Earnings and Gold in Focus

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Earnings and Gold in Focus

Stocks managed to gut out a second consecutive weekly gain in spite of fresh head winds out of Europe and slightly mixed results on the earnings front. For the week, the S&P 500 gained .9%, the Dow Industrials added .4% while the NASDAQ led the way after tacking on 1.4%.

The averages were off to a fairly strong start early in the week after aluminum maker Alcoa, Inc. (AA) reported that it expects to see strong demand in the first half of 2012. That provided a very nice injection of confidence into the Street because the company’s industrial exposure is viewed as a barometer for the health of the general economy. The forecast also played into China, providing hope that the massive consumer of resources recent bout of weakness is merely transitory in nature.

That bullish trend held strong through the middle of the week before the market hit some speed bumps on Friday.

The first was JP Morgan’s (JPM) Q4 results, coming in short of expectations as the financial mega-giant and financial sector in general continue to struggle with asset deterioration and weaker revenue growth. Keep in mind, the financial sector led the way into the recession of 2008 and also led on the way out in 2009. That means there are more than a few analysts, portfolio managers and investors keeping a very close eye on the group to gauge the health and trajectory of the economy.

Euro Zone Downgraded

But things got even more interesting on Friday after a leak hit the wire that ratings agency S&P was set to downgrade a number of euro zone countries after the close. The final tally came to nine, with France losing its coveted AAA rating while also being placed on negative outlook. That is definitely a build on the already troubling Euro zone scene, so the market is once again on notice that the union stands on shaky ground.

Looking forward, we’ve got a super busy week on our hands. Earnings season will continue to accelerate as a flurry of blue chips and high profile names step up to the plate. On the financial front we’ll hear from Citigroup, Inc. (C), Wells Fargo Co. (WFC), Goldman Sachs (GS) and Bank of America (BAC).

We’ve also got some headline technology companies in the mix, with Intel (INTC), Microsoft (MSFT), and Google (GOOG) on deck. And on Friday, we hear from General Electric (GE), another company that the Street views as being a bellwether indicator on the health of the economy.

We’ll also be seeing plenty of economic data in the holiday shortened week, giving the market some more information to sink its teeth into.

  • Tuesday-Empire State Manufacturing
  • Wednesday-Industrial Production
  • Thursday-Consumer Price Index & Philly Fed Manufacturing
  • Friday-Existing Home Sales

So as it stands, in spite of some turbulence on the earnings front and another chapter being written in the never ending Euro saga, stocks continue to trade relatively strong. For that you can thank a compelling valuation, with the S&P 500 back to peak earnings from 2007, and anticipation of more support and intervention from the central banks of the world. So with a little help from earnings and some respectable economic data, the market could be well positioned for another leg higher.

Updates:

Last week we introduced a new format to our updates, choosing to take a more in depth look at one area of the market as opposed to an overhead view of 4 or 5. So sticking with that concept, let’s go ahead and introduce our latest topic; Gold.

Gold has been one of the most divisive assets of the last few years, creating two very distinguished camps that are sharply positioned against each other; those who love it and those who hate it.

Those strong opinions come on the heels of what has been a historic run for gold, up more than 650% over the last ten years as investors continue to migrate into hard assets to protect their portfolios from currency devolution and central banks gone wild.

But while 2011 was another great year for gold, beating stocks and commodities with a 14% gain, various gold investments performed very differently.

At the top of the charts you have investments in physical prices, in this case X2, taking the form of Deutsche Bank Double Gold (DGP), which clocked in with a 28% gain over the last 12 months. Check out the killer one-year chart below where double gold handily outperformed the S&P500.

Double Gold vs S&P 500

But while the physical price of gold saw nice gains in 2011, there was a very unusual decoupling between the actual price of gold and gold stocks, otherwise known as gold miners. In spite of higher selling prices and robust earnings growth, gold miners had a terrible year. Below is a comparative chart that showcases that divergence pattern between Junior Gold Miners (GDXJ) and the actual price of gold in SPDR Gold Trust (GLD), with the S&P500 in green.

GDXJ vs. GLD and S&P 500

There are a few theories as to why this happened. The first is that investors are bypassing gold mining stocks and choosing to invest in physical prices through the use of ETF’s. These gold ETF’s have only existed for a few years and compete for a limited number of investment Dollars. So where as in the old days the only way to invest in gold was to buy a gold miner, investors now have more options.

The second theory is that gold stocks at the end of the day are still stocks, and growth stocks haven’t performed well in 2011. So even though the gold miners are posting impressive earnings growth on the back of higher selling prices, the market is still treating them as speculative growth stocks.

And finally, one for all the conspiracy theorists is that gold stocks and the price of gold are being manipulated by central and investment banks to try and keep a lid on gold prices. It would be hard to prove that, but at the very least it provides some context to how hot the conversations run with precious metals.

So big picture, the highest level take away is that there has been a massive divergence pattern between the price of gold and gold stocks. At some point, history tells us that gap will close, which requires either gold to collapse or the miners to rally. So if you’re still bullish on gold as the central banks continue to dilute, it could be a good time to load up on the group while prices and valuations remain at historic lows.

That’s all for this week, but until next time, here is an interesting article that discusses the probability China will lower interest rates in response to its cooling economy. If that happens, it’s good for gold, crude and stocks in general. Enjoy.

China on Verge of Easing?

Your Investment Partner,

Mike

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