FXIS Market Insights

Dear Friends & Fellow Investors

Here is the latest issue of market insights.  We are taking a break in November but will be back with a new issue by mid-November.  For any questions, please email: .  Enjoy reading!

In This Week's Issue
▪   Weekly Snapshot
▪   Chart Of The Week
▪   Thoughts On The Economy 
▪   Real Estate 101 
▪   More On Property
▪   More Jobs
▪   The Dollar Isn't Doomed
▪   Happy Halloween

Weekly Snapshot
• Average US Retail gas price at $2.70 per gallon, highest in a year (AP)
• Euro area unemployment up to 9.7% (Eurostat)
• US consumer sentiment index for October slipped to 70.6 from 73.5 in September (Reuters)
• US GDP increased at an annual rate of 3.5% in the third quarter of 2009 (ESA)
• Norway first European country to raise interest rates since financial crisis (FT)
• Britain’s economy contracted by 0.4% in the third quarter of 2009 (Economist)
• US New home sales in September 2009 declined 3.6% from August, to 402,000 (ESA)
• US durable goods in September increased 1.0%, to $165.7 billion (ESA)
• A maximum Euro/US$ rate of $1.55 is a critical pain threshold for German exporters (FT Deutschland)
• ING Bank agreed to EU demands to sell its insurance units to secure approval for its bailout (Bloomberg)
• US consumer confidence at 47.7 (1985=100), down from 53.4 in September (Conference Board)
• Home prices rise for the third straight month in August (AP)

Chart Of The Week  
A good overview of consumer confidence in various countries.

Source: http://blog.nielsen.com/

Thoughts on the Economy
US Equities rallied on Thursday after the announcement that GDP grew 3.5% in the third quarter.  So much for the worst recession since the Great Depression - or is it?

Friday came around taking back all the gains and more as the market apparently wasn't buying it quite yet.  After the initial cheers on Thursday the mood was dampened by another decrease in consumer sentiment.  But investors also realized that much of the GDP gains came from the cash-for-clunkers program (car buying incentive), the $8,000 tax credit for new home buyers and obviously the bulk of the 12 figure stimulus package to support the financial and banking industry. With this much stimulus pouring into the economy, no surprise that it is showing some upside now.  Remember, this is no longer a free-market economy but much closer to a control economy that has stimulus levers written all over.

While the majority of economists probably agree that the worst is over the debate has now changed to the question of the shape of the recovery.  Is it a V or a U shape? I would leave that debate to the economists and instead examine some of the concepts of the stimulus efforts. 

Let's assume for a moment that everyone agrees on the need for stimulus and let's also assume that the amounts of stimulus are agreed upon.  What remains is simply where to put stimulus to work. In terms of the stimulus efforts by the US government, I have a conceptual problem with the idea that a recovery should be based on housing.  Haven't we learned that the concept of a home as an ATM machine is flawed?  Instead, any sustainable recovery should come from efforts to create more jobs by giving incentives for productive capacity.  Innovation must be a driver and efforts to improve education, specifically in areas of sciences, would make sense.  If the US wants an educated work force, the country must promote educational efforts domestically.  Exporting education, technology and business intelligence overseas or worse even, outsourcing all the above is not the answer. 

In terms of housing, one must understand that, aside from the utility of owning a home for shelter, the house itself (not the land) is actually a depreciating asset, much like a car.  A house is prone to entropy and needs to be maintained; otherwise it falls apart.  Any home owner should know that.  If more people buy depreciating assets, how should that lead to sustainable economic growth? 

Real Estate 101
One may not agree with some of Peter Schiff's political views or some of his controversial predictions but he has a cunning ability to put clarity into some foggy financial concepts. Your realtor friends may hate you after you viewed this, but it's an important reminder of the basic concepts of real estate.  Enjoy!

More On Property  
With Peter Schiff's video in mind, property prices may not be quite as relevant any longer.  But let's examine the chart below anyway and just consider housing prices from a simple perspective of potentially matching inflation.  To assess whether the current home prices are sensible from the perspective of matching inflation, you can use this Inflation Calculator.

A general price level of 100 in the year 2000 would result in a price of 125.42 in 2009 if accounted for inflation.  On that basis, housing prices are still doing well outperforming inflation by about 20% or about 2.2% annually.  We have not assessed how that compares within a longer historical perspective, but should one not consider that housing prices could potentially fall another 20% to then be in line with inflation?  On that basis, how can lenders including government entities like the Federal Housing Authority fathom that a 3% down payment is sufficient to account for potential downside risk?

