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Please note: The Frank Talk articles listed below contain historical material. The data provided was current at the time of publication. For current information regarding any of the funds mentioned in these presentations, please visit the appropriate fund performance page.

Could the Stars Be Aligned for $1,500 Gold?
March 26, 2018

How the stars could be aligned for 1500 gold

In a January post, I showed how the price of gold rallied in the months following the 2015 and 2016 December interest rate hikes—as much as 29 percent in the former cycle, 17.8 percent in the latter. Gold ended 2017 up double digits, despite pressure from skyrocketing stocks and massive cryptocurrency speculation.

Will there be a fed rally in 2018
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I forecast then that we could see another "Fed rally" this year following the rate hike in December 2017. Hypothetically, if gold took a similar trajectory as the past two cycles, its price could climb as high as $1,500 this year.

As I told Kitco News’ Daniela Cambone last week, I stand by the $1,500 forecast. Before last week, investors might have been slightly disappointed by gold's mostly sideways performance so far this year. But now, in response to a number of factors, it's up close to 3 percent in 2018, compared to the S&P 500 Index, down 2.4 percent.

Living with Volatility

While I'm on the topic of equities, the S&P 500 dividend yield, for the first time in nearly a decade, is now below the yield on the two-year Treasury. Historically, the economy has slowed around six months after dividends stopped paying as much as short-dated government paper. This could spur some stock investors to trim their exposure and rotate into other asset classes, including not just bonds but also precious metals, which I believe might help gold revisit resistance from its 2016 high of $1,374 an ounce.

Two year treasury yeild is now higher than sp 500 dividened yield

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Volatility has also crept back into markets. It began with the positive wage growth report in February, implying the possibility of faster inflation. More recently, the CBOE Volatility Index (VIX), or “fear gauge,” has surged on the departures of Gary Cohn as chief economic advisor and Rex Tillerson as secretary of state, as well as the application of tariffs on steel and aluminum imports. Last week, President Donald Trump ordered tariffs on at least $50 billion of Chinese goods, stoking new fears of a U.S.-China trade war. In response, the Asian giant proposed fresh duties on as much as $3 billion of U.S. products, including wine, fruits, nuts, ethanol and steel pipes.

Volatility has returned to markets after a calm 2017
click to enlarge

As I see it, there could be other contributing factors pushing up the price of gold. A good place to start is with Trump’s recent appointment of former CNBC star Larry Kudlow as White House chief economic advisor.

Kudlow’s Kerfuffle Over Gold

Between 2001 and 2007, I appeared on Kudlow’s various CNBC shows a number of times, and though he always struck me as highly intelligent, informed and accomplished—he served as Bear Stearns’ chief economist and even advised President Ronald Reagan—it was clear he had a strong bias against gold. This was the case even as the price of the yellow metal was on a tear, rising from $270 in 2001 to more than $830 an ounce by the end of 2007.

Gold price continued to rise last decade even as bearishness in media persisted
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Kudlow showed his true colors toward gold as recently as this month, telling viewers: I would buy King Dollar and I would sell gold. As you can see below, this has't been a prudent trade for more than a year now.

Gold price vs US dollar
click to enlarge

Earlier this month, Kudlow wrote that falling gold is good, as it “bodes well for the future economy.” He said he agreed with a friend, who called the metal an “end-of-the-world insurance contract.”

While there are those who would agree with him, it’s important to remember that gold is used for much more than as a portfolio diversifier, and its price is driven by a number of factors. These include Fear Trade factors, from inflation to negative real interest rates, and Love Trade factors such as gift-giving during cultural and religious festivals. The precious metal has important industrial applications as well.

And since I first went on Kudlow’s program, gold has outperformed the S&P 500’s price action nearly two-to-one, as I showed you back in December. Even with dividends reinvested, the market is still trailing the yellow metal.

Gold price has crushed the market more than 2 to 1 so far this century
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So it’s fine if gold isn’t your favorite asset, but to dismiss it wholesale as Kudlow has again and again is, with all due respect, irrational.

