Sunday, May 28, 2006

Walking On A Thin Line

OVER the short term, developments in the global and domestic financial markets have fallen squarely to what I have projected for it; particularly of the continuation of the violent shakeout as well as some signs of an intuitive countertrend reaction or of a rebound.

During the last two weeks the Philippine benchmark or the Phisix has lost about 217 points or about a considerable 8.66%, while one may argue that recent events may signify signs a “typical profit-taking” in the eyes of the rabid optimist, the degree and intensity of the recent selling has not been your average “profit taking” but one of the extremes or found most commonly during the bear market cycles or the declining phase of a stock market cycle.

And as mentioned in our previous outlook, the gamut of events has been a globally coordinated one such that the recent selloffs have been seen across the wide spectrum of asset classes.

Just to give you an example, Bloomberg’s Michael Tsang reports that the some of the world’s best performing bourses as Russia and India were compelled to undergo a trading halt to forestall the massive declines, ``Russia and India, among the best-performing markets in the past year, have fared even worse. The Russian Trading System Index has slumped 20 percent since reaching a record on May 6, trimming its gain for the past 12 months to 110 percent. India's Sensitive Index has lost 14 percent of its market value since closing at its highest ever level on May 10. The measure surged 65 percent in the past year.

“On May 23, exchanges in Russia and India halted trading for an hour as prices plunged, while the Micex Stock Exchange in Moscow closed 15 minutes early. The declines helped send the MSCI Emerging Markets Index to its biggest loss in two years.”

Figure 1: Price movements in Russia’s Moscow Times and India’s Sensex (Bloomberg)

Of course, nothing beats visualization. As Figure 1 show, the Russia and India’s recent meltdown after coming off its liquidity-driven heights.

Figure 2: MSCI Emerging Free Index and Phisix

Figure 2 Morgan Stanley’s emerging market index (red line) falling to its critical support level (blue horizontal line) while the Phisix (black line) likewise bouncing off support levels (red horizontal line).

What I am trying to say is that the accentuated gyrations or dislocations have led major financial market bellwethers drifting near sensitive threshold levels. Albeit, present signs of relief, as shown above and below (US Dow Jones), indicate that instead of outright submission or simply falling apart, the bulls appears to have regained some momentum to counteract on the bearish uprising.

Figure 3 Dow Jones Holding Off

And this consolidation or signs of ‘indecision’ have remained so, as similarly evident in the bond and currency markets.

Despite slight indications of amelioration, my outlook has basically remained the same; considering that the risk environment remains high relative to returns, potentials of higher cost of money relative to prospective returns (19 central banks raising rates including the Bank of Canada) and more fools than money making opportunities, makes me extremely cautious and risk averse at the moment.

Nevertheless, the recent rebound could imply that one or two trading sessions does not a trend make or in parallel terms, that the latest volatility could even be an anomaly to the general upside trend. Until we see further concrete signs of stability I’d remain generally underweight unless specific “trading” opportunities arise.

Deutsche Bank: Fed’s Monetary Approaches Equals Different Outcomes

I recently argued that instead of the conventional inflation bogey bandied around by mainstream media, a possible global economic growth slowdown spurred by the US (transmitted via slowdown in US real estate industry), derivative based liquidity withdrawal or possibly a contagion arising from hedge fund losses cutting out margin positions as possible culprits to the recent shakeout.

Deutsche Bank's Asian Macro Strategy (lifted from seems to somewhat echo on my views (emphasis mine)...

``Our macro risk model sees this sell-off as a consequence of a deteriorating global growth/liquidity environment. However, the model is not short because our growth/liquidity overlay is not yet signaling sufficiently weak growth to trigger a short;

``However, the growth/liquidity overlay is deteriorating rapidly - so rapidly, in fact, that there is a strong likelihood we shall enter a new business cycle phase within a matter of weeks or even days;

``In this next phase - which we dub the early slowdown phase - markets reverse the way they react to growth. Weak growth switches from being a negative to a positive. We typically see an aggressive short squeeze and a final blow-off rally in this phase. This happens because markets come to accept that growth is slowing but find encouragement in the "promise" of potential Fed easing;

``Assuming we do enter this phase, we expect to see the markets consolidate above critical support and rally into the August/September timeframe;

``Please note, however, that our macro model sees significant risk that a bear market will eventually unfold if the growth deterioration persists. The risk of an eventual bear market becomes more pronounced if the Fed embarks upon further rate hikes. Our model suggests a Fed funds rate of 5.75% would be sufficient to bring on a bear market;

The anticipations for a FED easing have been floated for most of the second part of the early semester of the year and have led to a liquidity driven rally spread throughout the various assets throughout the world until the past two weeks. While Deutsche Bank sees a growth slowdown as the common denominator on the risk side, the countervailing repercussions arising from “expectations” of a possible Fed easing (a relief rally from short covering) or from further hikes (an unraveling bear market). In both instances, the risk factors appear to be “weighted” than prospective returns.

Merrill Lynch: Dead Cat’s bounce on Bullish Outlook

Merrill Lynch’s Emerging Market Outlook (Outflows = Lows) also lifted from equally stresses on the emerging risk prospects but at a much ‘subdued’ level (emphasis mine),

``Inflows have ceased and modest redemptions have begun. According to, EM equities have just had one of their worst weeks for fund flows this year. Inflows slowed to just $43 million (compared with weekly average of +$1.6 billion) and investors pulled money from both GEM and EMEA funds in the week to May 17th.

``Leveraged funds have shifted decisively from long to short and global equity mandates have reduced their emerging market exposure considerably. High daily levels of volumes indicate that non-dedicated investors have moved quickly to greatly reduce exposure. Less "greed" is a good thing. But investor positioning does not yet suggest that a quick return to the EM bull market is plausible. Sentiment is not "irrationally pessimistic" and the "buy-on-dip" spirit has not been broken, in our view. Moreover, we are yet to see the massive fund outflows which normally signal a decisive market low. The May meltdown best mirrors the 21% sell-off in EM in April/May 2004, both in terms of speed, magnitude (see Chart 4) and causation (risk aversion, rate tightening fears, EM FX and debt markets in a spin and so on)...

