LP L FINANCIAL R E S E AR C H

Weekly Economic Commentary

June 4, 2012

Beige Book: Window on Main Street

Sequel to Last Summer? John Canally, CFA
Economist LPL Financial

Highlights
We expect the Beige Book to still paint a picture of an expanding economy. The Beige Book should also discuss the uncertainties (Europe, the looming fiscal cliff, and the upcoming U.S. elections) and the return of normal weather. The Beige Book is expected to provide the Federal Reserve (Fed) with plenty of scope to initiate another round of quantitative easing.
Please See the LPL Financial Research Weekly Calendar on page 3

This Wednesday, June 6, the Federal Reserve will release its Beige Book one of our favorite economic reports. The Beige Book compiles qualitative observations made by community bankers and business owners about economic (labor market, prices, wages, housing, nonresidential construction, tourism, manufacturing) and banking (loan demand, loan quality, lending conditions) conditions in each of the 12 Federal Reserve (Fed) districts (Boston, New York, Philadelphia, Kansas City, etc.). Each Beige Book is compiled by one of the 12 regional Federal Reserve districts on a rotating basis the report is much more Main Street than Wall Street focused. It provides an excellent window into economic activity around the nation using plain, everyday language. The report is prepared eight times a year ahead of each of the eight Federal Open Market Committee (FOMC) meetings. The next FOMC meeting is June 19 20, 2012.

Warm Weather Impact

The Beige Book prepared ahead of the April 24 25, 2012 FOMC meeting (released on April 11, 2012) described an economy that was still expanding at a modest pace. At that time, there were few signs of the themes that dominated the Beige Books in the summer and fall of 2011: weak confidence, rising food and energy prices, European concerns, and high economic and financial market uncertainty. (Please see our April 16, 2012 Weekly Economic Commentary.) In addition, the numerous mentions of warmer-than-usual weather in the April 11, 2012 Beige Book suggested to us that warm winter weather almost certainly impacted economic activity.

Expansion and Uncertainty

Notably, compared with the Beige Books released in June of 2008 and 2009 when the economy was in the midst of the Great Recession this weeks Beige Book is likely to be far more upbeat.
Unfortunately, many of the themes that dominated the Beige Book in the summer and fall of 2011 may reappear in this weeks Beige Book, making it look like a sequel to the ones prepared in the middle of 2011. In addition, the return to more normal weather this spring has led to a noticeable cooling of economic activity in recent weeks. We have been describing that as payback from the warmer-than-usual winter of 2011 2012 that pulled forward hiring, home buying, construction activity, and even some consumer purchases. It will be interesting to see how business and banking leaders describe the weathers impact on the economy in recent weeks and months. The slowdown in economic activity in China will also likely be mentioned in this weeks Beige Book. On balance, we expect the Beige Book released this week to look more like the sequel to the Beige Books from last summer and fall, rather than the relatively upbeat Beige Books released thus far in 2012.

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We do not expect the Beige Book to be all bad news. Indeed, business and banking contacts across the country are sure to note several positives in this weeks Beige Book, including the:

Recent drop in consumer energy prices, Continued increase in bank loan activity (to both consumers and businesses), Sharp increase in refinance activity as the result of the sharp drop in mortgage rates, Ongoing revival in the housing market (sales, prices, construction, employment), Dramatic decrease in raw materials costs, and Revival of the manufacturing sector.

The number of times Japan was mentioned in April 2012, down from 25 mentions in June of 2011.

In addition, the global supply chain disruptions resulting from the earthquake in Japan that dominated the Beige Books last summer have now been resolved and are not acting as a drag on global growth as they were throughout the final twothirds of 2011. Notably, compared with the Beige Books released in June of 2008 and 2009 when the economy was in the midst of the Great Recession this weeks Beige Book is likely to be far more upbeat.

