Some encouraging news out of Europe this week. The Central and Eastern European region is in a good position to weather the current debt crisis, said Nemat Shafik, the International Monetary Fund’s deputy managing director. Further, European Central Bank head Mario Draghi said European officials have made a good start toward fixing the region’s economic troubles.
Conversation Starter
Bonds or Gold?
Ben Garber of Moody’s Analytics Capital Markets Research Group
Low interest rates and threats from inflationary monetary policies challenge the outlook for fixed income investments, increasing interest in alternative assets that can serve as hedges to traditional financial securities. But such investments carry considerable risks. Gold, a classic in this regard, has a record of highly volatile returns, and attracts a very speculative investor base. Furthermore, we believe that the economic fundamentals do not support the case for higher inflation, which is one of the scenarios that would boost gold’s attractiveness relative corporate debt.
Gold’s fortunes shift wildly
Gold has outperformed other investment classes by a wide margin in recent years. Demand has been fueled by rapid emerging market growth, new financial instruments, economic uncertainty, and inflationary fears. Since the end of the 2001 U.S. recession, the price of gold has risen by 20 percent yearly from less than $300 per ounce to its current value of around $1,600. This remarkable climb has reversed decades of poor returns, with 3 percent average annual losses in the twenty years ending in 2000. The surge by gold has lifted its historical average return to 11 percent–surpassing the 9 percent average for the Barclays US Investment Grade Corporate Bond Index (Figure 1). But gold’s boom-bust cycles bring uncomfortable levels of risk. Gold’s 27 percent standard deviation of yearly returns far outstrips the 9 percent range for corporate bonds. Such frequent large losses on gold holdings leave deep holes for investors to recover from, which belies the metal’s reputation as a store of value.
This extreme volatility takes some of the shine off of the massive gains of the past decade. The excess returns on gold relative to its level of riskiness, as quantified its Sharpe ratio is unimpressive relative to corporate debt (Figure 2). Gold’s average Sharpe ratio of 0.96 for the moving five year period from 2006 through the present of for gold significantly topped the 0.45 rate for corporate bonds. But the situation was much different prior to this period: from 1984 to 2005 bonds had an average Sharpe ratio of 0.75 vs. -0.42 for gold. Although the 10 percent yearly returns on corporate debt during the aforementioned 1984-2005 period substantially trail the 24 percent average for gold over the past six years, bonds have the advantage of producing consistent gains even in periods of relative underperformance.
Speculative investments drive gold demand
The volatility in gold’s price is underpinned by heavy influxes of speculative investment. Only an average of 13 percent of net new purchases of gold over the past ten years was for industrial purposes, according to the World Gold Council. The bulk of gold purchases have shifted from largely jewelry, to a mix of jewelry and investments via bars, coins, and exchange traded funds (ETFs). Jewelry accounted for 94 percent of gold purchases with 2,662 metric tons (t) in 2002, yet fell to 43 percent of demand at 1,973 t last year. Investment in physical gold or ETFs is picking up the slack, with 353 t in net investor buying taking 12 percent of the total in 2002, rising to 1,686 t worth 37 percent of all demand in 2011 (Figure 3). Though investment-related purchases have risen steadily, sharp fluctuations can be seen within the different vehicles for buying gold. Purchases of bars and coins nearly doubled from 786 t in 2009 to 1,524 t two years later, while over the same period ETF flows slowed from 617 t to 162 t. With gold’s demand resting on continued speculative purchases, stronger trends in global prices and economic growth must develop to lift gold’s perceived value.
One strong positive for gold demand is purchases for the reserves of governments and supranational organizations. After many years of shedding reserves, net buying by the official sector reached 456 t last year. The desire to diversify from major currencies may continue to drive such demand. But global official holdings by weight of 31,283 t lag holdings from a decade ago by 6 percent, which implies that recent purchases may not be consistently repeated.
U.S. debt aided by limited supply growth
In the U.S. fixed income universe, it would be easy to assume that supply trends would be overwhelmed by the massive increase in government debt since the onset of the financial crisis. Outstanding Treasury debt has exploded over the last five years from $5.0 trillion at the beginning of 2007 to $10.8 trillion in the last quarter. Yet supply growth across a wide range of fixed income assets including Treasuries remains historically low (Figure 4). Growth of total credit market instruments of 3.1 percent yearly to last quarter trails the annual average of 8.7 percent in the ten years ending in 2007. The devastation of once popular assets underpins the limited expansion in total available debt. Commercial paper outstanding, at $994 billion, has fallen from its pre-recession peak by 53 percent, while private ABS and MBS at $1.9 trillion has shrunk by 52 percent. This limited overall supply growth has been key to helping government and corporate debt maintain its value.
