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What Will 2012 Bring?

Looking at the year ahead, our research team has analyzed global developments and plumbed a variety of key markets. You’ll find a broad selection of our conclusions later in this newsletter issue and hope they will be useful in guiding your investment strategies. We will be following up in coming weeks with more details about specific recommendations.

In 2011, financial news was dominated by the festering turmoil in Europe.  Looking ahead, we believe the ongoing crisis will be addressed by a global money printing “jamboree” and coordinated funding from central banks in the developed world, including the U.S. Federal Reserve. When the money starts rolling off the presses, the liquidity infusion will create some genuine buying opportunities for American, European, and Asian stocks, as well as selected commodities. Why, because liquidity infusions are like a rising tide of money available to buy assets. Wise investors seeing the rising tide, buy stocks, commodities, and primarily gold to protect the buying power of their assets.

The Swap Line/Life Line: The Fed Gives and Europe Takes…but Quietly

We have mentioned many times that the U.S. Federal Reserve will help bail out Europe.  The rescue operation is underway…but oh so quietly. The talking heads on television, perhaps mostly on holiday hibernation, have missed the development thus far, and you may have as well unless you read a December 28 editorial in the Wall Street Journal.  It was written by Gerald P. O’Driscoll, Jr., a former senior economist and vice-president of the Federal Reserve Bank of Dallas, who is eminently equipped by education, experience, and connections to know the mechanics of the Fed.

The Fed action is surreptitious. That’s because the European Central Bank (ECB) wants to provide needed liquidity to Europe’s anemic banks without printing a lot of Euros. If the ECB blatantly cranks out Euros it would undermine its status as an inflation-fighting stalwart and incur the wrath of Germany. At the same time, many European heads of state want the ECB to purchase more sovereign debt, so what you have is an obvious conflict.

The U.S. Fed to the rescue.  But shhhhhhh….

Here’s what’s going on.  The Fed is engaging in a temporary U.S. dollar liquidity swap arrangement with the ECB. In common English, that means the Fed swaps dollars with the ECB for Euros. The ECB pays a small interest rate and guarantees to return a fixed number of dollars at a future date at a fixed exchange rate. Then, the ECB lends the money to the European banks that need it most.  In 2008, the Fed caught flak for loaning money to U.S. branches of the foreign banks, so this time they are attempting to maneuver by tip-toeing around the eggshells.

The artful maneuvering provides cover for both the Fed and the ECB because it allows for helping European banks without printing a lot of Euros or dollars in an obvious manner.

A most important part of the story now follows: In late 2008, the Fed had $600 billion of swaps on its balance sheet. By early 2010 they were mostly paid down as the panic of 2008 subsided and banks were able to raise capital from traditional sources, primarily by selling stock. By the end of last summer, the Fed’s swap renewal agreement had a balance of only $2.4 billion.  In recent weeks, the balance has grown to $64 billion.  We fully expect to see much higher numbers in the coming weeks as more dollars are channeled to Europe.

What’s happening is an obscure form of quantitative easing, aka money printing; but it is a type of money printing nonetheless. Central bank balance sheets…and future generations’ debt burdens continue to grow.

In addition to the dollar funding, there are other plans afoot to further liquefy European banks and strengthen the financial backstops. It was announced, for instance, this past week that Germany has agreed to enlarge the size of the European Financial Stability Fund (EFSF), the special funding pool financed by members of the Eurozone to combat the continent’s sovereign debt crisis.

 

U.S. Gallup Poll: Near-Record Fear of Big Government

In mid-December, the nonpartisan Gallup polling organization announced the results of its latest triennial survey about the biggest domestic threat to America. The specific question asked to a broad spectrum of American adults was this: “In your opinion, which of the following will be the biggest threat to the country in the future – big business, big labor, or big government.”

