Category Archives: Economy and Meltdown

Ken Rogoff: "Policymakers Should Be Cautious Seeing Gold's Drop As A Vote Of Confidence"

Authored by Kenneth Rogoff, originally posted at Project Syndicate,

In principle, holding gold is a form of insurance against war, financial Armageddon, and wholesale currency debasement. And, from the onset of the global financial crisis, the price of gold has often been portrayed as a barometer of global economic insecurity. So, does the collapse in gold prices – from a peak of $1,900 per ounce in August 2011 to under $1,250 at the beginning of July 2013 – represent a vote of confidence in the global economy?

To say that the gold market displays all of the classic features of a bubble gone bust is to oversimplify. There is no doubt that gold’s heady rise to the peak, from around $350 per ounce in July 2003, had investors drooling. The price would rise today because everyone had become convinced that it would rise even further tomorrow.

Doctors and dentists started selling stocks and buying gold coins. Demand for gold jewelry in India and China soared. Emerging-market central banks diversified out of dollars and into gold.

The case for buying gold had several strong components. Ten years ago, gold was selling at well below its long-term inflation-adjusted average, and the integration of three billion emerging-market citizens into the global economy could only mean a giant long-term boost to demand.

That element of the story, incidentally, remains valid. The global financial crisis added to gold’s allure, owing initially to fear of a second Great Depression. Later, some investors feared that governments would unleash inflation to ease the burden of soaring public debt and address persistent unemployment.

As central banks brought policy interest rates down to zero, no one cared that gold yields no interest. So it is nonsense to say that the rise in the price of gold was all a bubble. But it is also true that as the price rose, a growing number of naïve investors sought to buy in.

Lately, of course, the fundamentals have reversed somewhat, and the speculative frenzy has reversed even more. China’s economy continues to soften; India’s growth rate is down sharply from a few years ago. By contrast, despite the ill-advised fiscal sequester, the US economy appears to be healing gradually. Global interest rates have risen 100 basis points since the US Federal Reserve started suggesting – quite prematurely, in my view – that it would wind down its policy of quantitative easing.

With the Fed underscoring its strong anti-inflation bias, it is harder to argue that investors need gold as a hedge against high inflation. And, as the doctors and dentists who were buying gold coins two years ago now unload them, it is not yet clear where the downward price spiral will stop. Some are targeting the psychologically compelling $1,000 barrier.

In fact, the case for or against gold has not changed all that much since 2010, when I last wrote about it. In October of that year, the price of gold – the consummate faith-based speculative asset – was on the way up, having just hit $1,300. But the real case for holding it, then as now, was never a speculative one. Rather, gold is a hedge. If you are a high-net-worth investor, or a sovereign wealth fund, it makes perfect sense to hold a small percentage of your assets in gold as a hedge against extreme events.

Holding gold can also make sense for middle-class and poor households in countries – for example, China and India – that significantly limit access to other financial investments. For most others, gold is just another gamble that one can make. And, as with all gambles, it is not necessarily a winning one.

Unless governments firmly set the price of gold, as they did before World War I, the market for it will inevitably be risky and volatile. In a study published in January, the economists Claude Erb and Campbell Harvey consider several possible models of gold’s fundamental price, and find that gold is at best only loosely tethered to any of them. Instead, the price of gold often seems to drift far above or far below its fundamental long-term value for extended periods. (This behavior is, of course, not unlike that of many other financial assets, such as exchange rates or stock prices, though gold’s price swings may be more extreme.)

Gold bugs sometimes cite isolated historical data that suggest that gold’s long-term value has remained stable over the millennia. For example, Stephen Harmston’s oft-cited 1998 study points to anecdotal evidence that an ounce of gold bought 350 loaves of bread in the time of Nebuchadnezzar, king of Babylon, who died in 562 BC. Ignoring the fact that bread in Babylon was probably healthier than today’s highly refined product, the price of gold today is not so different, equal to perhaps 600 loaves of bread.

Of course, we do not have annual data for Babylonian gold prices. We can only assume, given wars and other uncertainties, that true market prices back then, like today, were quite volatile.

