Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Time for Big Gains in the Grains

Montreal, Canada

What's the worst-performing commodity sub-sector since 2000?

If you guessed livestock, then you're right. Live cattle and lean hogs have produced horrible results over the last decade as a combination of swine flu and China's ongoing ban on American red meat continues to hurt the livestock industry. Prices have indeed ratcheted higher over the last few months but have more to do with seasonal demand than a new bull market emerging for meat and pigs.

The second-worst performing sector over the past decade remains the grains. And since hitting a peak in the last commodity bull market in 1980, the grains are down more than 75% adjusted for inflation.

Despite a huge rally in the mid-2000s, the grains have collapsed since late 2008 following record harvests in many countries, including the United States, Argentina, Ukraine and Australia. From their highs earlier in 2007 and the first half of 2008, the grains (corn, wheat and soybeans) remain more than 50% off their best levels of the last decade after collapsing in the fall of 2008.

Favorable weather has also been a boon for production with Mother Nature nurturing yields to bountiful levels over the last 18 months.

The long-term trend for the grains is extremely compelling and for patient investors, rewarding. That's because we're outgrowing the Earth's resources, including food supply. It's only a matter of time until another series of poor harvests, volatile weather and demand spikes from China and elsewhere in Asia trigger a new bull market.

Falling water supplies, booming demographics, the loss of arable lands in the emerging markets due to rapid industrialization and rising global temperatures all combine to challenge supplies over the next decade and beyond.

The good news for investors is that we're at the cusp of a major super-spike for the complex as the bear market concludes this summer. Though incredibly cheap, the grains are now getting a boost from Mother Nature as erratic weather reducers crop estimates across most regions coupled by rising demand from China – now the biggest destination for U.S. corn and soybean exports.

The charts have also turned bullish on the grains (See JJG above). On July 15, my Commodity Trend Alert (CTA) investment service, now in its eighth year, turned bullish on the complex and issued a buy alert. So far, so good.

Asian and Latin Central Banks Tightening Monetary Policy, Fed Lags

Montreal, Canada

Buy surplus currencies and sell deficit currencies. That's the long-term trend now underway as global economic power continues to shift from West to East since 2008.

A major divergence has begun in some emerging markets as central banks in several countries raise interest rates while the Federal Reserve stands pat. And, as rates rise in these fast-growing countries, the dollar probably stands to lose unless a "flight to safety" trade remerges amid a renewed market plunge. But, over time, emerging market currencies are likely to continue appreciating vis-à-vis the dollar and the EUR.

A few years ago, The Sovereign Society, in conjunction with Everbank, launched the TSI Asian Currency Portfolio, backed by FDIC deposit insurance and diversified across major regional currencies.

Our reasoning back then was that Asia's major currencies would appreciate against the dollar over a period of time because of their compelling growth rates, accumulated surpluses and undervaluation versus the dollar. These secular trends are powering ahead this year as more central banks tighten monetary policy while the Fed keeps rates unchanged.

As the West struggles with growing austerity measures to combat huge fiscal deficits, Asian economies (ex. Japan) are growing strongly and their currencies are appreciating.

Yesterday, Thailand's central bank hiked interest rates while since early July, four other emerging market central banks have tightened; these include Peru, India, South Korea and Malaysia.

In June, China decided to loosen its trading band on the renminbi, triggering appreciation of its currency and compelling other regional banks to raise rates as inflationary pressures rise in Asia.

An interesting dichotomy has emerged for currency investors in mid-2010 as the West struggles with low growth and prolonged easy money amid softening inflation or accelerated disinflation. This contrasts starkly with Asia, whereby strong growth is being accompanied by rising inflation and increasingly, hawkish central banks tightening policy.

Based on economic growth trends, interest rate differentials and trade surpluses, emerging market currencies deserve to be upgraded. And it's a secular long-term shift that will last years, if not decades – only interrupted by systemic crises – which should serve as buying opportunities for dollar and EUR-based investors.

Global Recovery a Fraud

Montreal, Canada

In the absence of government fiscal spending since 2009 we'd probably be looking at massive bank closures, business bankruptcies and insolvencies at the state and municipal level.

The global economy is nearing the nadir of this government fuel-injected spending binge and companies must witness revenue growth to legitimize corporate earnings and rising stock values. Cost-cutting is yesterday's news; now companies need to show investors "the money."

The poor, unsuspecting investment public has been sold on a strong economic recovery in 2010. Nothing, however, could be further from the truth in a protracted environment of widespread deficits at the private and public level, ongoing asset deflation in stocks and real estate and a decline in real wages. In short, I'd coin this recovery a fraud.

