Emerging Markets Highlights (3/15/2010)

Monday, March 15th, 2010

Emerging Markets

Strengths

• The number of people living at or above the level of “medium development”— considered to live in reasonable conditions and have access to education, health care, clean water and electricity—has grown by more than 2 billion people during the past several decades. That is more than the entire global population in 1900.
• The Asia Pacific region provided 234 names to the latest Forbes World’s Billionaires list released this week, up from 130 last year. The region accounted for 23 percent of the total 1,011 billionaires globally.
• China’s February exports grew by a higher-than-expected 45.7 percent year over year due to a strong rebound in exports of textile, steel products, televisions and motorcycles. Imports rose 44.7 percent in February from a year earlier thanks to a large swing of crude oil prices from last year.
• Brazil highway traffic in February rose by 6 percent year over year. It was driven mainly by heavy vehicles traffic (up 11.9 percent) and passenger traffic (up 4.3 percent).
• Brazil’s budget minister says his country is likely to see 6 percent GDP growth this year and the creation of 2 million jobs.
• January retail sales in Brazil increased 10.4 percent year over year.
• Industrial production in India in January rose 16.7 percent and was driven by higher activity in the mining sector (up 14.6 percent) and manufacturing (up 17.9 percent).
• Turkish new-car sales in February jumped 42 percent year over year, aided by tax incentives and a low base. The rise was above industry expectations.

Weaknesses

• China’s growth in fixed-asset investment moderated to 26.6 percent year over year in January and February combined, compared with the stimulus-driven rate exceeding 30 percent between March and October 2009, as the government wound down new public investment projects.
• Despite restraining government policies, property prices in 70 cities in China climbed another 10.7 percent year over year in February, the fastest pace in 23 months, after January’s 9.5 percent gain. New and existing home prices increased 1.3 percent and 0.4 percent month over month, respectively.
• All three publicly traded airport groups in Mexico reported declines in passenger traffic during February.
• Turkey ended IMF negotiations without a loan agreement. In absence of the IMF loan, there will be little upside to 4 percent GDP growth projections for 2010.

Opportunities

• If home-buying sentiment in China has shifted toward “wait and see,” auto purchases have remained very strong as the government maintained policy incentives. Even in the seasonally slowest month of February, 1.21 million vehicles were sold. The combined 2.88 million units sold in January and February was 84 percent higher than the same period in 2009. Such strength is likely to carry into March and April, typically strong months for car sales, as potential auto buyers rush to purchase before subsidy programs are withdrawn. Opportunities still exist for Chinese automakers and steel mills.

• It is estimated that damage to Chile’s infrastructure from recent earthquakes will be $20 billion to $30 billion, and will result in a massive government revival program. Dealing with effects of the earthquake is going to be a priority for the new president, Sebastian Pinera. Chile has a very healthy fiscal position and should easily fund the program from its copper fund, as well as from local and external debt.
• After years of neglect, there is a structural shortage at the residential end of Russian real estate market. New strategy announcements from the Russian real estate companies suggest that they are coming out of hibernation and are planning to launch construction and start pre-sales.

Threats

• While China’s central bank governor said February’s 2.7 percent increase in consumer prices from a year earlier was in line with his expectation, the latest inflation figure did surpass the one-year deposit rate of 2.25 percent. Negative real interest rates may provide an additional incentive to drive asset prices further ahead, creating fears of imminent monetary tightening that may introduce short-term volatility into the market.

• Mexico’s official inflation in February rose 0.58 percent month over month (vs. 0.50 percent expected) and was up 4.8 percent on an annualized basis. While the rate is still within the 4.75 percent to 5 percent target range, we will closely monitor the trend in coming months.
• The issue of exiting from monetary stimulus becomes pressing in countries like Brazil and Turkey, where inflation pressures are building. The chart below shows Citi’s estimates of upcoming rate increases in emerging countries in 2010.

Tags: Asia Pacific Region, Asset Investment, Billionaires List, Brazil, Budget Minister, China, Cities In China, Crude Oil Prices, Education Health Care, Emerging Markets, Forbes World, GDP Growth, Global Population, Heavy Vehicles, Highway Traffic, India, Industry Expectations, Investment Projects, Motorcycles Imports, New Car Sales, Passenger Traffic, Public Investment, Russia, Steel Products, Tax Incentives
Posted in Markets | No Comments »

Get Ready for a Little Emerging Markets Inflation

Friday, March 12th, 2010

Today I was thinking about tightening cycles in emerging markets, and more specifically about those in China. Because let’s face it, China matters. China matters to the rest of Asia via competition for export income. China matters to Europe via competition for jobs. China matters to Brazil via domestic production via imports. China matters.

The inflation pressures are building in key emerging economies, especially in the BIICs (Brazil, India, Indonesia, and China) - see this previous post regarding my new acronym, and this article at the Curious Capitalist (curiously posted just shortly after my post), which leaves my omitted “R” but relays the intuition behind the second “I”.

Although the inflation is not prevalent in any BIIC except India, really, I wanted to comment about why it will build…quickly.

First round, the construction of consumer prices is heavily weighted towards food and energy costs across the BIICs. Indonesia, India and China are highly susceptible to food price shocks (either driven by shortages or demand growth). Expect this as a first-round driver of inflation as the global economy recovers further. It’s already  happening.

Second round, the BIICs are growing quickly and nearing, or are already at, potential. Annual industrial production growth has recovered or surpassed its pre-crisis rate in China, Brazil and India - 19%, 16% and 17%, respectively. This is expected, given the drop-off in world trade (an illustration can be found from this May 2009 post), but unsustainable as the output gap closes.

Third round, interest rate differentials. This year, the BIICs’ central banks are expected to raise policy rates. In fact, Brazil, China and India have already boosted reserve requirements. But with US rates expected to stay low for an “extended period”, international interest rate differentials will change and monetary flows will shift. Capital inflows can lead to inflation if not properly sterilised.

To date, inflows have not been properly sterilised, as evidenced by the ongoing accumulation of reserves and rising money-supply growth (again, I refer you to my previous post on M1 growth rates.

The chart above illustrates the one-year-ahead nominal interest rate differential between the two-year forward government rate for each respective BIIC country versus the two-year forward US Treasury rate. The forward differentials for China and India are on a steady upward trajectory, while those for Brazil and Indonesia are simply steady. I believe this appropriately represents the sterilisation efforts and monetary policy management on the part of the BIICs’ central banks: more managed in Brazil and Indonesia, not as much in China and India.

So where does this analysis leave us? With a very interesting policy mix in the emerging-market space. In fact, in my view this is the riskiest part of the emerging-market cycle: the recovery. If policymakers get this wrong, we could see a lot of price action, final goods and assets alike, on the horizon.

Source: Rebecca Wilder, News N Economics, March 11, 2010.

* Rebecca Wilder is an economist in the financial industry. She was previously an assistant professor and holds a doctorate in economics.

Tags: Acronym, Biic, BRIC, Capital Inflows, Central Banks, China, Curious Capitalist, Emerging Economies, Emerging Markets, Energy Costs, Export Income, Food Price, Gap, Global Economy, Illustration, India, India Indonesia, Indonesia, Inflation Pressures, Interest Rate Differentials, International Interest, Intuition, Jobs Brazil, Monetary Flows, Output Gap
Posted in Markets | No Comments »

Confessions of a Bull.

