Gold and Market

Many investors feel they're well informed if they stay abreast of the business news. That's fine, but it's really just the tip of the iceberg.

Far more important is the historical view or big picture. The big picture is the real story and it explains why the markets are moving the way they are.

In a nutshell, here's the primary backdrop, which got us to where we are today...

Around the time of World War II, several big countries agreed to keep their exchange rates pegged in terms of gold. The U.S. dollar became the world's reserve currency, but international payments could also be made in gold.

This worked for some years, but the U.S. spent too much money in the 1960s on the Vietnam war and social spending. So more countries wanted their payments in gold, which sharply reduced the U.S.'s gold reserves.

Finally, in 1971, Nixon stopped the gold payments, and the world went off the gold standard. In essence, countries were then free to spend and inflate because gold's discipline was gone. Overall, this situation seemed okay until about 2000.

Apple's run sustainable?

As shares of Apple Inc. briefly flirted with the $600 mark this week, the recent run-up is going to force many analysts to rethink their views on the popular stock.

Given the love that Wall Street has typically showered on Apple AAPL -0.08%  , it’s not a big mystery as to what many brokers will choose to do. In the past week, more than a dozen have pumped up their price targets on Apple’s shares, and more are expected to do the same, given that the stock is now well above the targets of several analysts who have maintained buy ratings on the shares.

In other words, don’t expect too many analysts to stick their necks out and downgrade Apple — especially in a year in which investors are expecting not only the first LTE-based iPhone but also an Apple-branded iTV.

“IPhone and iPad expansion are the key catalysts with room for upside as global penetration expands for both products,” wrote Ittai Kidron of Oppenheimer on Friday, who boosted his price target on the stock to $700 from $570.

Apple shares briefly touched $600 on Thursday morning, before falling back. The stock was up fractionally on Friday morning to $588.30 as the company’s new iPad went on sale in 10 countries, including the U.S

Dollar turns down on inflation data

The dollar turned lower against major currencies Friday after a U.S. government report on inflation was seen as giving policy makers more reason to maintain ultra-accommodative monetary measures.

The ICE dollar index DXY -0.60% , which tracks the U.S. unit against a basket of major currencies, turned down to 79.776, off from 80.255 before the data and compared to 80.158 late Thursday.

The move reversed the index’s week-to-date gain, and its now down 0.3% from last Friday. It’s still up 1.3% this month.

The euro EURUSD -0.15%  fetched $1.3174, up from $1.3086 earlier and $1.3097 in late North American trade on Thursday.

Against the Japanese yen, the dollar USDJPY -0.10% turned down to ¥83.36, off its high of ¥83.94 and versus ¥83.40 Thursday.

The greenback has gained 1.5% on the yen from last Friday -- its sixth weekly gain, pushing its year-to-date advance over 10%.

The British pound GBPUSD -0.01%  extended gains to $1.5831, up from $1.5672.

For the week, the euro reversed an earlier decline to be up 0.4% and the pound has gained 1% versus the dollar.

The dollar gave up modest gains against the euro after a report showed that the U.S. consumer price index excluding food and energy rose a less-than-forecast 0.1% for February. Overall, inflation at the retail level rose 0.4% on the month, roughly in line with forecasts. Read more on February CPI.

The lower core level allows the Federal Reserve to maintain its ultra-accommodative monetary policy for longer, so the data are “just what the Fed likes to see,” said Kathy Lien, director of currency research at GFT.

Dollar & Dirt

Of the 44 energy-sector stocks in the Standard & Poor’s 500 Index SPX +0.11% , Halliburton Co. HAL +0.38%  and National Oilwell Varco  rank No. 1 and No. 2 as the most highly recommended by Wall Street analysts, according to data compiled by FactSet Research.

Coal and natural gas producer Consol Energy CNX +5.16% , refiner Marathon Petroleum Corp. MPC -0.36%  and independent energy producer Apache Corp. APA +1.88%  rank third, fourth and fifth, respectively, among analysts’ favorites.

