Brexit: Anomaly or Awakening

/0 Comments/in , /by

This article originally appeared in Resource World Magazine. 

 

Gold and other safe haven assets have seen strong momentum leading up to the June 23rd ‘Brexit’ referendum when the United Kingdom will vote whether to remain within or exit the European Union. The lead up to the referendum has seen a populist political charade take place in a major Western power. A few years’ prior, these political events were confined to smaller and less economically significant economies, such as Greece. Now, investors are left worrying what the economic significance is of a major economy like Britain questioning their role in the economic union. Furthermore, asset classes such as precious metals, western government debt, and the dollar are showing strength as investors’ hedge the possibility of populism prevailing and upsetting the political status quo.

 

Fundamentally, it makes sense for gold to react positively given…. click here to keep reading.

Regressive Economic Policies

/0 Comments/in , /by

It says a lot about the state of the world economy when ideas dictated through extreme political leaders have populist appeal to them, and are what is driving the promotion of regressive economic policies. How these ‘populism ideals’ are beginning to trump (no pun intended) simple textbook economics paints a rather alarming picture. Certainly this is nothing new. We saw the emergence of this theme at the beginning of the European Sovereign Debt Crisis in 2011, but this nonsensical populism was taking place in what are relatively smaller and, without offence, insignificant economies, (such as Greece), to the world. Then, it was more a story of shock than significance. It’s unfortunately a theme that has gathered momentum.

 

What started in Greece then spread to bigger countries like the PIIGS (Portugal, Ireland, Italy and Spain), and Poland and France. We saw the emergence of far left or far right wing parties where platforms were founded on a sense of nationalism, communism, or religious ideals are gaining support and interest. In some countries, a vote could be split enough ways to keep a somewhat centrist regime in power, others didn’t see the same fate.

 

Now we have two key events in 2016 (one only a few weeks away), that have the ability to shape a real turning point in the direction of the global economy. And the reason for their significance is because this rise in populism from smaller and less significant economies has made its way to the main stage. The first upcoming event is the ‘Brexit’ referendum which takes place on the 23rd of this month. The second is the Presidential election in the United States this November.

 

Regarding Brexit, a first year college student could make a very simple argument for why Britain should remain in the Eurozone. At the most basic of levels the participation in a market almost equivalent in size to the United States makes British consumers better off vis-à-vis more competitive prices when they purchase goods at home. The same works for businesses selling their goods and services to a vastly larger market, saving duties and customs fees. With the instance of less restrictive barriers to trade, there are always losers, but the economy is better off in aggregate and a responsibly managed one compensates losers.

 

Another argument against ‘Brexit’ is the ‘yes’ voters don’t know what they are voting for should Britain leave the EU. Uncertainty plagues their side, as the most common concern is the future of the financial services industry based in London. And on that topic, uncertainty is about all the parallel’s one can draw to a US election, come November, that defies any allusion of normalcy. That’s simply because it’s unfortunately been a story more consumed for entertainment value than anything else than serious political consideration.

 

Some may attempt to just write these two major events of 2016 off as anomalies that will simply fail and go away. We’ll see, but it is highly unlikely. Unfortunately, is clearly a discontent in the perception of the way this world operates is what’s fueling the beast. Populism doesn’t care about right or wrong. And as investors, that’s a problem because markets can become just that much more unpredictable and volatile. Is there an answer? No, but a little diversification always helps.

Yellen’s Enigma

/0 Comments/in , /by

Hindsight is 20/20. That being said, 2015 saw a bull run in the US dollar that was forecast by many credible analysts. The year also saw commodities tumble and other assets that are negatively correlated to the US dollar show weakness, particularly the Canadian dollar.  Now, looking ahead to 2016, the Bank of Canada is no longer viewed or anticipated to be more accommodative. The federal government has planned stimulus spending to ‘invest’ in the Canadian economy. And surprisingly, we have seen somewhat strong economic indicators in the first few months of 2016 despite heightened levels of uncertainty from the global economy over same time period.