``So while we do not see the inflation or the U.S. dollar collapse to predict the bull market is over, our reading of investor positioning and sentiment today argues that a modest dead cat bounce is the best we can hope for in coming weeks (as was the case in 2004).

In other words, the recovery prospects recovery on the emerging market class as described by Merrill Lynch is likely to be one caution or “U-shaped” recovery rather than of an abrupt one (“V-shaped”).

BCA Research Hedge Emerging Market by Shorting Metals

BCA Research, on the other hand recommends emerging market investors to “hedge” their portfolios via taking on “short” position on metals instead of liquidations...

Figure 4 Emerging Market vs. CRB Metals

``We are still positive on EM stocks over the long haul, but the near-term turbulence could persist. A possible strategy to reduce risk for EM equity investors is to go short the CRB metals index as a hedge. EM stocks closely track the industrial metals index, due to the sensitivity of both to global growth. However, the gains in metals have outpaced EM equities by about 25% this year. In addition, there seems to be a well-defined cycle in EM equity relative performance against the metals index. The sharp drop in the ratio of the two indexes appears to have set the stage for a reversal, leading to a period of metals underperformance.”

BCA remains largely bearish on copper over the near term on the outlook of possible weakness from the demand story out of China.

Jim Jubak: Yen Carry Tumult

And there is also the Yen Carry trade factor previously discussed in my Apr 24 to 28, edition, (see Improving Your Portfolio Returns by Seeing the Unseen), where I mentioned that Japan’s monetary base has been bloated by its government to “reflate” the economy (even larger than the US), whose monetary policies (Quantitative Easing ‘QE’ and ‘ZIRP’ Zero Interest Policy) has led to massive exports of capital outside Japan to the tune of $1.8 trillion(!!!) or something like 15% of US GDP or 3% of US assets.

According to Jim Jubak MSN Money editor, writing for “How Japan Sank the US, (emphasis mine),

``Now that the economy is finally growing again and now that prices aren't sinking any longer, the Bank of Japan has given two cheers to the return of inflation and has started to remove some of that cash from the financial markets.

``In the last two months, the bank has taken almost 16 trillion yen, or about $140 billion, in cash deposits out of the country's banks. The country's money supply has fallen by almost 10%. The Bank of Japan isn't finished pumping out the liquidity that it had pumped in. That should take a few more months. And when it is finished, the Bank of Japan is expected to start raising short-term interest rates.

``The moves to date by the Bank of Japan aren't enough to radically diminish global liquidity, but they are enough so that the investors who have fed some of the world's riskier markets understand that the trend has turned.

In other words, some of the massive amount of leverage employed using the Japanese Yen as source funding for the hunt of yields across global assets could have been recently curtailed by the rising prospects of Japan to “normalize” its monetary policy.

In effect, Japan’s turn to tighten its monetary screws could have possibly let off a wave of destabilizing domino of deleveraging off the world’s financial markets!

Trader George Kleinman: Bullish Gold Prospects

Finally, one sanguine outlook comes from veteran commodities trader, Mr. George Kleinman. The impetus of the recent corrections in Gold has mostly been due to the unwinding of open interest defined by as the ``Total number of futures or options on futures contracts that have not yet been offset or fulfilled for delivery.”

As shown in Figure 5, while Gold had been reaching fresh 25 year record highs in mid May, open interest diverged with its underlying prices (blocked arrow bottom window) reflecting that “smart money” had been liquidating while weaker hands had been taking over.

Figure 5 Gold and Open interest courtesy of George Kleinman

On the other hand, the present decline in Open Interest is a possible sign that weak shorts have been bailing out.

Mr. Kleinman observes,

``OI is now down to approximately November 2005 level, around the same point where gold broke above $500 for the first time in more than 20 years. That began a $200-per-ounce bull run. This is potentially very bullish for the gold market.

``Here’s another way to look at it: When the last of the weak longs has liquidated (and the last of the strong shorts--the “smart money”--have covered their profitable short positions), there’s a lot of room for gold prices to move back up. The next bull run will unfold as OI is being built back up.

``As soon as OI and the per-ounce price start to rise again in unison, I look for the next leg up to begin. I think we’re very close to a major new buying opportunity in the gold market. The last leg took gold up about $200 ounce, from about $530 to about $730. Assuming $636 turns out to be the bottom, a similar up move would take gold to more than $800.”

And what has this “Gold” got to do with emerging markets? Figure 6 courtesy of gives away the correlation so far between gold and the MSCI Emerging Free during the past three years. A correlation is a correlation until it isn’t.

Figure 6 Gold vis-à-vis Emerging Markets

In essence, while today’s global financial markets reveal of heightened risks as detailed by the richly diverse outlooks of the distinguished institutions and personalities mentioned above, there are possible divergences in assets that may unveil itself in the fullness of time.

If indeed Gold, as a barometer given its present strong correlations between the performance of emerging assets and the monetary metal, could be seem to bottom out in the interim, the odds are that emerging markets could follow suit and may outperform anew as Gold seeks new highs in spite of the present uncertainties. It all boils down to alternative investments or fleeing from paper based assets.

In the invaluable words of the prescient commodity oracle, Mr. Jim Rogers, ``During a time when many of the world’s largest economies were in recession in the 1970s, oil prices increased several fold. The UK went bankrupt during that period and had to be baled out by the IMF. But oil and commodity prices boomed. Another major boom in commodities started during the depths of the Great Depression, in 1933. That was arguably the worst collapse in global demand in history. Global trade fell more than 50%, yet that was the start of a long commodities boom.