We see almost no sign that U.S. inflation is accelerating, despite extraordinary efforts by the Federal Reserve to boost growth. Core consumer price inflation of 2.3 percent early to May remains historically modest. One reason is that overall consumer and producer price growth are very restrained at 1.7 percent and 0.7 percent, respectively. Inflation trends closely track labor cost growth, and the job market is not putting much upward pressure on wages (Figure 5). Unit labor cost growth sank to a five-quarter low of 0.9 percent yearly for the quarter ending in March, and the cost index still trails its level at the end of the recession, falling short by 0.6 percent. When gold prices staged an inflation-assisted boom from 1977 through 1980, inflation soared alongside labor costs. During that period, average yearly core CPI growth of 8.9 percent was right in line with 8.7 percent average growth in unit labor costs. Nonfarm payroll growth of 219,000 per month from 1977 through 1980 helped push wages and prices higher. This time around, job growth of only 72,000 per month since the last recession ended has kept prices in check. The latest employment trends look particularly poor in relative terms: the U.S. population has grown about 40 percent since the late 1970s.
The poor outlook for housing also reduces inflation risk
Unfortunately for the broader economy, the drag on hiring and economic growth that is dampening inflation will persist, thanks to continued housing market woes. Despite positive recent news for home prices and construction, the very high level of distressed mortgages restrict consumer credit growth, and thus economic activity generally. Though the count of mortgages that are long-term delinquent or in foreclosure has fallen from the peak of 4.3 million to 3.2 million last quarter, the current number is quadruple the level that prevailed when home prices peaked in 2006. Heavy foreclosure activity and tight lending standards are fueling the extended contraction of home mortgage credit (Figure 6). At $9.7 trillion in the first quarter, home mortgage debt fell by 2.5 percent yearly, not much improved from the widest annual decline of 2.9 percent at the end of 2010. Thus, as housing holds down credit growth and wealth creation, the economy is unable to transcend the subpar growth in jobs and wages. The net result is that the Federal Reserve’s stimulatory maneuvers of low rates and quantitative easing are being counteracted with regard to driving faster price appreciation.
Gold may neither get a lift from inflation trends, nor realize price gains from investors avoiding the enduring financial market turmoil. With the euro in the crosshairs, trends that boost the dollar work against gold. When the USD/EUR rate fell from the February peak of 1.35 to 1.24 at the end of May, gold dropped from $1,778 to $1,558 per ounce. In the even more extreme circumstances during the heart of the financial crisis in October 2008, gold fell by 21 percent — mirroring the substantial declines of most other asset classes. If gold cannot provide shelter from rocky markets, investors may be better served collecting modest income from high grade debt.
**CN: According to Garber, the release this week of the minutes from the Federal Reserve’s June policy meeting further solidified the attractiveness of fixed incomes over gold. He said the minutes were a mild negative for gold because the Fed does not seem to be as “on the verge of QE3” as some had anticipated. This would be a positive for the dollar and positives for the dollar tend to be a negative for gold.
As a refresher on the contents of the minutes from the Federal Open Market Committee meeting June 19-20, the contents can be found here:
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June FOMC Minutes Stories
Fed Minutes Suggest QE3 May Not Arrive Soon
International Business Times
This afternoon’s release of the latest Fed minutes indicated that while Ben Bernanke and his fellow central bankers would consider implementing a third round of quantitative easing.
http://jlne.ws/P3dgyY
Fed FOMC Minutes Squash Hopes For Imminent QE3, Stocks Turn Down
International Business Times
Newly released minutes of the U.S. Central bank’s June 19-20 Federal Open Market Committee meeting were being taken by the stock market as indicating unwillingness to engage in further monetary easing.
http://jlne.ws/MkAVMy
A Few FOMC Members Said More Stimulus Probably Would Be Needed
Bloomberg
A few Federal Reserve policy makers said the central bank will probably need to take further action to boost the labor market and meet its inflation target, according to minutes of their June meeting.
