Phisix: MINING and SERVICES Outperform; Buy Mines When Gold Crosses $726!

``The most important thing about money is to maintain its stability; You have to choose (as a voter) between trusting to the natural stability of gold and the natural stability and intelligence of the members of the Government. And, with due respect to these gentlemen, I advise you, as long as the Capitalistic system lasts, to vote for gold.”-George Bernard Shaw

As we have propounded last week, it is our belief that while a decoupling may not manifest itself strongly yet, we may be entering into stagflationary period like the 70s to 80s where inflationary momentum would accelerate as authorities try to stave off a wave of debt destruction. Such politically calibrated policies should set precious metals and other commodities on FIRE.

We do not agree with those downplaying the decoupling scenario since their arguments have all been tied with the “economic” dimensions omitting the potentials of monetary leakages. In a complex world driven by multifaceted variables, tunneling or vetting on single dimension could lead to severely flawed analysis.

We also are inclined to view that as the US FEDERAL Reserves acts to rescue on its principal constituents in order to “safeguard” today’s paper money standard system, Asian markets being the “strong” link could benefit immensely from the opening of the money spigot, which would be initiated by the US Federal Reserves.

However, given that the present system is structured heavily from leverage, the risks of a US hard landing spreading globally and debt deflation overwhelming the inflationary activities by Central Banks could pose as a TEMPORARY SHOCK.

A further potential shock could be a DISORDERLY DECLINE of the US dollar (measured by its trade weighted index) which has been bluntly dismissed by the mainstream or perhaps a bust or collapse in the China’s skyrocketing stock and property markets.

Hence, given the shock potentials with undefined ramifications (Knightian uncertainty or Mandelbrotian Gray Swan), we will try to limit our exposures to the markets until signs are lucid enough to determine the strength of the seminal trend.

We’d like to remind our readers that if the 2000 tech bust would be the precedent then, despite the Fed’s gamut of rate cuts from 6% to 1% then, global equity markets could likely to suffer from a similar decline as discussed in our August 6 to 10 edition [see A “Normal” Correction in the FACE of Massive Government Interventions? No Can Do!]. Today’s juxtapositions to the 1998 or 1987 scenario presumes that the US eludes a recession; such is likely to be an apples-to-oranges comparison.

Since the Phisix is part of the Asian equity asset rubric then the likelihood is that movements in open markets in Asia are likewise to REFLECT on the Philippine benchmark.

As an example we’d like to point out how ASEAN have been sold last week, in spite of the recent rebound in US equities. The Philippines and Malaysia took the brunt down 1.18% and 1.15%, respectively but we saw similar but moderate declines in Indonesia (-.64%) and South Korea (-.79%).

The peculiar part is that the intensity of the selloff (Php 2.48 billion) by foreign money topped the height of the August panic (Php 1.42 billion) in the Philippine Stock Exchange last week!

Of course, anyone can easily blame these blights on politics. But since the local investors had been net buyers relative to their foreign contemporaries then it is UNLIKELY that politics had been the driver to last week’s activities.

Where the local populace has treated the recent saga of the ex-President as a TELE-Drama series, it is evident that the locals are the parties obsessed with banal political controversies centered on “Personality based politics”. Given such predisposition, locals are likely to be swayed by political developments.

On the other hand, foreign money has been stoic to Philippine politics if the records from 2003 are to be examined closely. Of course, past performance may not be indicative of future activities.

Since the Phisix has rebounded from its August lows, it appears that the recent activities have shown some departure from broad market moves to sector specific actions.

Notably as shown in Figure 5, the mining index and the Services segment of the Phisix has continued to show relative strength compared with the rest of the field.

Figure 5: PSE Sectoral Issues: Divergences at Work

The Bank sector (Red), the Phi-All (Violet), Phisix (Green), Commercial Industrial (Light Orange), Holding (Blue) and Property (Blue Gray), appears to have hit a wall and has been losing steam.

In contrast the Mining and oil index (black candle) and the Services (Lime Green) Index seems to have generated sustained momentum. The services sector comprises of the Telecommunication, Information technology, Transportation Services, Hotel and Leisure, Education and Diversified Services. In our view, the buoyant performance of the Telecom heavyweights could have been responsible for the levitated Services index.

Meanwhile, it can also be construed that since gold has performed strongly in the face of a sagging US dollar index and on the account of heightened inflation expectations, aside from parallel movements in the global mining sector (best performance has been the Australasia, shown in figure 6, and African Gold stocks), local mines could have responded in the same measure relative to its foreign peers.

Figure 6 Bigcharts.com: FTSE Gold Australasia

We received several feedbacks imputing the rise of specific mines or oil stocks to certain activities as the reopening of new mines, outstanding earnings, speculations on drilling activities or prospective deals, all these tend to focus on company SPECIFIC attributes. Yet, such view reveals of the inherent cognitive biases by the average investor and glosses over the scrutiny that mining and oil stocks have been RISING IN GENERAL.

While the outperformance of the mines is a recent wonder to behold, it has yet to be proven that the local mines could withstand any potential shocks seen in the global markets. Foreign money support on local mines have been sporadic and on select issues. Hence, we should still proceed with utmost cautiousness, regardless of our bullish outlook.

As we have previously explained, a monumental development found in the domestic stock market today is the signs of significantly increased participation by local investors. Since the August lows, local investors have spearheaded the recovery over the broadmarket. Last week’s foreign selling also demonstrated how local investors managed to absorb big amounts of foreign selling with limited damage. We have no data whether local retail investors or institutions have been responsible for this.

We discussed this phenomenon as early as 2004 see July 05 to July 09 2004 [To Expand Philippine Capital Markets, Demand Is Key]; whereby we expect the secular [long term cycle] transformation to draw back local investors into the markets. Aside from the deepening trends of global financial integration and technology-enabled connectivity and access to data, we believe that the overall weakness in the US dollar will likewise influence local investors to repatriate overseas investments as the Phisix goes higher. So much for our long term outlook.

For the moment, we believe that the risk prospect is greater for the overall markets, but we see some selective opportunities with respect to the commodity sector, particularly gold and oil. And we gladly observe, local investors have now been partially receptive to such outlook.

Our treatment of gold is as alternative money and not your run-of-the-mill commodity. Should gold continue to be responsive to the activities of global monetary authorities, then we will be increasing our exposure to the mines gradually, in the condition that the latter shows the same sensitivity (here and abroad).

As a barometer, a gold breakout of $726 of levels requires meaningful exposure to the mining sector, as proxy to owning the metal itself, considering the lack of gold market here.

Slowly but surely our projections are becoming a reality.