Archive for December, 2011

Where Falling Inflation Means Rising Valuations (Koesterich)

Thursday, December 29th, 2011

by Russ Koesterich, Chief Investment Strategist, iShares

One silver lining of the current slow growth environment is that inflation in emerging markets appears to have hit an inflection point.

In recent months, for instance, inflation in both China and Brazil has come down. In China, consumer prices rose 4.2% in November from a year earlier, a 14-month low. Similarly, in Brazil, annual inflation fell to 6.64% in November, close to the 6.5% upper limit of the Brazilian central bank’s target range.

Emerging market inflation should decelerate further in 2012 thanks to a combination of continuing slower global growth and the lagged impact of monetary tightening. Brazil’s central bank has said it expects inflation to “fall sharply” by the second quarter of next year.

With the outlook for emerging market inflation improving, my team recently ran an analysis to determine which developing countries are likely to see their valuations benefit the most from falling inflation.

Here is the list, with each country ranked in order of how much they should benefit.

1.      Brazil

2.      India

3.      Egypt

4.      South Africa

5.      Russia

6.      Turkey

To develop the list, we looked at the relationship over the last five years between valuations (as measured by price-to-book values) and inflation levels for various emerging markets. For some countries, the relationship is positive — modest inflation is better for growth and translates into higher valuations during periods of inflation.

However, for other countries, the relationship is negative and higher inflation means lower valuations. This is especially true for countries that have gone through hyperinflation in the past, where investors are particularly sensitive to inflation readings and where valuations should benefit from decreasing inflation.

For our ranking, we focused on countries with a negative relationship that also still have high levels of inflation. For instance, Mexico and Indonesia would benefit from declining inflation. But they didn’t make our list because their inflation has already come down to a good range, which has already helped their valuations.

So how much should our top six countries benefit from falling inflation? Historically, every percentage point increase of inflation in Brazil is associated with Brazil’s price-to-book value decreasing by 0.3. I would expect the opposite to hold if Brazil’s inflation decreases.

At the bottom of the list, every percentage point increase of inflation in Turkey is associated with Turkey’s price-to-book value decreasing by 0.03. The other countries on the list fall somewhere in between.

But keep in mind that emerging market inflation is likely to stay above the comfort zone of many central bankers. In addition, inflation is not necessarily slowing in all emerging markets on our list. In Turkey, for instance, inflation has accelerated since February due to a combination of an overheating domestic economy and very unconventional monetary policy.

(Potential iShares solutions: EWZ and ERUS)

Disclosure: Author is long EWZ and ERUS

Source: Bloomberg

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.

 

Copyright © iShares

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Ten Year Italian Bonds Sold at 6.98% – Strangely, Market Yawns

Thursday, December 29th, 2011

Riddle me this.  Yesterday, Italy had a ‘successful’ short term bond auctions but the market took a gash to the chest as the euro broke down to a yearly low – which of course meant the dollar rallied, which of course meant every risk asset on Earth had to be sold by the computers.   Of course those sub 3 year bond auctions were affected by the LTRO situation.  Today, we saw an Italian 10 year bond auction, which was relatively putrid at a nearly 7% yield, the euro falls again and…. no one cares.  Futures are up.  Boggling.  Just boggling.

On a side note – it looks like the ECB (which of course is not allowed to bid directly in an auction from a government) stepped in directly after the auction to buy buy buy.

Based on the difference in action in sub 3 year versus over 3 years we clearly see that yes the LTRO has had an impact….this was something I was very curious to see.  One wonders when the ECB will begin offering nearly free money at 7 years (or heck 10 years) rather than 3 years to “fix” the eurozone.

Via Reuters:

  • Italy’s borrowing costs fell from recent record highs at a bond auction on Thursday but cautious investors still demanded a near 7 percent yield to buy 10-year debt, a level seen unsustainable over time for the euro zone’s third-largest economy.  Traders said the European Central Bank stepped in after the auction to buy Italian bonds on the open market as investors worry about the country’s ability to sell enough long-term debt ahead of large redemptions early next year.
  • Italy raised 7 billion euros ($9 billion) of debt in thin holiday markets, just above the mid-point of its target range.  It sold the top planned amount of its 10-year benchmark bond but the yield was 6.98 percent, not far from a euro lifetime record of 7.56 percent a month ago.
  • “Today’s decline in the auction yield by ‘just’ about 60 basis points versus end-November in such a high-yield territory underscores that the genuine pressure on Italy is still tremendous, despite bold ECB actions that have given (short-term debt) a big boost,” said David Schnautz, a rate strategist at Commerzbank in London.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

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Investing in Gold has Been Solid in 2011; Gold Miners? Not So Much

Thursday, December 29th, 2011

It has been a head scratching year for the gold miners – despite a very good year for gold itself (until recently) and stable production costs, their stocks have simply not reacted as expected.  Some of the largest investors in the world have expected a different behavior – the WSJ takes a closer look at this divergence in 2011.

