The beginning of the end for Eurozone austerity?

May 31, 2013 11:24 am

by Gavyn Davies

Fiscal austerity, a concept which German Chancellor Merkel says meant nothing to her before the crisis, may have passed its heyday in the eurozone. This week, the European Commission has published its country-specific recommendations, containing fiscal plans for member states that are subject to excessive deficit procedures. These plans, which will form the basis for political discussion at the next Summit on 27-28 June, allow for greater flexibility in reaching budget targets for several countries, including France, Spain, the Netherlands and Portugal.

Furthermore, there have been rumblings in the German press suggesting that Berlin is beginning to recognise that fiscal consolidation without economic growth could prove to be a Pyrrhic victory. If true, this could mark the beginning of a new approach in the eurozone, helping the weakest region in the global economy to recover from a recession that has already dragged on far too long. So how real is the prospect of change?

The planned path for the fiscal stance

The commission proposals on budgetary policy have been widely heralded as providing more time for the troubled economies to reduce their budget deficits to below 3 per cent of GDP, and that is certainly true. Furthermore, Italy is rewarded for good behaviour by being removed from the excessive deficit procedure altogether. But the budget arithmetic is presented by the Commission in such an opaque form that it is very difficult to see how much the stance of fiscal policy will really change in the next few years compared to the recent past.

The attached document, prepared by my Fulcrum colleague Juan Antolin-Diaz, attempts to clarify the situation for the eurozone as a whole, and for each of the major economies affected. In summary, the essential point is that countries with excessive deficits can now use the automatic fiscal stabilisers in full in response to weaker GDP growth, provided that they continue to improve their underlying structural deficits over the medium term. The result is higher deficits in the near term, implying that it will take one to three years longer to reduce the deficits to under 3 per cent of GDP.

In previous years, member states have often been forced to “chase their own tails” by immediately acting to keep deficits on track as recessions have deepened. The full use of fiscal stabilisers for countries that exhibitgood behaviour” is an important change.

Apart from that, the planned path for future fiscal tightening in the eurozone has been modified, though the tightening has not been eliminated altogether. Graph 1 shows the intended path for the structural budget deficit in the group of troubled economies (including France) in the years ahead, while Graph 2 shows the change in the underlying fiscal stance between one year and the next (note that positive numbers represent fiscal tightening).

The conclusion is that there is much less tightening planned over the next three years than the amount that has occurred since the austerity programmes started. From 2009-13, the fiscal stance for the troubled economies was tightened by a little over 1 per cent of GDP per annum. In the next three years from 2013-16, the planned tightening runs at about 0.5 per cent of GDP per annum, about half the pace that has been implemented so far. If countries implement these plans as intended, the next three years would not see the “end of austerity”, still less its reversal, but its pace would be significantly less than before.

Developments in the German attitude

This raises the question of whether Germany might be ready to go further than the latest Commission proposals in easing the path for budgetary consolidation in the troubled economies. After all, a great deal of progress has been made on reducing the fiscal deficits, while very little has been made on regenerating economic growth. Finance Minister Schauble has recently changed his narrative, at least in public, saying that without growth “our success story would not be complete”. He has also gone out of his way to promise bilateral aid to both Spain and Portugal as they implement structural reforms.

It is most unclear, however, whether the German leopard is really changing its spots. There is no sign of them favouring any generalised easing in the fiscal stance, either in Germany or other eurozone economies. The economic approach which permeates German speeches, and indeed yesterday’s Commission documents, is the same as before: only when the budgets of member states have been brought into line with the rules of the new fiscal compact can we seriously contemplate doing much else. In the past couple of weeks, the Finance Minister has gone out of his way to oppose ECB proposals for common eurozone funding for bank resolutions, and to criticise Mario Draghi’s suggestions on funding for small business loans in the south.

This means that any changes in German thinking are happening only at the margin, rather than in the mainstream. It is hard to expect much different in the run up to the election in September. But some changes are underway. The Merkel chancellery has reportedly become exercised about the slow pace of structural reforms in the south, relating mainly to labour markets and pensions, and is thinking carefully about how to design contracts which would reward progress on this front by allowing access to additional structural funds from the common EU (or Eurozone) budget.The Commission has already published some proposals in this area, and more progress may be made before the summit.

In addition to this, there is a willingness to contemplate using the German KfW development bank to provide low interest rate loans to development agencies in Spain and Portugal, and to build on the E6 billion which has been earmarked to help address youth unemployment across the EU. Small beer, perhaps, but it is a start, and much better than nothing.

As Churchill said about El Alamein, this may not be the end of eurozone austerity, or even the beginning of the end, but it is the end of the beginning.

Chart of the Week: 10 Year Treasury Rates are ‘Backing Up’

Friday, May 31, 2013

David Franklin


It’s been a tough month for U.S. bond funds. Our chart of the week depicts the increase in the yield of the 10-year U.S. Treasury Bond. Yields have increased by more than 25% from 1.63% on May 1st to 2.12% on May 30th. This quick sell-off hurts investors most at funds holding long-term debt, which is sensitive to surging interest rates. Bonds have tumbled around the world this month with the Bank of America Merrill Lynch Global Broad Market Index down 1.3% in May, poised for the steepest loss since April 2004, while Treasuries have dropped 1.9%

Yields rose in May after a report showed U.S. consumer confidence climbed to a five-year high and the 20-city S&P Case-Shiller Home Price Index (to the end of March) climbed 10.87% on the year, the fastest pace of increase since April 2006. According to Bloomberg, the impact of rising rates has had a negative impact on most bond funds this month with the two largest bond funds in the United States now reporting negative total returns for 2013, year-to-date. 

