Currency Wars Heat up as Central Banks Race to Cut Rates by Frank Holmes
Next month marks the beginning of the Chinese Year of the Ram, but for now it looks as if 2015 will be the Year of the Central Banks.
I spend a lot of time talking about gold, oil and emerging markets, and it’s important to recognize what drives these asset classes’ performance. Government and fiscal policy often have much to do with it. But in the past three months, we’ve seen central banks take center stage to engage in a new currency war: a race to the bottom of the exchange rate in an attempt to weaken your own currency and undercut competitor nations.
Indeed, amid rock-bottom oil prices, deflation fears and slowing growth, policymakers from every corner of the globe are enacting some sort of monetary easing program. This month alone, 14 countries have cut rates and loosened borrowing standards, the most recent one being Russia.
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A weak currency makes export prices more competitive and can help give inflation a boost, among other benefits.
“The U.S. seems to be the only country right now that doesn’t mind having a strong currency,” says John Derrick, Director of Research here at U.S. Global Investors.
Since July, major currencies have fallen more than 15 percent against the greenback.
Two weeks ago, Switzerland’s central bank surprised markets by unpegging the Swiss franc from the euro in an attempt to protect its currency, known as a safe haven, against a sliding European bill. Its 10-year bond yield then retreated into negative territory, meaning investors are essentially paying the government to lend it money.
This and other monetary shifts have huge effects on commodities, specifically gold. As I told Resource Investing News last week:
Gold is money. And whenever there’s negative real interest rates, gold in those currencies start to rise. Whenever interest rates are positive, and the government will pay you more than inflation, then gold falls in that country’s currency. Last year, only the U.S. dollar had positive real rates of return. All the other countries had negative real rates of return, so gold performed exceptionally well.
Other countries whose central banks have put into effect monetary easing are Canada, India, Turkey, Denmark and Singapore, not to mention the European Central Bank (ECB), which recently unveiled a much-needed trillion-dollar stimulus package.
A recent BCA Research report forecasts that as a result of quantitative easing (QE), a weak euro and low oil prices, the eurozone should grow “by about 2 percentage points over the next two years, taking growth from the current level of 1 percent to around 3 percent. This is well above the range of any mainstream forecast.” The report continues: “[European] banks, in particular, are likely to outperform, as they will be the direct beneficiaries of rising credit demand, falling default rates and the ECB’s efforts to reflate asset prices.” This bodes well for our Emerging Europe Fund (EUROX), which is overweight financials.
Speaking of oil, the current average price of a gallon of gas, according to AAA’s Daily Fuel Gauge Report, is $2.05. But in the UK, where I visited earlier this week, it’s over $6. That’s actually down from $9 in June. You can see why Englanders don’t drive trucks and SUVs.
But that’s the power of currencies. As illustrated by the clever image to the right, of a Chinese panda crushing an American eagle, China’s economy surpassed our own late last year, based on purchasing-power parity (PPP).
Financial columnist Brett Arends puts it into perspective just how huge this development really is: “For the first time since Ulysses S. Grant was president, America is not the leading economic power on the planet.”
An easier way to comprehend PPP is by using The Economist’s Big Mac Index, a “lighthearted guide to whether currencies are at their ‘correct’ level.” The index takes into the price of McDonald’s signature sandwich in several countries and compares it to the price of one here in the U.S. to determine whether that certain currencies are undervalued or overvalued. A Big Mac in China, for instance, costs $2.77, suggesting the yuan is undervalued by 42 percent. The same burger in Switzerland will set you back $7.54, making the franc overvalued by 57 percent.
Earning More in a Low Interest Rate World
From what we know, the Federal Reserve is the only central bank in the world that’s considering raising rates sometime this year, having ended its own QE program in October.
Earlier this month we learned that the Consumer Price Index (CPI), or the cost of living, fell 0.4 percent in December, its biggest decline in over six years. We’re not alone, as the rest of the world is bracing for deflation:
Following Yellen’s announcement on Wednesday, the bond market rallied, pushing the 10-year yield to a 20-month low.
Interest rates remain at historic lows, where they might very well stay this year. But when they do begin to rise—whenever that will be—shorter-term bond funds offer more protection than longer-term bond funds. That’s basic risk management. We always encourage investors to understand the DNA of volatility. Every asset class has its own unique characteristics. For example:
Our Near-Term Tax Free Fund (NEARX) invests in shorter-term municipal bonds, thereby taking off some of the risk if the Fed decides to raise rates this year. We’re very proud of this fund, as it’s delivered 20 years of consistent positive returns. Among 25,000 equity and bond funds in the U.S., only 30 have achieved the feat of giving investors positive returns for the same duration, according to Lipper.
