Global Growth is Only Softer at the Margin
Gold's Decline Looks Very Overdone
Consumer Discretionary and Utilities Offer Best Prospects
Regional Equity Markets Are Still Cheap
India Benefits from Lower Gold Prices
Investors are fixated on gold's sell-off, China's marginally iffy GDP numbers and whether the generalized decline in commodity prices is more than just ETF liquidation. News that Greece has agreed terms with the Troika over reducing the size of its bloated public sector has largely been brushed off by those preferring to see negative news in the IMF's downgrade of global growth forecasts. Compared with the Fund's previous 2013 forecast of 3.6% growth in October 2012, global growth is expected to be 3.3%. But it's still back above 4% in 2014. Moreover, Athen's capitulation on the issue of austerity-sharing is good for progress, but it shouldn't be forgotten that lower public sector employment will make it harder for Greece's notoriously inefficient treasury to monitor spending and tax receipts.
Our house view sees an opportunity in the yellow metal around these levels, but on a strictly trading basis, and with tight stop-losses. Both the physical and the options markets signal overly negative positioning and sentiment. USDXAU 3mth 25 delta risk reversals have broken out to the downside of three-year lows and the relationship between inflation-adjusted US government bond yields and the price of gold also appears to be broken. On the basis of post-Lehman Brothers history, the 50bps decline in US 10-year government bonds since early March and the prospect of more Quantitative Easing from central banks implies that gold should, at the very least, trade sideways – if not potentially higher.
The almost 50% decline in the NYSE Arca Goldbugs Index, the index of unhedged gold mining stocks, has been on-going since October and therefore started well before the admission of many gold mining companies that their costs of production are possibly 50% above levels reported in recent years. In other words, gold isn't falling because investors have suddenly realized that the gold mining business isn't as profitable as previously believed. It isn't falling either because of the threat of 10 tonnes of Cypriot gold coming on the market. That amount would barely shift the price. It certainly wouldn't cause a USD200 (or 15%) price decline in a matter of 7 days.
There is still uncertainty in markets about the strength of world GDP recovery and whether G7 central banks will play ball and engage in even more quantitative easing. Good G7 economic data, paradoxically, has received mixed reviews for the last few years as it implies less chance of more QE – with one major exception in October 2011 when a robust rebound the US manufacturing PMI set global equities off on a four month run of risk-taking. Interestingly, the micro data points coming through on EPS growth tend to suggest that conditions are better in the global economy than implied by the 6.6% decline year-to-date in
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the CTRB Goldman Sachs Commodity Index. In the MSCI All World Countries Index, EPS projections for the last 4 weeks have been upgraded in most sectors. Of the ten major 10 sectors, only energy is close to experiencing negative revisions and that is mostly in Emerging Markets centered on Asia and Russia. The decline in the price of Brent crude to under USD100pb, for the first time since July 2012, hasn't helped the outlook for the sector.
Elsewhere though, earnings projections for equities are improving across the board – particularly in developed markets. The consumer discretionary story is improving in the United States on the back of better real estate numbers. Prices of residential properties are now up 8.1%y/y according to the Case-Shiller Composite 20-city index. This increase in housing prices may be making it harder for some members of the population to buy their own home, but it is reducing the amount of negative equity in the US housing market for those under water and thus making the choice of save or spend more skewed towards the latter. Utilities are a different game, being one part a signal on energy consumption and one part a dividend play. In Emerging Markets, technology companies in Eastern Europe and Asia Pacific are now trading at a 50% discount to their trend price-to-earnings ratio.
Closer to home, local equities continue to perform, with better news coming out of drag markets like Egypt. Qatar and Libya have both pledged substantial assistance to the new administration in Egypt after a number of months of falling FX reserves, what appeared like regressive economic policies and a reluctance to deal with the IMF over loan assistance. The first of these is now less important and should help to stabilize the country's international credit rating. Moody's downgraded Egypt's long-term foreign currency rating in December to Caa1. This puts the country on a par with Pakistan and Cuba. There is some way to go before we get clarity on whether the country is embarking on economically liberal policies or not, but long-term this is likely to be the low point for the country's rating. The possibility of a long-term recovery in Egypt's outlook is now dependent on domestic economic policies rather than international sentiment. In this respect the drop in domestic inflation from 8.2%y/y in February to 7.6%y/y in March may make it possible for the central bank to start reducing the price of credit.
Lastly, an improvement in domestic UAE conditions is already underway. The domestic purchasing managers' index is now well above the breakeven level of 50 – something we saw in Saudi Arabia last year and hoped that the improved KSA outlook would come across the border. It appears that it has and this has been reflected in local equity prices. In Q1 we decided to take profits across Frontier Markets and re-define our exposure to them through MENA markets. This is still the right way to go. Banking and property sector heavy equity markets in the UAE are trading at close to or below book value. According to Bloomberg, only 48% of stocks on the Dubai market are trading above their 200-day moving average – compared with 74% in Riyadh and 60% in Doha. In Frontier Markets, you only find these characteristics in Eastern Europe and in messed up Argentina. The only comparable index in Emerging Markets with similar characteristics is the Sensex, and it benefits from lower gold prices that reduce the current account deficit and pressure on INR.
In terms of data - Turkey cut rates unexpectedly yesterday (-50bps). The central banks of Sweden, Canada and Brazil set policy today. The first two are expected to sit tight while +25bps is expected from the BCB. Gold's decline makes this unlikely. Watch also for the Bank of England's minutes and the US Federal Reserve's Beige Book of national activity.
Chief Investment Strategist
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