  • Gold has been among the best investments in 2011.  Shares of gold miners? Among the worst.  Gold is up 12% this year but shares of gold miners have fallen almost 16%. Smaller gold miners are down almost 40%, based on the returns of leading exchange-traded funds tracking those stocks.
  • The surprising gulf has caused pain for some of the biggest names on Wall Street—including John Paulson, George Soros, David Einhorn, Seth Klarman and Thomas Kaplan—many of whom piled into gold shares over the past year, sometimes by shifting away from gold itself.
  • Bulls figured that gold miners had more upside than gold, partly because mining stocks outperformed during past bull markets for the metal.  But this year, gold miners have been hit by concerns that haven’t tarnished gold prices. Investors have worried that mining costs are rising, and that governments around the world are becoming more aggressive in taxing resources companies. They’re also concerned that gold miners might squander any windfall with ill-conceived acquisitions or other moves.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

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Update on Brazil, BRICs

Thursday, December 29th, 2011

In response to Brazil is World’s 6th Largest Economy, Overtaking UK Earlier this Year. Can Brazil Overtake France by 2016? What about BRICs in General? I received a nice email from Felipe Fiel, an economist from Brazil working in the hedge fund industry for Fram Capital.

Felipe writes …

Hi Mish, hope is all well with you. First of all I would like to congratulate you for your blog and outstanding contribution do financial observers. I’m an economist who lives in Brazil, working for the hedge fund industry.

I agree entirely with you about Brazil’s skepticism.

I would like to highlight that the way you show inflation and GDP might cause a distorted impression to your readers.

You show GDP growth quarter-over-quarter seasonally adjusted, without annualizing it, which is the norm for US viewers. It was running at almost 8% annualized growth before 2008 crises and even recently it grew at 3.2% in the 4 quarters before stagnating in 3Q.

For next year, even the most pessimistic projections see growth at 4.3% on average, which is more or less what is seen at GDP potential. However, I personally think we cannot growth at that rate without generating too much inflation.

Best,
Felipe Fiel

BRIC Decade Ends as Growth Peaked

According to Goldman Sachs, BRIC Decade Ends as Growth Peaked

Dec 28, 2011

In the past decade, mutual funds poured almost $70 billion into Brazil, Russia, India and China, stocks more than quadrupled gains in the Standard & Poor’s 500 Index and the economies grew four times faster than America’s.

Now Goldman Sachs Group Inc. (GS), which coined the term BRIC, says the best is over for the largest emerging markets.

BRIC funds recorded $15 billion of outflows this year as the MSCI BRIC Index sank 24 percent, EPFR Global data show. The gauge, which beat the S&P 500 by 390 percentage points from November 2001 through September 2010, has trailed the measure for five straight quarters, the longest stretch since Goldman Sachs forecast the countries would join the U.S. and Japan as the top economies by 2050.

BRIC indexes may fall another 20 percent next year, buffeted by the liquidity squeeze stemming from Europe’s sovereign debt crisis, Arjuna Mahendran, the Singapore-based head of Asia investment strategy at HSBC Private Bank, which oversees about $499 billion, said in an interview. Nations such as Indonesia, Nigeria and Turkey may overshadow the BRICS in the next five years as they expand from lower levels of growth, he said.

“The slowdown we’re seeing in the BRICs will continue for most of the first half,” Mahendran said. “Compared to the U.S., corporate profits haven’t been that good as companies face higher wages, higher interest rates and currency volatility, and at best, we’ll only start to see the effects of monetary policy loosening in the second half of 2012.”

2011 Losses

The BSE India Sensitive Index led declines among BRIC equity gauges this year, falling 23 percent. China’s Shanghai Composite Index also dropped 23 percent, while Russia’s Micex retreated 18 percent and Brazil’s Bovespa sank 16 percent. The 21-country MSCI Emerging Markets Index (MXEF) lost 20 percent, while the S&P 500 gained 0.6 percent.

The time to warn about BRICs and emerging markets was a year ago, which I did, specifically in regards to China (but also with many references to trade surplus nations and commodity producers throughout the year).

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

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2012 Forecast: David Rosenberg, Dennis Stattman and Others

Thursday, December 29th, 2011

In the video clips below, a number of commentators give short comments on topical economic and investment issues.

Part 1: Where’s the U.S. economy headed?


Part 2: Will the U.S unemployment rate improve in 2012?

