October 24, 2009

Market Insights - 24 October 2009

Dear Friends & Fellow Investors

Here is our new issue of market insights.
In case of questions, please email: .  Enjoy reading!

In This Week's Issue
▪   Weekly Snapshot
▪   Chart Of The Week
▪   A New Bubble? 
▪   More On The US Dollar 
▪   More On Gold 
▪   Qualifications Of A Regulator

Weekly Snapshot
• US existing home sales jumped 9.2% to 5.57 million units in September (Briefing.com)
• China was Brazil's largest trading partner in the first nine months of 2009 (Economy.com)
• German business climate index rose to 91.9 in October, a 13-month high (Economy.com)
• US federal-tax receipts down 16.6% since Sep '08; 54.6% decline in corporate tax receipts (Economist)
• China's annual GDP growth at 8.9% percent in the third quarter (Forbes)
• Euro area and EU27 government deficit at 2.0% and 2.3% of GDP respectively (Eurostat)
• US Leading Economic Index up 1% in September, after a 0.4% gain in August (Conference Board)
• U.S. government announced a record $123 billion worth of bond auctions next week (Reuters)
• Oil prices reached $82 on Wednesday, new high for 2009 (eSignal)
• US Housing starts in September rose 0.5%, following a revised 1.0% decline in August (Bloomberg)
• Brazil imposed a 2% tax on foreign purchases of equities and bonds (FT)
• US Producer Price Index declined 0.6% in September (BLS.gov)

Chart Of The Week 
Crude oil prices touched $82 earlier this week.  One apparent reason was the continued Dollar weakness.  Something slightly less talked about however, is the huge spike in Chinese oil consumption since the beginning of ‘09.  The increased demand at then depressed oil prices was a significant factor behind the run on oil so far this year.  The three charts below also give a hint of of times ahead when Chinese oil consumption may rival that of Europe and the US.


Source: http://europe.theoildrum.com/node/5896#more

A New Bubble?
With oil prices at new yearly highs, stock markets back at dangerously high valuations, Gold and other commodities at all-time record levels, some begin to question whether these are signs of yet another bubble.  Please consider:  Recognizing a Bubble – Dynamics of Free Money by Axel Merck.

In his assessment of the economy, Axel Merck outlines some of the options available to the Fed:

• Consumers could try to earn more money (or spend less) to pay off their debt. While some of that will happen, real wages are unlikely to go up on a national level as the unemployment rate continues to rise and consumer spending, the largest driver of economic growth, remains lackluster.

• Consumers could downsize. Indeed that’s the most prudent path as it would allow consumers to build up savings to one day afford a bigger house again. Politically, that’s not an attractive choice as it involves bankruptcies, bank losses etc., not the type of thing to promote if you want to get re-elected. Instead, consumers become slaves of their homes as they receive subsidies: such consumers are unlikely to build up savings, or even a rainy day fund to fix the leaking roof.

• The third option is for the Fed to induce inflation, so that the price level of homes rises, bailing out those with debt. Fed Chair Bernanke has testified that a key reason the U.S. pulled out of the Great Depression was to go off the gold standard “to allow the price level to rise to the pre-1929 level.” Gee – if someone takes away half your net worth (purchasing power), you will have a greater incentive to work, leading to top line economic growth. Those countries that devalued their currencies during the Great Depression recovered faster. Destroying purchasing power isn’t exactly the mandate of the Fed, but in Bernanke’s mind may be effective in promoting employment and economic growth.

This third option is a fairly accurate  description of what we have seen in recent months.  While the inflation argument has not convinced some economists, the recent sell-off in the dollar, combined with the run-up to higher commodity prices shows what the market expects.   No central banker and certainly no politician would ever admit to it,  but higher inflation can also be an antidote towards the massive debt burden faced by the US government (history lesson: Weimar Republic).  As long as central bankers can convince US investors and foreign holders of US debt that inflation is near zero, they can keep their financing cost at a minimum while being able to “water-down” the debt burden over time.

Whether you believe in the next bubble or not, there are some caveats that a recovery may not be as strong and as permanent as some bull market supporters might suggest.  Please consider:  Nouriel's Reasons for an anemic recovery.  Nouriel Roubini believes that the recovery will be anemic at best. In his usual dry and no-nonsense manner,  he gives a very concise outline as to why there is reason to be cautious.

