What Brexit Is All About: Taxation WithoutRepresentation

June 17, 2016by Frank Holmes

of U.S. Global Investors

I want to continue the Brexit conversation from last week. With only six days left before U.K. voters head to the polls,expectations of which side might win are beginning to shift toward the “Brexiteers,” while betting markets are still puttingmoney on the “stay” campaign. However, the probability of victory for those who favor keeping their European Unionmembership has weakened rather remarkably in the last month, falling from over 80 percent in mid-May to around 62percent today, according to BCA Research.

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One of the main grievances is the burden of EU regulations, which are decided by unelected officials in Brussels with littleto no cost-benefit analysis. These rules, which regulate everything from the number of hours someone can work (48 hours)

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to vacuum cleaner power, ultimately stifle growth and innovation.

Consider the so-called FANG stocks—Facebook, Amazon, Netflix and Google. These four tech behemoths, not to mentionApple, rank among the most disruptive, transformative companies the world has ever seen. They also happen to beAmerican. Nothing like them exists in Europe—or, for that matter, anywhere else across the globe.

When’s the last time a major scientific or technological breakthrough was made in France? In Germany? Where’s Europe’sanswer to Silicon Valley?

It’s not that these countries lack capable thinkers and entrepreneurs. Far from it. Europe was once at the center ofeverything, from science to music to business. But now that Piketty-style “envy economics” reign supreme in the EU,innovation has increasingly shifted west toward the U.S.

These are the questions and concerns Brexiteers and Eurosceptics are bringing to the fore. And no matter thereferendum’s outcome next week, they’re not likely to go away any time soon. In fact, this could very well be the beginningand should serve as a wakeup call to EU policymakers. Just as American colonists protested taxation withoutrepresentation over 240 years by dumping an entire shipment of English tea into Boston Harbor, many Brits today arestaging their own taxpayers’ revolt by demanding control over their own economy, budgeting, immigration policies andmore.

This is more broadly a debate over common law (the U.K.) and civil law (the Continent). Under common law, there’sgreater protection of wealth and intellectual property. You’re presumed innocent until proven guilty. Why are real estateprices higher in London, New York City and Hong Kong than in Rome, Paris and Berlin? Common law.

I invite you to watch Brexit: The Movie, a Hollywood-caliber documentary that spells out the many reasons why it’s in theU.K.’s best interest to consider leaving the EU. When London financial markets were deregulated in the 1980s under PrimeMinister Margaret Thatcher, it led to what is known as the “Big Bang,” named for the skyrocketing growth in market activity,and the same could very well happen to the U.K.’s economy post-Brexi.

The High Cost of Indirect Taxation

The U.K.’s EU club membership, so to speak, varies year-to-year, but it averages between 8 and 10 billion pounds—theequivalent of $11 billion and $14 billion—making the kingdom the third largest net contributor after Germany and France.But the costs don’t stop there. Towering above the contribution to the EU’s budget are costs associated with the bloc’sendless regulations—what I refer to as indirect taxation.

According to Open Europe, a nonpartisan European policy think tank, the top 100 most expensive EU regulations set theU.K. back an annual 33.3 billion pounds, equivalent to $49 billion. This amount exceeds what the U.K. Treasury collects inCouncil Tax (a tax on domestic property) on an annual basis.

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And remember, that’s just the top 100. The “acquis communautaire,” the EU’s body of rules, directives and regulations, is amammoth 170,000 pages long. Among the costliest regulations are the Renewable Energy Strategy (4.7 billion pounds ayear), the Working Time Directive (4.2 billion a year) and the EU Climate and Energy Package (3.4 billion a year).

Tim Congdon, a prominent British economist and businessman, shows that such regulations—again, passed by unelectedofficials, similar to agencies here in the U.S.—have been a significant detriment to EU growth. Writing for the pro-leavegroup Economists for Brexit, he states: “It is obvious that the economies of EU member states are falling behind those ofother high-income countries, falling behind consistently, and by a significant amount. Too much regulation must be themain explanation.”

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Of course, these rules won’t disappear overnight if the U.K. chooses to leave. But it would be a step in the right directiontoward repatriating a level of autonomy over the country’s own laws.

In the meantime, investors are bracing for the referendum with gold, which has rallied 7 percent this month, breaking above$1,300 an ounce . The yellow metal has historically been favored as a “safe haven” investment during times of political andeconomic uncertainty. Read my latest gold commentary on Forbes.

