Posts tagged ‘commodities’
Yesterday, just before lunch, some information was released by the Bank of England about the timing of the UK’s first rate hike. As a result, the pound posted its biggest one day fall against the dollar since August’s ghoulish gurgitations, the FTSE 100 reversed its morning losses and gilt yields fell across the curve. We know that markets are hanging on to every scripted syllable out of central banks these days – and the Old Lady had clearly delivered some big, big news.
Rather unfortunately it was not clear from the coverage exactly what this was. The headlines were all over the place. “Bank of England signals rates can remain at lows until 2017”, declared the FT, echoed by the equally authoritative voices of The Economist – “The Bank of England may not raise interest rates until 2017” – and the Daily Express (“Interest rates may not rise until 2017, hints Bank of England”). On the other hand the Daily Telegraph asserted that “Global growth risks likely to keep rates at record low well into 2016, BoE suggests”, a more hawkish position putting it in the same corner as The Guardian (“Bank of England to leave interest rates at 0.5% until well into next year”).
So what had happened? Had the Bank signalled, hinted or suggested? And was the substance of whichever denotation that it would hike next year, or the year after? A year is a long time in these uncertain markets, and it would be useful to know.
The headlines were inspired of course by the release of the unmissable quarterly that is the Bank of England’s Inflation Report. But what could explain such varied interpretations of exactly the same material?
Look below the headlines and there were suggestions, or perhaps signals of the answer. The Economist piece, characteristically, brimmed with patriotic vigour, noting that Britain’s economy was now so pathetically weak that it couldn’t even produce the laughably stunted amount of inflation necessary to warrant a single miserable rate rise. The FT referred to the forecast path of inflation. The Express covered the bases on both domestic growth and inflation, while noting the impact of weaker growth abroad in passing. Both the more hawkish papers touched on this ground too, but interestingly also gave space to the impact of low commodity prices and a seemingly contrarian view that the domestic UK economy remained resilient.
This blog does its own homework and usually reads the salient parts of the Bank’s Inflation Report, together with the accompanying and much shorter but (if anything) more instructive Conditioning assumptions, MPC key judgements, and indicative projections data. And it is obvious from the latter that future assumptions about energy prices are much lower now than they were back in the summer – understandably so: as the small print tells us, they are based on futures prices and these have fallen. The Bank’s new prices for gas and oil in 2016 are respectively lower by nine and ten percent. As the s.p. further helpfully explains, these numbers “are used as conditioning assumptions for the MPC’s projections for CPI inflation, GDP growth and the unemployment rate.”
Given that these energy price effects will prove more or less transitory – even assuming they do not reverse over the Bank’s two-year forecast horizon – it is perhaps foolish to read too much into them. It is certainly a mistake to confuse them with weakness in the domestic economy. As Governor Carney himself noted in an afternoon interview with Bloomberg Television:
“My personal view is it is important that we look at [core CPI] particularly because of this imported disinflation, it shows up through core inflation,” he said. “What we want to avoid is to have cost pressures build up too much domestically to the extent that once these foreign factors ultimately pass through the economy, we’re overshooting that inflation target because of domestic strength.”
And the headline of this piece? “Mark Carney: Prudent to Expect U.K. Rate Rise in 2016”.
Economically speaking there has been little drama or excitement in the UK over recent months. While markets agonized over Greece, and then China, and subsequently the Fed, the British economy quietly kept on going. There have been no growth surprises in either direction; no change to the Bank of England’s guidance or rhetoric on interest rates; no unexpected outcomes in the labour market, or price indices, or activity indicators. The PMI survey for September showed a bit of weakening in output. And Mark Carney did have some diverting things to say about topics other than monetary policy (climate change for instance). But all in all, it has been an uneventful time.
Nonetheless the UK markets are of key importance to British investors and do not always reflect goings on in the economy, to say the least. So while the economy might not invite too much scrutiny just at the moment, here is a summary of conditions across the major UK asset classes.
