Diwali, Dollars and Gold

Today marks the beginning of Diwali festival in India and the next stage in gold’s seasonal patterns. The five day “Festival of Lights” is a major Hindu holiday and involves the lighting of small clay lamps (diyas) filled with oil to signify the triumph of good over evil. During Diwali, lights illuminate every corner of India and fireworks light up the skies.

Activities during these five days include worship, many feasts, spending time with families and exchanging gifts. The latter is a big driver of gold demand.

Seasonality Chart

Traditionally, Indians are very sensitive to fluctuating gold prices but it appears they are adjusting to the concept of higher gold prices. Last year, China surged ahead of India in terms of jewelry demand until Diwali reignited retail demand in India.

It also didn’t hurt that India’s central bank bought 200 tons of gold around $1,000 an ounce. This put a floor under gold and changed the mentality of retail buyers who had been waiting for a pullback below $1,000. In fact as of June 2010, Indian jewelry demand was only off 2 percent on a year-over-year basis despite gold reaching new record highs. A report from the Bombay Bullion Association says that Indian gold imports rose to 43 tons, an 18 percent increase from the same time last year.

India isn’t the only place that jewelry demand is picking up. According to the World Gold Council’s most recent Gold Demand Trends report, jewelry demand experienced its smallest decline since early 2008 during the second quarter of this year.

Queen Elizabet 2 Sets SailGold as an investment has been grabbing headlines and is certainly a key factor in overall demand. However, demand for gold jewelry is still the king. In 2009, retail investment and ETFs totaled 1,348 tons of gold—39 percent of total demand. However, jewelry demand, which was at its lowest level in 10 years, totaled 1,759 tons—51 percent of total demand.

This is important because as retail buyers of gold grow more accustomed to gold’s current price levels, demand should increase and provide a tailwind for higher prices.

With the Federal Reserve’s announcement of its second quantitative easing (QE2) initiative this week, it’s a good time to update you on some data I’ve shared with you several times. This chart shows gold’s appreciation in major currencies since 1999. As you can see, currency devaluation has a dramatic effect on gold’s performance in that particular currency.
Gold in Various Currencies (Relative Performance)

The past few months have been very rough for the dollar.

Since June 1 through earlier today, gold prices have jumped 1.2 percent in Japanese yen terms and 2.6 percent in British pound terms. Gold prices in euro terms have actually dropped 1 percent during that time period.

In dollar terms, it’s a much different story. Gold prices in U.S. dollars have jumped 13.4 percent since June 1. Most of this appreciation came after the Federal Reserve announced its intention for a second round of quantitative easing. The Federal Reserve’s announcement this week was both larger ($600 billion) and longer (until June 2011) than many had anticipated.

The long-term depreciation effect this plan will have on the dollar could be a catalyst for higher gold prices all the way into next summer.

Another upside is a weaker dollar makes high-quality American products more attractive to export. We can expect rising exports over the next six months to help our unemployment numbers and boost our economy.

I wish all a Happy Diwali and the blessings of fortune, luck, riches and generosity.

P.S. If you didn’t get a chance to listen to Ian McAvity’s webcast presentation this week you missed a great one but don’t worry, a replay will be available on demand early next week.
Index Summary

  • The major market indices were higher this week. The Dow Jones Industrial Index gained 2.93 percent. The S&P 500 Stock Index advanced 3.60 percent, while the Nasdaq Composite finished 2.85 percent higher.
  • Barra Growth underperformed Barra Value as Barra Value finished 3.77 percent higher while Barra Growth rose 3.43 percent. The Russell 2000 closed the week with a gain of 4.73 percent.
  • The Hang Seng Composite finished higher by 6.87 percent; Taiwan was up 1.96 percent, and the Kospi rose 2.97 percent.
  • The 10-year Treasury bond yield closed at 2.54 percent, down 8 basis points for the week.
  • Domestic Equity Market

    The figure shows the performance of each sector in the S&P 500 Index for the week. All ten sectors were up but the best-performing sector was financials, up 6.9 percent. Energy and materials were other top-performers. The three worst-performing sectors were healthcare, utilities and consumer staples.
    Janus Capital Group was the best-performing stock within the financials sector, rising 16 percent. Rounding out the top five were Legg Mason Inc., Bank of New York Mellon, Wells Fargo and Principal Financial Group.

    S&P 500 Economic Sectors

  • The consumer electronics group, represented by Harman International Industries, was the best-performing group for the week. The audio products maker rose 19 percent after reporting quarterly earnings and revenue above the consensus estimate.
  • The construction materials group, represented by Vulcan Materials, was the second-best performer. Vulcan rose 16 percent despite reporting quarterly earnings below the consensus estimate. However, the CEO's remarks in the earnings report about contract awards for highway construction in Vulcan-served states continuing to outpace other states may have encouraged some investors.
  • The automobile manufacturer group, represented by Ford, rose 15 percent. Ford was energized by October cars and light truck sales which were up 16 percent from a year ago and up 19 percent when adjusted for the sale of Volvo.
  • Weaknesses

  • The agricultural products group, represented by Archer Daniels Midland, was the worst performer, down 6 percent. Archer Daniels reported quarterly earnings below the analyst consensus estimate.
  • The Apollo Group led the education services group to underperform, losing 3 percent. The University of Phoenix, Apollo's main segment, reported that the Department of Education is launching a review of how the University administers federal financial aid.
  • Discovery Communications led the broadcasting group to underperform, down 3 percent. Discovery reported quarterly earnings below the consensus estimate and a brokerage firm downgraded the stock based on valuation.
  • Opportunities