It’s Not About Steel, It’s About Stealing

Kudlow isn’t just anti-gold, however. He’s also anti-China, and even though he’s traditionally opposed tariffs in general, he supports Trump’s efforts to levy taxes on Chinese imports. Specifically, the duties are designed to offset the cost of intellectual property allegedly stolen by the Chinese over the past several years.

China’s J-31 fighter jet, for example, is believed to be a knockoff of Lockheed Martin’s F-35, the most expensive piece of U.S. military equipment. It’s for this reason that Lockheed’s CEO, Marillyn Hewson, was present when Trump signed the authorization to impose new tariffs.

The Chinese J31 fighter jet is thjought to be a knockoff of Lockheed Martins F35

Our intellectual property is hugely important to the U.S. economy. As important as steel and aluminum are, they account for only 2 percent of world trade, and in the U.S., it’s even less than a percent of gross domestic product (GDP). Technology exports, on the other hand, represent about 17 percent of U.S. GDP.

That said, the implications of a trade war with the world’s second-largest economy certainly have many investors concerned—all the more reason to consider adding to your gold allocation at this time. As always, I recommend a 10 percent weighting, with 5 percent in gold bullion, 5 percent in high-quality gold mining stocks and ETFs.

Is Trump Betting on the Wrong Guy?

On a final note, we were pleased to have an old friend visit our office last week. Michael Ding, a veteran of the U.S. Global investments team, joined us to share some laughs and his thoughts on what’s happening in Asian markets right now.

Specifically, Michael said that Ray Dalio, founder of mammoth investment firm Bridgewater Associates, which manages around $160 billion, has become something of an economic guru for members of the Chinese ruling party’s highest-ranking members, including Premier Li Keqiang. Dalio—whose most recent book, Principles, nowtops China’s bestseller list—is reportedly advising the country’s top bankers and economists on how to deleverage safely without triggering a so-called “hard landing.”

A trade war between the U.S. and China, Ray Dalio said recently, would be a “tragedy.”

So to put it in perspective: Whereas Trump has just now brought on Kudlow, the Chinese are leaning on a fellow American, Dalio, one of the smartest, most gifted money managers in the world—not just of our time but of all time.

Did Trump make the right call? Which player would you want on your team: Kudlow or Dalio? For my money, I would pick Dalio.

Learn more about investment opportunities in China by clicking here!

 

The trade-weighted US dollar index, also known as the broad index, is a measure of the value of the United States dollar relative to other world currencies.

The S&P 500 is a stock market index that tracks the stocks of 500 large-cap companies. It seeks to represent the stock market's performance by reporting the risk and return of the biggest companies.

The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE). It is colloquially referred to as the fear index or the fear gauge.

There is no guarantee that the issuers of any securities will declare dividends in the future or that, if declared, will remain at current levels or increase over time.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 12/31/2017.

 

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Worried About Rising Rates? I Believe this Strategy Could Be the Answer
March 21, 2018

Worried about rising rates I beleive this strategy could be the answer

With interest rates continuing to creep up, there’s a changing of the guard at the Federal Reserve. In my travels and during conferences, I’ve spoken with many fixed-income investors who wonder how they can best prepare for the uncertainty these changes might bring. I’ll share my favorite idea below, but first, a few words on the new head of the Fed, Jerome Powell.

The U.S. Senate voted in January to confirm Powell as the next chair of the U.S. central bank, and I don’t believe I’m alone in seeing his appointment as a political compromise. Although he has vowed to stay the course with former chair Janet Yellen’s cautious rate hikes—something President Donald Trump was in favor of—Powell is a skeptic of financial regulations.

To be clear, he’s expressed approval for some of the Fed's oversight of the financial market, but he’s also pointed to areas where he thinks regulation may have become too burdensome—especially to small regional and community banks. In his November confirmation hearing, he said he supported “tailoring” regulations to fit the institution.