I have been patiently waiting for such a divergence to meaningfully unfold.

Friday, May 26, 2006 Morgan Poliquin: "Sustainable Development" Privileges the Few

From "Sustainable Development" Privileges the Few
by Morgan J. Poliquin

Nomenclature and in particular, catchy phrases and slogans, are integral to the institution and leadership of political action and violence as well as simplifying or condensing the rational for such action into neat and all encompassing phraseology.

Take for example, "from each according to ability, to each according to need." This trite phrase uttered by Bolsheviks encapsulated the raison d'être and legitimized the terror inflicted by their foot soldiers against "bloodsuckers" and "enemies of the state" who were murdered and relieved of their property. Who was a bloodsucker or enemy of the state was decided upon by Bolshevik leadership.

In other words, the state, which manifests itself in the form of certain individuals supposedly acting on behalf of everyone, will determine what peoples' abilities and needs are. The problem with forcefully organizing society in this way is that every human is different, possessing unique abilities and needs according not to what someone in a position of power has allotted them, but to their own sensibilities.

Not only is force to achieve these ends immoral, but it is impractical and wealth-destructive. We all condemn slavery, so why is it not immoral to force people to act in a way that is deemed to be beneficial to them?

In 1987 a new but eerily similar political term was coined — "sustainable development" — which is defined as follows:

Development that meets the needs of the present without compromising the ability of future generations to meet their own needs.

This definition is attributed to Dr. Gro Harlem Brundtland, a medical doctor and the former Prime Minister of Norway, who, at the bequest of the then Secretary General of the United Nations, established and chaired the World Commission on Environment and Development. Her Committee produced a report entitled Our Common Future in which the definition first appeared.

Subsequent to the publication of the report, an enormous amount of meetings have been carried out, largely attended by state officials, state-financed intellectuals and the management of large corporations, to discuss the implications of such a statement and in particular its implementation in the form of coercive state regulations, which are coming into effect worldwide.

These regulations are far-reaching and designed to increasingly impact people's everyday decision making.

The private sector has been forced to swallow this new pill whole and almost without question. Companies are anxious to demonstrate how their practices are sustainable in order to curry favor with regulators.

This rush to compliance is all too reminiscent of the Y2K fiasco when every company and organization was required, by law, to devote significant resources to demonstrating that they were Y2K compliant.

Coercive communism is a failure because it consists of a self-appointed elite forcing needs and abilities upon people against their will. Needs and abilities cannot be determined arbitrarily by leaders; they stem from each person according to their own unique value system.

Similarly, "enlightened" leaders should not be able to force us to act according to their assessment of what future generations' needs may be. Yet this is precisely what they propose.

Apart from the immorality of such an imposition, it doesn't even make sense practically. This is no more apparent than in one of the most integral of activities to industrial and modern society: mining. Anything we utilize has either been grown or mined. The most useful, sturdy and long lasting of things, such as concrete, steel and copper wire, are made from material that is mined.

Metals are not naturally occurring in forms that are readily useful; formulae derived from experience and labor are required to produce metal in a useable form. The cost and effort to extract and refine elements such as iron and copper are so high that metal has always been recycled which is possible because the properties of metals are not lessened by nature over time, unlike wood and other "farmed" substances.

The Bible speaks of turning swords into plowshares and that is what even industrial societies do today. For example, roughly 50% of all copper "consumed" in the United States is recycled. There are no government mandates that force this on people, it is just good sense on account of the fact that it is cheaper to melt a metal item and remake something new with it than to search for a new copper mine, develop it, dig out the copper, refine it and then make the new item.

In this very real sense, mining is infinitely sustainable; the needs of future generations will be met over and over again by the metal that past generations have found, extracted and refined. Before the metal was found, extracted, and mined, it was useless to humankind and there was nothing to even evaluate as sustainable. The fact that the metal has been removed from the ground and no longer exists there is not a sign of non-sustainability; rather it has created a permanent and unending supply of copper that can be recycled and reused ad infinitum.

Legislating sustainability is another attempt to replace the collective decisions of many in the market place with the coercive will of the few. In a free market, with increasing scarcity of a given resource, its price tends to rise, encouraging economizing on behalf of those who consume the resource.

Why then all the fuss about making industries such as mining sustainable? Perhaps the people behind the legislation — the intellectuals, the legislators, and the large business firms that already dominate their industries — form an alliance that serves their own self-interests. The revered intellectuals sit on endless committees defining meaningless terms like sustainable development and are paid handsomely for doing so.

They are also lauded, much like actors, by their own organizations, which continually self-produce awards. Mingling with media, wealthy patrons, government officials, and business leaders, they frequent the most exclusive locations on the planet to discuss the implementation of their leadership. The self-interest of the legislators and government is readily apparent as their incomes are derived from the taxes that society is required to pay, purportedly for their management of the new laws and regulation that will ensure sustainable development.

Established business firms would like to prevent others from offering similar services to those they provide. As Dr. Gabriel Kolko pointed out in his Triumph of Conservatism, the rise of government regulation in the 1900s in the United States resulted directly from the appeal for its implementation by established businesses.

Regulation, far from being established by altruistic intellectuals and far-sighted politicians, creates government-enforced cartels for (and was conceived by) the established businesses that were losing their command of the marketplace to new business that were providing cheaper and better products and services.

The regulation favored the large, established firms. The implementation of sustainable practices is condoned, supported, lauded, and financed by the big businesses of today. Like their 19th-century counterparts, they have the accounting staff and present infrastructure to handle the extra costs of becoming "sustainable." It is the little guy — the new entrepreneur — who is paralyzed by the burden of the new legislation.

The enlightened intellectuals behind sustainability today are likely dupes who are happy to exchange accolades, notoriety, and large UN salaries for creating nonsensical legislation that only serves to inhibit new enterprise and entrench established business interests.