http://jlne.ws/M5lpCe
Federal Reserve Officials Show Disappointment With Growth
New York Times
Several of the central bank’s policy makers at a June meeting were prepared to take new steps if conditions worsened.
http://jlne.ws/LSoJhe
Federal Reserve officials split over new stimulus program
Los Angeles Times
Fed officials debated at their two-day meeting in June whether and when the central bank should expand its efforts to spur growth, according to minutes of the meeting. WASHINGTON — Federal Reserve policymakers are split over whether to launch another big stimulus program.
http://jlne.ws/Ns1edv
Fed minutes show few officials supported more quantitative easing
Market Watch
http://jlne.ws/OAxSe9
Lead Stories
IMF Deputy Managing Director: CEE Well-positioned to Weather Crisis
Nasdaq
VIENNA–The Central and Eastern European region is in a good position to weather the current debt crisis, Nemat Shafik, the International Monetary Fund’s deputy Managing Director said Thursday. For that, strong institutions and the revival of the Vienna Initiative are essential, Ms. Shafik said.”I’m a believer of the notion that the key difference between rich and poor countries is the quality of their institutions,” Ms. Shafik said at a financial conference.
http://jlne.ws/MmHXer
European Central Bank Chief Draghi Says Leaders Must Press Anti-Crisis Efforts
Asbury Park Press
FRANKFURT, GERMANY — European Central Bank head Mario Draghi says European officials have made a good start toward fixing the region’s economic troubles.
http://jlne.ws/LM7wed
CFTC proposes exempting cooperatives from swaps clearing
Reuters via Yahoo! News
WASHINGTON – The U.S. Commodity Futures Trading Commission on Tuesday unanimously approved a proposal to exempt cooperatives like credit unions and farm credit institutions from the swaps clearing requirement included in the 2010 Dodd Frank financial reform.
http://jlne.ws/Lizn42
Ben Bernanke To Face U.S. Senate Questioning Over Barclays Fallout
Free Internet Press
Federal Reserve Chairman Ben Bernanke is set to be quizzed about the failure of U.S. regulators to stop bankers manipulating interest rates as the fallout of the Barclays Bank scandal spreads to the U.S.
http://jlne.ws/MkzwFF
U.S. judge: Dodd-Frank beefs up protection for whistleblowers
Reuters via Yahoo! News
- A U.S. judge bolstered protection for corporate whistleblowers on Monday by ruling the Dodd-Frank law gave retroactive protection to employees of subsidiaries, not just people who work directly for the parent companies.
http://jlne.ws/NrUQTF
Libor Needs More Transparency, Pimco’s Crescenzi Says: Tom Keene
Bloomberg
Barclays Plc, the U.K.’s second-largest bank by assets, was fined a record 290 million pounds on June 25 for rigging Libor, a global benchmark, for profit.
http://jlne.ws/NknQ4f
A Barclays split would only resurrect Lehman
CNN Money
A breakup of Barclays would essentially bring Lehman Brothers back from the grave, sending Wall Street in the wrong direction.
http://jlne.ws/NknV82
Barclays Former Chief Bob Diamond Could Be Brought Before U.S. Congress
Free Internet Press
U.S. politicians are considering summoning Barclays’ former boss Bob Diamond to Washington to answer questions about the Libor-fixing scandal, in a sign that the controversy is becoming an ever hotter issue in the U.S.
http://jlne.ws/LM8Cq8
Treasury to auction Fidelity Financial’s preferred stock
The Wichita Eagle
Fidelity Bank’s holding company is one of a dozen financial holding companies whose preferred stock will be auctioned by the Treasury Department later this month.
http://jlne.ws/LcwKfC
Judicial Watch Sues Federal Reserve for Records Detailing U.S. Taxpayer Bailout of European Banks
Marketwire via Yahoo! Finance
WASHINGTON, DC– – Judicial Watch , the public interest group that investigates and fights government corruption, announced today that it has sued the Board of Governors for the Federal Reserve System.
http://jlne.ws/LiDdu3
Germany’s Regling to head ESM bailout fund: EU source
AFP via Yahoo! News
Germany’s Klaus Regling, head of the eurozone’s temporary EFSF bailout fund, has been named to run its permanent successor, the European Stability Mechanism, the 17-nation group said Tuesday.
