Jan 30, 2012

Fitch Places the Big 4 Aussie Banks on Negative Watch

In a press release, Fitch has placed Commonwealth Bank, NAB, Westpac and ANZ on negative watch, citing that
Australian... banks are each subject to many of the same themes and trends as other banks globally including an uncertain macroeconomic environment and evolving regulatory regimes.
As we have mentioned before, Australia's economy is not necessarily sounder or on a better footing than the rest of the world, if one were to take into account its strong reliance on China.

Another Step Forward in the Creation of the United States of Europe

In politics crisis only brings opportunity for radical reforms. As WhatIf mentions in a previous post, the ongoing situation in Greece will only help further the fiscal consolidation of the Eurozone. And now the next step along that long road has officially been made. According to this Reuters article,
"If the Greeks aren't able to succeed themselves with... (the austerity measures), then there must be stronger leadership and monitoring from abroad, for example through the EU," added Roesler, chairman of the Free Democrats (FDP) who share power with Chancellor Angela Merkel.
Germany is thus openly asking that Greece give up a token of sovereignity in return for their next bailout. Of course this will certainly not pass this time. But the fact that this radical (some may say outrageous!) step has been suggested and is even considered, very much indicates the future direction of European integration.

Jan 27, 2012

Commodities Super Cycle Reversing Course

According to this Reuters article,
Last year had the lowest commodity inflows of the past nine years, with fresh investments dropping almost 78 percent compared with 2010, Barclays Capital said on Thursday.
Investors in precious metals and energy had a very volatile experience in 2011 and many are wondering if it really is the sure bet that they expected. For example Gold has had a big rollercoaster of a ride and Silver has been even more volatile (see a previous WhatIf post Gold Appears to have Lost its Shine for more details on the metals).

With Beijing trying to rebalance China's economy away from investment and towards consumption, the huge bursts of residential construction and capital investment may be behind us. As we have seen before, construction is unlikely to be picking up anytime soon and if China is headed for a slowdown, demand for most industrial commodities will drop considerably. Barclay's prediction of volumes and prices picking up notwithstanding, it appears that the market has reached a turning point in its 10-year cycle.

Jan 25, 2012

Japan Logs Annual Trade Deficit in Calendar 2011

On the back of bad numbers for Nov (see Japan Nov Trade Deficit Worsens - Usd/Jpy to Turn the Corner Soon) Japan has logged another negative surprise for Dec, as announced on The Ministry of Finance website today. This makes the first annual trade deficit in 30 years. The income earned on foreign exchange reserves will likely partially offset that but there is no doubt that Japan's fiscal and current account position is only getting worse. Once the market starts pricing that in, we would expect an upside breakout of Usd/Jpy with an intermediate target in 85.00 area.

(For more on Japan's fiscal situation see Japan's Budget Mess. This WhatIf post is from about month ago but the analysis is still valid.)

Jan 24, 2012

AUD a New Safe Heaven? Bad Joke

As WhatIf has mentioned earlier, the fundamentals are not looking good for Australia. All the non-resource sectors appear to be stagnating, to a large extent hurt by the strong currency. At the same time material exports, while very strong at the moment, are mostly going to China. And China is slowing down.

There has been some talk in the market / media of the AUD becoming a new safe heaven as one of the very few remaining AAA economies. It's a nice story but clearly not true - a minor hiccup in equities still sends Aud/Usd tumbling. As it should, seeing as Australia's economy is to a large extent just a leveraged, liquid bet on China.

Jan 23, 2012

Greece Talks Restart but Brinkmanship Continues

In line with WhatIf's analysis yesterday, the Greece talks have indeed hit a snag over the weekend. CNBC reports that IIF says creditors at limits of "voluntary" Greek deal. There is nothing surprising there, as Greece's negotiations with the "Troika" have been a never ending game of political brinkmanship. And to be fair to the private creditors, there is no legal justification for the losses (a.k.a. "haircut") they are expected to take, given that the ECB will be repaid in full.

Jan 22, 2012

Greek Talks Break Down

Equity markets and the Euro have rallied hard last week in anticipation of a deal to be reached between Greece and its private creditors during negotiations in Athens. However the negotiators on the creditors' side left Athens on Saturday without an agreement having been announced. It appears that the talks have hit a snag yet again. The Institute of International Finance was quick to deny it but that rings hollow. If Dallara and Lemierre had really planned to leave on Saturday, the reduced time frame should have been taken into account during the talks. Sometimes there is no better confirmation than an official denial!