Part 3: Will the European Union survive 2012?

Part 4: Will China boom or bust?

Part 5: What’s the best safe haven in 2012?

Part 6: What’s the best investment idea for 2012?

Source: Bloomberg, December 23–27, 2011.

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Debt Crisis 2012: Forget Europe, Check out Japan

Thursday, December 29th, 2011

This post is a guest contribution by Dian Chu, market analyst, trader and author of the EconMatters blog.

The recent massive demand for ECB’s LTRO (Long Term Refinancing Operation)–nearly 490 billion euro in three-year 1% loans from 523 banks–only confirmed the suspicion of some market participants that European banks are having financing issues, and that the LTRO is unlikely to flow into the Euro Zone supporting the troubled sovereign debt and economy.

In addition to the current Euro crisis which we discussed here and here, Japan, the world’s third largest economy, could have its own debt crisis as early as 2012 bigger than the Euro Zone. (see graph below)

Japan has long been mired by an aging population, sluggish growth and deflation since an asset bubble popped in the early 1990s. The country already has the highest debt-to-GDP ratio in the world–about 220% according to the OECD — and a debt load projected at a record 1 quadrillion yen this fiscal year.

Based on a plan approved by the Cabinet in Tokyo on 23 Dec, the country is now looking to sell 44.2 trillion yen ($566 billion) of new bonds to fund 90.3 trillion yen ($1.16 trillion) of spending in fiscal year 2012 starting 1 April. That will raise Japan budget’s dependence on debt to an unprecedented 49%.

According to Bloomberg, the government projects new bond issuance will surpass tax revenue for a fourth year. Receipts from levies have shrunk about a third this year after peaking at 60.1 trillion yen in 1990. Non-tax revenues including surplus from foreign exchange reserves also halved to 3.7 trillion yen. Social-security expenses, now at 250% of the level two decades ago, will account for 52% of general spending next year.

Moreover, an April 2011 analysis by CQCA Business Research showed that “Japan has an extremely near-future tilted debt maturity timeline” (see chart below). CQCA estimated that in 2010, Japan was able to push 105 trillion yen into the future, but concluded it is doubtful that Japan will be able to continue this.

Indeed, as one of the major and relatively stable economies in the world, and since almost all of its debt are held internally by the Japanese citizens or business, Japan has been able to still borrow at low rates (10-year bond yield at 0.98% as of Dec. 26, 2011), partly thanks to the Euro debt crisis going on for more than two years.

So as long as Japan could keep financing a majority of its debt internally without going through the real test of the brutal bond market, the country most likely would not experience a debt crisis like the one currently festering in Europe.

But the chips seem to have stacked against Japan now. On top of the new and re-financing needs, the Japanese government estimated that the economy will shrink 0.1% this fiscal year citing supply-chain disruptions from the earthquake and tsunami disaster in March, the strengthening of the yen and the European debt crisis. Moreover, S&P said in November that Japan might be close to a downgrade. After a sovereign debt downgrade to Aa3 by Moody’s in August, 2011, it’d be hard pressed to think Japanese bond buyers would shrug off yet another credit downgrade.

Burgeoning debt, coupled with the global and domestic economic slowdown, and continuing political turmoil (Japan has had three Prime Ministers in the last two years, and the current PM Noda’s popularity has fallen since he took office in September), would suggest it is unlikely that Japan could continue to self-contain its debt.

It looks like its massive debt could finally catch up with Japan in the midst the sovereign debt crisis that’s making a world tour right now. While some investors might see Japan as a bargain, it remains to be seen whether the country will continue beating the odds of a debt crisis.

Source: Dian Chu, EconMatters, December 27, 2011.

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5 Reasons Why 2012 Will Not Be A Replica Of 2011… At Least Not For Europe

Wednesday, December 28th, 2011

With many expecting 2012 to be a replica of 2011, at least for US stocks which the non-permabull consensus sees closing the year largely unchanged for the second year in a row, one open question is whether this will also be applicable to Europe. As a reminder, the EURUSD opened this year near the 52 week lows, only to rise by several thousand pips as concerns about European contagion were brushed away on hopes Europe’s politicians had it “under control.” They didn’t, and the EURUSD returned to its year’s lows recently. But is the same pattern in store for early 2012, where as we already noted, the bulk of gross debt issuance is due to take place, especially in January? Below are UBS’ 5 other key reasons why the European resurgence (however brief) that was experienced early this year will not be recreated in the new year that is now just around the corner.

