Frequently prospecting for new opportunities in natural resource-rich nations, Rodman & Renshaw Senior Analyst Alka Singh is just back from Argentina. The Gold Report caught up with her to sift through her thoughts on the precious metals industry. Her current objective is to seek out gold and silver producers with growth potential beyond the price appreciation of commodity metals.

Recent market action is causing much anxiety. This past week, I received two mailings on the Hindenberg Omen again. Pundits are hyperventilating about sovereign loan defaults. After Ireland, their attention is focused once again on Spain and other European countries. The world seems to be filled with worryworts (which is bullish as the market always climbs a wall of worries).

BUYERS BEWARE

Not only is sentiment wildly bullish on stocks and equally as bearish on bonds, but history says that when yields and equity values soar in tandem, as they did in the summer of 2007, we almost always see a reversal in both markets.  Have a look at the Lex column (The Odd Decouple) in the weekend FT, which cites some nifty research to that effect. On average, equity prices corrected 12% in the next six months.  Some food for thought perhaps to the seers partaking in the Barron’s Outlook 2011 ― none of the 10 strategist see a down market, the average forecast is for a double-digit advance and the range is 1,250 to 1,450!

Quote from the weekend FT:

The Odd Decouple

Something’s gotta give. US Treasury yields have surged since September but equities have managed to rally amid the bond market carnage. The two are not mutually exclusive, but such symmetry is rare. Rising bond yields can coincide with the return of animal spirits after a nasty shock or the expectation of tighter monetary policy around the corner as the economy recovers. The reasons may be entirely different this time but the result – usually a selloff in stocks – may be similar.

Analysts at Bespoke Investment Group looked over the last four decades at instances when there was a simultaneous six-month peak in benchmark 10-year US Treasury yields and the S&P 500, as happened on Tuesday. The confluence was rare and, on average, negative for stocks over the following one-, three- and six-month periods. The very worst performance came in 1966 when ambitious federal social spending and the costs of a foreign war (sound familiar?) stoked inflation worries. The S&P 500 was 11.7 per cent lower six months later even as yields kept moving higher. In 1979, with stagflation taking hold, a similar result ensued – an 8.2 per cent drop in stocks and a hefty surge in yields.

…read more HERE (might require subscription)

There is an old adage on Wall Street: no one rings a bell to signal a market top or bottom. Yet, I have found that bells do ring; it’s just that few people know exactly what sound to listen for.

There is an old adage on Wall Street: no one rings a bell to signal a market top or bottom. Yet, I have found that bells do ring; it’s just that few people know exactly what sound to listen for.

Perhaps the biggest and most liquid of all markets is for US government bonds. That market has been rallying for almost thirty years. The bull can be traced back to 1981, when Treasury bond yields peaked at about 15%. At that time, high inflation and a weakening dollar had justifiably squelched demand for Treasuries. Even the ultra-high interest rates were not enough to attract buyers.

But this was also when the proverbial bell was rung. Fed Chairman Paul Volcker had signaled, by jacking up interest rates so high, that he would stop at nothing to break the back of inflation. Volcker’s iron will, and Reagan’s unflinching support, restored demand for Treasuries for the next three decades.

We have arrived today at a similar inflection point. After falling steadily for 30 years, bond yields are now heading north with a full head of steam.

Many are taking the recent moves in stride. The consensus is that despite the recent spike, yields are still historically low, and that they are unlikely to go much higher from here. Once again, most on Wall Street are either tone deaf or plugging their ears.

For years, the Fed has been able to prevent market forces from correcting our growing economic imbalances by inexorably pushing rates lower. This happened in 1991, 2001, and most notably in 2008. These easing campaigns succeeded in boosting the economy in the short term by greatly increasing the amount of debt held by both the private and public sectors. As such, these episodes have allowed our economy to delay and magnify the ultimate reckoning. 

Just like a junkie who requires ever-increasing doses of heroine to achieve the same high, the Fed has needed to take rates ever lower to boost the economy after its previous stimulants had faded.

To stimulate after the bursting of the housing bubble (which itself resulted from the low interest rates used to juice the economy following the bursting of the dot-com bubble), the Fed lowered interest rates to practically zero. At that point, rates could go no lower. However, when that stimulus failed, the Fed decided to bring on the heavy artillery in the form of “quantitative easing,” or as it is known in the vernacular, “printing money to buy government debt.”

Lowering the federal funds rate, its traditional weapon, tends to make the most impact on short-duration debt. By its own words, the goal of quantitative easing (QE) was to lower long-term interest rates. It was hoped that this would achieve what low short-term rates had not: an increase in stock and real estate prices, a rise in household wealth, and consequently greater consumer spending, economic growth, and job creation.

However, the Fed’s plan backfired. The selling pressure on long-term bonds is overwhelming the Fed’s buying pressure. Spiking rates (which move inversely to price) are powerful evidence that the bond bubble has finally burst. The Fed threw everything but the kitchen sink at the bond market to force yields lower, yet they rose anyway. If bond prices failed to rise given such a Herculean effort to lift them up, there can be only one direction for them to go: down.

In true form, few on Wall Street hear the ringing. In a shocking display of rationalizing cognitive dissonance, some (such as Wharton Professor Jeremy Siegel in a WSJ op-ed) have even suggested that the spike in yields is proof that quantitative easing is working. Siegel heralded higher rates as indicative of economic resurgence, which supposedly was the Fed’s goal all along. In other words, QE2 worked so well, we skipped the lower rates and went directly to the higher rates that go with growth!