And with interest rates at near-zero or negative levels, droves of European fixed-income investors are abandoninggovernment debt for American municipal bonds. The German 10-year government bond yield fell to subzero levels thisweek for the first time ever, spurring additional European flight into munis, which still offer attractive yields, relatively lowvolatility and diversification.

Let’s Not Forget to Clean House Here in the U.S.

The EU is hardly the world’s only offender when it comes to passing onerous regulations. The U.S. government continuesto add to the already-bloated Federal Registry, which now stands at 80,260 pages as of the end of 2015. That year, federal

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regulations cost U.S. businesses a staggering $1.885 trillion, or $15,000 per household, according to the CompetitivenessEnterprise Institute (CEI). If U.S. regulations were its own economy, in fact, they would be the world’s ninth largest,sandwiched in between India and Russia.

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This is something our next president will have no choice but to address. 2015 was a record year for adding newregulations. We can’t keep going down this path. The problem is that I haven’t seen either Donald Trump or Hillary Clintonmake a serious commitment to streamlining rules and laws that affect businesses, especially small to medium-sizebusinesses. According to a 2015 National Small Business Association (NSBA) survey, “regulatory burdens” was near thetop of the list of challenges small business owners said threatened growth and the survival of their companies. I’mconvinced that the candidate with the strongest economic and deregulatory plan has the best chance at winning theelection in November.

For whatever it’s worth, a poll in Institutional Investor found that large-scale investors appear to favor Clinton for presidentright now by a pretty wide margin. When asked if Wall Street will rally behind Trump, a whopping 84 percent said no.

Happy Father's Day!

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As you’re no doubt aware, Father’s Day is coming up this Sunday. I hope everyone has the opportunity this weekend tospend some quality time with your father(s) and child(ren).

I was interested to read today that the first Father’s Day was celebrated in Spokane, Washington, in 1910—around thesame time as the first Mother’s Day. But whereas Mother’s Day received official federal recognition in 1914 underPresident Woodrow Wilson, it wasn’t until President Richard Nixon’s administration that fathers got their due respect.Before that time, it was even proposed that both Mother’s and Father’s Day be rolled into a single Parents’ Day.

Have a blessed weekend!

Index SummaryThe major market indices finished down this week. The Dow Jones Industrial Average lost -1.06 percent. The S&P500 Stock Index fell -1.19 percent, while the Nasdaq Composite fell -1.92 percent. The Russell 2000 smallcapitalization index lost -1.65 percent this week.The Hang Seng Composite lost -3.49 percent this week; while Taiwan was [down -1.69 percent and the KOSPI fell -3.18 percent.The 10-year Treasury bond yield fell 3 points to 1.61 percent.

Domestic Equity Market

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Strengths

Telecommunications was the best performing sector for the week, increasing by 1.39 percent versus an overalldecrease of -1.17 percent for the S&P 500.

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Symantec Corp was the best performing stock for the week, increasing 15.43 percent. The company purchased BlueCoat Systems Inc. in a deal that will expand its clientele to 385,000. BTIG raised the rating to buy from neutral.Microsoft announced it would acquire professional networking site LinkedIn for $26.2 billion in the biggest company-for-company tech buy since HP and Compaq merged back in 2001. The deal is expected to see Microsoft andLinkedIn mostly operate as independent entities and is expected to be completed this calendar year.

Weaknesses

Health care was the worst performing sector for the week, decreasing by -2.08 percent versus an overall decrease of-1.17 percent for the S&P 500.Synchrony Financial was the worst performing stock for the week, falling -16.33 percent. The stock fell after thecompany announced that it is expecting a 20-30 basis point increase in its net charge-off rate over the next 12months and is setting aside more money for loan losses.According to Bank of America Merrill Lynch's latest fund manager survey, the amount of cash being held by thosesurveyed by the bank is at the highest level in about 15 years (since November 2001). Markets are concerned aboutthe U.K. voting to leave the European Union, China slowing more than official data says, the potential for the FederalReserve to raise interest rates and/or make a policy mistake, all while labor is beginning to eat into capital's profits inthe U.S.