This is a welcome and refreshing change in thinking. If you recall, during one of her final speeches at the Jackson Hole symposium in August, Yellen defended the strict, broad-based financial regulations put in place after the financial crisis—Dodd-Frank included. But as I shared with you this week, Congress and President Donald Trump are now working to roll back many of the provisions of the mammoth 2010 financial reform law.

Wealthy, Yet “Annoyingly Normal”

Jerome Powell nominated Donald Trump Novemeber 3 2017

A former lawyer, businessman and investment banker, Jerome Powell gained experience working in the public sector in President George H.W. Bush’s Treasury Department. After Bush’s presidency came to an end, he joined the private equity firm Carlyle Group, where he enjoyed a very lucrative career. The latest financial disclosure from June 2017 shows his net worth at between $19.7 million and $55 million, making him the wealthiest Fed chair since banker and economist Marriner Eccles, who held the position from 1934 to 1948.

Despite his vast wealth, Powell is known among friends and colleagues as being frugal and “annoyingly normal.” A resident of Chevy Chase, Maryland, he regularly rides his bike the eight miles between home and work.

Powell Expected to Be More Flexible Than His Predecessors

He also has a reputation for being bipartisan and unafraid to stand up to members of his own party. In 2011, when congressional Republicans were threatening to allow the government to default on its debts if their policy wish list was not met, Powell met with a number of GOP lawmakers, urging them to reconsider their strategy by pointing out the serious risks involved.

“In my experience, the best outcomes are reached when opposing viewpoints are clearly and strongly presented before decisions are made,” Powell stated in a March 2017 speech at the West Virginia University College of Business of Economics.

Unlike his immediate predecessors—Yellen, Ben Bernanke and Alan Greenspan—Powell is a lawyer by training, not an economist. However, colleagues are reassured that his five years serving as a governor of the Federal Reserve Board have adequately prepared him for the top job.

In fact, his unique background might very well make him more flexible and less entrenched when it comes to economic theory. The Fed and its members tend to be highly academic in nature, and Powell’s pragmatic, real-world style could prove to be a valuable asset.

As I said earlier, Trump reportedly is a fan of Yellen’s gradual rate hikes—they’re less likely to derail the monster stock bull market than a more aggressive policy—and I imagine this contributed to his decision to pick Powell.

Managing Risk with the Near-Term Tax Free Fund (NEARX)

With Powell set to carry out the Fed’s process of raising short-term interest rates and gradually unwinding a $4.2 trillion portfolio of mortgage and Treasury securities, fixed-income investors are contending with big risks. Adding to these are the prospects for higher inflation as a result of faster economic growth.

So what are we doing at U.S. Global Investors to manage our funds in the face higher yields?

Our Near-Term Tax Free Fund (NEARX), which offers tax-free municipal income, appears to be well-positioned to minimize the impact of rising yields by keeping a short duration. Traditionally, shorter duration funds have outperformed longer duration funds in periods of rising rates. Longer-term funds, conversely, have done better when rates were in decline.

Additionally, in an effort to mitigate the impact of Fed rate increases on the front end of the curve—where we are largely positioned—we are tactically employing a cash buffer as well as maintaining exposure to floating rate notes. This defensive positioning is designed to help safeguard investor’s capital while still providing an attractive risk-adjusted yield income.

We wish Jerome Powell the best of luck! In the meantime, learn more about the Near-Term Tax Free Fund (NEARX) by clicking here!

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com. Read it carefully before investing. Foreside Fund Services, LLC, Distributor. U.S. Global Investors is the investment adviser.

Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Though the Near-Term Tax Free Fund seeks minimal fluctuations in share price, it is subject to the risk that the credit quality of a portfolio holding could decline, as well as risk related to changes in the economic conditions of a state, region or issuer. These risks could cause the fund’s share price to decline. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local taxes and at times the alternative minimum tax. The Near-Term Tax Free Fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

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With Rollback, Dodd-Frank Is Now Officially a Dud
March 19, 2018

With Rollback, Dodd-Frank Is Now Officially a Dud

I often remind investors to look past the negative and find the positive. Last week provided no shortage of big splashy headline stories, from yet another high-profile personnel shakeup at the White House to a nail-biter special election in Pennsylvania’s 18th Congressional District, from Russia’s alleged nerve agent attack on a former double-agent spy to a tragic bridge collapse in Miami.

