Where Gold, Bonds and Emerging Markets Converge
Our narrative today begins with gold-buying in New York, then wanders past bond-selling in Lisbon and ends with some squiggles in Shanghai.
First, the gold-buying…
The precious metals rebounded yesterday – and are maintaining their elevated levels this morning. The reason, according to Bloomberg News, is that “Europe’s debt crisis is spreading. Portuguese bond yields [are] rising to levels that may force the nation to follow Greece and Ireland in requesting a bailout from the European Union.”
Nonsense! Says Portugal’s Prime Minister, Jose Socrates. “Portugal won’t request any financial help, for the simple reason that it doesn’t need it,” the proud Prime Minister insists. “The government is doing its job and is doing it well.”
Hmmm… Portugal’s soaring bond yields provide compelling testimony to the contrary. The Portuguese government may be doing part of its job well – like repairing cobblestone streets or boosting global cork sales – but it is clearly not doing a great job of managing the nation’s finances. At last count, Portugal’s budget deficit was brushing up against 10% of GDP.
The government is promising to reduce that shortfall to a somewhat less terrible number over the next couple of years. But so far, bond investors are skeptical.
As recently as one year ago, Portugal’s 10-year bonds paid a respectably low yield of 3.70%. But now that Portugal has joined the ranks of Europe’s fiscally infirm nations, its bond yields are nearly twice as high.
Portugal managed to sell a little bit of its debt this morning, but only because it offered a “junk bond” yield of 6.72%. (Your California editor could have securitized and sold his personal credit card debt at a lower rate of interest). Even so, the financial news outlets were quick to hail the Portuguese bond sale as “a success.”
But this “success” was more theatre than real life. The size of the auction – at a mere 599 million euros – was little more than a ribbon-cutting ceremony to show the world that Portugal is in okay shape after all. The auction was a success, only if one ignores the fact that the ECB has been aggressively buying Portuguese debt to suppress bond yields. Bear in mind also that this 599 million euro sale occurred in the context of chatter about Portugal receiving a 60 billion euro bailout from the ECB.
The Portuguese government’s finances may not be in dire straights just yet, but they are hardly in tip-top shape.
Not surprisingly, Portuguese stocks have been slumping for the past few months (as have Spanish stocks). These lackluster stock market trends on the Iberian Peninsula are eerily similar to those of several major Emerging Markets.
The goings on in these peripheral markets may not mean anything at all. On the other hand, they may mean a little something. In recent years, Emerging Market stocks and bonds – as the quintessential “risk on” assets – have tended to lead the financial markets of the Developed World – either higher or lower…
Which brings us to those squiggles in Shanghai…
The Shanghai Composite Index bottomed out in early November of 2008 – four months before the S&P 500 reached its ultimate low. Most of the other major Emerging Markets bottomed out at the same time as the Shanghai Composite and had established clear uptrends, even as the S&P 500 was tumbling to lower lows. As such, the Emerging Markets clearly led the Developed Markets out of the 2008-9 bear market.
Today, a completely opposite phenomenon may be unfolding. Emerging Markets have been weakening for several months, even as the Developed Markets have continued to new post-recovery highs. This recent divergence may not portend doom and gloom, but neither does it inspire confidence.
Net-net, there may be no relevant connection between the recent gold-buying in New York, bond-selling in Lisbon and squiggles in Shanghai. But if there were a connection, it would probably be that investors are slowly embracing the “risk off” trade. They are backing away from assets like Portuguese bonds and Chinese stocks. And in place of these “risk on” investments, they are buying gold, silver and other hard assets.