It’s worth reconsidering what factors drove the loonie and oil prices to the levels they are today. A major contributor to sharp movements in the global currency markets was the US Federal Reserve out in front in terms of tightening monetary conditions. With steadied and continued improvement in the US labour market, the Fed prepared to gradually raise their key policy interest rates. And, with regards to commodities markets, the world economy faced both weakening demand, particularly from China and the emerging economies and an oil supply glut that focused heavily on shale production in the US.

The reason it’s worth revisiting those two aforementioned factors that caused such disruption for global markets, is because they currently remain at the forefront of what’s driving investment markets. Janet Yellen was speaking at the Economics Club of New York this past week, and seemed to do a course change on how the Fed views international developments. What was previously not a concern of the US Federal Reserve and just a mere acknowledgment in their prior policy statements suddenly became a focal point of Ms. Yellen’s speech. Following the Fed’s initial rate hike in December, anticipation was for four additional quarter point moves this year.  Now the question is whether there will even be two.

Regarding commodities, there is still clouded uncertainty over whether OPEC members will come together to cut production levels and assist in putting a floor under the oil market. This question will have greater clarity by the middle of this month when OPEC and Non-OPEC producers meet, but at this time oil prices are a factor that continues to weigh on commodity markets, as the possibility of lower prices is continuously debated.

This in essence represents Yellen’s paradox, and it seems she is willing to delay and shift back to a wait and see approach. Her enigma is heightened by the fact that a strong US dollar stemming from central bank policy in tandem with a supply glut in commodities led to dogged market volatility. Many of her fellow Fed members have been vocal these past few weeks, and appeared ready to continue to hike rates. Other members, including Yellen, have seen how a strong US dollar has challenged the US economy with the expectation of a Fed rate anticipated with a vibrant US labour market. While waiting, however, the Fed risks their credibility of being able to raise interest rates as they had previously guided investors to believe.

A Common Theme

/0 Comments/in , /by

The theme of divergence has been playing out in the global economy. One example is how the US Federal Reserve has begun their path of gradually raising interest rates whereas central banks like the Bank of Japan or European Central Bank have acted in recent months to lower policy interest rates and provide further economic stimulus through quantitative easing. Another, in the United Kingdom there is talk of a “Brexit” where citizens will vote in a referendum this June whether to remain a part of the European Union. Even in Canada we see divergence in the form of how the BC economy performs compared to the rest of the country.

Over the course of 2015, as commodities prices continued to tumble, the Canadian energy sector has had a net negative effect on the countries labour market. The province of Alberta lost more jobs last year than they did in 1982 when they were in recession. BC on the contrary, has seen employment growth of 3 per cent in the twelve months trailing February 2016. It leads the pack of Canadian provinces and is one of three to actually add jobs over the last year. Parts of this country are very challenged with economic opportunity while other regions are forecasted to show modest growth.

This in itself presents a very difficult challenge for the new Federal Liberal government as we begin to examine and digest the details of their first budget over the next couple of months. There are very clear have and have not regions of this country, and they must insure stimulus spending is (to quote Harvard economist Larry Summer’s) “targeted, timely, and temporary.”

Of the three T`s, all imply their own level of importance, but I`ll expand on the notion of being temporary. Whether the government runs a deficit amounting to half a percent or full percent of GDP is really inconsequential in the short run. That being said, TD`s Economics department updated their projections for the Fed`s budget with the latest data from the Finance Department and found from their estimates they are on track for run deficits totalling 150 billion over the next five years. This would in-fact twice break a Liberal promise of first capping deficits at 10 billion per annum and then second keeping the debt-to-GDP ratio fixed. This risks government spending creating negative connotations for returning to economic growth over the long run and having a debt that runs away like during the late 1980`s and early 1990`s.

Thankfully Canadian politics have exhibited a level of civility that is absent in most other western nations making headlines at the moment, and our new government has been given a mandate to spend as they see fit to reignite the Canadian economy. As BC`s forecasted to be most prosperous province through 2016 though we should hope for two things. The first being that the fiscal stimulus measures of the federal budget can provide an effective temporary lift to the Canadian economy. But, the second is certainly be careful what we wish for as the risks to over spending mean either higher taxes down the road or higher deficits bigger than planned as the government gets itself mired in debt.