Jan 19, 2012

Australia's Markets Defying Gravity (For Now)

Today the Aussie employment numbers surprised on the negative side. About 30k jobs were lost in December according to the Australian Bureau of Statistics press release. This compares to a consensus estimate of a net creation of 10k jobs, for a negative surprise of -40k. Both the Aussie stock index and the Aud/Usd fx rate met this with slightly more than a yawn.

The -40k surprise may not seem like a whole lot, but normalized by population size (22mm in Australia vs 310mm in the United States) this would be equivalent to US payrolls disappointing by approx 560k and such news would have completely tanked the SPX!

The Aussie (the currency that is) has been trading in line with global risk sentiment and out of synch with the fundamentals of the local economy. Other currencies have done that in the recent past, most notably the Euro. However when the regime shifts and the market starts pricing in the negative fundamentals the moves can be quite large. We just need to wait for the decoupling.

Jan 18, 2012

Chinese Real Estate in Broad Decline

We have already seen anecdotal evidence of sharp price cuts by property developers eager to move inventory of unsold homes (China's Housing Crash is Gathering Momentum) or sharp drops in the most speculative luxury vacation home market (Property Prices in "China's Hawaii" Down Almost 30%). The market reversal is now spreading with Dec marking the third month in a row of negative average growth of home prices in all of China. Moreover, according to Reuters, prices dropped in 52 out of 70 cities. The situation is far from desperate but can get worse very fast with the government continuing efforts to reduce property speculation, developers losing access to funding and new home sales slowing to a crawl. The real trouble will probably start when prices in all cities start dropping at the same time.

Jan 17, 2012

Mass S&P Downgrade Will Help Further European Fiscal Consolidation

The analysts at S&P love the limelight. The timing of their announcements plus the multiple rumours and leaks (sometimes subsequently denied) seems to indicate so. But putting that aside, the mass downgrade issued on Friday has had a few interesting side-effects. Finally France has had to face the reality that there is only one regional superpower in Europe and it is not them. Also the revision of the outlook on Germany's credit rating from negative to stable has shown that the core is still strong and has probably contributed to the relative strength of the Euro. (As a large exporter Germany is the main beneficiary of the common currency - please refer to The Flip Side of Germany's European Bailouts).

The pundits have been quite negative on the "European experiment" in the aftermath. And admittedly the economic situation in the European Union certainly does not look rosy. But one should not forget that the Euro is first and foremost a political project. It is an attempt to bring a fractious continent together and avoid the political and military mistakes of past centuries. And sometimes the only way to push through painful reforms is when there is simply no alternative. By escalating the European credit crisis, rating agencies will ultimately help Europe on the path to harmonization of fiscal policies.

Jan 16, 2012

Gold No Longer a Hedge Against Currency Debasement

On Friday after the close, S&P issued a credit downgrade on a number of European countries. This had been anticipated ever since they had been placed on credit watch in December. As would be expected, the Euro dropped to a new multi-month low against the USD and stock markets followed. What may not have been fully expected is that Gold also dropped with the news and tracked the US equity market. Gold was supposed to represent a hedge against fiat currencies (read "paper money") and should have spiked when the European situation worsened. Yet this did not happen and it traded like any old investment asset in line with overall risk sentiment. Buy at your own risk. (For more details, refer to Gold Appears to have Lost its Shine and a more recent WhatIf post Technical Bounce in Gold To Present a Selling Opportunity)

Jan 13, 2012

Imminent Greek Exit Positive for the Euro

The drive for ever more "austerity" in Greece is having the opposite results. It is pushing the Greek economy further into recession, reducing tax revenues, worsening the country's fiscal deficit and debt load, and thus only necessitating further belt-tightening. It is a vicious cycle with no way out. Even the IMF has acknowledged that and it is now becoming clear that the only choice is bankruptcy or a Euro exit. An option that was politically inconceivable 6 months ago is currently on the table. (See Greek Euro Exit Weighed By German Lawmakers on Bloomberg.)