Over the last two weeks, I've urged investors to sell stocks or lighten-up. The risks in stocks, commodities and other high-risk assets will only intensify this summer before markets once again post another in a series of short-lived rallies this fall. After falling about 16% from peak-to-trough, the S&P 500 Index has posted a strong rally since last week – up more than 7.5%.

I urge you to sell stocks in this brief rally because spectacular macroeconomic risks will continue to pose serious headwinds for investors. The eurozone crisis isn't over; the housing debacle continues in the United States; companies aren't hiring; inflation across most industries is falling sharply as companies lose pricing power and China is slowing markedly since the first quarter. Austerity is now the buzzword in 2010 and that won't boost domestic consumption or economic growth. Au contraire, we're heading down Japan's morbid path of near zero growth and accelerated disinflation or outright deflation.

Worse, government financial regulation is on the way as Obama continues to wage war on Big Business. FDR went on the same path in the 1930s and lost that battle. Obama will lose this one. And along with new government regulation – never a bullish development – the stock market will vote with both thumbs down. That's exactly what happened starting in 1937 following FDR's assault on business and new government regulations; stocks swooned.

And as for small business, responsible for more than 50% of new jobs growth, this administration is out to lunch. Small businesses still can't obtain the financing they need. Only the big banks have the cash and they're mostly hoarding it.

By the time we hit 2011, I expect another wicked bear market to inflict the final cut as it pertains to the post-2008 credit crisis and its peripheral victims. There's almost nothing positive about the outlook heading into the second half of 2010 and as we head into 2011, I think high quality bonds, gold, the dollar and the yen will once again dominate asset markets as just about everything else crashes again. We're heading down the wrong path. Investors beware.

Asset Protection and Overseas Accounts Vital in Age of Big Government and Big Deficits

Montreal, Canada

At the Las Vegas Freedom Fest this past week, I met numerous investors alarmed by the shockingly disastrous state of government finances – federal and state. Most investors at our Sovereign Society presentations – over 2,000 delegates this year – didn't have an offshore or European bank account and were hungry to move some assets overseas.

I urged delegates to immediately open a European private banking account to shield some of their assets from domestic economic uncertainty; asset protection is important. But most people are clued-out and think private banking is only for the Big Boys. Not true.

I've always believed it's a big mistake in financial planning to have most, if not all of your assets, denominated in one currency and under the auspices of one legal system. To me, this is a recipe for financial suicide in the age of violent capital markets, the destruction of credit and massive fiscal deficits. This is the essence of The Sovereign Society since its inception 13 years ago: it's your right to diversify worldwide and seek the best strategy to protect your nest egg and minimize taxes.

When you think about it, most of us earn an income in dollars; maintain IRAs or 401ks in dollars; hold insurance and life policies in dollars; investment portfolios in dollars; housing assets in dollars – you get the point. Just how much of the dollar do you need?

But increasingly, more people are learning about the attributes of parking some money in a European private bank. This includes countries like Switzerland, Austria or Denmark. These folks aren't looking to dodge taxes; rather, simply they want to diversify their assets outside of their home domicile because they're genuinely concerned about what Obama is doing to the country.

Many international investors living in Europe feel the same way. More and more people are moving some money outside of their home residence and, increasingly, are buying gold because of the growing instability of the global exchange-rate system.

My advice is to move a portion of your assets to Europe now. It's only a matter of time until the next financial time-bomb hits world markets and governments possibly introduce foreign exchange controls. Don't think it can happen? Look no further than Britain in the mid-1970s, which introduced currency controls. By 1975, the IMF was lending to a near-bankrupt United Kingdom and residents couldn't take more than £50 pounds out of the country.

Bear Takes a Bite Out of the S&P 500

- Dugald Malcolm, Montreal

Recent market action has resulted in the bear striking a considerable technical blow to the charts of the S&P 500. When I last provided an update in early June, the charts showed the S&P 500 struggling around resistance at the 200 day moving average. Although it managed to sneak just slightly above it for a few trading sessions, there were just not enough trading volume to keep it there. From an intraday high of 1,131.23 on the 21st of June, the S&P 500 shed close to 10% by July 2nd. The severity of the decline, however, was not the biggest problem with this recent move. The most significant problem lies in where the market slide technically took us on the charts.

