Gold is starting to shine

Isn’t gold supposed to shine when we have a financial crisis? So what has taken the shine out of gold since we started this crisis? Gold hit its peak back in March at over $1000, dropped to $700 at its trough and closed at $828 on Friday. Unexpectedly, investors shifting assets to US$ instead of gold during the last 5 months of the financial crisis hurt the price of gold.

The S&P/TSX Global Gold index is a representation of Canadian and other International gold producing companies. Some examples of the Canadian companies represented on the gold index are Agnico-Eagle Mines Ltd. (AEM), Alamos Gold Inc. (AGI), Aura Minerals Inc. (AQI), Barrick Gold Corporation (ABX), Goldcorp (G) and Kinross Gold (K). An example of an International company not traded on the TSX but included in the S&P/TSX Global Gold Index is Newmont Mining Corporation (NEM-N) which trades on the New York Stock Exchange.

When we look at S&P/TSX Global Gold index, it was as high as $390.93 on March 17th this past year and recently, was as low as $153.03 on October 24th this year. This is over a 50% drop in the index from March till the low in October. On Friday December 12, 2008 the Global Gold index was 276.38, a gain of over 50% since the low. The trend is bullish for gold from a technical standpoint, crossing the 50-day moving average on November 21st and now approaching the 200-day moving average at $290. Is this the shine returning to gold?

Recently, gold fell in line with other commodities as the deal to rescue the big 3 US car manufacturers came into question. When people refocused on the bigger picture, problems and risks associated with Global recession, gold increased. Is this the start of gold’s big move? In an article in CNN.com Fortune Magazine, “Gold Shines on”, December 9, 2008, Katie Benner writes about the merits of gold. She argues that Gold is going to shine because of fundamental weakness in the US$. The US$ as a safe haven won’t last long due to the vast amount of currency that the US will have to print to support financial aid for the Auto industry and TARP (Troubled Asset Relief Program), not to mention the spending proposed for infrastructure. All currencies are coming under pressure around the world due to slashing interest rates. This eventually will lead to a devaluation of currencies and ultimately inflation. Donald Luskin, Chief Investment Officer of Trend Macrolytics points out in his article, “The Case for Gold Hasn’t lost Its Luster”, December 5, 2008, that gold is the single most inflation sensitive thing in the world. Even though the bond market is currently telling us that they expect deflation (lower yields on 30 year bonds), Mr. Luskin argues that we will see gold around $1000 within a year as inflationary pressures takeover from all the money the US Government is printing. Lastly, there is an expectation of a shortage of gold supply due to flat production around the world.

Keep in mind that gold has never outperformed stocks in the long term, however, now is a time when gold should shine from a fundamental standpoint. Technically, it is already shining.

Are you catching a falling knife with REITs?

REITs are a subsector of the larger income trust sector, which includes energy, pipelines and other business trusts. REITs hold properties that generate income from leases and rents. These include things like apartment blocks, retirement & healthcare facilities, malls and commercial offices. Some of the companies included in the REIT index listed on the TSX are Boardwalk Equities (BEI.un), Calloway (CWT.un), Canadian Apartment Properties (CAR.un), Canadian Real Estate Investment (REF.un), Dundee (D.un) and Extendicare (EXE.un). This component of the TSX is relatively small in size making up about $27 billion in market capitalization.

On Friday December 5, 2008 the REIT index closed at a price of $71.04. The low over the past year was $64.84 reached on November 21, 2008 and the high was $144.62 reached last December. In the past three months I have not been able to infer anything from the technicals so I won’t start now. The chart does look like it has formed a downward trading channel with any rises bumping up against resistance long before the 50 day moving average. The most recent rise from the bottom on November 21st was only 5.5% which is better than the TSX at -.05% but falls short of the S&P 500 at 9.5%.

Further to Rob Carrick’s article in Saturdays Globe & Mail, “REITs battered down to eye-catching levels”, where he outlines the challenges REITs face with the slowing economy. I would also point out that REITs are highly leveraged to exacerbate the problems of financing he suggests they face. With a recession the component most likely to be ill affected is anything to do with mall or commercial offices as businesses see tougher times. There is a component that I would agree is worth looking at from a practical perspective and that is the apartment REITs. As he points out “demand for rental housing is more recession-resistant than other types of property.”

If you are exploring this sector because the price has dropped, I would be very selective given that this recession is a credit focused one. After all, as Dennis Gartman warns in his 22 rules of trading “never try to catch a falling knife.”

Are Investors becoming desensitized to bad news?

Is there going to be a year end rally for the financial sector? In most years, financial stocks have tended to perform better in the last quarter of the calendar year. According to the research in Thackray’s 2009 Investor’s Guide, Financial Stocks start their year-end rally about the middle of December in the US and continue the rally until mid April. With the exception of the last four years, financial stocks have outperformed the S&P 500 during this period. In Canada, the year end for financial stocks is October 31st so the rally should come earlier than the US if it does come at all.

The financial sector has a market capitalization of a little more than $1 trillion dollars. This represents a little more than 25% of the TSX composite market capitalization of just shy of $4 trillion dollars. The average P/E ratio is 10.22 and the dividend yield is 4.93 for the financial sector while the TSX market is 10.68 and 4.13%, respectively. The financial sector includes the major commercial banks, diversified financial services and insurance companies. For example, Royal Bank is a commercial bank, AGF Management is a diversified financial service provider and Sun Life is an insurance company.

In the last week the financial services sector increased by 18.34%. On Friday November 28, 2008 the financial sector closed at $141.01. The high over the last year was $217.49 reached on November 30, 2007 while the low was $110.41 reached in November this year. Since August 27th 2008, the financial sector has outperformed both the TSX and the S&P 500. The financial sector dropped -20% while the TSX was down -31.5% and the S&P 500 was down -30%. From a technical standpoint there are no clues as to the direction other than a bearish signal represented by a downward channel since August.

So where does that leave us? We just had a rally of six days in a row in the market and the financial sector was one of the leading point getters. However, I might remind you that not only are the technical’s bearish but we are in the middle of earnings reports for banks and more write downs are expected. The only question is, will investor’s refocus on the economy or are investors becoming desensitized enough to bad news in order to support a year-end rally?