This year credit conditions in the US look to be worsening, possibly dramatically. Of that the National Association of Credit Management (NACM), which surveys credit companies in the US about debt, has become increasingly convinced. In February NACM warned of deteriorating conditions, though there was some question if the decline in its index was temporary.
But after March data, it decided it wasn’t a one off.”There is quite obviously some serious financial stress manifesting in the data and this does not bode well for the growth of the economy going forward,” NACM wrote in late march. “These readings are as low as they have been since the recession started and to see everything start to get back on track would take a substantial reversal at this stage. The data from the CMI is not the only place where this distress is showing up, but thus far, it may be the most profound.”
In a recent note UBS’ commodities team took this, among other factors, as a “flashing red” signal that credit conditions in the US have gone sour and that the US Federal Reserve will be forced back to loosening its belt again. As UBS has argued for some time, it sees this as making for a bull run in gold, and gold equities in particular.
As mild warning: UBS’ commodities team acknowledges that in its thinking on debt/gold it is at odds with consensus view on debt conditions in the US and the broader in house view at UBS. That is, that they are not dire. But the UBS’ commodities team argues the US economy is not as healthy as it may seem. It says, “broad US economy returns (over the cost of capital) are in structural and cyclical decline, credit appetite is deteriorating, and that will lead to a trend widening of spreads, deteriorating credit availability and uptake, slowing growth and a new round of Fed reflation.” Under these conditions it notes that gold and gold equities do well.
To build its case, UBS highlighted credit rejections, as reported by NACM in March, that appear to be falling precipitously – faster than in 2008. It also noted that receivables of US companies – which can point to cash-strapped companies delaying bill payments to suppliers – have risen sharply this year.
Of course, as UBS notes, oil companies were hard hit in recent months and this in part accounts for the deteriorating debt data by the NACM. But it says the tightening credit situation extends beyond. UBS points to declining residential demand in the mid-range of homes, saying they are “in the doldrums”. UBS also says manufacturers were recently having a tough go of it internationally with a strong dollar and poor demand. “Following the rise of the US dollar, many firms were facing increasingly tough foreign competition, while demand in Latin America was very weak, and Asia was quite weak,” UBS said.
Other debt related signals don’t look so bad, as UBS’ commodities team notes. Growth of US bank loan assets has recently looked strong. But UBS’ commodities team sees this sort of signal as slow to react to economic issues. For example, companies may have healthy open lines of credit (often taken as cash flow tightens). But banks don’t get cautious about lending until after calamity strikes, not before. So such indicators lag economic shocks. “Only once banks have tightened lending standards aggressively will we see a clear net slowdown in credit growth,” UBS writes. “Just like in 2007/8, we suspect that the market will price in trouble well before the bank loan data confirm it.”
So with tightening credit and pressured cash flows, the UBS commodities team sees possible signs of a market correction, which in its view would push the Fed to act. “Our late cycle model – which takes the change in high yield spreads and EPS -momentum has spiked,” UBS says. “The last four times this has happened equities corrected 20-60%.”
Which brings us back to UBS’ view of the Fed. Its reaction to such a correction might help reignite gold and gold equities. “In our view in commodity strategy, this brings the Fed back into the equation. Over the past 20 years, the Fed has always moved to reflate the economy, cutting rates or announcing QE, whenever the S&P has fallen by 20% from peak and high yield has become stressed (we use HYG at 85 as a proxy).”
UBS sees this as setting the stage for excellent returns on gold companies which meantime have been driving down costs. This contrasts starkly to the last bull run, when company costs were driving up. UBS top picks are: Randgold, Acacia, Agnico Eagle and Goldcorp.