Gaps are Appearing in the Gold Market

The gold market continues to act as if the forces of supply and demand don’t exist. The number of claims per ounce of gold stored at COMEX’s vaults have reached a high of 110 per physical ounce. Meanwhile, record levels of physical gold have been flowing into Hong Kong and Shanghai. One of the biggest sellers of the yellow metal to Chinese buyers has been the well publicized GLD ETF, which has been selling off its physical holdings. Numerous other funds have been following suit to the extent that some are now refusing physical delivery to clients who have demanded it. Further, there is also a gap in China’s gold consumption data, 500-tonnes to be exact, in other words $23 billion worth of gold has disappeared within China. This has sparked speculation that The People’s Bank of China has been an aggressive buyer, secretly stockpiling — the bank does not publish data on reserves.

The price of gold has been distorted, while paper traders in the West sell the metal, physical buyers continue to snatch it up, distorting the price. According to Ed Moy, chief strategist at Morgan Gold, this could be the beginning of a gold shortage.

Chinese Debt; The Looming Crisis

2.6 trillion yuan, or around $0.5 trillion of Chinese non-financial corporate debt is expected to come due during 2014. This figure includes principal repayments and interest and is the largest figure on record for Chinese companies. Last year gear ratios among non-financial Chinese companies reached 93%, while the average across Asia remained below 70% and has done for the past decade.

But with so much debt coming up for repayment, Chinese companies are facing an increasingly hostile lending environment. Back during December Chinese ten-year AAA rated corporate bond yields hit 6.2%, while the average rate for similar-rated notes globally touched 2.68%.

Still, there have been no corporate bond defaults in China’s publicly traded debt market since the central bank started regulating back in 1997. However, with levels of gearing hitting a record, a record amount of debt coming up for maturity and bond yields soaring, a perfect storm could be brewing.

Cracks already appear to be showing in the market as the Industrial & Commercial Bank of China more than tripled its bad loan provisions during the first six months of last year, from 7.7 billion yuan, to 22.1 billion yuan. China’s courts have also seen a surge in bankruptcies.

Unfortunately, if things start to go wrong the whole country could be engulfed in a financial crisis very quickly. The shadow banking industry within China is huge and the use of wealth management products, of WMP, which use a pool of instruments such as securitized debt to achieve an above average return, has surged recently. The yields on these instruments has hit an all-time high of 5% to 8% recently. Defaults by corporate bodies, or local government agencies could hit this WMP market hard and it would not be long before the market capitulated.

Luckily, the Chinese credit market is somewhat contained, so a credit crisis would not be as catastrophic as ’08 but with around $2.8 trillion in government and many trillions in corporate debt outstanding within China, repercussions of a debt crisis would be felt around the world.

Actively Managed Funds Consistently Outperform Trackers

According to research conducted by FE Trustnet, the average active UK growth fund has beaten an average, standard tracer fund over a period of one, three five and ten years. To say that this is astonishing is an understatement. Many market commenters have been reiterating the benefits of passive of active for some time now, and even market oracle, Warren Buffett has bet against actively managed hedge funds, making a $1 million bet with hedge-fund manager Protégé Partners that a simple stock-index fund would beat a handpicked selection of five hedge funds over a decade. Of course, hedge funds are not identical to actively managed trusts and funds as fees are usually higher and range of investments broader.

FE Trustnet summarizes that over the last ten years, the average UK All Companies fund has delivered 128%, while the average tracker has returned 105%. What’s even more worrying is the deviation of tracker returns from the mean. For example, the Halifax UK FTSE 100 Index Tracking fund returned 72% over the period, with a tracking error of 7.5%. Halifax’s FTSE All share tracker also significantly underperformed its benchmark, returning just under 90% compared to a benchmark return of 130%.  

It would appear that the problem is fees. The investment community has been so driven on selling these products, boasting that they have such low fees and transparent structure, that many have missed the point. If a fund has fees, no matter what they are, it is not a true representation of the index. A fund with a TER of 1.5% per annum, will underperform the index by 1.5%, after fees are taken out. Compounded over a longer time frame this is bound to have an effect.

Personally, I would be prepared to pay extra for an actively managed fund with a chance of outperforming the market. Trackers have no chance of outperforming and will certainty underperform including fees. 

