We leap straight from the nuclear chaos in Japan to a war in Libya, and even as the former shows some signs of gradually coming under control, the new crisis in North Africa is apparently only beginning. The main difference between the Japanese crisis and the Libyan War in terms of their relevance to the market is that while the Japanese shock could have easily crashed any rally, the Libyan War may be put forth as an excuse to appreciating oil prices and commodities due to the peripheral role of the country and its resources in the overall scheme of things. In other words, we do not believe that the war itself is a major threat to overall market sentiment, other factors remaining constant.
In Libya, the West has a new war after Colonel Qaddafi violated a U.N. Resolution passed one day ago by refusing to halt the assault of his army on rebel positions. Libyan airpspace is now closed to planes, and bombs of various kinds are raining down on the regime`s Army and its various facilities. The assault is apparently directed on military targets alone, and there are no plans of attacks on power plants, TV stations or other kinds of civilian infrastructure that had been commonplace during the NATO assault on Serbia more than ten years ago. This means that the military campaign is less costly than it could be in terms of public relations, and the coalition is easier to maintain, but it also means that it may be quite harder to achieve a decisive result inside Libya. One important result of this state of affairs is that the upward pressure on oil prices may be longer lasting than many traders would assume.
In Yemen, the last props of President Ali Abdallah Saleh`s government are crumbling as his own tribe calls him to step down, and a prominent general in the army defects to the rebel cause in the aftermath of bloodshed. It is unclear how many more leaders will sever their ties to the regime, what action they will take, and how high the risk of a civil war is in the country. But Yemen`s regime is agreed to be a highly corrupt, and an inefficient one even by the standards of the region, so support for it will not be very enthusiastic. Events are generating their own momentum, and with a few exceptions, risk of upheaval in Syria, Jordan, and other dictatorships in the region is rising with each passing day. This situation, in turn, should contribute to keeping gold, and oil, relatively supported for some time.
In Japan, the cost of rebuilding is expected to reach $250 billion over 5 years. Engineers are reported to have restored power to the nuclear facility but steam continued to leak from one of the reactors on Monday.
EURUSD stays above 1.41, USDJPY rallies strongly to beyond the 80 handle, while risk pairs such as the AUDUSD remain supported with a general market rally around the world. Speculators are convinced, it seems, that the nascent U.S. growth has a while to last in part because it is generated by fundamental dynamics, and in part because of the Fed`s support. We do not expect stock markets to suffer a long lasting collapse from now on, with the Fed`s clear commitment to inflating the economy, but volatility is surely to remain a major fixture of the scene for a long time to come.
The main focus of the markets remains being the Japanese nuclear issue in Asia, and the Portuguese debt problem and the Libya War in the West. Portugal`s yields are already at unsustainable levels, and there is talk of the President forming a caretaker government to pass a new budget, with the purpose of implementing austerity rules and reinforcing confidence to allow a refinancing of the June redemptions. We doubt that the President will choose this path, since the budget is a major point of contention in the political field, and an aggressive stance may well lead to a backlash from the new parliament, which could potentially complicate an already difficult situation.
Meanwhile, representatives of 40 nations from the E.U., the Arab League and NATO will be meeting in London today to discuss the future of the operations against the Libyan regime. Today news reports speak of the Colonel`s forces defeating and pushing back the rebel army from some of the coastal cities that they had gained on Sunday, but there is no sign of the initiative changing hands as the bombing campaign goes on. Statements from the U.S. side have detailed plans to use low-flying attack planes in ground attacks against the Libyan Army, and it is clear that pressure will be kept up. On the domestic front, a recent poll has shown that support for the Libyan campaign among U.S. Citizens does not exceed 48%, which is the lowest level of support for a military operation at its inception so far, and does not bode well for the president`s popularity if results are not obtained soon. If the campaign ends prematurely, oil prices could naturally see a significant correction.
