Why metals are beating metals stocks

Desjardins Securities may be one of the few observers to stick with its forecast of no – repeat, no – U.S. recession in 2008. But if there is a recession, metal markets should be able to absorb the shock, according to John Redstone, an analyst at Desjardins.

“In our view, a U.S. recession would have much less impact on metal markets than in previous cycles,” he said in a note to clients. “Indeed, we would argue that metal consumption in the U.S. has already been reduced to a recessionary level.”

He showed that U.S. copper demand fell 4 per cent in 2007, aluminum demand fell 6 per cent, nickel demand fell 7 per cent and zinc demand fell 10 per cent – and Mr. Redstone does not expect a significant rebound through to 2009, when demand will still be below 2006 levels. Yet prices for these base metals have remained strong thanks to continuing demand from other places. (Yes, China.)

Still, the stock market appears to have a different view. Equities of commodity producers are underperforming their underlying commodities out of concern about the U.S. economy. According to Mr. Redstone, the mines and metals sub-index of producers had risen just 9.5 per cent for the 12 months ended Mar. 7, 2008. But over the same period, the London Metals Exchange Index of actual commodities rose 28 per cent.

“We believe the upward metal price movements on the LME in part reflect a more positive view for incremental world metal demand as driven by the BRIC countries (Brazil, Russia, India, China),” Mr. Redstone said. “Ultimately, the more positive market supply/demand fundamentals for base metals worldwide should reassert themselves in higher share prices for companies on the mines and metals sub-index.”

Jobs, Jobs, What Jobs?

Clearly, Canadian investors are in no mood for good news. Or, they simply just don’t care that Canada can churn out jobs when the U.S. is cutting them.

The S&P/TSX composite index dipped 130 points at the start of trading on Friday morning, down 1 per cent o 13,230, after Statistic Canada said the Canadian economy pumped out 43,000 jobs in February. Once again, banks were a major drag on the index. It has become something of a sport to watch Bank of Montreal plumb new depths. In early trading, the beleaguered bank was down another 1.8 per cent, to $41.23.

In the United States, the Dow Jones industrial average fell 120 points, or 1 per cent, to 11,921. No surprise here: Payrolls declined by 63,000, far worse than expected. The broader S&P 500 fell to 1294, down 11 points or 0.8 per cent in early trading. There is sport in watching Citigroup Inc. fall as well. It declined another 2.4 per cent in early trading, falling to $20.67 (U.S.).

Besides being force-fed awful jobs numbers for February, some investors may also be rattled by the fact that the broader S&P 500 broke through an important technical barrier on Thursday, closing lower than its January trough to a new 18-month low – a sign that maybe there is no floor to this stock market correction after all. Now, many investors will be looking at the index's intraday January low as another technical indicator. That low is 1270, or just 24 points away.

In Europe, the selling accelerated after the U.S. jobs numbers were released. The U.K.’s FTSE 100 fell 1.4 per cent and Germany’s DAX index fell 1.8 per cent.

Looking for good News, It may be hard to find right now

Jobs, jobs, jobs – that’s what investors have on their minds on Friday morning before stock market trading begins in North America.

In Canada, the news was upbeat: The economy added more jobs than expected in February for the second month in a row, with payrolls rising by 43,300 – many of them in loonie-scarred Ontario.

In the United States, where – let’s face it – the majority of eyeballs are focused right now, the news was far less sunny: Payrolls shrank by 63,000 in February, defying an expectation among economists for a slight bounce and confirming some of the worst suspicions about the declining health of the U.S. economy. The unemployment rate decline 4.8 per cent, but only because many job seekers had simply given up looking for work.

Just before the jobs data was released, U.S. index futures were pointing down. Futures for the Dow Jones industrial average fell 109 points, to 11,961. For the broader S&P 500, futures fell 9 points to 1299.

Overseas, major stock market indexes followed the big declines in North America on Thursday. The U.K.’s FTSE 100 and Germany’s DAX index each fell 0.9 per cent on Friday. In Asia, Japan’s Nikkei 225 feel 3.3 per cent and Hong Kong’s Hang Seng index fell 3.6 per cent.

Margin calls, a realy bad sign, drives down market

North American stocks fell on Thursday at midday amid more concerns about blow-ups, writedowns and margin calls, unsettling a market that is already operating with frayed nerves.

The Dow Jones industrial average fell to 12,124, down 130 points or 1.1 per cent. The broader S&P 500 fell to 1316, down 18 points or 1.3 per cent. Both indexes are once again approaching their low-closes in January, a trough that many observers had hoped (and perhaps still do) would serve as a benchmark for a sustained rebound among equities.

Thornburg Mortgage and Carlyle Capital Corp. both missed margin calls, leading to concerns that credit-driven market mayhem is entering a new phase of rippling defaults. The downturn was widespread, with about 90 per cent of the stocks in the S&P 500 down, led by General Electric Co., Exxon Mobil Corp., JPMorgan Chase & Co. and American International Group Inc.

The S&P/TSX composite index is still well above its January low-point, thanks to the spectacular surge in commodity prices, but the trend is not looking favourable. The benchmark index fell to 13,454, down 150 points or 1.1 per cent.

