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Tags: PMI | gold | dollar | US

US Economy Is in Second Gear

By    |   Tuesday, 02 July 2013 01:26 PM EDT

The Institute for Supply Management Purchasing Manufacturers' Index (PMI) for the United States came in at 50.9 for June, which was up from a weak 49.0 in May, indicating a slight increase in growth momentum in the months ahead, but still far below the 58+ numbers we saw in January 2011 until April of that year.

Unfortunately, it was not all positive news, as the employment indicator came in at 48.7, down from 50.1 percent in May, and prices, delivery times and inventories remained flat.

At the same time, we got a similar picture from the JPMorgan Global Manufacturing PMI, which came in at 50.6 in June, unchanged from May, but confirming an on average slightly weaker second quarter as compared with the first-quarter performance so far this year. Also, here we saw employment declining, coming in at 49.6 in June against 50.3 in May. Yes, global growth is far from robust.

I can't see any reason for getting really optimistic on solid sustainable growth prospects in the West as well in the East, where the Chinese economy is still in the process of trying to find its "new" growth model that could easily accept a "new" lower growth rate of about 5 percent in the second half of this decade. If that was to happen, no doubt this could cause unpleasant/negative surprises to the global recovery/growth scenario, as is still generally expected for now.

Long-term investors shouldn't overlook if the "Great Chinese adjustment" takes shape against the frightening background of developed and developing economies that will remain, proportionally of course, awash in debt. This includes hidden and off-balance sheet debts, at literally all levels of the spectrum — private, institutional as well as countries themselves. It won't be pretty.

That said, I have no doubt whatsoever we are bound for much higher volatility in interest rates from now on, which will translate into higher interest rates than we have been accustomed too since the start of the Great Recession.

In China we see the credit-driven growth model falling apart and we already have, for now at least, an inverse yield curve, which is not supportive for its economy. It becomes clearer by the day that authorities are trying to deploy all the means they have at their disposal to discourage credit creation for speculative ends and instead try to concentrate on providing credit to the real economy sectors like service, high tech, agriculture and smaller private businesses. From now on, indiscriminate loosening of monetary policy in China should be considered as definitively off the table.

In the United States, Federal Reserve Chairman Ben Bernanke was blamed for causing the latest sudden rise in yields for only saying in relation to quantitative easing (QE), "let up a bit on the gas pedal." There is no doubt this has caused the sell-off we've seen in commodities, bonds and stocks and has caused in these various markets short-term, oversold conditions.

As I see it, this latest turn of events should definitively warn long-term investors about the enormous hidden mine field(s) that lies ahead when any form of "exit" from QE will take place. Once it's under way, it will cause harmful volatility that will remain in the markets for a very long time.

I can't see how yields could remain low and not move higher under such circumstances. Investors would do well taking the possibility of higher yields into account when they recompose our portfolios, probably in the near future.

So far, the QE end result is not in sight. No, not by a long shot. Only then, and it doesn't matter whenever that is, we will know if Bernanke's experiment will have been successful or not. I sincerely hope it will be, but I have my serious doubts.

In the European Union, the next "foreseeable" crisis will push yields up again for all eurozone member sovereign bonds, now that the much-touted banking union was definitively put in the "freezer" for not saying decapitated last Friday in Brussels.

This event will have deep negative economic consequences, not at least for the so-called southern peripheral economies that remain in depression with record-high unemployment rates, of which the youth unemployment rates in the southern peripheral states are now even higher than during the Great Depression. In my opinion, it's only a question of time when renewed doubts about the viability of the monetary union will resurface again.

Let me explain with an example concerning Spain. To rescue Spain, which had a total external debt — including private and public debt — of about 170 percent of gross domestic product at the end of 2012, if the EU banking union would have become operational, it would have cut definitively the link between the Spanish state and the banks, and that by itself would have provided sufficient security for "sustainably" remaining inside the EU monetary union.

Now, as this form of security, or let's say guarantee, is no longer there, I have a lot of difficulty to imagine how Spain's economic reforms and fiscal adjustments will be implemented and accepted by the Spanish population going forward from here on. Of course, wonders can happen, but I surely wouldn't bet on it.

Finally, on gold in the short to median term, it's a fact that the "easy" selling of commodities, which includes of course gold but doesn't include crude oil for now, has been accomplished for a large part, which is in great contrast with the situation in stock, bond and emerging markets.

Any bounce like the ones we have seen now should be considered as completely logical when you have a short-term, oversold situation. These short-term bounces should certainly not be considered as victories for the long-term investor because they most probably will end up as nothing more than Pyrrhic victories. But that doesn't mean I don't see the U.S. Treasury yields move down and prices up somewhat for a relatively short period of time.

I'm still convinced that when U.S. bond prices have their first "real" wave down it will NOT be announcing "recovery" or "inflation." Of course, this will not be supportive for gold prices, as well as for stock and commodity markets.

Last Friday, there were only 9 percent gold bulls in the U.S. markets, as measured by the Daily Sentiment Index, which was interestingly the first time that happened in the 26 years since that index began. Yes, when optimism is at the bottom, that is normally a moment when buying becomes interesting. It's also a fact that the gold price per ounce is now down by about 64 percent since its high at $1,923 in September 2011.

In today's price situation and provided the gold price per ounce doesn't move below $1,210, it could easily move back up toward $1,300 and even $1,400. Take care, once it moves below $1,210 per ounce it could easily move further down to the $1,050 to $1,100 per ounce zone, at which levels I'd start to consider starting to buy.

Please take care, a lot will depend where the U.S. dollar moves.

Long-term investors should not overlook the fact we are at the dawn of an extended period of an unfolding "global cash crunch," with higher interest rates that will be dictated by the markets and not by the central banks as well as a higher U.S. dollar.

Watch out when the dollar index (DXY) moves back above $84.60, which was its high in May this year.

Thereafter, if the dollar index moves back above $88, where it stood in June 2010, there is a potential we'd see gold below $,1000 per ounce.

Please keep in mind it is generally accepted the total production cost for gold is in the $1,200 per ounce zone.

Besides all that, my expectation of a broad-based correction hasn't changed at all, as technically spoken (waves) we're only at the beginning of an extended, long-term downward wave C.

All that said, my preferences remain mostly concentrated on the United States and U.S. dollar.

Christine Lagarde, head of the International Monetary Fund, just made an interesting remark when she commented on the state of the U.S. economy saying it is in "second gear."

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Long-term investors should not overlook the fact we are at the dawn of an extended period of an unfolding "global cash crunch," with higher interest rates that will be dictated by the markets and not by the central banks as well as a higher U.S. dollar.
Tuesday, 02 July 2013 01:26 PM
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