In Asia, reports of higher-than-natural radiation levels have been emerging across a wide region. USA, Vietnam, Korea, and China have discovered radioactive particles in the air, but the authorities insist that the level of detection remains very low, posing no significant hazard to public health for now. The death toll in Japan has reached over 10,000 as 17,000 people remain missing, while cooling efforts at the reactors continue in spite of very high radiation readings. The latest reported leak of plutonium has compelled the government to publicly discuss plans to temporarily nationalize TEPCO, on the back of complaints that the company has not been responsible and effective enough in battling the crisis. The PM Naoto Kan has described the situation in Fukushima as "unpredictable", while Yukio Edano has characterized the same as being "very grave".
Interestingly enough, the FX market is somewhat more optimistic today than the stock market, which is performing rather poorly on a global scale. The USD is lower against most peers, but up with respect to USD JPY, which is usually a sign of improved optimism. On the other hand, gold and oil are both lower, but the downtrend does not show a lot of signs of conviction, and could reverse rapidly and easily if the factors that dampen global sentiment once again dominate news reports.
After yesterday`s important events were accounted for, markets looked to regain the bullish mood once again. The fall in U.S. home prices has not had a perceptible negative impact overseas, nor was the response in the U.S. strong enough to necessitate a reconsideration of long-term viewpoints. Perhaps traders are pleased that with the pressure on consumer net-worth exerted by falling house prices remaining in place, the Fed will be unwilling to adopt any radical measures to curtail speculative activity indirectly, or to fight inflation risk.
In the Middle East, a little bit of a stalemate is in place after the events of the past few days, and it is reported that while loyalist forces are too afraid to launch an open assault on rebels, due to Coalition airstrikes, the rebels remain too weak in terms of equipment and training to stage a major offensive against their enemies. Leaders of the Coalition against Colonel Gaddafi are worried about such a stalemate becoming entrenched, and there is increasing talk of arming the rebels coming from both sides of the Atlantic. In Syria, President Basshar Assad is expected to give a speech outlining his reform proposals, but it remains unclear how serious he is. His own supporters staged large demonstrations in support of the regime in many cities yesterday, and it looks like the rule of the Assad family is in no risk of a quick collapse anytime soon. Oil prices remain stable in response to these developments, with WTI a little lower, while Brent crude is slightly more expensive than yesterday.
In Asia, we are especially interested in reports of the new "copper as collateral" paradigm shaping the Chinese bubble, where it is reported that companies exploit latencies in supply and delivery of copper stocks in order to finance speculation. The article in the Financial Times blog is certainly worth a read for anyone curious about how the greatest bubble in the history of mankind is developing. While there is no sign yet that the game will be over soon, we believe that the PBOC and the Chinese Communist Party are committing a fatal mistake by refusing to restrain the creativity of China`s speculators more aggressively. It is especially worrying, and strange, that no precautions are being taken to prevent the diversified techniques of financial "innovators" in the country, in light of the fact that their deeds are counteracting the goverment`s tightening measures..
Stocks around the world are higher before U.S. open, while risk sentiment among currency traders is somewhat more mixed. News of an apocalyptic tone continue to come from Japan, and no end to the crisis appears to be in sight. Attention is focused on tomorrow`s NFP release, where anything less than a solidly bullish number indicating an employment gain in the 200k range will be regarded as a disappointment, although the short term price reaction remains as unpredictable as ever.
Markets have been exceedingly resilient against the disappointing releases and difficult events of the past weeks, and as such releases become rarer, traders are displaying a great deal of enthusiasm about purchasing risk. Today is a bullish day although there is nothing particularly bright in the political or financial news flow.
In Japan, "radioactive iodine-131 at a concentration of 4,385 times the maximum level permitted under law has been detected in seawater" near the Fukushima Daiichi nuclear plant today, according to the Kyodo news agency. The government is continuing to deny that the leaks constitute an immediate health hazard, but fears about the so-called recriticality are being voiced both in and outside Japan as the crisis drags on.