From UBS:

So how do we expect the Eurozone crisis to evolve in early 2012 and how will it affect the euro? Last year, most observers expected Q1 2012 to bring an escalation of the crisis, particularly on peripheral bond markets. Instead, the periphery rallied and so did the euro, from about 1.30, just where we are today, to almost 1.50. Could the same happen early next year? We do not think so for the following reasons:

1) The ECB

In early 2011, the ECB sounded hawkish and then went on to hike rates in April and July, just as the Fed prepared to embark on QE2. 2012 will arguably be very different as the ECB is likely to cut rates to a new historic low of 0.50% and might well then embark on outright QE. At a time when the Fed looks largely done with its QE efforts, this could hit EURUSD hard and for us is the single most important reason to be structurally bearish the euro in 2012.

2) Greece

There is now a non-negotiable deadline for the Greek PSI, which is the bond redemption on 20 March. Negotiations for the new troika programme continue to assume a ‘voluntary’ PSI resulting in a 50% haircut and a debt-to-GDP reduction to 120% by 2020. However, revenue shortfalls due to the deeper-thanforecast recession look set to result in additional financing needs, which in the absence of new official money might mean a larger haircut and hence a coercive restructuring.

3) Contagion

If Greece is forced to impose an involuntary restructuring on investors, the market might quickly move on to Portugal or even beyond. Eurozone leaders have frantically worked at erecting a ‘firewall’ for countries beyond Greece in case of a default occurring. So far they have had limited success apart from raising more cash for the IMF and advancing the European Stability Mechanism (ESM) to mid-2012. Still, these instruments are arguably not yet powerful enough to deal with a country like Spain or Italy loosing market access.

4) CDS

The above Greek scenario would result in a credit event being declared and credit default swaps (CDS) being triggered. Many observers might welcome such an event as a proper default would mean that Greece was finally declared ‘insolvent’ and unable to pay its obligations, which most would argue might be better for the longer term health of the system than pretending otherwise. Still, nobody knows how the financial system would handle CDS payouts of more than €80bn (gross). At least as an initial reaction, the market would probably be highly stressed.

5) PoliticsThe EU has an impressive track record in pushing through projects even against resistance from individual countries and with minimal explicit or implicit support from electorates. However, there may come a point where populations start to rebel, possibly when they are simultaneously faced with ever deeper cuts in public services and ever higher taxes. A relatively benign problem might be resistance to ESM ratification in some countries, but more serious social  unrest could occur both in debtor as well as creditor countries.

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India Slows Rush for Gold

Wednesday, December 28th, 2011

It appears even Indian demand for gold falls under the age old supply/demand dynamic of Economics 101.  Despite a cultural affinity for the yellow metal, sky high prices are finally having a real impact on end demand.  The WSJ takes a look:

 

  • Many Indians are either scaling back or eliminating their gold purchases outright. The drop-off in demand is exposing cracks in what gold investors have traditionally perceived as a solid support for global prices. With many of its religious and cultural traditions steeped in the precious metal, India historically has been the world’s biggest consumer of gold, much of it cast into jewelry. Gold plays a particularly important role in wedding ceremonies, and physical demand for gold usually rises significantly in the fall and winter, which are considered auspicious times for getting married.
  • This year, however, the wedding season dovetailed with a rapid depreciation of the rupee against the dollar as investors fled India amid jitters about the broader economy.  India’s imports of gold fell to 20 million metric tons in November, down as much as 75% from a year earlier, according to estimates from the Bombay Bullion Association, an industry group for the country’s gold dealers.
  • Many investors and analysts believe that is a key reason why gold prices haven’t bounced back even though concerns about Europe’s debt load and the viability of euro persist.
  • Roughly a third of global demand for gold in the form of jewelry, or 649.9 metric tons, came from India in the year ended Sept. 30, according to the World Gold Council.  Ornate necklaces, armlets, earrings, bangles, gold chains and finger rings are an essential part of a Hindu bride’s trousseau and are usually bought by her parents.

 

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

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Things that Happen Every 60 Seconds on the Internet

Wednesday, December 28th, 2011

We all realize the Internet is growing at a very rapid pace. But just how fast? “On average, more than a billion new pages are added to it every day,” said GO-Gulf.com on its website (via The Big Picture). “To give you an idea of how big world wide web is, our Infographic 60 Seconds covers some really interesting facts about websites that we use on day-to-day basis.”

 

Source: Shanghai Web Designers & GO-Gulf.com (hat tip: The Big Picture), December 26, 2011.

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Jim Rogers says “Better to take the Pain Now”

Wednesday, December 28th, 2011

In this video, investor Jim Rogers discusses his views on the global economy and more. “We have big problems of money printing, debt, too much consumption. Be careful,” he said.

Source: Finance News Network (via YouTube), December 22, 2011.

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