Who is hurt by this? Certainly anybody who would like to enter a new business into the marketplace, but more importantly it is the consumers of the products these industries produce who are harmed. Coercive legislation reduces the diversity of quality and prices among competing products. It robs consumers of options, raises prices, and destroys wealth.

Nobody can decide what is "sustainable" for another person. Every action requires a weighing up of costs and benefits. To implement any one person's idea of sustainability on everyone else will result in loss. The idea that people are not able to make these decisions on their own, and require leadership and coercive laws to determine what is best for them, is essentially to implement slavery.

Communists told us to follow them because humanity was at stake. Today we are told that the planet itself is at stake. It sounds like a new way of saying the same old thing. To sacrifice the needs of individuals for the sake of the many will result in great benefits to the very few, at the cost of the many.

Morgan Poliquin is a registered professional Geological Engineer, holds a Masters degree in Geology, and manages a publicly traded exploration company.

Sunday, May 21, 2006


One of the amazing feats during the recent run up has been the rush of adrenalin by Petroenergy Resources . The small company has a market capital presently of about P 1.9 billion (as of May 19th) which jumped from only about P 500 million in the 22 sessions past. It has been the only oil revenue generating publicly listed exploration company in the Phisix. While other oil exploration companies have sizeable contract rights over prospective domestic oil fields, PERC’s revenues emanates from its partnership with Vaalco Energy Inc., at a large prolific offshore project site in Gabon, West Africa.

PERC’s story is practically an embodiment of the quintessential investing mindset of local investors; with a knack of speculations and devoid of fundamentals.

Since its peak during the initial run, prompted by a dividend play, sometime middle of last year, PERC’s share prices remained stuck in inertia, even despite its pronouncements that it had doubled its earnings as early as the third quarter! Investors were basically unmoved by such an earnings surprise!

Further, its operating partner Vaalco Energy declared a 28% rise in diluted earnings for 2005 as early as March 9th of this year, yet the market appeared to have ignored such pleasant positive unexpected news while PERC’s share prices continued to languish even as its oil peers Oriental Petroleum and Philippine Overseas made substantial advances due to a bullish general sentiment...until of course, April 18th.

PERC: Technically still overbought

On the 19th of April, PERC’s prices suddenly caught fire and trailblazed upwards for about 22 days until Friday May 19th where it closed at 16.75.

The move caught me by surprise since it leapt from about P 4 to over P 19 with apparently no logical explanation for such stellar performance.

I had initially thought of another dividend play at work, but for an advance of over 300% looks something immensely more than what it seemed.

Then came thoughts of a possible new oil reserve find or an activation/speculation of its oil drilling project/s locally. Yet, the market remained as animated and heaped by persistent speculations with no news to back it up.

I attended Thursday’s investor’s briefing precisely to find out the reason for its recent explosion only to be disappointed. What has been said in the presentation, aside from the financial updates, was basically the same as what it had reported last September.

Then came Friday morning’s news disclosure. The company announced that its chairman Delfin Lazaro sold his 1,000,000 shares on the March 16th and 17th alongside with colleague Director Cesar Buenaventura and company president Milagros Reyes.

At the end of the trading day Friday, the company likewise disclosed that Monte Oro acquired 10,015,098 shares which represented 9.51% of the company’s outstanding stock! This had to be it! From April 19 to Friday’s close, total shares traded was a little over 65 million shares! This meant that about 15% of the accrued activities during these days had been due to Monte Oro’s acquisition at the board!

Without such substantial acquisition activities there would not have been a big advance, not earnings not dividends, as previously shown have driven its share prices but a serious investor willing to accumulate at market prices!

With the completion of the buy-in plus the unloading of insiders, it certainly looks likely that the play is over!

What remain for the company would be the dividends it may likely declare, considering the huge windfall arising from the sizeable spike in oil prices. However, the impressive advance of its share prices has made this more or less moot.

I remain bullish over this company, which allowed me to score a homerun for a second time, but would acquire back its shares when the public has dispensed of its speculative interest.

Besides, I foresee a major oil find by the consortium given the bright potentials of its fertile oil fields.Posted by Picasa

Global Capital Flow Analysis;Raising the Yellow Flag!

``If a man gives no thought about what is distant, he will find sorrow near at hand”-Confucius

If there is anything that has been validated during the past week or so, is that global markets have been porous and that capital or portfolio flows have reflected a singularity of action across a variety of asset classes all over the world. This is what I have been writing about all along, that the world financial markets have been evolving towards increased integration such that global capital flows have been materially correlated to the directional paths of the financial benchmarks, including that of the Philippines. In the words of acclaimed French critique and Nobel Laureate Andre Gide, ``Everything has been said before, but since nobody listens we have to keep going back and beginning all over again.”

Well, some of my contemporaries have commented on these, mostly taking a leaf out of the observations from the international media, yet the others appear to be in a pertinacious state of denial citing “knee-jerk” reactions over what has been happening. Knee-jerk reactions are usually a very short-term phenomenon and not stretching over a week or longer.

On the other hand, there are also some who bluster about some arcane formulaic “timing” elixirs towards stock market investing. Of course, I have to admit that at times there have been occasions where “hot strategies” had one way or another worked, such as the Nifty Fifty in the late 60’s or the Dogs of the Dow in the 1990s, however, once they have become too popular or when the crowd starts to jump in they cease to deliver what is expected of them. Further, these erstwhile “hot strategies” were not timing tools, unlike those ventilated by our local “hotshots.” Market savant Warren Buffett once admonished on this, ``Read Ben Graham and Phil Fisher, read annual reports, but don't do equations with Greek letters in them."

