Go Gold!

Today marks one week since the start of the Rio de Janeiro Olympics, and it’s been nothing short of amazing. Michael Phelps, whose name should forevermore be synonymous with the Olympics, won his 22nd overall gold medal. He also was awarded his 13th individual gold, effectively breaking a record last set in 152 B.C. by runner Leonidas of Rhodes.

What I find most remarkable about Phelps’ success is that he’s had to overcome strong personal challenges to reach the level he’s at. He was diagnosed with attention deficit hyperactivity disorder (ADHD) at a young age, and when he chose to get off his medication, he turned to swimming. More recently, he’s dealt with alcoholism, which landed him a DUI in 2014. His is a quintessentially American story of otherworldly success born out of failure, of meeting the obstacles that block his path to his goals head on.

When Phelps made the decision to compete again, he reteamed with his longtime swim coach Bob Bowman and set his mind to training harder than he ever had before—which, at his “advanced” age of 31, would be necessary if he hoped to have a shot at winning the gold.

The most decorated Olympian in history, Phelps, like all winners, focuses on winning. Losers, on the other hand, focus not on winning but on the winners in front of them. They’re more concerned about the short-term noise, at the expense of their long-term goal. The image above is a perfect illustration of this.

But many investors, I’ve found, are the same way. Today there’s a lot of noise and distraction. Much of it is coming from the presidential election, which is already turning out to be one of the most negative and highly contentious in American history.

Trump Self-Sabotages

Someone who could benefit from Phelps’ steadfastness and commitment to his craft is the Republican presidential candidate, Donald Trump, who all too often sabotages his own campaign with controversial and incendiary remarks.

We saw this happen this week. While speaking to the Detroit Economic Club on Monday, Trump promised that, if elected, he would place a “temporary moratorium” on any new financial regulation. Further, he would repeal the Dodd-Frank Act and reform the tax code to include only three income-tax brackets, down from the current seven.

These are solid proposals, appealing to not only everyday taxpayers but also many of the CEOs I speak with on a regular basis. After all, they’re the ones who must deal with regulations on a daily basis.

The problem, though, is that Trump can’t stay on message. In the opening image, Trump is more like the guy who’s distracted by Phelps rather than Phelps himself. Trump invariably will say something inflammatory soon after making a sensible remark on policy, thereby effectively resetting the news cycle. In this week’s case, it was his comment on “Second Amendment people”—a veiled threat against Hillary Clinton, some interpreted—that dominated the headlines, taking all attention away from the moratorium on financial regulations.

Research Firm: Get Ready for Madam President Clinton

The cover of TIME’s August 22 edition displays a striking likeness of Trump melting like an Air Wick candle. A single word punctuates the stark image: “Meltdown.” Whether or not you support the New York billionaire, you must admit that the “Trump train” has repeatedly jumped the track since the Republican convention just three weeks ago. What’s more, we just learned that GOP Chairman Reince Priebus is being pressured by dozens of insider Republicans to withdraw all party support, including campaign financing, from Trump’s candidacy.

Things aren’t looking good. Even regression analysis now appears to show that Trump’s chances are retreating.

In a new report, investment research firm Ned Davis makes the case that, based on historical precedent, economic as well as stock and bond market performance so far this year is pointing to an incumbent party victory in November. The chart below shows that the upward trajectory of the Dow Jones Industrial Average in 2016 more closely resembles the average performance seen in all years when the incumbent party—Republican or Democrat—held on to office.

Dow Jones Industrial Average Performance Pointing to Incumbent Party Win in November

According to Ned Davis strategists Ed Clissold and Victor Jessup, “When the economy has not been in a recession, the odds of the incumbent party retaining control of the White House has jumped to 71 percent.” Since 1900, presidential elections have landed during recessions five times. In four of these instances (1920, 1932, 1960 and 2008), the incumbent party lost. The exception was 1948 when Harry Truman won—just barely, if you remember your history—but the recession began the same month as the election.

The group points out, however, that it’s extremely rare for a two-term Democrat to pass the baton to a new Democrat via election. How rare? The last time this happened was in 1836, when Andrew Jackson—the very first Democratic president—was succeeded by Martin Van Buren.

Hillary for Precious Metals

I’m very often asked which candidate will be better for gold: Trump or Clinton? The honest truth is that the answer changes week-to-week. Sometimes it’s Trump because he has demonstrated recklessness and unpreparedness. Other times, it’s Hillary because she has proposed policies that were clearly inspired by the socialism of Bernie Sanders. In her economic address this week, she laid out her plan to make college “debt-free” and tuition absolutely “free” to children from families who earn less than $125,000 a year.