The results: 64 percent believe big government is biggest problem.  Seen by political preference, it comes out to 48 percent of Democrats, 64 percent of Independents, and 82 percent of Republicans who share this view.  A quarter of all those polled pointed to big business as the greater villain, and 9 percent cited big labor. See the tables from Gallup Poll below:

Source: Gallup
Source: Gallup

 

Outlook 2012: A Guild Global Projection

U.S. and Canada Overview: Mixed bag with high-yielding stocks topping the most attractive list, followed by some exporters with strong Asian business

The positives

  • S&P 500 earnings estimates of $100 in 2012 put the U.S. market at lower than normal P/E ratio.  Stocks priced below average. Small cap U.S. stocks cheapest in 30 years.
  • Election years have positive history. Meaning: both parties work to help the economy and stock market before elections.
  • Investors attracted to many high-yield investment opportunities in energy, transportation, chemicals, real estate, and specialty business lending.
  • Excellent conditions for exports, such as coal, timber, food, and technology, aided by  continued growth in Asia and Latin America,
  • Continued Middle East difficulties with Iran and others indicate strong oil price for 2012.

The negatives

  • General pessimism among investing public about stocks and bonds. Shaky confidence generated by fast trading and short-seller smears of companies.
  • Dysfunctional Congress cannot agree on a realistic plan for cutting, spending, and moving toward a balanced budget.

We are recommending investors buy the U.S. S&P 500 (SPX) for a rally.

 

Europe Overview: Generally not attractive, with the exception of some exporters

The positives

  • Some progress by miscreant nations toward rational financial behavior.
  • European banks being totally backstopped from failure by the U.S., Japan, Switzerland, U.K., and Canada.
  • Stocks are cheap

The negatives

  • Many politicians out of touch with economic reality
  • Many countries still unwilling to take the necessary medicine.  The exception is Ireland, which has done an admirable job addressing its deficit. However, the Irish austerity measures have exacted a heavy toll on the middle class and poor.
  • European banks need to sell stock to raise more capital.
  • Countries need more financing.

Asian and Australian Markets Overview: Bullish on some countries, neutral on others

The positives

  • Some markets have gotten cheap.
  • Profits will grow in 2012 due to increased regional consumer spending.
  • Inflation will decline, and stay down.
  • Some high-yield stocks available for income investors.

The negatives

  • Exports to the developed world will decline overall, and emphatically so to Europe.  However, increases in inter-Asian trade and stable trade to North and South America should help blunt the European losses.

Latin America Overview: Neutral, but may become attractive soon

The positives

  • The Brazilian market is getting cheaper.  This week President Rousseff announces a push for 5% growth in 2012. This means lower interest rates ahead.
  • Continued strong demand from Asia and North America for Latin American commodities.
  • Oil discoveries in Argentina, Columbia, and Peru.
  • President Hugo Chavez of Venezuela losing influence at home and in the region.  Good news for free markets.
  • Some regional currencies are undervalued.

The negatives

  • Since her election in 2007, Argentine President Cristina Fernandez de Kirchner has done much damage to her country’s economic future.
  • In her first year in office, Brazilian President Dilma Rousseff has reversed some of previous President Luiz Lula da Silva’s popular programs and damaged investor confidence.

Base Metals Overview: Currently unattractive 

Volatility in 2012; wait for dips to buy.  For first six months of the year, China’s growth rate will slow a bit, as we have been reporting, and result in less interest in base metals. As holders get discouraged by slowing Chinese growth, and prices dip, the metals may become more attractive. We may buy later before prices resurge later in the year.  Which base metals we buy will be a function of worldwide economic activity as it unfolds.

 

Gold Overview:  Attractive

We recommend buying on dips and with a long-term attitude.  Clearly, the continued improvident behavior by politicians in the U.S., Europe, and other parts of the world will lead to inflation, fears of deflation, and slowing economic growth. Simultaneously, the need by Europe, U.S. and Japan to repair their banking systems will lead these countries to debase their currencies. Gold is the beneficiary in all of this.