More Jobs  
The economic outlook has improved, global stock markets have come back and emerging markets have been leading the way towards a recovery, although the shape of which is still up for grabs.  Any sustainable recovery however, particularly in consumer driven economies like the US, must be on the back of job growth.  As the chart below illustrates, many countries still have a long way to go.

The Euro area (EA16) consists of Belgium, Germany, Ireland, Greece, Spain, France, Italy, Cyprus, Luxembourg, Malta, the Netherlands, Austria, Portugal, Slovenia, Slovakia and Finland.  The EU27 includes Belgium (BE), Bulgaria (BG), the Czech Republic (CZ), Denmark (DK), Germany (DE), Estonia (EE), Ireland (IE), Greece (EL), Spain (ES), France (FR), Italy (IT), Cyprus (CY), Latvia (LV), Lithuania (LT), Luxembourg (LU), Hungary (HU), Malta (MT), the Netherlands (NL), Austria (AT), Poland (PL), Portugal (PT), Romania (RO), Slovenia (SI), Slovakia (SK), Finland (FI), Sweden (SE) and the United Kingdom (UK).

The Dollar Isn't Doomed  
Martin Wolf, the chief economics commentator at The Financial Times, has been in the business of assessing global economic trends for several decades and he is one of the most highly respected economic journalists.  It is with a typical sense of British understatement that he assess some of the claims of the Dollar falling to zero.  And yet, as he suggests with a rather assertive "BUT", the Dollar value has been influenced by 1) a reversal of the trend towards the illusive flight to safety and 2) the fact that the US$ is a long-term decline that has begun in 2000 (Ed. Note: some consider the long-term decline to have started in the early 70's when Bretton Woods was abandoned and currency exchange rates were allowed to freely float). 

So the Dollar won't fall to zero, we can all relax now; and yet, as long as the interest rate differential between the US and other countries still ends itself to carry trades, as we discussed at length, the pressure on the US Dollar remains despite temporary respites.  Only when US rates will climb would there be a possibility of big demand pull for the Dollar.  Please consider the full interview with some very insightful views by this highly respected market commentator.

Happy Halloween
Just in time for Halloween, please consider Midnight Candles, a seriously spooky investment outlook by Pimco's Bill Gross.

Happy Halloween!

Disclaimer
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.

The Chicago Mercantile Exchange (CME) announced that it will offer options contracts to manage exposure to snowfall.  The contracts will be available on 7 December ‘09 for the following snowfall locations:

New York LaGuardia Airport
Chicago O'Hare International Airport
Minneapolis/St. Paul Airport
Detroit Metro Airport
New York Central Park
Boston Logan International Airport

This may seem strange  to some but we would consider this a welcome development.  In fact, it has been the CME’s noted strategy to offer more non-financial futures and options contracts. By bringing these derivatives onto the exchange rather than having the contracts written directly by investment banks the investing public should regain some confidence that in the event of another crisis, their contracts and hence their exposure can actually be guaranteed.

Even a decade prior to last year’s credit crisis, companies like Enron were notoriously exposed to off-exchange derivatives by making markets in all sorts of contracts including weather futures.  In the absence of an exchange that can handle the settlement and counter-party risk, investors and institutions entering into these contracts incur much greater risks of default by their underwriters.  There is a downside to bringing this contracts onto the exchange.   Exchange listed contracts have to be standardized and may not be ideally suited for the needs of some investors.  However, with exotic products such as weather futures, one would think that less flexibility as opposed to potential default risk may be the lesser of two evils.

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.

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. 

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!

Disclaimer
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.

US Dollar bears controlled the sentiment in Foreign Exchange markets today.  Euro, Australian $ and New Zealand $ made new highs for the year.  Aside from being extremely oversold, there is not much standing in the way of further Dollar shorts.  Australian $ is now only about 6 cents away from its all-time high against the US$ established last summer.  New Zealand $ is in exactly the same position fast approaching it’s previous all-time high.  On the back of continued US$ weakness, oil prices touched $82 today.

Meanwhile, the US$ Index touched a new low for the year at  74.94. 

Oil prices went above $80 a barrel today, a new high for the year.  Meanwhile US producer prices declined by 0.6% in September. 

Speaking of of hot commodities, a commodity driven currency, the Brazilian Real may have seen the first set of measures intended to slow down a further rise in the currency.   Starting today, the Brazilian  government imposes a 2% tax on money entering the country to invest in equities and fixed income instruments.  

On first glance, this appears to be an effective deterrent which may slow down the rise of Brazil’s currency.  Indeed, the Brazilian Real fell about 3% today and Brazil’s benchmark stock index fell over 8% on the news. 