Opportunities

Evidence is materializing that media companies are through the worst. While value has been restored to the S&Pmovies & entertainment index, consumers continue to demonstrate a healthy appetite for content consumption.Personal spending on recreation and electronics has reaccelerated as a share of total outlays.Many Wall Street analysts are reading Microsoft’s acquisition of LinkedIn as a sign that the technology space couldbe ready for some serious M&A activity.The latest retail sales report shows that pharmacies are enjoying a boom in top-line growth, while hypermarkets arefinally regaining traction.

Threats

On Monday, the latest poll from The Guardian showed the 'leave' camp is up 53-47 on the 'remain' camp, buckingconventional wisdom that has long held the 'remain' would eventually win the day. A decision to leave the EuropeanUnion would have a big impact on financial markets.The latest wage tracker from the Atlanta Fed shows that wages are going up. The tracker follows median worker payin the U.S., which has risen 3.5 percent year-over-year, as of May. Note that the 2.5 percent year-on-year increase inthe May jobs report brought average hourly earnings gains for 2016 to a tracking rate of 3.2 percent, not far off theAtlanta Fed's measure. This latest wage indicator also came after the latest NFIB Small Business Optimism report,which showed optimism in May ticked up slightly to 93.8. More significantly, however, the report shows the labormarket continues to be squeezed. This upward pressure on wages could lead to lower margins and profits ifcompanies are unable to pass on wage inflation to the consumer.The current tight correlation between the 2-year Treasury yield, a good proxy of Fed funds rate expectations, andU.S. equities suggests that higher share prices require better economic/profit growth rather than simply a lesshawkish Fed. Also, history shows that P/E multiples get squeezed on a sustained basis once monetary conditionstighten courtesy of the Fed. Thus, a sustainable advance in U.S. equities from current levels requires a new profit up-cycle. For this to happen, it is critical for the rest of the world to demonstrate an internal demand impulse. That seemsunlikely given present global conditions.

The Economy and Bond MarketStrengths

The May report on retail sales showed they were up 0.5 percent over the prior month, more than the 0.3 percentincrease that was expected. The report suggests consumer spending is gaining steam despite the slowdown in jobcreation.Prices for imported goods rose in May at their fastest pace in over four years, a sign that rising oil prices and thefading strength of the dollar are contributing to firming domestic inflation. This is a welcome sign amid globaldeflationary pressures.Month-over-month housing starts in the U.S. came in better than expected on Friday, falling only 0.3 percent, better

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than analysts’ expectations for a drop of 1.9 percent.

Weaknesses

Industrial production for May came in at negative 0.4 percent, down from prior growth of 0.7 percent and belowexpectations of negative 0.2 percent. The report highlighted the factory sector’s continued struggles.The U.S. Supreme Court rejected Puerto Rico’s bid to let its public utilities restructure bonds over the objection ofcreditors, leaving the island’s $70 billion debt crisis squarely in the hands of Congress. The Supreme Court casefocused on the federal law that bars Puerto Rico and the District of Columbia from doing what U.S. states are entitledto do: authorize bankruptcy filings by public utilities and other municipalities. Puerto Rico sought to get around thatprovision in 2014 by passing a local law that offered an option similar to bankruptcy.The Federal Reserve’s specific reference this week to “Brexit” considerations further underscores the recent globalangst over the upcoming U.K. referendum.

Opportunities

According to BCA Research, following its recent decline, the 10-year U.S. Treasury yield appears to be fairly valued.Accordingly, the group advocates a benchmark duration stance on a 6 to 12-month horizon.While consumer spending contributed only 1.66 percent and 1.29 percent to GDP growth in the fourth quarter 2015and first quarter 2016, this weakness was driven entirely by spending on goods. Consumer spending on servicesremained robust. Spending on durable goods, which subtracted 0.09 percent from GDP in the first quarter, is verysensitive to changes in interest rates. The lower Treasury yields of the past few months should lead to a rebound inthis segment of GDP.If a "yes" vote for Brexit were to materialize, the ensuing drop in yields could provide an opportunity for a short-termtactical long duration position.

Threats

The disappointing payroll report is in sync with a number of other measures showing that the U.S. labor market issoftening. The share of U.S. workers involuntarily stuck in part-time jobs has risen while the hiring rate has decreasedand the rate of people quitting has come off its highs, suggesting workers are becoming less confident about theemployment outlook. This is consistent with a decline in online job advertising and waning consumer optimism aboutthe job market outlook. Reflecting these trends, the Fed's Labor Market Conditions Index has fallen for five straightmonths. The big risk is that the softening labor market is foreshadowing sharply weaker growth ahead.