Starting with property, the residential market rally that took off in 2013-14 continued into this year but has abated somewhat. Government data showed a 5% increase in house prices in the twelve months to August, down from a 12% annual rate in the early autumn of last year. Valuations are mixed: the simple average earnings to average house price measure suggests the market is red hot but on this measure that has been true since 2004. Using a measure of mortgage affordability (which takes account of interest rates) the market is priced fairly: the ratio of average mortgage payments to average earnings is almost exactly in line with the average since 1976.
The commercial property market has been having a jollier time of things, with the Investment Property Databank All Property total return index up 15% over the twelve months to September. Again, the valuation picture is mixed. Rental yields have fallen sharply over the last couple of years and are about as low as they were at the peak of the late 1980s boom (though still a little way off the lows seen before the Great Recession). On the other hand, the rate of capital growth has not been as aggressive as in previous rallies and there is some distance before the market surpasses its 2007 peak.
Staying at the riskier end of the spectrum the equity market has been picking up nicely in recent days. The FTSE 100 has risen by 5% so far this month and is now 8% above the low it marked towards the end of August – though remains 10% below the record set back in April. There has been pressure on earnings from currency and commodity effects this year so the improvement in valuation since then has actually been rather muted: the forward p/e ratio has risen from 14x to 16x, which looks toppy against a ten year average of 12x. At the same time, however, the dividend yield has risen from 3.5% at the end of last year to 3.9% today (the ten year average is 3.6%).
Talking of yields, the gilt market has barely shifted from where it began the year. All the key maturities – two year, five year, ten year, thirty year – as well as the ultra longs are within 10bp of where they ended 2014. There is one exception: the ultra long end of the index-linked market has rallied, with the yield on the 0 3/8% 2068 linker down 16bp to an uncompelling -0.8% in real terms. The ten year conventional gilt yield stands at 1.8%.
Corporate bonds have similarly had a dull time of things, at least in the investment grade arena where widening spreads have seen total returns of about 0.5% according to the Bank of America Merrill Lynch family of indices. High yield has done better: spreads are about where they were at the start of 2015 so there has been relatively little capital impact on income return (the total return on the sterling high yield index stands at 4% for the year to date). In valuation terms credit spreads are much higher than they were in the years preceding the 2007 crunch but not very compelling against average levels given the scale of the collapse at that time. Using the Markit iTraxx Europe index as a benchmark the price of investment grade credit is just over 80bp today, up from a pre-crisis low of 20bp but somewhat below a ten year average of 90bp.
There is nothing much to say about cash with base rate stuck at 0.5% for the last six and a half years, though the worst performing assets of all are to be found in the commodity space. The near Brent crude oil future has rallied from the new bottom it reached in August (by some 14% in fact), but is still worth less than half what it was before the crash last year. The economic and market consensus is for very limited improvement over the coming months and with supply still materially stronger than demand there seems little reason to argue with this. There would also appear to be the will in some important quarters for oil to stay cheap: Saudi Arabia alone increased daily production by just over one million barrels during the first seven months of this year.
Precious metals have had a better time of things too lately and both gold and silver are trading very near the levels at which they began the year. Still, gold at $1183 an ounce remains expensive relative to inflation-adjusted 30 and 40 year averages of $793 and $825, even though that price is almost 40% below the $1900 reached at the peak of the bubble.
At this point we have departed from strictly British assets of course but that, at least, is all the key bases covered!
It has not been the easiest of years for UK investors and readers will have noted that this blog sees continued volatility ahead. But there are always opportunities amid uncertainty. Time will tell if we are able to find them out.
With 2014 now a few days old it is time to have a look at what markets delivered during 2013. (All returns data is given in GBP terms.)
The risk-on pattern established from the summer of 2012 continued, with the MSCI World Index returning exactly 25%. Of this, 23% had been reached by the time of the Japanese market crash towards the end of May. Risk-on was highly selective, however. By the same point, the MSCI Emerging Markets Index had lagged on concerns over growth in developed markets, delivering only 8.1%. EM took a particularly hard battering in the weeks that followed. With recovery into year end only partial, returns for the whole period were modestly negative and trailed the World Index by a staggering 29.3%.
