FYI | Jun 13 2007
By Greg Peel
The recovery in US stock markets witnessed on Friday was all but wiped out last night as US bonds were sold heavily once more and yields reached as high as 5.295%. After spending a long time eking up toward the 5.00% level over past months the breach of this significant marker (significant only because it is a round number) has ushered in a wave of volatility for the bond market. There are various negatives implicit for equity traders as yields march higher.
Higher bond yields erode the value of future corporate earnings and thus reduce stock valuations. As bond yields move to exceed dividend yields by a greater margin bonds become more attractive to yield investors. Higher bond yields are a portent of inflation ahead, suggesting a rise in the cash rate may also be imminent. Again such a move undermines equity valuations as earnings are discounted at a greater value. A higher cost of borrowing renders private equity leveraged buyouts more expensive, undermining internal rate of return potential and scaring off would be buyers.
The only upside is that “public” M&A activity – corporations, as opposed to private money, acquiring corporations – may become more frenetic if share prices pullback to lower levels. But then premiums over traded price are worked off a lower base.
The Dow fell 130 points or 1% overnight with similar moves experienced in the S&P 500 and Nasdaq. It was all a post-lunch slide. Having opened lower the market grafted its way back into the black until 2pm but then it was Goodnight Irene. The Dow closed on its lows. Weakness was also experienced in the UK and Germany.
Rate rise anticipation also forced the US dollar higher, reaching a two-month high against the euro. This set off the gold market once more, such that the metal slid US$6.50 to US$646.50/oz to fail at the US$650/oz support yet again. A US62c fall in the oil price didn’t help.
Gold experts suggest the market is currently torn between fundamental support and technical resistance. While market dynamics suggest gold is cheap below US$650/oz, technical traders are reading bearish signals and are set to sell as lower levels are breached. A breach of US$635/oz could well send the price back below US$600/oz according to some tea-leaf readers. The fundamentalists are prepared for this, stoically suggesting any further falls offer good longer term buying opportunities.
All the talk in the base metal market has been about nickel in recent weeks. The price has confounded most analysts despite tightness of supply, and many had been calling an inevitable correction. Well it’s happening, courtesy of a little trigger from the LME which tightened up nickel lending requirements last week and set the correction in train. The metal fell 6% in both London and New York last night, taking falls to 12% since the LME announcement. To top things off, demand has begun to ease and supply increase recently. Citi’s Alan Heap suggests the price could fall by half in coming months before the correction is over due to increasing supply coming on to the market.
The SPI Overnight has closed down 78 points, a precursor to another weak day. It appeared local traders were not convinced by the Wall Street rally on Friday, as a strong opening was eroded all day yesterday. It remains to be seen whether bargain hunters will again emerge, or whether a retreat to the sidelines is the most sensible prescription as the US bond situation plays out.