All investments contain risks and may lose value. This material is the opinion of its author(s) and is not the opinion of Border Gold Corp. This material is shared for informational purposes only. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.  No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission.  Border Gold Corp. (BGC) is a privately owned company located near Vancouver, BC. ©2012, BGC.

Coming to the Rescue

/0 Comments/in , /by

If the Wednesday morning bank of Canada announcement revealed anything, it’s that Canada and Stephen Poloz may be shifting course to join the group of central bankers that are no longer attempting to save the world. Furthermore, they have accepted that the year ahead will be one of slow and tepid in terms of economic growth. As the first month of this year is already shaping up to look fairly ugly for the markets, we are constantly reminded of the troubled outlook for the global economy by consistent downward revisions for economic growth, as the most recent one came from the International Monetary Fund at the beginning of last week.

Harvard professor and former IMF Chief Economist Kenneth Rogoff said exactly that in an interview with Bloomberg from Davos, Switzerland at the World Economic Forum. Where people may be looking to central bankers to save the world and contain some of this market volatility, expectations should perhaps be paired back as we begin a year of expected moderate economic growth and wild market volatility. Central bankers will only concern themselves with market volatility if they begin to see evidence of a transmission to the real economy.

But back to Canada, a year on, it’s safe to suggest the challenges facing the Canadian economy have become that much broader and a little more complex. For example, the bank of Canada refers to slack and deflationary pressures from lower energy prices, and the toll it takes on Canadians and businesses linked to that sector. Challenging from the other side will be inflationary pressures from rising import costs hitting consumers on everything from groceries to electronics.

Finally, there is also a concern of a currency that mirrors some of the instability of the world’s emerging economies. This in particular has Canadians with strong business ties to the US either cheering as they get paid, or on the edge of their seat as they see margins slip away.

There is, however, a case for the Bank of Canada cutting interest rates a little further into 2016. A few important aspects they may be looking for are the degree of fiscal stimulus from the Federal Liberal’s first budget and where oil prices may settle going into the spring. However, as long as oil prices and the dollar keep slipping, I am of the view the weaker currency will do the bank of Canada’s heavy lifting for them, and they will not need to lower rates. But to quote the governor in a speech earlier this month, “the economy’s adjustment process can be difficult, and painful,” and unfortunately certain regions and aspects of the Canadian economy are in for just that.

Paring Their Bets

/0 Comments/in , /by

January 21st of 2015 stunned investors and economists as the Bank of Canada lowered their key interest rate by a quarter of a per cent. Prior to that, since September of 2010 policy interest rates in Canada had remained unchanged and the Bank of Canada was perceived to have a more hawkish bias. The surprise announcement last January from the more fluid and accommodating Bank of Canada governor, Stephen Poloz, has lent way to a loonie that continues to struggle to find any degree of stability. As focus remains on the Canadian dollar (in light of recently falling below the key psychological level of 70 cents), the question for Canadians, will the bank of Canada cut again next week?

To go out on a limb, the greatest probability heading into this January announcement is, not likely.

Numerous bank economists made headlines in the financial press this week for their calls for the bank of Canada to cut rates next Wednesday. Unfortunately, it seems the recent unpredictability of Canadian interest rate policy has led to greater uncertainty for the country’s top forecasters. A crucial point as well, made by CIBC’s Avery Shenfeld was where we have a dozen Fed Governors and Regional Presidents making speeches on current policy in the US, in Canada we aren’t afforded the same luxury of voting members utilizing speeches to offer guidance to the market. This makes predicting the bank of Canada a little more difficult.

There are a few simpler reasons, however, why it is unlikely for the Bank of Canada to take action next week. The first is that we are heading into the newly elected Federal Liberal’s first budget. With downgraded forecasts for Canadian economic growth, and some sluggish indicators from the final months of 2015, pressure is beginning to mount on Canada’s progressive new regime. With anticipated plans for short term infrastructure spending to boost economic activity, the Canadian central bank has reason to stand aside and let the new government officially unveil some of their plans. Then, should they anticipate a need for further measures to stimulate economic activity, a subsequent rate cut could come by the spring.