So the recent collapse of gold prices has not really changed the case for investing in it one way or the other. Yes, prices could easily fall below $1,000; but, then again, they might rise. Meanwhile, policymakers should be cautious in interpreting the plunge in gold prices as a vote of confidence in their performance.


The Remarkable Goldman Extrapolation Engine Strikes Again

When it comes to Muppet-bating, there is still only one; and “The Highlander” of all strategists is none other than Goldman’s David Kostin. His somewhat-exuberant year-end target for the S&P 500 at 1,750 pales in comparison to his wonderfully extrapolated – never gonna be another recession ever again – view of earnings and implicitly the S&P 500 out to 2015. At 2,100, his forecast based on 8%, 9%, and 11% rallies seems so possible when all one can see is the last few years of data… we just hope he and his clients are not disappointed when the hockey-stick doesn’t turn and peak margins finally weighs on the reality of a rising debt-cost corporate universe unable to fund buybacks or dividends on the cheap anymore.



What could go wrong?


Here Is Why Alcoa Just "Beat" Earnings

Moments ago Alcoa reported adjusted earnings (because the unadjusted earnings were a disaster) of $76 million, or $0.07, on consensus expectations of a $0.06 print. In other words, a beat. So just how did the company beat its forecast?

Here’s how.

Presenting the company’s Q2 EPS consensus forecast over time in the short term:

And over the longer-term:

Summarizing the above:

  • A week ago AA was expected to make over $0.07 (or today’s result would have been a miss)
  • A month ago: over $0.10
  • In January: $0.17
  • Just over a year ago: $0.30
  • In January 2011: Q2 2013 EPS was supposed to be almost $0.70 cents

So: from January 2011 to today, the company’s “consensus” EPS forecast was revised from just under 70 cents to $0.06 cents. But hey: at least it “beat“.

By the way, here is why the EPS number is absolutely meaningless: it “excludes” $244 million in restructuring charges – something which makes a complete mockery of both an apples to apples comparison, and also the company’s tax rate. Of course, not excluding the restructuring charge from Net Income would have meant a $148 million loss. But at least Alcoa provisioned $21 million in income taxes in Q2…

As for what actually mattered, here are the highlights:

  • Revenue of $5.849 billion, down 1.9% Y/Y
  • CapEx $286 million, down 1.7% Y/Y
  • Free Cash Flow $228 million, down 7.3% Y/Y

But at least the company still sees a stable and growing China, expecting Chinese aluminum demand to rise 11% in 2013 versus 9% in 2012. Well, it’s not like China is undergoing an unprecedented, historic deleveraging or anything so why not…


Bonds Best, Stocks Rest, And USD Depressed

Following Friday’s ugliness in bond-land, today saw the Treasury market’s best day in around 13 months as UST are starting to look a lot like JGBs in terms of volatility regime – which really won’t help collateral. Gold and silver also had a positive day (both up around 1.1%) as the USD leaked 0.3% lower (led by a surging AUD that recovered a lot of Friday’s gap-down losses). The Nasdaq underperformed on the day (as AAPL tumbled 3% from pre-open highs) but remains in the green (just) post-FOMC while the Dow, S&P, and Trannies are all holding red post-FOMC. Discretionary and Financials are now in the green post-FOMC as Builders continue their open-high-close-low regime (now down 7% from FOMC). WTI trod water around $103. Credit markets modestly outperformed on the day but remain significantly below pre-FOMC levels as stocks have almost regained it and VIX slid back to its lowest in 6 weeks (under 15%) though slipped higher from the open today.


The entire treasury complex rallied aggressively today…


with the underperforming belly of the last few days outperforming the most today…


The Nasdaq is just in the green since FOMC but the rest (aside from RUT) remain modestly in the red…


And sectorally, financials (despite today’s FDIC / BIS / Dodd-Frank news) are back above the FOMC highs (because all anyone can think about is NIM – not the MtM losses they are getting hit with) and builders once again open high and close low…


The outperformance of the shorts post-FOMC has been rebuffed and they have been unwound en masse back above the FOMC levels…


The USD dropped 0.3% (as the AUD surged)… Gold jumped and flatlined after EU close as did stocks…


On a side note, S&P 500 futures volume was around half that of Friday’s!!


Charts: Bloomberg and Capital Context