Weakness in gold and materials continues to weigh on Canadian equities
Global equities continued their impressive streak of gains while Canadian equities were lower thanks to continuing weakness in the materials and energy sectors. The S&P/TSX Composite Index shed 2.07%, while the S&P 500 gained 0.95% in Canadian dollar terms. The star of the month was the MSCI EAFE Index gaining 4.43%, besting all other major indices. Regionally, both Europe and the Pacific Rim were sharply higher, gaining 3.7% and 5.9% respectively.
In Europe, news of a bailout agreement in Cyprus and the continuation of accommodative central bank policies were positively received by investors. Japan looks near unstoppable, with the Nikkei 225 index soaring by more than 33% since the start of the year. If we take the effect of a weakening Yen into account, the gain is lower, but still impressive at approximately 20% in Canadian dollar terms.
While the falling Yen has fueled most of the rally, there are a number of other factors contributing. These include a series of bold policy initiatives that contain significant monetary easing, fiscal stimulus and economic reform. Combined, these are expected to help provide some level of support to the nations flailing economy.
Many now believe that the valuation gap between Japanese and other developed market equities has now closed, and any further gains will be driven by improving company fundamentals. It is likely that recent momentum will carry the market higher in the short term, which will be followed by a pullback.
Canadian equities continued to struggle because of continued weakness in the materials sector, which fell by 13.5% in April. The price of gold continued its freefall, dropping another 9%, bringing the price of gold companies with it.
There are many who believe that the long term outlook for gold remains strong. This is because gold has historically been a great inflation hedge and the massive amounts of liquidity that central banks have pumped into the global economy are expected to fuel future inflation. While this may be the case, the shorter term outlook is considerably less positive.
Many central banks have begun to talk about unwinding their massive quantitative easing programs much sooner than many had predicted. The sooner this happens, the more the future inflationary pressures will be reduced, lowering demand for gold.
Many heavily indebted European countries are rumored to be selling some of their gold reserves into the markets to raise funds to help reduce their debt. Combined, the PIIGS nations of Portugal, Ireland, Italy, Greece and Spain own a combined 3,200 tons of gold. Should some of this hit the market, it will throw the delicate supply and demand equation out of balance, putting further pressure on the price of gold.
Yet another headwind comes from the continued strength in the U.S. dollar. Gold has historically shown near perfect negative correlation with the U.S. dollar. It has been strong of late, and many expect that until China and Europe show signs of a sustained recovery, it will continue to be strong, putting further pressure on the price of gold.
Regardless of the direction, we expect to see more volatility in the short term in the materials sector. Because of the high weighting in the broader index, volatility will likely remain elevated for many Canadian equity funds, particularly those which closely track the S&P/TSX Composite Index.