Investing.com – Gold prices eased slightly in early Asia on Friday as investors continued to assess the likely timing of a Federal Reserve rate hike expected this year.
On the Comex division of the New York Mercantile Exchange, gold for December delivery eased 0.06% to $1.088.10 a troy ounce.
Silver for September delivery fell 0.04% to $14.690 an ounce. Copper for September delivery rose 0.05% to $2.378 a pound.
Overnight, inched down on Thursday amid a stronger dollar, as investors digested mixed signals from the Federal Reserve on the likelihood of a September interest rate hike.
On Wednesday, the Federal Open Market Committee (FOMC) concluded its two-day July meeting without offering any indications on whether it will adjust its benchmark Federal Funds Rate later this fall. U.S. short-term interest rates have remained level between zero and 0.25% for nearly six years since the end of the Financial Crisis. Nearly a decade has passed since the Federal Reserve last instituted a rate hike.
In its July monetary policy statement, the FOMC said the labor market has shown signs of progressing, citing indicators that showed the underutilization of labor resources have diminished in recent months. Last month, the U.S. unemployment rate fell by 0.2% to 5.3%. In addition, the FOMC noted that it has observed signs that the U.S. economy has grown moderately during the second quarter of the year.
Gold, which is not attached to dividends or interest rates, struggles to compete with high-yield bearing assets in periods of rising rates.
The U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) in a quarterly release on Thursday morning reported that U.S. GDP for the second quarter increased by 2.3%. The reading fell below high end of consensus estimates of a 3.5% increase, but was above the low end of forecasts for a gain of 1.9%. The BEA also upwardly revised first quarter GDP to a 0.6% increase from a prior reading of negative 0.2%.
Elsewhere, the closed on Thursday down 83.44 points or 2.2% to 3,705.73, one day after halting a three-session, 11% romp. On Monday, Chinese stocks fell by 8.5% experiencing their worst session since 2007.
China is the world’s largest consumer of and second-largest consumer of gold, behind India.
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Buffett Recommending S&P Index Fund A Mistake, Says Berkshire Shareholder
In an article earlier this week, we posed a simple question: has Warren Buffett lost his touch?
Mark Hulbert, of the Hulbert Financial Digest, says skeptics are being “unfair” on Buffet. Hulbert adds that anyone suggesting he’s lost his touch should cool their heels. He says Buffett hasn’t lost money in the last 10 years. He also mentions that nobody beats the market all the time.
Others, like Howard Gold, a columnist at Marketwatch, points out that Buffett has been “profoundly underperforming” against the S&P 500 and most of his recent deals have been duds.
Buffet Gives Advice
But what irks one investor, in particular, was Buffett’s advice that the average investor should just buy an S&P index fund.
Buffett’s comment came during the Berkshire Hathaway conference call, when he stated “In my view, for most people, the best thing to do is to own the S&P 500 index fund.”
That may be practical advice for the vast majority of Americans. However, Tony Scherrer, a CFA at Smead Capital Management, says that Buffett’s comment completely goes against his own advice.
Scherrer believes that by recommending an S&P index fund, Buffett is telling investors to buy the exact type of companies that he himself has spent his career avoiding.
Specifically, a quote from the 2007 Berkshire Hathaway shareholder letter, where Buffett says:
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”
Scherrer takes each part of the statement and points out where Buffett contradicts or simply ignores his own advice. He starts with:
“The worst sort of business is one that grows rapidly…”
The S&P 500 has 21% of its weighting in just five stocks: Microsoft, Apple, Amazon, Facebook and Alphabet. Scherrer points to research by David Kostin at Goldman Sachs that shows these top five names have an expectation of revenue growth of 14% over the next two years, and trade at 28x the forward two-year earnings average. The other 495 stocks in the index are expected to grow revenue much slower, at 4% over the next two years, but also trade at a much lower 14x the forward two-year earnings average. In other words, buying the S&P index fund means paying twice as much (28x vs. 14x) for a handful of stocks that are growing rapidly.
“…requires significant capital to engender the growth…”
Netflix, Amazon and Facebook are among the heavily weighted stocks in the index, and Scherrer says they are all burning through significant amounts of money to keep growing.
“Netflix’s cost for its content has mushroomed from $4.5bn five years ago to an expected $15bn in 2020 and will have to continue to expand to operate its business. Amazon… recently announced a $4bn increase in costs associated with safety of its workers and protection in its warehouses on the heels of its deficiencies… Facebook’s recent quarter included a 34% increase in expenses year-over-year to a whopping $46.7bn, as its cost to acquire new customers and increased regulatory expenses spiked.”
“…then earns little or no money”
Looking at the numbers, Scherrer says ”Netflix burned $3.1bn in free cash flow last year and must persistently ramp that up to attract and retain subscribers. Amazon’s flywheel generated an eye watering $280bn revenue number in 2019, but operating profits for everything outside its cloud business came in at a measly $5.3bn. You currently pay 68x forward price-to-earnings for Netflix, 126x for Amazon, and 28x for Facebook.”
Buffett of the Past v.s. Buffett of the Present
Scherrer believes that if 2007 Warren Buffett met today’s Warren Buffett, there’s no way he would allow him to buy an S&P index fund that is highly concentrated into a handful of stocks that are high growth, capital incinerators that earn very little money.
But 2007 Warren Buffett would probably be most appalled that 2020 Warren Buffett would be selling airlines stocks. That means at some point, Warren Buffett thought investing in airline stocks was a good idea.
In the same 2007 shareholder letter, Buffett outlined what “The Great, the Good and the Gruesome” businesses look like. Buffett described a “gruesome” business by using airlines as an example.