Schlumberger, the largest oil service company by market cap, ranks No. 6 on the list of S&P 500 energy stocks, which includes electric power producers, big oil companies, independent energy companies, refiners and oil service firms.

Noticeably absent from analysts’ top recommendations are the two largest energy-sector firms, Exxon Mobil Corp. XOM +0.41%  and Chevron Corp. CVX +0.04% . With a combined market capitalization topping $600 billion, the pair are major components of the 30-stock Dow Jones Industrial Average DJIA -0.15% . Exxon reflects 11% of the Dow by market size, according to data from Dow Jones Indexes. Chevron ranks fourth with almost a 6% share.

China weakens Yuan

China raised the dollar-yuan parity on Wednesday, further weakening the local currency against the greenback, amid easing inflationary pressures. The dollar exchange rate USDCNY +0.16% was set at 6.3328 on Wednesday, compared with 6.3259 on Tuesday. The People's Bank of China allows the dollar to move 0.5% in either direction from the parity level on a given day. After allowing the yuan to rise against the dollar in 2011, Chinese authorities have effectively rolled back some of those gains so far this year. The dollar is currently buying 6.3422, according to FactSet Research data, rising 0.8% so far in March. In the year to date, the dollar is up 0.7%, after falling 4.5% in 2011.

Weak Yuan would lead to reduced exports to the Mainland from the US (aircraft etc.) which might trigger a recessionary phase in the US

China's Super Cycle coming to an end?

The China super cycle is over. China will still grow at a heady pace, but I believe the torrid growth rates of 10% plus are a thing of the past.

In October of last year, I described that a new cycle was starting. Among several characteristics of the new cycle were two related to emerging markets. First, there was the prediction that inflation in emerging markets would fall. This call has now proven to be spot on. 

The second call was that growth in emerging markets would slow. GDP numbers from several emerging markets show that this call was also spot on. Now there is confirmation from China. Wen Jibao, Prime Minister of China, has just lowered GDP growth target to 7.5%. This is the first target that is less than 8% since 2004. 

The new target for inflation is 4%. Inflation in China peaked at 6.5% last year. China has three big transitions ahead. The first is the transition from a primarily export-oriented economy to one with more domestic consumption. Second is a transition to a younger generation of leadership. There are no open and free elections in China, therefore, how the transition takes place becomes critical. China does not have a long history of smooth transitions in leadership.

Wen Jibao is stepping down. China is ruled by a nine-member politburo of the Communist Party. Seven members of the politburo, including President Hu Jintao, are scheduled to step down.

Third, the big government stimulus money is about to run out. Most of that money has gone into infrastructure development. As the stimulus money disappears from the economy, infrastructure development will slow considerably.

Here is the breakdown of the indicators for the short-term:

• Economic Indicators: Negative
  
• Fund Flows: Negative
  
• Commodity Price Movements: Mildly Positive
  
• Relationship Between Currencies: Negative
  
• Sentiment: Neutral
  
• Earnings Momentum: Mildly Negative
  
• Risk Appetite: Neutral
  
• Quantitative Indicators: Negative
  
• Technical Indicators: Neutral
  
• Geopolitical Indicators: Negative
  
  
  

Aggressive investors can consider short-selling China and hedging it with long positions in other related emerging markets with more favorable short-, medium- and long-term ratings.

ETFs of interest are iShares FTSE China 25 Index Fun FXI -0.03% , ProShares Ultrashort FTSE China FXP +0.39% , SPDR S&P China ETF GXC -2.13% , ProShares Ultra FTSE China 25 XPP -5.46% , PowerShares Dynamic Mid Cap , EGShares China Infrastructure E CHXX -1.78% , Global X China Financials ETF CHIX -2.90% and Guggenheim China Real Estate ET TAO -1.18% .

European funding sows seeds of next crisis

By Jon D. Markma

Courtesy: marketwatch.com

 

The European Central Bank's second long-term repo operation is in the books now, and no matter what cognoscenti may say about whether it was a bigger or smaller number than expected, the fact of the matter is that some 320 billion euros were created out of thin air and dumped into the European economy in a single day.

