Eurozone
Our view has been that the recession in the eurozone is likely to persist well into 2013, and recent data points support this outlook. According to Eurostat, unemployment in the eurozone rose to more than 19 million in February, which kept the unemployment rate at a record 12.0%. Job losses have persisted for 16 consecutive months. European car sales contracted for the 18th consecutive month in March and were down 10.2% from year ago levels, according to the European Automobile Manufacturers Association. The first quarter results were the worst start to a year since 1990 when comparable data were available. Germany is the largest country in the European Union (EU) and considered the economic anchor. Car sales fell 17.1% in March, and according to ZEW research economic sentiment also declined sharply in March.
Markit’s manufacturing purchasing managers index fell to 46.5 in April. In addition, the new orders index fell to 44.9 from 45.3 in March. The weakness in new orders suggests there will be little improvement in coming months and higher rates of unemployment are likely in many of the eurozone countries. We expect the European Central Bank (ECB) to cut rates from .75% to .5% in coming months. The challenge for the ECB is not the cost of money, but how to get banks to lend to small businesses during a recession. This is critical since European banks provide 80% of credit and are the lifeblood of small and medium size business throughout the 27 nations in the EU. We think the decision in Cyprus to allow holders of senior bank bonds to absorb losses and hit those with more than 100,000 euros on deposit with a 40% tax will have negative ramifications should the crisis flare again in Italy, Spain, or France. At the first sign of trouble holders of bank debt will be reluctant to roll over their bonds or demand a higher return. This could exacerbate a short term liquidity problem or at a minimum increase the banks funding costs. Wealthy depositors will also be more inclined to pull their money from any suspect bank which could ignite a run on deposits. The decision to make bond holders and depositors pay for a bailout rather than tax payers was a watershed event.
Gold and Gold Stocks
In our January commentary, we discussed the potential that gold had been consolidating its significant rally from $700 in 2008 to its peak at $1,920 in September 2011. Technically, we thought gold had been tracing out a triangle, and might dip one more time to $1,525-$1,550 to complete the triangle. Last month we emphasized that gold must hold above $1,480- $1,500 on a closing basis to keep the triangle pattern intact, and noted that a decline below this support area would be a long term negative
We also noted that gold stocks were historically cheap relative to the price of gold based on the ratio of the gold stock index (XAU) to gold. From 1998 until the financial crisis in 2008, the ratio fluctuated in a range of 3.6 to 5.3. In early March, the Gold/XAU ratio climbed above 12, indicating that gold stocks were the cheapest they had been relative to gold in the last 25 years. We cautioned that gold stocks were inherently volatile, so they were not appropriate for many investors, no matter how attractive they appear. And if gold dropped below $1,480-$1,500, we thought the gold stocks could decline materially, so risk management was essential.
We expected there to be stops under gold below $1,525 which is why we thought it critical that gold hold above $1,480 and that any decline be reversed quickly. Needless to say, once gold broke below $1,525 there was an avalanche of selling. This is an excellent example of being wrong but how good risk management can limit the loss.
Although the decline damaged the longer term outlook for gold, it is so over sold that a good rally is likely in coming months. Gold stocks relative to gold have become even more attractive, with the XAU/gold ratio climbing to over 13. We would like to see the relative strength of the gold stocks improve before looking for another entry point.
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Definition of Terms
A Credit Rating is an assessment of the credit worthiness of individuals and corporations. It is based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities.
The European Central Bank (ECB) is one of the world’s most important central banks, responsible for monetary policy covering the fifteen member countries of the euro zone. The ECB, established by the European Union (EU) in 1998, is headquartered in Frankfurt, Germany.
Gold/XAU ratio is a ratio of gold to the gold stock index.
Gross domestic product (GDP) is the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports. The GDP of a country is one of the ways of measuring the size of its economy.
Markit’s Manufacturing Purchasing Managers Index (PMI) is an indicator of economic health of the manufacturing sector based on the key benchmark indicators for measuring the business and economic conditions in any given economy.
The NASDAQ is a capitalization-weighted index designed to measure the performance of all NASDAQ stocks in the industrial sector.
New Paradigm is a totally new way of doing things that has a huge effect on business. New paradigm draws its roots from the idea of a paradigm shift in science, in which technology or new findings completely change the way people think about or interact with something. In business the idea is the same; a whole new way of looking at things.
Price-to-earnings (P/E) ratio of a stock is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income.
Quantitative easing refers to a form of monetary policy used to stimulate an economy where interest rates are either at, or close to, zero.
The S&P 500 Index is a capitalization-weighted index of 500 stocks traded on the NYSE, AMEX and OTC exchanges, and is comprised of industrial, financial, transportation and utility companies.
TINA – There Is No Alternative
Total Credit Market Debt is calculated by total debt (including government, corporations, and consumer debt) divided by the Gross Domestic Products. Credit Market is the market for debt offerings as seen by investors of bonds, notes and securitized obligations such as mortgage pools and collateralized debt obligations (CDOs).
Valuation is the process of determining the value of an asset or company based on earnings and the market value of assets.
Vanguard Total Stock Market Index is comprised of stocks with exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks.
XAU index is a gold stock index traded on the Philadelphia exchange.
One cannot invest directly in an index.
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RISKS
Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.
This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.