If this is all you were focused on, you might have missed what I believe was the most significant development of the past few days. Last Wednesday, the Senate, in a bipartisan vote, quietly approved plans to roll back key banking rules in 2010’s Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

If the House also approves the bill, President Donald Trump is expected to sign it into law, thereby providing much-needed relief to smaller lenders and community banks that millions of rural Americans and small businesses depend on. Aside from tax reform, I think the relaxation of Dodd-Frank will be seen as Trump’s crowning fiscal achievement so far, as it has the potential to contribute greatly toward his goal of at least 3 percent economic growth.

Investors piled into an ETF that holds small to midsize banks following the news last week. The SPDR S&P Regional Banking ETF attracted $606 million in daily inflows, a record for the fund, according to Bloomberg.

Dodd-Frank rollback optimism fueled regional banking ETF record daily inflows
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The most sweeping and complex financial reform package since the Great Depression, Dodd-Frank was drafted in response to the financial crisis—yet few believe it would do much in the way of preventing another such crisis. Last year, the Treasury Department declared that the law, despite its ambitious scale and scope, has “failed to address many drivers of the financial crisis, while adding new regulatory burdens.” As such, the agency recommended a number of changes, including improving efficiency and decreasing unnecessary complexity.

Among the likely changes to Dodd-Frank: raising the threshold for tougher oversight from the current $50 billion in assets to $250 billion; exempting small banks from the so-called Volcker rule, which currently bars them from speculative trading; reducing the amount of financial reporting, particularly racial and income data on mortgage holders; lowering the frequency of regulatory exams; and easing the conditions of stress tests.

Community Banks Are Vital to the U.S. Economy

The cumulative effect of the rollback will be to lower compliance costs and allow banks to better service clients and shareholders alike. I can’t stress enough how important this is. Small community banks—those with under $10 billion in assets—are tremendously vital to the U.S. economy. According to the American Enterprise Institute (AEI), they provide a substantial percentage of lending to U.S. farms—about 44 percent. Nearly half of all small business loans in the U.S., and more than 15 percent of all residential mortgages, are issued by small banks.

16 year of small u.s. bank failures
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Last year, I included Dodd-Frank in a list of the five costliest financial regulations of the past 20 years. Since 2010, the legislation has undeniably had a negative effect on the banking industry, driving dozens of institutions to ruin and giving borrowers far fewer options. Between the year of its signing and 2014, the U.S. lost more than 14 percent of its small community banks, while the number of large banks rose 6.3 percent, according to the Mercatus Center at George Mason University.

Dodd-Frank Falling out of Favor

Support for Dodd-Frank is waning more and more. Both former Federal Reserve chair Alan Greenspan and billionaire investor Warren Buffett have come out strongly against it, with Greenspan saying he’d love to see the 2010 law “disappear.” For his part, Buffett believes that, as a result of the law, the U.S. is less well equipped to handle another financial crisis, as Dodd-Frank stripped the Fed of its ability to act.

Case in point: When now-defunct investment bank Bear Stearns was headed for failure 10 years ago this week, the Fed arranged an emergency loan of nearly $13 billion routed through JPMorgan. It also agreed to purchase $30 billion in Bear assets. But now, because of Dodd-Frank, such assistance is illegal since the law stipulates Fed lending must be broad-based and not directed toward a single institution.

Pres. Trump “cutting the red tape” in the Roosevelt Room, December 2017

Possibly the most telling sign that the 2010 law is losing favor among proponents is that Barney Frank himself, the former chairman of the House Financial Services Committee and one of Dodd-Frank’s chief architects, recently acknowledged he “sees areas where the law could be eased,” according to the Financial Times.

Speaking at this month’s annual Futures Industry Association meeting in Boca Raton, Florida, Frank said he “supports regulating banks differently based on their size” and sees the need to make it “easier for smaller banks to make loans such as mortgages.”