The smartest move is to buy dips. We see gold as the big winner during the first twenty years of this century. Gold has been going up for about eleven years. Why would we panic if it goes sideways to lower for a few months at a time?  One can use those occasions to buy and expand your ride on the biggest winner or you can jump ship every time a period of inactivity and decline occurs?  Buying dips seems wiser.

 

1 Year Chart of Gold

Source: Bloomberg

Energy Overview: Attractive to Neutral

  • Oil

Oil-related shares should do well, but we recommend focusing energy investments on high-yielding income producers, MLPs, and royalty trusts. Look for 10 percent yields and keep down the beta of your portfolio and your capital relatively safe. We will recommend some of these in coming letters when prices dip.

  • Natural gas

Prices are falling. In North America, prices have been weak for the past few years as major discoveries and technologies have opened up multiple tight shale deposits, thus increasing the gas supply. Using the same successful shale technologies developed in North America, natural gas deposits are being found in many parts of the world, including Europe, Australia, and China. Such discoveries are creating a rapidly growing appetite for this low-cost and abundant resource. East Asia (Korea, Japan, and China) is one prominent region of growing demand.  We expect more substitution of coal by natural gas in many parts of the world. We will not buy natural gas producers until we believe gas prices will stabilize.

  • LNG (liquefied natural gas)

LNG global traffic is on the rise, a result of more discoveries of a relatively cheap energy commodity. Thus, we expect demand to thus increase  for equipment that processes gas and turns it into LNG, which is easier to transport, and for equipment that re-gassifies LNG when it reaches its destination.

Our research indicates that the international demand for LNG carrier ships far exceeds the size of the current fleet. Ship capacity is growing, but not nearly fast enough. LNG vessels are not cheap. They cost about $200 million each, and take years to construct. We expect shippers to take advantage of the situation and inflate their charges accordingly. As a result of the shipping pinch, we’ve seen day rates for LNG shippers soar to $150,000 per day, which is over 300 percent higher than 2010 levels.  One destination country that will obviously pay more for shipping is Japan. Last March’s destruction at the Fukushima Daichi nuclear power plant has created a greater need for natural gas. The only way to bring Qatari, Indonesian, and Australian gas to Japan is by sea.

LNG seaborne routes are expanding.  Soon, large amounts of U.S. and Canadian natural gas will also be cruising the oceans.

Source: www.whatlng.com

Golar LNG (NASDAQ: GLNG), a Norwegian company, is the world’s second largest fleet of LNG carriers, and has been our favorite way to play this theme for some time. We recommend GLNG. Another way to play the trend here is Chart Industries (NASDAQ: GTLS), a company supplying equipment to transform gas into liquids and back to gas form, as well as equipment for the purification, liquefaction, distribution, and storage of natural and industrial gases. We believe that GTLS has gotten too expensive, but we are adding Golar LNG to our recommendation list this week.

 

Agriculture Overview: Rising grain prices… attractive for some, negative for others

We see a continuation of big opportunities in agriculture plays in 2012.  More wealth in the developing world is leading to more food consumption, thus creating even more demand for grains, meats, and dairy products. For several years, we have been heralding this trend and others more recently have been jumping on the bandwagon. We still see strong demand and growth trends because of the simple dynamics involved. There are opportunities in food and food-related investments cropping up ahead.

  • Meat and dairy production – Mixed results

In general, price increases in grains do not bode well for livestock and dairy. Grains represent a large input cost. Some producers and retailers are hurt more than others. Ranchers, for instance, are pinched by rising grain prices, causing them to cull herds. The timing here is critical. If you have to sell your livestock when herds are being culled, you get low prices, but if you sell after other herds have been culled, you could benefit and enjoy fatter profits. Producers of processed meat and dairy products hedge their cost inputs, but they can still be hurt if unable to pass their cost increases to retail customers in a timely manner.

Feeding time is getting expensive
  • Grains – Bullish on wheat

Producers in this sector are pleased with the rising price trend. The fundamentals are excellent.