Oh, and if you’re interested, according to Reuters and a study commissioned by KPMG, during the period 1994 to 2011, hedge funds delivered an annual return of 9.07%, compared to a 7.27% return from commodities, 7.18% from stocks and 6.25% from bonds. 

Corporate Cash Reaches a Record High.

We live in a period of all-time highs. NYSE margin debt is at an all-time high, US debt is at an all-time high and the S&P 500 and DOW are at all-time highs. 

However, interest rates remain at all-time lows. So then, it is surprising to find out that cash & short-term investments on the balance sheets of S&P 500 companies, excluding financials, have reached a level not seen before. 

Indeed, according to data from Factset the S&P 500 cash and short-term investment balance hit $1.36 trillion at the end of the third quarter, excluding financials; up 18% year-on-year.

The good news is that this was positive for shareholders as cash distributions in the form of dividends and net repurchase of stock hit an aggregate of $169.6 billion for the quarter; up 25.6% year-over-year .Meanwhile, cash flows from operations amounted to $351.3 billion for the period, an increase of 7.2% year-over-year.

Unfortunately, this indicates that companies are just not investing for growth, which is worrying.

In a period of low interest rates, designed to spur growth, companies would rather return cash to investors through stock repurchases, albeit at a time when the market is at an all-time high and it is likely that many stocks are overpriced.

Is this bad management, or are management teams just unable to find the right opportunities for investment and expansion? If it’s the latter then perhaps this recovery is not as robust as we thought.

Earnings Growth Compared To Market Returns

In theory, the S&P 500 should rise in line with earnings. In practice  this does not happen.

While this comes as no surprise, the scale of the difference is astounding.

Earnings Growth
S&P 500 Returns

Across three decades the date shows that the S&P 500 has almost no correlation to earnings growth. The current period, 2003 to 2013 has seen the fastest earnings growth but the slowest S&P 500 growth.

However, the period of 1983 to 1993 saw earnings only grow a measly 5%, while the S&P 500 expanded 179%.

Congress’ Approval Rating Reaches A New Low

Earlier this week Gallup announced that Congress’ approval rating among the American public had reached a new low of only 9%, down from the 10% approval rating reported from the last poll.

This is by far the lowest rating that Congress has achieved since Gallup started asking Americans how they feel about Congress 39 years ago. Since 1974, the average approval rating has been 33%, reaching a high of 56% after the Sept. 11 attacks.

I should state however that Gallup only surveyed 1,039 across the country for the poll and the results carry a margin of error of plus or minus 4%.

Russian Privatization Continues

It is everywhere you look, on television, in newspapers, on flags, coins and books. I am talking about the world famous Mikhail Kalashnikov’s AK-47, possibly one of the most influential ‘tools’ of the past decade.

The Avtomat Kalishnikova 1947 (AK-47) was finally perfected and issued to Russian troops in 1947, as the name suggests. Nearly 60 years on the weapon is still responsible for an estimated 250,000 deaths a year, which could make the AK-47 more deadly than any weapon, nuclear or otherwise ever created.

Ironically, it may just be that the AK-47 death machine is the most durable, popular and effective ‘tool’ ever created by humans.


There’s a famous story of the American Army Colonel and military journalist David Hackworth coming across the body of a Russian soldier that had been dead and buried in mud for more than a year. He drags the soldier’s AK-47 out of the earth, points it at the sky and fires a clean 30 rounds without even dusting it off.

If you look after a Kalashnikov, you can get up to 40 or 50 years’ worth of active service out of them. Abuse the hell out of the thing with sand, water, poor maintenance and you might find it lasting a mere 20 years. And if a part does break, the design has proliferated to every corner of the globe and it’s hardly changed in more than 60 years. You can grab a 1950 magazine and plug it straight into an AK that rolled off a Chinese production line yesterday and start shooting. It’s like the Volkswagen Beetle of firearms.

Why is this important? Well, up until last week the company that has manufactured AK-47′s in Russia since the end of The Second World war has just been partially privatized.

Izhevsk Machine Works has only recently returned to profitability after several years of robust gun sales to American civilians. Two private Russian investors are buying a 49% stake in the company, for a paltry sum of $80 million. Izhevsk made profits of $193 million last year, so these investors should see a profit within the year.

Yet another case of Russian state enterprise being sold off at rock-bottom prices to the ‘connected few’.