FXIS Market Insights

Weekly Snapshot
• US House passes the package extending the Bush tax cuts (AP)
• US leading indicators jump 1.1% in November, suggest economy will strengthen early in 2011 (AP)
• Moody's slashed Ireland's credit rating by five notches, to Baa1 from Aa2 (Reuters)
• General Electric expects its businesses to show solid earnings growth in 2011 (WSJ)
• US current account deficit increased to $127.2 billion, or 3.5% of GDP in Q3 of 2010 (ESA)
• Fed will maintain the target range for the federal funds rate at 0 to 1/4% (Federal Reserve)
• A federal judge ruled key part of Obama's healthcare overhaul as unconstitutional (WSJ)
• US factory output grew for the fifth straight month increasing 0.4% in November (AP)
• US retail sales in November 2010 were $378.7 billion, an increase of 0.8% from October (ESA)
• China's central bank left rates unchanged despite another jump in consumer inflation (Reuters)
• Chinese consumer prices rose 5.1% in November to a 2-year high, year-over-year growth at 9.6% (AP)

Market Barometers 

Chart Of The Week
The 10-year Treasury peaked at 3.57% this week, the highest since May of this year. This could be the first sign of inflation slowly and finally creeping in on us. Higher rates for savers are still far off though and we sometimes forget what the current rates mean in historic perspective. Take a look at the chart below to get a a sense of what Bill Gross was hinting at when he predicted the end of a 3 decade long bull run in Bonds. 

Recommended Read 
As we are nearing the end of the year, the media tends to lock back at what has been.  Here’s a slightly abstract albeit rational look at a possible world 10 years from now.  Please consider: The shape of the world in 2020 

Recommended Video
Quite different from the doom & gloom that we usually get inundated with, here’s a really upbeat view of the world. Please consider this great video featuring Hans' Rosling’s unique view of the progress during the past 200 years.

 

Good luck and good investing!

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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Doug Elmendorf, the director of the Congressional Budget Office, published an interesting assessment of Trends in Federal Tax Revenues and Rates. This is timely information considering the heated debates over a tax compromise that includes extending the Bush-era tax cuts.  The CBO’s report concludes among other things:

Even with the projected substantial increase in revenues, under current law deficits between 2015 and 2020 will range between 2.6 percent and 3.0 percent of GDP. If the Congress extended most or all of the 2001 and 2003 tax cuts and made no other changes to taxes and spending, revenues would be lower and deficits would be significantly larger.

In an ideal world, the leaders of a country would understand the implications of poor financial management the way every business owner does. And perhaps, the long-term solution to fiscal deficits would be a requirement for all elected officials to pass a set of Business Management and Economics classes. Sadly, this seems even more illusive than getting a grip on the ever-growing public debt. 

Maybe we need to take a kid’s financial literacy approach to this tax debate to make our financially illiterate politicians understand the dilemma.  Economics is all about scarcity. As a whole, society has unlimited wants but very limited resources. You can drive home this fundamental principle by taking your children to a toy store and giving them a limited budget and a choice of only one toy they are allowed to buy.  Your kids learn very fast that they can only get a few of their unlimited wants satisfied within clearly set constraints. Clearly set constraints however have not been applied by US administrations for decades and it has only been getting worse culminating in last week’s tax compromise.

Given two choices, cut spending on the one hand while extending the Bush-era tax cuts or continue spending while raising taxes, a reasonable person would understand the constraints and choose one of the two.  Our political leaders however behaved like kids in a toy store while the parents gave them a blank check.  Translate this into the ongoing tax debate where some politicians still believe that more spending and lower taxes can miraculously fix the economic problems.  As the CBO graph below indicates, the optimistic scenario still means that revenues are trailing outlays (I love that word because it somehow makes expenses sound more like a temporary thing) by a considerable margin. In essence, this is more akin to wishful thinking.

If that is the optimistic case, how much more devastating could it get by increasing spending while lowering tax revenues? 

Granted, nobody wants to pay higher taxes and the word austerity is not part of the American dictionary. But as gloomy as it may sound, in order to get US public finances under control, we actually don’t have a choice anymore.  We must cut spending AND increase government revenues.  We’re no longer allowed to go to the toy store and choose one toy. We have to stay home and build our own toys from now on…

Weekly Snapshot
• S&P 500 at its highest level since the week Lehman Brothers collapsed (Reuters)
• US consumer sentiment rose more than expected in early December (Reuters)
• US trade deficit shrank 13.2% from September to October 2010, to -$38.7 billion (ESA)
• China raises bank reserve requirements by 50 basis points - 6th time this year (FT)
• US Treasuries hit by biggest sell-off in two years as capital costs soar (FT)
• The yield on 10-year T-notes jumped from 2.95% to 3.17% on Tuesday (Economist)
• Bank of England kept the base rate at its record low of 0.5% (Reuters)
• Crude oil prices rose above $90, highest level in over 2 years.
• Copper prices surged to an all-time high above $9,000 per ton on Tuesday (FT)
• The U.S. government exits Citigroup stake and earns $12 billion profit (Reuters)
• Moody's cut Hungary's sovereign rating by two notches, just above "junk" grade (Reuters)