To begin with, not only has the S&P 500 moved below its 200 day moving average, but so has its 50 day moving average. The result is what is called the Death Cross, a very bearish indicator indeed. The las time we witnessed a Death Cross of the moving averages was at the end of 2007. The next technical dent was made in the breaching of the 1,040 level. Not only does 1,040 represent a previous level of support during 2010 it could also represent a neckline for a Head-and-Shoulders Top formation. I had mentioned in my previous blog in early June that this was a real possibility. This continues to be true as we go into July. We have already seen a break of the neckline of this pattern but have come back above it during the recent rally. To get confirmation that this pattern has in fact completed would be when prices break above and subsequently close 3% higher above the neckline. We will keep a close eye for a close below 1,008, therefore, to validate the bearish pattern.

The rally we have witnessed over this week is of no surprise. The S&P 500 was deeply oversold after two weeks of steady declines. We might see a move back up to test the current downward trendline in the coming days. Whether we can break above it remains doubtful as trading volume in the recent rally has been anemic at best. If, however, it does muster the strength to move above the trendline, the next level to keep an eye on would be between 1,110 and 1,120. This level represents significant resistance of the 200 day moving average as well as the most recent highs put in during June. It looks, however, with all these negative technical indicators, that we might be in store for the S&P 500 to be putting a lower high, thus continuing the bearish decent lower.

The View from Freedom Fest

Las Vegas, Nevada

This marks my first trip to Freedom Fest in Las Vegas. Nowhere will you find a greater concentration of Libertarians and bears than right here. Some big guns in the past have spoken at this conference, including Texas Congressman, Ron Paul -- a Libertarian.

My personal favorite is Doug Casey, an incredibly gifted investor, contrarian and, if you've ever heard him speak, a great entertainer. Nobody gets an audience going more than Doug.

This is my second visit to Las Vegas since March and my third trip here in less than 12 months.

A year ago, the streets on Las Vegas Boulevard were almost deserted; I always make it a point to ask merchants, hotel clerks and taxi drivers how business is coming along. A year ago, it was dreadful. But my latest survey, conducted on Wednesday, discovered a joyful mood among my leading indicators with taxi drivers exclaiming how busy it's been here recently, including the July Fourth weekend. The Bellagio Hotel, where I'm staying, is packed.

I interpret the revival in tourism in Las Vegas as a bear market rally where heavy discounting attracted visitors and bargain-hunters. Hotel rates plunged. I doubt this mood will last. People are still losing jobs in the United States and wages are barely keeping pace with expenses. Also, the state of housing remains depressed – still more than 30% off its all-time high – implying most people are probably spending above their means.

In other words, domestic consumption hasn't fully reflected the loss or deterioration in balance sheets since 2008. Stocks also remain about 35% below their October 2007 all-time highs.

Walk into Bally's, where Freedom Fest is being hosted, and you turn an eye-popping cautious on the economy and the markets.

In many ways, this seminal conference is a contrarian's dream because virtually everyone is tired of big government, fiscal deficits, the dollar and the direction of the Obama economy. Delegates here are convinced Obama is a one-term president and that he'll sink the economy.

Under normal economic circumstances, I would interpret this crowd as a buying opportunity for stocks and a bearish signal for all things hard like gold, silver and other raw materials.

But not this year. And not in the confines of what I would coin the most dangerous market environment since 2007-2008. Most investors still fail to appreciate the grave danger unfolding in Washington regarding policy initiatives, financial reform (barely any reform at all) and the growing fiscal crisis spreading across most states and municipalities.

Stocks are now mustering a long overdue rally since Tuesday and that should come as no surprise following weeks of heavy selling.

Yesterday's big gain for U.S. averages was accompanied by unimpressive volume and new lows were more than new highs. I'm a bear and would use this rally to unload unwanted equity risk and add to intermediate and long-term Treasury bonds as prices ratchet higher this week. I remind investors that with the exception of 2009 – a massive bear market rally – most summers since 1997 have been marked by big declines in asset prices; governments have a habit of unloading bad news in the summer.

The primary trend of the market since May is down. The economic backdrop has deteriorated markedly over the past eight weeks with unemployment stubbornly high, bond yields triggering a sell signal for risk assets and TIPS' break-even rates crashing to levels unseen since the depths of the credit crisis in late 2008.

The sovereign debt crisis in Europe has just begun with more pain ahead for the fiscally challenged in the eurozone's periphery. Deflation is accelerating across Europe – and that alone will provide a huge gap in global demand over the second half of the year. This leaves the United States, Japan and China as the world's consumers of last resort. And that's not a bullish picture.

Sell into Rallies

Montreal, Canada

Sell 'em when you can, and not when you have to. This morning's strong opening is the first positive session in more than a week and I plan on reducing my equity exposure – already near record lows in terms of overall asset allocation.

