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An Interest Hike Doesn’t Mean That Gold Price Must Crash

Summary The Fed chairwoman Janet Yellen stated that the U.S. economy is strong enough for the Fed to start raising the benchmark interest rate. The pace of the U.S. GDP growth and the inflation rate don’t indicate that there is any need to raise the interest rate. Any interest rate hike will be probably only symbolical and it won’t be followed by another interest rate hike anytime soon. History shows that gold and GLD prices often react on the interest rate changes in contrary to the theory and general expectations. Gold price has been in a strong downtrend for the last couple of weeks. The SPDR Gold Trust ETF (NYSEARCA: GLD ) reached a new multi-year low, just shy of the $100 level. It represents a more than 10% decline since the middle of October. The decline was driven by increased expectations that the Fed will raise the key interest rate as soon as in December. The probability was further supported by a very strong October job report . Although the November data are a little weaker and some of the economists, including Peter Schiff claim that the state of the U.S. economy is worse than the numbers show, statements of the Fed representatives still indicate that the interest rate may be hiked this month. According to Janet Yellen, chairwoman of the Fed, the U.S. economy is strong enough for the Fed to start raising the benchmark interest rate. Is an interest rate hike needed? The probability of a December interest rate hike is high, although I don’t see any good reason why to raise it. Yellen explained why the Fed wants to raise the interest rate when she stated : Were the FOMC to delay the start for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from overshooting. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into a recession. Yes, the reason is good. The above-mentioned statement makes sense. But the officially-presented data don’t indicate any risk of an overshooting anytime soon. The annual pace of the GDP growth rate is only slightly above 2% and the inflation rate is at 0.2%! Actually, the deflation is much more probable than overheating of the economy, according to the official data. There are a lot of discussions about the accuracy of the officially-presented data. For example, according to John Williams and his website Shadowstats.com , the current inflation rate is close to the 4% level using the 1990 methodology, and it is around 7.5% using the 1980 methodology. In this case, we can start to speak about overheating of the economy. It really seems that the Fed publicly presents one set of macroeconomic data and it makes policy decisions based on another one. (click to enlarge) Source: Trading Economics Moreover, raising the interest rate too much may damage the U.S. economy. The strong USD already has a negative impact on the U.S. exporters. It may also damage the foreign economies, as a lot of the companies around the world have big USD-denominated debts, and they are dependent on revenues denominated in other currencies. As the value of these currencies falls, the companies will have more and more problems with the debt service. There are a lot of reasons why to expect that if there is any interest rate hike this December, it will be only symbolical and it will probably take quite a lot of time before another hike will occur. There are various economists who have the same opinion and they don’t see any good reason to increase the interest rate right now. One of them is Peter Schiff who expects that the Fed will leave the interest rate unchanged or it will raise it by 0.25%. He assumes that both of the outcomes will be positive for gold, as the markets have already factored in substantially more than a 0.25% interest rate growth. How did GLD share price react in the past? Although theory says that GLD price should decline after an interest rate hike and it should grow after an interest rate cut, history shows that this anticipation is often wrong. The financial markets always try to predict the future development, and the interest rate change is often reflected by the asset prices before the rate change itself is officially announced. And if there was a strong trend before the rate change, the trend may get disrupted for some time, although it tends to resume after the dust settles down. 22 interest changes occurred since the inception of GLD. In 12 cases, the interest rate was increased and in 10 cases it was decreased. The table below shows the development of GLD share price 20, 10 and 5 trading days before the rate change and 5, 10 and 20 days after the rate change. It is interesting that on average, GLD price grew before the interest rate change and it was in a slight decline 5 and 10 trading days after the rate change. But 20 trading days after the rate change, it was back in green numbers. Only in 4 out of 12 cases (33.33%), the GLD price recorded any losses 20 trading days after the interest rate hike. It declined by 4.73% on average. On the other hand, in 66.66% of cases, the GLD price recorded gains (5.08% on average). In 4 cases (33.33%), the GLD price just kept on growing, without any reaction on the interest rate hike. After the Fed started to cut the interest rates, GLD was down in 50% of the cases after 20 trading days. After the interest rate cuts on March 18, 2008, October 8, 2008 and December 16, 2008, a strong growth trend turned into a steep decline. It shows that GLD often reacts contrary to the theory not only after interest rate hikes but also after interest rate cuts. (click to enlarge) Source: own processing, using data of Yahoo Finance and the Fed Conclusion If the Fed hikes the interest rate during its meeting on December 15/16, it doesn’t mean that gold and GLD prices must crash. The official macroeconomic data don’t indicate that the U.S. economy should start to overheat anytime soon; moreover, a too strong USD may hurt not only the U.S. economy. Any rate hike will be only symbolical and it will probably take a long time before another one will occur. The markets may actually welcome that the more than a year long saga is finally over, and the GLD price may react positively. As the not-so-distant history shows, it wouldn’t be the first time when GLD price grows after an interest rate hike. Adding to it the problems the gold miners have to face at the current gold prices and the high demand for physical gold, GLD presents an interesting contrarian opportunity.