Tuesday, March 9th, 2010

This article is a guest contribution from John Thomas, madhedgefundtrader.biz, via ZeroHedge.com

Confessions of a Bull. Barton Biggs, founder of mega hedge fund Traxis Partners, spent an hour outlining his current investment strategy with me. Barton is a man of strong opinions, backed with intensive research, which he communicates with his characteristic gravel voice. I spent the better part of the eighties debating every pebble of the investment landscape with Barton. As I recall, “what to do about Japan?” was the topic of the day, and I was bullish.

Today, Barton can say with “real certainty” that large cap multinational equities are the cheapest they have been in 30 years using sophisticated models that analyze price/sales, price/free cash flow, price/earnings, and a whole host of other metrics. Looking just at price/book ratios, these stocks have been this cheap only three times in the last 120 years.

Big cap technology stocks, like Microsoft (MSFT), Intel (INTC), Cisco (CSCO), and Oracle (ORCL) are at the top of his list. Other multinationals with plenty of emerging market exposure are attractive, such as Caterpillar (CAT). The easy way in here is to simply buy the S&P 100 ETF (OEF). The market is now at a 15-16 multiple, discounting S&P 500 earnings for 2010 at $75/share. A stronger than expected economy will take that figure as high as $90/share, which the market is not expecting at all.

Microsoft Corpora - MSFT	29.42		+0.13
Intel Corporation - INTC	21.37		+0.20
Cisco Systems, In - CSCO	26.06		-0.02
Oracle Corporatio - ORCL	25.13		-0.15
Caterpillar, Inc. - CAT	59.45		-0.01
iShares S&P 100 - OEF	53.04		+0.13

The grizzled old Wall Street Veteran sees the US as half way through an economic recovery, and the main benchmark indexes could surprise to the upside, as they have such heavy big cap weightings. He would avoid domestic companies, such as those in real estate, as the environment for stocks generally is poor. He foresees a “new normal” of a lot of volatility in stocks for the next 4-5 years. Longer term he sees US GDP growth downshifting from the heady 3.8% annual growth rate of the last decade to only 2.5 % in this one. But big cap multinationals should be able to bring in a reliable 5%-6% annual return on top of inflation.

Looking at the world as a whole, Barton thinks Asia is the place to be. A mammoth bubble may be developing in China (FXI), but it is at least 3-5 years off, and there will be plenty of money to be made until then. India (PIN) is another big pick because it is ten years behind China, and has yet to experience its big growth spurt. South Korea (EWY), Thailand (THD), Taiwan (EWT), H-shares in Hong Kong (EWH), and Turkey (TUR) are also lining up in Barton’s sites. Looking at a 1%-1.5% growth rate, things look grim for Europe, with the possible exceptions of Poland (PLND) and Russia (RSX). Traxis is short Brazil (EWZ), because it has already had a great run, and because the country still faces some severe social problems.

IShares Trust ISh - FXI	40.67		-0.08
BMO CHINA EQUITY - ZCH.TO	14.54		+0.00
ISHARES CHINA IND - XCH.TO	20.07		-0.09
TAO.TO - TAO.TO	0.00		+0.00
PowerShares Excha - PIN	22.06		+0.20
ISHARES S&P CNX N - XID.TO	20.50		+0.27
BMO INDIA EQUITY - ZID.TO	14.30		+0.20
iShares Trust (Ba - EWY	48.31		-0.02
iShares Trust iSh - THD	45.30		+1.27
iShares Trust (Ba - EWT	12.24		+0.05
iShares Trust (Ba - EWH	16.06		-0.06
iShares Trust iSh - TUR	53.06		+0.33
Market Vectors Po - PLND	25.09		+0.19
Market Vectors Ru - RSX	33.20		+0.25
iShares Trust (Ba - EWZ	73.25		+0.05

Commodities had their run last year, and won’t do much from here, but they aren’t going to crash either. He sees oil (USO) grinding up because the cost of new sources is becoming astronomically high. Barton avoids gold because it has no yield or PE, and would rather not be associated with the crazies that inhabit that space. Bonds (TBF) will be deflation driven for the next year, but are definitely not for your “Rip Van Winkle” investor, as they represent poor value for money. Real estate is dead money. To hear my interview with Barton at length on Hedge Fund Radio, please click at http://www.madhedgefundtrader.biz/Barton_Biggs.html

For more iconoclastic and out of consensus analysis, you can always visit me at www.madhedgefundtrader.com , where the conventional wisdom is mercilessly flailed and tortured daily.

Source: Zerohedge.com, March 9, 2010.

Tags: Barton Biggs, Cap Technology, Caterpillar Cat, China, Cisco Csco, Commodities, Downshifting, Emerging Markets, ETF, Free Cash Flow, GDP Growth, Gravel Voice, India, Intc, Intensive Research, Investment Landscape, Last Decade, Market Exposure, Msft, oil, Oracle Orcl, Price Earnings, Sophisticated Models, Street Veteran, Technology Stocks, Traxis Partners
Posted in Markets | No Comments »

India - Markets give thumbs up to Budget 2010

Friday, February 26th, 2010

Markets give thumbs up to Budget 2010

Courtesy of Equitymaster.com

The Union Budget 2010 brought some cheers to the Indian markets, which had been reeling under fear for the past few days with respect to the government’s stimulus withdrawal. However, the Finance Minister did not tinker much with the stimulus but for partially rolling back some excise duty benefits. However, much of this seemed in line with what the markets had been expecting. Anyways, realty, auto, and metals stocks led today’s gains.

The BSE Sensex and NSE Nifty closed with gains of around 175 points (1.1%) and 65 points (1.4%) respectively. Mid and small cap stocks also closed with gains. The BSE Midcap and BSE Smallcap indices closed higher by 1.5% and 1.1% respectively. On the broader BSE, one stock lost today for every two that closed in the positive.

Among other key Asian markets, while China closed marginally in the red, Hong Kong (up 1%) and Japan (up 0.2%) were among the gainers. European markets have opened today on a positive note.

Apart from just a small rollback of the stimulus, one of the key reasons for today’s gains was the clear roadmap announced by the government with respect to reducing its fiscal deficit over the next 3-4 years. As against an estimated figure of 6.9% and 5.5% of GDP in FY10 and FY11 respectively, the rolling targets for fiscal deficit are pegged at 4.8% and 4.1% for FY12 and FY13 respectively. Also, as the Budget notes, taking into account the various other financing items for fiscal deficit, the actual net market borrowing of the government in FY11 would be around Rs 3,450 bn, which would leave enough space to meet the credit needs of the private sector.

Auto stocks gained strongly today, Key gainers here included Bajaj Auto, Tata Motors, and Ashok Leyland. A lower than expected rollback of excise duty seemingly enthused investors in these stocks. Then there was the lowering of personal income taxes that we believe might foster increased spending by consumers on discretionary items like automobiles. But for the increase in the ad valorem component of excise duty on large cars and multi-utility vehicles by 2% points to 22%, today’s was a positive budget for the auto sector as a whole. We also believe that the extension of R&D benefits will encourage more investments in the sector and will make it competitive in the long run.