Elevated radiation levels have been detected as far away as Britan and Switzerland, and some radioactivity has been detected in milk in the U.S. as well, although these levels are extremely low so far and do not pose any risk to people, according to official reports. Markets appear to have shrugged off the risk of wider contamination and seem to have settled for the viewpoint that the greatest economic and political impact of the leaks will be felt in Japan itself, with negligible results for global growth.
In Libya, Colonel Gaddafi`s foreign minister, and former intelligence chief, Moussa Koussa has defected to the U.K. after taking a flight through the neighboring Tunisia. There are signs that the Libyan leader`s regime is cracking from the inside, but the military situation remains inconclusive, so markets did not react strongly to the news.
In the U.S., some focus is on the release of the list of banks that borrowed from the discount window during 2008-2009 - the most difficult days of the global financial crisis. The Fed will be releasing the identities of future borrowers after the passage of two years, in line with the Dodd-Franks Bill on banking regulation passed last year. If anything, this should make Fed officials a bit more cautious while bailing out financial firms, since from now on they may be accused of corruption and collusion of interest once the details of their past actions are made public. However, we are skeptical that the impact will be as strong as many would like.
Markets outside of the U.K. and the Eurozone were optimistic today, in anticipation of a favorable unemployment report. Most Asian markets were higher, as were gold and oil, and EUR USD appreciated while USD JPY fell. In Europe, focus remains on the uncertainties surrounding the Eurozone sovereign debt issues, the resolution of which is likely to stretch years into the future. Some concern is caused also by the ambigous position of the Irish government vis-a-vis their creditors. How much private lenders of the government will have to swallow in losses is an issue that is still haunting the Eurozone, suppressing the Euro currency even as the rest of the world retains a rather strong sentiment towards risk.
On the first trading day of 2011, markets were showing an optimistic performance, with stocks around the world ending the day higher, the dollar gaining against most of its peers, while gold rises once again above the 1410 level. Gold has been testing these levels for almost two months now, and a breakout to either direction should easily bring sustained momentum. We cannot disregard the possibility of a solid correction if the Chinese authorities signal too much pessimism about the performance of the economy, or if the Eurozone sovereign debt worries return without finding a decisive commitment from the Germans. But on the whole, the trends are being determined by the Federal Reserve and its anticipated bond purchases, which creates optimism about the global economy, boosts commodities, and of course gold too, which has its own additional reasons. For as long as the current mild atmosphere continues, we think that the present state of affairs in the markets will be maintained, and gold will continue to appreciate.
On Friday we will have the NFP release, so market focus will be on the numbers, but this piece of data is clearly not as dominant or powerful in the minds of traders as it used to be for much of the past decade. Instead, what everyone seems to be focusing on is clearly the Fed`s stance, partly because it is understood that the private sector is not in a position to create the necessary momentum in the jobs market, and partly because stock prices are nowadays driven almost entirely by inflation and risk expectations. That is not to say that growth will not pick up as well, but there is a difference between building a car factory for the middle class and building an empty city of skyscrapers in the middle of an empty desert (of which the greatest experts live in China). Both are recorded as growth, but whether they are the same kind of growth is a matter of debate. As such, NFP does not have the kind of relevance that it had when everyone believed that data and economic activity drive stock prices. The Fed is easing, and easing is good for U.S. stocks, so they appreciate.
In any case, the U.S. is performing better, having been smashed earlier in the crisis on the implosion of the real estate bubble, and the cleanup process is naturally less painful than the contraction that precedes it. Reflecting this, Bloomberg reports that investors are demanding a smaller premium to own U.S. corporate bonds than global company debt at 166 bps vs. 169 bps. for the latter. We think that this trend will continue for another reason apart from the better U.S. outlook. We believe that in the coming years home bias among speculators will increase, as the international political environment becomes difficult and cloudy, protectionism becomes the new fashion, and capital controls are introduced or tightened around the world. This is only a natural, corrective reaction to the liberalism of 1990-2008, and it probably does not signify a permanent reversal, but clearly, from a speculative point of view, it does imply that U.S. stocks will do better as the U.S. transforms itself, painfully, to a more balanced growth model with a heavier emphasis on exports.