    The Economy and Bond Market

    The Federal Reserve implemented phase two of its quantitative easing program this week, announcing an additional $600 billion of Treasury bond purchases. The surprise to the market is what the Federal Reserve will be buying. The Fed is focusing its purchases primarily in the 2 to 10-year Treasury range and less on the long end of the market. The bond market reacted accordingly with 5 to 10-year Treasuries rallying as yields fell as much as 12 basis points. Meanwhile the 30-year bond sold off, pushing yields up by 14 basis points.
    30 Year Treasury Yields

    Strengths

  • The Federal Reserve followed through on the much anticipated quantitative easing program, more or less meeting investor's expectations.
  • The October employment report was much better than expected. The economy created 151,000 jobs and the prior two months were revised higher as well.
  • The ISM Manufacturing Index unexpectedly rose to its highest level since May.
  • Weaknesses

  • Retailer's same store sales for October were generally disappointing, rising a modest 1.5 percent.
  • The housing crisis continues as Standard & Poor's estimated that the total cost for the bailout of Fannie Mae and Freddie Mac could be $685 billion. Standard & Poor's also reported that large U.S. banks could experience losses of up to $31 billion if forced to buy back mortgage securities.
  • Central bankers around the world are taking a different approach than the Federal Reserve as the Bank of England and the European Central Bank both kept monetary policy unchanged. In addition, Australia raised interest rates this week.
  • Opportunities

  • Inflation is unlikely to be a problem for some time and this gives central bankers and other policy makers around the world room for expansive policies.
  • Threats

  • Inflation expectations as measured by Treasury Inflation-Protected Securities (TIPS) spreads have risen sharply this month. Inflation expectations will be key data points to drive Fed policy changes going forward.
  • World Precious Minerals Fund – UNWPX • Gold and Precious Metals Fund – USERX

    For the week, spot gold closed at $1,393.65 per ounce, up $34.25, or 2.52 percent for the week. Gold equities, as measured by the Philadelphia Gold & Silver Index, rose 5.19 percent. The U.S. Trade-Weighted Dollar Index fell 0.86 percent for the week.

    Strengths

  • Gold rallied to close at a new all-time high of $1,393.65 per ounce on Friday as the Fed's QE2 decision and continued weakness in the U.S. dollar powered bullion higher.
  • The gold-to-silver ratio has fallen to its lowest level in two years as silver hit a 30-year high, continuing to bounce from an underperforming status in years past. Silver is also benefiting from its double role as an investment and industrial commodity.
  • Peru's Ministry of Mines and Energy said that the country's September gold production dropped 23 percent from the same month last year. For the first nine months of this year, gold production was reported at a 10.9 percent decline compared to gold production during the same period of 2009. Peru is roughly the world's fifth largest gold producer.
  • Weaknesses

  • A poll conducted by Barron's showed that 62 percent of portfolio managers see equities as the top-performing asset over the next 6-12 months. Only 15 percent felt precious metals would be the top performer, 6 percent for cash and 3 percent for bonds.
  • Iran became the latest nation to increase its gold holdings as the nation announced that it has converted approximately 15 percent of its foreign exchange reserves into gold and now does not need to import the metal for the next 10 years.
  • “The global financial crisis has weakened mining and metals companies' defenses against fraud,” an Ernst & Young reports says. “That provides increased exposure to corruption as mining and metal companies must expand their operations to territories.”
  • Opportunities

  • Shayne McGuire, manager of the $330 million gold portfolio pension fund at the Teacher Retirement System of Texas, predicted the price of gold could soar to $10,000 an ounce. McGuire predicts gold will surge due to a series of fiscal crises that hit around the world, China's view on gold as a savings vehicle and the ascendance of ETFs.
  • U.S. Representative Ron Paul, who is likely to chair the House subcommittee overseeing monetary policy, says he will urge an audit of U.S. gold reserves and has called for the dollar to be backed by gold and silver.
  • Julian Phillips, founder of the Goldforecaster, recently stated his opinion of where the financial globe will be in the next 12-18 months. Phillips stated, “I see it very much as a going concern, I don't see a collapse but I do see an increase in uncertainty, in tensions, in confrontations and in fears. We are looking for confirmation of the Comex traders spreading views of potentially vastly higher prices but I don't see lower prices and therefore I see a very positive market for gold ahead.”
  • Threats

  • The South African mining ministry has imposed a six-month halt on new prospecting bids in order to overhaul mining laws, iron out irregularities in the way rights are awarded and audit existing exploration and drilling contracts.
  • A senior South African official said the country's mining sector is filled with problems including illegal drilling, rights sold without permission and companies having competing claims to the same plot.
  • German Chancellor Angela Merkel and Mark Rutte, the Dutch Prime Minister, raised the theme of “burden sharing.” This envisions that private investors would be tapped to sponsor any future bailouts. Luxembourg's Prime Minister noted this issue is very sensitive and could lead to confusion in markets. It is not clear if government leaders are contemplating a system where those who made money or avoided serious losses would be called upon to make losers whole.
  • Global Resources Fund – PSPFX • Global MegaTrends Fund – MEGAX