To make this plan happen, income taxes will most likely need to be hiked. And if history tells us anything, it’s that gold demand has increased when socialist policies threatened economic growth. The price of gold is inversely correlated with the five-year and 10-year Treasury yields, which fall when the economy is floundering. This makes the yellow metal all the more attractive to investors.

That’s why I always recommend a 10 percent weighting in bullion and gold stocks, in both good and bad times. Gold has a history of holding its value even during economic turmoil, which is why it’s prudent to maintain an allocation in your portfolio.

Alibaba Beats Expectations. Is China Next?

Yesterday, giant Chinese ecommerce site Alibaba posted spectacular numbers, suggesting a turnaround for the world’s second biggest economy possibly isn’t too far behind. Alibaba—whose 2014 IPO stands as the largest in U.S. history, according to Renaissance Capital—posted quarterly revenues of $4.8 billion, a whopping 60 percent increase from the same time last year, and the biggest ever since before the company went public.

This is constructive news for China. Alibaba works with a reported 8.5 million sellers, from mom-and-pop-type shops to multibillion-dollar, international corporations, making for a good cross-section of the Chinese economy. (You could argue the same of Amazon and the U.S. economy.) That Alibaba’s sales are up indicates that consumption in China is stronger than perhaps analysts anticipated. Indeed, Beijing reported that retail sales grew nearly 11 percent in the second quarter  year-over-year, beating estimates of 9.9 percent.

Index Summary

  • The major market indices finished mixed this week.  The Dow Jones Industrial Average gained 0.18 percent. The S&P 500 Stock Index rose 0.05 percent, while the Nasdaq Composite climbed 0.23 percent. The Russell 2000 small capitalization index lost 0.12 percent this week.
  • The Hang Seng Composite gained 2.91 percent this week; while Taiwan was up 0.64 percent and the KOSPI rose 1.61 percent.
  • The 10-year Treasury bond yield rose 8 basis points to 1.51 percent.

Domestic Equity Market

SP 500 Economic Sectors

Strengths

  • Energy was the best performing sector for the week, increasing by 1.24 percent versus an overall increase of 0.05 percent for the S&P 500.
  • Endo International was the best performing stock for the week, increasing 33.81 percent.
  • Randstad Holding NV will acquire Monster Worldwide, the online recruitment business. Randstad is the world’s second-largest human resources services provider.

Weaknesses

  • Materials was the worst performing sector for the week, falling by -0.88 percent versus an overall increase of 0.05 percent for the S&P 500
  • First Solar was the worst performing stock for the week, falling -12.06 percent.
  • Delta Air Lines flights were grounded on Monday due to a nationwide system failure. The outage led to 1,800 canceled flights over two days. Business Insider’s Myles Udland argues that this reflects an issue much bigger than the airline industry: Capital investment is a problem for all of corporate America.

Opportunities

  • Walmart is buying Jet.com. The deal will be worth about $3 billion, according to Recode’s Jason Del Rey, citing anonymous sources. Walmart hopes the acquisition will help jump-start its struggling online business, which is just a fraction of the size of Amazon’s. Walmart generates about $14 billion in annual e-commerce sales, compared with about $99 billion from Amazon.
  • Disney topped estimates. The entertainment giant earned an adjusted $1.62 a share on revenue of $14.3 billion. Disney announced it bought a $1 billion minority stake in BAMTech, a video-streaming company previously formed by Major League Baseball. CEO Bob Iger says the acquisition will help bring the sports network’s content over the top on the Internet.
  • Retail drug stores have been undermined by concerns about the opaque pricing structure of the pharmacy benefits management arms, which has pushed relative valuations to extremely attractive levels. While it is difficult to forecast whether any major concessions will be made to appease health insurers, this focus is masking an increasingly upbeat picture for the rest of the core business.