Realty stocks were amongst the biggest gainers on the broader markets today. The BSE-realty index closed up by almost 3%. Key gainers here included HDIL, DLF, and Unitech. These gains were on the back of some relief provided by the Budget to real estate companies. As the Finance Minister announced, with a view to provide one time interim relief to the housing and real estate sector that was impacted by the global recession, the government has allowed pending projects to be completed within a period of five years instead of four years for claiming a deduction on their profits. The Budget has also proposed to relax the norms for built-up area of shops and other commercial establishments in housing projects to enable basic facilities for their residents. The realty firms couldn’t have asked for more!

This is given that these companies have already been amongst the biggest beneficiaries of the government’s fiscal stimulus programme that has helped them restructure their strained balance sheets. The interesting thing is that these realty companies have come back to their greedy ways by not lowering property prices by keeping them artificially inflated through hoarding. Some like Deepak Parekh of HDFC have come out heavily on these companies’ tactics. But now, given that the Finance Minister has allowed them some more time to relax, real estate companies and their investors are making merry.

Key India Budget Highlights

Courtesy of L&T Mutual Funds, India, here are the budgetary highlights for FY11.

• Total expenditure proposed for FY11 stands at Rs.1108749 cr (US$239.6-billion) up by 8.6%. Plan expenditure up by 15%. Non plan expenditure up by 6%.Fiscal Deficit estimated at 5.5% for FY11 (from 6.9%FY10), 4.8% in FY12 and 4.1% in FY13.Direct tax proposals in form of lower income tax slabs would lead to a loss of Rs.26,000cr. (US$5.6-billion)
• Indirect tax proposals would lead to a gain of Rs.46,500 cr. (US$9.8-billion)
• Total tax revenue and other receipts would lead to Revenue Gain of Rs.20,500cr. (US$4.4-billion)
• Corporate Tax: MAT increased from 15% to 18%
• Surcharge on corporate tax reduced from 10% to 7.5%.
• Need to review stimulus, move to fiscal prudence, says FM
• Partial withdrawal of fiscal stimulus measures through roll back of excise duties
• Excise duty on all non oil products increased from 8% to 10%.
• GST and DTC to be introduced together by April 2011.
• Service Tax rate retained at 10%
• Subsidy to oil companies to be given in cash and included in budgetary estimates.
• Subsidy on Fertilisers to be reduced.
• Divestment receipts expected to be more than Rs.25,000 cr (US$5.39375-billion) in FY10. Disinvestment targets for FY11 to the tune of Rs. 40000 crs. (US$8.63-billion)
• To provide Rs 165 bln (US$3.58-billion) to PSU (Public Sector Undertaking, or State-run) banks
• Infrastructure spending pegged at Rs. 1,73,552 crs (US$37.4-billion), which is 46% of plan outlay.
• Net borrowing for FY11 set at Rs 3,45,000 cr (US$74.4-billion) ; Gross borrowing at Rs 4,57,000 cr (US$98.6-billion)

Equity View

• Hike in excise duty has been on expected lines.
• Increase in MAT would impact some corporates.
• Increase in tax slabs for individuals will give more in hand of consumers, key positive as it would enhance consumption.
• Hike in petrol prices by ~Rs. 2.50 on account of increase in duties would lead to inflation spike in near term.
• Overall we believe budget would push higher consumption and over period private capex would pick up. Economy would thrive without the requirement of large government expenditure over medium term.

Fixed Income View

• Net borrowing number of Rs 3.45 lakh crores (US$74.4-billion) a reasonable number. Bond markets expected to take it positively.
• However divestment and 3G auction revenue estimates on higher side for FY11. There could be risk of not meeting these targets as planned. Risk of fiscal deficit slippage (increasing from budgeted 5.5%) exists.
• Discontinuing practice of issuing bonds for oil and fertilizer companies and giving cash a positive fiscal consolidation measure. Will reduce interest burden in the long run.
• Fuel price hike due to increase in duties lead to inflationary effect and negative for bonds
• Continued support to PSU banks through capital infusion to help maintain their credit quality for issuance of CDs and Bonds.

Tags: Ascii, Ashok, Ashok Leyland, Asian Markets, Auto Stocks, Bse Sensex, Cambria, Div, Emerging Markets, Enough Space, European Markets, Excise Duty, Finance Minister, Fiscal Deficit, Font Definitions, Font Format, Footer, Gainers, India, India Markets, Indian Markets, Lt, Midcap, Mso, Orphan, Panose, Paper Source, Personal Income Taxes, Pitch, Props, Rollback, Sans Serif, Small Cap Stocks, Smallcap, Stimulus, Style Definitions, Style Name, Style Type, Tata Motors, Theme Font, Times New Roman, Union Budget
Posted in Markets | No Comments »

Marc Faber: Face-to-Face

Thursday, February 25th, 2010

Marc Faber, editor of the Gloom, Boom and Doom Report, sits down with Ben McLannahan, Asia Lex Writer of the Financial Times, to discuss a variety of pertinent economic and investment topics. In short, he suggests investors should make 2010 the year of “capital preservation”.

Part 1: Warns of partial US debt default
Faber says irrational monetary policy means there are asset-class bubbles forming somewhere, only we don’t know exactly where yet.

Click here or on the image below the view Part 1 of the interview.

Part 2: Forecasts negative US real interest rates
Faber says stocks won’t reach new highs this year.

Click here to view Part 2 of the interview.

Part 3: On gold and China’s economic slowdown
Faber predicts Asian stocks will underperform this year because of China’s inevitable economic slowdown and suggests accumulating gold and shifting more money to India and Japan.

Click here to view Part 3 of the interview.

Part 4: On the year of “capital preservation”
Faber says global investors should make 2010 the year of “capital preservation”.

Click here to view Part 4 of the interview.

Source:  Ben McLannahan, Financial Times (here, here, here and here), February 23, 2010.

Tags: Asia, Asian Stocks, Boom, Bubbles, Capital Investors, Capital Preservation, China, China Economic, Debt Default, Doom, Economic Slowdown, Face To Face, Financial Times, Global Investors, Gloom Boom And Doom Report, India, interest rates, Interview Source, Japan, Lex, Marc Faber, Monetary Policy, New Highs
Posted in Markets | No Comments »

WSJ: India Joins China in Global Hunt for Commodities

Thursday, February 25th, 2010

This article is a guest contribution by TraderMark, of Fund My Mutual Fund Blog.

A few weeks ago we noted the world’s largest coal producer, Coal India, was on the hunt for global assets to expand their reach.  [Feb 12, 2010: WSJ - World's Largest Coal Producer Has $6 Billion in the Bank and is on the Prowl for Assets]  It appears this is now part of a broader national strategy mimicking what China has been doing the past half decade+.

If you have any Malthusian bones in your body,  [Mar 24, 2008: WSJ - New Limits to Growth Revive Malthusian Fears] [Jun 20, 2008: World Population to Hit 7 Billion by 2012] you have to wonder as certain countries waste all their national treasure on bailing out banks, financing the lifestyles of those who refuse to save for themselves, and funding pet projects of their politicians -  while others are attempting to snatch up as many long lived assets across the globe, what the long term implications will be.  This is more or less parallel to a company who lives for today - happy to kick the can down the road -  rather than spends heavily on R&D to prosper for tomorrow. Of course any such national directives would be considered “socialistic” in certain countries, hence anathema to even consider as national policy.   Oh well, much better to send countless paper monies out into the atmosphere to help prop up home prices and capital market values from going where they belong - a much sounder national directive.