From the beginning it has been somewhat ill-defined notions of contagion, exacerbated by forced "voluntary" debt forgiveness that has lead the crisis to spread into Spain and Italy. So much so that even the troubles in non-Eurozone Hungary lead panicked investors to dump EU government bonds and the currency (see previous WhatIf post).

With Greece out, the situation would appear manageable and in retrospect Fitch's warning of "cataclysmic' collapse of the common currency would likely mark the low for the Euro against other G-7 currencies. At the time the panic was running so high that investors were willing to pay to lend their money to safe-haven Germany (see prior WhatIf post on negative German yields). Time is running out for Greece and it will likely reintroduce the drachma, putting an end to this chapter of the Euro crisis and giving a major boost to the Euro.

Jan 11, 2012

Gold Approaching Sell Target of 1650

In a WhatIf post from a week ago we were expecting a bounce in the Gold market with a sell target of around 1650. Spot bullion is now trading at 1635 with daily RSI in the 50's. We are approaching the target and Gold is no longer oversold so it would be appropriate to consider the timing of an entry. Recently the metal has been trading with a positive correlation to equities, and yesterday the S&P500 printed a new multi-month high, so we should wait for a change of sentiment in the equity market before establishing a short in Gold.

Jan 10, 2012

The Price of Credibility or Why Hildebrand Quit

The head of the Swiss National Bank Philipp Hildebrand quit his post over a USD 500,000 currency trade executed by his wife without his knowledge (see Bloomberg article). She sold CHF and bought USD just before the SNB floored the EURCHF rate at 1.20 thus profiting around  USD 50,000. It is quite clear that the trade was executed without his knowledge. Still the ethical question would have remained and could have endangered the central bank's credibility which is its most valuable asset. With credibility weakened, the Euro peg may have come under pressure by speculators and a good policy may have been ruined. The Swiss economy needs the reprieve from a constantly appreciating currency and so the objective was worthwhile. (Incidentally Japan could also benefit from a similar exchange rate regime - for that refer to a previous WhatIf post.)

Jan 9, 2012

Negative Yield on German Bills Indicates Maximum Level of Panic

Today's auction of German 6 month bills resulted in investors paying a negative yield (see Reuters article). Of course this does not make sense logically, but it has happened before - 3m US Treasury bills were in such high demand in the middle of the financial crisis in late 2008 that the winning bids were so high that yields went negative. In both cases investors are afraid to keep their money in the bank in case it goes bankrupt and would rather pay a fraction of a percentage point for the peace of mind. So either the Eurozone is coming to an end sometime very soon or the panic has reached such proportions that a bounce (in the Euro, as well as Eurozone sovereigns) is coming very soon. I would be tempted to bet on the latter.

Jan 6, 2012

China's Housing Crash is Gathering Momentum

While it is nothing new, watching this in real time is really quite instructive. Vanke is the largest mainland property developer and according to Caixin Online:
In the fourth quarter, Vanke's sales in 14 major cities dropped 45 percent by area from a year earlier, while home transactions in smaller cities also slowed down significantly 
The drop in sales of 45% is staggering! At the same time properties are exiting the construction pipeline, increasing inventories and necessitating an aggressive sales approach (read "fire sale"). Developers are already starting to offer deep discounts on new condos. Realtors are also getting desperate - one WhatIf source in Shanghai said agents would position themselves at crossroads and after waiting for the light to turn red, try to pass out leaflets to the drivers of expensive cars.

Hungary Takes the Euro Hostage, But Watch Out for Short Covering

Most people were probably unaware that lawmakers in Hungary had recently re-written its entire constitution. The new so-called Basic Law took effect Jan 1st and now has everyone up in arms. Tens of thousands protested against it in Budapest on Jan 2nd (see Reuters article) and many EU and US leaders have officially expressed concern. The controversial law appears to limit the independence of the judiciary, the media and the central bank. The concern that the central bank will have to do the government's bidding is what caused talks for an IMF bailout to break down last month and is making sovereign default a realistic possibility. The uncertainty has caused a near collapse of the domestic economy, with the Forint dropping to multi-year lows against the Euro and the most recent government bond auction requiring a yield of 2% higher than the one in December and still remaining undersubscribed.