Market sentiment was dampened yesterday by today`s large debt auctions in the Eurozone, where the weaker members of the union will be borrowing at least $43 billion. Credit default swaps rose on Ireland, Belgium, Portugal, and while the CDS index that measures that default risk of Western European governments rose to match a record yield of 228 bps. There is a strong sense of tension all around the world as the results of these events approach.
Stocks were lower in response, and in Asia, Indonesia and India were the biggest losers. India`s not being treated very kindly nowadays after the scandals that shook the country a short while ago, while Indonesia is suffering from a worrisome inflation trend in line with the rest of the region. In Europe, naturally, the falls were sharper, while U.S. markets performed reasonably well in spite of the tense atmosphere.
The dollar, naturally, gained against almost all of its peers, while oil rose on anticipation that Asian demand will remain strong. We are pessimistic on oil in the near term, and expect it to reverse course if the European problems intensify, or the Chinese aggressively continue with their rate rises. Commodities are likely to gain to some extent this year as the Fed continues its easy money policies, but perhaps the first half will not be as rosy as some seem to be expect. Gold, meanwhile, should stay on its upward track, notwithstanding the severity of its up and down swings as volatility remains high.
Today`s events are obviously of great significance. What we expect is that, while auctions will find sufficient buyers, in line with the trend of the months, rates will be higher, and money will be supplied at a high price. Regardless of the result, markets are unlikely to be convinced one way or the other, since lacklustre demand is unlikely to signify a withdrawal of borrowers, and a strong showing doesn`t imply much for the future. This makes sense, because the debt issues are long term and will not be settled by one or two auction`s results. If Ireland is shunned by creditors, however, we suspect that it will only trigger stronger European intervention, and not capitulation, as some commentators seem to expect. It is hard to see, as we like to emphasize, how they can reverse course after committing so much to the economic and political integration of the continent. And while perhaps dropping some aspect of the European Monetary Union doesn`t signify a lot from a pragmatic viewpoint, the same cannot be explained to voters in the region. All that convinces us that European politicans will only capitulate when they are absolutely out of options, but with the Fed allied to them on the other side of the ocean it is hard to see how that even sort of situation would develop.
In summary we don`t expect much to happen as long the present governments remain in place. But we still believe that the Eurozone will disintegrate at some point in some way, only with the additional qualification that this development will be the consequence of powerful political events, and not some predictable surrender to speculators and the markets.
Events Friday appeared to be dominated by the release of Q3 Chinese GDP data, which came at 9.8, above the expectation of 9.4-9.6 current in the market. Inflation is reported to have eased to 4.6% in December, but that will provide no change to the government`s assessment of the current situation, and the need for rate increases, since price pressures in the commodity market, and the domestic sector leave very little room for any delay of the necessary action. We should recall that the government`s inflation target is just 3%, way below the 4.6% just mentioned.
The expectation of Chinese tightening has battered gold prices, which were lower to as much as $1345 per ounce during the last day of the week, as oil was similarly sold, losing around 2.65% off its value in Friday`s trading. We expect the difficulties in the commodity market to continue for the first half as the Chinese need to tighten is very real. In any case, prices of some commodities like silver and oil are probably already out-of-synch with their fundamental and technical trends, so a reversal of course will not be surprising. Still, we don`t expect the Chinese to be too aggressive with their tightening, and since the Fed will keep undermining the dollar, commodity trends will survive in the longer term, barring a major catastrophe such as a disorderly breakup of the Eurozone.
In separate developments, in a speech today Hu Jintao, the Chinese President, emphasized the necessity of "U.S. respecting Chinese sovereignty over Tibet and Taiwan", warning that acting in the opposite direction would create tensions in the Asia-Pacific region. He was rather frank in his words, saying that the history of bilateral relations shows the potential for steady growth if the countries respect each other`s points of sensitivity, concluding that "otherwise our relations will suffer constant trouble or even tension".
