Sunday, March 18, 2012

Inflation, Oil, U.S. Treasury Yields and the Velocity of Money

Last week, as equity markets rallied, U.S. Treasury yields climbed (which negatively affected many Last week, as equity markets rallied, U.S. Treasury yields climbed (which negatively affected many interest rates sensitive investments) and market commentary about inflationary fears significantly increased.   Additionally, while oil prices dropped last week, concerns about high price levels persist with Wal-Mart Stores Inc.’s chief financial officer Charles Holley recently stating, “the one wildcard, though, is going to be gas prices. If oil continues to go up, I think that could be a drag on economies around the world”. 

A mix of unprecedented monetary intervention by central bankers and limited budgetary changes by government leaders continues to present an uncharted economic environment.  This point is illustrated in the chart  Velocity of Money in the U.S.: March 1959 – Dec. 2011, with an all-time low during December 2011. A reversal in the current down trend that is not accompanied by strong economic growth may signal the start of inflation.  In markets -  sometimes momentum begets momentum; with inflation - sometimes the simple expectation of inflation can trigger a trend that will challenge the best efforts of central bankers. 

The U.S. Economy: Still Fragile, But Not Broken

Driving last week’s positive equity market performance were:
  1. generally positive results from the Federal Reserve's banking stress test,
  2. improving employment and manufacturing trends and 
  3. comments from rail operator CSX Corp. that container and merchandise shipment demand was improving.  
On Thursday, U.S. Treasury Secretary Tim Geithner’s speech at the Economic Club of New York highlighted that the U.S. economy:
  1. is benefiting from improvements in private investment and exports,
  2. is still adjusting from too much consumer debtfinancial sector leverage and excessive real estate development and
  3. remains challenged by high unemployment, a weak residential construction market – with depressed home values in many parts of the country and high energy prices.  
The economy is showing signs of recovery with improving auto purchases and retail sales; however, other critical components associated with a recovery such as a bottoming of the debt deleveraging process, strong GDP growth (i.e. +4%) and strong wage growth have not yet taken hold. These conflicting signals may continue to dampen investor conviction.

Sunday, March 4, 2012

Gold Takes a Hit and Other Dynamics

On Wednesday, when Federal Reserve Chairman Bernanke’s  testimony  to the U.S. Congress suggested the potential lack of additional quantitative easing (printing money), gold swiftly dropped – down about 5% for the day. For many investors, investing in gold is driven by hedging against global economic stability, inflation fears and general speculative activity. Interest also increased when positions were taken by investment managers such as John Paulson (who bet on the sub-prime mortgage market collapse) and Greenlight Capital’s  David Einhorn who said “I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible.”   


Einhorn’s comments may provide the best understanding about gold investing.  However, the erratic performance of gold in recent months, along with its price decline last week, suggest that the conviction of gold investors may be in decline. In addition, the lack of additional quantitative easing could drive speculators out of the equity and selected commodity markets resulting in a short-term market pullback.

Bernanke Talks about "Massive Fiscal Cliff" and More

Chairman Bernanke’s testimony  last week also included comments on: 
  • government spending -  “under current law, on January 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases,” and “I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date”, 
  • growth  - "we do not see at this point that the very severe recession has permanently affected the growth potential of the U.S. economy”, 
  • oil prices  - ” when you have shocks to commodity prices arising from geopolitical events and the like, those are unambiguously negative, and they are bad for both households and for the broader economy", 
  • housing  - “right now there is still uncertainty about where the housing market is going, which I think is troubling” and
  • unemployment - “one concern we do have, of course, is the fact that more than 40% of the unemployed have been unemployed for six months or more. Those folks are either leaving the labor force or having their skills eroded.”  
Mostly improving economic data has had a positive impact on many markets.  A renewed focus on the U.S. government deficit, along with heightened oil prices and the continuing decline in home prices may present headwinds for the economy and investors.