Raising the Yellow Flag

``All of our knowledge has its origins in our perceptions." Leonardo da Vinci

Today’s investing environment seems to manifest a ‘yellow’ or warning flag. In my case, such milieu translates to a necessary action: portfolio underweighting. I have learned to identify cautionary indicators on the following circumstances; when “there are more fools than money than of money more than fools”, when “cost of capital rises above returns of invested capital”, and/or when “the risk prospects rises above rate of return potentials”.

I have noted in our previous outlook that world financial markets appear to have weakened arising from explanations in the causalities of “continued higher interest rate expectations and high inflation data” when these phenomenon has bizarrely been long imbedded into the financial markets or into the global economic framework for quite sometime.

As argued for last week, as in the past (see November 14 to 18 Inflation Cycle A Pivotal Element to Global Capital Flows) global central banks have nurtured the seeds of another secular inflationary cycle as to pump up economic growth taking advantage of the “disinflationary” backdrop caused by the inclusion of formerly closed economies as China and India, which have greatly contributed to competitive “low price/cost” pressures of globalization via the transmission mechanisms of excess capacities and labor surpluses (in the past), aside from the rapidly evolving technological breakthroughs especially in the field of information technology and communications. Of course, such inflationary cycles would vacillate over the long term with peaks and troughs rising over generations and have been manifested in the past by rising gold and commodity prices as discussed previously (see March 27 to 31 edition, Listen To Your Barber On Higher Rates and Commodity Prices!).

In short, I am predisposed to think that ‘rising inflation and interest rate concerns’ have served as the scapegoats for the largely vulnerable investing public seeking for “oversimplified” explanations to the present crosscurrents.

US led Global Market Correction

Figure 1: Chart of the Day: Nasdaq Testing Critical Support

While there have been incipient signs of stresses in a rather risk complacent or previously low volatile world, the recent selloffs in Iceland’s currency & bonds and the crash of Middle East bourses from their stratospheric perch could have been a warning signal. But no less than the recent swoon in the US markets have led to a ripple effect throughout global financial markets not limited to equities (suggested reads from the GuardianTen days that shook the world's markets”).

Figure 1 shows of the former market leader the major technology weighted benchmark, the Nasdaq, courtesy of Chart of the Day, testing on its 21-month CRITICAL support level. The Nasdaq and the major US benchmarks could be expected to bounce off coming in the coming sessions from the succession of serial selling (due to technical oversold levels) but needs to keep the 21-month trend intact.

Figure 2: Philadelphia Housing Index Breaks Down!

Could this be a mere hiccup? With the US debt driven and consumer led economy banking on its housing or real estate industry for continued financing of its consumption driven engine, the recent breakdown of the benchmark housing index as shown in Figure 2 aggravates my concern about the resiliency of the global markets, especially under the background of an inimical continued tightening “expectations” and high energy prices. Rising cost of capital appears to be edging towards or closing in on Returns of Invested Capital?

Aside, according to estimates by economist Ms. Asha Bangalore of Northern Trust, ``housing has accounted for roughly 40 percent of new private jobs since the end of the recession.”

Figure 3 courtesy of Northern Trust, Rising Rents and Slowing Homeownership in the face of rising rates

In another case of what goes around comes around, the US CPI index which was allegedly designed to suppress inflationary indicators for political and financial expediency has manifested rising inflation figures emanating from an emerging trend of RISING Rents!

Bloomberg analyst Caroline Baum in her recent article wrote (emphasis mine), ``Sure, owners' equivalent rent, an imputed rental measure that is 30 percent of the core CPI, accounted for 40 percent of the April increase. But it was that same component that artificially depressed the core CPI in 2003. And the Fed wasn't warning everyone that inflation was understated.”

As shown in Figure 3, courtesy of Asha Banglore of Northern Trust, the left chart shows that from the depths in 2003, rents as manifested by Rent of Primary Residence (blue line) and Owner’s equivalent Rent (red bars) has been on an emerging uptrend to collaborate the views of Ms. Baum. This comes in the face of rising mortgage rates (30-year red line), as depicted on the left chart, coincidental with an equally “toppish” percentage of homeownership (blue line).

In other words, the global financial markets could have been telling us possibly of an unraveling of the US real estate industry which is expected to slowdown the consumption driven US economy.

As to whether the Big “R” word comes into fore, or is simply just a slight deceleration remains to be seen. However, in ten days, what has clearly devolved was of a well know axiom `` when the US sneezes the world catches cold”. As to when a probable divergence among asset class would emerge remains to be seen. An attendant sign of rising prospects of risk/uncertainty relative to returns?

Commodity and Bond Markets Aver!

One thing that I learned and adhered from one of my favorite strategic thinkers Dr. Marc Faber is that not to listen to analysts but to listen to the markets instead. And that is essentially what I have been doing; interpret from what the market is essentially saying instead of trying to portray myself as “intelligent sounding” as most contemporary analysts are wont to do. It is the same premise that I ask you not to listen to me but to make your own deductions from your source of data. This outlook is simply a result of my lowly research to aide my decision making process relative to investing which I have been imparting with you.

For those of you who can recall, I mentioned during the last outlook that signs had been that the outstretched prices of precious metals have been petering out. I have likewise suggested you to take profits off the table for some mining issues which remained exceedingly overbought.

Figure 4: courtesy of stockcharts and shows of confirmed downward dynamics of Copper and Gold

If inflation had been the “primary” concern then why has gold been going down as well, (when gold is widely reputed to be an insurance against inflation)? One may explain that the surge in gold prices has “come too fast too soon”, which appears to be a big possibility, aside from of course, the possible unwinding of several hedge funds positions which recently piled upon the monetary metal as previously evinced by the huge jump in commodity derivatives (see May 1 to May 5 editon...and the Falling US Dollar Index For a Rising Phisix, Albeit Caution is Warranted).

Over the week, gold fell $54.30 or 7.6%, whereas copper has lost 10.2%, silver down 13.2% and palladium off .6%.