EWZ October Review: The Brazilian Market Grows, But Major Risks Still Remain

Summary EWZ increased by 4.19% in October. The economy is in a bad shape, unemployment and inflation rates keep on growing and GDP should decline also in 2016. Rousseff’s approval rate is extremely low and the probability of an impeachment keeps on growing. The situation in Brazil is complicated and hard to predict. Shares of iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) increased by 4.19% in October. Growth was fueled by growing commodity prices during the first decade of October, but as the commodity markets started to weaken again and some new negative news about the Brazilian economy were published, EWZ started to decline. The Brazilian economy is in a bad shape. The Brazilian government revised its 2015 GDP decline estimate from 2.44% to 2.8%. It also estimates the 2016 GDP decline at 1%. Government debt should grow above 70% of GDP in 2016. The unemployment rate is at 7.6%, which is a huge increase compared to last year’s 4.9%. And there is also the inflation rate of 9.79%. And the political crisis deepens as well. The opposition filed a petition for the impeachment of president Dilma Rousseff. The petition is based on the ruling of the federal audit court that Rousseff’s government manipulated the accounts to hide the real extent of government deficit in order to enable a higher level of government spending before the presidential elections. Rousseff’s approval rate is below 10%, according to recent opinion polls. The 8 biggest holdings of EWZ remain the same as in September. The biggest weights have shares of the beer and soft drink producer Ambev (NYSE: ABEV ) (10.72%) and preferred shares of Itau Unibanco (NYSE: ITUB ) (9.49%). The combined weight of common and preferred shares of Petrobras (NYSE: PBR ) is 6.28%. The 15 biggest holdings represent 62.22% of EWZ’s portfolio. Source: own processing, using data of iShares.com EWZ share price increased by 4.19% in October. Out of its 15 biggest holdings, the best results were achieved by Embraer (NYSE: ERJ ) and Petrobras. Shares of the airplane maker Embraer grew by more than 10%. It was second consecutive month of double-digit gains for the company. The share price was supported by new airplane orders. Petrobras shares had a great start to the month, as oil prices spiked and the company announced huge spending cuts. Although the initial enthusiasm faded gradually, the oil giant finished October up by almost 10%. On the other hand biggest decline was recorded by BRF-Brasil Foods (NYSE: BRFS ). Shares of the major refrigerated and frozen food producer declined by almost 15%. Most of the decline occurred after the company announced its Q3 2015 financial results. (click to enlarge) Source: own processing, using data of Bloomberg Petrobras still shows its importance for the Brazilian economy and the stock market and it maintains very high and stable correlation with EWZ. On the other hand, the correlation between RSX and the United States Oil ETF (NYSEARCA: USO ) and between RSX and S&P 500 declined strongly during the last two decades of October. (click to enlarge) Source: own processing, using data of Yahoo Finance Volatility of EWZ share price was very high during the first half of October, when it reached a new 2015 high at the 7% level. But the situation calmed down rapidly in late October and the 10-day moving coefficient of variation declined to levels last seen back in early July. However, given the pattern from the last months, the relatively calm time period probably won’t last for too long. (click to enlarge) Source: own processing, using data of Yahoo Finance Some of the more interesting news: Petrobras announced that it plans a partial spin-off of Petrobras Gas. Petrobras also revealed the September production numbers. The company produced 2.72 million barrels of oil equivalent per day in September. It represents a 5.55% decline compared to August. Petrobras confirmed its 2015 and 2016 production targets and announced the intention to divest $14.4 billion in 2016. The 2015 and 2016 investments were cut by $11 billion. Embraer announced that SkyWest (NASDAQ: SKYW ) ordered 19 E175s jets. The company also estimates that there will be demand for more than 1,500 new 70-130 seat airplanes in Europe over the next 20 years. BRF-Brasil Foods announced the acquisition of sausage, hamburger and margarine trademarks present in the Argentinean retail market. The transaction was worth $43.5 million. The company also announced that it intends to acquire a part of the frozen distribution business of the Qatar National Import and Export Co. Vale announced that it produced 88.2 million tonnes of iron ore in Q3 which is a new production record. The company also announced that it has become the lowest-cost iron ore producer in the World, with cash costs as low as $12.7 per tonne. Conclusion Although EWZ grew in October, there are a couple of issues that prevent any sustainable long-term growth. The Brazilian economy has a lot of problems. Commodity prices are weak. Various foreign entities sued Petrobras due to the corruption scandal and kick-back schemes. And the position of president Rousseff seems to be more and more unstable, and the probability of an impeachment grows. Although the impeachment may be welcomed by financial markets in the end, the initial period of insecurity may hit the Brazilian stock market hard. It would be too brave to claim that the bottom has been already reached and growth will continue.