http://jlne.ws/MmI2yz
India GDP growth seen at 6.5 pct this year: ADB
Reuters via Yahoo! Finance
BANGKOK – The Asian Development Bank cut its growth forecasts for developing Asia on Thursday..
http://jlne.ws/OdXmwR
Greek unemployment hits new record of 22.5 percent in April
Reuters via Yahoo! News
ATHENS – Greece’s jobless rate scaled a new record high in April, data showed on Thursday, providing gloomy news for the hard-pressed coalition government that emerged from the country’s rerun election in June.
http://jlne.ws/N3i3kU
Events
Bond China Congress
September 4-5, 2012, Shanghai, China
http://jlne.ws/KXsmS0
CTA Expo Chicago
September 13, 2012
http://jlne.ws/LmhfFu
Economic News
Trade Deficit in U.S. Narrowed in May as Imports Decreased
Bloomberg
The trade deficit in the U.S. narrowed in May as falling crude oil prices and weakening demand for consumer goods trimmed the import bill.
http://jlne.ws/OAxFaS
Trade deficit narrows on exports, cheaper oil
Reuters via Yahoo! News
WASHINGTON – The trade deficit narrowed slightly in May as lower oil prices and a rise in exports, including those bound for Europe and China, eased the pain of a slowdown in the broader economy. The gap shrank 3.8 percent to $48.7 billion, the U.S. Commerce Department said on Wednesday.
http://jlne.ws/LM6qz3
Mortgage applications fell last week: MBA
Reuters via Yahoo! News
NEW YORK – Applications for home mortgages fell last week due to a drop in refinancing activity even as interest rates hit record lows, an industry group said on Wednesday.
http://jlne.ws/LiyCYJ
Firms & Banks
BofA shareholders may pursue lawsuit over MERS, mortgages
Reuters via Yahoo! News
- A federal judge refused to dismiss a lawsuit accusing Bank of America Corp of misleading shareholders about its exposure to risky mortgage securities and its dependence on an electronic mortgage registry known as MERS.
http://jlne.ws/ObOI21
Dump Moody’s as Credibility of Ratings Crumbles, BTIG Says
Bloomberg
Moody’s Corp. shares may drop as the market’s indifference to its downgrades prods bond issuers to stop paying for ratings, according to Mark Palmer, an analyst for BTIG LLC, a trading firm in New York.
http://jlne.ws/NaINzp
Dresner Partners Names Michelle Moreno Managing Director
Marketwire via Yahoo! Finance
CHICAGO, IL– – Dresner Partners, a leading FINRA-registered, middle-market investment bank, announced today that Michelle Moreno CFA has joined the firm as managing director.
http://jlne.ws/MnsHiP
Countrywide won influence with loans
Minneapolis-St. Paul Star Tribune
The company sought to curry favor with its use of VIP loans for lawmakers and Fannie Mae executives, a House panel reported.
http://jlne.ws/MntmRo
Pimco’s Gross Holds On to Treasuries, Mortgages in Flagship Fund
Bloomberg
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., held holdings of Treasuries and mortgages steady in June after saying that U.S. securities are still the safest bet.
http://jlne.ws/MkALoj
Futures firm PFG collapses amid fraud accusations
AFP via Yahoo! News
US futures brokerage Peregrine Financial Group filed for bankruptcy protection late Tuesday amid fraud allegations by regulators and after its founder attempted suicide.
http://jlne.ws/Ns0m8I
Regulators Charge Futures Brokerage Firm and Chief With Fraud
New York Times
The Commodity Futures Trading Commission charged a futures firm and its chief executive with fraud and making false statements after nearly $200 million in customer funds went missing. It is also asking a federal court to appoint a receiver for the firm and freeze its assets.
http://jlne.ws/MmNEcf
Peregrine Financial Futures Accounts by SIPC, Chief Says
Bloomberg
Peregrine Financial Group Inc. futures customers won’t have their losses covered by the Securities Investor Protection Corp. even if they were defrauded, the fund’s chief said.
http://jlne.ws/NPJ9Z2
U.S. Bank investigated in Peregrine case
UPI
CHICAGO, July 11 — Investigator are looking into U.S. Bank’s role in overseeing client funds for Peregrine Financial Group, officials said Wednesday.