Variety within these numbers was enormous. While markets in Nigeria, Bulgaria and Argentina all returned around 40-45%, stock indices in Brazil, Turkey and Peru lost around 30%. Among developed markets the US did best, delivering 29.7%. The Nikkei 225 and Euro Stoxx 50 were close behind, returning 26.5% and 25.8% respectively; and the FTSE 100 turned in a most respectable 19.2%.
Major government markets generally had a poor year. The 10-year gilt yield rose by 1.2% to close at 3% – exactly the same story as for the 10-year US treasury. Japan did better, closing broadly flat at 0.7%, and Germany wound up somewhere in between, with the 10-year bund yield creeping up from 1.3% to 1.9%.
In returns terms the top performers came from the eurozone periphery, with the Greek market delivering an extremely un-bondlike 40%. Spanish and Irish markets returned 14%, paltry by comparison, but again, rather extraordinary for government markets. Allowing for currency weakness the poorest performers were South Africa, Australia and Japan, which lost 18-20%; in local currency terms, however, it was the big developed markets which fared worst.
Credit generally had a storming time. The iTraxx main index of European CDS prices registered a fall in investment-grade spreads from 117bp to 70bp, only 5bp above the post-crunch low seen in January 2010. The crossover index, a measure of high yield risk pricing, saw spreads fall by almost 2%, smashing through similar lows to reach 282bp, a level not witnessed since late 2007. The exception was emerging market sovereign debt. Here, the BofA / Merrill Lynch index of hard-currency-denominated bonds from EM issuers saw spreads rise from 248bp to 297bp with the weakness concentrated in the first half of the year.
After a shaky start the pound had a respectable year, closing 1.7% higher on a trade-weighted basis. It was little changed against the dollar and the euro (about 2% stronger and 2% weaker respectively), though put on 19% against the yen. In fact, only a handful of what Bloomberg calls the “expanded majors” beat it, with the top performer in that basket being the Israeli shekel, which topped sterling by 5.5%. The Chinese yuan, subject as it is to a policy of gradual, managed revaluation, gained 1% against the GBP, and a couple of the emerging European countries squeaked a little higher too.
At the bottom of the pile the action was much more dramatic: emerging market currencies from South America to the Far East tumbled by as much as 20+%.
Appearing as they now do on various currency screens it seems appropriate to link this section with the last one by starting out with a look at gold and silver. And what an unpleasant sight meets the eyes: gold dropped by 29% against the pound and silver by 37%. In fact, in its “home” currency of US dollars, gold saw a twelve-year bull run end in 2013 and its biggest yearly percentage fall since 1981. (The latter point also goes for silver.)
It was a quiet year for oil, with the near Brent future flat over a year which saw price volatility reach some key lows. More interesting was the gas market, with the NYMEX future rising by 26%, its second consecutive annual increase.
Less interesting from an investment point of view but of some economic interest, the Bloomberg index of industrial metals prices dropped by 8% while the Baltic Dry Index of freight more than tripled (+226%).
Last, but for UK investors especially, far from least: bricks and mortar. The Nationwide index of house prices for December was out this morning and showed an increase of 8.4% on the year, the highest rate since June 2010.
Commercial property has had a duller time. IPD data for December is not yet available but the trend in recent months has been positive and we are on course for an increase in capital value across all sectors (retail, office and industrial) of about 2.5% for the year. Interestingly, this index remains 36% below its 2007 peak, and lower even than the previous high reached in 1989.
In Conclusion …
2013 presented investors with a decidedly mixed bag of results. Past performance is of course no guide to future returns and it would be otiose to extrapolate from or over-interpret them. What is clear, however, is that trends in some markets have been much more pronounced than others; and although much market behaviour has been logically and intuitively correlative, in some cases these trends have diverged to the point of incompatibility. Should they reconverge in 2014 it could be a good year for investors – if we manage to find ourselves on the right side of the reconvergence …
The S&P 500 index has roared through 1700 for the first time ever. US GDP for Q2, expected to come in at 1.0% annualised, hit 1.7% on the advance estimate instead. Jobless claims reached a new five-year low. It is clear in some quarters that “the US is the engine of global recovery“.