Threats

  • The strong July employment report may tempt investors to lean into bank stocks relative performance weakness under the assumption that signs of solid domestic growth will finally lead to higher rates. However, it is important to keep in mind that the bulk of the deflation impacting the U.S. is being transmitted through a strong U.S. dollar, which acts as an overall corporate profit drag. Thus, to the extent that the currency continues to appreciate, it will be difficult for inflation expectations to recover from depressed levels or allow the long end of the yield curve to rise.
  • A bearish outlook for refiners is becoming a more mainstream thesis. Refined product consumption has been solid for much of the past year but as a result, refiners have operated at full capacity in order to produce enough gasoline to meet demand. However, overproduction has occurred and that is being compounded by accelerating refinery production outside the U.S. Increased import competition is a serious threat.
  • With the major indices at all-time highs and the economy still muddling along, it seems like there could be a disconnect between the two. Any sign of weakness could cause major turmoil in the markets.

The Economy and Bond Market

Strengths

  • The number of foreclosures in America is at an all-time low. “Mortgage originations grew to $427 billion. About 83,000 individuals had a new foreclosure notation added to their credit reports between April 1 and June 30, a new low in the 18-year history of the data,” according to the Federal Reserve Bank of New York.
  • Consumer sentiment edged up to 90.4 in August from 90.0. Long-run inflation expectations were unchanged at 2.6 percent.
  • The impressive gain in the quit rate is indicative of greater job switching and stronger wage pressure. Still, wage rigidity remains elevated, which should limit the speed by which wages accelerate. Overall, the path likely remains higher for wage inflation, but it will continue to be gradual.

Weaknesses

  • U.S. retail sales were unchanged in July, a worrisome sign for an economy being held aloft solely by consumer consumption. A 0.4 percent drop in the Producer Price Index reinforces the notion that despite robust labor markets, the U.S. Federal Reserve will stay on the monetary sidelines for some time to come.
  • Productivity has fallen for three straight quarters, the U.S. Department of Labor reported this week. That’s the longest slump in output per worker since 1979. Falling productivity is raising concerns about corporate profits and the pace of future hiring.
  • Job openings rose less than expected in June. The number of jobs open in the U.S. in July hit 5.624 million, less than expected, but up from May’s reading of 5.5 million, according to the latest Job Openings and Labor Turnover Survey (JOLTS) report.

Opportunities

  • The minutes of the U.S. Federal Reserve’s Federal Open Market Committee meeting will be released on Wednesday, August 17. The commentary will likely reflect a patient stance, which should buffer market volatility.
  • Arizona and Tennessee have received credit rating increases from S&P this year. In contrast to many states that have been downgraded or are dealing with issues such as severely underfunded pensions or budget shortfalls, the stability in these states could be a boon to their municipal bonds.
  • With some global growth indicators starting to pick up and deflationary pressures easing along with highly accommodative central bank liquidity, this “sweet spot” could allow non-government bonds to outperform government bonds in the near term.

Threats

  • Credit ratings have been cut on six states by S&P Global Ratings this year, already the second-highest amount for a year during the past three decades. The three-to-one ratio of state rating downgrades to upgrades has only been met or exceeded four other times since 1986. While the economy is expanding, the slow pace is adversely impacting state budgets and credit quality as increases in tax revenue at the state level have failed to keep pace.

Average State Tax Revenue Growth

  • Saudi Arabia is pumping out more oil than ever before. Saudi Arabia increased its oil production by another 123,000 barrels a day to 10.67 million, the most on record. The record production is evidence that Saudi Arabia doesn’t care so much about the oil price and would rather wipe out its competition.
  • The trade balance and the first estimate of Japan’s second-quarter GDP will be released next week. If the data releases are weak, it will place more pressure on officials to provide additional policy stimulus.

Gold Market

This week spot gold closed at $1,335.40, down $0.15 per ounce, or 0.01 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 2.09 percent. Junior miners outperformed seniors for the week, as the S&P/TSX Venture Index traded up 3.30 percent. The U.S. Trade-Weighted Dollar Index slipped 0.48 percent.