The second reason the bank of Canada can afford to hold off on a rate cut next week is attributable to the Canadian dollar. It is no secret Governor Poloz has been a cheerleader for a weaker dollar. With an approximate 20 percent decline in oil prices to begin 2016, the loonie is down nearly four per cent against the greenback. The continued deterioration of the Canadian dollar is the natural stabilizer the country needs to adjust from an economy over reliant on the energy sector to one of non-energy export led growth. Investment bank Macquarie Capital recently updated their forecast for a 59-cent loonie by the end of 2016. The reason for an even lower dollar is they see that as the level required to fully transition Canada from being an attractive market again for foreign investment.

Given the Bank of Canada Governor has come across as a bit of a wildcard to date, I don’t think any option is off the table for next Wednesday. But the continued weakness in the Canadian dollar has prompted large inflationary pressures on Canadian consumers from grocery bills to consumer electronics. Also, the quick pace of deceleration in the loonie will only be exacerbated by another rate cut, and no policy maker looks to shock markets. With the timeline for a federal budget and a focus of increased government spending from the newly elected Federal Liberals, there is their potential to surprise with a larger than anticipated deficit. Accounting for the aforementioned factors, my guess is like the span between September 2010 and January 2015, the bank remains on hold, and the loonie even sees a bit of a relief rally.

What a Week

/0 Comments/in , /by

What a week. It’s a new year for the world’s financial markets, but it sure didn’t take long for investors to realize that the themes of 2015 are still very much prevalent. The week and the year began with Chinese regulators attempting to maintain control of their currency as the offshore market continues to discount the official rate has seen investors sell Chinese stock markets and prompt fear of further weakness in the world’s second biggest economy. The immediate and pertinent questions as fear of contagion spreads around the globe is, are the events over the previous week indicating some sort of paradigm shift in the global economy like a crisis or is this simply volatility that is to be expected in 2016?

At this point, it seems the latter scenario of increased volatility is more likely. Furthermore, ending the week Friday with strong US job numbers only added credence to this point. As the US labour market created 292 thousand net jobs in December, the year of 2015 topped out as the second best year for job creation since 1999. The US economy continues to moderately advance as the least dirty shirt in an obstacle-ridden world.

The US Federal Reserve remains in their challenged position as the world’s central bank. As the IMF points out, global growth in 2016 will be muted and uneven, but domestically US businesses continue to have a positive outlook and hire. Hence, there is an environment to continue to support a strong dollar. Shifting overseas, part of the fear of the rapid currency depreciation in China, and other emerging markets is linked to local firms holding US dollar debt that inflates with currency weakness. This currency weakness is being prompted by diverging central bank policy between the US and the rest of the world. This has certainly been the dark cloud that has reappeared over financial markets, not unlike August and September of last year.

Chinese equities perhaps tell part of this story as they represent investors fleeing their domestic market, but don’t share a link to their economy that financial markets in more advanced economies may have. This is why they only an incomplete story. Proof of this is in the issues over the past week where circuit breakers and trading halts that failed to restore investor confidence and minimize what was an incomplete emotion-filled rush for the exits. As their equity markets require reform, it will be important for investors to keep this in mind in the year ahead and anticipate further violent moves. Chinese equities, while making headlines surrounding trading halts and selling bans, are only a small part of the story for global markets.

In retrospect, the outlook for the markets circles back to the US Fed and their interest rate policy. Despite the fact that we are now past the point of quantitative easing and emergency level interest rates, it is still the pace at which the US Fed continues to raise rates that will be the focus of investors. The unconventional measures of the past allowed the fed to maintain a liquidity backstop for global markets. This game is now changing as their ultra-accommodative measures are tapered back. Less liquidity prompts more volatility, and that is why in 2016 it is most important investors are tempered and have a plan for when the market sells off, instead of being caught in shock.