Over the past few weeks, a blizzard of economic data in the United States strongly implies a softening economy over the second half of the year. Virtually every indicator since May has shown a marked deterioration, including employment, housing, consumption, consumer confidence, auto sales and the highest office vacancy rates in 17 years – suggesting employers don't plan on a hiring binge any time soon.

Worse, credit indicators have also deteriorated since May. Credit spreads across the board have blown wide open, especially the difference between short-term and long-term interest rates. The rapid compression of the Treasury yield-curve is flashing a warning sign to investors just as it did in late 2007; the difference between ten-year and two-year rates has crashed from 282 basis points on March 31 to 235 basis points this morning. That's a big drop.

But it's not just the United States that's showing signs of a slowdown. I think we're only at the beginning stages of a multi-year collapse in Chinese real estate values – clearly at absurd levels and, for the most part, completely out of reach for the average Chinese buyer. Chinese manufacturing has also slowed since April coupled with a marked decline in the country's trade surplus. The Shanghai Composite Index is down more than 23% this year.

If the assumption is correct that corporate earnings are too optimistic over the next six months then stocks are still overvalued. The S&P 500 Index yields a lowly 2.1% -- hardly a bargain. And if that's true then investors should use any intermittent rallies as an opportunity to get out of Dodge and sell stocks.

To be sure, many large-cap stocks do trade at attractive multiples this summer. I discussed this at length yesterday. Dividends for some of the largest S&P 500 companies are anywhere from 50% to 100% higher than the yield available on the broader market. Still, cherry-picking at these levels probably isn't a bad idea but the investor must make purchases with the intention of doubling-down over the next several months as stock prices head lower.

We're living in extremely dangerous economic times. The bulls might use this pessimistic view as fodder to build the case for a resumption of the post-March 2009 cyclical rally; I certainly do not. The bond market is much smarter than the stock market and it's telling investors that big trouble lies ahead, probably in 2011.

Since I'm a horrible market-timer and a big bear anyway, I'm using any rallies to sell stocks and, instead, raising cash reserves. Stocks are barely 10% of my portfolios.

For my U.S. accounts, I'll be adding to Treasury bonds on any correction – probably in conjunction with a rally in stock prices. I'm especially drawn to long-term T-bonds and strip or zero-coupon bonds, which should rally sharply as we surpass the December 2008 yield levels. It's deflation first, inflation later. This makes high quality bonds still attractive.

My European accounts, however, are heavily invested in some of the best risk-adjusted CTAs in the world – mostly based in London, Rotterdam and Zurich. CTAs, or diversified managed futures funds, have been mired in a draw-down since last year and should be aggressively purchased at these low levels since they have always shown a negative correlation to stocks amid severe market breaks. In 2008, CTAs gained an average 16%.

At some point over the next 24-36 months, I suppose, stocks will be the greatest value-based investment in a generation. That's when I plan on selling bonds, managed futures (CTAs) and unloading some of my gold. From now until then, however, this is a time to be very cautious ahead of great danger.

I'm en route to the Freedom Fest in Las Vegas tomorrow morning for The Sovereign Society. I'll be back on Thursday. Dugald will provide his insights on the technical picture for stocks on Friday.

 

Large-Cap Dividends a Value Trap?

Montreal, Canada

Are investors better off buying large-cap stocks paying a 4% dividend over the next 3-5 years or buying a ten-year U.S. Treasury bond yielding 2.96%? What would you rather own?

If we're struggling with renewed deflation now then inflation won't be a primary concern for the next few years. That's what Treasury bonds and TIPS are telling us now. It's also the message derived from the yield-curve where short-term and long-term interest rates are compressing at their fastest rate since late 2007. Credit doesn't lie. The market is beginning to price in a slowdown.

David Rosenberg of Toronto-based Gluskin-Sheff accurately called the bond rally. Rosenberg was one of the few bond bulls heading into 2010 believing a heavily leveraged American economy would act as a drag on economic growth; he doesn't believe Treasury's are in a bubble, either. Long-term Treasury bond prices have soared 23% this year.

The U.S. broader market, as defined by the S&P 500 Index, open this week 16% below its post-March 2009 high and yields 2.14% in dividends. U.S. equities are now down 8.3% in 2010 and have posted a loss for the last seven consecutive trading days. That's the worst skid since October 2008.

Another four percentage points lower and we're technically in a new bear market. Investors define a bear market for stocks as a loss of 20% or more. On that measure, several indexes are already in bear market territory, including banks, oil services and energy stocks, telecoms, retail etc. Foreign stocks as measured by the MSCI EAFE Index are also technically in a bear market. The MSCI World Index is just a few points away from that infamous threshold.

