Summertime doldrums return as old adage holds true
July 27, 2009 by Brien Lundin
It seems you can’t fight the calendar after all.
In June, as you’ll fondly remember, gold and gold stocks were in full-blown rally mode. At the time, I was telling you how this summer was shaping up to be the exception to the rule of seasonality for gold and other investments.
That rule—capsulized by the adage, “Sell in May, and go away”—holds that buying demand for investments withers away during the summer months, as vacations and other pursuits distract attention from the markets. For gold the effect is even more pronounced, because physical demand from Asia also dries up during this time frame.
But, as gold and other commodities were rallying in April and May… as even the much-beleaguered U.S. stock market was marching steadily higher… it seemed that we might be in store for an exception to the rule. In short, the summertime doldrums were on the verge of being replaced by a very hot summer market.
That might still happen. But there have been some big shifts in market direction and sentiment since our last issue. As far as the commodity play goes, not only has the bloom come off the rose, but the entire plant has begun withering under the summer heat.
The Rally Falters…
The rally in commodities was based on the idea that the worst was over for the global economy and a rebound was either imminent or already under way.
This idea was helped along by a Chinese buying spree in commodities, particularly copper. While most recognized this for astute restocking at bargain-basement prices, it also helped build faith in a China-led global economic recovery.
The Middle Kingdom, after all, led the world in the relative size of their economic rescue plan and the speed in which they enacted it. Moreover, their spending was directed toward infrastructure projects that actually stimulated the economy—an idea that would seem obvious anywhere but Washington. Therefore, one would expect that China would lead the world out of the recession, and in fact economic data out of China, to whatever degree it was reliable, began to point toward recovery.
So, there was some basis for the argument that the tide had turned for the global economy. And there was enough basis to lead speculators to pile into commodities, driving prices to heights that discounted a far stronger economic rebound than could possibly be provided.
Money was finally being made again. And considering the depth of the bottoms from which stocks and commodities were bouncing, the profits were quite extraordinary.
Coming from a trying period when profits of any kind were scarce, investors began to take profits by early June. The momentum was dying, and all that was needed by mid-June was some kind of spark to send the crowds rushing for the exits.
On June 22, a World Bank report projecting a deeper global economic downturn through the end of the year provided that spark. Commodities plunged, extending a slide that had begun at the beginning of the month for the metals, and about mid-month for oil. This sell-off further bolstered the argument that the party had ended for commodity bulls.
Rebound…Or Double-Dip Recession?
The late-spring rally in metals faltered because there just wasn’t enough evidence supporting the argument for a significant and imminent economic rebound in the U.S. and the rest of the developed world.
Yes, China was looking better. But would it be enough to pull the entire world higher? Not likely.
At this point, investors are still torn between the prospects of an extended downturn (perhaps even a double-dip recession that would test previous lows), or a recovery beginning in the third or fourth quarter of this year.
The factors that would contribute to a continuance of the recession are painfully obvious, and it wouldn’t take much for them to destroy any hope of a rebound.
From an economic viewpoint, the U.S. remains in a precarious position. Housing must recover before any significant or sustained recovery will be possible, and the real estate market remains mired on the downward slope of the cycle. Prices have only begun to fall to levels that reflect reality, and massive inventories remain to be drawn down.
In addition, the credit markets, while improving upon the disastrous state of affairs last fall, are still dancing along the edge of a precipice.
Mortgage rates must remain low if there is any hope of a housing market recovery, which places the Fed smack dab into a vicious cycle. To keep rates low, the Fed will be forced to continually accelerate its purchases of Treasury and mortgage paper…thereby monetizing the debt, fueling inflation and pressuring interest rates higher.
The investment markets recognize the trick box Bernanke and Co. are locked into, and will certainly take full advantage of the Fed’s supporting bid.
From the viewpoint of the markets, the rally in stocks, and commodities, was obviously far ahead of any economic justification. In stocks, every standard of value, from P/E ratios to book values, show that the market has made the transformation from undervalued to quite expensive.
While the U.S. stock market has come up with more than its share of surprises over the past few months, the technical and fundamental underpinnings look exceptionally weak at this point.
Add it all up and you might consider the path to recovery as being uphill…and passing through a minefield. After all, while the pace of the U.S. economic decline is slowing, it is still in decline. Any negative development at all—from new interruptions in credit flows, to a crisis in commercial real estate, to a major banking default or any other “dropped shoe”—could collapse fragile consumer sentiment and send the economy back in the tank.
Conversely, we have to recognize that there are valid arguments for a rebound in the second half. Bulls on the economy argue that companies wasted no time cutting to the bone in this downturn. Employment and inventories are at barest minimums, and any increases in production will lead to dramatically improved inventory builds, employment and investment.
The auto industry is a prime example. Analysts estimate that auto production has fallen so low in the U.S., that it could increase by up to 75 percent without adding anything to inventories.
Because of this anticipated effect, some bullish economists are forecasting that July will be the first month this year to show actual growth in industrial production.
And, of course, companies also used the global economic collapse as an excuse to take massive write-downs and losses, which led to even worse earnings (and losses) over the last two quarters. Thus, any earnings at all in the quarters ahead will show dramatic improvement. While these earnings improvements will be somewhat misleading, they will still add fuel to a potential market rally and resulting positive sentiment.
Any positive sentiment will add to another factor many analysts are now banking on: pent-up consumer demand. The idea here is that consumers have put off many purchases that are temporarily discretionary but ultimately necessary. It’s the theory of a “threadbare economic recovery”—businessmen, for example, can put off buying a new suit for some time. But eventually, when they wear a suit down to bare threads, they simply have to go out and get a new one.
Those arguing for economic growth this year are banking on this effect helping to some degree.
But the most important factor may be the long-awaited arrival of stimulus spending. Granted, the stimulus package foisted upon us by Congress and the Obama administration was misdirected and hugely inefficient. But it was also stupendously large—so large that its sheer size ensures that the flood of spending will assuredly juice up the U.S. economy to some extent.
On balance, looking at both sides of the argument, it would seem that the prospects for an economic rebound in the near term remain dim, and that the summer slowdown in the markets—including the metals—will remain in force.