That equates to a rare 0.1 percent, roughly the same probability that your son or grandson will make it in the NFL and play in the Super Bowl.
In the past 30 years, we’ve experienced massive volatility in both the equity and bond markets, and we’re thrilled for our shareholders that we’ve been able to deliver such a stellar product, under the expert management of John Derrick. What’s more, NEARX continues to maintain its coveted 5-star overall rating from Morningstar, among 173 Municipal National Short-Term funds as of 12/31/2014, based on risk-adjusted return. If you are in Orlando next week, come by the World Money Show to hear John talk about the fund’s history of success. The event is free and my team would love to meet you at booth 514.
To those who listened in on our last webcast, “Bad News Is Good News: A Contrarian Case for Commodities,” we hope you enjoyed it and received some good, actionable insight. If you weren’t able to join us, you can watch the webcast at your convenience on demand. Our next webcast is coming up February 18 and will focus on emerging markets, China in particular. We hope you’ll join us! We’ll be sharing a registration link soon.
- The major market indices finished lower this week. The Dow Jones Industrial Average fell 2.87 percent. The S&P 500 Stock Index dropped 2.77 percent, while the Nasdaq Composite declined 2.58 percent. The Russell 2000 small capitalization index fell 1.98 percent this week.
- The Hang Seng Composite fell 1.38 percent; Taiwan dropped 1.15 percent while the KOSPI advanced 0.68 percent.
- The 10-year Treasury bond yield fell 15 basis points to 1.65 percent.
Domestic Equity Market
The S&P 500 fell 2.77 percent this week as financial markets reacted negatively to a possible rate hike by the Federal Reserve later this year, along with less-than-robust reactions to company earnings. Although it was difficult to assign specific themes to various sectors this week, it was a heavy week for earnings releases. This was partially responsible for the outperformance in materials and consumer discretionary sectors and the underperformance in technology and staples sectors.
- The materials sector was the best performer this week. Mead Westvaco was the best performer rising 11.63 percent as the company agreed to merge with Rock-Tenn. Other areas in the sector were mixed, but select gold and chemical names were positive drivers.
- The consumer discretionary sector was also a solid performer this week on the back of strong earnings results from Amazon and the home builders. Amazon’s profitability was better than expected and somewhat atones for disappointment during the last quarter. The home builders saw better-than-expected results from numerous companies.
- Harman International was the best performing company this week, rising 27.64 percent. The company’s earnings report was very well received. Earnings beat expectations and raised the company’s 2015 guidance on strong demand for its connected car audio equipment.
- The technology sector was the worst performer this week as Microsoft, Qualcomm and Seagate all had disappointing earnings announcements. It was a tough week for “old tech” in general as Intel, EMC and Hewlett-Packard were also among the worst performers.
- The consumer staples sector underperformed this week as Proctor & Gamble and Hersey disappointed. Keurig Green Mountain was the worst performer in the sector on a cautious brokerage note highlighting the limited appeal of cold beverages for the company.
- The worst performing company this week was Microsoft, which fell 14.37 percent. Microsoft reported quarterly results that were okay, but sales guidance was soft and the company continues to be in strategy-transition mode, which raises execution risks.
- After outperforming in 2014, defensive stocks may be poised to continue their outperformance. The Federal Reserve appears intent on normalizing monetary policy and the bond market is responding by sending long-term yields lower. This implies that the market believes a tighter Fed will materially slow the economy.
- Earnings season will be busy again next week. Some key companies to keep an eye on include Disney, General Motors and Merck.
- If oil can find a bottom and move higher, small and mid-cap energy stocks would be among the first beneficiaries.
- The rally in U.S. energy producers may be short lived as OPEC countries seem to be acting individually rather than as a collective cartel. This makes predicting future actions more difficult, but is positive for the inverse beneficiary companies in sectors such as airlines and consumer discretionary.
- The Federal Reserve maintained its hawkish tone even as Europe struggles with outright deflation and other global central banks are easing. The market did not respond positively to this week’s announcement, possibly signaling to the Fed that this is not the right time to change policy.
- Earnings season got off to a rough start and hasn’t improved much over the past two weeks. A strong dollar and weak global backdrop are the primary culprits. A lackluster earnings season may be the catalyst for that 10-percent correction the market has been bracing for (but which has yet to materialize for more than two years).