Although relative to copper prices, its recent furious rise amidst the prospects of a slowdown is nonetheless an expected development. According to, ``Building construction accounts for more than 40% of all copper use. Residential construction is about two-thirds of the USA building construction market.” In short, falling metal prices (industrials) appear to be conforming to the recent US led decline in the global financial markets bolstering my case for a US led slowdown.

With the prospects of a material correction in key metal prices (as shown above) which may continue for quite sometime, confirmed by the downward dynamics in its prices, compounded by attendant increase in volatilities in the global financial markets, and coupled with a possible risk of a slowdown in the global economies, I would suggest for you to take rebounds as opportunities to significantly underweight on resource based issues. While I remain bullish over the long cycle for the resource based investments, the possibility of a sharp correction could be large enough to merit buying on bargains instead of simply holding on.

Figure 5: Rallying US dollar and falling US 10 year yields

Finally, US treasuries appear to be mounting a rally, following the recent sharp selloffs, as shown in Figure 5, in the light of a firming US dollar. Rallying US sovereign bonds deemed as “risk free” are essentially a flight to safety. Gold’s recent infirmities have spurred the rally in the US treasuries. It likewise could be interpreted as a short term respite from inflationary expectations, ergo appended outlook for a possible economic deceleration in the US.

Further, the firming US dollar could be emblematic of a “lighting rod” syndrome following the recent shocks. These developments highlight capital efflux from global assets back into the US dollar and US bonds, for the moment. Again, all these are manifestations attendant to intensifying volatility, increasing instability and heightened risk of a slowdown.

In Asia for instance, currencies fell almost across the board mostly on outflows from equity markets. According to Bloomberg’s Jake Lee, Indonesia’s rupiah fell 5% while its equity benchmark fell a massive 7.9%! ``For the week the Thai baht, Philippine peso, Singapore and Taiwan dollars also weakened. The baht dropped 1.1 percent to 38.11 per dollar. The Philippine peso slipped 1.8 percent to 52.68, according to the Bankers Association of the Philippines. The Singapore dollar declined 1.4 percent to S$1.5838. The Taiwan dollar lost 1.8 percent to NT$31.948...The Korean won dropped 1.5 percent this week to 946.25 per dollar, according to Seoul Money Brokerage Services Ltd.” It has indisputably been a global event.

Derivatives Provoked??

There are of course, jitters that the present shakeout had been derivatives based. Leveraged derivative positions on stock markets or ``variance swaps” have been forced to close due to the recent spike in stock market volatility. Gillian Tett of the Financial Times reports, ``The recent sharp falls in stock markets appear to have been exacerbated by an unusual wave of derivatives activity on the part of hedge funds and big banks, some traders on Thursday indicated...In particular, some banks and big investors appear to have been forced into selling large amounts of equity futures because they have been taking large, leveraged bets on the direction of stock market volatility in recent months – and these bets are now unravelling because the equity markets have recently fallen sharply.”

Some may argue that the recent declines may represent Wall Street’s metaphorical tenet of buying “when blood is on the streets”. But this is no blood on streets. Blood on the streets denote of panic, outright fear or of bullish capitulation. The global financial markets are coming off from record highs (“euphoria” so to speak) which means that given the profuse liquidity backdrop and the reduced risk premia, there had been more fools than money or fools chasing for money, in the hope that a greater fool would assume his risks (Greater Fool theory).

There are those who take on a bullish outlook as the BCA Research, which views the diminished prospects of inflation based on the activities of bonds would set pace to a next rally phase. My assumption here is that BCA could be expecting the FED to sanguinely resolve its present dilemma (raise rates provoke a slowdown; pause and risk runaway inflation). I doubt such optimistic resolve but instead share of Dr Frank Shostak’s, of the Ludwig von Mises Institute, viewpoint (emphasis mine)...

``Sooner rather than later, Bernanke's Fed policy will assume a reactive nature — the US central bank will respond to the data. The fact that the data tends to mirror the effect of past Fed's monetary policies means that the Fed is likely to respond to its own past actions.

``The Fed tries to control the future but ends up only chasing its own tail, which leads to more confusion and uncertainty. All this could be further aggravated if Bernanke were to start setting targets for price inflation. As is always the case with centralized monetary planning, attempts to stabilize only bring about more destabilization.”

In essence, the markets today have been running on ambivalence. As to whether this signifies as simply a typical correction or most importantly, a possible critical threshold that embodies an “inflection point” is something that has yet to be established. As such, prudence would be a better alternate to valor. Staying on the sidelines would be rather judicious while waiting for the markets to resolve its impasses or until a clearer trend would have surfaced.

To recap, the present market debacle has been attributed by mainstream media and personalities to “rising inflation and interest rate expectations” whereas markets appear to tell us that an economic growth deceleration by the US could have been the effective trigger for the recent selloffs. This has diffused into the global markets and among a variety of assets. Moreover, circumstantial evidence reflects on a possibility of a derivative ignited carnage. Under both circumstances, heighten volatility presently suggests more than a simple shallow correction but of a possibility of the risk of a major “inflection point” or a market “top” (US).

The selloffs has markedly damaged several financial market indicators such that even if we expect a short term bounce off the oversold levels, present threshold levels need be mended or rectified as to be reckoned as merely “short term” blips.

Under the shadow of greater risk more than the prospects of returns, plus rising expectations of a narrowing margin between cost of capital and returns on capital, plus manifest dominance of more fools chasing for lower profits, I would take to consider the present environment as underweight or alternatively overweight cash or short term bonds (for Peso denominated assets).

Saturday, May 20, 2006

Bloomberg: Commodities, Led by Metals, Have Biggest Weekly Drop Since 1980

Time for that much needed excerpt from Bloomberg:

"Commodity prices had their biggest weekly drop in more than 25 years, led by metals and grains, on speculation that higher interest rates will erode the appeal of copper, gold and silver as alternative investments.