However, one would imagine that in view of limited alternatives in terms of high yielding assets, smart money might just find ways to circumvent the measure through direct foreign investment or other investments in underlying assets.   One note of caution though: The new measure makes investing in Brazil very much like investing in a hedge fund and extra care has to be taken as to possible implications by this tax.  Investing in hedge funds bears additional risks. In addition, the higher effective cost right from the start should make investors think twice before entering into such investments, no matter how lucrative returns may be from the outset.

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. 

Hmm, let us give this some thought:

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 very 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?

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
▪   More On The US Dollar
▪   Higher Returns Elsewhere 
▪   FHA Loans Return To 0% Down 
▪   Back To Record Earnings 
▪   Fed Up With Banks

Weekly Snapshot
• Australian $ and New Zealand $ reach new 14 month high against US$ (eSignal)
• Crude Oil closed above $79 on Friday, highest level since October 2008 (Reuters)
• Euro area annual inflation down to -0.3% (Eurostat)
• US industrial production rose 0.7% in September (Economy.com)
• US consumer sentiment for October fell to 69.4, from September's 73.5 (Reuters)
• Gold hit new all-time high on Wednesday @ 1,070.50 (eSignal)
• US Consumer Price Index rose 0.2% in September (BLS.gov)
• US Jobless claims show 5th drop in 6 weeks (AP)
• The Fed kept interest rates near zero, disagreement on inflation among board members (MarketWatch)
• The Finnish government made broadband Internet access a guaranteed legal right of its citizens (PC World)
• US retail sales fell 1.5% in September but rose 0.5% excluding autos (Economy.com)
• Industrial production up by 0.9% in Euro area (Eurostat)

Chart Of The Week 
Most major market indices had a strong recovery since last October.  Emerging markets outperformed US and European markets in multiples.  From an international perspective, investment returns in US stocks were not all that impressive.  After accounting for the decrease in the value of the US$, net average returns were only about 6% for foreign investors in US stocks.

More On The US Dollar
Although regaining some ground in late trading on Friday, the US Dollar was again under pressure this week.  Australian $ and New Zealand $ were among the strongest currencies against the US Dollar as more and more investors shunned the greenback.  This week’s FOMC meeting resulted in no change in terms of the expected interest rate policy of the Federal Reserve Bank.  As the minutes of the board meeting revealed, there was some disagreement on inflation among the board members.  With practically everyone raising concerns about the future of the US Dollar, we could find one rare supporter in Mike (Mish) Shedlock who suggested that the only 3% of all traders are in support of the Dollar.  As a fervent deflationist, he argues that we are still in a period of credit stress and in his view, deflation is currently still a bigger threat than inflation.  He also takes the extremely bearish US$ sentiment as a signal to “temporarily” take the other side of the trade.

From a trading perspective, this “temporary” bullish Dollar position may be plausible.  However, it is a rather risky strategy particularly if one were to take leveraged positions e.g. via futures contracts.   Timing is everything and for a trader to go against the general trend can be profitable by taking quick trades in and out of the market.  I do not suggest these strategies for an average investor however.  It is also interesting to note that his “temporarily” taking a bullish US Dollar position suggests that he too would agree on a longer term depreciation of the US$. 

Unlike Mish, I believe it is questionable whether the US stock market and the Dollar will continue to be this negatively correlated.  Historically, there is no clear relationship of US$ versus US stocks. If indeed government stimulus was withdrawn, or if the stock market were to fall simply because of the poor underlying economic conditions, I can see little reason why this would be positive for the US Dollar.  As the graph below depicts, institutions and foreign investors have been increasingly crowding out private households in terms of share ownership.  If expectations of returns in US equities were to diminish one could make an even stronger case for institutions and foreign investors to get abandon the US Dollar and to seek higher returns elsewhere.

Source: www.ft.com

Higher Returns Elsewhere 
We discussed the notion of a carry trade before.  A carry trade is a strategy not commonly known by average investors but it has been a favored play among the institutional traders.  The Financial Times has an easy-to-understand visual guide explaining the basics of a carry trade. 

Click on graph to view the presentation

As long as US$ deposit rates are still practically zero it continues to put pressure on the US Dollar by enabling institutions to borrow in US$ converting them to e.g. Australian $ or New Zealand $ and enjoying gains from the interest rate differential.  As long as the US$ remains weak, this strategy will be one of the favorites among the smart money traders.  Oh, and in case you wondered where Goldman Sachs, JP Morgan et al. made their record earnings this quarter, look to strategies like carry trades, further enabled by the US government by allowing these institutions to borrow at 0% and investing them in higher yielding assets, including foreign currencies.  Still amazed why banks aren’t lending to US consumers and businesses?