Dollar, Debt, and Politics

/0 Comments/in , /by

Like a rock tumbling down hill, oil prices have broken 40 dollars per barrel and sustained their downward momentum. Bearish reports ranging from the outcome of the OPEC meeting in Vienna over a week ago to supply outlooks from the International Energy Agency continue to weigh on the global crude market and have further dampening effects on global financial markets. Particularly equity markets look troubled with the notion of a diminishing global growth picture, and the prospects of a global recession come 2016. Not just limited to the aforementioned reasons, but markets remain on a jittery footing heading into the Fed meeting this week. It is remarkable how much can change in one short week as market participants exhibit signs of discontent with what’s in the pipe for the year ahead.

The greater probability though is not so much a fear for how North American markets will react to Fed actions next week, but instead what will result in the world’s emerging markets. South Africa reminded us this week that there are greater fears for emerging market (EM) investors than simply the price of the US dollar and commodity markets. Simply put, the commodity markets slump has put downward pressure on some of the world’s EM’s as returns are depleted and pressure mounts on government revenues. A strong US dollar also inflates the burden of US dollar denominated debt many of the countries and residing corporations have issued to finance themselves. But with the pressure of inflated interest payments and depleted revenues comes political risk.

With South Africa as the example, the Treasury and the Central Bank have long been viewed as stable and independent institutions. The benefit of an independent treasury is that it is an added pressure to government to restrain their finances and keep government debt in check. This all changed for the Republic of South Africa this week when the President Jacob Zuma fired his finance minister and replaced him with an unknown party insider. The Economist Magazine actually cited a spike in Google searches of the man’s name as people were unfamiliar with who would be taking the helm of the country’s finances. As the fear is this was a politically motivated decision, the rand, South Africa’s currency, in a swift reaction sold off 5 per cent against the US dollar despite sitting on multi year lows.

This is a critical time for emerging market economies. Also, given the demand from EM’s for precious metals, it has direct implications for the gold market. At the beginning of December Fitch Rating Agency downgraded South Africa’s debt to one notch above junk status. This is as Debt-to-GDP rose from 2009 until present time from under 30 per cent to just above 45 per cent. Political risks, whether from South Africa or any other nation, become more prevalent for investors and can change the dynamic of global markets.

This will likely reinforce a theme for the beginning of 2016 that the dollar, if not for investment opportunity in US markets, will be attractive for its safe haven and even more so liquidity status. It’s a challenge for commodity markets to counter trend a strong US dollar and as long as the outlook for EM’s is bleak, a strong dollar may persist. The global economy will be challenged in 2016, and objectively, remains one of the bearish factors weighing on the gold market.

Divergence and the Dollar

/0 Comments/in , /by

This past week in the markets set the scene for a diverging picture in terms of monetary policy in the United States versus the reset of the world. Through speeches and congressional testimony, US Fed Chair Janet Yellen made clear that a December rate hike remains on the table as the US Federal Reserve looks to lift off of rock bottom interest rates on December the 16th. This would be the first rate hike by the Fed in ten years. On the other side of the Atlantic, Mario Draghi and the ECB perhaps fell short of investor’s expectations Thursday, but nonetheless remain in an accommodative stance as they extend the duration of their bond purchasing program and cut key policy rates. The path of rate hikes by the US Fed and how their policy diverges from their fellow G7 nations continues to be heavily debated and will be one of the foremost important themes for the global economy in 2016.

There is no question the decision makers at US Fed sit between a rock and hard place. A report out of the Financial Times at the end of last week revealed more than a trillion dollars in US corporate debt has been downgraded so far this year. This represents a 72 per cent jump in the total value of US debt that was downgraded in the first 11 months of 2014. Much of the story is related to the energy picture and US companies that face declining revenues with weaker commodity prices, but also linked is the fear and pressure created from higher interest rates from the path of Fed rate hikes.

Fitting in the commodity story is another very relevant question. The old adage use to be the cure for lower oil prices is lower oil prices. This current down period in energy markets is certainly putting pressure on that theory. As OPEC meetings finalized in Vienna this week, there is only more excess supply uncertainty for the market with the cartel opting not to constrain output and abandon a production target until their next meeting. Relating to the dollar story, it’s not only higher interest rates in the US prompting a strong dollar trade, but also a continued outlook for weak commodity markets.

