Welcome to 2012!

North American markets started off 2012 on a positive note in the 4-day shortened week when traders returned to work on Tuesday thanks to some better than expected economic data out of the U.S. and China. However, the European debt problems of 2011 did show their ugly face yet again and will continue to do so in the weeks and months ahead as European countries get in line for some debt financing.

The Germans managed to sell some bonds to start off 2012 as did the French, but demand was not particularly strong for the French auction as investors continued to debate whether or not France would lose its AAA credit rating in the near future.

While Europe was its usual source of volatility, the United States provided investors with a few sources of optimism as the ISM Manufacturing Index, ADP Employment Change, Initial Jobless Claims, Unemployment Rate and Nonfarm Payrolls all beat consensus expectations.

The energy sector was helped by rising oil prices as the geopolitical tensions in the Strait of Hormuz escalated over the Christmas break with crude oil prices shooting north of US$103 per barrel. Some of those tensions eased towards the end of the week, but oil prices still remain above the US$100 per barrel mark.

Gold prices bounced back to start off 2012 after a difficult month of performance in December. While bullion prices are nowhere near their all time high, they did manage to close the week back above US$1,600 per ounce.

Thanks to euro weakness, the U.S. dollar has been on a tear recently and continued to rise into the new year with the U.S. trade weighted dollar passing through 81.0. This is a level not seen since the beginning of last year, thus illustrating how uncomfortable some investors are with the current situation in Europe.

U.S. Job Creation Picks up Momentum

Most equity markets finished the year on a down note in 2011; however, the U.S. employment market started off the new year with a very positive surprise. Total nonfarm payrolls increased by 200,000 vs. expectations of 155,000, while private payrolls increased by 212,000.

Last Thursday, we saw an even greater surprise as the ADP Employment report indicated that 325,000 private jobs had been created in the U.S. when the Street was looking for 178,000. While the December reports may be revised down in the months ahead for seasonal reasons, we can’t ignore the fact that the U.S. employment market has picked up momentum since the summer.

Yes, last week’s reports were encouraging, but we don’t want to get ahead of ourselves as almost 6.5 million jobs lost from the recession have not returned. To regain that many jobs over the next two years will require a job creation rate of 270,000 jobs per month through to 2014. Easier said than done.

The Trading Week Ahead

This week will be the calm before the storm in the United States as fourth quarter reporting season is about to begin with many companies reporting their year-end results. As is tradition, Alcoa will get things started on Monday, but we won’t see a lot of earnings reports released until the following week.

Corus Entertainment and Shaw Communications will report earnings in Canada, but most Canadian companies with a calendar year-end won’t release their Q4 earnings until the end of the month.

After a busy week of economic data, the news flow will slow down next week. Likely the most anticipated statistic will be U.S. retail sales as investors will be looking for an indication that consumption was strong during the busy holiday shopping season. You’ve heard us say it before and we’ll say it many more times in 2012, Europe will continue to be on everyone’s radar next week as more countries come to the market with more bond auctions and negotiations. European developments will naturally have an impact on the Euro and thus the U.S. dollar.

Even though the U.S. dollar has strengthened, we’ve also seen strength in oil and gold prices at the same time, thanks to events in the Middle East. While the situation in Iran appears to have calmed down, oil speculators will be keeping their eyes on developments in the Gulf.

The Canadian dollar was a victim this past week of a stronger U.S. dollar and a disappointing employment report, but the loonie will be looking to get a lift in the days ahead from the higher oil and gold prices we’ve seen so far in 2012.

On behalf of everyone at Richardson GMP, we’d like to wish you all the best in the year ahead and happy investing in 2012!

QUESTION OF THE WEEK: I hear oil prices are back above US$100 per barrel because of military activity in the Strait of Hormuz. What is the Strait of Hormuz and why is it influencing energy prices?

The Strait of Hormuz is the strait connecting the Persian Gulf to the Gulf of Oman. More importantly, it’s the only sea passage to the ocean for many oil exporting countries in the Gulf region. It’s estimated that about 14 tankers carrying 15.5 million barrels of crude oil pass through the strait on an average day, making it a very economically sensitive and strategic location.

It’s also estimated that the amount of crude passing through the strait represents about 35% of the world’s seaborne oil shipments, and 20% of oil traded worldwide in 2011. You’ll also notice that Iran is the country to the north of the Strait and it’s this country which is keeping crude oil prices on edge. As you are likely aware, Iran and the United States (and other European countries) have not seen eye to eye dating back to the Islamic revolution that put Ayatollah Khomeini into power in 1979. Recently, tensions have escalated as Iran developed a nuclear program which the west is convinced has one purpose, to create nuclear weapons.

Many countries, including Canada, have responded to this potential threat by implementing sanctions against Iran and in December the Iranian navy inflamed the situation by running military drills near the Strait of Hormuz claiming that they could shut down the oil passage if they wanted to. While it’s unlikely such a scenario would unfold as the world would respond aggressively to such a threat, the thought of this much oil being blocked by the Iranians is enough to get speculators increasing the geopolitical risk premium in oil prices to elevated levels.

Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @Gareth_RGMP