Market Barometers

Chart Of The Week
The S&P 500 closed at a new high for the year and reached a level last seen since Lehman Brothers collapsed in 2008.  Are stocks overvalued now or are prices still relatively fair? Please consider this chart courtesy of Doug Short showing the historic data points of cyclical PE ratios.  On the basis of comparing the PE multiples with inflation, the markets are somewhat close to the center. We’re currently 4 1/2 points above the long-term average of 16.4 but still nowhere near the insane valuations of the Tech bubble.

Source:  www.dshort.com

Treasury Notes 
In the spirit of the US administration’s efforts to provide more transparency, you can now get it directly from the horse’s mouth. Please consider Tim Geithner’s new blog Treasury Notes.

Our Money Is Committing Suicide
Putting some humor on a rather serious subject, please consider Jon Stewart’s take on Ben Bernanke’s Quantitative Easing efforts. File this one under “things that make you go hmm”…

Good luck and 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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

This week, Business Insider revealed the key market predictions for 2011 by your favorite investment bank: Goldman Sachs.  Many of their predictions are very bullish and essentially call for a global rally almost across the board. A few notable exceptions are seen with some exchange rates.

With this information on hand, let’s focus on the prospects of Gold and the Australian Dollar.  As we all witnessed, Gold has had an incredible run in the past 10 years. After reaching an all-time high of $1,424 in early November, the precious metal dropped almost $100 but it has since been off to the races again closing the week at $1,414.

Spot Gold – Daily Chart

Goldman’s predictions call for a near 20% increase in Gold towards the end of 2011.  Considering how fast Gold has risen since last summer, this is much less than a remote possibility.

Taking nothing away from this massive bull-run, a huge component of the Gold price increase is the loss of value in the US Dollar.  When you value Gold in other currencies, the price strength is somewhat muted, particularly against high yielding currencies such as the Australian Dollar.

Gold in Australian Dollar – Weekly Chart

The all-time high of gold valued in Aussie Dollars appeared during the darkest days of the financial crisis. Against the strength of the Australian Dollar buoyed by numerous rate increases from the Australian Central Bank, Gold’s ascent has since been hampered. The first attempt at breaking the previous record earlier this year fell short of reaching that target.  However, technical factors as well as the increasingly favorable market sentiment for Gold make a strong case for a second attempt at breaking through the all-time high of A$1,565 from early 2009.

To get there, a few technical hurdles still stand in the way.  The next major resistance levels towards breaking through on the upside are A$1,491 and A$1,538.

Gold in Australian Dollar – Daily Chart

If you believe in Goldman’s prediction of a 20% increase while the Australian Dollar remains relatively flat, Gold valued in Australian Dollars should break the previous record and line up at approximately A$1650 very close to Goldman’s forecast for Spot Gold valued in US$. But is there a chance that Goldman could be wrong and the Aussie Dollar might rise much more than just 3%?

Considering that Australia is one of the world’s top commodity producing countries, its currency is invariably influenced by the demand for commodities.  The demand for raw materials and commodities is bound to accelerate in coming years.  That demand will keep the Aussie Dollar a hot item, perhaps more so than the demand for Gold does.

Looking at recent price history, the Aussie Dollar bears some resemblance with Gold having reached a recent high just above parity with the correction following suit.

Australian $ versus US$ – Daily Chart

It has been off to the races again this week however, falling just short of parity at 0.9925.  In assessing the prospects for the Australian Dollar going forward, we cannot exclude the outlook for the US Dollar from this equation though. At the present moment, a big factor speaking for the Aussie Dollar is the huge interest rate differential of about 4.5% in favor of the Australian currency. Now that QE2 has become a reality, Bond yields are set to rise which should be a benefit for the Greenback while giving less of an incentive to implement a carry trade “down under”.

Question though remains, can the US administration afford to finance their gaping deficits at higher financing costs? The sovereign debt crises in Greece and Ireland have shown how fast the rapidly rising cost of financing can bring government finances to their knees.  My guess is that the Fed, with heavy elbowing from the US administration, will continue to create the illusion that inflation is going to be benign. After all, they have done so for at least a decade now. Rising stock prices aside, the real US economy cannot afford a rate hike in the foreseeable future.  It would be far too high a risk to cause a double-dip recession and the certain end of any hope for re-electing the current administration.  It is far more likely that the Australian Central Bank would stop their rate hike cycle, perhaps even reduce rates by 25-50 basis points sometime next year. 

