The Industrial Sector is Strong and Gold Benefits
On Good Friday the Fed reported that industrial production increased 0.6% in March after a downward-revised gain of 0.5% in February. For the first quarter as a whole, industrial production rose at an annual rate of 4.5%. These are solid gains compared to historical averages. It comes as no surprise then that the Commodity Research Bureau/Reuters U.S. Spot Raw Industrials index (RI) remains near its highest level since at least 1981.
I focus on the raw industrials index more than the Reuters/Jeffries CRB Futures Price Index (CRB) because the CRB index is more heavily influenced by food prices than the RI, which contains commodities used in industrial activity. The 22 commodities in the raw industrials index, include hides, tallow, copper scrap, lead scrap, steel scrap, zinc, tin, burlap, cotton, print cloth, rosin and rubber. The index is not heavily influenced by oil or food, which makes it useful as a gauge of the health of the economy and of producer price inflation. The index is now up about 15% since it began a sharp climb in December.
It may be useful to focus on this indicator because it gives us a good feel for the underlying trends in the economy. If for example industrial production is currently rising at an annual rate of 4.5%, then one can assume that the industrial sector continues to expand. Hiring in the industrial part of the economy is probably robust (despite China "stealing" our jobs) and hours worked probably increased along with total take home pay for the average worker. Tony Crescenzi for example wrote today, that incomes increased by $600 in each of the past two years, much more than the yearly energy cost increase of about $100 billion. The economy is chugging along in the face of rising interest rates, rising oil prices, record deficits and a wobbly currency.
Copper, meanwhile, has reached new highs amid continued signs of global economic growth. China reported first-quarter GDP growth of 10.2% on Friday, which sent copper sharply higher while U.S. markets were closed, according to Nell Sloane, metals analyst at NSFutures.com. "It certainly feels like the flow of money toward all metals is accelerating," she wrote in her daily commentary.
Gold and metals, which are dollar-denominated, also received a boost Monday from dollar weakness. A weak greenback normally boosts the value of dollar-denominated commodities, as it takes more dollars to buy the same amount of goods. The dollar index, which measures the U.S. currency vs. most key world currencies, fell 1% Monday. The drop came after a Wall Street Journal article on Friday suggested that the Federal Reserve is not committed to hiking interest rates beyond May 10. It seems that currencies are still driven by interest rate (yield) differentials and not by considerations of a currency's economic soundness.
So far, the dollar has remained supported by the Fed's 15 successive rate hikes since June 2004. But once the Fed stops, the dollar will have to weaken to rebalance the soaring U.S. current account deficit, gold bugs believe. What has kept the dollar afloat to date has been continued inflows of foreign capital into U.S. assets -- providing the "funding" of the current account deficit. On that front, the dollar received support on Monday after a report showed foreign investment into U.S. assets had increased in February. Emerging Market Millionaires and Billionaires only have a handful of choices when they consider where to park their profits. The dollar still seems attractive because it represents the single biggest economy in one country, whereas the EU has the disadvantage of representing two dozen countries with shifting power balances. "The devil you know is always preferable."
So while the Dollar should continue to be the destination of choice for private money, the officials directing public money are getting anxious. China, for example, which has become the largest holder of foreign currency reserves in the world, has repeatedly said it wants to diversify its reserves away from dollars. On Monday, Cheng Siwei, vice chairman of the Standing Committee of the National People's Congress, called for a reduction of Chinese purchases of U.S. debt, according to Bloomberg. "The choice of currency in which to hold their surpluses is limited," writes Peter Spina, gold analyst at goldseek.com. "This choice is further restricted by the need to hold the dollar in their reserves with which to buy oil."
Gold should therefore remain a hedge against potential dollar weakness for a long while. We have inflation slowly rising with oil at $70 and copper and zinc boosting input costs on the one hand, and a slowing housing market on the other. If the economy weakens, the dollar is probably going to fall. When this day will come is unclear, but it probably will come this year. Meanwhile Chinese growth remains very strong and looking at everything that is on the table, I believe that hard assets and precious metals in particular are still a very good place to be.