending to five cycles.
The first cycle in Barrick ran from a mid 2000 trough to a peak in late 2002 at (1) and then to trough at the 2003 low at (A). The second cycle ran from a trough at (A) to peak in January 2008 at (2) and then trough at the late 2008 low at (B).
It is quite normal for the second cycle (A to B) to extend beyond the normal 40 months and be the longest of the three or five cycles.
Barrick is now in the early months of a new third cycle advance which should peak at all-time highs sometime in late 2011 at (3).
Clearly what is good for Barrick is good for the gold complex and a rising gold complex suggests that we are in the early stages of an inflationary period which is bullish for stocks.
Inflation may be a problem late next year but I can’t think about that right now, after all tomorrow is another day.
Bill Carrigan, CIM is an independent stock-market analyst.
Daw: Don’t lose your head over gold now Analysts foresee prices falling
Sometimes a stranger will surprise and dismay you.
For me, it was a middle-aged, Canadian actuary I met waiting for dinner at a conference in Halifax back in mid-2002.
“I’ve put all of my money into gold,” he revealed.
This seemed like a donkey-headed move, particularly for someone trained to gauge risk and uncertainty. His only explanation was that the United States was in a lot of trouble.
He was right, of course. But the price of gold had already risen within a year from about $400 Canadian to more than $500, about a 25 per cent increase.
What more could he expect? Not much in the next three years it turned out. Yet, just more than eight years later, he is looking far more prescient.
The price of gold has topped $1,330 Canadian. If the actuary has continued to hold bullion since we spoke, his average annual return will have been about 13 per cent.
That’s very good, although not quite spectacular. Much more impressive was the Royal Precious Metals Fund, which returned an average of nearly 23 per cent, according to Bloomberg News.
Meanwhile, the S&P/TSX Composite Index, which now includes gold stocks representing nearly 13 per cent of its entire value, returned 9 per cent if you count dividends.
An index that tracks various Canadian gold stocks returned more than 10 per cent, while the leading gold stock, Barrick Gold Corp., returned 8 per cent.
Gold will attract more attention if prices rise further from here. Investors accounted for half of gold demand this past spring, when total demand rose by 36 per cent, according to the World Gold Council.
But there is also the danger this rush of interest could lead to a bubble, followed by a sudden rush to sell gold jewellery, gold coins and other forms of the precious metal.
Only governments have agreed not to sell and drive down prices.
Nouriel Roubini, the New York University economist whose public profile soared during the 2008 banking crisis, said Friday in Italy “I believe that gold is going to trade around current levels.”
He foresees no spike in price inflation to scare investors into gold while global economic growth is so weak. Yet he does not see much risk of a global financial meltdown and falling prices now that governments shored up their banks.
Economists Dina Cover at TD Bank Financial Group agrees. “Gold prices are likely to move sideways in the near term, before trending down in 2011 as the economic and financial outlook improves,” she wrote this week.
Analysts Tanya Jakusconek and Tara Hassan at National Bank Financial Inc. issued a five-year forecast this week. They predicted only an 8 per cent rise in U.S. gold prices from this year to next, followed by 27 per cent decline by 2014.
For Canadians, the temporary further increase could be muted by a rise in the value of our dollar relative to the U.S. dollar.
Paul Taylor, chief investment officer at BMO Harris Private Banking, does see some value in using gold stocks as a way to diversify your investment portfolio heading during the next several months.
But he says he is not a “gold bug.” He would not advise putting all of your money into gold. Nor would he advise going higher than the 13 per cent weighting already built into Canada’s main stock market index.
“The gold and precious metals sector represents a disproportionately large place in the Canadian equity market versus its place in other equity markets,” he replied to a question Thursday.
“That having been said, we like exposure to gold at this juncture as an effective hedge within a client’s portfolio to mitigate the risk of an extreme outcome going forward (either inflation or deflation).”
If only I could ask that actuary I met in Halifax for his thoughts.
Unfortunately, I was so skeptical of his strategy I did not write down his name.