The Economy and Bond Market
U.S. Treasury bonds rallied this week, sending yields lower across the board, but especially in the intermediate and long end of the yield curve. The Federal Reserve more or less stuck to its guns, indicating it will remain “patient” with regard to raising interest rates but, at the same time, modestly upgraded its assessment of the economy. The Fed effectively backed the view in the marketplace that it will raise interest rates sometime in mid-2015. In an interesting twist, instead of selling off, the bond market roared on Wednesday, sending long-term yields sharply lower. This implies the market believes if the Fed raises interest rates the economy will slow.
The Fed’s view is likely influenced by initial jobless claims, which have historically been a good leading indicator for the economy. As the chart below shows, initial jobless claims are at the lowest level since 2000. The Fed will want to raise interest rates when it can and when the economy is improving, to allow for more flexibility in monetary policy.
- Global central bankers continue to surprise the markets with unexpected interest rate cuts or other easing policies. This week we had Russia and Denmark cut interest rates, along with currency-related easing in Singapore.
- The Consumer Confidence Index hit the highest levels since August 2007. Other consumer confidence indicators are also indicating an improving mood and confidence.
- The German Ifo Business Climate Index was better than expected in January and is another data point indicating improving sentiment in Europe, even as it seems we are bombarded with negative headlines.
- Fourth-quarter GDP modestly disappointed, expanding by 2.6 percent, shy of the 3.0 percent expected.
- Durable goods orders were surprisingly weak in December, falling 3.4 percent.
- German Consumer Price Index (CPI) fell 1 percent in January, which was the biggest decline since 1958. The European Central Bank (ECB) was perceived to be behind the curve and this appears to resoundingly confirm that.
- While the Federal Reserve is still moving toward raising interest rates, the rest of the world continues to fight deflation risks and is generally easing monetary policy. On a relative basis this makes U.S. fixed income assets very attractive.
- The Fed stuck to its guns and didn’t back down from a mid-2015 interest rate increase but, the interesting thing was the market responded with a big rally this week. At the moment, it appears the market will rally on any talk of a rate increase as the market senses the economy won’t be able to take it.
- Municipal bonds continue to look like an attractive alternative in the broad fixed-income universe.
- The Greeks have elected a left-leaning party into power that is intent on restructuring the current austerity program with the Europeans. This has caused a lot of hand wringing regarding the possible exit of Greece from the eurozone and potential consequences that are not well understood.
- Oil prices appear to be extremely oversold and even a bounce in oil could change the mood in the market and bonds could sell off in reaction.
- Deflation is a real threat and global central bankers may be “pushing on a string.”
For the week, spot gold closed at $1,284.49 down $9.61 per ounce, or 0.74 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 1.71 percent. The U.S. Trade-Weighted Dollar Index drifted up 0.03 percent for the week.
|Jan 27||Hong Kong Exports YoY||3.00%||0.60%||0.40%|
|Jan 27||U.S. Durable Goods Orders||0.30%||-3.40%||-0.70%|
|Jan 27||U.S. New Home Sales||450K||481K||438K|
|Jan 27||U.S. Consumer Confidence Index||95.5||102.9||92.6|
|Jan 28||U.S. FOMC Rate Decision (Upper Bound)||0.25%||0.25%||0.25%|
|Jan 29||German CPI YoY||-0.10%||-0.30%||-0.20%|
|Jan 29||U.S. Initial Jobless Claims||300K||256K||307K|
|Jan 30||European CPI Core YoY||0.70%||0.60%||0.70%|
|Jan 30||US GDP Annualized QoQ||3.00%||2.60%||5.00%|
|Feb 01||HSBC China Manufacturing PMI||49.8||—||49.8|
|Feb 02||US ISM Manufacturing||54.5||—||55.5|
|Feb 04||US ADP Employment Change||223K||—||241K|
|Feb 05||US Initial Jobless Claims||289K||—||265K|
|Feb 06||US Change in Nonfarm Payrolls||238K||—||252K|
- As of Thursday, assets in exchange-traded gold products rose for a tenth session, reaching the highest level since October. Investors added 65.6 metric tonnes so far this month, the most since September 2012. Gold equities, as measured by the NYSE Arca Gold Miners Index, are up 20 percent for January while the S&P 500 Index finished down 3 percent.
- Gold demand out of Greece is ten times the average number since the election on January 25. According to London-based gold dealer Coin Invest, sales of gold coins and bars to its Greek customers rose to GBP 2 million (Great Britain pounds) in just five days following the election, compared with a weekly average of GBP 200,000.
- Klondex Mines increased its mineral resource estimate at Fire Creek, announcing that measured and indicated ounces are up 47 percent. Wesdome Gold increased its proven and probable reserves by 57 percent at its Eagle River Mine.