If you recall, lending procedures became so restrictive following Dodd-Frank that Ben Bernanke himself, Fed chair from 2006 to 2014, had trouble refinancing his home.

“I think it's entirely possible [lenders] may have gone a little bit too far on mortgage credit conditions,“ Bernanke remarked during a 2014 conference on housing.

More recently, President Trump claimed he had friends with “nice businesses” who couldn’t borrow money because of Dodd-Frank.

The easing of banking restrictions is just the latest in Trump’s ongoing effort to cut red tape that has stymied economic growth and disrupted the creation of capital. For many voters, his pledge to push for deregulation tops the list of reasons why he was elected, and I’m happy to see that he’s making good on this promise.

10 Years Since the Demise of Bear Stearns

The Senate’s approval to weaken Dodd-Frank came, appropriately enough, on the 10-year anniversary of Bear Stearns’ stunning collapse. The once-powerful institution—in 2007 it was the fifth largest U.S. bank, with $400 billion in assets—was among the earliest warning signs of a broad economic meltdown that would ultimately result in the stock market losing nearly half its value. Below is just a sampling of headlines from 10 years ago last week:

headlines from 10 years ago this week

As you’re no doubt aware, Bear Stearns’ demise was fueled primarily by excessive leveraging and overweight exposure to junk mortgage-backed securities. In an attempt to prevent the pathogen from spreading further, the Fed, as I mentioned earlier, brokered a deal for financial giant JPMorgan to buy Bear for as little as $2 a share.

We now know that the bailout provided only temporary relief. Six months later, Lehman Brothers, then valued at $691 billion, also fell victim to the subprime mortgage crisis. Today Lehman’s remains the largest bankruptcy filing in U.S. history.

So what lessons can we take away from Bear? Countless articles and thought pieces have been written on this topic over the years, including an excellent one by Justin Baer and Ryan Tracy that appeared last week in the Wall Street Journal.

Two lessons in particular stand out to me.

One, Bear showed us the painful consequences of failing to diversify. The bank had historically been known for its aggressive and risky investment strategies, but it was finally done in by its heavily concentrated position in bad mortgages. According to an analysis by former Lehman CFO Erin Callan, mortgage-backed securities accounted for a whopping 71 percent of Bear’s Level 3 assets—defined as those that are hard to value.

“Our liquidity position in the last 24 hours had significantly deteriorated,” announced Bear Stearns CEO Alan Schwartz, explaining to shareholders why he had no other choice than to accept an emergency bailout.

This is one of the many reasons why I recommend a 10 percent weighting in gold, one of the most liquid assets in the world. With 5 percent in gold bullion and 5 percent in gold mining stocks, along with an annual rebalancing, investors could potentially offset their losses in other holdings.

The second takeaway I’d like to point out is to focus on well-managed companies with healthy balance sheets. Near the end of its life, Bear Stearns was leveraged about 36-to-1, according to some estimates. For most firms, this is unsustainable.

Gold and the Global Ticking Debt Bomb

Unfortunately, corporate debt relative to U.S. GDP has now returned to prerecession levels, a risk made even riskier by rising interest rates. U.S. household debt, meanwhile, hit a new high of $13.15 trillion in the final quarter of 2017.

It’s for this reason that, when evaluating gold mining firms, we prefer those that do not rely primarily on debt to finance their operations. This recipe doesn’t always guarantee success, but should another financial meltdown occur, such companies will be in a much better position, financially, to weather the storm. 

To learn more about what we look for in mining firms, click here!

 

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

Diversification does not protect an investor from market risks and does not assure a profit.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 12/31/2017.

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The Many Uses of Gold
March 14, 2018

The many uses of gold

As our loyal readers know, at U.S. Global Investors we carefully monitor the price of gold. We pay close attention to the macro drivers moving the yellow metal, like government policy and cultural affinity spurring demand globally. We also monitor the micro drivers, like company management and quant factors that make one gold stock superior to the next.