Behind the Key Words and Phrases

We expect an increase in mentions of uncertainty, Europe, and confidence in this weeks Beige Book, and perhaps even a sharp uptick in the number of mentions of China. Weather mentions will likely remain elevated as well. We dont expect to see any mentions of Japan/Thailand as it relates to global supply chain disruptions, but we do expect plenty of mentions of lower gasoline, fuel, and commodity prices impacting the economy. The nearby figure provides the progression of the mentions of some key words and phrases from the most recent Beige Books, from the Beige Books released in the summer and fall of 2011, and those released in June 2008 and June 2009, when the economy was in recession. On balance, the Beige Book will likely paint a picture of an economy that is growing, but perhaps growing more slowly than it was just a few months ago. The slowdown in the pace of economic growth here and abroad, growing policy uncertainty overseas and at home, along with a sharp decline in food and energy prices ought to provide the Fed with the scope to pursue another round of quantitative easing later this year, and perhaps even as soon as the end of this month, when Operation Twist is scheduled to end.
Nov 30 2011 10 19 10 4 10/7 4/11 Oct 19 2011 0 26 2 9 9/0 2/4 Sep 7 2011 12 38 5 11 14/0 2/12 Jul 27 2011 8 20 2 6 21/0 10/12 Jun 8 2011 18 7 1 8 25/0 14/18 Jun 10 2009 3 13 0 6 0/0 6/5 Jun 11 2008 10 7 2 5 0/0 7/29

The number of times Uncertainty was mentioned in April of 2012, down from the 38 mentions in September 2011.

10
Feb 29 2012 29 9 14 5 1/1 5/12

Beige Book Breakdown

Apr 11 2012 Jan 11 2012 13 13 16 7 2/2 5/4

Weather Uncertainty Europe Confidence Japan/Thailand Gasoline/Fuel

34 10 6 1 0/0 16/27

Source: Federal Reserve's Beige Book LPL Financial Research 06/04/12

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LPL Financial Research Weekly Calendar

U.S. Data
2012 4 June 5 June

Fed

Global Notables

China: HSBC Service Sector PMI (May) Australia: Central Bank Meeting Canada: Central Bank Meeting Germany: Factory orders (Apr) ECB Meeting Brazil: CPI (May)

Service Sector ISM (May)

Fisher Bullard Evans

6 June

Lockhart* Beige Book Williams* Yellen* Rosengren Bernanke * Lockhart * Kocherlakota Fisher Kocherlakota

7 June

Initial Claims (6/2) Chain Store Sales (May) Consumer Credit (Apr)

UK: Bank of England Meeting South Korea: Central Bank Meeting Mexico: Central Bank Meeting Argentina: GDP (Q1) China: CPI (May)

8 Jun

Trade Deficit (Apr)

Hawks: Fed officials who favor the low inflation side of the Feds dual mandate of low inflation and full employment Doves: Fed officials who favor the full employment side of the Feds dual mandate * Voting members of the Federal Open Market Committee (FOMC) Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. China CPI: In total there are about 600 "national items" used for calculating the all-China CPI. The list of items is revised annually for representativeness based on purchases reported in the household surveys. The number of items can change from year to year, but rarely by more than 10 in any given year. ECB: European Central Bank ISM: Institute for Supply Management Chinese Purchasing Managers Index: The PMI includes a package of indices to measure manufacturing sector performance. A reading above 50 percent indicates economic expansion, while that below 50 percent indicates contraction. The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

LPL Financial Research 2012 Forecasts

GDP 2%* Federal Funds Rate 0%^ Private Payrolls +200K/mo.

Please see our 2012 Outlook for more details on LPL Financial Research forecasts.

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IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. * Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. ^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Private Sector the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesnt include: - general government employees - private household employees - employees of nonprofit organizations that provide assistance to individuals - farm employees The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. This research material has been prepared by LPL Financial. The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.
Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

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Weekly Market Commentary

June 4, 2012

Gold: Its Back

Jeffrey Kleintop, CFA
Chief Market Strategist LPL Financial

Highlights
Fortunately for investors, as Treasuries became the most expensive they have ever been, another safe haven emerged last week that had been lost to investors seeking safety in recent years: precious metals. While stocks may be nearing an attractive entry point, precious metals after suffering bigger losses and beginning to exhibit a return to a traditional safe-haven behavior may be rising on investors shopping lists as they start to look at deploying cash positions.

