The implications of Gold's sharp sell off

The dramatic fall in gold price has continued on Monday, with the price passing below $1,400 and heading as low as $1,390. Many investors, particularly retail investors, are often slow to react and it could be that Friday and Monday morning's sell off were just the start and we see further selling this week.

Short selling of gold, which has passed through various support lines, is also likely to increase and just adds further fuel to the flames, which are currently sending gold into meltdown! So what does all this mean for the wider world? Well obviously holders of gold bullion are going to be hit hard, with prices down over 10% from Friday. Gold mining stocks are also likely to be hit very hard, as many are a leveraged play on the gold price, and we have witnessed this today with many gold stocks down double digits already. The logic for gold miners falling in value is fairly basic; the price of the good they are selling falls, and assuming costs stay the same their margins are therefore eroded and so profits are likely to fall, all in all making the stock less attractive on various valuation techniques.

The question is just how low can gold go? Has it been oversold and is now a buying opportunity? Well this is probably the hardest question in investing. Equities and bonds can often be quantifiable, with companies have earnings (or predicted earnings) and cost structures that allow investors to generally determine fair value. Gold however, has no real economic value and so determining what price is fair value is very hard, and this is why, I suspect, gold will continue to fall further as sentiment is particularly important with the precious metal.

Factors driving the price back up are also harder to work out. Recent events such as Japanese Quantitative Easing, or North Korea tensions have historically been supportive of gold, but not of late, which does raise the question has gold lost its shine?

Japan - Exporting Deflation?

It's been well publicised how the aggressive 'loose' monetary policy adopted by central banks is likely to be inflationary. The logic of this seems sound; they are printing trillions of dollars of money, and an increase in money supply should lead to inflation over the longer term.

Japan has recently undertaken extensive quantitative easing and has also directly attempted to depreciate their currency. One would presume this will cause inflation pressures; as mentioned above they have more money supply and also imports will become more expensive, thus importing inflation.

However, there is another take on this which I think is worth some consideration, and something I have not read too much about to date. Firstly we need to consider the Japanese economy. It is an export driven economy. Then we need to consider what a weaker Yen means for these exports. Well in essence it makes exports cheaper to foreigners who are importing them and this is the key to the deflationary pressures that Japan's latest policy could cause. So around the globe countries will be importing goods and services from Japan which are now cheaper, allowing businesses to lower prices and still maintain margins which could lead to deflation.

So what are the possible implications of this? Well the world has generally come to a consensus view that inflation could spike at some point due to the monetary stimulus mentioned above. However, if in fact Japan and other nations with weakening currencies are exporting deflation this may not be apparent, or at least to the extent markets are pricing in.

If you believe inflation may be 'overpriced' then one option is to 'short' inflation linked bonds whose returns are directly linked to inflation. Their price will fall if they have priced in too high inflation.

So for now lets hopefully look forward to some cheaper goods from Japan and be aware that high inflation is not yet a foregone conclusion!

Infrastructure Investing

Here at Fundgurus we've discussed various investment themes and this latest article looks at Infrastructure as an investment theme.

'Infrastructure' is a broad term and I generally think of it encompassing areas such as utilities, transport (airports, railways, roads) and schools and hospitals. Infrastructure investment is something that is always required, whether it be to initially install the facility, or to improve or update existing infrastructure.

Often infrastructure is heavily supported by public spending and government policy. By investing in high-speed railways for example, governments can make their country more attractive to businesses and investment which helps support the economy. At the same time it creates jobs in the immediate term to actually build the infrastructure. With governments looking to stimulate economies there is a possibility we will see them target infrastructure directly, and we have actually seen the beginnings of this with Japan and U.S. policy.

Infrastructure can also provide an inflation-hedge. Real assets such as buildings have exhibited inflation protection in the past. Revenues, such as those from toll roads, are often linked to RPI and therefore also offer inflation protection.

For investors there are various funds and stocks available to invest in this infrastructure theme. HICL Infrastructure is a closed ended investment trusts (HICL) and has an attractive yield (c. 5.7%). First State Global Listed Infrastructure is an open ended fund investing in companies that are linked to the inflation theme. This provides a more global portfolio, but has tended to exhibit slightly more volatility then HICL.

This type of investment can produce steady returns making an attractive addition for portfolios for the long term investor.

Interest Rate Decisions and Further QE

It has been a busy day today as central banks around the world announced interest rates and quantitative easing for this month .  Japan led the way as the new Bank of Japan governor Haruhiko Kuroda hit the ground running after his first meeting as they announced further bond purchases of 7 trillion Yen ($75bn) a month over the next two years easily beating market estimates of 4 trillion Yen.