1.  The labor market still bad and worsening
2.  The US consumer is "shopped out" - has to save more and consume less
3.  A glut of capacity in the corporate sector will keep capex spending subdued
4.  The financial system is damaged; credit growth will be limited
5.  Fiscal stimulus will become a drag by 2010
6.  On a global basis, the US will spend less while China, Germany and Japan will not increase private domestic consumption to compensate for the fall in US demand

More On The US Dollar
US Dollar bears controlled the sentiment in Foreign Exchange markets again this week.  Euro, Australian $ and New Zealand $ made new highs for the year.  Aside from being extremely oversold, there was not much standing in the way of the Dollar shorts.  Meanwhile, the US$ Index touched a new low for the year at  74.94. 


As of this week, there were still not too many supporters of the greenback.  If one was to enter a trade simply on a contrarian basis, proper stop levels should be placed to have some down-side insurance.  As several currencies are close to their all-time highs against the US Dollar, market volatility should remain high.   Day-traders beware!

More on Gold  
As the list of US Dollar supporters appears to be fading, Gold seems to be the favored asset to provide some hedge against a possible dilution in the value of the greenback.  Gold reached an all-time high above $1,070 last week and it remained stubbornly high closing this week at $1,055.   One may consider owning gold as an asset in its own right particularly in times of crises.  Some suggest a certain percentage of Gold holdings  simply as an insurance; depending on who you talk to, they suggest anywhere between 5%-20%.    If Gold is then considered an insurance policy, it also means that long-term returns may not be the primary reason to buy Gold.  The often underestimated cost of holding Gold can indeed equal the cost of various insurance programs. Please consider the video below for additional views on Gold.

Meanwhile, the US government shows no signs to counter the trend of debasing its currency but one still needs to be careful in terms of holding gold for the long term and as a pure hedge against inflation.  This is more obvious for holders of currencies other than US Dollars.  The charts below show the Gold price from the perspective of holders of other currencies e.g. Euros and Australian Dollars.

Gold Prices-12 months

When converting the Gold price to these currencies, the rise in the value of Gold is no longer as significant.   The official Gold price rose from $722 to $1,055 in the past 12 months, returning a 46% gain.  However, a holder of Euros had only a 26% gain while a holder of Australian Dollars saw a mere 7% rise in the precious metal during the same period.  The discrepancy has become more obvious since the beginning of this year. 

Gold Prices-ytd

The nominal gold price in US$ terms rose about 20% while the precious metal only increased 12% for Euro holders; but it also never peaked above the previous high in early February.  More significantly though, the Gold price fell 8% in Australian $ terms and it dropped a stunning 26% since the peak in mid-February. 

One could argue that all this is due to the weakness of the US Dollar but that debate may easily turn into a “chicken and egg” discussion.  Ultimately, one needs to decide a) if the assessment by the majority of market participants, i.e. that the US will continue to debase its currency, is correct and b) what possible hedges and investment strategies should be undertaken to support this view.  Gold would be one of those options but as we demonstrated above, currencies might be an equally attractive alternative with the same risk profile albeit at effectively no holding cost.   The decision is perhaps equally vital for US investors as well as holders of US denominated assets.  On a personal level, I would agree with Axel Merck’s dynamics of free money.  I typically favor investments in currencies over Gold or other asset classes because that is where I feel “comfortable with the dynamics”.

Qualifications Of A Regulator
What makes a 29 year old qualified to run the SEC enforcement division’s operations?  Look towards Goldman Sachs for an answer.  Bloomberg reported, Adam Storch was appointed to be the enforcement division’s first chief operating officer. 

Before and during the credit crisis, regulators were considered asleep at the wheel.  Now that yet another ex-Goldman employee is in charge of a crucial position at a government agency, can we have a sense that enforcement of rules would be any better than before?  Age and sufficient hands-on financial markets experience aside, how confident can the public be that Mr. Storch would be unequivocally objective if he was to enforce those rules upon his ex-employers?

And, in case you are still not angry about Banks and Financial Institutions, read this rather interesting Blog from Mike Shedlock and you might on the way...

From Mish’s Global Economic Trend Analysis: Where The Hell Is The Outrage? 


Good luck & good trading!

Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

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