Via WSJ:

• India wants to join the club of global energy giants.  Some of the country’s largest private and state-run firms are in hot pursuit of oil and gas assets overseas as they seek to take advantage of depressed asset prices during the downturn and break free of burdensome regulations at home.
• In the latest move, oil-to-textiles conglomerate Reliance Industries Ltd., run by billionaire Mukesh Ambani, raised its bid over the weekend for LyondellBasell Industries, a bankrupt petrochemical maker and oil refiner. The new bid values the Netherlands-based firm at $14.5 billion, according to a person familiar with the matter.  A deal with Lyondell would significantly advance the ambitions of Reliance’s Mr. Ambani to build a global energy conglomerate. It would create a behemoth with $80 billion in combined revenues and interests in oil-and-gas exploration, refining and petrochemicals used for food packaging to textiles. (Reliance is akin to a combination of General Electric and Exxon Mobil in the States - a powerhouse in India with hands in countless industries)
• Reliance, India’s largest private company by market value, already operates the largest oil refining complex in the world, a site in the western state of Gujarat that can process 1.24 million barrels of crude a day. The facility is designed to handle the kind of ultra-heavy crude that could be extracted from Value Creation’s oil sands.
• Reliance also is scouting other foreign targets, including Canada’s Value Creation Inc., which has large oil-sands deposits in Alberta, people familiar with the company’s thinking said. (China has also been in Canada purchasing oil sand deposits) Smaller rival Essar Group is stepping up its own bargain hunting abroad, with an eye on assets that Royal Dutch Shell PLC and other oil majors are unloading.
• In recent months, Reliance and Essar, both based in Mumbai, have hired top executives from global oil majors to aid their international expansion efforts.
• Meanwhile, India’s flagship state-run oil company, Oil & Natural Gas Corp., said recently it may spend as much as $30 billion over the next decade on an international acquisition binge.
• Indian companies are scouring the globe to secure crude resources and reduce their dependence on imported oil. India imports 70% of its oil, with a price tag of more than $90 billion annually. The companies are also looking to expand their global footprint with refineries and other assets in far-away markets. And they want relief from the regulatory headaches of their home turf, where government influence in exploration and pricing of natural resources has slowed expansion.
• India is likely to face competition as it shops for oil and gas, especially from Chinese firms. Last summer, Sinopec Group, a large Chinese oil company, paid $7.2 billion for Addax Petroleum, a Geneva-based company that has oil and gas assets in the Middle East and Africa.  “We see the international players being more often the buyers of these types of assets now, and there’s no reason to think that won’t continue,” said Jon McCarter, oil-and-gas transactions leader for the Americas at Ernst & Young.
• Cross-border acquisitions by Indian companies fell 37% last year to $11.4 billion, according to Dealogic. But activity is picking up as Indian companies rev up for big-ticket deals in sectors such as energy, telecommunications and media.
• The country’s largest cellphone company, Bharti Airtel Ltd., offered $10.7 billion last week for most of the Africa assets of Kuwaiti operator Mobile Telecommunications Co., known as Zain.  Essar Group, a conglomerate with $15 billion in revenue and interests in steel, oil and telecom, controls oil exploration blocks in places including Nigeria, Madagascar, Myanmar and Vietnam.  Now the company has emerged as an eager buyer for European and U.S. oil companies that are struggling with extra refinery capacity due to slumping demand for fuels.

You can almost feel the sands shifting under our feet, month by month - year by year.

Source: TraderMark, fundmymutualfund.com

Tags: Asset Prices, Burdensome Regulations, China, Coal India, Coal Producer, Commodities, energy, Energy Giants, Gas Assets, Global Assets, Global Energy, Global Hunt, Hot Pursuit, India, Long Lived Assets, Market Values, National Strategy, oil, Paper Monies, Pet Projects, Reliance Industries, Reliance Industries Ltd, Term Implications, World Population, Wsj
Posted in Markets | No Comments »

Gold and Euro: A New Tango For 2010

Sunday, February 21st, 2010

By Dian L. Chu,  Economic Forecasts & Opinions

The U.S. dollar rose, commodity prices dropped and stocks fell last Friday after the Federal Reserve unexpectedly lifted an emergency lending rate for the first time since the financial crisis.

The dollar hit an eight-month high against a currency basket, while gold prices rose as investors bought the metal to hedge against paper currencies and debt default risks in Europe. Gold futures ended on Friday with a weekly gain of 3.1% at $1,122.10 an ounce.

Gold’s Retreat

Gold had rallied to a record of $1,218.30 an ounce on Dec. 3, 2009, as near-zero U.S. interest rates and government spending weighed on the dollar and countries including India and China boosted gold reserves.

However, bullion in the spot market has declined more than 6% since December, as the U.S. dollar benefited from the unfolding debt crisis in Dubai, Greece and the rest of southern Europe.

New Inverse Tango with Euro

Since gold is primarily a hedge against the dollar and inflation, it typically has the strongest inverse correlation with the US dollar. In the last month, however, the trend has broken with gold trending inversely with the euro and positively with the dollar (Fig. 1). The euro has now taken center stage in dictating the price of gold as it pertains to the fiscal health of Greece and other eurozone countries.

Fears over the outlook for the euro have been driving investors out that currency, and lifted both bullion and the dollar as alternative assets. The euro has declined, particularly against the dollar and gold, almost 5% against the dollar, and gold in euro terms is up 4.2%, so far in 2010.

Mariachi - PIIGS & The Fed

The new trend between the euro, dollar and gold is expected to continue amid fiscal challenges in the UK and Eurozone, PIIGS (Portugal, Iceland, Italy, Greece and Spain) in particular. Uncertainty over the details of any financial rescue package for Greece will likely keep the mood in the markets nervous, and the currency markets volatile in the near term.

In addition, the Fed’s discount rate hike signals that other central banks will likely follow suit in exiting from stimulus measures, while the eurozone, UK and Japan will likely lag behind. This view has partly triggered selling of the euro against the dollar, and some other currencies to seek a positive yield and perceived safety.

These two factors will likely continue to be the major forces driving the euro’s direction for the rest of Q1, and may spill over into Q2 depending upon solutions to the Eurpoean Union`s debt problems and dearth of future growth opportunities.

Technicals - Short-term Mixed

Technically speaking, the short term indicators of gold are mixed and still trending bearish as gold prices remains in the lower part of its recent trading range.

Technical analysts have widely diverging views as well. For instance, Chartered Market projects gold to reach about $1,400 within 12 months as long as the $1,000 level holds; whereas Barclays Capital considers a “fair value” for gold around the $700 to $800 an ounce level.

Meanwhile, Nouriel Roubini, economics professor at the Stern School of Business, New York University, says that there is a bubble in commodities, and that the price of gold should be no higher than $1,000 an ounce given the current market conditions.