This commitment is what the market wanted and they certainly have delivered, the Yen fell 3.4% against the USD following the announcement and Japanese equity markets rebounded from earlier losses.  I expect many foreign investors will be eager to increase their exposure to the 3rd largest economy as other equity markets have hit a recent stand still.  This was certainly evident after the Japanese market closed up 2.20% the futures market rallied a further 2%. 

Back to Europe...Many were eager to here from Mario Draghi following issues with Cyprus and the worsening state of the Eurozone's economy.  Rates were kept the same as expected however, Draghi hinted at lower rates down the line if the economic situation did not improve.  His comments lacked the commitment many were hoping for as previous statements have been bold and provided direction.  The Euro weakened further as the hint of lower rates caught traders ears, however recovered slightly as the day went on.  A weaker Euro will help ease the blow for exporters, and Draghi mentioned an economic recovery should begin during the later part of 2013 (fingers crossed).

Mervyn King may have failed to convince the monetary policy committee once again that further quantitative easing(QE) should be implemented as interest rates and QE were kept level.  The UK's economy has been relatively flat since last month and data has failed to inspire either on the up or downside. 

An interesting time for equity markets, it highlights the importance of sector allocation, some markets this year I expect will massively outperform others so pick wisely.

Japanese Equities - time to get on board?

One of the top performing equity markets this year has been Japan, since Shinzoe Abe returned to being the Prime Minster last November his determination to get the economy back on track has spurred investment back into Japanese equities.  The Yen has devalued to levels not seen since 2009 and as such this heavily exporting nation is beginning to show signs of improvement.

To further strengthen Abe's campaign the new governor of the Bank of Japan, Haruhiko Kuroda shares his doveish (favouring low interest rates) views and he has spoken out about the state of the economy.  With debt to GDP at 230%, the highest of any developed nation there is a significant amount that needs to be done to get the economy back on track.  Monetary easing of around £72bn earlier this year saw the first steps in the right direction, markets now expect utter commitment from the current administration as previous false dawns have occurred.  This first round of QE will be one of many steps that need to be taken in order to successfully navigate out of years of depression and meet the 2% inflation target set.  Any diversion from this plan will see investors running to hills yet again and markets will almost certainly crash to the floor.  

Auto Sales - A Sign of Improvement

Construction and industry are what many great nations have been built on. In the midst of the industrial revolution the first automotive was created in 1806, since then they have played a fundamental role in the growth of the global economy.  Now around 62 million cars are sold around the world each year. 

During the credit crisis one of the most affected sectors hit was the automotive industry.  As many see cars as a luxury, new car purchases crashed to the floor.  A number of companies sought emergency loans, most notably GM Motors, Ford and Chrysler receiving a record bailout from the U.S and Canadian government of around $85bn. 

These big three have recovered somewhat since 2008, however global competition has been ever increasing.   Since the start of the Eurozone, Germany its primary contributor has benefited hugely and as one of the major producers of cars they have seen profits rise significantly on the back of a weaker currency. 

Asia follows suit as currency plays a key role in exports.  Japan has historically been a major producer of cars, such as Toyota and Honda.  However, these companies have been hampered over recent years by the strengthening Yen and until recently has had trouble competing with the likes of South Korea and China. Since the introduction of the new Prime Minister, Shinzo Abe, the Yen has weakened significantly by around 20% and this will inadvertently roll through to company profits. 

The gathering pace in automotive industry should start to show in company profits by April, and a number of funds are well positioned for this.  Aberdeen Japan Growth and JOHCM Japan have a heavy weighting in the automotive sector and would be my pick.

Over the past twelve months, we have seen consecutive rises in auto sales and this is a good sign the global recovery is gathering pace.  This lagging indicator has a powerful message and is one to look out for.

Japan and Abenomics

Since the introduction of the new Prime Minister Shinzo Abe, the Japanese equity markets have reacted strongly to his dovish views and determination to move the economy out of over a decade of inflation.

Since commencing ¥13.7tn of Quantitative Easing (QE), the Yen has depreciated significantly falling approximately 14% against the USD.  Japan is a large exporter and this currency depreciation has increased confidence that profits from companies such as Toyota and Sony will react strongly. 

Although initial actions have been positive, a lot must be done to solve the countries underlying debt problems and ageing population dependencies.  With Debt to GDP of over 220% (compared to Greece at 170%), aggressive monetary policy is needed to kick start the economy.