Welcome back to December! Remember when the financial markets thought the Federal Reserve was going to raise interest rates three times or maybe even four times in 2016 and suddenly bank stocks were the thing to own? (At least until January when the Fed pulled back from its three or four times language and the market decided that one or none was more like it for interest rate increases in 2016 and sent the sector into a dumpster.)
Well, the positioning was back today–even if just for a day. After last week’s minutes from the April meeting of the Federal Reserve and after jawboning by half the Fed board of governors (it seems), financial markets have decided that a June interest rate increase could be back on the table–odds are now up to 36% from 4% before the release of the Fed minutes–and if not June then quite likely July–odds for a July increase climbed to 54% today.
That was more than enough to help the Standard & Poor’s 500 stock index to a gain of 1.4% as the index tacked on 28.02 points to hit 2076.06, comfortably, again, above the 2050 level that triggers worry that the S&P 500 is going to break through the bottom of its recent trading range.
The way upward was led by, you guessed it, banks as the SPDR S&P Bank ETF (KBE) climbed 1.86% led by stocks such as Morgan Stanley (MS) up 2.16%, JPMorgan Chase (JPM) up 1.7%, Bank of America (BAC), up 1.45%, and Capital One Financial (COF), up 1.37%. (Capital One is a member of my Jubak Picks Portfolio.)
The logic here is that bank earnings will climb if the Federal Reserve raises interest rates since that would increase the interest rate that banks can charge on their loans.
Of course, the growing conviction that the Fed will raise interest rates sooner rather than later (just two weeks ago you had to go out to February 2017 (and not July 2016) to find a Fed meeting that got better than 50% odds for an interest rate increase) took its toll on other sectors today. Gold fell another 1.8% to $1232 an ounce to set its longest losing streak since November. The dollar held near its recent two-month high against the euro.
There’s been precious little staying power to any market trend recently and today’s love affair with banks may prove to be short-lived as well. At an investor day event today Wells Fargo (WFC) lowered its projections for its 2016 return on assets to 1.1% to 1.4% from the 1.3% to 1.6% it projected at its 2014 investor day. For the full 2016 year the bank is now looking for a return on equity of 11% to 14%, down from 12% to 15%.
The big culprit is the bank’s large portfolio of energy loans and the company told investors it was taking steps to reduce the size of its portfolio of those loans. Wells Fargo said it had cut credit lines on 68% of the energy companies it had reviewed.
But it’s what the bank said about its net interest margin that might have the most impact on a continued bank stock rally. Because Wells Fargo, like many banks, has moved to reduce risk in its portfolio, it now expects that a 100 basis point upward shift in the yield curve after a Federal Reserve interest rate increase would add 5 to 15 basis points to its net interest margin. Previously the bank had estimated that a 100 basis point shift in the yield curve would add 10 to 30 basis points to its net interest margin. (100 basis points equal one percentage point.)
Playing catch up here.
I sold Yamana Gold (AUY) out of my Jubak Picks portfolio back on January 28, 2016 on my subscription site JubakAM.Com, but the sell never made it to this site or the portfolio. I’m fixing that omission now. (For portfolio bookkeeping purposes I will use the price on the original January 28 date.) In that original post I also noted that I’ll keep Yamana Gold in the long-term 50 Stocks portfolio.
In retorspect I was really early, unprofitably early on this call. I sold Yamana out of Jubak Picks on January 28 at $1.61 a share. It closed at $3.59 on April 8.
For what it’s worth, here’s what I wrote back then:
“Today’s [January 27] statement from the Federal Reserve should remind us all that inflation isn’t a danger lurking just around the corner. Like the European Central Bank and the Bank of Japan, the Fed lamented the low rate of inflation and its inability to push the inflation rate to the central bank’s target of 2% or higher.
For the moment deflation, caused at least partly by the massive overcapacity produced in global industry after global industry by the cheap money the central banks used to fend off a Great Recession after the Global Financial Crisis, is the danger.
