STOCK MARKETS

GOLD & COMMODITIES

CAD & AUD

Wednesday, August 11, 2010

INDEX SUMMARY
Stock Markets Stock markets – Factors underpinning rally are fading
Gold & Commodities We believe that the factors that have been favorable to the stock markets will from
USD/CAD & AUD/USD now on wear off (slowly). The positive impact of inventory building and the fiscal
stimulus on the economy is waning, and businesses have already profited maximally
from the cost cutting that has been achieved since the recession broke out. As long
as markets remain upbeat about growth prospects, prices could rise for (at most) a
few more weeks, although probably not by more than 5%. Over the coming months
to quarters stock prices will likely fall sharply. Drops in the S&P 500, the DAX, and
the NIKKEI below 1,080 respectively 6,200 and 9,400 will be the first signals.

Goud – Significant price drop imminent

Following an impressive rally the gold price appears set to stall before falling sharply.
We foresee mounting deflation fears and plunging stock prices. If this proves to be
correct, investors could sell off gold in order to offset their losses. The price (now
around $1,200) could first drop to around $1,000 then slide towards $700. However,
we think gold will soar to new record heights in the longer term.

Commodities, CAD & AUD

Confidence in a soft landing in China is growing. The Chinese authorities have stated
they are still committed to large-scale investment in infrastructure, which will impact
positively on commodity prices. However, we do not expect the upswing to continue
much longer. Over the coming months to quarters growth expectations and asset
prices will likely decline. This applies to resource prices as well. By that time
investors will increasingly seek out safe havens such as the US dollar. The CAD as
well as the AUD could in the coming quarters on balance depreciate around 15%
against the USD.
 STOCK MARKETS
GOLD & COMMODITIES
CAD & AUD

STOCK MARKETS – FACTORS UNDERPINNING RALLY ARE

FADING
Falling stock prices is a We think it is a matter of when – not if – the stock market rally will end. Mainly
matter of when – not if because economic developments do not tally with the present optimist expectations
that many analysts entertain concerning stock prices.

The stock market rally of the past quarters has predominantly been fueled by
extensive fiscal and monetary impulses and substantial profit increases. In March
2009, large numbers of investors feared the collapse of the financial system and/or a
negative deflationary spiral, leading to a depression. Businesses reacted by hefty
cost cutting, redundancies, inventory reduction, and deferment of investment. The
authorities responded by applying a huge fiscal and monetary stimulus, which a)
helped to prevent an implosion of the financial system, and b) underpinned demand.
This combination was ideal for stock prices:

It led to a (tentative) economic recovery and downward pressure on

inflation. On this basis both the United States and Europe have until now
been able to pursue a loose monetary policy. Therefore in many cases the
dividend yield was more profitable than the short-term interest rate. On top
of this, central banks have created a lot of additional money whereas lenders
are providing less credit. Consequently, a lot of surplus liquidity has been
flowing to the asset markets.

Many companies saw turnover rise much faster than costs. Especially
businesses with a high operational leverage (relatively high recurring
expenses) profited greatly by stronger takings, and have achieved higher
profit increases. Particularly compared to a year ago when profit margins
narrowed due to lower turnover. As unemployment is high, wages are barely
going up.

Slowing growth and In our view this propitious situation will change over the coming quarters. First,
diminishing profit global economic growth will likely slow. In the West because of less inventory
increases will probably building and a waning fiscal stimulus, in Asia due to a tighter monetary policy.
trigger this downswing
Second, we think increases in revenue will also shrink as a result of lower growth
and because the positive effect of the cost cutting measures is now behind us. For
instance, a data snap suggests that 2Q productivity in the US has dropped whereas
in previous quarters the increase in productivity was very high.

From a chart-technical In addition to fundamental considerations, chart-technical developments also

viewpoint the present indicate that the end of the stock price rally is near. In recent weeks the rally went
rally will not last long hand in hand with shrinking volume, while its underlying vigor decreased. In the past
this would often herald a (substantial) downswing. In addition, the rally in small cap
equities lags the rally in large cap stocks. This minimally signifies that the rally is not
broad-based. Finally, the market itself is hinting that it is not "really in the mood for
a forceful rally". Although conditions for stock prices have been exceptionally
favorable in 2010 (as mentioned above) the performance of the stock markets has
been very disappointing.

Unfortunately, such developments do not reveal when the – anticipated – downswing

will start. So far stock prices have tended to rise rather than to fall, and substandard
figures can easily be "cast aside". Therefore we take into account that prices may
continue to climb in the coming weeks. Albeit probably not by more than
approximately 5%, whereas on balance stock prices will over the coming months to
quarters likely plunge towards the March 2009 lows. A drop in the S&P 500 index

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 STOCK MARKETS
GOLD & COMMODITIES
CAD & AUD
below 1,080 in the NIKKEI below 9,400 or in the Dax below 6,200 would be initial
signals that the descent has started. A drop in the indexes below 1,000 or
respectively 9,000 and 5,800 would confirm this.