Gold’s qualities make it one of the most coveted metals in the world and a popular gift in the form of jewelry – this is what I call the Love Trade. From the beginning of the Indian wedding season in September until Chinese New Year in February, the price of gold tends to rise due to higher demand from the two biggest consumers of gold, China and India.

The Love trade China and India gift gold for weddings and other celebrations

On the other hand is the Fear Trade, driven by negative real interest rates and the fear of poor government or central bank policies that could result in currency devaluation or inflation. This fear triggers people to buy gold as a hedge against possible negative returns in other asset classes, which in turn, pushes the gold price higher. 

For more on gold’s seasonal trading patterns, download the free whitepaper Gold’s Love Trade.

Gold in a Portfolio

We believe gold is an essential part of a portfolio due to its history as a protector against inflation. I’ve always recommended a 10 percent weighting in the metal, 5 percent in gold bullion or jewelry, and 5 percent in gold stocks, mutual funds and ETFs.

In fact, current economic conditions make an even greater case for gold. The stock market is still on a historic bull run, and the tax reform bill is helping ratchet up share prices. It’s important to remember that the precious metal has historically shared a low-to-negative correlation with equities. For the past 30 years, the average correlation between the LBMA gold price and the S&P 500 Index has been negative 0.06.

Gold has also performed competitively against many asset classes over the past few decades, as seen in the chart below. This makes the metal, we believe, an appealing diversifier in the event of a correction in the capital markets or an end to the bull market.

Gold has performed very competitively against a number of asset classes over the years
click to enlarge

Our investment team brings knowledge and experience in a variety of fields, with one of the most notable being gold. As such, we have written numerous pieces about the precious metal. One of our most popular is the Many Uses of Gold slideshow that outlines eight different uses of gold, other than in your portfolio. From dentistry to electronics and space travel to currency, gold remains widely used in everyday life.

We believe it’s important to truly understand the asset class you are investing in, and we hope this slideshow does just that. Explore gold’s many uses here!

Explore the many uses of gold slideshow

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

The Standard & Poor's 500, often abbreviated as the S&P 500, or just the S&P, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices.

The LBMA Gold Price is the global benchmark prices for unallocated gold delivered in London. The auctions are run at 10:30 am and 3:00 pm London time. The final auction prices are published to the market as the LBMA Gold Price AM and LBMA Gold Price PM.

Correlation, in the finance and investment industries, is a statistic that measures the degree to which two securities move in relation to each other. Correlations are used in advanced portfolio management. Correlation is computed into what is known as the correlation coefficient, which has value that must fall between -1 and 1.

The Bloomberg Barclays Short Treasury Bill Index tracks the market for Treasury bills issued by the U.S. government.

The Bloomberg Barclays US Aggregate Bond Index, which until August 24, 2016 was called the Barclays Capital Aggregate Bond Index, and which until November 3, 2008 was called the "Lehman Aggregate Bond Index," is a broad base index, maintained by Bloomberg L.P. since August 24, 2016, and prior to then by Barclays which took over the index business of the now defunct Lehman Brothers, and is often used to represent investment grade bonds being traded in United States. 

The MSCI USA Net Total Return Index is a market capitalization weighted index designed to measure the performance of equity securities in the top 85% by market capitalization of equity securities listed on stock exchanges in the United States.

The MSCI EAFE Net Total Return Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada. It is maintained by MSCI Inc., a provider of investment decision support tools; the EAFE acronym stands for Europe, Australasia and Far East.

The Bloomberg Commodity Index (BCOM) is a broadly diversified commodity price index distributed by Bloomberg Indexes. The index was originally launched in 1998 as the Dow Jones-AIG Commodity Index (DJ-AIGCI) and renamed to Dow Jones-UBS Commodity Index (DJ-UBSCI) in 2009, when UBS acquired the index from AIG. The S&P GSCI (formerly the Goldman Sachs Commodity Index) serves as a benchmark for investment in the commodity markets and as a measure of commodity performance over time. It is a tradable index that is readily available to market participants of the Chicago Mercantile Exchange.