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The yield on the 10-year German bund fell below zero for the first time in history and joined Japan and Switzerland’sin the “negative yield club.” Tuesday's drop below zero came amid a renewed demand for safety assets as fears of aslowing global economy and the possibility of a British exit from the European Union weigh on investor confidence.The International Energy Agency (IEA) says the oil market will rebalance in the second half of 2016 but will return tosurplus in 2017. “At halfway in 2016, the oil market looks to be balancing; but we must not forget that there are largevolumes of shut-in production, mainly in Nigeria and Libya, that could return to the market, and the strong start for oildemand growth seen this year might not be maintained," the IEA said.

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Gold MarketThis week spot gold closed at $1,299.00, up $25.10 per ounce, or 1.97 percent. Gold stocks however, as measured by theNYSE Arca Gold Miners Index, lost 0.87 percent. Junior miners outperformed seniors for the week as the S&P/TSXVenture Index traded off just 0.03 percent. The U.S. Trade-Weighted Dollar Index slipped with a 0.40 percent loss.

Date Event SurveyActualPriorJun-12China Retail Sales YoY 10.1% 10.0% 10.1%

Jun-15U.S. PPI Final Demand YoY -0.1% -0.1% 0.0%

Jun-15FOMC Rate Decision (Upper Bound) 0.50% 0.50% 0.50%

Jun-16Eurozone CPI Core YoY 0.8% 0.8% 0.8%

Jun-16U.S. Initial Jobless Claims 270k 277k 264k

Jun-16U.S. CPI YoY 1.1% 1.0% 1.1%

Jun-17U.S. Housing Starts 1150k 1164k 1172k

Jun-21Germany ZEW Survey CurrentSituation

53.0 -- 53.1

Jun-21Germany ZEW Survey Expectations 4.8 -- 6.4

Jun-23U.S. Initial Jobless Claims 270k -- 277k

Jun-23U.S. New Home Sales 560k -- 619.k

Jun-24U.S. Durable Goods Orders -0.5% -- 3.4%

Strengths

The best performing precious metal for the week was gold; with a 1.97 percent rise in what was a volatile week oftrading. As gold prices head for a third straight weekly gain, reports Bloomberg, at least one measure shows thatbullion could have even further to run. Open interest, which is a tally of contracts in Comex futures, reached a one-month high as traders remain bullish.Investors continue to add money to precious metal funds, even as the gold rally shows signs of slowing, reportsBloomberg. Assets in gold-backed ETFs have risen every day in June due to the increased geopolitical stress causedby the U.K. referendum. Similarly, at Sharps Pixley, a gold showroom in London’s Mayfair district, the demand forbullion bars and coins is rising, as investors seek a safe haven metal in case of a British exit from the EU.Gold jumped this week as fewer Federal Reserve officials expect the central bank to hike interest rates more thanonce this year. According to Bloomberg, projections from the FOMC show the number of officials who see just oneincrease rose to six from one in the previous forecasting round in March.

Weaknesses

The worst performing precious metal for the week was platinum; with a loss of 2.18 percent. The platinum price togold price ratio has hit its lowest point since 1982. Historically, platinum has traded at a premium to gold. Whileplatinum may look like a bargain relative to gold, the future acceptance of electric cars could be a game changer.On Thursday, the British pound erased losses against the U.S. dollar following the killing of a U.K. lawmaker, reportsBloomberg. The tragedy fueled speculation that the nation’s voters will be more likely to favor remaining in the EU innext week’s referendum, continues the article, sending gold down from near two-year highs after it surged post theFOMC meeting.Sabina Gold and Silver Corp. received a report from the Nunavut Impact Review Board (NIRB) this week relating toits Back River Gold Project in Nunavut, Canada. In the report, the NIRB recommended that the project not proceed tothe licensing and permitting regulatory phase, noting the need for further consideration concerning caribou andclimate change. Sabina’s share price was down 38 percent for the week.