FHA Loans Return To 0% Down
Please consider the recent Business Week article: FHA Loans: Return to 0% Down

Having just learned that the FHA is back to providing basically zero down mortgages again, I am flabbergasted.  Henry Blodget of Yahoo!techticker put it best by coining a new term:  “Be Glad To Help You Screw Yourself” Mortgages.  To think that this is all done under the watchful eye of our government...

Back To Record Earnings 
Please consider the Wall Street Journal report: Let the Good Times Roll, Again

It is difficult not to feel empathy for the growing public outrage over compensation at financial institutions.  The Wall Street Journal estimates that $140bn will be allocated towards employee compensation in 2009.   Transparency, often advocated by politicians and regulators, may have tilted public opinion in favor of something closer to an understanding of why financial executives are being compensated at the expense and at the risk of tax-payer funds.  But the scale and complexity of various compensation packages remains a mystery to most of us.  So here goes one example then: The graph below depicts the projected compensation of financial institutions as a percentage of revenue.  Topping the list is Blackstone, a private equity group, with stunning results compensating their own with almost 4 times the projected revenue.

Data Sources: WSJ, the companies, Thomson Reuters

Blackstone and a few other firms were not on the list of TARP fund recipients.  As long as they operate within the legal framework of a free capitalist system and entirely at their own risk, public outrage would be relatively tame.  However, at a time when the real economy is still in limbo, jobs are at the worst in decades and a recovery in the real economy is not yet in sight, any notion of excessive bonus packages would naturally anger the public.  How can banks get away with it?  Because they can...

Fed Up With Banks 
The outrage over banks’ bonuses continues and understandably so.  Elizabeth Warren, chair of the Congressional Oversight Panel,  gives her analysis of the status quo one year after the biggest financial crisis since the Great Depression.  To sum up what has changed since last October:

The large Banks today are even “Too Bigger to Fail”.
Toxic Assets, which were supposed to be removed by TARP, "are still there by and large."
Current economic situation is worse than the “worst-case scenario” in the stress tests conducted.

Enjoy these two important videos; highly recommend!

   

Good luck & good trading!

Disclaimer
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.

The outrage over banks’ bonuses continues and understandably so.  Elizabeth Warren, chair of the Congressional Oversight Panel,  gives her analysis of the status quo one year after the biggest financial crisis since the Great Depression.

To sum up what has changed since last October:

The large Banks today are even “Too Bigger to Fail”.
Toxic Assets, which were supposed to be removed by TARP, "are still there by and large."
Current economic situation is worse than the “worst-case scenario” in the stress tests conducted.

And yet, Banks have been allocating a new record in compensation and bonuses...

Not angry enough yet about consumer struggles in the face of higher profits from Banks and Financial Institutions?  Here is an interesting interview of Bill Moyers with Marcy Kaptur and Simon Johnson.  It is worth every minute of your attention...

Click on image to see the video

The Dow closed above 10,000 today, the first time since October 2008.

 

While the US Dollar took another beating today, other markets showed continued strength at higher levels.
▪ Gold: 1,070.50 new all-time high
▪ Euro: 1.4945 - highest since August 2008
▪ Australian $: 0.9160  - highest since August 2008
▪ Swiss Franc: 1.0128 strongest since July 2008
▪ Silver: $18.09 - highest since August 2008
▪ CRB Index: 270.25 - highest in 2009

Having just learned that the FHA is back to providing basically zero down mortgages again, I am flabbergasted.  As Business Week reported: FHA Loans: Return to 0% Down

Henry Blodget put it best by coining a new term:  “Be Glad To Help You Screw Yourself” Mortgages.  To think that this is all done under the watchful eye of our government...

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
▪   US Dollar Unplugged
▪   Time Has Come? 
▪   A Hat-Trick For Gold 
▪   The Magic Triangle 
▪   Signposts

Weekly Snapshot
• US trade deficit declined by 3.6% to $30.7 billion in August (AP)
• Asian central banks intervene to slow the decline of the US Dollar (FT)
• US retailers in first monthly sales gain since Sept-2008 (FT)
• Bank Santander of Spain raises $7bn in Brazilian IPO (FT)
• Bank of England kept their benchmark interest rates at 0.5% (Bloomberg)
• The ECB kept rates unchanged at a record low of 1% on Thursday (Reuters)
• US jobless claims fell by 33,000 to a 521,000 lowest in 9 months (Bloomberg)
• Euro area GDP down by 0.2% and EU27 GDP down by 0.3% (Eurostat)
• Spot Gold reached a new all-time highs on Tuesday, Wednesday and Thursday (eSignal)
• The Australian and New Zealand dollars climbed to their highest levels in 14 months (Bloomberg)
• Australia's Central Bank unexpectedly raised rates to 3.25% and signaled further increases (Bloomberg)
• Australian Stocks at highest level in 12 months (eSignal)

Chart Of The Week 
Gold broke all records this week and reached a new high of $1,061.50 on Thursday before closing the week just under $1,050.   Much of the gold strength was related to the Dollar weakness.  More on Gold below...