Back to summary ^

Chart-technical Analysis
S&P 500: The S&P 500 index is still in the
medium term rally phase that started at
the floor in July. Major resistance against
an additional rally in the S&P 500 may be
found near 1,135 and subsequently at
1,140. Should the index clear those hurdles
it could rise additionally into the 1,151-
1,157 zone. A rally towards those
resistance levels remains likely as long as
the S&P 500 continues to exceed support at
1,100. We should point out that the S&P
500 index is overbought. In combination
with a shrinking volume and a rising wedge
chart this has in the past often turned out
to be a negative sign that heralded falling
prices.

DAX: The peaking process in the DAX

continues. The index has been fluctuating
around the resistance level of 6,350 for
quite some time. Presently, the trend
remains upward, especially if the index
clearly starts to exceed this level. Until that
is the case 6,200 will continue to provide
major support. A drop below 5,800 would
suggest that the long-term downtrend has
resumed.

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 STOCK MARKETS
GOLD & COMMODITIES
CAD & AUD
Nikkei: The uptrend in the Nikkei is
weakening. A temporary downswing (at
least) would not surprise. Important
support for this can be found between
9,400 and 9,430. A drop in the Nikkei
through this support zone would be a
negative signal.

Back to summary ^

GOLD – SIGNIFICANT PRICE DROP IMMINENT

Not just investors, but many central banks too are actively purchasing gold. For the
first time in years central banks have become net buyers. The Russian central bank
announced it had added 200,000 tons of gold to its reserves in June. This means the
bank has amassed 2.1 million ounces of gold since January.

Gold price about to drop Yet if we examine the graph closely it appears that following an impressive rise the
sharply gold price is ready to take a breather. A number of reasons can be identified.

Investors initially feared In recent years the gold price has climbed sharply. Investors fled into gold on fears
rising inflation … that interventions by central banks will drive up inflation. They were also convinced
that if central banks are forced to choose between deflation and inflation they will opt
for the latter.

Slowly but surely this conviction is losing strength. The financial woes at the banks –
which are by no means over it would seem – have depressed economic growth. We
expect the global economy to cool over the coming period (see also our earlier
reports). Compared to what happened after previous recessions, present growth
rates are still minimal. The same applies to inflation. As a result there is now a
higher risk that the important economies will be struck by deflation.

… but they are becoming It is also increasingly clear that central banks are not all-powerful. The Fed, the ECB,
aware that central banks and other major central banks have hardly any room left for further monetary
are all but powerless … easing. Of course they could print and distribute even more dollars, euros, and yens
but the disadvantages outweigh the advantages. In short, an economic downturn
and easing inflation mean that central banks are with their backs to the wall.

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 STOCK MARKETS
GOLD & COMMODITIES
CAD & AUD
G old (USD )
1275

1250

1225

1200

1175

1150

1125

1100

1075

1050
Feb Apr Jun Aug
10
Source: Reuters EcoW in / ECR

…so deflation is In our view deflationary forces will gain strength over the coming period. This will
increasingly viewed as a take many investors by surprise. In response we expect stock prices to plummet. If
real risk so investors will need to sell off other assets in order to offset mounting losses. As
the price of gold has increased substantially in recent years – in other words, high
profits have been realized on paper – gold will be a prime candidate for selling.

Gold to fall to $700? Against this backdrop we foresee that gold (now trading at around $1,200) will drop
in price over the coming quarters. First to $1,000 and later even further, i.e. towards
$700. Yet this will still be a downswing within a long-term uptrend. At a later stage
deflation risks and a prolonged bout of low economic growth around the world will
likely fuel concerns over the stability of the financial sector. In contrast with the
situation in 2008 and 2009 governments can no longer help out. Budget deficits are
already huge and indebtedness is constantly expanding. Once investors start to fear
that the situation becomes completely untenable (and increasingly begin to mistrust
money) we think they will again seek the safe haven of gold. Eventually this will
push up the price to record highs.

Back to summary ^

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 STOCK MARKETS
GOLD & COMMODITIES
CAD & AUD

Chart-technical Analysis
Gold: By now the temporary rally towards
$1,200 has occurred. We think $1,212 and
$1,235 may turn out to be important
resistance levels. Once the price exceeds
$1,235 additional rises may be in the
offing. In contrast, a drop below $1,157
would strongly suggest that the downtrend
has resumed.