See if you can spot a trend among the biggest drags on the index: Royal Bank of Canada fell 2.2 per cent, Barrick Gold Corp. fell 2.5 per cent, Bank of Nova Scotia fell 2.3 per cent, Toronto-Dominion Bank fell 2.1 per cent and embattled Bank of Montreal slid another 4.8 per cent.

In Europe, major indexes fell further later in the day there. The U.K.’s FTSE 100 fell 1.5 per cent and Germany’s DAX index fell 1.4 per cent.

Wild Ride on the Markets

Unless you had any doubts, Wednesday’s trading activity confirmed that the stock market is a nutty place right now. Major indexes rallied at the start of the day, partly on the hope that Ambac Financial Group Inc., the troubled monoline bond insurer, would be on the receiving end of a bailout that would remove a tremendous weight from the market’s shoulders.

It did, in the form of plans to raise $1.5-billion (U.S.) in common shares and equity units – and then the market gasped.

“The market was looking for between $2 billion and $3 billion. It got one and a half billion. It looks like the private equity money walked away from the deal, leaving Ambac short of market expectations,” said DealBreaker, the online business gossip site.

The Dow Jones industrial average went on a wild ride. It was up as much as 136 points before the Ambac news. It then fell more than 200 points, before recovering near the end of the day. It closed at 12,254.99, up 41.19 points or 0.3 per cent. The broader S&P 500 closed at 1333.70, up 6.95 points or 0.5 per cent.

In Canada, surging commodity prices weren’t enough to protect the S&P/TSX composite index from a similar ride. Before Ambac: up 173 points. After Ambac: down 160 points. The close: 13,603.32, up 126.51 points or 0.9 per cent.

The benchmark index was helped, of course, by rising commodity prices. Oil rose to a new record of $104.52 a barrel in the late afternoon, up $5. Gold also hit a new high of $988.40 an ounce, up $24.40.

The falling market and the net that may or may not be there

There is a lot of talk about the precarious situation the U.S. Federal Reserve is in these days. To borrow the analogy of the day, Ben Bernanke, the Fed’s chairman, is walking a tightrope between the competing demands of economic growth and inflation.

Enough, argues James Hamilton, professor of economics at the University of California, San Diego, on Econbrowser. The tightrope analogy is misleading because it implies there is an ideal solution for the Fed, in setting its key interest rate, that will accommodate both demands.

“In my opinion, there is no such ideal target rate, and the notion that we can address the difficulties with a sagely chosen combination of monetary and fiscal stimulus and regulatory workout is in my mind doing more harm than good. Better for everyone to admit up front just how bad the problem is, and acknowledge that there is no cheap way out,” Mr. Hamilton wrote.

“No, I don’t believe that Bernanke is walking a tightrope at all. But I do hope he’s checked out the net that’s supposed to catch him if he falls.”

The Big Banks Make Big Money no matter what

Royal Bank of Canada [RY-T], the country's largest bank, reported a 17 per cent drop in first-quarter profit on Friday to $1.245-billion.

The cash earnings of 97 cents per share fell short of analyst forecasts of $1.06 per share.

The profit, which was $249-million lower than a year ago, was hurt by $430-million (pretax) in writedowns related to U.S. subprime mortgages, the bank's municipal GIC business, its U.S. commercial mortgage-backed securities business and its U.S. auction rate securities portfolio.

The charges amount to $187-million after taxes and the resulting lower bonuses for employees are factored in.

“Almost all of our businesses within our four segments delivered solid performance this quarter and while a few have been affected by the difficult market conditions, our diversified business mix, proactive approach to risk management and rigorous operational discipline continue to underpin strong earnings,” stated chief executive Gord Nixon. The bank's profit one year earlier had been a record high.

The investment banking, or capital markets, division of RBC saw profit fall $92-million to $304-million primarily as a result of the writedowns. The stronger Canadian dollar also took a $24-million bite out of its earnings.

RBC's core Canadian consumer banking division showed no growth from a year ago, contributing $762-million to the bottom line, but profit was up 8 per cent once insurance gains a year ago are excluded.

Profit from the bank's insurance operations dropped by $96-million, or 52 per cent, to $89-million. Wealth management was down 14 per cent, or $30-million, at $181-million.

“We remain focused on aggressively growing this segment and, as our recent announcements demonstrate, we are committed to pursuing opportunities that leverage our strengths and position us to capitalize on favourable long term trends in wealth management,” stated Mr. Nixon. The bank recently announced plans to buy Phillips, Hager & North Investment Management Ltd. in Canada and Ferris, Baker Watts, Incorporated in the United States.

RBC's U.S. and international banking operations saw profits fall $36-million to $31-million this quarter, due to higher provisions for bad loans. The provision for credit losses rose to $61-million as the bank contends with more bad loans in its U.S. residential builder finance business as well as its commercial and consumer portfolios.

“Our U.S. residential builder finance business continues to face pressure as the U.S. economy remains under stress, but we are managing the current challenges and I am encouraged by the work being done to strengthen our retail banking operation in the U.S. Southeast,” Mr. Nixon stated.