|
We are extremely comfortable that our
prognosticating for 2012 may or may not work out. Which
puts us in the same camp as most others. That said,
a contrarian turn ahead of possible normalizing of the debt issues still with
us that we suggested in December does seem to be gaining ground in the
market. With that should come a greater focus on basic technical
indicators like metal stockpile changes. We note small copper stocks on page
4, but will point out here these are focused by direction over weeks.
Don’t get hung up on day to day changes. Both bull and bear issues in
this market are really year to year, which means looking for value and for
sustainability.
This month we review a gold juniors
merger in the making. It involves two Canadian focused explorers we have
mentioned in the past, and which we put in the same room for reasons outlined
in the review. We are in an environment of high metal pricing, by historic
standards, but weak risk appetite. Combinations like this that pool talent in
a busy sector plus complimentary assets may become more common. They can
lower risk in even early phase stories.
Generally speaking, we are a little less cautious
and a little more optimistic. At a minimum, we expect gains to be more
notable gains later in the year.
2012 has started out stronger than many were
predicting. Granted, the year is only two weeks old but some bullets have
already been dodged. Some credit for this should go to new ECB head
Mario Draghi. He's been a calm hand on the tiller
so far.
The European Central Bank operates under many policy
constraints. Germany's Bundesbank had heavy
influence over the ECB's core mandate and it’s a Teutonic one indeed
with inflation control and price stability as its sole remit.
Former ECB head Jean Claude Trichet
followed the mandate closely until last year when he became more proactive. Trichet still stuck to the script but became more
creative in interpreting it. His frustration with the Euro political class
also became more evident as he neared the end of his tenure.
Trichet was ahead of the curve
in raising interest rates twice and too slow to reverse the increases but he
recognized the danger of a liquidity crunch in the banking sector. Opening
the lending window when he did in 2009 gave the Eurozone banking sector some
breathing room. Unfortunately, that respite wasn’t taken
advantage of to clean up balance sheets in any meaningful way.
Draghi took over the ECB on
November 1 and started to make changes quickly. The first ECB governing
meeting after he started the job marked the first cut in ECB rates in two
years. The real impact of the rate cut was psychological. The message was
sent that the new head of Europe’s central bank would do as much as he
could while still staying within ECB mandate.
Draghi has generally agreed
with the party line when discussing things like Eurobonds which Germany still
flatly refuses to consider. He has gotten considerably more creative when it
comes to dealing with bank liquidity issues however.
In December, Draghi
introduced the first three year refinancing operation for Euro area banks.
The facility allowed qualified institutions (basically any Euro area bank) to
borrow from the ECB at a zero interest rate for a three year term.
Banks are required to put up collateral, normally holdings of sufficiently
high grade sovereign bonds.
The facility was expected to total about 150-200
billion Euros. The market was shocked when the loan total came in at
close to 500 billion.
Banks needed the funding. Euro area banks hold large
amounts of medium term debt that has to be rolled over before the end of 2013
and many of the larger ones are being pressured to increase reserve ratios
and tier one capital.
So is this the Euro version of Quantitative Easing?
Not exactly, though it looks like it if you squint. Quantitative Easing is
the creation of money out of thin air by a central bank for asset purchases.
The ECB didn’t (and probably won’t) take that step which would
directly contravene its price stability mandate. Draghi
gets around that by setting up loan facilities. When banks pay the loans back
in three years (assuming they do) the ECB balance sheet would shrink
again.
There would and should be some monetary expansion if
the banks are taking these funds and re-lending them. Traders treating the
lending facilities as money printing are one reason for the Euro’s
recent weakness.
A more important side effect can be seen in the
charts above and below. The chart above shows 10 year yields for the main
Eurozone countries. The scale is exaggerated because of Greece, but even at
this scale you can see rates which were running higher start to peak and drop
off after Draghi announced the credit facility in
early December.
The chart below is shorter term and deals only with
the three year yields for Italy and Spain. The effects of the refinancing
operations are much more obvious at this scale. By the end of November things
had spun out of control. Yields were spiking higher and jawboning by
politicians across the EU was having exactly zero impact on the yield curves.
The impact of the credit facility on the other hand
has been dramatic. Its helped to thaw the interbank
lending market and some of it at least seems to be going into the sovereign
debt market at well. Draghi has noted that there
are drops in money on deposit with the ECB on days when member states were
holding bond auctions.
The implication is that some of these funds are
being used to buy new sovereign bond issues. These bonds can be used as collateral
for the ECB credit facility. There is little doubt this is part of what Draghi was hoping would happen though the health of the
inter-bank market itself was a major concern.