Tying this together speaks to investor caution of whether the credit cycle seen in global bond markets is nearing its end. Eight of the largest US banks were downgraded by rating agency Standard and Poor’s this week and four of them including Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley were stripped of their coveted A ratings. Only 3 US corporations now have AAA rated credit (and potentially soon to be 2 as one is ExxonMobil) whereas five years ago that number was over 20. In broad terms, as creditworthiness declines and risk increases, investors must look for preservation and return of their capital.

It was interesting to see gold Friday surge over 25 dollars an ounce against the backdrop of fundamentals that would otherwise be bearish for the precious metal. By no means am I attempting to call a bottom in gold prices, but as commodity markets got hammered Friday with the OPEC news and the dollar strengthened with Fed rate hike anticipation, gold as well traded higher in tandem. This rare occurrence when gold and the dollar strengthen together can often signal investors are in search of a safe haven at a time of heightened uncertainty. Whether gold has bottomed is to be determined, but with limited opportunity from relatively stretched credit markets, and an uninspiring equity market backdrop, diversification to gold is worth examining in 2016.

The Next Phase

/0 Comments/in , /by

A lot is being made of remarks from Federal Reserve Chair Janet Yellen earlier this week and the likelihood of the Federal Reserve raising rates as early as December. This is because, all else being equal, the US economy no longer warrants emergency level interest rates. Fridays US jobs report added further evidence to this, and that in fact the lame payroll numbers of August and September look more to be anomalies than a slowdown of the US economy, which was immediately impacted by economic instability in Asia. With the anticipation of action from the US Fed in December, it seems likely to expect a second phase of US dollar strength.

For starters, the global economy is shifting back to a precedent where US financial markets remain the most attractive home for capital on a relative basis. Over the previous couple of months anticipation was that like the Federal Reserve in the US, the Bank of England was ready to adjust rates higher, but policy uncertainty there in the last week has led forecasters to look to the latter half of 2016 for a rate rise. Furthermore, during this current period the global economy finds itself in a similar situation where the US sits alone as the only western central bank with a tightening bias, and is almost akin to September 2014 when the first wave of dollar strength began.

Another cautious sign was revealed in a research note by Bank of America Meryl Lynch earlier last week that money is fleeing out of Canada at the fastest rate of the 10 major developed economies. The author examines two main factors, and the first is that Canadian investors and money managers are looking to US financial markets for better opportunity. The second is perhaps a more troubling sign that Canadian businesses are merging with or acquiring firms abroad as apart of 73 billion dollar outflow in acquisitions so far this year. Very simply this is money leaving the country because there are better prospects elsewhere. And it is without a doubt that there was anticipated to be a flight of capital from a decrepit energy sector, and it’s resoundingly clear that opportunities domestically are few and far between.

Bank of Nova Scotia estimates the Canadian dollar could go as low as 72 cents by the first quarter of 2016, and that forecast sounds bullish compared to some of the independent forecasters for the loonie. The reality though is that it fits into a scenario where we are about to embark on another phase of weak commodity prices and US dollar strength. That is why in turn Bank of Nova Scotia doesn’t see oil prices recovering until at least the end of 2016. Further to this, CIBC Economics Department wrote a very important note a few months back directed at firms that hedge their foreign exchange risk, and their message was clear. The downside is limited with a loonie that is ‘fair value’ around 78 cents, and it’s not likely we’ll overshoot back into the 80-cent range. Albeit, there’s always reason to be wary of a consensus call, but the evidence for another wave of US dollar strength seems overwhelming.

A final thought is how this theme encompasses precious metals. Gold is currently retesting the August low of 1,085 US per ounce. Further downside would almost be anticipated with a hike in interest rates, but the shallow liquidity of the gold market and its quick readjustments encourage that this news has already been priced in. In less than two weeks the price of gold has given back 90 dollars. Whether support at the 1080 level holds will be the ultimate question, but with the next phase of conversation around the US Fed will not be when they raise rates, but when can they do it again and to what level. My call is for eventually lower gold prices, but the downside will be short-lived.