CIO Weekly - Golden Buying Opportunity

Summary

• Gold is a steal - don't miss the opportunity now.
• Asian equities the better quality momentum play.
• Chinese equities have up to 10% more upside potential this year.
• Top up your 10 year U.S. government bond holdings into any further price weakness.

Gold is a steal anywhere near the $1200 level. I wonder how much more North Korea is going to have to say or do before investors turn to gold in more numbers. Irrespective of the geopolitical issues we are moving into a seasonally stronger period for gold. My favorite technical analyst Bill Sarrubi at Cycle Research Investments points out that gold has risen more frequently in July than in any other month since 1969. He expects gold to move back to 1240-45 in the very near term before pushing higher from August onwards. September has been the single strongest month in any year. I would remind investors that an allocation of 6-8% as a core holding in gold is appropriate for long-term wealth preservation.

Investor patience is needed in buying global equity markets where last week’s very modest losses of around 0.5% may presage a bout of weakness in the coming six to eight weeks. After a good run, the markets are looking to consolidate. We see any setback in equity markets as a selective buying opportunity in Emerging markets and especially in Asia.

Janet Yellen’s speeches to Congress this coming week are likely to see her continue to set out a mildly hawkish position on the path for further interest rate increases. However economic data later in the week is likely to underpin my view that the U.S. economy is providing insufficient reasons for the market to believe that there will be a sharp tightening of monetary policy in coming quarters. One further rate rise this year looks to be the most likely scenario something that is not going to derail the recovery in Asia or the positive performance seen from emerging market assets since the start of the year.

There are good signs of life in the Asian economy and further good potential returns from Asian equity markets

I believe investors can garner more return from the Chinese equity market through the balance of the year. Hence I wouldn’t be tempted to take profits on Chinese despite the stellar year-to-date performance. In the first half of 2017 MSCI China rose 24%. The second half is likely to be tougher, but that doesn’t preclude further reasonable returns of around 10%, which targets a still reasonable level of valuation for the market.

Despite calls for its imminent demise, the Chinese economy continues to turn out reasonable growth with signs of a small acceleration in the past month. Last week release of the Markit survey of Chinese industrial confidence for June was ahead of economists’ expectations improving from 49.6 to 50.4. This coming week, economists are expecting strong trade numbers with import growth of around 18% year-on-year underlining the strength of the domestic economy.

The Chinese economy is achieving reasonable growth while the authorities to rein in the size of the shadow banking industry. As a sign of the government’s success in reducing the risks of shadow banking, banks’ outstanding wealth management products stood at 28.4 yuan at the end of May compared to 30.0 trillion yuan at the end of 2016. However such pressure does come with a cost as it forces market interest rates higher and M2 money supply growth has slowed – this coming week the market is expecting M2 growth to have slowed further to (a still healthy) 9.3% in June from 9.6% in May.

In a perverse the way the more the government reins in the excesses in the economy, the more that investors’ confidence grows and the more that the market has the potential to show further absolute gains. I believe there is increasing confidence amongst investors that the authorities are not going to be heavy-handed in addressing some of the structural imbalances in the financial system. Better control over the shadow banking industry should be helpful to the Chinese banking sector in the offshore market, which has been a persistent underperformer versus the broad equity market since the start of the year.

International investors are back buying Chinese equities

We are seeing signs of U.S. investors, in particular, returning to the market. January through to May U.S. mutual funds investing in China saw net redemptions of some $100m however in June there were net inflows. I believe this is one part of the world where an actively managed fund should outperform index funds. The broad range of investment themes with clear winners and losers gives good stock pickers the opportunity to outperform a passive strategy. From my quick screen of one Morningstar database around 65% of actively manage have outperformed the index year-to-date.

There are good reasons for a positive view of Asia ex-Japan beyond the confines of Mainland China. Economic news-flow has remained upbeat across the region translating into upgrades to corporate profit forecasts. I expect the upgrades to continue. I don’t believe that analysts have fully discounted the better economic news-flow in their corporate profits forecasts. Understandably many analysts have been cautious about pushing their forecasts too far having been burnt in previous years when economic optimism at the start of the year has often proved to be a false dawn. However countries such as Malaysia and Indonesia, despite their political challenges, have seen consistent economic growth in recent quarters. Malaysia, for example, is this week expected to report industrial production growth of above 4% year-on-year. I expect analysts to push their corporate profits forecasts higher providing support for further gains in the regional equity markets.

I believe U.S. longer-dated government bonds are getting into buying territory although if you are trying to perfect your timing, I would urge investors to be a little patient. The U.S. 10-year yield is now at the top end of its trading range at 2.39%, which looks tempting. However, Janet Yellen’s likely hawkishness in her comments this week may push yields a little higher before we are done. Also, the trend of U.S. economic data releases coming in below expectations appears to be reversing as economists take a more cautious view in their forecasting. Hence we could see a period where the data seems to be coming in much better than expected only because the economists cut their forecasts too far.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

I may initiate further buying in gold ETFs