Back to summary ^

COMMODITIES – SUBSTANTIAL CONFIDENCE IN SOFT

LANDING CHINA
Prices are rising China is very important to commodity prices as it is the world's largest importer of raw
regardless of slowing materials. Many economists believe this will be the case for quite some time. Several
Chinese growth months ago the Chinese authorities announced that they were aiming to cool the
commodity market. Essentially this should depress commodity prices, especially as US
economic growth is also slowing. Yet in recent weeks resource prices have risen fairly
fast.

To an important degree the optimism is triggered by the belief that the Chinese
economy will experience a soft landing. The Chinese authorities tightened their policy
on fears of a housing market bubble. If this had burst, it could have been calamitous to
the Chinese banks and wider economy. The outcome could have been a "hard landing"
with growth slowing towards 0%.

The cause could be a There are a number of reasons why confidence in a soft landing (with growth merely
potential soft landing in decelerating from around 12% to around 8%) is growing:
China

By now exports are again expanding significantly.

The bubble is largely confined to the higher segments of the market. In the
lower regions there is still a high demand for property and the government

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 STOCK MARKETS
GOLD & COMMODITIES
CAD & AUD
plans to continue to invest substantially in infrastructure. As a result demand
for raw materials will remain high.

In addition, inflation is on the rise in Asia. Many Asian central banks try to keep their
currencies maximally pegged to the dollar, and real interest rates are often minimal.
Because of this many investors find it profitable to buy commodities as an inflation
hedge. This is positive to commodity prices. As is growing faith in a soft landing in
China.

CRB Com m odities Index (U SD )

450

445

440

435

430

425

420

415

410

405
Feb Apr Jun Aug
10
Source: R euters Ecow in / ECR

Toch zien we de stijging van de grondstoffenprijzen niet lang aanhouden. De

ontwikkelingen in China zijn belangrijk voor de grondstoffenprijzen, maar dit geldt ook
voor de ontwikkelingen in de VS en Europa en de mate waarin beleggers risico willen
lopen. De groei in het Westen zien we sterk terugvallen zodra de positieve effecten van
voorraadopbouw en fiscale stimulansen de komende kwartalen verdwijnen. Vanwege
de hoge werkloosheid en onvoldoende stijging van de kredietverlening en asset
prijzen, zien we de onderliggende economie niet sterk genoeg om de groeiterugval op
te vangen. Een nieuwe ‘ronde van fiscale stimulansen’ zou uitkomst bieden, maar veel
hoop hierop is er niet. De tegenstand in de VS hiertegen neemt toe en in Europa wordt
er zelfs fiscaal verkrapt.

It is merely a bear Nevertheless we think resource prices will not continue to rise for long. Developments
market rally that will in China are relevant to commodity prices, but so are events in the US and Europe,
not last long and the willingness of investors to take risks. In our view growth in the West will slow
significantly over the coming quarters once the positive effects of restocking and the
fiscal stimulus start to fade. Owing to high jobless rates and insufficiently strong credit
supply and asset price rises the underlying economy will likely not be sturdy enough to
overcome the growth slump. A new round of fiscal stimulus measures would offer relief
but chances of this are low. There is growing opposition in the United States while
Europe has embarked on fiscal tightening.

On the one hand we foresee that sluggish growth in het West will lead investors to sell
off risky assets (like commodities) as they seek out safe havens (such as the US dollar
and government bonds). But we also think that this will hit the Chinese

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 STOCK MARKETS
GOLD & COMMODITIES
CAD & AUD
economy harder than investors presently assume. This will be equally bad for resource
prices. In short, we regard the upswing in commodity prices as a bear market rally.
Over the coming quarters prices could easily drop (further).

CAD & AUD

As long as the bear market rally in commodity prices continues, CAD as well as AUD
could yet appreciate several percentage points against the US dollar. Also relevant is
that the Australian and Canadian economies have profited much more from the global
economic recovery than other western countries. In response, central banks in both
countries have tightened their monetary policies. In contrast, financial markets in the
US are gingerly discounting a very loose monetary policy for the time being.

USD / CAD AUD / USD

1.08 0.950

1.07
0.925
1.06

1.05 0.900

1.04
0.875
1.03

1.02 0.850

1.01
0.825
1.00

0.99 0.800
Feb Apr Jun Aug Feb Apr Jun Aug
10 10
Source: Reuters EcoWin / ECR Source: Reuters EcoWin / ECR

Yet as soon as growth expectations and asset prices decline sharply (which we expect
over the coming months to quarters) the CAD and the AUD could depreciate markedly
against the US currency. Partly because such a scenario entails plunging commodity
prices but also as the demand for dollars as a safe haven would surge. In that climate
we expect both currencies to weaken around 15% against the US dollar.

Back to summary ^

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