Incredibly, he described them as “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”
FOMC Minutes Reveal Uncertainty, Fear Over Second Wave of Outbreak
Minutes from the April meeting of the Federal Open Market Committee show that Fed officials are happy with their recent actions. The said actions aims to keep the economy afloat during the coronavirus pandemic. However, they are also deeply worried about the likelihood of further outbreaks. They also expressed concern about how the pandemic will harm lower-income families the most.
The April meeting concluded with the committee talking about the steps they took during the initial outbreak. They said those actions were were “essential in helping reduce downside risks to the economic outlook” of the country. They also decided to keep interest rates at their current level of 0% – 0.25%.
The committee said that the pandemic created both near and medium-term economic uncertainty. Also, “participants commented that, in addition to weighing heavily on economic activity in the near term, the economic effects of the pandemic created an extraordinary amount of uncertainty and considerable risks to economic activity in the medium term.”
The group expressed worry about the negative effects on unemployment and GDP growth of another outbreak of coronavirus cases later in the year. The minutes also say the group views this as a “substantial likelihood.”
“In this scenario, a second wave of the coronavirus outbreak, with another round of strict restrictions on social interactions and business operations, was assumed to begin around year-end, inducing a decrease in real GDP, a jump in the unemployment rate, and renewed downward pressure on inflation next year,” the summary said.
The minutes also mentioned that this “more pessimistic” outlook was just as likely as the baseline forecast for improvement.
Baseline For Improvement
There was discussion amongst the members to provide more explicit assurances that rates wouldn’t move higher until a recovery was “firmly in place.” This is defined by the country meeting certain unemployment or inflation rates before the committee would consider raising interest rates. Another idea was announcing a specific date which would be the soonest that the FOMC would consider raising interest rates.
They call this type of forward guidance the Evans Rule. The Fed used this in 2012 when it openly broadcast that it would hold rates steady until unemployment rates started to fall. It also used this to broadcast that there were signs of rising inflation.
The notes also reveal that the committee is very concerned that while the 30+ million jobs lost since the outbreak began also hit all socioeconomic levels. The brunt of losses “would fall disproportionately on the most vulnerable and financially constrained households in the economy.”
Some are concerned that many small businesses, the backbone of our country, simply won’t survive in the “new normal” of social distancing. Meanwhile, other businesses are going to hold off on hiring or growing. Owners say this may last until the threat of a second outbreak passes.
The minutes state “a large number of small businesses may not be able to endure a shock that had long-lasting financial effects. Participants were further concerned that even after social-distancing requirements were eased, some business models may no longer be economically viable, which could occur, for example, if consumers voluntarily continued to avoid participating in particular forms of economic activity.”
Budget Group Sees GDP Plunging 38%, Rising Unemployment
The nonpartisan Congressional Budget Office released its latest projections for economic growth, unemployment, and the federal budget yesterday. Given these, it looks like we are in for some rough times ahead.
The group says the budget deficit could balloon by $2.1 trillion in fiscal 2020 and $600 billion in 2021. This increase may come primarily due to the stimulus packages the government has rolled out. The government released these checks in an effort to combat the coronavirus pandemic. The deficit increases equate to about 11% of nominal GDP in fiscal 2020 and 3% in 2021
The CBO expects the unemployment rate to trend higher in the coming months. This may get an average of 15.1% in the second quarter before peaking at 15.8% in the third quarter. They see the unemployment rate tapering down to 11.5% in the fourth quarter, which sounds encouraging. However, it’s still a double-digit unemployment rate.
They also warn that even as states reopen and businesses start to bring back workers, we shouldn’t expect businesses to go on an immediate hiring spree. According to the CBO, “persistence of social distancing will keep economic activity and labor market conditions suppressed for some time.”
The CBO’s projections for the second-quarter GDP is an astonishing 38% decline on an annualized basis. This, then, would be the single-largest GDP drop in our nation’s history. The CBO’s projections are consistent with what many on Wall Street are expecting. However, it’s still not as bad as the projection by the Atlanta Federal Reserve, which sees a 42% decline.
A quick GDP recovery should occur according to the CBO. This may happen with the GDP growing 21.5% in the third quarter and 10.4% in the fourth quarter.
On The Brighter Side
There is a silver lining to the report. The CBO sees a recovery in the second half of the year. This may come as the coronavirus pandemic subsides. Additionally, the report says the stimulus money that was spent was worth it. It mentions that it may help in keeping up the GDP and employment rates higher than they would have been otherwise.
“The economy is expected to begin recovering during the second half of 2020 as concerns about the pandemic diminish and as state and local governments ease restrictions,” the CBO said before adding, “In CBO’s assessment, that legislation will partially mitigate the deterioration in economic conditions. In particular, greater federal spending and lower revenues will cause real GDP and employment to be higher over the next few years than they would be otherwise. The effects of the legislation on economic activity will be largest in the second and third quarters of 2020 and smaller thereafter, CBO projects.”
The massive caveat to the CBO’s report is that they acknowledge that everything has happened so quickly. Because of this, they are unsure of what could really happen next.
“For example, if the disease spreads less widely than CBO expects—because of testing and contact tracing, a vaccine, or for some other reason—the degree of social distancing could be lower and the economic recovery faster than what CBO currently projects. The opposite could also be the case,” the agency said. They also added that, “the extension, reversal, or reimplementation of different types of social distancing policies (such as stay-at-home orders, bans on large public gatherings, closures of specific kinds of businesses, and closures of schools) might have different effects on the economy.”
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