Hungary is not even part of the Eurozone, but that has not stopped the fear of contagion from making investors dump EU government bonds and the Euro itself. The constant string of bad news coming out of the EU has made everyone nervous to the point of selling first and asking questions later - somewhat similar to the way the Asian Crisis of 1997 engulfed good and bad economies alike. This panic has taken EURUSD down to levels last seen in Sep 2010. At the same time the speculative futures positioning on the pair is at an extremely bearish level, so a short covering may be overdue.

Jan 4, 2012

US Sanctions on Iran May Backfire

On Saturday Obama signed the most recent and toughest US sanctions on Iran, effectively shutting out Iran's central bank from transactions denominated in USD (see Reuters article). Their aim is to provide Iran with an incentive to end its nuclear program but has so far only prompted Iran's navy to threaten closing the Strait of Hormuz (through which 40% of world's crude oil is transported). So far nothing out of the ordinary - politics does get boring without a little brinkmanship. What the US probably miscalculated is the internal economic collapse this has caused - Iran's currency has dropped around 30% since the sanctions were announced. This will certainly punish the regime but will also drastically affect the lives of ordinary people and provide further domestic support for the government to play tough with the US. North Korea is a good example against driving an opponent into a condition where he has nothing left to lose. The last thing anyone wants is an Iranian submarine sinking a US warship and potentially taking the conflict to the brink of an all-out war.

Jan 3, 2012

Technical Bounce in Gold To Present a Selling Opportunity

The metal has bounced from a low of 1522 reached in thin trading in the last few days of Dec. The precipitous drop from a Sep high of 1920 had taken it into oversold territory amid anecdotal evidence of large funds reducing positions into year-end. There will undoubtedly be fast money playing the bounce, but should it trade into the 1650 level this would present a good selling opportunity. The fundamentals for Gold continue to be quite negative, with the world's biggest consumer, India logging a 50%+ drop in imports in the third quarter of last year (see Reuters article). The US dollar was the first major currency to suffer from the effects of quantitative easing but will arguably also be the first to recover. Since Gold has been heavily used as a bet on the de-dollarization of the world economy, one of its main investment functions is also waning.

Jan 2, 2012

What if 2012 is the Year of the Samurai?

Forget the dragon, cards may be stacking up for Japan to outperform significantly in 2012. The Nikkei was down 17% in 2011 and in fact after peaking just over 20 years ago it is currently trading at around 20% of that all-time high (true, the component stocks and weights have changed so this is not an exact comparison). In fact for the majority of currently active investors and fund managers simply ignoring Japan has been a very successful strategy for most of their careers.

But lets take a careful look. Japan has a smoothly functioning, possibly overly harmonious, society with amazing infrastructure and a highly educated and motivated labor force. The quick recovery from the recent tsunami and nuclear disaster was no mean feat. When power shortages were looming in the summer, a modest amount of moral suasion by the government was enough for businesses and consumers to reduce consumption and mostly avoid blackouts. Japan, Inc. is alive and well.

And on a global scale the alternatives are disappearing fast. In terms of equities, US is unlikely to do anything spectacular, Europe is probably setting up for a recession, as for the BRICs its definitely time to handle with extreme care. Except for Treasury's, government bonds can be quite painful and even Gold is no longer the safe haven of years past. It is by no means a certainty, but the year of the samurai may be upon us.

Jan 1, 2012

Forget Japan - China Is Still in Treasury's Crosshairs

Much has been said in the popular press about the recent semi-annual Treasury FX report (officially Report to Congress on International Economic and Exchange Rate Policies) and how it has targetted Japan for its unilateral interventions, while again choosing not to label China a currency manipulator. See for example Reuters article. This view is not completely without merit. Indeed, when Japan last intervened in the FX markets in 2004, the Treasury described the actions purely factually without divulging an opinion. Compared to that, the current treatment does seem somewhat negative:
"...the United States did not support these interventions. It is worth noting that these operations took place at a time when foreign exchange market activity and risk aversion were being predominantly influenced by financial developments elsewhere in the global economy that were impacting all of the major currencies." (See full report)
What is important here, however, is that there has been no negative rhetoric out of Washington right after the interventions or immediately before the official publication of the report. Also the language used is still very much benign. In fact, I believe the negative mention of Japan is included to make the report appear as unbiased as possible in order to avoid giving China a chance to complain about its objectivity. And while it was not labeled a currency manipulator for political reasons (as in practice it certainly is) China and not Japan is still the main target for Washington's foreign exchange policy.