Diversification does not protect an investor from market risks and does not assure a profit.

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The Historic Bull Market Faces Off Against Steel Tariffs
March 12, 2018

the historic bull market faces off against steel tariffs

Friday marked the ninth anniversary of the stock bull market, the second longest since World War II following the spectacular run in the 1990s that finally met its match when the tech bubble burst in March 2000. The current expansion, which some consider the “most hated bull market in history,” has largely been fueled by extraordinarily accommodative monetary policy in the form of massive money printing and near-zero interest rates. It’s withstood a number of significant headwinds, including a relatively slow economic recovery, the collapse in the price of oil and other commodities, ongoing conflict in the Middle East and an especially nasty presidential campaign cycle. If it can avoid dropping more than 20 percent in the next six months, it will become the longest-lasting ever.

can this bull market become the largest in history
click to enlarge

No doubt you’ve heard before that bull markets don’t die of old age. I can’t say for sure what will end this particular business cycle—no one can—but we’re seeing huge shifts in monetary and fiscal policy right now that investors can’t afford to ignore. As I often say, government policy is a precursor to change.

Unintended Consequences of Steel Tariffs

For one, the decade-long era of easy money is coming to an end. The Federal Reserve is unwinding its enormous balance sheet, its enormous balance sheet, which carries some risk.

us steel demand by industry

Meanwhile, the Trump administration is ratcheting up its protectionist trade policies. After surprising markets in recent days with plans to impose tariffs on steel and aluminum imports, President Trump signed the authorization Thursday afternoon, applying taxes broadly to all countries except Canada and Mexico. It was greatly feared that Canada, the number one supplier of steel and aluminum to the U.S., would be included, but it appears someone managed to change the president’s mind. When former President George W. Bush imposed a steep 30 percent tariff on steel imports in 2002, Canada was likewise spared.

The 2002 tariff, by the way, had some serious unintended consequences that critics of Trump’s policy hope are not repeated. A report put out by the Consuming Industries Trade Action Coalition (CITAC) found that about 200,000 Americans, in every U.S. state, lost their jobs in 2002 as a result of higher steel prices, representing some $4 billion in lost wages. More people, in fact, lost their jobs than the total number of people working in the domestic steel industry itself. Not surprisingly, a quarter of lost jobs occurred in steel-consuming industries such as machinery and equipment, automotive and parts manufacturers.

To be clear, U.S. steel companies did benefit from the tariffs, with profits in the first three quarters of 2002 rising $2.1 billion. This growth was offset, though, by a $15 billion decline in profits for steel-consuming companies.

Today, representatives of those same industries warn that the current tariffs could do more harm than good.

Roy Hardy, president of the Precision Metalforming Association, claims that they “will damage downstream U.S. steel and aluminum consuming companies.” Hardy estimates the tariffs could cost the U.S. economy 146,000 jobs this year alone, a figure that—as was the case in 2002—outnumbers the 140,000 Americans currently employed by the domestic steel industry.

As many as 107 House Republicans expressed deep concerns last week, writing in an open letter to the president that the “new taxes in the form of broad tariffs would undermine” the “remarkable progress” made by the tax overhaul. Meanwhile, outgoing Republican Senator Jeff Flake of Arizona said he would introduce a bill that would block Trump’s tariffs.

The tariffs come at a time when domestic steel producers’ balance sheets are steadily improving. According to Bloomberg data, the industry posted net profits totaling $2.5 billion in 2017, up from $60 million in 2016. The group lost a whopping $2.5 billion in 2015, with Pittsburgh-based U.S. Steel contributing the heaviest losses at $1.6 billion. 

domestic steel industry has seen three straight years of rising profits
click to enlarge

In the coming days and weeks, the tariffs should serve to boost domestic steel production and employment. The Wall Street Journal reports that U.S. Steel has plans to reopen a blast furnace in Granite City, Illinois, and call back 500 workers. This follows an announcement by Century Aluminum that it will double its workforce to 600 at a Kentucky smelter.

