see no evil hear no evil

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Overnight market action reflected the mixed data investors are getting on the state of the global economy. European markets ended firmly in negative territory while the DOW, after being down 112 points at one stage, rebounded to finish off 0.25%. Certainly there was some cause for renewed investor optimism withUS weekly jobless claims coming in lower than expected, and Eurozone industrial production bouncing back unexpectedly in May. The positivity of these impacts however was no doubt restrained by nervousness over second quarter GDP numbers from China. 

Nonetheless the afternoon session in the US provided some pointer as to what can happen when there is a positive surprise or when data is not as bad as expected. US weekly jobless claims of 350,000 were some 22,000 lower than that forecast. This was shrugged off as a ‘seasonal distortion’ initially, but a realisation did start to sink in that that there was some legitimacy in the improvement. 

Another positive surprise came from an unlikely source- Europe. Industrial production in the Eurozone bounced back unexpectedly in May, rising 0.6% following a 1.1% fall in April. There were also other signs that some confidence is returning. Overnight deposits with the European Central Bank dropped to a seven-month low of €324.9bn from €808.5bn. While this, to some degree, would be attributable to the deposit rate being cut to zero, it could also suggest confidence is returning among banks and that these funds will ultimately reach the real economy. 

And the steps being taken on Spain, which I talked about in yesterday’s daily, are also feeding through to the attitude towards other peripheries. Italy saw the cost of one-year funds fall sharply at its auction overnight. Clearly it will be a painful road to recovery for Spain and others but a belief that they can get there, in addition to support from Germany and others, will be vital in this endeavour. 

Many eyes however today will swing to China and the release of second quarter GDP data. Markets seem to be somewhat fixated on whether GDP growth will come in below 8%, however as I mentioned earlier in the week, this is hardly an apocalyptic scenario. 

A move back to more sustainable levels of growth is to be encouraged and Beijing has stated that it has a target rate of 7.5% annually. At this level there will be more than enough petrol in the tank for China to remain a key engine of global growth. Meanwhile China clearly has the ability and the willingness to boost internal demand if needed. Over $3 trillion in foreign exchange reserves, low levels of inflation, further capacity to urbanise, and last month’s rate cuts are all evidence in this regard. 

Nevertheless the market certainly remains sensitive to any signs of weakening in the China story, including data from key trading partners. Such explains the initial negative reaction to an unexpected rate cut by the Bank of Korea.

Similarly, Australia saw a rise in unemployment in June and some were pointing to this as evidence of the Asian slowdown. Payrolls here fell by 27,000 in June, erasing most of May’s gain, and the jobless rate ticked up from 5.1 to 5.2%. 

However the data goes more to cementing the nature of the two speed economy here. The Asian driven mining sector continues to perform robustly with unemployment falling in resource states Western Australia and Queensland. It is the industrial, financial and retail areas of the economy which are faltering. Although there are some signs that rate cuts are starting to feed through (such as this week’s improved consumer confidence figures),I believe the RBA will keep a watchful eye on the headline unemployment rate. Further weakness will no doubt herald calls for another rate cut. 

Back to the US, the earnings season enters another interesting phase tomorrow with JP Morgan the first of the major US Banks to report. Whilst under a cloud over its ‘whale’ of a credit derivative exposure it will be keenly watched to see how underlying earnings are faring. 

It was interesting to see Warren Buffett sounding less sanguine on the state of the US economy. In an interview overnight he admitted that US growth was slowing. However it was telling that he talked about the UShousing market displaying signs of a rebound. He has previously remarked that the economy and jobs will “come back big time” when residential construction recovers. Certainly I believe that the US property market has bottomed and a recovery here will have natural flow on impacts to consumer spending, a substantial driver of economic growth. 

As I have said in previous dailies, the recovery in the US construction market is certainly being borne out in share price action in the likes of Toll Brothers and other builders. 

Gold 

Considering general risk aversion, the gold price has held up well in recent days keeping above the $1570 level. We continue to believe that the inflationary consequences of central bank actions around the world will ultimately push the metal much higher. Many in this regard will no doubt be looking for further signals of the next move by the Fed when it meets at the end of the month. 

Action in the gold miners meanwhile continues to disappoint and frustrate. The likes of Newcrest and Evolution were down yesterday despite the ongoing resilience of the gold price, and also the fact that the miners have significantly underperformed the price of bullion over the past year. 

In our view the gold miners continue to be irrationally priced with respect to the underlying gold price, and something has to give. Pricing of the gold stocks can only be explained if the gold price were about to collapse, and current price action there, along with the inflationary actions of central banks would make this seem unlikely. 

Even allowing for some slippage in the gold price, the gold miners are trading on relatively low historical multiples, and margins in the sector, despite some cost pressures, remain buoyant. The pricing therefore seems to make no sense at all in the current environment and this reaffirms our belief that it is not the time to throw the towel in on the gold sector. 

See no evil, hear no evil, report no evil. 

In the midst of the bickering over editorial charters and ‘public interest’ tests in Australia, spare a thought for journalists in Mexico. 

In Nuevo Laredo, the daily newspaper, El Manana, has decided to cease all coverage of drug-related crime after a second grenade attack on its offices this year. El Manana said it was too dangerous to report on execution-style murders, car bombs and decapitations that are all too common in the Mexican drug war.