China`s concerns about about Tibet and Taiwan are well-known, of course. The Tibet issue is probably the easier one, since, apart from the well-publicized protests of the Dalai Lama, and the occasional censure of various international bodies and U.S. Congress, there is not the remotest possibility that the Tibetans will be able to throw away the yoke imposed on them, or that the Chinese will face any significant security risks. India, which is the only relevant Asian backer of the Dalai Lama, has been trying to improve relations with the Chinese recently, and another conflict over the Aksai Chin or any Tibet-related issue seems extremely unlikely.
The Taiwan problem is an altogether different matter. We believe that the Chinese are make a mistake by playing their cards so openly, and leaving no room for doubt in their relations with the Americans. Arguably, this is born of their desire to maintain stability through an effective diplomatic deterrent, in that, if their partners and rivals are aware of what they will not be tolerating, the risk of a conflagration should be expected to be lessened. This approach makes sense from a Chinese point of view, since they see themselves as the righteous aggressors over the Taiwan issue, defending Chinese honor and power against the humiliation of the past centuries. It also means that the Chinese do not expect the Americans to make a first move, such as inciting the Taiwanese to some declaration of independence, or an equivalent action that would force them to take action in terms defined by the U.S. It is unclear how much of a risk this poses for China over the longer term.
Apart from the propaganda value of such a stance, it is hard to see what strategic benefit the PRC gains from its current stance on the Taiwan issue. The U.S. can at any moment trigger a highly predictable Chinese response by encouraging the Taiwanese leadership to be more aggressive about the independence issue, potentially creating a crisis situation in which the Chinese have little opportunity to adapt to the emerging situation. The PRC leadership is, undoubtedly very well aware of this risk, and its very buildup of forces in the region, strong concentration of naval and air forces is probably directed at giving a clear sign of how powerful its response will be in case that a Taiwan crisis emerges. President Hu`s recent comments in the U.S. emphasizing this point, are to be understood in this context, and not a sign of belligerence or hostility, in our opinion.
On the CNY issue in Washington, Democratic Representative Sander Levin of Michigan is reported to be planning to introduce a legislation as early as Monday next week, which will be reproducing the language of a similar bill passed by the House in September 2010. Hu`s response, while being questioned on it by senators, was that the problem is that "we, the China are more productive", and "have lower labor costs", according to Senator John McCain. Not very constructive, but one cannot expect Hu to say much else either. We are surprised that he was so candid with his answer.
In short, Friday was not a good day for stocks, commodities, or risky currencies, with the dollar, yen, and bonds generally being the better performers. We don`t expect this to change much in the near term, with the trigger point being signalled by Chinese rate rises, and their end marking the reinception of the previous bull trend. On U.S.-China relations, the main concern remains the currency issue, since, as both political parties are deeply out of touch with voters, it is but a matter of time that the politically lucrative, and low-cost USDCNY issue becomes too enticing a target for exploitation. In the meantime, smiles will be maintained, since big business has as big a stake in seeing the status quo continue just as the Chinese leadership does, and with so much cash to spread around, it seems that the resolution can be delayed for quite a while.
On the first trading day of 2011, markets were showing an optimistic performance, with stocks around the world ending the day higher, the dollar gaining against most of its peers, while gold rises once again above the 1410 level. Gold has been testing these levels for almost two months now, and a breakout to either direction should easily bring sustained momentum. We cannot disregard the possibility of a solid correction if the Chinese authorities signal too much pessimism about the performance of the economy, or if the Eurozone sovereign debt worries return without finding a decisive commitment from the Germans. But on the whole, the trends are being determined by the Federal Reserve and its anticipated bond purchases, which creates optimism about the global economy, boosts commodities, and of course gold too, which has its own additional reasons. For as long as the current mild atmosphere continues, we think that the present state of affairs in the markets will be maintained, and gold will continue to appreciate.