http://jlne.ws/NPGWwR
Advocate for futures trading, PFGBest boss accused of fraud
Chicago Sun-Times
Time and again, the father-and-son team that runs PFGBest has defended the integrity of the futures brokerage, the same company now crawling with regulators who have shut it down and leveled charges that more than $200 million in customer funds are missing.
http://jlne.ws/LiCMQq
MF Global redux as Iowa broker hid missing millions for years
Reuters via Yahoo! News
CHICAGO/WASHINGTON – The U.S. futures industry reeled on Tuesday as regulators accused Iowa-based broker PFGBest of misappropriating over $200 million in customer funds for more than two years.
http://jlne.ws/NteDpq
Regulators
NFA Signs Agreement with Phoenix Partners Group to Provide Regulatory Services to Phoenix’s Swap Execution Facility
July 12, 2012, Chicago and New York – National Futures Association (NFA) and Phoenix Partners Group LP today announced that they have entered into an agreement that paves the way for NFA to perform regulatory services for Phoenix’s swap execution facility (SEF). Phoenix Partners Group is a New York-based derivatives broker.
Fed’s Bullard: Monetary Policy Appropriate Right Now
Wall Street Journal Blogs
U.S. monetary policy is “appropriately calibrated” right now and more bond buying would only be needed if the economy looked like it was heading into recession, a U.S. central banker said Tuesday.
http://jlne.ws/Oe0EA9
Fed’s Bullard Says Current Policy Is Appropriate
FOX Business
Current monetary policy “is appropriately calibrated” to the current economic environment, said James Bullard, president of the St. Louis Federal Reserve Bank, on Tuesday.
http://jlne.ws/MkyQQA
Global News
Will Tucker get Bank of England top job?
Reuters via Yahoo! News
LONDON – Paul Tucker, the long-time favorite to become the next Bank of England chief, was quick to brand the Libor rate-rigging scandal “a cesspit” earlier this week — but the twists and turns of the saga have left doubts about whether he will now get the top job.
http://jlne.ws/NrV4dx
Bank of Japan tweaks policy, points to steady growth
AFP via Yahoo! News
Japan’s central bank Thursday said the world’s third-largest economy would grow slightly less than expected amid turmoil overseas, but held off making major policy moves as it pointed to a recovery.
http://jlne.ws/NaKexE
ECB Attributes Monetary Policy to Economic Risks and Steady Inflation
DailyFX via Yahoo! Finance
http://jlne.ws/NknMRR
BOJ keeps policy on hold, sticks to recovery view
International Business Times
The Bank of Japan kept monetary policy unchanged on Thursday and maintained its view that the country’s economy is gradually picking up, signaling its conviction that solid domestic demand will help a recovery resume without additional stimulus.
http://jlne.ws/Oe0wRm
IMF’s Lagarde says Indonesia needs prudent monetary policy
Reuters via Yahoo! News
JAKARTA – Indonesia needs prudent monetary policy and a flexible exchange rate to safeguard it against external risks, the head of the International Monetary Fund said on Tuesday.
http://jlne.ws/NmSbOH
South Korea unexpectedly lowers key policy rate
Associated Press via Yahoo! News
South Korea’s central bank unexpectedly lowered its key interest rate on Thursday, urgently attempting to guard Asia’s fourth-largest economy against Europe’s persistent debt woes and slowing growth in China.
http://jlne.ws/Nt9jm5
Czech Central Bank Governor Singer: Still Room To Cut Interest Rates
Nasdaq
http://jlne.ws/LM7LWL
Bank of Italy’s Visco: Italian Spreads “Unjustified”
Nasdaq
http://jlne.ws/OdYYa4
Mexican Central Bank Board Member Sees Years of Peso Volatility
Bloomberg
Mexico’s peso may remain volatile for years as Europe’s sovereign debt crisis roils international markets, central bank Deputy Governor Manuel Ramos Francia said.
http://jlne.ws/NoHfzE
Spanish Bank Bailout Means Forcing Losses on Cooks, Pensioners
Bloomberg
Maribel Martinez, 51, was counting on income from the 82,000 euros of savings she invested in Bankia preferred shares two years ago after losing her job cooking meals for nuns in a Barcelona convent.
http://jlne.ws/NrUexg
South Korea central bank surprises with quarter-point interest rate cut
Market Watch
http://jlne.ws/N3j5ND