Elsewhere, enthusiasm about the growth data in particular has been tempered. After all, the number for Q1 this year – which began life estimated at 2.5% and was later cut to 1.8% – was revised down further to 1.1%. And the figure for Q4 2012 was cut to an almost flat 0.1%. In fact, in real terms the American economy expanded by a rather torpid 1.4% over the full year from Q2 2012 to Q2 2013.
Which brings us on to the stock market. The S&P 500 is 25% higher than it was a year ago but reported earnings per share for the quarter so far (393 index members) are up by only 3.6%, and have actually fallen by 2% for non-financials. So over the last twelve months the p/e ratio has jumped back to its pre-recession level – about in line with the long run average for the index. US stocks are not yet expensive by this measure but they are no longer cheap.
This is not to knock the rally. There is a bigger gap between rhetoric and reality than there is between reality and market behaviour. Confidence and activity indicators are consistent with continued, solid growth, albeit at a sub-trend pace, and that’s always better than the alternative. There was a marked correction across equity markets in May-June, which slowed the pace a little, and there will doubtless be more volatility to come. It does not look as if there should be much reason to argue with a measured, patchy uptrend in the US stock market. That’s what’s happening to growth and earnings too.
It is instructive to compare the lie of the land this year with the immediate aftermath of the credit crunch. In 2009 confidence began to improve way before the Great Recession ended. It became clear that capital losses and writedowns in the banking system had peaked in Q4 2008, and that was enough for the S&P to return 50% over the year to 31 March 2010. It was not until the Greek crisis that the scale of contagion began to be more widely understood, and market confidence has still not fully recovered from the demeaning misery of having to absorb fixed income ephemera such as what a “Fitch” is and how one might go about swapping a credit default.
So US equity has shown about half the exuberance in price terms since last summer as it did over the 12 months from Q1 2009. Again, let us stress that this does not appear unreasonable. But back in ’09 of course it was not just a select group of developed-world stock markets that embraced the transformation in morale.
Over the same 12-month period – from Q1 ’09 to Q1 ’10 – the MSCI Emerging Markets index returned 82%. The yield on the ten year Treasury rose by 1.4%. The trade-weighted dollar fell by over 8%. Investment grade credit spreads in Europe fell by 95bp. Brent crude futures were up 68%, COMEX copper futures up 93%.
Much of this seemed absurd at the time, and in hindsight seems especially so. What is useful, perhaps, is to note what a really abandoned recovery in confidence looks like, and to compare these numbers and others with the very much more tentative present upturn.
The move in Treasuries has been similar, with the ten year yield up 1.2%. Compared to ’09, therefore, bond bearishness has outpaced stock market optimism. And that optimism has been much narrower: the MSCI EM equity index has returned only 4%. Credit markets have broadly kept in step with Treasuries, tightening by most but not all of what they managed back in 2009-10 (80bp so far). On the other hand oil has gone nowhere and base metals have fallen.
There are always risks and always fundamental changes to consider. So there were four years ago. What differentiates markets today is that they are less certain – more confused – than they were back then. If the confidence felt on Wall Street is justified, and if this confusion should diminish, there are a number of dots which need to be joined before the picture across asset classes looks composed once again.
The gold market has been interesting again recently. Following a few months’ stately decline it suddenly collapsed over the weekend, losing more than $200 per ounce in the course of two days’ trading (prices here). It has bounced a little since but remains 20% down over the past six months. Now the gradual decline could be explained by reference to dollar weakness, but the spike down suggests something else.
Reuters has some interesting comments from Singapore overnight. Asian investors are at least as hooked on gold as are some of us in the west, and generally assumed to be keener buyers at a retail level. Here’s what a gold trader had to say:
Prices have suddenly jumped but I guess it’s because gold
has broken the $1,400-level again. Technically, people are just
buying up again …
This is from the global head of commodity strategy at ANZ:
A key factor to watch will be gold (exchange-traded fund)
ETF holdings, with a stabilisation in ETF holdings and then
fresh ETF buying to restore some of the lost confidence for
longer term gold investors.