But my guess is that the Reserve Bank of Australia will continue its course and focus more on domestic inflation rather than showing too much concern for a specific currency level. This is unlike China’s approach which, despite higher interest rates, cannot seem to contain domestic inflation that well. The culprit, the Chinese Yuan, could be an important escape valve keeping domestic prices at reasonable levels but China keeps that valve fairly tight.  By contrast, Australia has been using the currency valve ever since the crisis hit which is part of the reason why the Aussie Dollar is so volatile.

It is plausible that some of the demand for Australian commodity exports will suffer with an ongoing rise in the Australian currency.  However, if Goldman’s bullish global market projections are turning out to be correct, demand for commodities will be even higher and Australian commodity producers should have no problem finding buyers, even at elevated prices.  In this context, the Goldman projections for a mere 3% increase in the Australian Dollar are rather modest. The Aussie Dollar may not be able to keep up with the rise in Gold prices, but taking a historic perspective into consideration, the Australian Dollar is still way “down under” from its peak in the 1970’s.

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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Weekly Snapshot
• US unemployment rate edged up to 9.8%, and nonfarm payrolls up by only 39,000 jobs (BLS)
• The Fed released details on the $3.3 trillion it extended during the financial crisis (CNBC)
• The Euro area seasonally-adjusted unemployment rate was 10.1% in October 2010 (Eurostat)
• Australia's economy grew at only 0.2% in Q3 -annualized growth remained flat at 2.7% (WSJ)
• The Euro fell below 1.30 in the wake of investor concerns about Eurozone debt (Reuters)
• US consumer confidence increased further in 54.1, up from 49.9 in October (Conference Board)
• US house prices fell by 0.8% on a seasonally adjusted basis from August to September (FT)
• India's economy grew 8.9% in the quarter ended Sept. 30 (WSJ)
• China is to raise next year's official inflation target and tighten monetary policy (AP)
• Peripheral Eurozone bond yields spiked, as investors fear default of Greece, Ireland and Portugal (AP)
• European Union nations agreed to give Ireland a $89 billion bailout (AP)
• Overall size of Ireland's aid package is €85bn at an average interest rate of 5.8% (Bloomberg)

Market Barometers

Chart Of The Week
A bit of a downer was this week’s US employment report. The unemployment rate rose from 9.6 to 9.8 percent in November; nonfarm payroll employment improved just marginally.  Only 39,000 jobs were added, much less than expected. These numbers clearly pose a problem in terms of the wider economic recovery. But even more concerning is the persistently high number of long-term unemployed which just took a small turn for the worse.

Source:  www.calculatedriskblog.com

Recommended Read
US Markets were up almost three percent this week and the outlook for equities in 2011 has just got a bit boost from a rather optimistic outlook by Goldman Sachs that hit the wires this week.  Nevertheless, the recovery remains jobless thus far and the employment outlook for the next year doesn’t appear to change the job prospects dramatically. In this context, please consider the Investment Outlook for December by Pimco’s Bill Gross.  Instead of spending our way to prosperity he recommends doing things the old fashioned way:

The constructive way is to stop making paper and start making things. Replace subprimes, and yes, Treasury bonds with American cars, steel, iPads, airplanes, corn – whatever the world wants that we can make better and/or cheaper. Learn how to compete again. Investments in infrastructure and 21st century education and research, as opposed to 20th century education are mandatory, as is a withdrawal from resource-draining foreign wars. It will be a tough way back, but it can be done with sacrifice and appropriate public policies that encourage innovation, education and national reconstruction, as opposed to Wall Street finance and Main Street consumption.

Fed Helping Everyone – Courtesy of the US Taxpayer
This week, the Fed disclosed details of some $3.3 trillion in loans made to all the financial institutions and a big list of other firms, including foreign banks, during the financial crisis.  It is clear now that many of these firms would have been toast without the US taxpayer as this interactive graphic by the Wall Street Journal confirms. The Fed did indeed act as lender of last resort and yes, the financial world as we knew it would have probably come to a dramatic halt without the Fed’s support. But considering how many of these near-death institutions have managed to rake in record profits and continue to dish out bonuses as if the crisis never happened, we must question the Fed’s rather generous help in purchasing essentially worthless paper from the institutions that created the mess in the first place.  I can live with the idea that lending facilities for institutions were put in place. But transferring a pile of @#$% from the banks’ balance sheets onto the Fed’s balance sheet should have never been allowed.  In the interest of the US taxpayer, those transactions should be reviewed in detail and Banks should be forced to take the paper back and deal with it themselves.

In this context, please consider the following interview with John Cassidy: Wall Street Banks Are Doing Less and Less Good For Society.

Good luck and 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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.