As investors sought a safe haven from falling markets last week, the yield on the 10-year Treasury note (which moves in the opposite direction of the price) hit a record low going back to the 1950s, as it fell to 1.45% [Figure 1]. Fortunately for investors, as Treasuries became the most expensive they have ever been, another safe haven emerged last week that had been lost to investors seeking safety in recent years: precious metals. While historically acting as a refuge for investors during stormy markets, gold prices have been driven by multiple factors including the demand from China and India in recent years. This has resulted in a departure from golds former role as a defensive investment. Gold has tracked the ebb and flow of global growth, especially growth in Asia, in recent years. For example, gold plunged 30% from mid-March to mid-November of 2008 (according to Bloomberg data), as the global financial crisis emerged, offering investors little safety from the similar decline in the stock market. Furthermore, this year, gold prices tracked the slowdown in Chinas economic growth, moving down in lockstep with Chinas Leading Economic Index as key data releases reflected slowing growth and missed economists estimates. But that behavior changed last week as gold prices rose despite weak global economic data, including data from China that pushed bond yields lower (and prices higher), as you can see in Figure 2. The release on Friday, June 1 of Chinas PMI, a widely-watched manufacturing gauge for China, was surprisingly weak and registered a sharp pullback to 50, the threshold between a growing and shrinking manufacturing economy in China. Investors began to look at gold as a safe haven again rather than a barometer of global or Asian economic growth. Gold had fallen 19% from early September of last year until mid-May 2012, as the price in dollars per troy ounce fell from 1900 to 1540, nearly making it a bear market for the precious metal. Since May 16, 2012 gold is up 5.5% with most of that gain, 4 percentage points, coming on Friday, June 1 as stocks, as measured by the S&P 500, fell 2.5%. This change in golds behavior may be lasting. Currency is a major driver of gold price movements. For example, the rise in the value of the dollar accounted for about half of the 19% decline in gold prices prior to this week. The strong dollar, driven by money flowing into the U.S. from Europe and elsewhere, has weighed on the price of gold measured in dollars. A turnaround in the direction of the dollar would be a plus for gold prices.

History of 10-Year Treasury Yield

10-Year Treasury Yield 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1954 1960 1966 1973 1979 1985 1992 1998 2004 2011

Source: LPL Financial, Bloomberg Data 06/04/12

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Golds Sudden Change in Behavior

Gold in $ Per Troy Ounce and Yield on 10-Year Treasury Note 10-Year Treasury Note Yield (Left Scale) Gold (Right Scale)

2.1% 2.0% 1.9% 1.8% 1.7% 1.6% 1.5%

1700 1650 1600 1550 1500 1450

Last weeks softer U.S. economic readings for key data like the Institute for Supply Management (ISM) and employment make it more likely we will see a new program of stimulus from the Federal Reserve (Fed) as the current Operation Twist draws to a close this month. That action by the Fed may weaken the dollar and add further fuel to gold prices, sustaining golds new behavior as a safe haven. A safe haven may be valuable given the volatility that may result from upcoming events: June 6: European Central Bank meeting June 10 & 17: French parliamentary elections June 17: Greek elections June 19 20: Federal Reserve meeting June 28 29: European Union summit And as of mid-July 2012, Greece will run out of money if the second round of bailout funds are not dispersed due to Greece failing to live up to the agreement that was crafted late last year. While stocks may be nearing an attractive entry point, precious metals after suffering bigger losses and beginning to exhibit a return to a traditional safe-haven behavior may be rising on investors shopping lists as they start to look at deploying cash positions. n

1.4% Apr 12

Apr 22

May 02 May 12 May 22 Jun 01

Source: LPL Financial, Bloomberg Data 06/04/12

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IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Precious metal investing is subject to substantial fluctuation and potential for loss. Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Investing in specialty market and sectors carry additional risks such as economic, political or regulatory developments that may affect many or all issuers in that sector. The fast price swings in commodities and currencies will result in significant volatility in an investors holdings. Chinese Purchasing Managers Index: The PMI includes a package of indices to measure manufacturing sector performance. A reading above 50 percent indicates economic expansion, while that below 50 percent indicates contraction. The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks. The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys. Treasuries: A marketable, fixed-interest U.S. government debt security. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.

This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

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