But as stocks have declined sharply over the last five weeks, dividends have risen for some of the largest stocks in the S&P 500 Index. Many large-cap companies also hold a tremendous hoard of cash – north of $850 billion dollars and the most in nearly twenty years. Indeed, some of these companies have boosted buybacks this year and hiked dividends.

Amid the growing nervousness out there this summer I wonder if an investor looking out three years or more might be better off buying and holding the likes of Johnson and Johnson (3.7% yield), Coca-Cola (3.5%), Kimberly-Clark (4.4%), Elli Lilly (5.8%) or Exxon-Mobile (3.1%) compared to sitting at near-zero percent money-markets or lowly T-bonds?

Unfortunately, barring a short-term rally, stocks have further to drop before really offering outstanding values. They didn't offer exceptional values in March 2009 and they certainty don't offer great values now, either. Exceptions, however, abound. The above five large-caps are attractive at these levels and are trading near their 52-week lows. Combined, the five yield an equally-weighted dividend of 4.1%.

Dividends, though attractive at these levels for many large-cap non-financial companies, also face the uncertainty of tax hikes in 2011. Nobody really knows where the new Obama dividend and capital gains tax rates will stand next year – and investors hate uncertainty.

Energy stocks are cheap; but again, the fallout from the Justice Department's witch-hunt and the reverberations of the BP disaster in the Gulf also raise uncertainty.

One thing is certain. The V-shaped economic recovery in the United States isn't happening. The economy is running out of steam and the second half of 2010 doesn't look too encouraging. This assumes corporate earnings expectations are too high and the market might have further to adjust.

If you choose to bargain-hunt amid a falling knife market then be sure to apply stock-hedges to your longs. If the market doesn't arrest this string of losses this week, then the odds are pretty good that we'll enter the gates of a bear market for the first time since October 2007. And large-cap stock dividends will get much cheaper.

Who's Selling Gold?

Montreal, Canada

Yesterday’s $39 decline in the August gold contract makes me wonder just who exactly is unloading bullion in this increasingly uncertain economic environment. With the EUR surging, hedge funds and trading desks at major banks might have felt compelled to unwind their gold hedges. Even after Thursday’s EUR rally, gold prices are up 24% in EUR terms in 2010.

But with the U.S. dollar logging one of its biggest single day declines on Thursday, I’m sort of confused why gold prices would fall almost 4% and not rise amid dollar weakness. The EUR rally doesn’t explain everything.

In addition to traders dumping gold, my best guess is that some government-controlled conduit, perhaps the International Monetary Fund (IMF), entered the market and sold gold. The IMF has been looking for other buyers since selling a few hundred tons of gold to India and other regional central banks in the Indian sub-continent in late 2009; I’m not convinced the IMF wants to control its velocity of gold sales so it doesn’t disrupt the market. On the contrary, I think central banks are highly concerned as gold prices topped $1,250 an ounce recently.

It’s no secret that major central banks in the world, especially in the West, have a vested interest in keeping gold prices down. In the 1980s and 1990s, in the absence of central bank agreements limiting gold sales, governments dumped an enormous amount of bullion in return for fiat money, which provided a yield. But in the 2000s, central banks transitioned to net buyers of gold bullion led by the emerging markets of China and India. Even central banks in Europe have slowed their gold sales and some have turned into net buyers again.

In the end, it doesn’t really matter who sold gold on Thursday. The big picture remains very bullish for the long-term trend because central banks have already lost control of their finances in the West; austerity measures in Europe will only exacerbate the economic pain, inflict more economic discontent and result in deep recessions in some countries – especially if the EUR recovers.

Plus, the credit crisis in Europe will eventually swarm the United States in the absence of any deficit reduction plan; on the contrary, another stimulus program, though unpopular in Congress, might be imminent if Round II of the mortgage meltdown forces the government’s hand. I also have serious reservations about state finances and whether we’re at the gates of a default or debt restructuring in one or more states.

But more fundamentally, the destruction of credit has now shifted to Europe and the next attack will focus on European bank balance sheets, which hold questionable assets that have not been marked-to-market. The next episode in this story will be a sovereign debt default in Europe, possibly others on the periphery in the Balkans. After that, I expect carnage to spread to the United States as printing goes into high gear amid total desperation to quash the rising menace coined deflation and the destruction of asset values.
Not a pretty picture. But that’s the view from Montreal on this long holiday weekend.

Happy July 4th to my American readers – have a great weekend! See you on Monday.