FXIS Market Insights

Weekly Snapshot
• California struggling to close a $24.3 billion budget gap
• Moody's is considering a downgrade of California's credit rating
• Oil futures closed the week under $70
• Obama calls for a new Consumer Financial Protection Agency
• US index of leading economic indicators jumped 1.2 percent in May
• US consumer price index for May is up 0.1%
• MySpace laid off 30% of its US work force
• US current-account deficit dropped to $101.5 billion - lowest level since 2001
• FedEx posted a $866bn quarterly loss - CEO says worst of the economic downturn is over
• International Energy Agency (IEA) warns about further oil price hikes and inflation
• ECB predicts that European banks will have to write off up to $283bn for 2009/2010
• G8 Finance Ministers cautiously optimistic that worst is over

Market Developments
The markets were relatively quiet this week; treasury yields retraced somewhat from this year’s highs and stocks also fell again from the recent highs. Two week's ago, we pointed out that the S&P500 broke through the 200 day moving average, a generally bullish signal. But there was no conclusive follow through since and the index continued to hover around just slightly above the moving average (blue line). The big question now is: What comes first - S&P 500 hitting 1000 or 800? That would give some clues as to whether the US benchmark prices in a V-shaped or W-shaped recovery.


While the financial markets were tagging along, there were some other interesting developments this week. Please consider the following, possibly benign events, but in my opinion rather significant in terms of indicating a "New Normal":

Bourses in Brazil and HK leap up global rankings
http://www.ft.com/cms/s/a16e7520-5944-11de-80b3-00144feabdc0,dwp_uuid=ebe33f66-57aa-11dc-8c65-0000779fd2ac,print=yes.html

Who would have thought, Stock exchanges in Brazil and Hong Kong ever to overtake US or European exchanges... Granted, the metrics used here may not be as significant and particularly the Brazilian markets are nowhere near as deep and as liquid as the US or European markets. However, the fact that by some measure these developing countries are more than just catching up could be a sign post of things to come. In a previous newsletter I pointed out that China now holds the top 3 spots in terms of market capitalization of the largest financial institutions. By contrast, America’s largest bank, JP Morgan Chase, is merely in 5th place (Market Insights 28 March 09). Yet another sign post of small shifts was an agreement between China and Brazil to use their own currencies rather than the US$ for bilateral trades (Market Insights - 23 May 2009). I am certain we will come across more and bigger sign posts of a new global order and a shift in terms of economic powers to be.

Dollar's role may shrink in multi-currency global regime
http://www.ft.com/cms/s/0/14ddd5c6-5b9f-11de-be3f-00144feabdc0.html

This is important in terms of taking a long-term view and how the portfolio of an international investor might need to be adjusted. If we assume that the estimate in this article is correct and about $5,000bn (70%) of total Central banks' international reserves are held in dollars then there is of course a huge asset concentration in one currency, something a diversified investor tries to avoid to mitigate risk. This was not such a big issue 20 or 30 years ago; but just within this decade for instance, Chinese FX reserves have grown more than ten-fold. Knowing that the majority of their holdings are in US$, this indeed represents an asset concentration risk for them. A similar situation exists for other members of the BRIC countries who have all been accumulating massive US$ reserves in the past decade. Recently, Chinese, Russian and other G20 member officials have been indicating a concern about the US debt level and a possible devaluation of their own US$ holdings. As an international investor, I would keep a close watch on the currency holdings of some of these Central Banks. A look at the proportionate holdings in their currency basket might be a good benchmark for developing your own currency portfolio allocation. I would not be surprised if one day we will see an ETF tracking these baskets of currencies.

ATM dispenses with cash to put gold in pocket
http://www.ft.com/cms/s/0/1e36a664-5ad4-11de-8c14-00144feabdc0.html

Hard to believe but apparently true, a German company is planning to install 500 gold vending machines in airports and railway stations across the country. This event is along similar lines of the "Gold Parties" which have been reported earlier on this year indicating a growing demand in the retail market. There were some stories floating around online and one Blogger in particular noted: "Surely this marks the top in gold?" - http://macro-man.blogspot.com/ It remains to be seen whether this type of development has any significance in the price determination of Gold. The surge in retail demand has been strong but we have seen previous runs on asset classes wearing off. Even though the phenomenon of Gold Parties did not coincide with a fall in Gold prices (yet), I would still caution buying retail gold as a viable investment for small investors. Certainly, paying a premium of 30% over the current market price cannot be helpful in hoping to achieve returns and/or providing some form of inflation hedge.

New York broker moves to sell Iraqi securities
http://www.ft.com/cms/s/0/8803f8b2-5944-11de-80b3-00144feabdc0.html

This is an Interesting development, considering the images and headlines of killings, bombings, and other acts of violence coming from this country still at war. Without being political here, it is important to note that the mere fact of a developing financial market has the underpinnings of business going back to normal and hopefully a life with much less violence.

Hold on tight for a bumpy ride to the 'new normal'
http://www.ft.com/cms/s/0/f38a596c-5a0e-11de-b687-00144feabdc0.html

Mohammad El-Erian raises four important questions of how economic and market developments may be affected going forward. While I agree that these are important questions to ask, I wonder how much credo can be given to "The drivers of more government involvement in markets are primarily non-commercial." Maybe I'm somewhat cynical here, but did we ever find out what the rationale was to let Lehman Brothers fail while bailing out Bear Sterns? Why are some too big to fail and others aren't? A group of high level decision makers must have positions on either side of the political debate and I cannot believe that the objectives are entirely for the greater common good. Once a government is a big stakeholder in a company, how can an objective and non-partisan investor believe that the financial landscape will be a level playing field? What will be the criteria and who will decide as to when and how the government stakeholders will exit? Financial and commercial considerations, among many others of course, must ultimately play a big role here.

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Good luck & good trading!