09 Dec 2005 How Much Longer Will the Fed Ride the Brakes?
The asset category leader for the fourth quarter so far, aside from Internet stocks, is gold. The metal is up almost 13%, quarter to date. Traditionally a move like this signaled bad news – too much liquidity leading to inflation, or falling currencies, or recession. But, not this time. Inflation remains tame, the dollar is actually rising with gold, and the economy continues strong.
So why is gold so strong? It likely has to do with demand. The majority of the precious metal is used in jewelry, 70-80%, with India leading the demand. With increased affluence comes higher demand for the finer things in life.
An additional cause is noted by our friend Don Hays. ETF’s or Exchange Traded Funds are another major cause for the huge increase in demand lately. The recently created StreetTracks Gold ETF has been the fastest growing ETF inUShistory largely because it makes buying the actual metal infinitely easier. The ETF must hold the actual gold. In a little over a year, the StreetTracks ETF has grown from 0 tonnes of gold to 232 tonnes, with an increase of 10% in just the last month. At this level the ETF holds more gold than the country of Belgium, pushing the gold ETF into the top twenty when compared with central bank holdings of over 100 countries.
This week the government delivered more compelling proof that the economy was as sound as ever and inflation was a non-starter. The Bureau of Labor Statistics revised its gauge of third-quarter productivity growth in the non-farm business sector to a seasonally adjusted annual rate of 4.7%, up from an earlier reading of 4.1%. It was the fastest growth in output per worker hour, in two years. The Bureau also said that unit labor costs were far lower than first estimated in the second and third quarters, due in large part to the continuing “productivity miracle.”
As the economy has grown, the labor market has tightened in a few areas, pushing up wages in some areas. The increases have frightened some at the Fed encouraging them to continue raising rates. But, as the Wall Street Journal notes, “wages and payrolls grew at a far faster pace in the late 1990s without sparking much inflation. Doves (those whom believe that inflation is not a problem) blame a two-year Fed campaign then for sparking the 2001 recession and warn that history may repeat itself soon.” The Fed meets next Tuesday. Most believe they will raise rates another quarter point, but they will remove the “accommodative” language, signaling a near end to the increases. Stock investors will applaud such news.
Consumer confidence, as tracked by the University of Michigan, rose considerably more than expected in November and December, the largest two-month increase in more than two years. As the effects of the Gulf coast hurricanes and record energy prices fade in memory and the coming Christmas shopping season looms, consumers are telling pollsters that they feel very good and very confident. This confidence bodes well for continued spending and economic expansion.
But energy prices rebounded recently as temperatures cooled across most of the country and another extremist Islamic call went out to disrupt the flow of oil. Since the end of November oil has increased 8% and Natural Gas, an astonishing 28%. But the rise was mostly predicated on the fear of potential supply disruptions and shortages that have not materialized. Now that the bad weather is here supplies are proving to be adequate, reason is returning, and prices are leveling off and declining.
We’ll have to watch in the coming months to know if the Fed will go too far with rates as they have in the past, or if the new regime headed by Ben Bernanke will save the day in February clearly signaling a halt to the increases. Corporate earnings are slowing, but with huge sums of cash on their balance sheets capital spending will likely rise in the coming year sparking a boom cycle for productivity-enhancing technology and equipment. We still favor technology, investment banking, asset management, and oil services. Our offshore holdings range from 14% to 24% in our models with concentrations in Latin America and Asia.