Source: http://www.stockcharts.com 

US Dollar Unplugged 
Plenty of newsworthy developments with regard to currencies this week.  You may have heard about “secret meetings”  by some nations to consider the end of US$ dealings for oil.  Robert Fisk of the Independent outlines various scenarios in his recent article: The demise of the dollar.

In direct opposition to these findings, Mike Shedlock gives a rather different perspective in his post: Ridiculous Hype Over Secret Oil Meetings. 

I would like to share his “Ten Simple Facts” as to why he considers this a non-issue:

1) Oil is priced in dollars.
2) Oil trades in Dollars and Euros right now in spite of the pricing unit being dollars. OPEC has recently admitted this fact.
3) Clearly oil does not have to be priced in Euros to trade in Euros, or for that matter priced in Yen to trade in Yen. The same applies to any major currency.
4) Neither Venezuela or Iran hold any dollar reserves. To the extent that either is taking trades in dollars, there is clearly nothing forcing them to hold dollars. By extension there is nothing forcing any OPEC country to hold dollars if it doesn't want to.
5) It takes less than a second for Forex trades to take place. 24 hours a day, 7 days a week, one can sell any currency they want and buy any other currency.
6) The above logic applies to any currency and any commodity.
7) Nothing is stopping anyone at any time anywhere from selling dollars for whatever currency they want to hold. Nor is anything stopping anyone anywhere at any time from selling any major currency for U.S. Dollars.
8) Because currency conversion is instantaneous no one has to hold U.S. dollars to buy oil, copper, gold, iron, lead, wheat, soybeans, or anything else.
9) Dollars are held (or not held) for reasons totally unrelated to pricing unit. Some of those reasons are political, some are based on sentiment, some on trade patterns and trade relationships, and some to suppress the value of local currencies to improve exports.
10) Currencies float and so do the price of oil and commodities. Pricing oil (or any other commodity) in Euros will not cause a price change in dollars. Look at gold which is simultaneously priced in everything as proof.

The news about these secret meetings, first reported by the Independent, sparked somewhat of US Dollar sell-off earlier this week.  Yet, there are more significant factors influencing the possible demise of the US Dollar.  However, we should not discount the huge psychological impact on a change in pricing policy for one of the most sought after global commodities.  A departure from pricing oil in US Dollars is yet another sign of the changes in global economic powers and an indication of the “new normal”.   

While Mike Shedlock makes some valid points, the realities of managing a commodity and its pricing unit compared with the holdings of Dollars or another currency are NOT totally unrelated.  Anyone having done a series of trades in different currencies and different commodities can attest to the fact that there are certain correlations at play.  Views on exchange rates need to be re-assessed on the basis of long-term planning and the expectations of future price increases in the commodity are very much having an  impact on the currency holdings of an exporter or seller of that commodity.   If there was no impact, why would these nations even consider a pricing unit other than the US Dollar?  It is obvious that many of these nations, particularly those with vast holdings of US Dollars, fear a decrease in the value of the Dollar and by considering a reference price of their goods in another currency or within a basked of currencies, they wish to achieve some price stability.

On a slightly lesser note, currencies can indeed be traded 24 hours a day and many countries allow holdings of foreign currencies within their banks (Ed. Note: Did you ever wonder why no bank in the US offers foreign currency savings or multi-currency accounts?) but there is also a cost associated with changing currencies on a regular basis.  Historically, all OPEC nations from the Gulf have pegged their currencies to the US$.  As recipients of vast amounts of Petro-Dollars this not only made practical sense, it also guaranteed a relatively stable domestic economy on the basis of piggy-backing onto the growth and the stability of the world’s most powerful economy.  That concept has worked fairly well over decades until recently when some Gulf nations started to open up their currency peg and included other currencies, namely the Euro as a reference currency.  It remains to be seen how soon the Gulf nations can wean themselves from the Dollar.  The mere fact that these discussions occur more frequently these days is a sign of things to come...