Techincal levels of significance would be a breakout above the $1150 level, which would be bullish; and breakout below the $1050 level of support, which would be bearish for the commodity.  (Fig. 2)

Vulnerable to Rapid Unwind

According to the Commodity Futures Trading Commission (CFTC), NYMEX gold futures open interest increased 3.2% in January. Commercial traders increased their long positions, while holding net short positions. Non-commercial speculators held net long positions but increased their short positions. Overall, about 54% of the participants held net long positions in January. (Fig. 3)

Gold has attractions for those managers of private institutional funds. Many investors from George Soros to John Paulson have been buying gold as lower interest rates and continued money-printing could devalue the U.S. dollar in the long term.

Billionaire fund manager George Soros, for instance, told the financial elite at Davos that gold represented the “ultimate asset bubble”; however, data from SEC filing showed his fund more than doubled the stake in the SPDR Gold Trust (GLD) three months earlier. In fact, the gold trust is now his fund’s biggest investment, valued at $663 million.

The large number of long speculators playing in the Gold market could leave the market vulnerable to a rapid unwinding when sentiment changes – the crowded trade scenario. One can only speculate that Mr. Soros could be seeking to exploit this market vulnerability with his seemingly uncharacteristic and contradictory actions.

Other Market Factors

Furthermore, the gold price direction also hinges on several events about to unfold within the next few months:

1) Greece’s borrowing needs are covered only until mid-March, and is set to launch a new bond offering of $7 billion in coming days – Eurozone/euro could stand or fall on the success or failure of this bond sale.

2) European finance ministers gave Greece a one-month reprieve to show its deficit reduction plan was being rolled out effectively.

3) Dubai World will present a proposal to creditors in March to restructure about $22 billion of debt.

4) The IMF’s phased open-market sales of the remaining 191.3 tons of gold it planned to sell last year as there are no more official buyers – Bearish for gold, unless another central bank steps up.

5) The Federal Reserve will end a $1.25 trillion program of mortgage-debt purchases in March – Gold-bearish as it reduces liquidity.

As ever gold thrives on financial, economic and monetary uncertainty, there is certainly plenty of that in the world today.  Sovereign risk will likely remain the main theme for 2010, and possibly 2011.  This all sets the stage for the next five years of monetary and fiscal policy decisions around the globe which will ultimately define the future for this precious metal from an investment standpoint.

Disclosure: No Positions

Tags: Alternative Assets, China, Commodity Prices, Currency Basket, Debt Crisis, Debt Default, Economic Forecasts, Emerging Markets, Euro Dollar, Europe Gold, Eurozone Countries, Fiscal Challenges, Fiscal Health, Gold, Gold Bullion, Gold Futures, Gold Prices, Gold Reserves, India, Inverse Correlation, Italy Greece, Paper Currencies, Price Of Gold, Southern Europe
Posted in Markets | No Comments »

Gold Market Highlights

Saturday, February 20th, 2010

Gold Market

For the week, spot gold closed at $1,119.20 per ounce, up $25.82, or 2.36 percent. Gold equities, as measured by the XAU Gold & Silver Index (XAU) gained by 3.03 percent for the week. The U.S. Trade-Weighted Dollar Index (DXY) gained 0.41 percent.

Strengths

• The World Gold Council said China was the only emerging country to record growth (22 percent) in investment demand in 2009. Also, strong investment demand in developed markets offset weaker emerging-markets demand.
• Gold, at more than $1,100 per troy ounce, has been supported by concerns over the outlook for the currency markets. VM Group Analysts say the only feasible solution to the debt crisis in Greece is either through a devaluation or inflation, both of which are gold-supportive.
• Contrary to earlier reports, India retained its position as the largest gold-consuming nation in 2009 primarily because of higher consumer demand in the fourth quarter of the year. Indian festivals and weddings created demand, and jewelry dealers offered year-end promotions to strengthen sales.

Weaknesses

• The Federal Reserve raised the discount rate by 25 basis points to 0.75 percent, causing the U.S. dollar to strengthen across a basket of currencies as risk-averse investors flock to where monetary tightening is evident in efforts to avoid market turbulence.
• The World Gold Council has said that total identifiable gold demand fell 11 percent to 5,386 metric tons in 2009.
• The U.S. Labor Department said core consumer prices fell 0.1 percent in January, signifying that the outlook for inflation remains low. Bonds linked to inflation are losing ground globally as investors see little need to protect against price increases as the dollar rallies and banks restrict credit growth.

Opportunities

• The chart above, courtesy of Pimco, marks the countries in red that have the potential for public debt to exceed 90 percent of gross domestic product within a few years, making sovereign credit risk a greater threat. Bullion stands to benefit as the economies of countries in the “ring of fire” experience anemic growth rates that weaken their currencies.
• The most recent Treasury capital flows report showed that China sold a record $34.2 billion in American debt in December 2009, in the process relinquishing for the first time in many years its position as the top U.S. debt holder. China has been marginally diversifying its reserves into other currencies and other assets.
• South African President Jacob Zuma silenced the African National Congress’ Youth League, which earlier called for nationalization of mines, by reiterating that nationalization is not government policy. Gold miners firmed upon Zuma’s comments.

Threats

• The International Monetary Fund announced it will start selling 191.3 metric tons of gold in the open market, after already selling 212 metric tons to central banks in India, Sri Lanka and Mauritius.
• Greece’s prime minister said Greek workers and companies have evaded more than $42 billion in taxes, more than 10 percent of GDP. Repairing the country’s fiscal imbalance by lowering debt levels to acceptable European Union standards may be more difficult than initially expected.

Tags: China, Core Consumer, Currency Markets, Debt Crisis, Devaluation, Dollar Index, Dxy, Emerging Markets, Feasible Solution, Gold, Gold Demand, Gold Equities, Gold Market, India, Indian Festivals, Investment Demand, Investors Flock, Jewelry Dealers, Losing Ground, Market Turbulence, Silver Index Xau, Spot Gold, Troy Ounce, World Gold Council
Posted in Markets | No Comments »

Emerging Markets Highlights

Saturday, February 20th, 2010

Emerging Markets

Strengths

• Overseas worker remittance to The Philippines in December reached an all-time high of $1.57 billion, representing 11.4 percent growth year over year. Remittance reached $17.4 billion for all of 2009 and accounted for 10.8 percent of nominal GDP.
• South Korea’s power sales to industrial users rose 24 percent in January from a year earlier in volume terms, the fastest pace in nearly 34 years due to continued recovery in global demand for auto and steel.
• More than 180,000 net new jobs were created in Brazil in January, bringing the total for the past 12 months to about 1.3 million.
• Eastern European countries are running a tighter fiscal policy and are far less indebted than the major world economies (see chart), enabling them to grow faster than the developed countries saddled with ever-higher deficits and debt burden.

Weaknesses

• Singapore’s non-oil domestic exports in January grew at a slower than expected 20.8 percent year over year, representing a seasonally adjusted 8.9 percent decline month over month, due to a moderation in both electronics and pharmaceuticals exports.
• Thailand’s daily trading turnover has shrunk 34 percent this month from January’s average, as investors stayed on the sideline ahead of Supreme Court’s Feb. 26 ruling on whether to confiscate the former prime minister’s assets, a decision that could lead to domestic political turmoil.
• Official Argentina CPI in January reached 1 percent, bringing year-over-year CPI to 8.2 percent compared to 7.7 percent in December. However, private sector estimates of the CPI are much higher and range between 14 and 17 percent.
• Data released Tuesday by Poland reveals a deep deflation in gross wages and salary income during the month of January, defined by a single-month plunge of 11.5 percent.