That doesn’t mean that someday we won’t be worrying about spiking inflation again–and on that someday we’ll want to own inflation hedges such as gold bullion and the shares of gold mining companies. But not, as far as I can see, within the 12-18 month time horizon of my Jubak Picks portfolio. So tomorrow I’ll be selling shares of Yamana Gold out of that portfolio. The shares are, however, at a close on January 27 of $1.66 cheap enough so that they constitute the equivalent of long-term option on the eventual return of inflation. For that reason I’m keeping Yamana in my long-term Jubak Picks 50 portfolio. (Especially because I’m selling Goldcorp (GG) out of this long-term portfolio. I don’t need two inflation hedges and I think at the moment that Yamana is superior long-term option. When I decide the time is right to increase the inflationary theme in the 50 Picks, I’m likely to look first at Randgold (GOLD).) I’m not urging you to buy Yamana today if you don’t already own it–but I would like to keep this stock on your mind for the day when we start talking about inflation again. (In my Jubak Picks portfolio shares of Yamana were down at the close today, January 27, by 90.38% from my purchase date of February 19, 2012.
I’ve held onto Yamana for so long in my Jubak Picks portfolio because the company came so very close to pulling off a transformational asset sale.
It helps if, for the moment, you think of Yamana as two companies.There are the core asset mines. Because of the relatively high ore grade at these mines Yamana has been able to increase production at these mines while lowering costs. And then there are the non-core asset mines, largely in Brazil, which don’t have the same high grade ores and which, therefore show higher production costs.
In the third quarter of 2015, Yamana as a whole raised over all production by 9% year over year and saw all-in sustaining cost of just $841 an ounce. All-in costs were $1002 in the first quarter. That enabled the company to show cash flow from operations of $78 million.
But if you break out just the high-grade core assets the cost picture looked even better. Since a mining company has to move and process fewer tons of rock to produce an ounce of gold when ore grades are high, costs at the core asset mines were just $748 an ounce in the quarter.
Now Yamana has been working to increase production at its non-core mines and had managed to reduce all-in costs t those mines to $866 an ounce. But the fact remained that Yamana would be a much more profitable company if it didn’t own those non-core, lower grade mines.
Brain storm: Why not put all the non-core mines together in a new company–we’ll call it Brio Gold–and then sell it off to somebody, anybody. That would leave behind a company with just the high-grade assets and an all-in cost structure that even at current low gold prices would be immensely attractive.
The problem with that plan is that Yamana didn’t want to give away the non-core assets and it wasn’t clear that anybody would buy Brio Gold, even with its reduced all in costs, in the current gold market. For a while this winter it looked like Yamana might be able to pull the divestiture off and transform its cost structure. But then in December, Yamana pulled the plug on selling or spinning off Brio Gold, saying that it couldn’t get s high enough price for these assets in the current depressed market to justify their sale. Instead of a transformative divestiture, Yamana announced a dividend cut to conserve cash for the longer haul. The right move, but certainly not terribly popular with investors.
Yamana has moved up slightly recently along with a general increase in gold prices and prices for gold mining stocks.From a low of $1.41 a share on January 21, Yamana has climbed almost 18% to the $1.66 close on January 27. But with deflation rather than inflation as the danger of the day, I think further advances are likely to be limited.
So I’ll leave this one in the long-term 50 Picks portfolio to marinate for another day.”
Do I wish I’d held on for the move up in gold? Of course, but decisions are decisions, even if you regret them.
Financial markets in the United States and Europe fell modestly as investors and traders waited to see what happens next after Turkish fighters shot down a Russian war plane near the Turkish-Syrian border. The Turkish military is saying that the Russian plane had entered Turkish airspace and was shot down after repeated warnings. Russia is denying that its plane had violated Turkish airspace and that it was operating against terrorists in Syria.
As of 10 a.m. New York time traders were selling down risky assets—such as the Russian ruble and the Turkish lira, the MSCI Emerging Markets Index, and European equities—although declines are, so far, measured, with the Emerging Markets Index, for example, down just 0.3%. On the other side of the trade, safe haven assets such as the yen and gold have climbed with gold rising 1%. Oil has gained on speculation that something might happen to disrupt production somewhere. U.S. benchmark West Texas Intermediate was up 1.7% this morning.