Around 800 banks participated in the quantitative easing with a continental twist, borrowing money at 1% for three years with virtually any sort of collateral.

I know that we get a little jaded from time to time, but that is a lot of money -- mucho dinero, big kwan, a whole lotta lettuce, a smokin' stack of simoleons -- and especially all at once.

This credit splash is supposed to prevent a funding blowup for the ailing banks and states in the euro zone, but veteran analysts are also pointing out that it kicks the potential cost up to disastrous levels if the underlying causes of the crisis in the region drag on through mid-decade.

So far the wizard behind this magical mountain of money, rookie ECB chief Mario Draghi, has won praise from colleagues and academics that he acted just in time to avert a contraction of the money supply and a banking catastrophe, giving banks and governments time to recover.

The cheap loans are now widely expected to help sprout a wide economic recovery in Europe by the end of the year even though governments are paring budgets to the bone to meet austerity targets. Think of the money as Novocain administered for a very difficult operation on a live patient.

You can see the difference dramatically by observing the value of the new PowerShares exchange traded funds tracking super-risky Italian bond futures ITLY +1.89% and supersafe German bond futures BUNL -0.18% . The former are up 16% this year, while the latter are flat.

And yet there is no pranzo libero, or free lunch, in economics, even in Rome, so there are without doubt unexpected and dangerous consequences lurking on the horizon. The ECB has acted unilaterally without any rules or precedence, so policy makers are making it up as they go along.

Ambrose Evans Pritchard, international economics columnist at The Daily Telegraph in London and a euro skeptic from way back, observed that Spanish banks used the first LTRO to boost holdings of sovereign debt by 29% to 230 billion, and just about the same occurred in Italy. If you think about it a minute, he argues, what has happened is that the weakest banks are buying the weakest government bonds in volumes that exceed their equity base. The columnist quoted a credit strategist at RBS as stating, "It is a levered option on sovereign risk."

Well if you put it that way, yeah, that could be a problem. Banks have to provide the ECB with collateral at a sizable discount to their value, which eats up some of their balance sheet. Since the ECB would have a first claim on those assets in case of trouble, other creditors are pushed down in rank. Essentially anyone who has lent money to those banks is now subordinated to the ECB, which means that in a bankruptcy a banks' bondholders could get bupkis .

In this light, you can see that the line between the real economy and the government-supported economy has been stretched very thin. The ECB's backdoor bailout of insolvent euro zone states will absolutely make matters much worse if policy makers cannot use the next three years to get the region's economy back on its feet. You could easily imagine a real contagion develop in which sovereign debt defaults bring down countries one after another like dum-dum dominoes.

The upshot is that this is a money-laundering scheme with an asymmetrical risk profile. The banks borrow from the ECB to buy government debt, which is then used as collateral to borrow more money from the ECB. This gets around ECB rules against money printing. Yet it ignores the fact that banks have to be browbeaten to take southern euro zone government debt because it is risky. So the more debt the ECB bullies banks into owning, the riskier it is making banks' conditions.

The whole gambit is a gigantic, trillion-euro bet that banks will lend the new funds wisely, helping their economies to flourish, which will create the taxes necessary to service the debt on all these loans. I hope it works. But if that doesn't happen — and frankly, it has not happened in the past three years — watch out. Not even Germany and France will be immune to the fallout.

It is important to realize is that creating money and initial confidence is the easy part. The hard part is forcing banks to lend the funds judiciously and generously to deserving, ambitious entrepreneurs, and for those borrowers in turn to generate valuable new business. Unfortunately the history of cheap money is that lenders and businesses tend not to value it properly, and much is hoarded, spent on banker bonuses, wasted on bad loans, and recycled back to government officials via corruption.

So while the LTRO has juiced hopes for a while that the global financial system won't fall apart in the first half of 2012, it is now up to all those other policy makers and business leaders to prevent it from becoming one more failure of technocrats trying to plan the global economy from the center.