The rest of the article waxes on about declining inflationary risks in the US and putative bullion sales by European central banks. As regular readers will know, the economic arguments used to explain the price behaviour of gold have always been utterly specious. The rally has been driven by sentiment – a heady mix of panic over the world at large and greed at the prospects for the supposed opportunity presented by gold ownership in particular.
So what is interesting about the discussion and coverage now is that the focus has shifted to this way of thinking. Note that the professionals comment on technically-driven trading and investor interest. This is what is getting the attention. Wise-sounding opinions on “fiat currency”, quantitative easing and so on are being displaced by the rather less elevated analysis of the commodity market’s real drivers: supply and demand.
Gold has always been a safe haven – in a sense. (It is, after all, a costly and highly volatile one.) Should funk set in again it might well reach the $2,000 or even $10,000-an-ounce levels being predicted for it with some confidence only 18 months ago.
Meanwhile, however, it would be consistent with growing confidence for investors to lose their appetite for gold as a haven asset. Perhaps what we are seeing is a buying opportunity, as is being advocated by some. Alternatively, this could be the early popping sound of a major bubble.
We are only 46 days into 2013, but it feels as though markets have covered a lot of ground already. The FTSE 100 index is up 7.5% so far, which would make a decent positive return for a full year. So it is something of a relief that risk assets have had their exuberance contained in the last week or two by weaker than expected Q4 growth numbers from the major developed economies (the US at the end of last month, Japan on Wednesday and the eurozone a day ago).
With all the excitement we have been enjoying in equity markets, however, it has been easy to overlook the more mundane – and in some cases, divergent – pricing behaviour of other assets.
Oil, for example, is only $4-$5 a barrel higher, and remains well below the levels reached in early 2012. The story is similar for industrial metals.
Precious metals have been more enigmatic. Silver had a strong January but has since fallen to where it ended last year. Gold shrugged off the euphoria last month to begin the year flat, before dropping just shy of 3% in dollar terms in what we have seen of February so far. Both metals remain on the downward trajectories established for them since risk assets began to recover a few months ago, but the shorter term dislocations and contradictions are as mystifying as ever.
More mystifying still has been the behaviour of credit. Safe haven government bond markets have been acting as one might expect: 10 year yields in the US, Germany and the UK are 25-35bp higher on the year so far. But investment grade credit spreads, as measured by the Markit iTraxx Europe index, are barely narrower from December’s close. At the same time, the rally in emerging market debt has stalled, with the JP Morgan EMBI Global spread a few bp wider.
Currency markets, more reassuringly, are aping equities in that they have also paused for breath this month after following a consistent pattern. The euro rallied strongly, and has now faltered. The yen continued its sharp decline – which has slowed. The world’s new-found and startling allergy to sterling has stabilised. All this could tie rationally in with improving sentiment over the world economy (now paused) and the abandonment of safe havens (ditto).
The economic outlook, as always, is uncertain. Those GDP numbers we’ve seen of late have not been encouraging. But other data has been positive: on American jobs, Chinese activity, European (and UK) sentiment … So far, despite the hiatus, and the short term dislocation in risk pricing between some asset classes, markets are giving the world the benefit of the doubt.
This blog is inclined to agree with them. There is one market we have been following for some time: the peripheral European bond market. Back in November ’11, when panic was the only thing some wanted to buy and Italian 10 year paper was hovering around 7-7.5%, we observed:
It was hugely significant during the recent [Aug 11] crash that Italy’s bond yields did not rise to dangerous levels. If they continue to hold their ground – or better yet, if confidence improves and they fall – catastrophic contagion in the eurozone is unlikely to occur. Talk about the banks, and haircuts, and credit derivatives is all very interesting. But if you really want to know how afraid to feel, just keep an eye on those bonds.
Year to date, spreads on Spanish, Italian, Greek and Portuguese debt to Germany have continued to narrow. This measure has survived the stall in equity pricing. In terms of absolute yield, Portuguese 10-year debt has fallen from almost 14% to a little over 6% in under a year.
Bond markets have decided that fear is not going to win this winter. As ever, their view is subject to the verdict of time. And as ever, the inconsistencies and dislocations we have seen emerging during the excitement of 2013 so far will be resolved – one way or another.