The situation is full of potential pitfalls. Since Turkey is a NATO member this incident immediately increases tensions between the Western alliance and Russia. Russian planes in operation on this section of the Syrian-Turkish border have been targeting, Turkey and the United States say, Turkmen villages fighting against the Assad regime and not ISIS positions. The Russians have been flying bombing missions in support of an offensive by the Syrian army, Iranian-affiliated militias, and units of Hezbollah, Turkey has protested. The Sunni Muslim Turkmen minority in Syria is regarded by many Turks as ethnically Turkish. Iranian militias are Shia Muslim.
The Turkmen villages facing the Syrian army/Iranian militia/Hezbollah offensive are also seen by the Turkish government as an important buffer zone not just against the Syrian fighting but also against the expansion of Kurdish forces along the Turkish border.
If you think this is a mess, you’re right. The most likely outcome, though, is a step down in tensions short of more military incidents after a wave of intensive diplomacy by countries such as France that are trying to put together a coalition that includes the Russians and the Turks against ISIS. Russia is Turkey’s second largest trading partner and the source of 60% of its natural gas.
These factors don’t mean, however, that we won’t see other incidents in the short-term. (Both Russia’s Putin or Turkey’s Erdoğan are proud nationalists and aren’t known for shrinking from confrontation.)
Any short-term incidents are likely to increase downward pressure on risky assets.
How to trade this situation?
If tensions do ratchet upward and risk assets do sell off, I’d look to buy positions in stocks or bonds or currencies that you’ve been avoiding because they were too pricy. I’d be particularly interested in any sell off in U.S. market favorites on a movement away from risk. I don’t see any reason that these tensions should radically depress the prices of high-PE U.S. stocks such as Netflix (NFLX) or Facebook (FB) but I would note that both are down today by 2.7% and 1.6%.
Oil and gold will both move up if tensions continue but I don’t see those moves as sustainable unless this turns into a much bigger conflict than currently seems likely. You might use the bounce to trim positions that you’ve been looking to sell in these assets.
One of the most interesting non-financial effects to watch is whether this incident has the power to change rhetoric or positions among Republican and Democratic presidential contenders. Will it cause anyone to re-think the dangers and difficulties of imposing a No-Fly zone in Syria? Will it lead to any reconsideration of calls for a coalition of local powers to fight ISIS? Considering how U.S. politics works there days, I’d doubt it.
Commodity prices continue to tumble and are now down to the lowest levels since dinosaurs walked the earth.
But both the gold futures and spot market broke below $1100 an ounce this morning before rebounding to slightly above that level. That puts gold near a five year low.
And gold isn’t alone.
Both West Texas Intermediate and Brent crude have ended the recovery that had taken oil from a six-year low. U.S. benchmark West Texas Intermediate is back below $50 a barrel with futures touching $49.92 this morning. That’s the lowest intraday price since April 6. Brent crude has continued a decline that began in June to drop well below $60 to $56.51 in London.
And copper, widely seen as the commodity most sensitive to growth rates in the global economy because it is used in so many sectors from construction to electrical goods, continued to fall, declining another 1.44% in London to $5480 a metric ton.
I can see three reasons for the drop across all these commodity sectors.
First, the continued strength in the U.S. dollar is depressing the dollar price of all commodities. The widely held belief that the Federal Reserve will raise interest rates in 2015, perhaps as early as its September 17 meeting, contributes to a belief that the dollar will continue to climb.
Second, forecasts continue to say that the global economy in general and the Chinese economy in particular continue to slow and that in the absence of faster growth, supply is in excess of supply. This is especially true for commodities such as oil and iron ore where increases in supply have overwhelmed demand. Iron ore, for example, has recovered from the panic selling that accompanied what looked like an uncontrolled plunge in the Shanghai stock market. That panic took iron ore down to $44 a metric ton, a 10-year low. But even today’s price above $50 a ton is shockingly low when you remember that iron ore traded at $120 a metric ton as recently as June 2014.
And third, traders and investors simply have no appetite for commodity positions in their portfolios and without a reason to buy, they are cutting back their allocation to commodities in general. Whereas not so long ago, I heard recommendations for a 5% to 10% allocation to gold, for instance, today I’m hearing recommendations for 2% to 3%. Even a price drop to $1100 hasn’t led to an uptick in demand from the world’s two swing markets in gold—India and China. In Mumbai, for instance, gold typically trades at a premium to London, since jewelry demand in India helps support gold prices in that market, but right now gold in Mumbai is trading at a discount to London. It looks like Indian and Chinese retail purchasers of gold, known for waiting until the price is low before buying, have concluded that prices are still headed lower.