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Opportunities

On Sunday, George Ogilvie resigned as CEO from Kirkland Lake Gold and won’t stand for election as a director atthe company’s annual meeting, reports the Canadian Press. Former CEO of Lake Shore Gold, Anthony Makuch, willstep in as CEO. We have great respect for George Ogilvie as he was the catalyst that turned Kirkland Lake around.He accepted the CEO position in November of 2013, and as you can see in the chart below, during Ogilvie’s time atKirkland, you would have never known this was a gold company that he was managing. Under Ogilvie’s tenure theshare price of Kirkland Lake rose 262.46 percent while the S&P/TSX Global Gold Index only gained 41.29 percent.The gains for the index really only came over the last six months when the gold price started to rise. We wish Georgefurther successes in his future endeavors.

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Brexit or not, James Steel of HSBC believes that gold can still rise to $1,400 an ounce, Barron’s reports. If Britainchooses to stay, Steel says the precious metal is likely to fall, but to no more than $1,220 an ounce, or a 7 percentdownside. And if the Brexit campaign succeeds? According to a Bloomberg survey of 22 traders and analysts, goldprices could rise to the highest in more than two years – potentially reaching $1,350 an ounce within a week of thevote.Under new proposed regulations, India is looking to open up mining of gems and precious metals, reportsBloomberg, in order to cut reliance on imports. Mines Secretary Balvinder Kumar said in an interview that the countryis set to auction about 50 blocks for diamond and gold exploration in the fiscal year starting April 1, aided by changesin the national mineral exploration policy to be unveiled by month end. Historically, it has been extremely difficult forany company to move a mining project forward. Rio Tinto Group has been trying to get approvals for its Bunderdiamond mine site since 2004. If India’s new mineral policies provide an economic path to production, then watch thisspace for potential new discoveries in the future.

Threats

The current ratio between gold and copper is showing a “recession-era fear level,” Bloomberg reports. Gold jumpedto the most expensive relative to copper since 2009 this week. The price of copper (seen as an economic bellwether),has slumped over Brexit worries, while the low interest rate outlook has fueled demand for bullion – driving the ratiobetween the two farther apartIndia’s monsoon season could be reduced by the receding El Nino, reports Bloomberg Intelligence, leading to a poorharvest in the country, and thus, rising food prices. This could lead the world’s largest consumer of silver, and secondlargest in gold, to spend more on food this year than jewelry, ultimately undermining demand for precious metals inthe country.Jeff Rhodes, CEO of Zee Gold in Dubai, added color to India’s situation this week during an interview on BloombergTV. Rhodes said there is no demand for the metal now in India due to the monsoon, adding that kilo bars are evenselling at a $30 discount in the country. The price of gold, according to Rhodes, could fall to $1,100 an ounce if theU.K. votes to stay in the EU, but has the potential to climb to $1,600 an ounce if the U.K. leaves.

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June 16, 2016

The Fed Stays Put As Gold PushesHigher

June 15, 2016

Negative Rates Continue to Be Positive forGold

June 3, 2016

Frank Holmes: Energy, Gold and Short-TermDebt

Energy and Natural Resources MarketStrengths

The U.S. oil rig count rose for a third consecutive week. The rig count is viewed as a proxy for activity in the sector,and recent strength suggests that market conditions have improved to a level where producing companies arecomfortable redeploying cash into exploration and development.The best performing sector for the week was the TSX Capped Metals and Mining Index. The index of base metalmining companies rose 3.9 percent for the week led by a small rebound in copper prices, and positive read-throughfollowing takeover speculation of index-leader Turquoise Hill Resources.Turquoise Hill Resources, a Canadian major base metals producer was the best performing stock in the broadernatural resource space after rallying 16 percent for the week. The stock rallied on renewed speculation that Rio Tintomay bid for Turquoise Hill in order to consolidate its ownership of the Oyu Tolgoi mine in Mongolia.

Weaknesses

WTI crude prices dropped 1.9 percent for the week as fears of a “Brexit” event weighed heavily on investors’ minds.The commodity reached a one-month low on Thursday before recovering much of its weekly drop on Fridaysupported by a weaker dollar.The worst performing sector for the week was the S&P 500 Oil & Gas Refining and Marketing Index. The indexdropped 4 percent for the week as oil prices nearing $50 per barrel erode refining margins.The worst performing stock for the week in the S&P Global Natural Resources Index was Petrochina. The Beijing-based integrated oil producer dropped 8.3 percent for the week as data showed China’s oil output dropped the mostsince 2001 as companies, including Petrochina, struggle to maintain output volumes at current oil prices.