The only negatives we see – and they are slight – for the U.S. grain scenario is the removal of U.S. corn-into-ethanol subsidies and tariffs on Brazilian sugar imports.

In 2011, wheat prices fell as Russia increased its wheat acreage by more than 30 percent. North American and Latin American farmers are storing more on the farm, and awaiting higher prices. In spite of the extra wheat from Russia we are bullish on wheat. Hot, dry weather has negatively affected the Brazilian and Argentine soybean crops, adding to demand for U.S. soybeans as a substitute and causing livestock producers to buy corn or wheat for animal feed.

1 Year Chart of Wheat

Source: Bloomberg

1 Year Chart of Corn

Source: Bloomberg

1 Year Chart of Soybeans

Source: Bloomberg

Several weeks ago we recommended a buy on wheat. The traditional mechanisms to buy wheat are via wheat futures or a wheat exchange traded fund that trades in the U.S and London under the symbol WEAT. A word of caution about investing in agriculture futures-related ETFs like WEAT, DBA, and JJG. They typically use U.S. listed commodity futures to mimic the price action of the world commodity markets.  If the agriculture commodities get too strong, we expect there could be regulatory efforts to control price rises through position limits or rule changes for non-commercial hedgers. Food price run-ups tend to grab the attention of government officials. Investing in a good theme may not be enough here.  It’s important that investors fully understand the instruments – and the risks thereof – that they own.

 

  • Fertilizers – Benefitting from strong grain prices

Potash refers to various mined and manufactured salts that contain potassium. More than 30 million tons are produced annually, mostly for use in fertilizers, and constitute the single largest global industrial use of the element potassium.

Mining for potash in Saskatchewan, Source: Potash Corp. of Saskatchwean

In recent weeks, we have seen a pullback in most fertilizer prices, causing us to become more bullish. Longer term, we expect higher potash prices from producers.  Our favorite investment is the biggest and most liquid of the publicly-traded companies, Canada’s Potash Corp of Saskatchewan, (NYSE: POT). Other companies that produce potash are Intrepid Potash (NYSE: IPI) in the U.S, Brazil’s Vale International is more known for its iron ore, but also produces potash (NYSE:VALE, Brazil: VALE3), K+S Potash (DAX: SDF) in Europe, and Uralkali (LSE: URKA) in Asia.

 

  • Brazil Sugar – Attractive

The recent removal of U.S. import tariffs on Brazilian cane sugar for ethanol creation and stoppage of subsidies for American corn-ethanol producers are smart moves. These actions increase the amount of U.S. produced corn and will have a modest price-suppressing influence on corn prices. The removal of the tariff is a plus for Brazil which will now be able to sell sugar for export.  It may also be positive for U.S. ethanol prices as it is more efficient and less expensive to create ethanol from imported sugar than from corn. We are not making a formal recommendation of Brazilian sugar.

  • Agricultural equipment makers and retailers – Attractive

We expect farm profits in the U.S., Canada, and Latin America to rise in 2012. This should lead to further demand for farm equipment and products sold by farm-oriented retailers. The obvious plays are John Deere (NYSE: DE) and Tractor Supply Company (NASDAQ: TSCO).  Others that benefit from rising farm profits include: Agco (NYSE: AGCO), CNH Global (NYSE: CNH), Agrale (Brazil: AGRA3), Agrenco (Brazil: AGEN11), Agrium (TSX: AGU, NYSE: AGU), Ag Growth (TSX: AFN), and Viterra (TSX: VT). We may recommend these stocks in the future, but currently we are waiting for a more opportune time.

Summary

We remain bullish on gold, wheat, Singapore and Canadian dollars. We are adding buy recommendations on Potash Corp of Saskatchewan (NYSE and TSX: POT),  Golar LNG (NASDAQ: GLNG, and Oslo: GOL) and the U.S. S&P 500 (SPX).

Watch for us again next week, and in the subsequent weeks, with more insights to share for the new year.

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Current Recommendations

Recommendation Tracker: 1/05/2012