On Friday we will have the NFP release, so market focus will be on the numbers, but this piece of data is clearly not as dominant or powerful in the minds of traders as it used to be for much of the past decade. Instead, what everyone seems to be focusing on is clearly the Fed`s stance, partly because it is understood that the private sector is not in a position to create the necessary momentum in the jobs market, and partly because stock prices are nowadays driven almost entirely by inflation and risk expectations. That is not to say that growth will not pick up as well, but there is a difference between building a car factory for the middle class and building an empty city of skyscrapers in the middle of an empty desert (of which the greatest experts live in China). Both are recorded as growth, but whether they are the same kind of growth is a matter of debate. As such, NFP does not have the kind of relevance that it had when everyone believed that data and economic activity drive stock prices. The Fed is easing, and easing is good for U.S. stocks, so they appreciate.
In any case, the U.S. is performing better, having been smashed earlier in the crisis on the implosion of the real estate bubble, and the cleanup process is naturally less painful than the contraction that precedes it. Reflecting this, Bloomberg reports that investors are demanding a smaller premium to own U.S. corporate bonds than global company debt at 166 bps vs. 169 bps. for the latter. We think that this trend will continue for another reason apart from the better U.S. outlook. We believe that in the coming years home bias among speculators will increase, as the international political environment becomes difficult and cloudy, protectionism becomes the new fashion, and capital controls are introduced or tightened around the world. This is only a natural, corrective reaction to the liberalism of 1990-2008, and it probably does not signify a permanent reversal, but clearly, from a speculative point of view, it does imply that U.S. stocks will do better as the U.S. transforms itself, painfully, to a more balanced growth model with a heavier emphasis on exports.
Market sentiment was dampened yesterday by today`s large debt auctions in the Eurozone, where the weaker members of the union will be borrowing at least $43 billion. Credit default swaps rose on Ireland, Belgium, Portugal, and while the CDS index that measures that default risk of Western European governments rose to match a record yield of 228 bps. There is a strong sense of tension all around the world as the results of these events approach.
Stocks were lower in response, and in Asia, Indonesia and India were the biggest losers. India`s not being treated very kindly nowadays after the scandals that shook the country a short while ago, while Indonesia is suffering from a worrisome inflation trend in line with the rest of the region. In Europe, naturally, the falls were sharper, while U.S. markets performed reasonably well in spite of the tense atmosphere.
The dollar, naturally, gained against almost all of its peers, while oil rose on anticipation that Asian demand will remain strong. We are pessimistic on oil in the near term, and expect it to reverse course if the European problems intensify, or the Chinese aggressively continue with their rate rises. Commodities are likely to gain to some extent this year as the Fed continues its easy money policies, but perhaps the first half will not be as rosy as some seem to be expect. Gold, meanwhile, should stay on its upward track, notwithstanding the severity of its up and down swings as volatility remains high.
Today`s events are obviously of great significance. What we expect is that, while auctions will find sufficient buyers, in line with the trend of the months, rates will be higher, and money will be supplied at a high price. Regardless of the result, markets are unlikely to be convinced one way or the other, since lacklustre demand is unlikely to signify a withdrawal of borrowers, and a strong showing doesn`t imply much for the future. This makes sense, because the debt issues are long term and will not be settled by one or two auction`s results. If Ireland is shunned by creditors, however, we suspect that it will only trigger stronger European intervention, and not capitulation, as some commentators seem to expect. It is hard to see, as we like to emphasize, how they can reverse course after committing so much to the economic and political integration of the continent. And while perhaps dropping some aspect of the European Monetary Union doesn`t signify a lot from a pragmatic viewpoint, the same cannot be explained to voters in the region. All that convinces us that European politicans will only capitulate when they are absolutely out of options, but with the Fed allied to them on the other side of the ocean it is hard to see how that even sort of situation would develop.
In summary we don`t expect much to happen as long the present governments remain in place. But we still believe that the Eurozone will disintegrate at some point in some way, only with the additional qualification that this development will be the consequence of powerful political events, and not some predictable surrender to speculators and the markets.