Opportunities

The gold bull market is likely just beginning. A recent article by the team at Red Cloud KS shows that the gold priceratio to the S&P 500 Index has started to turn, suggesting that precious metals and related equities may continue tooutperform other asset classes. In addition, the current ratio of 0.6 is far below the 1.2 historic average ratio, whichsuggests that gold is significantly undervalued relative to the overall market.

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Global crude oil demand expectations may be understated. The International Energy Agency (IEA) revised its globaldemand forecast higher for crude oil this year. The agency now expects oil demand globally to grow by 1.3 millionbarrels per day in 2016, leading to the conclusion that the oil market will reach a supply demand balance in thesecond half of 2016.China, the world’s top consumer of base metals, will boost stockpiles according to a Bloomberg story. The nation willincrease its reserves and study a program for companies to build stockpiles in addition to inventories, resulting in ademand boost for base metals (which have seen weak demand amid a global economic slowdown).

Threats

China’s growth in fixed asset investment (FAI), a proxy for construction and infrastructure spending, slumped to a 16-year low in May. While government sector spending remained strong, the private sector continues to slow at aworrisome pace, suggesting that the property sector has peaked. China’s infrastructure investment and propertysector construction are key demand sources for global commodities.Monetary stimulus in China has stalled. China M2 Money Supply dropped to a growth rate of 11.8 percent, the lowestpace of expansion since the turn of the century. In addition, total social financing, a broader measure of creditavailability in the country slumped to RMB 660 billion in May, down 12.1 percent since last month, and down 37.2percent on a yearly basis. The resulting environment puts huge pressure on small- and medium-sized companiesputting a sustained recovery in jeopardy.The divergent paths of gold and copper prices are reminiscent of a recession era. The spread between the prices ofthe two major commodities reached its highest since 2009, and displays similar characteristics to those seen duringthe global financial crisis, leading some market commentators to suggest we may be nearing a crisis event.

China RegionStrengths

The Philippine Stock Exchange Index continues to be one of the region’s strongest-performing indices in recentmonths. The index capped another positive week post-elections and is once again approaching 52-week highs.

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TCL Communication Technology Holdings rose some 29 percent this week as TCL Industries Holdings proposed totake the communications company private for 7.5 Hong Kong dollars a share.Continued strength in the Japanese yen may prove useful to Chinese exporters. Yen strength hit a 52-week highsthis week, as the dollar-yen cross fell below 104.

Weaknesses

MSCI announced it would not include China’s A-shares in its global emerging markets index, which, while perhapsshort-term negative, had at least been well-telegraphed and may well spur additional and necessary reform in China.Renhe Commercial Holdings was the worst performer in the Hang Seng Composite Index over the last five days,falling nearly 17 percent in that time. S&P Global Ratings continues to assess the company’s leverage and liquidityas the underground mall operator plans a sale of assets.The risk-off surge in the Japanese yen this week dwarfed movement in Asia ex-Japan currencies this week, thoughthe Malaysian ringgit, Korean won and Philippine peso all declined between 0.6 and 0.7 percent over the last fivetrading days.

Opportunities

The $5.5 billion Shanghai Disneyland Resort officially opened its doors to visitors on Thursday. Although Disneyholds only a minority position in the park, reports the New York Times, analysts believe the profit potential for thecompany remains nothing short of spectacular.On Thursday, the State Council of China posted guidelines on its website indicating the nation will increase metalsreserves, accelerate the closure of excess capacity and provide tax breaks for producers, reports Bloomberg News.The Asian nation is struggling with a raw-materials glut “amid the slowest growth in decades,” continues the article.“The guidelines have boosted market sentiment,” Li Wei, an analyst with Huatai Futures said. “Increasing stockpiles,especially state reserves, will support prices.”Wealthy Chinese consumers have increasingly turned to Western sports brands like Adidas and Nike, reportsBloomberg, shifting their preference from luxury brands. Catherin Lim, an analyst in Singapore with BloombergIntelligence, believes that Chinese consumers concerned about flaunting their lavish spending want to buy productsthat are obviously expensive, but not excessively glitzy. Last year, sales in Greater China for Adidas grew 38 percent,and Nike sales were strong too—orders are up from September 2015 to April 2016.