Time Has Come?
The Australian central bank raised interest rates by a quarter point on Tuesday.  Australia is the first G20 nation to tighten monetary policy this year and this could be a significant turning point in the aftermath of the global financial crisis.   Markets were taken by surprise and it triggered some questions as to which countries would follow suit in starting their rate tightening cycle.   Australia, being a commodity rich country may be a special case, having avoided a massive recession and enjoying a comparatively robust banking system. It does however highlight the views of some optimists that the worst is over and that time has come for new period with higher rates.  See the benchmark rates for that major currencies below and consider that a significant factor for the recent strength of Australian and New Zealand Dollars is the interest rate differential.  With no sign of a change in US monetary policy, this rate differential continues to encourage carry-trades.

Central Bank Rates
AUD 3.25%   NZD 2.50%   EUR 1.00%  GBP 0.50% 
USD 0.25%    CAD 0.25%  CHF 0.25%   JPY 0.10%

A Hat-Trick For Gold 
Gold prices reached a new all-time high of $1,061.50 achieving a hat-trick of three consecutive new all-time records this week.

Can Gold maintain its current trajectory and reach levels of $1500 and above as some analysts predicted? Or will we see some profit taking of the smart players now while the herd may jump in too late?  As a reference point, compare Gold with Copper.  Even more volatile than its more precious cousin, Copper has doubled in price since the beginning of the year and has outperformed Gold five-fold.

It remains to be seen whether commodity prices will reach higher levels yet but volatility in these markets is unlikely to disappear anytime soon.  As for Gold, anytime a tradable asset reaches a new high or a new low the crowd mentality kicks in sparking yet more demand and supply for a perhaps already over- or undervalued asset.  This can drive price-trends in the same direction for a while longer.  However, one needs to step back and carefully consider if the rationale for buying the asset still holds true at even higher prices. 

Meanwhile the list of Gold supporters goes on. The always outspoken Peter Schiff, never shy about making controversial predictions, recently predicted Gold might hit $5,000 per ounce.

Perhaps less far-fetched was a commentary by Jim Rogers that Gold will hit $2,000 an ounce within decade
That seems reasonable;  assuming no major changes from current economic conditions and imputing an average annual inflation rate of say 4%, a Gold price of $1,000 today should be valued at $1,480 within a decade.  If one were to take the view of some inflation hawks that inflation could average over 7% per year, we have then arrived at the $2,000 Gold price within 10 years.  Although the inflation record of Gold is somewhat controversial $2,000 an ounce is not nearly as far fetched considering that the inflation adjusted all-time high of Gold in 1980 is over $2,000.

The Magic Triangle 
How vivid is your memory in terms of your first encounter with percentages?  We use percentages on a daily basis and yet, the magic of this mathematical concept can sometimes elude us.

Did you know that –58 + 61  =  -32?   That is the result of figuring out the returns in equities since the peak of the major benchmark index in late 2007.  Just a reminder of where we stand.

  

Signposts
As the Financial Times reported this week, Spain’s Bank Santander completed a share offering for its Brazilian banking unit that raised $8 billion. This is the world’s biggest IPO so far this year and not the first time that institutions are looking towards developing and natural resource-rich countries to raise capital.  This trend is likely to continue and traditional creditor nations for developing countries are increasingly becoming debtors of countries like Brazil.  It also raises the question:  Will countries like Brazil continue to make loans in US$ or will they insist on financing in their own, increasingly stronger currency?  At this time, the largest debtor nation can still call the shots, demanding capital on their terms (at historically low rates)  and in their own currency (US$).  But how much longer?

Good luck & good trading!

Disclaimer
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.

Gold prices reached a new all-time high of $1,061.50 achieving a hat-trick of three consecutive new all-time records this week. At the same time, the US Dollar took a beating depreciating against all major currencies.  New Zealand Dollar and Australian Dollar reached new highs for the year.  The Australian Central Bank raised interest rates by 0.25% on Tuesday, the first Central Bank of the G20 nations to do so.  This may be an important signal and invariably, some other Central Banks will follow suit. 

Is this the signal for a turn-around? 

With commodity prices, particularly metals, at increasingly higher levels, inflation fears may have sparked concerns among the Central Bankers down under.  Can Gold maintain its current trajectory and reach levels of $1500 and above as some analysts predicted? Or will we see some profit taking of the smart players now while the herd may jump in too late?  As a reference point, compare Gold with Copper.  Even more volatile than its more precious cousin, Copper has nearly doubled in prices since the beginning of the year.  It remains to be seen whether commodity prices will reach higher levels yet but volatility in these markets is unlikely to disappear anytime soon.  As for Gold, anytime a tradable asset reaches a new high or a new low the crowd mentality kicks in sparking yet more demand or supply for a perhaps already over- or undervalued asset.  This can drive price-trends in the same direction for a while longer.  However, one needs to step back and carefully consider if the rationale for buying the asset still holds true at higher prices.