Bourses have been doing very well today, as European stocks outperformed U.S. equities. Asia is also showing a strong performance, with Japan being the main weakness in the region. Low volumes, and lack of meaningful data has been exploited by those few who are active in the market in order to drive prices higher. Bigger actors are probably evaluating the year and keeping trade volumes to at a minimum.
Data from the U.S. continues to be positive in line with our generally U.S.-positive outlook for next year, although this does not imply that the USD is a good choice for safety and stability. The U.S., like Japan, is going through a period of recuperation and readjustment, which, by definition, does not involve radical changes and upheavals. The shocks and scandals are mostly over. The GSEs are nationalized, Madoff is in jail, investment banks are no more, government intervention is ubiquitous, the private sector is continuing to cut costs, while the consumer is cautious about risk taking, after seeing what happened to the foreclosed neighbor, or the laid-off worker. None of this is good from a growth perspective of course, but slumber is better than panic or intoxication, two states between which the rest of the world seems to oscillate as a great deal of effort is made to place events and actors into context.
In many ways, the U.S. is benefiting and will benefit from being the first to suffer the consequences of the global speculative bubble that developed, in large part, after the goobal interest rate cuts at the beginning of the century. Yet there can be no doubt that no nation will be isolated from the consequences. Imbalances are not troublesome for those in deficit, they are also troubling for lenders, as the spate of foreclosures in the U.S. has demonstrated to great effect.
No one has ever thought that big banks would be fine while borrowers defaulted just because they happened to be on the opposite side of the mortgage transactions. What would convince us, then, that just because China and the Asians are creditors, they will fare better than the borrowers in the Western World. If Citibank or Bank of America suffer when homeowners default, why do we believe that the Chinese will be fine, when they are the real lenders, after all, to cause all the massive bubbles and balloons on this side of the ocean?
The Chinese can no longer inflate America and its markets in order to create demand like they did in the past, so the wise government there is now applying its addictive medicine to its own economy in order to create the same fake demand that all but destroyed the U.S. economy during 2007Q3-2009Q1. Just like most speculators were blind to the mortage bubble back then, they are blind to the domestic Chinese bubble now, believing that, because the Chinese have huge cash reserves and a strong export sector, they can weather any storm. This argument is in fact very similar to that advanced in defence of Merril Lynch, Lehman Bros, and others, when they had almost incredible profits during the boom years. Yet those profits did not prove sufficient to save them from bankruptcy, because of the crucial term, "leverage". And so, what makes us believe that the Chinese will be able escape the cataclysmic consequences of their own bubble blowing, once their gigantic edifice of leverage and monetary inflation collapses, as it inevitably will?
The developing world story is a real story, and in spite of all the risks, the gains that have been made over the past two decades are real and will lead to a real convergence in performance around the world. We are convinced that the days when certain parts of the world were permanently backword are over for now. The immense improvement in communication technologies, the widespread availability of information at all levels has accelerated the pace at which knowledge is shared around the globe, and, as most people believe, permanently improved the growth capacity of the world as a whole. But none of this excludes the possibility that bubbles will develop, and none of it implies in any way that people, investors, or voters have become any wiser. All that it means is that they have become more similar, and their actions and choices are easier to analyze with a single set of data that is applicable to very different geographies and cultures. The fact that few nations, perhaps with the exclusion of sub-Saharan Africa, for now, will be left behind in technological and scientific advancement of the human race does not mean that the human race as a whole cannot go through difficult and turbulent phases. Indeed, the basic law of oscillations makes us think that the more momentous the upward swings are, the more momentous the downward movements will be.
These facts remain facts as long as the global economy is run by people who are delighted to see citizens enjoy the fruits of temporary bubbles and dreams. Emotional approaches towards economic issues is bound to yield disastrous consequences, as history has shown us time and again, but let`s allow our hearts the freedom to have more hope these days, as the year approaches its end.