Threats

On Tuesday, index provider MSCI announced its decision not to allow Chinese A-shares into its emerging marketsindex, reports Reuters, citing the need for Beijing to do more work to liberalize its capital markets. Although marketstumbled following the news, losses were reversed Wednesday as investors shrugged off the decision.According to a survey of Chinese CFOs regarding their expectations for the climate of China moving forward,particularly as the country settles into its “new normal,” or slower growth, many have a pessimistic view of the future.According to the China Business Review, the survey done by Deloitte China, shows that CFOs are less optimistic inthe medium to long term, citing further economic turmoil and detrimental governmental policies and regulations as thebasis for their outlook.

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Despite accelerating home sales in China, stocks of developers on the mainland have lagged their counterparts inHong Kong where prices are going the other way, reports Christopher Langner of Bloomberg News. Even thoughcompanies on the mainland are much bigger, shares of the 10 biggest publicly traded Chinese developers byrevenue are down, on average 15.8 percent this year. One explanation, in addition to the overall bleak view ofChina’s economy, points to Chinese developers steadily increasing their amount of debt since given access to localbond markets.

Emerging EuropeStrengths

Romania was the best performing country this week, gaining 1.2 percent. Central Emerging Europe (CEE) countriessold off this week on increasing fear of a Brexit, however Romania managed to outperform. It could be the mostresilient country within the CEE during the Brexit, given the powerful fiscal stimulus injected by the governmentstarting last year.The Russian ruble was the best performing currency this week, gaining 50 basis points against the U.S. dollardespite Friday’s announcement that EU sanctions are being extended for another year over Russia’s annexation ofthe Crimean peninsula. The announcement came one day after the EU Commission President Jean-Claude Junckermet with Russian President Vladimir Putin in St. Petersburg. Brent crude oil declined 2.4 percent and closed below$50 per barrel.The energy sector was the best performing sector among Eastern European markets this week.

Weaknesses

Greece was the worst performing market this week, losing 5.2 percent. The Athens Stock Exchange sold off at thebeginning of the week along with other markets, but gained 5.4 percent on Friday after Eurogroup approved therelease of EUR 7.5 billion to Greece. The year-to-date government budget was reported at a surplus of EUR2.3billion, way ahead of the EUR.8 billion deficit target.The Polish zloty was the worst performing currency this week, losing 1.2 percent against the U.S. dollar. Poland isvulnerable to a U.K. exit, as it may curb the subsidies Warsaw receives from the bloc’s common budget. Also, thevote to leave the eurozone may question the existence of the EU as a whole and lead to a weakening of countriesthat have not adopted the euro, Erste Bank Group said.The consumer discretionary sector was the worst performing sector among Eastern European markets this week.

Opportunities

More than $2 trillion have been wiped from global equities in the past week on speculation that the U.K. will vote toleave the eurozone. The latest polls show the “leave” camp gaining votes but it is still too close to call. Should theU.K. vote to stay in the eurozone, markets will likely rebound sharply.Poland received its first commercial liquefied natural gas from Qatar, and another shipment from Norway is scheduledto arrive in the Polish port on the Baltic Sea later this month. Poland relies on Russian gas for two-thirds of its needsand is seeking to lower prices under a long-term contract with Gazprom that expires in 2022.The pace of Russia’s GDP contractions slowed to 1.2 percent year-over-year in the first quarter of this year, from 3.8percent year-over-year contraction in the fourth quarter of last year. HSBC’s global research team believes that therecession in the economy appears to be coming to an end; the Russian economy will hit bottom in the secondquarter, and annual growth will turn positive in the third quarter.

Threats

Germany’s 10-year bond yield dropped below zero for the first time as the odds of a U.K. exit from the EuropeanUnion are increasing, boosting demand for safe havens. Investors who buy and hold the securities until the due datewill get back less than what they paid

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Raffaella Tenconi from Wood & Company, in her latest publication “CEE macro: preparing for Brexit,” said that if theU.K. exits the eurozone, the EU funds will shrink. On a positive note, Tenconi commented that if Great Britain votesto leave the EU next week it may take a few years to actually accomplish this due to long processes of negotiations.She expects the EU to face the drop in funds from 2021 onward. The U.K. is the third largest net contributor to theEU budget as the chart below illustrates.

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Sberbank’s CEO Herman Gref, in an interview with Bloomberg, said the Brexit will have a very negative influence onthe Russian economy along with the country’s currency, potentially shaving off 1 percent of GDP. Banks’ sharesdeclined about 10 percent during the past week and the announcement of the U.K. leaving the EU could cause aneven further decline.

© US Global Investors

www.usfunds.com

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