Please, click here to read this article in pdf format: august-18-2010

 

We hesitated about writing yesterday or today, but write we must. Indeed, we find it hard to understand how investor, markets, can have doubts as to what it is to come. The road the Fed has taken is a one-way only, and there is no return. Hundreds of books have been written about the current situation the world is in and many countries in the developing world have already gone through a similar experience, not too long ago.

Why doubt about gold’s potential in this environment? Perhaps because stocks are first in line, to receive the flow of money that is about to be printed. Just like in 2009? No, not necessarily. Back then, we had very depressed asset prices. The upside today is not so visible.

Yesterday, the Euro gained a bit of what had been lost in the past week, on the positive news of Ireland’s EUR1.5BN auction for a 2014/20 refinancing. Euro zone sovereign spreads tightened and this opened the door for the rally in stocks. However, as we have repeatedly written, the weakness of the Euro is based on the weak institutional foundation of the currency zone. As a clear example, while we are all watching with interest the peripherals’ debt auctions vs. today’s  10yr Bund, most will not have noticed on Tuesday that President Obama signed HR 1586, providing $26BN to states with liquidity problems, and extending to Jun/11 Medicaid’s temporary enhanced Federal Medical Assistance Percentage. That’s right, while we all pay attention to how different Euro zone members perform fiscally (pretty uneven, by the way) and in the debt markets, we all find solace in the unified bond market that Treasuries represent. Europe lacks it and is paying dearly for it. Growth differentials, interest rate differentials may only matter temporarily, as the July Euro rally proved. The trend is defined by the institutional weakness.

Along with gold, the Japanese Yen makes also an interesting story these days. You won’t find anyone who will not tell you it is overvalued and yet, it keeps strengthening. Is it truly USD weakness after all? How can we justify weakness in a fiat currency, when its sovereign debt is so demanded?

On the other hand, those who still see a double dip in the horizon base their forecast on a double dip in the US housing market. Yet, when stocks rise, the resources and materials sector seem to lead and most monetary policy is specifically addressed towards the housing market. Why not base the double dip on a sovereign crisis in the US? Did the government not assume the private sector’s liabilities last year? And if indeed the double dip is finally triggered by a sovereign crisis, why not bet on the sure thing?  Why bet on precious metals rather than short Treasuries? The collapse of the Treasuries market looks more certain than the rise in the price of gold. The collapse of Treasuries will precede and fuel the rally in gold and gold shall only rally if it rallies against all currencies, we think. But first, capital must flee from government debt and only then, among other alternatives, it can chose to go to gold.  Last comment on gold:  Yesterday we noticed that gold lost $4/oz after the announcement of Potash’s unsolicited takeover by BHP Billiton. That was a commodity bullish news and yet gold did not rally nor remained unchanged. It dropped. That was indeed interesting.

As you can see, we have more questions than answers this week. But we are certain that if the recovery holds, it will only do so at the expense of a stable/growing supply of money and that no exit strategy will be achievable by any serious central bank. The growth rate in money supply will be incorporated to the market’s collective expectation on the liquidity picture and any deviation from this path will be painful and politically expensive. With this macro backdrop, although counter intuitive, we can see a weak Euro, a timid appreciation in gold and commodity currencies, massive curve/relative value trades in sovereign debt and stable volatility levels. We can also expect stocks to trade range-bound, in the absence of a clear catalyst to shoot them above their 200-day moving average or way below it. In corporate credit, the spread compression picture should hold and we should not be surprised if we see another wave of refinancings to mitigate liquidity risk.

 

 
Martin Sibileau.