Gold is continuing to fluctuate in the 1380-1390 area, while oil is rising in line with stock market sentiment. Although equities have run out of steam today, December has been a very good month on the whole, and the weakness of the day doesn`t have a lot of significance even in the context of the week.
Oil, in particular, seems to have found a strong basis justified by the uncertainties surrounding the global supply-demand picture, as well as the political tensions in the Middle East. What we understand from the Israeli`s Stuxnet operation is that they do not see inaction as an option, even though they are prepared to be creative in order to protect their somewhat lukewarm relationship with Washington under the Obama administration from further damage. They have bought some time by delaying t Iran`s nuclear enrichment program through highly creative means, while the sanctions contribute to the slowdown by reducing the regime`s field of maneuver. But none of these is a permanent solution, and sooner or later, barring a regime change, or perhaps a gigantic step forward in the Israeli-Palestinian peace process, the Israelis will have to confront the danger of a fully nuclear Iran, which, in fact we believe that they will refuse to accept and will respond to by resorting to some form of aggression in the end.
Naturally such prospects place a floor under the long-term price movements of the commodity. At the same time movements in the commodity complex are going to be dependent on the short term trends of the USD index for direction, and in that context, risk perceptions, and expectations of QE by the Federal Reserve are of paramount value. Our final assessment is that until the Chinese go bust, commodity prices will continue to move higher, and while the European situation may continue to create a lot of volatility now and then, prices are unlikely to be checked meaningfully as the whole world races to devalue national currencies in a shrinking global market.
The favorable outlook for commodities as an asset class is only slightly dependent on the role of supply-demand dynamics. Commentators like to stress that the tight supply of many different industrial goods and raw material is driving prices higher, but the very demand that is creating the tight supply situation is essentially dependent on the flow of credit from advanced nations, and their large speculators and investors, who are, ironically, the buyers of commodity futures on the notion that rising demand will stress the supply side. The argument seems circular in many ways, and we believe that it is contradictory in essence. The opinions advanced in defense of the multiple bubbles in this sector are lacking in logical basis, and are only being listened to because the opposite case is neither pretty nor constructive for the long-term outlook. The idea that the authorities are building up bubbles of a size which will probably dwarf the subprime bubble once they explode, and is not very pleasant to listen to.
Gold is a commodity as well, and it is difficult it to expect to survive a lasting commodity crash when it does happen. Still, it could survive for a couple of quarters as speculators anticipate the total breakdown of the world`s financial structures, with trust in governments, politics, and trade partnerships rapidly evaporating. One can conceive of a situation in which the worst case scenario materializes and we see gold skyrocketing to extreme levels, but the more moderate, and still severely damaging outcome where a rapid readjustment of imbalances leads to cash squeezes, price controls, imposition of tariffs seems a lot more likelier. In this case, prices would be quickly targeted by international bodies and large owners of the metal in order to undermine trust in the metal, and to boost the profile of central bank issuances. Coupled with meaningful rises in interest rates, this would mean the end of the bull trend for gold, coinciding with a precipitous collapse of the global growth rate. But arguably, even that is less costly and dangerous than the wholesale breakdown of trust on an international basis.
For 2011, though, we suspect the main theme will be the Eurozone where authorities are committed to keeping their heads in the sand as long as an imminent default is not being expected by the markets. With elections, loan repayments, restructurings, and rating downgrades in store for much of the year, stocks and the Euro will have to battle a constant barrage of difficult news from the region if they manage to end the year in the black. That is possible, if only because of the Fed denying freedom of trade to one type of point of view makes it totally unwise to bet on a nominal fall in stock prices for quite a while. We know little about what will happen China or Korea, or the Eurozone, and the ECB`s future course is open to debate. But with the Fed, matters are simpler, and as long as the sovereign credit rating of the U.S. is not being questioned, the present posture is going to be maintained. That, naturally, means that the USD will remain under pressure during any selection of a one year period on the charts...
