Goldman recommended sellingcommodities early last week which sent the TSX and TSX Venture exchanges into a2 day free fall. Commodities had the wind taken out of their sails...but onlyfor a moment.
Gold and silver have beenresilient. Investors in precious metals clearly saw through the recent 'toughtalk' of Obama. Smart investors realize that we face years of financial turmoilin the US - even if it's able to avoid a debt crisis or potential default.Although the pull backs at the beginning of last week were a harsh reminder ofhow fragile the markets can be, it doesn't bother us in the slightest.
We are not saying Goldman iscompletely wrong in its predictions given that many commodities have been longoverdue for a pullback. Our belief is that Goldman may be right on a handful ofcommodities in the short term, but grouping them all together as one asset classset to fall is a mistake.
Commodities are volatile innature and many could easily pull back 10 or 15% as we head into May and thesummer months, but we still remain in a secular bull market - nothing goesstraight up.
During market gyrations it isimportant to remind oneself of a simple question:
How did we get here?
How did we get to recordhighs in gold and most commodities?
The catalyst prior to the2008 crash was the emerging markets, and in particular, the insatiable growth ofChina. Emerging markets are still expecting to outperform, with high GDP numbersacross the board. The second and strongest reason for record high commodityprices is, without question, the demise and falling value of the US dollar.Although the US dollar recovered a tiny bit following the not so big budget cut,the US dollar is in as worse shape as ever and expected to head lower by mostcredible analysts. The prolonged, low interest rate, free money environment hasalso fuelled much of the rally in commodities to date and has further fuelledthe decline in the US dollar.
Obama recently vowed to cut$4 trillion in cumulative deficits within 12 years through a combination ofspending cuts and tax increases. Key words being 12 years.
The government barely agreedto muster up $38.5 billion in cuts recently to avert a government shutdown!Where does Obama get a $4 trillion cut from? The fact is, the deficit isincreasing this year by roughly $1.5 trillion and by more than $1 trillion in2012. Obama's administration has already reported that its government will pileup a cumulative deficit of $3.8 trillion over the next five years. So when doesthis $4 trillion in cuts begin? After the US has piled on another $4 trillion indebt?
This $3.8 trillion expectedto be piled onto the deficit will take the US well beyond the 100% debt to GDPratio. Most economists argue this is basically a point of no return and thechances of paying off the debt is very unlikely.
The budget tells us that thedebt ceiling will have to be lifted next month. This will be a huge benefactorto commodity investors and those short on the dollar as it will spark reducednegative sentiment towards the greenback.
Both of the fundamentalreasons which brought us to this point in the markets are still intact:
1.) Thecontinued strong growth of the emerging markets
2.) Adeclining US Dollar.
The long-term secularcommodity bull market is still intact. A secular bull market, by definition, hascorrections and sometimes very sharp corrections on the way up. We are still inthe trend and believe it will take the United States a minimum of 3-5 years toresolve its debt issue. As commodity investors, this is very bullish.
As QE2 comes to an end, webelieve the markets will have to focus more on growing demand from the emergingmarkets. If the markets begin to sell off too sharply and unemployment stayshigh, we will expect another round of monetary easing. The IMF reported on April11th 2011 that BRIC countries will continue to see robust economic growth in2011.
The global output isprojected to increase by 4.4% this year, while emerging economies are expectedto rise by 6.5%. The IMF made these projections in the most recent WorldEconomic Outlook report.
The IMF was quoted as saying,"As leading emerging economies, the BRICS countries, which is the combination ofBrazil, Russia, India, China and South Africa, will continue to outpace othercountries."
China's economic growth isexpected to remain at 9.6 percent this year and 9.5 percent in 2012. China willcontinue to lead the BRICS nations and emerging market demand for commodities.India is also expected to put up solid numbers in 2012 with 7.8% growth. Chinaand India continue to deliver demand to the commodities markets.
As QE2 comes to an end inJune we are expecting an increase in liquidity across the markets as tradersbegin to make bets prior to the end of stimulus. If the US Dollar continues toshow a bit of life amidst government promises decades into the future, it couldalso throw a wrench in the short-term commodity trade; but it's nothing to worryabout. QE3 is going to happen at some point, they just might give it a differentname.
Gold continues to beunderweight in most portfolios and not in a bubble. In late 2010 Eric Sprottestimated that the actual amount of new investment into gold since 2000 is about$250 billion. Compare that to the roughly $98 trillion of new capital thatflowed into other financial assets over the same time period. From 2000 to 2010,$2.5 trillion flowed into U.S. mutual funds, but only $12 billion of that wentinto precious metal equity funds.
It takes years for a bubbleto reach its peak and burst. Gold is not there yet. Gold remains heavilyunderweight in many institutional portfolios and will continue to rise in valueas the US debt crisis approaches.
All the best with yourinvestments,