- The Federal Reserve upgraded its U.S. economic assessment to “solid growth” from “moderate growth” on strong job gains. It also noted the lower unemployment rate and voiced expectations of labor market improvement. The Fed is choosing to ignore soft retail sales, disappointing income growth, the lowest labor force participation rate since 1978, dismal durable goods orders, collapsing industrial commodity prices, and a negative S&P 500 earnings growth rate (-0.5 percent, excluding Apple).
- Gold traders are split over the gold price outlook, ending eight bullish weeks. Survey results for next week show eight bullish, eight bearish, and four holds.
- The U.S. Geological Survey figures show that production of gold by U.S. mines was 6 percent lower in October compared to September, and 11 percent lower compared to the previous year. The 10-month output was down 7 percent year-over-year. The U.S. is the world’s fourth-largest gold producer after China, Australia and Russia.
- Paradigm Capital published a report arguing that 2015 is positioned for gold equities to outperform bullion. This is due to margins being positioned to expand thanks to the impact that lower oil prices and exchange rates are having on operating costs. In prior periods where conditions were similar, gold equities tended to outperform bullion. This was the case in 2009 and 2010 for example, when gold equities soared 113 percent and 67 percent, respectively.
- Goldman Sachs announced that over the past month it has witnessed a broad-based change in sentiment among investors when it comes to gold, especially among generalists. Three main reasons were given for the sentiment change: 1) with the global deflationary environment, the U.S. will be forced to maintain low interest rates for longer; 2) a resurgence of the “safe-haven” appeal, given global economic uncertainty; 3) with gold significantly underperforming the S&P 500 in the past two years and valuations looking extended, a reversion is overdue.
- Roxgold announced that the exploitation permit for its Yaramoko gold project in Burkina Faso has been issued following the endorsement of the Mining Decree by the President of Burkina Faso and other government authorities. This was the last permit required for Yaramoko and the company expects to commence initial site works in the coming weeks.
- Greece’s new left-wing government is opposed to a Canadian gold mine that is one of the biggest foreign investment projects in the country, the energy minister announced on Friday. The gold mine operated by Vancouver-based Eldorado Gold in northern Greece was the flagship project of the previous government’s foreign investment drive and was considered a test case that would reveal whether Greece could protect foreign investors despite local opposition. Eldorado’s share price fell by more than 14 percent.
- President Joseph Kabila of the Democratic Republic of the Congo (DRC) has made plans to run a census, a move the opposition views as a ploy to extend his time in office rather than stand down next year as planned. In response, four days of violent protests occurred last week, with human rights groups reporting 42 people killed.
- The DRC is jeopardizing billions of dollars of potential investment by seeking to rewrite the mining rules and raise royalties during a downturn in commodity prices. This is the view of Moise Katumbi who is the governor of the mineral-rich province of Katanga. There is speculation that he is positioning himself as a potential successor to Joseph Kabila. His opinions contrast sharply with those of the current prime minister who might remain in his role if Joseph Kabila remains in power.
Energy and Natural Resources Market
- Oil & gas refiners continue to outperform as many companies reported strong earnings this week. The S&P Supercomposite Oil & Gas Refining & Marketing Index rose 4.21 percent this week while Tesoro Corp. rose 2.65 percent.
- Fertilizer stocks outperformed this week. Company margins continue to expand due to weaker natural gas prices. CF Industries Holdings Inc. and Agrium Inc. were up 1.20 percent and 2.05 percent, respectively.
- Gold stocks ended the week positively as real yields continue to head lower and global currencies weaken. The NYSE Arca Gold Miners Index rose 1.48 percent this week.
- Tankers stocks continued their downtrend this week amid growing fears of a global slowdown in demand. The Bloomberg News Tanker Index fell 6.89 percent this week.
- This week TSX energy stocks fell as investors pursue more cautious, low-beta alternatives. The S&P/TSX Capped Energy Index fell 0.21 percent this week.
- Major integrated oil stocks continue to decline alongside depressed oil prices. The BI Global Integrated Oils Valuation Peers Index fell 3.77 percent this week.
- Major oil companies are announcing plans to cut capital expenditures before making any changes to shareholder payouts. Protecting shareholder value while limiting supply should be positive for investors in the long run.
- The fall in fuel prices amounts to roughly $60 per month for the average consumer. This increase in disposable income should continue to be positive for the economy as a whole.
- Gold remains an extremely attractive alternative investment in the current economic climate. If rates continue to decline and currencies continue to weaken, gold could experience a further breakout.
- The U.S. dollar continues to rise as the global economy shows very little signs of life outside of the United States.