Spain and Italy both sold bonds last week at roughly
half the yield they had to offer to attract funds in December. Bid to cover
ratios were also significantly higher than later 2011 indicating generally
stronger demand.
None of this makes the debt and deficit issues go
away, but lower rates can help buy time and that is really the name of the
game right now. For most EU members and large European banks this is
more a liquidity issue than a solvency issue. Being able to roll over debt
and issue new paper at half the interest rate is a huge help.
Note that we said it’s a liquidity issue for
“most”. For Greece it is very much about solvency and liquidity
operations won’t be much help. Greece needs a big debt write off.
Period. That was still being argued as this was written and there is real
potential for it to end badly.
The biggest outlier on the chart on the previous
page is actually Ireland. It too is indebted to the point that it became a
solvency issue. Ireland’s issue was a real estate bubble that
wiped out its largest banks that the government felt obligated to
rescue. Its fiscal situation was dire and it will take a long time to
fix. Unlike Greece however, the government and people of Ireland have made a
lot of tough decisions to cut spending and the markets are taking them seriously.
Ireland’s yields have dropped 50% since
mid-year. While we’re leery of the short term economic impacts of hard
austerity programs there are several countries that need to undertake them.
Ireland is proof the market will respond to a county’s efforts if they
are serious and focused.
In the mist of these market changes S&P
announced debt downgrades to a large number of EU states, notably France, as
well as a rating cut for the European Financial Stability Fund.
It’s the last that was the largest concern.
S&P had telegraphed most of the other rating
cuts, including France, and the markets took the changes in stride. All three
major rating agencies have seen their market credibility diminished after the
subprime crisis. They are viewed correctly as being behind the curve most of
the time. The other two major bond raters, Moody and Fitch,
haven’t said what they would do though Fitch indicated it didn’t
plan on downgrading France.
Both France and the EFSF carried out bond issues
right after the downgrades. France sold bills at better yields than last
month and the short term EFSF bills were little changed.
None of the foregoing is going to change the drive
for greater government austerity by northern Europeans. That austerity will
take its toll on this year’s EU growth rate. How much of a toll
will depend on how much slack gets picked up by the private sector and
consumers to replace lost government expenditures.
The combination of ECB actions and market fears
should help to ease things here too. Recent investor surveys in Germany have
shown the largest one month improvement in years and confidence surveys have
also improved. Most economic stats have been better than expected in the EU,
though few doubt there will be some contraction this year at least. It may be
less severe that expected though if consumers in
Europe continue to cheer up. One side benefit of the uncertainty is the large
drop in the Euro. Germany is the world’s strongest export economy next
to China. Getting a 10% discount on its currency is a good thing.
Gold, Copper
The Euro discount is helping German exporters but
didn’t do the gold price any favors. Gold has seen a nice bounce in the
past two weeks aided by Iranian sabre rattling.
The Euro could see more weakness if the economy gets
worse or traders convince themselves the ECB’s ultimate aim really is
printing Euros. Draghi plans another
lending facility in February and if it’s another big one that might
generate Euro selling.
Notwithstanding the Euro, gold has seen heavy
physical buying with strong demand from Asia and from ETF buyers. Copper has
also gotten an assist from China. Beijing announced above consensus growth
numbers for Q4. It was sort of a Goldilocks number; strong enough to allay
fears of a hard landing but weak enough to generate hope that Beijing would
open its wallet and start spending heavily. Strike activity has kept
copper warehouse stocks on a downtrend. LME stocks are sitting at the 350kt
level they bottomed at in 2010. More drawdowns should be supportive of
copper prices.
Gold managed not to enter a “bear
market” and has seen a good bounce. More good news from Europe and
stronger markets that generate more risk on trading can both help it. The
amount of physical and ETF demand as gold prices neared a 20% drop was
impressive. Traders are still very much “buying the dip”
which is classic bull market behavior.
Stocks
Equity markets are looking less classic,
but they have advanced much further than many seem to think. The bottom for
US markets followed the debt ceiling debacle and they have been climbing by
fits and starts since. Large US indices have now reached levels they
last saw in July.
Unscientific as this may sound this simply feels
like a market that wants to go up. Its felt that way to us for over a month.
Recent trading activity and economic numbers have simply strengthened that
impression. It would not take a lot of good news to start the next leg up.
Things have been tougher in the junior space, but
trading is constructive. We’ve been seeing strong volume on some of the
most beaten down stocks. This may be tax loss sellers repositioning which is
the first step to recovery. More high volume days are needed but a spring
rally still looks like a strong possibility to us.
|