There is also a widespread belief that long-term rates will remain contained at historically low levels. Four percent is seen as the ceiling above which ten-year yields will not rise. I believe this ceiling will prove to be of the thinnest glass. Once yields easily break that level, they may quickly rise above five percent, where they will likely encounter some resistance, before heading significantly higher.

In fact, if rates approach six percent next year, we will be seeing a ten-year high in ten-year yields. If our economy is this fragile with record low rates, image how much weaker it will be with rates at ten-year highs? If the Fed believes that lower rates revive an economy through the ‘wealth effect,’ what does the Fed feel will happen when higher rates produce a reverse ‘wealth effect’?

Not only does this bell herald the end of the bond bull, but it also marks the end of the Fed’s ability to artificially engender economic “growth” through monetary policy. More significantly, the new tax compromise President Obama is about to sign will add more than $900 billion in new debt onto the government’s balance sheet over the next 10 years. This will put additional upward pressure on interest rates, and more political pressure on the Fed to monetize the debt.  It is no coincidence that the real upward movement in yields began immediately after the tax/stimulus deal was brokered in Washington. 

What lies ahead is a new era of rising interest rates, soaring consumer prices, increasing unemployment, economic stagnation, and lower living standards. Instead of stimulating the economy, quantitative easing and deficit spending will prove to be a lethal combination. Bondholders beware, the bell tolls for thee.

Peter Schiff is president of Euro Pacific Capital and host of The Peter Schiff Show.

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We are in a Cowardly Lion market, whose occasional bursts of bravery are ultimately overrun by fear that leads to a subsequent decline.

For the US stock market, the past ten years have earned the title “the lost decade.” The next ten years probably will not be much different: The market will likely set record highs and multiyear lows, but index investors and buy-and-hold stock collectors will find themselves not far from where they started.

Every long-lasting bull market of the past two centuries (and we had a supersized one from 1982 to 2000) was followed by a sideways market that lasted about 15 years. The Great Depression was the only exception. Despite common perception, secular markets spend a lot of time in bull or sideways phases, and roughly an equal amount in each. They visit the bear cage only on very rare occasions.

This doesn’t happen because the market gods want to play a practical joke but because stock prices are driven in the long run by two factors: earnings growth (or decline) and price-earnings expansion (or contraction). Though economic fluctuations are responsible for short-term market volatility, long-term market cycles are either bull or sideways if the economy is growing at a close to average rate.

Prolonged bull markets start with below-average P/Es and end with above-average ones. This vibrant combination of P/E expansion and earnings growth – which doesn’t have to be spectacular, just more or less average – brings terrific returns to investors. Sideways markets follow bull markets. As cleanup guys, they rid us of the high P/Es caused by the bulls, taking them down to and actually below the mean. P/E compression – a staple of sideways markets – and earnings growth work against each other, resulting in zero (or near-zero) price appreciation plus dividends, though this is achieved with plenty of cyclical volatility along the way.

Bear markets are the cousins of sideways markets, sharing half of their DNA: high starting valuations. But whereas in sideways markets economic growth softens the blow caused by P/E compression, during secular bear markets the economy is not there to help. The US, however, has never had a true, long-lasting bear market like the one investors have experienced in Japan, where stocks have fallen more than 80 percent from the late 1980s to today. If the US economy fails to stage a comeback with at least some nominal earnings growth over the next decade, what started sideways in 2000 will turn into a bear market, as high valuations are already in place.

I should mention the role interest rates and inflation play in market cycles. They are secondary to psychological drivers, but important. They don’t cause the cycles, but help shape their magnitude and duration. For instance, if interest rates and inflation had not been scraping low single digits in the late ’90s, the bull market would have ended sooner and at lower P/Es. The higher inflation and interest rates that are around the corner will take their toll on the duration and P/E of this market too.

In sideways markets you as an investor need to adjust your strategies:

• Become an active value investor. Traditional buy-and-forget-to-sell investing is not dead but is in a coma waiting for the next secular bull market to return – and it’s still far, far away. Sell discipline needs to be kicked into higher gear.

• Increase your margin of safety. Value investors seek a margin of safety by buying stocks at a significant discount to protect them from overestimating the “E.” In this environment that margin needs to be even more beefed up to account for the impact of constantly declining P/Es.

• Don’t fall into the relative valuation trap. Many stocks will appear cheap based on historical valuations, but past bull market valuations will not be helpful again for a long time. Absolute valuation tools such as discounted cash flow analysis should carry more weight.

• Don’t time the market. Though market timing is alluring, it is very difficult to do well. Instead, value individual stocks, buying them when they are cheap and selling them when they become fairly valued.

• Don’t be afraid of cash. Secular bull markets taught investors not to hold cash, as the opportunity cost of doing so was very high. The opportunity cost of cash is a lot lower during a sideways market. And staying fully invested will force you to own stocks of marginal quality or ones that don’t meet your heightened margin of safety.

What if a sideways market isn’t in the cards? If a bull market develops, active value investing should do at least as well as buy-and-hold strategies or passive indexing. In the case of a bear market, your portfolio should decline a lot less.

Regards,

Vitaliy N. Katsenelson
for The Daily Reckoning

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing: Making Money in Range-Bound Markets.

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