Drug cartel gunmen have been known to attack journalists for unfavourable coverage and to pressure them to cover mass murders they carry out, all in the name of propaganda. 

Journalism has become a very dangerous occupation in Mexico. More than 80 journalists have been murdered since 2000, with many of them reporting on crime and police. Human rights violations and corruption within the police, army and politicians only add to the risk associated with reporting on drug trafficking. 

Only Pakistan and Iraq are worse, according to Reporters Without Borders (www.rsf.org). 

In the context of Mexico’s drug war, there have been more than 40,000 drug-related killings and more than 6,000 disappearances since President Calderon initiated an offensive against the cartels five years ago. His successor, President Nieto, will have a difficult job ahead trying to end the violence. Can he protect the media too? 

Heading May trade winds blow-up a little US surprise. 

The US trade balance in May narrowed to negative US$48.7 billion from negative US$50.1 billion for April. The May deficit narrowed primarily on the back of lower crude prices, but was aided by a minor rise in exports. The May number was inline with consensus of negative US$48.7 billion. Consensus numbers ranged from negative US$42.5 billion to negative US$51.5 billion. 

The value of imports of petroleum goods for May fell sharply to US$24.9 billion, compared to US$28.1 billion in April. Partially offsetting the decline in the deficit in imported petroleum goods was a rise in the non-petroleum goods deficit to US$37.9 billion, compared to US$36.7 billion in April. The services sector surplus widened in May to US$14.8 billion from US$14.6 billion in April. 

The US recorded country deficits in May (in billions of US dollars), with China $26.0 ($24.6 April), OPEC $11.2 ($11.5), European Union $10.5 ($8.7), Japan $6.4 ($6.3), Mexico $6.3 ($5.4), and Germany $4.9 ($4.6). For Members interest, the US’s trade position with Australia in May was a surplus of US$1.7 billion. 

Tension between the two global trading giants in China and the US will continue to simmer as the US attempts to drive China’s trade position with it toward a balanced position. Interestingly, the US continues to help the EU with its deficit to the region widening to US$10.5 billion. Growth in the deficit with the EU indicates there must be some activity taking place and for May on the US account it was positive. 

Turning to the individual components, goods exports rose by 0.3%, following a fall in the month of April of 1.4%. Leading the way for May was a US$0.9 billion gain in foods, feeds and beverages and a US$0.7 billion gain in the non-aircraft related capital goods (excluding autos). On the weaker side were industrial supplies that fell US$0.7 billion as well as marginal falls in automotive and consumer goods. 

Goods imports fell 0.8% in May after printing a 1.8% fall in April. A drop in industrial supplies of US$3.6 billion was primarily as a result of lower crude prices. While consumer goods also fell by US$0.4 billion. Positive movements were printed in capital goods (excluding autos) up US$1.4 billion and auto which rose US$0.7 billion. 

Key takeaways from the May data are that the US is still, albeit small, able to generate increased global exports and an overall narrower trade gap will retain income within the US. The Trade Account does remain a problem for the US, one it appears it cannot contain unless activity slows dramatically as occurred in 2009 and that only slowed the problem. 

In complete contrast to the US international trade position for May, China recently reported a merchandised trade surplus for June of US$31.7 billion. We will have to wait until 9 August before we see how the US faired for the same month. China’s merchandised trade surplus for May was US$50.1 billion. China will have to continue to find ways to redistribute this trade imbalance. 

Feed the World 

With the prices of many key commodities under pressure recently, it is easy to miss the fact that the softs segment has been putting in a stellar performance. Food prices have taken off in the last month (corn prices rose 4% yesterday alone) with the US facing its worst drought in 25 years. We have been bullish on the soft commodity spectrum for many years, having added soft commodity ETF’s or funds in our UK and US research reports. Global population growth, emerging market dietary changes, and increasingly extreme weather patterns (as shown by the US drought) remain key drivers. 

We remain bullish longer term on the softs but the recent spike has encouraged us to take some profits off the table. I have reproduced parts of last night’s UK report coverage of AIGA, a broad soft commodity ETF, below. 

Recent M&A activity from major commodity traders such as Swiss giant Glencore and Japanese house Marubeni snapping up assets in the grain space would seem to suggest these commodity-trading experts believe substantial gains are on the horizon for wheat producers. We concur with this outlook and are bullish on soft commodities in the long term.

We view the fundamentals for soft commodity prices to be positive due to a number of factors we will soon go into in more depth but the second reason is that soft commodities also represent a useful diversifying asset.Agricultural demand is one of the most inelastic due to the essential nature of food in day-to-day existence.

This also means that food prices are prone to rapid price spikes due to supply shocks such as droughts with prices then falling back overtime. The strength of prices recently reflects negative weather conditions and presents an opportunity to take partial profits. 

A bullish double bottom formed at the 7.2388 region, which saw prices rotated sharply higher. Resistance is located at the 78.6% Fibonacci retracement of 9.010 in the near term. The rapid increase in price has resulted in the RSI to reach overbought territory, which is indicative of a pullback at hand. 

With reference to the weekly chart, firm support held at the technically important 200 week moving average. Over the broader term, we are targeting a move towards the psychological 10 level, however only after a short term correction is complete.

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