Becareful. There is a clear and present danger.
It has not been the best of times for the markets this past week. The Toronto Stock Exchange saw its biggest one-day loss in almost three months this past Thursday, with red arrows carrying over to Friday.
From the fears mounting in China regarding their tighter monetary policy, the growing numbers of U.S. unemployment claims to U.S. President Barack Obama's get-tough approach to banks, the markets have been reacting.
But there's a darker secret hidden behind the headlines
For months we have discussed the topic of inflation (see We're Back and It's Time to Prepare). Now recent economic data and events are making our predictions of inflation seem that much more apparent.
The Bank of Canada, which kept interest rates unchanged this week, has committed to maintaining the policy overnight rate at 0.25 per cent through the first half of this year. The bank also said that "considerable excess supply remains" and inflation won't return to policy makers' 2 per cent target until the third quarter of next year. So in Canada, we still have a few years to go.
But this past week, China showed fourth quarter GDP growth of 10.7, the fastest pace since 2007's fourth quarter and a lot faster than the world expected. Coming out of a global recession, one would think that an accelerating and better-than-expected GDP report would not only send the markets higher, but give investors the optimism needed to push and sustain the markets. Instead, the numbers assisted in one of the sharpest declines of the markets this year.
Here's why
As well all know, growing too fast almost always leads to one thing: inflation.
The Chinese have already been taking steps to put the brakes on economic growth by raising bank reserve requirements, putting a cap on lending and raising rates on some bonds. This may also indicate that they will need to accelerate monetary tightening and begin raising interest rates. The only question is how high and how fast they will need to raise interest rates to combat this situation.
Remember that China's currency is almost completely tied to the US. They own more than 70% of their international foreign reserves (see Facts on Gold You Need to Know) in US dollar and much of their exports stem from the Greenback. As the US recovers and begins a stronger re-growth period, think about how hard inflation will hit China if they're already growing at this pace after a global meltdown.
China's impact has already begun to affect their neighbours. The pace of Real Estate prices are now rising the fastest in 18 months. In Shenzhen, southern China's manufacturing hub, property prices have surged 19 per cent from last year.
The price of water, food, and tea are all soaring with their main stock market leading the way, surging 80 per cent last year.
Home prices both in Hong Kong and Singapore are flying. Revived demand and rising house prices in Australia are sending interest rates higher. Meanwhile, ballooning prices for items such as rice and potatoes in India nudged its inflation rate to a one-year high of 7.3 per cent last month.
Analysts are predicting China will surpass Japan as the world's second largest economy in 2010.
It is very possible that China could be in line for a real estate bubble burst, but the numbers and trends are stating otherwise. Either way, the impact of China will have an adverse effect on the world markets.
Including our own
Our market reliance on China is more staggering than many believe yet very apparent. If China decides to slow growth, you'll see the basic materials sector fall sharply. This would be a signal to wash and clean your portfolio of any basic material sector stocks. If China's growth continues, inflation could easily make its way over to our side of the world and add to the fuel of inflationary worries already presented by the US (see The Impressive News Release).
The situation in China is not the only thing that hampered the markets. The number of Americans filing initial claims for unemployment insurance has risen for the second straight week. Keep in mind, these jobless claims are only attributed to people who are actually making these claims. The amount of true unemployment in the US will remain unknown. These economic signs clearly show that the markets, as we have mentioned before, shouldn't really be where they are right now.
But therein lies a darker secret
Right now, the US is doing everything they can to slowly prevent the onslaught of inflation or worst yet, hyperinflation. Except, unlike China, the US will do it by sneaking in policies to deter the public of what is really going on.
Think about it this way.
It's no longer a secret that the Obama administration has the world running around in circles. First they threw more money than we can count at TARP to achieve market stability, re-growth and encourage lending.
Now that the big banks appear to be recovering, President Obama proposes a huge tax on them. Then he announces a new proposal that will limit the size and scopes of the major U.S. banks by putting in place policies that would force financial institutions to choose between commercial banking and proprietary trading, or trading done for its own profit.
The proposed regulations would bar commercial banks from: trading in securities for their own profit; operating, sponsoring or investing in hedge funds or private equity vehicles; and trading complex financial derivatives such as credit default swaps without oversight.
If his proposals are passed, this will most certainly cause the banks some major grief and restrict their ability to lend, which in turn, will slow the recovery of the economy: "The proposal will restrict lending, increase risk, decrease stability in the system, and limit our ability to help create jobs," warned Steve Bartlett, president and chief executive of the Financial Services Roundtable, which speaks for the big banks.
Now we understand Obama is trying to penalize the banks for over-leveraging themselves and requiring government intervention to survive. We also understand that this is the penalty the big banks are paying for not stepping up their lending policies to small businesses while giving themselves big bonuses, as we predicted would happen (see Get Ready For More Outrageous Compensation).
It's pretty obvious that if these proposals come into effect, the growth needed to bring the economy back will be hampered. This will soften the impact of inflation momentarily, but not for long.
With all of the curve balls that are being thrown by China and the Obama administration, making decisions on investments will become that much harder. Emerging markets and financials will suffer if Obama gets his way with the banks. Basic materials will suffer if China decides to implement further policies to hinder growth. The list of uncertainties stretches miles long.
But there is one thing that may prevent a strike out and give us a an opportunity for a home run...
Precious Metals
If you go back and read our past newsletters (every one of them), you can see all the reasons why we are bullish on precious metals .
For the first time in nearly 30 years, central banks around the world have now become net buyers of gold. In addition, hedged players in the mining industry (see Facts on Gold You Need to Know) have begun covering their hedged gold positions indicating they expect the price of gold to go higher, or at the very least, stay at these levels.
All of the recent events leading up to today have indicated to us that precious metals are continuing their dominance in the markets. (see Where the Billionaires Invest)
Especially the Juniors
You see, the markets have peaked for a lot of the larger producers and their share values are now tied to the price increase and decrease of their precious metals focus. In order for the majors to give their investors any real returns, they'll have to increase their asset base through new discoveries or acquisitions.
This means the major miners are in desperate need of acquiring new deposits
But the majors are generally not the ones to go and find a new discovery. They simply takeover and buyout the juniors or form alliances to increase reserves and production. This has already been happening for the last year and we expect a lot more of these situations in 2010. Take for example, Alexis Minerals (TSX: AMC) which just recently completed the acquisition of Garson Gold Corp. to increase their resource base for shareholders.
Sunday, January 24, 2010
Market Signals a Clear And Present Danger...
Companies Under Evaluation
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