Date Event Survey Actual Prior

Aug-11

U.S. Initial Jobless Claims

265k

266K

267k

Aug-11

U.S. Retail Sales YoY

10.5%

10.2%

10.6%

Aug-12

Germany CPI YoY

0.4%

0.4%

0.4%

Aug-12

U.S. PPI Final Demand YoY

0.2%

-0.2%

0.3%

Aug-11

Germany ZEW Survey Current Situation

50.2

49.8

Aug-11

Germany ZEW Survey Expectations

2.0

-6.8

Aug-11

U.S. Housing Starts

1180k

1189k

Aug-11

U.S. CPI YoY

0.9%

1.0%

Aug-12

U.S. CPI Core YoY

0.9%

0.9%

Aug-12

U.S. Initial Jobless Claims

265k

266k

Strengths

  • The best performing precious metal for the week was gold, holding in with a 1 basis point drop.  According to the World Gold Council, global gold demand in the second quarter increased 15 percent due to a 141 percent rise in investment demand. The Royal Mint also commented on a “surge” in demand, specifically when the Bank of England cut rates – during that week the Mint saw a 25-percent increase in transactions on its bullion website, reports BBC. The Mint’s “signature gold” has also allowed buyers to purchase fractions of gold bars, causing sales to jump 140 percent.
  • Japan is the “star performer” among smaller gold consumers, reports Bloomberg, with four straight quarters of positive net investment into bars and coins. Demand expanded to 5.8 metric tonnes in the second quarter. The World Gold Council cites distrust of Abenomics, negative interest rates and a rising yen for the investment boost. In China, vehicle sales in July gained the most in 17 months, sending palladium to touch a one-year high. Speculation is that supply won’t be enough to meet demand, reports Bloomberg, as the metal is used in the making of car parts.
  • Gold prices jumped this week as investors reevaluated the likelihood that the Fed will raise rates this year, reports Investing.com. The Labor Department said nonfarm business sector labor productivity fell 0.5 percent in the second quarter (extending the longest decline since 1979). According to BMO Private Bank, economists surveyed expected a 0.4 percent gain for the three months ended June.

Weaknesses

  • The worst performing precious metal for the week was platinum losing 2.03 percent, on what may have been profit taking following the very strong rally in the platinum group metal prices over the last two weeks.
  • According to BCA Research, the U.S. labor market strength is a “conundrum.” Last week’s jobs report came in strong and although U.S. real GDP is up only 1.2 percent year-over-year, employment has grown by a stronger 1.9 percent year-over-year, the group points out. It is uncommon for GDP growth to be weaker than employment growth, and such a gap is “unsustainable as businesses will experience continued erosion in profit margins.”
  • Following the U.K.’s vote to leave the European Union, gold prices soared to the highest level since 2014. The higher price is one reason that China, the world’s biggest producer and consumer of gold, cut purchases in July, reports Bloomberg. The People’s Bank of China increased its gold holdings by the smallest amount since it began disclosing purchases about a year ago.

Opportunities

  • David Haughton of CIBC says the gold rally we’ve experienced so far this year is sustainable. He points to three key factors: 1) Comparing this rally to five others over the past 40 years shows gold equities are still 40-50 percent off the previous high, while historical cycles reached around 20 percent of old highs in the same time frame. 2) Most companies are now demonstrating fiscal discipline that could support outperformance ahead. 3) Investors are mostly underweight gold equities and macro factors appear supportive.

Relative Performance of Gold Equities vs. Metal Price from 2001

  • In its Gold Sector Review report, Credit Suisse points to several demand trend updates for the second quarter of 2016. The group explains that mine supply was flat year-over-year, as production from new streams was offset by declines in existing assets. They forecast mine supply to fall 7 percent by 2018 versus the 2015 level driven primarily by declining grades and a lack of new projects coming on-stream due to industry capex cuts since 2013.
  • In the Financial Times this week, investment expert and precious metals analyst Diego Parrilla writes that the gains seen this year in gold are just the beginning of a new gold bull market. “My view that there is a perfect storm for gold is based on three closely interrelated dynamics, whereby central banks and global markets are both testing the limits of monetary policy and credit markets as well as the boundaries of fiat currencies.”

Threats

  • Andrew Garthwaite of Credit Suisse published his opinion on gold and gold mining stocks Friday, pointing to three tactical concerns he has with the metal: 1) Gold moves inversely with real bond yields, and he thinks real rates will rise. 2) Gold moves inversely with banks, and he thinks financials will outperform if bond yields rise. 3) Gold is overvalued base on his model.
  • With the probability of three rate hikes from the Fed through to the end of 2017, Picet Wealth Management believes that gold may have met its match after a stellar start to the year, reports Bloomberg. “With the dollar in a long-term uptrend, bullion isn’t likely to break the $1,430 an ounce level,” said Luc Luyet, a currencies strategist at the Picet.
  • With a rally in gold prices so far this year, purchases in India (the world’s second-biggest consumer) will be reduced, reports Bloomberg, trimming import prospects amid high inventories. Historically, the second half of the year is normally better for gold demand from Indian brides, but so far this year a “rally of 25 percent in the first six months has hit the buffers,” continues Bloomberg, with higher costs deterring jewelry buyers.

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors