Watch Gold Tonight!

Downtrend stacks coins,on the financial stock charts as background. Selective focus
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There’s plenty happening to finish off the week. Let’s start in the all-important, Fed controlled, US markets, before moving on to Australia, where the RBA doesn’t seem to have much control at all. More on that in a moment…

The big news in the US overnight was that the manufacturing sector contracted in August for the first time in six months. The Institute for Supply Management’s manufacturing index fell to 49.4 in August, down from 52.6 in July. A reading below 50 indicates a contraction.

In contrast, the manufacturing sectors in the UK, China and Europe all expanded in August. This suggests the US is losing the currency wars, as manufacturing is sensitive to exchange rate movements, and US firms are obviously losing orders to their overseas competitors.

The news put a dampener on the prospects of a near term US rate rise and, after selling off earlier in the day, US stocks rebounded to finish slightly higher. Keep the bad news coming!

The Fed, of course, has brought this on itself. In telling the market that a rate rise is probably coming, albeit still ‘data dependent’, investors are now hypersensitive to any semi-important data release.

The manufacturing data is important because it tells the Fed the strong US dollar is having a detrimental impact on the economy. With Europe, the UK and China all running ridiculously easy monetary policies, it means an interest rate rise now in the US will have a big effect on the dollar.

Despite that setback for a near term rate rise, global markets will now anxiously await the non-farm payrolls report for August, due out at 10:30pm AEST tonight.

As the report comes out at 8.30am New York time, most markets will be closed when the data hits. The gold market is one exception. If you have nothing better to do tonight, check out gold’s reaction when the employment numbers hit. Sharp moves — up, down, or both — are pretty much guaranteed.

Given gold has sold off consistently this week thanks to Fed ‘jawboning’, it could well be a case of ‘sell the rumour, buy the fact’. Which means people sell on the fear of a strong employment number and imminent rate rise, and then buy back when the news isn’t as ‘bad’ (or good, depending on your take) as feared. So watch for a rally tonight.

But the fact that the market is so uptight about a single (and ultimately forgettable) data point just goes to show how screwed up the Fed’s ‘communication policy’ is. As the Financial Times reports:

Some policymakers and economists worry about the idea that one employment release can be seen in markets as pivotal — suspecting that it muddies Fed communications. “It is right to be concerned that a single number could sway a policy decision,” said Mr Perli, “It is not an ideal situation.”

Frankly, it’s a ridiculous situation to be in. But because we know everyone else thinks it’s a big deal, we have to think it’s a big deal too, even though it’s not.

Crazy…

Which is a description not far removed from the Aussie economy. Sure, above the surface everything looks like rainbows and lollipops. But behind the scenes, there’s a fair bit of sweating and panicking going on.

Yesterday, the Australian Bureau of Statistics (ABS) reported two pieces of ordinary news for the Aussie economy: stagnant retail sales and plunging business investment. From the Financial Review:

Business investment continues to crumble, falling more than expected in the June quarter, while the outlook in what companies expect to invest in the coming years shows further weakness is ahead.

Separate figures showed retail sales stagnated in July.

In fresh evidence of the rapidly diminishing remnants of the resources boom, total new capital spending shrunk 5.4 per cent from the March quarter to be 17.4 per cent lower than a year earlier, the Australian Bureau of Statistics said on Thursday.

Economists had forecast that business investment would fall 4.1 per cent from the previous quarter.

Falling business investment has been a feature of the Aussie economy for a while. That’s because the massive spending associated with the resources boom (think iron ore and LNG expansion) was never sustainable.

It’s also the number one reason why the RBA slashed interest rates starting in 2011. They knew the investment bust was coming and wanted to try and cushion the blow with an increase in housing investment.

If you want to ignore the structural damage done to an economy that now relies almost completely on rising house prices for growth, the RBA’s efforts were a success.

But it begs the question: How much fuel is there left in the housing construction tank? Earlier this week, the ABS reported another surge in building approvals in July. With nearly 21,000 approvals for the month, it was the second highest reading in the history of the release.

The issue is that all of the growth came from multi-unit dwellings — apartments or townhouses. There is already concern about the growing glut of apartments across the major east coast cities, and this will do nothing to allay that concern.

While the strong approval numbers suggest there is still a bit of work in the pipeline, we are clearly nearing a cyclical peak in the construction cycle. Already, a number of stocks exposed to this sector are off their highs.

Keep an eye on stocks like Brickworks [ASX:BKL], Adelaide Brighton [ASX:ABC], Boral [ASX:BLD] and Fletcher Building [ASX:FBU]. Out of the four, only FBU looks strong. The rest are off their highs, suggesting the building boom has peaked, or at the least that it’s about to.

Are there any rabbits left in the RBA’s hat?

Cheers,

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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