Opportunities

• Walmart de Mexico in 2010 is planning to open 300 new stores in Mexico and 30 in Central America. Around 60 percent of new stores will be in the Express format to gain market share from the informal sector.
• Mexico’s National Infrastructure Fund is planning a substantial increase in its investment program in 2010. In total, 30.4 billion pesos ($2.37 billion) will be committed to 42 projects, up from 22.1 billion pesos in 23 infrastructure projects last year.
• Citigroup revised its expectations for Russian growth upwards to 6.2 percent in 2010, with two-thirds of the growth to come from household consumption. A number of indicators suggest that the recovery in consumption is already under way – there was substantial improvement in retail sales in December and real household income was up 7.1 percent in January.

Threats

• An earlier-than-expected increase of the discount rate by the U.S. Federal Reserve might help sustain the current U.S. dollar rally and prolong the unwinding of the U.S. dollar carry trade. Emerging-market equities in general are susceptible to near-term selling pressure given their negative correlation with the U.S. dollar.
• The arrest of a prosecutor in Turkey revived tension between the courts and ruling AK Party. A Financial Times article suggests that any government attempts at constitutional reform that could precipitate early elections would hit sentiment, as the recent polls suggest that AK Party could not win an outright majority.

Tags: Brazil, BRIC, China, CPI, Debt Burden, Deflation, Domestic Exports, Eastern European Countries, Emerging Markets, Fiscal Policy, Former Prime Minister, Global Demand, Gross Wages, India, Industrial Users, Month Of January, New Jobs, Nominal Gdp, Political Turmoil, Remittance, Russia, Salary Income, South Korea, Volume Terms, Walmart, World Economies
Posted in Markets | No Comments »

IMF Gold Sales v. the Alchemy of Gold Futures – What’s the Impact on Gold Prices?

Thursday, February 18th, 2010

This article is a guest contribution by J.S. Kim, of SmartKnowledgeU™.

The recently announced IMF sale of 191.3 tonnes of their gold reserves, though it caused an immediate sharp knee-jerk reaction in gold futures markets, will have a negligible effect on the long-term price of gold. Here’s why.

In December, 2009 the commercial bullion banks that serve as agents for the leading Western Central Banks were net short 303,791 contracts of gold. Each COMEX gold futures contract represents 100 troy ounces, so the Commercials were net short 30,379,100 troy ounces of gold. With the average price of gold $1,134.72 per troy ounce in December 2009, this net short commercial position represented $34.47 billion worth of gold. There are 32,150.74533 troy ounces in one metric tonne. So 30,379,100 troy ounces/ 32,150.74533 troy ounces = 944.90 metric tonnes of gold. Since gold contracts are supposed to be good for physical delivery, the commercial bullion banks that were short nearly 38% of annual world production of gold this past December should have had 944.90 physical metric tonnes of gold in their vaults to back up their short position at that time. In reality, this situation never exists.

The amount of physical gold that the COMEX delivers on a daily basis is negligible compared to the massive historical short positions that have existed for decades. For example, during a two-week span across January and February, COMEX arranged for the physical delivery of 543,500 troy ounces of gold with their contracted warehouse depositories, a figure that represents an average of just 38,786 troy ounces of gold per day. At this rate of daily delivery, it would take the COMEX more than two years to deliver all the gold represented by the current net commercial short position should the holders of long contracts ask for settlement in physical delivery.

Through the use of futures markets, the Commodities Futures Trading Commission (CFTC) has granted bankers a mechanism to perform alchemy and turn paper into gold on the COMEX by allowing them to establish obscene short positions that represent 25% to nearly 40% of annual gold production at times while simultaneously allowing them to renege on their fiduciary responsibility to actually physically possess the gold represented by their short positions. In other words, the CFTC has allowed gold to operate under the principles of the fractional reserve banking system on the COMEX futures markets. As I stated above, the net short position of the commercials in gold represented more than 30 million troy ounces yet for the past few months they almost never exceeded delivery of 0.2% of their short position on a daily basis. Many people would refute this argument by stating that COMEX only delivered a minute fraction of physical gold represented by this obscene short position because no institution asked for substantial physical delivery of their long contracts. While it is true that less than 1% of most commodity futures contracts are ever settled by physical delivery, futures markets should not exist to serve the purpose of distorting the underlying reality of supply-demand fundamentals of the actual physical commodity. With gold and silver, this has been the case for decades.

However, the real question should be, “If I asked for physical delivery of an amount of gold that I should be able to receive, would I receive it?” Why? If you were India, China or the United Arab Emirates and you wanted to buy 200 tonnes of gold at the price established in futures markets, but you knew that there was no possible situation whereby 200 tonnes of gold would ever be delivered to you via the futures markets, what would you do? Would you buy 200 tonnes of gold in the futures markets only to know that you would suffer a default of this delivery and likely be forced to pay a much higher price in the open market in the future or would you try to arrange to buy 200 tonnes of gold NOW from the IMF or another Central Bank? Of course, you would choose the latter tactic. The fact that gold cannot be printed out of thin air is the essential quality that makes gold as a form of money much more sound than the Euro, the dollar, the Yen or any other form of fiat currency.

However, tens of billions of dollars of gold exist only in digital form on the COMEX and the CFTC has allowed bullion banks to indeed achieve alchemy with gold (and silver) in the futures markets. By allowing these mechanisms to persist that have absolutely zero to do with physical supply and demand of gold and silver, bullion banks can suppress the price of paper gold and paper silver in futures markets. But in the end, they will never be able to perpetually suppress the price of real physical gold and real physical silver. There will come a time when the prices for real physical gold and real physical silver completely sever the already tenuous umbilical cord they maintain to the suppressed prices of gold and silver established by the agent bullion banks of the US Federal Reserve and the Bank of England in futures markets.

As of February 17, the CME warehouse report stated that their depository warehouses contained 1,645,000 troy ounces of registered gold and 8,292,887 troy ounces of eligible gold. Only two of their depository warehouse have significant amounts of physical gold worth mentioning, HSBC, with 4,311,493 ounces of eligible gold and 266,677 troy ounces of registered gold; and Scotia Mocatta with 3,826,013 ounces of eligible gold and 936,855 troy ounces of registered gold. What does “registered” and “eligible” gold mean? As in everything bankers do, these terms are meant to confuse the average person. Central Bankers have used the same tactics to obscure their true holdings of gold reserves by alternately labeling their gold reserves as Bullion Reserve, Custodial Gold Bullion Reserve, and Deep Storage Gold, without granting any transparency to the definitions of their gold stores whenever they arbitrarily reclassify them with different names.