- While positive for certain assets, the recent decline in government yields around the world is a sign of slowing global growth, and in turn commodity demand in the near future.
- South African stocks outperformed this week as the country reported a much higher than expected trade surplus and left interest rates unchanged. The FTSE/JSE Africa All Share Index rose 2.91 percent this week.
- Philippine stocks rallied on news that economic growth in the country rose much higher than expected in the fourth quarter. Gross domestic product increased 6.9 percent year-over-year, up from 5.3 percent in the previous quarter. The Philippines Stock Exchange PSEi Index rose 1.87 percent this week.
- Qatar stocks came back this week after a recent slump due to continually depressed oil prices. The Qatar Exchange Index close up 1.72 percent this week.
- Greece suffered through extreme volatility this week after the Syriza party came into power on Sunday. The appointment of a new left-wing cabinet as well as increasingly hardened rhetoric against Greece’s current arrangement with the European Union has rattled Greek markets, causing the yield on Greek 10-year government bonds to skyrocket. The Athens Stock Exchange General Index fell 14.10 percent this week.
- Petroleo Brasileiro SA’s corruption scandal led Moody’s Investor Service to cut the state-owned oil producer’s credit rating to one step above junk. Petrobras (as it is commonly referred to) has been dragging down Brazilian markets alongside a tumbling real. The Ibovespa Brasil Sao Paulo Stock Exchange Index fell 3.83 percent this week.
- Standard and Poor’s cut Russia’s credit rating to Junk this week, sparking a quick selloff in the ruble. A response to tightened liquidity as well as the appearance of policy inflexibility, the Russian Central Bank surprised markets by lowering its key interest rate 200 basis points to 15 percent. As a result, the ruble fell to its lowest level since the massive sell off in mid-December of last year. The MICEX Index fell 1.44 percent this week, while the ruble fell 7.64 percent.
- Financials stood out among top sector performers in Asia three months after previous rounds of quantitative easing or liquidity facilitation programs in the U.S. and Europe, and the best-performing style post-QE was value investing. Chinese banks traded in Hong Kong fit both profiles and we believe they should resume their outperformance after the recent correction, thanks to expectations of further domestic policy easing, globally high and rising dividend yields, and ongoing recovery of investor confidence in banking asset quality driven by structural reforms of local government financing.
- The Federal Reserve maintained its “patient” language in this week’s Federal Open Market Committee (FOMC) meeting. While markets still expect a rate hike as early as June, global and domestic conditions continue to build a stronger case for pushing rate hikes out further.
- Chinese coal demand may remain on a secular downtrend given a slowdown of economic growth to a new norm and government policy direction for clean energy adoption. Ample coal inventories at Chinese power producers should continue to limit coal price recovery, and weigh on investor sentiment towards equities of Chinese coal companies.
- Despite the announcement of the European Central Bank’s (ECB) massive quantitative easing program, global growth sentiment appears to be weakening further. One striking indicator of the lack of robust global growth is the continued decline in the U.S. Government 10-year Treasury yield, which made fresh 52-week lows on Friday.
Leaders and Laggards
The tables show the weekly, monthly and quarterly performance statistics of major equity and commodity market benchmarks of our family of funds.
|S&P/TSX Canadian Gold Index||194.25||+9.32||+5.04%|
|Korean KOSPI Index||1,949.26||+13.17||+0.68%|
|S&P Basic Materials||299.22||-3.65||-1.21%|
|Hang Seng Composite Index||3,344.74||-46.98||-1.39%|
|10-Yr Treasury Bond||1.65||-0.15||-8.51%|
|Natural Gas Futures||2.68||-0.31||-10.31%|
|S&P/TSX Canadian Gold Index||194.25||+48.45||+33.23%|
|Korean KOSPI Index||1,949.26||+33.67||+1.76%|
|S&P Basic Materials||299.22||-6.06||-1.99%|
|Natural Gas Futures||2.68||-0.21||-7.30%|
|Hang Seng Composite Index||3,344.74||-332.01||-14.83%|
|10-Yr Treasury Bond||1.65||-0.53||-24.26%|
|S&P/TSX Canadian Gold Index||194.25||+59.63||+44.30%|
|Hang Seng Composite Index||3,344.74||+59.53||+1.81%|
|Korean KOSPI Index||1,949.26||-15.17||-0.77%|
|S&P Basic Materials||299.22||-5.17||-1.70%|
|10-Yr Treasury Bond||1.65||-0.69||-29.58%|
|Natural Gas Futures||2.68||-1.20||-30.85%|
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.