The Reuters/Jefferies CRB Index of 19 commodities fell 5.4 percent this week, the most since December 1980. The CRB reached a record on May 11, fueled by investor demand for gold and shortfalls of industrial metals such as copper. Oil declined to a six-week low today from a record last month as U.S. fuel supplies gained and tensions over Iran's nuclear program eased.

``The speculators are piling out of the metals,'' said James Vail, who manages $700 million in natural-resource stocks at ING Investments LLC in New York. ``There's been so much money made in this sector that people are trying to protect themselves. There was skepticism on the upside, and now there's panic on the downside.''

This week, copper plunged 10 percent, the most since October 1994, and gold tumbled 7.6 percent, the biggest drop in more than 15 years. The CRB Index dropped 19.46 this week to 342.29. It reached a record 365.45 six sessions ago."

Monday, May 15, 2006

Inflationary Pressures Long Extant; Asian Equities Depends on Growth

``By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” -- John Maynard Keynes

We are living on interesting times indeed.

The Phisix remained vivacious (up 1.94% week-on-week) amidst the recent precipitate correction across diverse asset classes in the global financial markets. (Needless to say, the Philippine benchmark has been markedly supported by torrential foreign money inflows and surprisingly inexorable signs of continued enthusiasm exuded by local investors taking up a majority of last week’s trading turnover despite the huge groundswell in aggregate peso volume turnover sans special block sales.)

Whereas in contrast to 2003 to early 2005, despite the falling US dollar trade weighted index, global markets rose on a tide of ex-US dollar asset accumulation, today, we are witnessing an antipodal perspective; falling markets in synchronicity, as shown in Figure 6.

Figure 6: Dow Jones Asia and World Stock Index (left), JP Morgan Emerging Bonds and Morgan Stanley Dean Witter US Government Trust Bond Index (right)

One week does not a trend make though, yet what is bruited about by mainstream media as the causal factor behind the series of decline is of the growing “inflation” concerns as exhibited by rising commodity prices. And that being so, rising inflation would translate to the FED continuing to raise interest rates. I have noted that rising gold prices has in the past signaled rising interest rates (see March 27 to 31 edition, Listen To Your Barber On Higher Rates and Commodity Prices!).


Today’s market has been dissonant. Commodities have been rising since the advent of the millennium (media notices it only now?). Second, if the Fed’s continued rate increase is a concern then why is the US dollar down 1.3% this week to its lowest level since March 2005, considering that the trade deficit has fallen below expectations should have ameliorated its cause? Should it not be that rising short rates would benefit the US dollar by manner of a larger yield disparity as the case was throughout most of 2005?

Inflation has long been extant in the financially driven global economy suppressed only by government’s manipulation of its statistical data.

For instance, courtesy of Gavekal Research as shown by Figure 7, three leading indicators have been warning of a rising clip of economic growth indicative of emerging inflationary pressures since its trough in 2005 in OECD countries.

Figure 7 Gavekal Research: OECD leading indicators

Second, in the US, the changes enforced or effected by the different administrations (from the Clinton regime to the present) on the computation of the key inflation indicator, the Consumer Price Index (CPI), has arbitrarily suppressed the inflationary figures.

Economist John Williams see figure 8, shows that using past methodology prior to the massive changes in the statistical makeup of the present CPI framework, CPI figures are running about 3 percentage points above officially stated figures!

Figure 8: Shadow Government Statistics: Alternate CPI Measures

Such is the reason why Gold and commodities are running berserk simply because real interest rates are still in the negative! This translates to effectively a still EZ money policy in spite of the recent 16th rate increase by the US Fed.

What we could possibly be seeing now is a symptomatic prelude to a US dollar run, if gold ever hits over and above $1,000 per oz, aggravated by signs of continued decline of US sovereign bonds and rising inflation pressures! Again I don’t wanna sound alarmist but we’ll take the market as it is.

Finally, rising currencies have not been detrimental to the advancement of the equities in Asia, but a slowing world growth will, notes the BCA Research’s on its latest outlook on present currency trends and Equity performances Asia; (emphasis mine)...

Figure 9: Emerging Asia Rising Currencies and stock Indices

``Currency appreciation will not derail the Asian equity advance unless global growth decelerates markedly. Asian currencies have been steadily appreciating against the U.S. dollar this year, with a weighted basket up nearly 4% year-to-date. But the rise in regional currencies has not proved to be a headwind for stocks—while Asian equities have lagged their emerging market counterparts, they have posted solid gains this year. Moreover, with the U.S. dollar falling against other major currencies, Asian currencies remain cheap on a real trade-weighted exchange basis. The bottom line is that a modest, albeit steady, appreciation of Asian currencies will not prevent the region’s equity markets from moving higher.

Need I say more? Posted by Picasa

A Real Estate Boom in Asia Pacific

Even prior to the recent improvement seen in the domestic equities market, one industry that has benefited from overseas remittances inflows has been the real estate industry (see January 10 to 14 edition As the Peso rises, Domestic Investment Stocks Lead the Way).

In addition, the prospects of a domestic investment led recovery could augment the industry’s present conditions, (see November 29 to December 30, 2004 Domestic Investment to Help Drive the Phisix?).

Aside, parallel roseate growth prospects from the services sector; particularly, the information and technology, Business Process Outsourcing (BPO) and Business Services Outsourcing (BSO) (see November 14 to 18, 2005 edition, Age Of Internet Boosts Domestic Economic Environment), tourism and the medical services could help churn a ‘critical mass’ to bolster the industry.

Notwithstanding, the recent surge in the prices of soft commodities such as sugar, rice, coffee and other agricultural products could likewise attract sufficient investments that may lead to more demand for properties catering this previously depressed sector, one which has a sizeable impact to the rural population.