“Registered” gold is gold that has been assigned ownership and cannot be sold to another party while “eligible” gold is gold awaiting registration or delivery. In other words, a large portion of “eligible” gold may not be eligible at all. Furthermore, there are many questions regarding the “registered” gold that these depository warehouses hold as to whether multiple claims exist upon this “registered” gold. Many may say that questioning the validity of “registered” gold is non-justified paranoia, but the historical deceit of bankers justifies our skepticism, not our trust, in them. Just as multiple claims exist upon every single dollar, Euro, pound and yen that shows up in your savings or checking deposit bank passbook, I still believe that the gold listed as “registered” gold may have multiple owners as well (When it comes to the money in your bank savings and checking accounts, you may have the only claim on the digital representation of the cash money that exists in your bank savings and checking accounts, but that digital representation, since it has not yet been printed in cash, is an abstract concept that exists only in your mind and not in real life).

Though “registered” gold represents gold that has already been assigned to someone, unless that physical gold is in your hands, this does not preclude the fact that bankers may have assigned this “registered” gold to “multiple” owners no matter what they claim. Remember if one reads the fine print of the prospectuses of the GLD and SLV paper ETFs, it seems very likely that multiple claims exist on the physical gold and silver that back both the GLD and SLV even though the vast majority of buyers of these ETFs believe otherwise.

Last week’s Commitment of Traders report indicated that commercial bullion banks were still net short 21,342,700 troy ounces of gold. Given the definitions of “registered” and “eligible” gold, and the amounts of registered and eligible gold that exist in COMEX depository warehouses, it is obvious that bullion banks short gold with zero intention of ever physically delivering well over 90% of the gold ounces they short, even though market mechanisms require them to have the physical capacity and means to do so. Thus, if China, India or any number of Sovereign Wealth Funds wanted to buy another 1000 tonnes of gold, it would be physically impossible for them to even partially fulfill this desire. The 663.83 metric tonnes of gold that are currently represented by the physical offset of the current net short positions of the commercials that is supposed to be physically sitting in the vaults of depository warehouses contracted out by COMEX simply is not there. Furthermore, what is “eligible” for delivery may not even be eligible, and multiple claims may exist on both “eligible” and “registered” gold that exists in the contracted depository warehouses.

In the end, the announced IMF sale of 191.3 tonnes of their gold reserves, though it caused an immediate sharp knee-jerk reaction in gold futures markets, will have a negligible effect on the long-term price of gold. The IMF stated that “it would stagger the sales in order not to affect the markets too much”. However, since sovereign state buyers of gold can not get anywhere near the tonnage of gold they desire from the futures markets, the reality is that the IMF could probably dump all 191.3 tonnes on the market in one month and it would be instantly absorbed by China, India and Middle Eastern sovereign funds before any other Central Banks that also wants in on the sale could get their hands on any of it.

More than a year ago, I wrote an article describing the beginning of a disconnect between gold futures markets in Asia with those in London and New York, as well as the disconnect between physical gold and silver prices with the spot prices established in the futures markets in London. Eventually, due to the fraudulent nature of the gold and silver futures markets that have nothing to do with the physical supply and demand of the underlying commodities and everything to do with the desire of the US Federal Reserve and the Bank of England to suppress gold and silver prices, I believe that this disconnect will widen until there is an eventual total disconnect between the AM and PM London Price Fixes for gold and silver and the actual prices demanded by bullion dealers for real physical gold and real physical silver.

About the author: JS Kim is the Managing Director & Chief Investment Strategist for SmartKnowledgeU™, a fiercely independent wealth consultancy company with zero affiliations with the commercial investment and banking industry. Our independence allows us to critically analyze macroeconomic conditions with a completely unbiased eye, a crucial factor in a market where government intervention into free markets is heavily influenced by their friendly relationships with the investment and banking sector.

Tags: Bullion Banks, Central Banks, Comex Gold Futures, Commercial Position, Commodities Futures Trading, Commodities Futures Trading Commission, Daily Basis, Emerging Markets, ETF, Futures Commodities, Futures Contract, Futures Markets, Futures Trading Commission, Gold, Gold Prices, Gold Reserves, Imf Gold Sales, India, Knee Jerk Reaction, Metric Tonne, Metric Tonnes, Physical Delivery, physical gold, Price Of Gold, Troy Ounce, Troy Ounces
Posted in Markets | No Comments »

Emerging Markets Highlights (week ending 2/15/2010)

Monday, February 15th, 2010

Emerging Markets Highlights (week ending 2/15/2010)

Strengths

• China’s passenger car sales continued to surge by 113 percent in January from a year earlier to 1.32 million units. While year-over-year growth may be affected by the low base one year earlier, January’s print represented a solid 20 percent increase from December.
• Indonesia’s GDP expanded by a higher than expected 5.4 percent year-over-year in the fourth quarter, as lower interest rates and government stimulus continued to encourage consumer spending.
• Taiwan’s exports grew 75.8 percent in January from a year earlier, the highest year-over-year increase in more than thirty years and ahead of expectations, thanks to better electronics demand driven by holiday spending before the Chinese New Year.
• The 4Q 09 results of Itau Unibanco and Vivo in Brazil slightly surpassed market expectations reinforcing the view that Latin American largest economy is on the way to recovery. The results of the home builder, Gafisa, were also ahead of expectations.
• Brazilian industry capacity utilization in December rose to 81.7 percent from 81.3 percent in November, above the consensus expectation of 81.4 percent.
• Brazilian air traffic in January rose 31.6 percent year-over-year with the load factor rising by 6 percent to 78 percent as a result of stronger economic activity.
• At 25.2 percent growth over last year, December industrial production in Turkey came in considerably stronger than expected. It is also worth highlighting that the increase was broad based (see chart below, courtesy of Citi research), with capital and durable consumer goods leading the advance.

Weaknesses

• Although attributable largely to a jump in labor force participation in response to government’s job creation programs, South Korea’s unemployment rate climbed to a ten year high at 4.8 percent in January from 3.6 percent in December.
• Despite government intervention, average property prices in 70 cities in China continued to rise 1.3 percent month-over-month in January, an eleventh consecutive monthly increase.
• Chile CPI in January came in at 0.5 percent month-over-month (vs. 0.1 percent expectation) while CPI in Colombia reached 0.69 percent month-over-month (vs. 0.6 percent expectation).
• All the three airport groups in Mexico (ASUR, GAP, OMA) posted declines in traffic in January.
• January sales of new vehicles fell by 37 percent year-over-year in Russia. There was a strong base effect from January of last year when buyers rushed in to convert collapsing currency into hard assets. Also, the start of its “cash for clunkers” program was postponed from January 1 March 8, so customers are holding out for the state subsidy.

Opportunities

• Weaker than expected inflation in consumer prices, moderating bank lending, and narrowing trade surplus in China in January may provide some relief to lingering fears of early monetary tightening from Chinese policymakers in the near term.
• Grupo Televisa in Mexico, the largest media group in the Spanish speaking world, received a permission from authorities to bid for a stake in the mobile operator, Nextel Mexico (NIHD) that will permit it to offer triple play services for clients. Televisa and NIHD are expected to bid jointly for a new 3G spectrum.
• Earnings release by a bellwether bank in Turkey provides a positive glimpse into outlook for 2010, according to Morgan Stanley banking analyst Magdalena Stoklosa. Margin contraction is less than expected as rebalancing out of government securities had already begun, and improvement in asset quality is coming sooner than expected.