Gold spiked the second day in a row and reached a new all-time high after yesterday’s rally.  Spot Gold traded at a high of $1,048.25 in European Trading today.

Inquiring minds are wondering how much of this rise in Gold is attributable to the growing lack of confidence in the US Dollar.

As reported yesterday, Goldman Sachs analysts raised the outlook on some banks from neutral to attractive.  At the same time, Billionaire investor George Soros said US banks and financial companies are “basically bankrupt”. Read the full story on Bloomberg: Soros Says ‘Basically Bankrupt’ Banks Restrain U.S.

Curious:  Who are we to believe?  The investor or the banker?  Could their opinions possibly be influenced by the trading positions they may have? 

Goldman Sachs in the center of it all again. The inquiring mind is trying to get its head around two interesting news headlines: 

“Goldman to be paid $1bn if CIT fails”

“Goldman analysts raised the outlook on banks from neutral to "attractive"

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
▪   US Labor Pains 
▪   Recommended Read 
▪   Currencies Unplugged 
▪   Meritocracy
▪   Signposts

Weekly Snapshot
• US job losses  worse than expected at 263,000, lifting the unemployment rate to 9.8% (Reuters)
• Sharp Drop in U.S. Auto Sales in September: GM -45%, Chrysler -42%, Ford -6% (Washington Post)
• US 30-year fixed mortgage rates dip below 5% on Thursday (AP)
• Ken Lewis, CEO of Bank of America, to step down at year's end (AP)
• Euro area inflation estimated at -0.3% (Eurostat)
• US GDP fell 0.7% in 2nd Quarter - better than market expectations of a 1.2% drop (Reuters)
• Industrial new orders up by 2.6% in euro area (Eurostat)
• US Consumer confidence in September fell back to 53.1 from 54.5 in August (Bloomberg)
• US home prices in 20 major cities rose 1.2% percent in July. Prices are still 13.3% below July 2008 (Reuters)
• Almost 1m US homes in some stage of  foreclosure; completed foreclosures exceed 130,000 (Economist)
• Germany set for centre-right coalition - Merkel pledges swift income tax cuts (FT)
• The Japanese Yen advanced to an eight-month high against the US dollar (Economist)

Chart Of The Week
A reminder of where we stand...  

Source: http://dshort.com/articles/2009/unemployment.html# 

US Labor Pains 
US jobs have now contracted for 21 straight months and the unemployment rate hit 9.8% in September.  Since the beginning of the recession, 7.6 million have been added to the now 15.1 million unemployed.  As the chart above depicts, unemployment being a lagging indicator, is somewhat inversely related to stock prices.  If history were to repeat itself, and assuming the low of March 2009 was indeed the bottom of the current bear market, we should see an improvement in the labor market sometime soon.  The rate of increase in job losses has been declining but jobs are still lost each month which adds to the quagmire of the real economy.  

Since the US economy is largely consumer driven (roughly 70% of GDP depend on consumption), any real and sustainable recovery will depend on jobs.  That might also spill over to the markets, at least to certain sectors which are more vulnerable to a long-term decrease in consumer spending.

Mike (Mish) Shedlock has a good summary of the current US employment situation at his Blog Post: http://globaleconomicanalysis.blogspot.com/2009/10/jobs-contract-21th-straight-month.html

The report by Bureau of Labor Statistics is available here: http://www.bls.gov/news.release/empsit.nr0.htm

Recommended Read 
Please consider reading: Wanted: new model for markets 

John Authors’ article in the Financial Times is somewhat lengthy but it is an excellent summary of some of fundamental flaws with the theories of modern finance.  Modern Portfolio Theory, efficient markets and “normal” bell curve distributions have not only been at the core of the curriculum for finance and business education, they have also formed the basis of pricing a vast array of financial products.  As with all theoretical models, they are based on certain assumptions; when assumptions are not met in the real world, the models fall apart.

Over 40 years ago, Benoit Mandelbrot, the mathematician who invented fractal geometry, proved that markets did not follow a normal distribution as in the typical bell curve.  He noted:

If stocks really followed a bell curve, he observed, then a swing of more than 7 per cent in a day for the Dow Jones industrial average should happen once every 300,000 years.

John Authors added that “there were 48 such days during the 20th century.”

Let’s go one step further and look at the daily swings of the Dow since 1928.  Based on widely accessible data at Yahoo! Finance, we can examine the daily prices of the Dow and we found that there were 83 days when the Index moved 7% or more.  In fact, 16 days exceeded a move of more than 10%.

