Bernanke takes the shine off gold

While commodity stocks may have been somewhat volatile this week, the TSX saw solid support from Canadian banks which started reporting fiscal Q1/12 earnings on Tuesday. Results were quite strong out of TD Bank, R and National Bank with TD and Royal raising their quarterly dividends.

Oil prices closed lower for the week but still remain closer to the U.S.$110 per barrel mark as the situation with Iran was unchanged, and as false rumours spread of a Saudi pipeline explosion on Thursday. We remain concerned about higher oil prices and the impact they’ll have on what is already a fragile global economy. You only have to go back to this time last year to realize that higher oil prices can quickly dampen an economic recovery.

The Bernanke speech resulted in lower gold prices for the week. However, the Canadian dollar still found support amongst currency traders reaching a level not seen since September and closing the week above the US$1.01 mark.

We are not immune

Considering how the Canadian economy has performed relative to many other countries since the financial crisis, it might be possible for the average Canadian to assume that U.S. economic malaise and the European debt crisis won’t impact our own domestic economy. However, such an assumption would be wrong. Our chart of the week shows Canadian quarterly GDP going back to the recession of 2008-2009 and the most recent print of 1.75% for Q4 of 2011. While it is true that such a print is positive, with the exception of a poor second quarter last year, this is the lowest GDP print for Canada since the third quarter of 2009. If we have to point to a culprit in particular for this weakness it would have to be the very slow and painful economic recovery in the United States since we do about three quarters of our trade with our neighbors to the south. So, while Canadians didn’t feel the pain of the recession to the same degree as people in other developed countries, be cognizant that U.S. economic growth will be a leading indicator for our economy for many years to come.

Trading week ahead

As we look forward to next week, for once Europe may not be the primary focus of the market even though it will always be a concern for months and years to come. Instead, all eyes will be on the U.S. employment report due out on Friday. For the past few months, employment has surprised to the upside even though over half of the jobs lost during the recession in the U.S. have not yet returned. Combine the relatively positive employment reports with other encouraging U.S. economic data, and you have a market that believes the U.S. economy is on the mend for the time being. However, it’s imperative for us to see this momentum continue in order to support the equity gains witnessed thus far in 2012. In addition, the jobs created have to be high quality (full-time) and wages have to rise in order to have an impact on wealth, and thus consumer spending. Canada will disclose its February employment report on Friday, but investors will also be paying attention to Bank of Canada Governor Mark Carney on Thursday as the Central Bank makes an interest rate decision. While there is no doubt that the overnight lending rate will stay at 1.0%, the market will want to see if the Bank of Canada’s tone has changed at all when it releases its policy statement.

Earnings reports in the U.S. will fall to a whisper since most companies have now released their Q1 earnings, but Canada is a different story as we will see results out of CIBC and Scotiabank along with a number of resource companies and REITs. Energy traders will continue to focus on Iran, especially as Iranian parliamentary election results will be revealed over the weekend, and commodity investors will pay close attention to the employment reports to gauge where there U.S. dollar may be headed. Tuesday, or “Super Tuesday”, will be a significant day in the U.S. Republican nomination process as 10 states will hold primaries or caucuses to select a candidate before the Republican National Convention in August.

Question of the week

What happened to the gold price on Wednesday?

Indeed! What did happen to the price of gold on Wednesday when bullion suffered an intraday decline of US$102.35 per ounce, finishing the day US$87.38 per ounce lower by market close? To answer this question we need to understand events or situations that support gold prices and they include inflation concerns, increasing money supply, and a falling U.S. dollar to name a few. On Wednesday, Federal Reserve Chairman Ben Bernanke testified in front of Congress to provide lawmakers with an update on the state of the U.S. economy and monetary policy. When the U.S. economy has struggled in the past, the Federal Reserve (the Fed) has initiated programs called “quantitative easing”, which is a term essentially given to the process of adding more money to the U.S. financial system. When the Fed pursues quantitative easing it is increasing the money supply, but by doing so it lowers the value of each U.S. dollar in the system thus weakening the U.S. dollar and strengthening commodity prices such as gold since most are denominated in the U.S. currency. Leading up to Mr. Bernanke’s testimony there was an expectation amongst some investors that he might pursue another round of quantitative easing which would likely be called QE3, in particular to help the U.S. housing market. However, the Chairman made no such mention of QE3 in his speech. Therefore, investors who had such an expectation and bid up the price of gold were disappointed by Mr. Bernanke’s silence on this subject, and decided to sell their gold holdings. Since gold is now closer to US$1700 an ounce than US$1800 per ounce, do we feel the positive story for gold is over? Absolutely not. First off, while Mr. Bernanke didn’t say he was going to pursue QE3, he also didn’t say he wasn’t going to pursue such a program. Regardless, we feel that many countries, including the United States, will have to print off more money to tackle the substantial debt problems that exist within the developed world. We’d also note that we did not see any further selling on Thursday which makes us believe that many investors still want to hold onto their gold positions in this environment.