What is an investor to do? Michael Craig, Portfolio Manager at Sprott Asset Management had this advice, “We are entering a generational bear market for bonds. Investors should reduce allocations to index bond funds. Clients should consider adding positions to ‘go anywhere bond funds that have the flexibility to increase their cash levels and potentially short bonds where appropriate. 

10yr -treasury -rates

The Best Contrarian Play on Gold I’ve Ever Seen…

Written on 28 May 2013

by Dr. Alex Cowie

The Best Contrarian Play on Gold I’ve Ever Seen…

Calling it ‘Wetting the baby’s head‘ is pure genius.

It sounds so innocent. All the boys get their leave pass. And before you know it: mayhem.
It was a fun night out celebrating the arrival of a mate’s baby son last Friday.

That is apart from when one of the guys wanted to talk about gold.

He pounced on me for a comment on the least loved metal in the market, and normally I’d be up for it. But I couldn’t have thought of anything I’d rather chat about less.

It was written all over me. He said, Wow! When the gold bull goes quietTHAT’S when I start buying.’

And I’ve got to say, he’s right.

Let Me Explain Why…

Buy low, sell highinvesting’s easy right?

To ‘sell high, you usually have to go against all your instincts. It took me years to learn that when I’m high-fiving myself, and planning a fancy a holiday with future winnings, THAT’s when you sell.

And to buy low, first you just have to stomach buying something everyone else wants to sell. To buy close to or at the bottom of the market, you have to buy an asset when it has no friends.

And gold has blown up, burnt, or deeply tested all of its friends recently.

Gold equity professionals are miserable. Funds loaded up on gold stocks have been getting redemptions. Long-term friends to gold, like me, have had a gutful too.

When the mood is bearish at the very core of the sector, only then can you have what we see in the chart below: the gold miners bullish percent index (BPGDM) hitting ZERO. There isn’t a shred of love out there for gold stocks. Wow.

But here’s the thing

When the sentiment is at zerothen how much worse can things get? Really the only way from there…is up.

So when sentiment is at very rock bottomthen you’re probably at the very bottom of the market.

You can see what I mean below. The gold miners bullish percent index (in black) last hit zero in October 2008. Mood was as dire as it gets. But that was also immediately before gold stocks (in red) began to rally.

And they rallied for the next three years

Major Gold Stock Rallies (red) Begin When Sentiment (black) is Zero – Like Now

Source: StockCharts

This is exactly what my mate at the ‘head wetting recognised. That when even an ardent old gold bull like me didn’t want to talk about gold, then sentiment must be running pretty low in general. And like the man says, THAT’S when you buy.

You can see in the chart above, the gold miners bullish index has now bumped against zero twice in two months. That’s about as extreme as it gets. Maybe it could hit zero a third time. Who knows? It’s possible.

But when sentiment is at zerologically things can only get better from there. Gold stocks have now become an incredible contrarian play.

We’re getting the same signal from other places. The Mark Hulbert Digest Gold Sentiment index has swung to an all-time low of -35%. This measures the gold stock positioning across a swathe of newsletters.

Over the last fifteen years, like clockwork, a fall to under -20% has signalled the start of a new rally. So to be a record low of -35% today is another warning shot to expect a seismic shift in this sector.

It’s the subjective things I use as signposts too. A well regarded international gold analyst emailed me this week simply saying:’I need some inspiration in this horrible market and was hoping you could give me some.‘If you wanted a contrarian signal, that’s it right there.

How can I be so positive when gold itself has been beaten up so badly, and is down 17% (in $US) for the year?

Two Reasons to Back Gold…

One: the best time to buy is when things are cheap. And right now, gold is cheap. All the reasons to buy gold when it was at $1700 are still in place, yet gold is selling for $1400. This is why bullion dealers worldwide have all had their busiest two months of sales on record.

Two: the gold price is following a well-trodden script. A script that should mean the worst is now behind us for gold. When I wrote to you last week, I told how I warned of gold pulling back again from $1470 to the $1300′s.

I thought it would play out like this based on how gold has traded after the three previous 30% corrections over the last decade.

The good news is that if it keeps following the same script, then…we’re now at the start of the bull market that follows.

Of course, it doesn’t feel like we’re in a bull market today. But as the age old saying goes, ‘Bull markets are born of pessimism, and grown on scepticism.‘ Well there are several large steaming truckloads of both to nurture gold stocks, so get ready.

And it’s not just the corrections in the last decade that offer a credible roadmap for a recovery from here.

Gold has also been following the trading pattern from the greatest shellacking gold has ever had: the 46% crash in price seen in the mid-70′s.

Source: ETFS

Back in 1976, I was too busy mastering potty training to be overly aware of this, but gold had just fallen by nearly half, after completing a multiyear rally. Bears declared the end of gold, and investors panicked.

What happened next was legendary. From its lows, gold then increased in price by eight times.

As you can see in the chart above, gold seems to have been following a remarkably similar pattern over the last six months.

So I’ve been sitting tight with the gold stocks that I’ve tipped already for Diggers and Drillers. When we get a clear signal that a bull market has started, I may add more.

Until then, I’m tipping cashed up stocks. Companies with cash are in short supply, but are your best bet in tricky markets. And if we see a resurgence in resource stocks like I expect, cashed up stocks will lead the way, just like they did last time.