I’m pleased to hear this news but remain skeptical on the long-term impact. The U.S. now faces retaliation from its trading partners, from China to the European Union.

A Recession in the Near Term Doesn’t Look Likely

Despite some of the negativity, I see no cause for alarm with regard to the U.S. economy. The country added a whopping 313,000 jobs in February, the most since July 2016 and the 89th straight month of gains—a new record. Economists had anticipated only 200,000. Earlier, Moody’s chief economist Mark Zandi called the job market “red hot,” adding that with “government spending increases and tax cuts, growth is set to accelerate” even more.

One of the most historically reliable economic indicators currently looks very healthy. The Conference Board Leading Economic Index (LEI) opened 2018 on sure footing, posting a 108.1 in January, up a full percent from the previous month. The reading reflects “an economy with widespread strengths coming from financial conditions, manufacturing, residential construction, and labor markets,” the Conference Board writes.  

According to FactSet, a record number of S&P 500 companies have issued positive earnings per share (EPS) guidance for 2018. The financial data firm classifies positive guidance as an EPS estimate that’s higher than the mean estimate before the guidance was issued. As many as 127 companies shared positive EPS guidance for the year, more than double the 10-year average of 49 companies for the same period. FactSet attributes this optimism to tax reform, an improving global economy and weaker U.S. dollar.

record number of s and p 500 companies issued positive guidance for 2018
click to enlarge

And it’s not just large S&P 500 companies that are feeling confident. January’s Small Business Optimism Index found that a record percentage of small business owners are eager to expand. Thirty-two percent of owners said that “now is a good time to expand,” the highest such reading in the survey’s 45-year history.

Could Fertility Be a Leading Economic Indicator?

On a final note, a new study lends additional credibility to the theory of “wisdom of crowds,” which states that large groups of people are smarter and better at analyzing data than an elite few. In one recent example, I showed you how investors accurately predicted the election of Donald Trump as far back as July 2016.

But could declining fertility rates predict the next recession? A team of researchers from the University of Notre Dame thinks so, and they have some compelling evidence to support their idea.

Granted, there's nothing unique about the idea that birth rates drop during and after economic downturns. Married couples have tended to put off expanding their families when they see friends and neighbors being laid off and a greater number of foreclosed homes in their neighborhoods.

What makes this study worth discussing is that it suggests conceptions, those that result in live births, noticeably begin to drop months before a recession strikes. This pattern, according to the study’s authors, can be observed in recessions beginning in 1990 and 2001, as well as the Great Recession.

united states conception rates began to fall months before a recession
click to enlarge

Above, you can see the percent change in conception rates tumbled sharply sometime before GDP growth began to stall or even reverse course. Conception, then, could be used to anticipate recessions just as well as any other economic indicator.

In fact, conception rates could end up being even more accurate “in situations where employment significantly lags the overall economy, and where conceptions lead the economy,” the authors write.

So how are families able to anticipate and act on economic trends more reliably than professional economists? Again, the wisdom of crowds prevails. Everyday people no doubt sense the tremors before the earthquake by hearing things in their firms and comparing observations with friends and acquaintances. There’s no way to quantify this, of course, but live birth records in the U.S. are readily available.

You might be wondering what the data tells us about the economy’s health in the near term. Sadly, the study makes no mention of this. But in January, the Pew Research Center reported that U.S. fertility rates fell to 62 births per 1,000 women of childbearing age in 2017—a new all-time low.

Before you begin to panic, though, it’s important to know that there are different ways to measure fertility, which could skew the data. Also, the drop in fertility could just be further evidence that young adults are choosing to delay starting a family.

Regardless of the rate, people will continue to have babies, increasing the need for even more raw materials and resources.

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All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The S&P 500 Index is a stock market index that tracks the 500 most widely held stocks on the New York Stock Exchange or NASDAQ.

The Small Business Optimism Index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members.

The Conference Board Leading Economic Index is an American economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a non-governmental organization, which determines the value of the index from the values of ten key variables.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 12/31/2017.

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