Dow Jones Industrial Average Daily Trading Ranges

Date	Open	High	Low	Close	Daily Range
19/10/87	2164.16	2164.16	1677.55	1738.74	22.48%
20/10/87	1738.74	2067.47	1616.21	1841.01	21.83%
29/10/29	252.38	252.38	212.33	230.07	15.87%
21/07/33	96.26	98.69	84.45	88.71	14.43%
10/10/08	8568.67	8989.13	7773.71	8451.19	13.52%
28/10/29	295.18	295.18	256.75	260.64	13.02%
24/10/29	305.85	312.76	272.32	299.47	12.93%
06/10/31	87.51	100.49	87.51	99.34	12.92%
30/10/29	230.98	260.93	230.98	258.47	11.48%
13/10/08	8462.42	9501.91	8462.42	9387.61	10.94%
13/11/08	8281.14	8898.41	7947.74	8835.25	10.68%
28/10/08	8178.72	9112.51	8153.79	9065.12	10.52%
09/10/08	9261.69	9522.77	8523.27	8579.19	10.50%
18/12/31	73.79	81.1	72.62	80.69	10.46%
20/07/33	103.58	105.65	94.76	96.26	10.31%
07/11/29	232.13	242.1	217.84	238.19	10.02%

With just a few crude statistical calculations, we can easily spot how far off the assumptions of normal distribution are.  A 7% move every 300,000 years means 1 in 75 Million days or 0.00000133%.  By contrast, the Dow moved 83 times over 7% in one day, that’s 83 times in 20,342 days or 0.41%.  Still a very slim chance that the markets won’t follow normal distribution, but 306,017 times more likely than traditional models suggest (email if you like a copy of the data) .

Another hallmark of modern portfolio theory is the assumption that one should diversify risk by investing in asset classes and markets that are not (highly) correlated.  This makes obvious sense as well.  The problem with the assumption however is the fact that correlation, unlike some models suggest, is not static and it changes over time.  Since last year, many asset classes, previously thought to be highly uncorrelated, have moved in tandem.  We discussed correlation before (Market Insights 31 May 2009, 11 July 2009 & 22 August 2009).  The charts below depict how big of a problem correlation was during the crisis.

     

A new theory known as adaptive markets hypothesis might find an answer to this dilemma.  However, it remains to be seen how well the theory fares in practice when markets are flying again next time.

Currencies Unplugged  
Merk Mutual Funds have a neat outline of some key concepts of currency trading.  Often misunderstood, a main feature of currency trading emanates from the fact that currencies are always traded in pairs.  Hence it brings about different sets of advantages and challenges when examining these types of transactions.

What Does it Mean to Buy a Currency?  < >  What Does it Mean to Short a Currency?

To clarify further, very few investors do a physical exchange of currencies when they trade.  The majority of currency transactions these days are done on a margin basis.  So you don't actually give up one for another; instead consider it a leveraged trade as if you were to trade commodities futures. 

Meritocracy 
Think you live in a meritocracy?  Think again.  CNN Money has a list of the 5 most overpaid CEOs.

     

Signposts
In our quest to look for signs of things to come, here’s a thought:  Despite considerable efforts by US President Obama to promote his home town of Chicago, Rio de Janeiro will be hosting the 2016 Olympic Games instead.  Coincidence or another sign that the US is slowly handing over the baton in terms of global dominance?  No pun intended, but compare the Brazilian Stock Market versus the US benchmark Index.

Good luck & good trading!

Disclaimer
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.

Mike (Mish) Shedlock has a good summary of the current US employment situation at his Blog Post http://globaleconomicanalysis.blogspot.com/2009/10/jobs-contract-21th-straight-month.html 

The actual employment report of Bureau of Labor Statistics is available here: http://www.bls.gov/news.release/empsit.nr0.htm

US jobs have now contracted for 21 straight months as the unemployment rate hits 9.8%.  Since the US economy is largely consumer driven (roughly 70% of GDP depend on consumption), any real and sustainable recovery will depend on jobs.  

It was all over the tickers this morning, Ken Lewis announced his decision to step down as CEO of Bank of America at the end of this year.  Surprise to some, others saw it coming.  I would like to use this story in context with our blog post of yesterday (More lovely stories about banks) to illustrate that correlation is not causation.  A debtor’s revolt by a disillusioned consumer who took his battle with Bank of America to the Internet certainly caused some public outrage.  It may have been one of the many factors that tainted an already dismal image of one of the leading financial institutions. But it was not the cause of Mr. Lewis departure. However, one cannot help notice the timing of these two somewhat related events.  Is it a sign of more power to the people or just wishful thinking?