That seems likely, not just for gold but also for commodities in general. Inflation, a key driver in past commodity rallies, is conspicuously absent this go round. The Federal Reserve will raise interest rates in late 2015 or early 2016 and that will push the dollar higher. While it looks like the Greek debt crisis has been postponed and that China’s bear market in Shanghai and Shenzhen has stabilized, temporarily I believe, there’s not much evidence of a recovery in economic growth in emerging world economies, especially China, that would push demand for commodities higher. And, finally, from oil to iron ore, supply in key commodities looks likely to growth over the next 12 months.
In other words it looks like it’s too early to buy crushed commodities or the even more savagely depressed shares of commodity producers. For some of these commodities—gold is a prime example—asset sales are ramping up as the most stressed companies look to raise cash. Oil production is still climbing as Saudi Arabia and Iran both position themselves for a fight for market share. The big iron ore producers have cut back on capital spending but the pipeline is still full of new projects scheduled to come on line next year and into 2018. The one commodity to keep a close eye on is copper, where some projections show a supply deficit as early as 2016.
I’m going to sell Goldcorp (GG) out of my Jubak’s Picks portfolio http://jubakam.com/portfolios/jubaks-picks/ today, June 23. I still think that portfolios need gold as a hedge on inflation fears. But gold and more especially shares of gold mining companies have rallied big time on worries that the Federal Reserve is getting complacent about inflation.
I think the next step in the price of gold and gold mining shares is likely to be a pull back as traders and investors decide that inflation is not an immediate threat and then move to take some profits. I’d be surprised if both gold and gold mining stocks didn’t pull back by 10% or so over the next month before resuming an upward trend. The last stages of a rally like this off the May 27 bottom in an asset that has been so scorned lately is largely composed of traders who sold short and who are now buying shares to cover. When that buying for short covering ends, it removes some of the fuel that had been driving shares higher. I’m not sure that we’ve seen a wide spread conversion from gold skeptics to gold believers in this move so an end to short covering could easily produce a pullback.
What I’d like to do is sell part of my gold position now to take profits with the intention of buying back into gold after any pull back. I don’t want to just buy and sell the same asset. My strategy is to sell a stock, such as Goldcorp that has seen a bigger than average gain and then to buy a stock, such as Randgold (GOLD) that hasn’t gained as much and that has a better cost and production profile than the stock I just sold. (Any purchase will come after the pullback, if we get it, and is almost certain to come after the July 4 weekend.)
Shares of Goldcorp were up 15.75% since the May 27 through June 20 and were up 20.56% during the same period. At $27.88 at 2:30 P.M. New York time on June 23, the shares are way above my target price of $17 a share. (I’m still looking at a loss of 27.3% since I added these shares to the picks portfolio on November 5, 2009.
One of my reasons to sell Goldcorp here (besides it recent appreciation, that is) is a curious gap that showed up in a chart of the company’s production pipeline in its presentation for its April 10 investors’ day. The chart showed very attractive prospects for six projects in the execution stage moving into the production stage. That should push up free cash flow at the end of 2014 and into 2016. (The company projects reaching free cash flow positive—that is cash flow including capital spending—in the fourth quarter of 2014.
But then there’s a big gap in the pipeline with only two in what the company calls the feasibility group—the category that most immediately feeds into execution—before the pipeline fills up again with nine projects in the scoping and pre-feasibility categories. The consequence of that, projections from Credit Suisse show, is that while free cash flow rises dramatically in 2016 the growth rate slows in 2017 and then free cash flow actually falls in 2018.
Now 2017 and 2018 are indeed a long way off but the nearer term increases in free cash flow are likely to get revised downward as the gold mining sector recovers and companies begin to increase capital spending again. Think of a robust pipeline as the margin that ensures that free cash flow will continue to increase even as capital spending does.
A gold mining company’s production pipeline is also leverage for the future that will multiply the effects of any increase in gold prices
Goldcorp has less future margin and less future leverage than I’d like at current share prices. I’ll be looking to upgrade in those two areas if we get a pullback after this rally
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.