Wednesday October 21

Stocks fall after weak earnings and Valeant movements dragging down equities. The S&P500 fell 0.6% to 2,018 and the Dow Jones was down 0.3% to 17,168. So far S&P500 earnings have largely been better than expected with 71% of the companies who have reported beating earnings. The US Treasury yield fell four basis points to 2.03% on equity weakness. The euro was quiet and little changed against the dollar at $1.1340 ahead of the ECB’s meeting tomorrow. The yen fell 0.1% against the dollar to Y119.95 as the monthly trade deficit data reflected weakness due to China. Japan’s economy is at risk of entering another recession. The economy contracted 1.2% at an annualized rate in the second quarter, and many expect that Shinzo Abe will combat this with increased stimulus.  Brent oil fell 1.6% to $47.91.

Oil production and supply levels continue to show resilience. It seems as if each week analysts predict that supply levels will finally start to show decreasing production however supply levels have continually beaten expectations. This week is no different as data from the EIA showed that inventories in the US rose by 8mm barrels last week compared to the expected 3.5mm. Commercial crude inventories are at their highest level in 80 years at 476mm barrels. WTI oil dropped 2.4% to $45.20. Prices are struggling to find upward momentum amid expectations for decreasing supply levels because new Iranian supplies that are expected to reach the market will at the very least meet supply cutbacks from US shale.
Traders are beginning to have second thoughts about the Saudi Arabian riyal. The riyal has been pegged against the dollar at riyal 3.75 per dollar for the past 30 years. With oil prices trading at half of their level from one year ago it is becoming increasingly expensive for the country to maintain this peg. However the government has expressed its commitment to the peg and the country has a large amount of foreign reserves. The Saudi Arabian budget needs oil prices at least $50 in order to balance their budget and run a surplus. The government is already running a deficit, and prices have not been above $50 on a consistent level in recent months. The IMF expects that the country will run a fiscal deficit of 20% of GDP this year. One year forward contracts trade at riyal 3.78 against the dollar which shows that traders expect a slight devaluation from the current level. The government has requested a halt in public hiring, new infrastructure projects, and to stop public purchases of cars and furniture which reflects the fiscal pressure on the government.
While many commodities have been selling off gold prices have found support in recent weeks rising more than 9% over the past month. The metal in recent months has been called into question by investors for its ability to serve as a haven asset and inflationary hedge. Gold peaked in 2011 and has since suffered as there have been virtually no signs of inflation around the world. One analyst notes that gold’s current rally will be very temporary and it is largely due to traders covering short positions. Gold valuations are somewhat abstract due to the fact that it pays no coupon or dividend. One way that analysts value the commodity it through comparing it to a zero coupon Treasury bond. This method gives the metal a fair value of $907 currently. This method is based on the idea that gold could be valued as a zero coupon, inflation linked bond and gold value should fall as interest rates rise on bonds. Another way to value gold is through housing and wages, and this method gives gold a fair value of $1,000. This method relies on the idea as housing and wages as a measure of the metals buying power. The price of gold is now $1,179 which is above both of these fair value estimates.
Wednesday October 21

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