Threats

• If the higher than expected rise in China’s Producer Price Index (PPI) in January, primarily driven by energy and raw materials, proves more than transient, Chinese manufactuers’ profit margin may face challenges as their costs inflate whereas competition severely limits their pricing power.
• A potential deceleration in the economic activity in China would negatively impact resource rich countries in Latin America.
• Continued monetary tightening in China would have a cooling effect on commodity exports, despite current strong demand for steel and raw materials.
• Risk aversion over public finance in crisis Greece is likely to spill over to the periphery countries of European Union, such as Poland, Czech Republic, and Hungary.

Tags: 4q, Brazil, Brazilian Industry, Capacity Utilization, China, Chinese New Year, Cities In China, Consumer Spending, Contin, Creation Programs, Durable Consumer Goods, Emerging Markets, Gafisa, Government Intervention, Holiday Spending, India, Job Creation, Labor Force Participation, Latin American, Market Expectations, More Than Thirty Years, Passenger Car Sales, Russia, South Korea, Unemployment Rate, Unibanco
Posted in Markets | No Comments »

Sovereign Risk and the Price of Oil

Monday, February 8th, 2010

European and U.S. stock markets have taken a hit recently as spooked investors from Shanghai to Sao Paolo were fleeing risky assets amid concern that the financial crisis in Portugal and Greece could spread through the euro zone with vast implications for the fate of the fragile global economic recovery. (Fig. 1)

Liquidate & Buy Dollar

A steep drop in crude-oil prices triggered declines across the commodities spectrum, as investors nervous about the pace of the economic recovery gravitated back to the dollar. Crude oil tumbled to a seven-week low of $71.19 a barrel last Friday, down 14% since the 2010 high of $83.18 reached on Jan. 6.

Investors’ fled for safety drove the U.S. dollar near a nine-month high against the euro. Emerging market currencies also weakened in Asia, while U.S. stocks fell a fourth straight week, the longest streak since July.

A Shift of Sovereign Risk

According to EPFR Global, risk aversion has prompted a withdrawal of $1.6 billion from emerging market equity funds during the week ending Feb. 3, the biggest outflows in 24 weeks, and $516 million has left Asian equities outside of Japan.

The charts from CDR (Credit Derivatives Research) tell the story of this investors’ perception. According to CDR, there has been a dramatic shift of risk in developed nations relative to emerging and less-developed nations when comparing three sovereign risk indexes, SovV, EM and CEEMEA. (Fig. 2)

In SovX, the GIPSI (H/T Zero Hedge) - Greece, Italy, Portugal, Spain and Ireland, represent around 65% of the index risk. In EM, Venezuela accounts for 26%, Turkey, Brazil, and Argentina represents 12% respectively of the EM risk. In CEEMEA, Turkey and Russia represent 49% of the index risk (followed by Hungary and Ukraine each at over 8%).

In addition, CDR finds that the sovereign risks of the emerging economies appear to be closely tied to the price of oil:

“It would appear that the CEEMEA and EM sovereign risk indices are threatened more by commodity price pressures than credit risk currently - and given the ‘relatively’ high price of oil/gas, their risk remains less of a concern than developed nations where the Ponzi appears to be in question.”  (Fig. 3)

Oil Price - A Key Risk Factor

Emerging market countries, such as Brazil, China or India, are evolving since the early 90s. During this period, the issuance of bonds by these countries has increased significantly reflecting their needs for substantial long term and infrastructure investment.

Among the many determinants of risk bonds, the price of oil is a key factor as it plays a significant role in economic growth, inflation, production costs, trade balances and currency. Nine of the 10 economic recessions in the United States since the end of World War II were preceded by a dramatic increase in the price of oil.

A Sensitivity Issue

Oil prices nowadays are extremely volatile, and sharp fluctuations in oil prices contribute to macroeconomic volatility all over the globe. The impact of this volatility on economy varies according to a country’s relative dependence on oil production and exports.

For oil-exporting countries like Russia and Saudi Arabia, a rise in oil prices caused a perception of risk reduction relative to its obligations. Conversely, an oil-importing country sees its risk index increase due to a barrel price shock.

Financial Crisis 2.0?

Last week’s wild commodity price swings underscore how investors aren’t totally convinced that the world economy is on an upward trajectory. Investors are worried that multi-governments’ debt problems will spread globally similar to the subprime crisis in 2008.

In addition to concerns about GIPSI sovereign debt defaults in the 16-nation euro zone, the U.S. is grappling with its own deficits and the high jobless rate, while China began restricting lending last month to prevent high inflation.

Some analysts expect global commodity prices would eventually firm up reflecting economic recovery albeit high volatility; and fundamentals should increasingly dominate expectations and drive prices.

But there are others see the current “correction” as caused by factors very similar those brought on the “financial crisis of 2007-2010” and warned this could signal “a new crisis in development.”

Seeking Negative Beta

In this environment, a defensive play would be to invest or allocate a portion in regions that are less prone to the price of oil, which is a significant sovereign risk factor. Sector wise, agriculture and alternative investment vehicles in real estate or land development should provide some good diversification to any long term portfolios.

Jeff Rubin, Chief Economist at CIBC World Markets pointed out that the United States is less sensitive to oil price volatilities because it is itself an oil producer (5 million barrels out of 19 million barrels the US consumes are produced in the US), so it receives some of the benefit of both higher and lower oil prices. An IEA analysis also indicated that the U.S. should be less affected by oil price shocks than Japan, OECD and Euro zone. (Fig. 4)

This competitive edge probably partly explains how investors still see the U.S. dollar as a safe haven, and Mr. Geithner’s optimism that more debt won’t hurt U.S. credit rating, in spite of the fiscal and economic challenges quite similar to what the Euro Zone is facing.

BRIC minus R

In addition to the United State, GDP growth in Brazil, China and India could get boost from the softening and stabilizing of oil prices and should increase their competitiveness. Brazil and Chindia are all oil producers with aggressive state-sponsored exploration and production efforts and strong economic growth prospect. Brazil, with a new and improved investment grade credit rating, is now largely self-sufficient and has insulated its economy from oil price shock on net basis.

The economic impact of oil prices on oil-importing, developing countries such as China and India could be more pronounced primarily because Chindia are more energy-intensive due to its strong growth rate, and less energy efficient. From that perspective, Chindia, though good prospects could be more of a roller-coaster ride for investors.

Among the emerging economies, lower crude oil prices will be a big dampener for Russian economy. Russia’s two oil wealth funds declined by a total $1.54 billion over the last month, as more funds were transferred to aid federal budget shortfalls. The Reserve Fund, one of Russia’s two oil wealth funds, is expected to run out by the end of 2010.

Hat Tip: Professor Pinch

Tags: Asian Equities, BRIC, China, Commodities, Credit Derivatives, Crude Oil Prices, Derivatives Research, Developed Nations, Dramatic Shift, Emerging Economies, Emerging Markets, Equity Funds, Euro Zone, Gipsi, Global Risk, Greece Italy, India, Market Equity, oil, Portugal Spain, Price Of Oil, Risk Aversion, Risky Assets, Sovereign Risk, Sovereign Risks, Steep Drop
Posted in Markets | No Comments »