EWZ: August Review

Summary EWZ share price declined by more than 13% in August. The decline was caused by weak commodity prices, uncertainty on global financial markets and Brazilian political instability. Brazilian GDP declined by 1.9% in Q2 2015, unemployment rate is at 7.5% and inflation rate attacks the 10% level. It is hard to expect any major recovery of EWZ share price anytime soon. Share price of the iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) kept on falling in August. Its value declined by 13.3%. The Brazilian share market has been hardly hit not only by the problems of Chinese economy but also by its own economic problems, weak commodity prices and continuing Petrobras corruption scandal. On August 11, Moody’s downgraded credit rating of Brazil from Baa2 to Baa3, with outlook negative. Another downgrade will push Brazilian bonds to the junk territory. The data published in late August showed that Brazilian GDP declined by 1.9% in Q2. It is the biggest decline since 2009. The unemployment rate increased to 7.5% and inflation rate hit a new 12-year high at 9.56%. The bad economic situation and still growing corruption scandal led to a series of demonstrations against president Rousseff. The 15 biggest holdings represent 62.2% of EWZ’s portfolio. The biggest weight have shares of Ambev (NYSE: ABEV ) that represent 10.35% of the portfolio. Slightly lower weight have preferred shares of Itau Unibanco (NYSE: ITUB ). There are preferred shares of 5 different companies (Itau Unibanco, Banco Bradesco (NYSE: BBD ), Petrobras (NYSE: PBR ), Vale (NYSE: VALE ), Itausa-Invetimentos ( OTC:IVISF )) among the TOP 15 holdings. Their cumulative weight is more than 25%. Source: Own processing, using data of iShares.com EWZ shares lost more than 13% of their value and only share price of BMF Bovespa and Vale increased slightly in August. On the other hand preferred shares of Banco Bradesco and Itausa Investimentos declined by 15.51% and 13.33% respectively. Shares of other companies from the financial sector were hit hard as well. The economy is in a bad shape. Brazil has a negative GDP growth as well as high inflation rate and the fiscal and monetary policies can’t tackle both of the problems at once. And downgrade of Brazilian credit rating weighed on the financial sector as well. (click to enlarge) Source: Own processing, using data of Bloomberg EWZ was strongly correlated with oil prices represented by the United States Oil ETF (NYSEARCA: USO ), however this correlation declined notably during the last week of August, as oil price bounced hard off its bottom while EWZ kept on declining. On the other hand EWZ still maintains very high positive correlation with Petrobras share price. (click to enlarge) Source: Own processing, using data of Yahoo! Finance EWZ was highly volatile in August. But it is important to note that given the wild ride experienced during the first seven months of 2015, August was relatively calm for EWZ, despite the turbulent developments on global financial markets. It is hard to expect that the Brazilian share market’s volatility will start to calm down and stabilize anytime soon. (click to enlarge) Source: Own processing, using data of Yahoo! Finance Some of the more interesting news: The Brazilian government approved an austerity measure that should help to balance the government budget and save Brazilian investment grade credit rating. The measure will lead to higher corporate taxes which should increase tax revenues by $2.9 billion. A prosecutor at Brazilian Federal Account Court said that Rousseff broke the fiscal responsibility law. The government was systematically delaying debt repayments to Brazilian state controlled lenders in order to make the fiscal account look better. The money were used for various social programs. It is said that repayments worth $11.6 billion were delayed in 2012 and 2013 alone. According to the Brazilian constitution, president who violates the fiscal responsibility law should be impeached and removed. It is estimated that Petrobras may need to pay more than $1.6 billion to settle the investigations related to the corruption scandal that are held in the USA. But Petrobras denied any ongoing negotiations regarding an eventual payment of a fine. Itau Unibanco announced that between August 5 and August 26, it acquired 30,380,000 of its own preferred shares. According to the share buyback plan approved on July 30, the company is authorized to acquire 11 million of its common and 55 million of its preferred shares, during the time period from August 5, 2015 to August 4, 2016. Conclusion Brazil is in huge trouble. The economy is weak, GDP is declining, inflation and unemployment rates are growing. Not only energies and metals but also agricultural commodity prices are weak. The Petrobras corruption scandal hasn’t been fully resolved yet and there is another scandal, as president Rousseff used some creative accounting to make public finances look better before the last year’s presidential elections. Adding to it the uncertainty on the global financial markets that are afraid of the slowing Chinese economy and the potential U.S. interest rate hike, it is hard to expect any meaningful recovery of EWZ share price anytime soon. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.