Moreover, relative to investment flows, growing regional trade, financial and economic integration could help boost direct or indirect demand for various categories of properties in the country.

Finally, the rising Peso has been providing for a subliminal trigger for local investors to reinvest back into Philippine based assets, as well as, foreign portfolio flows into the country considering a higher yielding currency relative to its traditional favorite safehaven; the US dollar, given the present deluge of global liquidity. Ergo, the Philippine real estate sector could be seen as one channel or beneficiary for possible investment flows from local or foreign investors looking for outsized or above average profits.

Figure 3: USD/Philippine Peso (blue line) and Philippine Property Index (black candlestick)

As shown in Figure 3 the recent attempts by the USD/Philippine Peso to fall or a rising Peso coincided with a jump in the Philippine Property Index as indicated conversely by the red arrows above, i.e. peak USD/PHP=trough Philippine Property Index and vice versa. In short, somewhat like the Phisix, the Property sector appears to manifest an inverse relationship in its movements with the local currency vis-à-vis the US Dollar.

By the way, the domestic Property bellwether consists of the two major heavyweights such as Ayala Land and SM Primeholdings , as well as second and third tier issues such as Belle Corporation , Camella Palmera Homes , Cyber Corporation , Empire East Land , Fairmont Holdings , Filinvest Land , Megaworld Corp. , Metro Pacific Corp., Robinson’s Land Corp and Uniwide Holdings .

I find it refreshing to see the widely followed and respected Canadian independent research outfit, BCA Research, conform to my views. In its latest outlook entitled ``Asia-Pacific Real Estate: Laggard Poised To Outperform”, Bank of Credit Analyst highlights on a possible catch up by Asian real estate markets, writes BCA (emphasis mine)...

``Asia-Pacific real estate markets should catch-up to the global housing boom in the next few years...The 1990s property bubbles in several Asia-Pacific markets have been fully unwound, and real estate in this region is now perking-up anew. However, the recoveries have been very subdued compared with real estate market trends in the rest of the world. This is consistent with history: Asset markets which have experienced a mania and a consequent bust tend to stay depressed for a period and, as a rule, underperform their peers for some time. Looking forward, fundamentals suggest that Asian property markets are set to deliver solid gains in the years to come, outperforming those in the Anglo-Saxon world.”

Figure 4: BCA Research: A Real Estate Boom in Asia-Pacific

While BCA has ostensibly omitted the Philippines and Indonesia as part of its portfolio outlook, the movements of the Philippine Property index has been consistent or congruent with their analysis in spite of the omission as shown in Figure 5.

Figure 5: Philippine Property Index’s J.LO Bottom

Over a long term perspective, the recovery seen in the sector has been validated by its latest “rounded bottom” breakout or in Wall Street’s lingo a ‘JLO’ bottom breakout when reckoning from the 1999 high.

Today, the Philippine Property index is seen advancing towards its 1996 high of 1,793 buttressed by another huge and massive JLo bottom (from 1996 to date) formation, as marked by the blocked arrow.

As of Friday’s close it is about 600 points away from the 1996 target which looks quite realizable over a medium term perspective (1-2 years or even less!).

In short, it is imperative for a Peso based investor (local or foreign) to allocate a significant portion of their portfolio to the said real estate sector to achieve Alpha “outperformance” returns. And to use dips in the market to accumulate. Posted by Picasa

Wednesday, May 10, 2006

Bloomberg: Copper Rises to $8,000 a Ton for First Time as Metals Rally

Global Liquidity chasing profits....and pushing up commodities....

From Bloomberg's Chanyaporn Chanjaroen:

Pension and hedge funds are pouring money into commodities as raw materials from sugar to oil produce returns that are outpacing other assets. Crude oil has gained 16 percent this year in New York and traded above $71 a barrel today. Fund investments in commodities may exceed $120 billion by 2008, up from $80 billion last year, according to Barclays Plc.

Sunday, May 07, 2006

Philippine Peso: Loss of Export Competitiveness Against Who?

``The wild geese do not intend to cast their reflection; The water has no mind to receive their image.” -Zenrin poem, The Way of Zen

This reminds me of the undue harangue by a slew of experts on the alleged “ills” of a strong Peso (“damned if you do and damned if you don’t” situation). In an incisive article, ``Will a unicameral parliament save us?” Honesto C. General business columnist for the Philippine Daily Inquirer enumerates the flawed cumulative economic policies adopted by the past administrations that have led to the country’s present predicament.

In short, his message was that when government assumes to know in behalf of its constituents and adopts policies in what it believes is for the better, in most instances THEY HAVE BEEN WRONG. And it is us who pays for such flawed policies instead of allowing market forces to determine where resources are best allocated for. More interventionism translates to more government bureaucracy, more red tapes, more corruption, and a more distorted economy. Think Soviet Union, central planning’s showcase. To quote leading Free Market advocate Ludwig Von Mises, ``Economic interventionism is a self-defeating policy. The individual measures that it applies do not achieve the results sought.”

Of course, I do share the concern that a precipitate surge in the Peso may lead to the so-called “Dutch Disease” or ``the deindustrialization of a nation's economy that occurs when the discovery of a natural resource raises the value of that nation's currency, making manufactured goods less competitive with other nations, increasing imports and decreasing exports. The term originated in Holland after the discovery of North Sea gas” ( However, it appears that the present developments (belated Peso rise) does not highlight to such scenario, but instead reflects on the global if not regional trends. Yet, strong Peso critics argue most frequently about the “loss of export competitiveness”...against which currency?

Are we referring to our neighbors or to our distant relatives at the far side of the globe?

As you can see in three instances above except for Argentina’s Peso, the Brazilian Real, the Thai Baht and Indonesia’s Rupiah has appreciated steadily against the Philippine Peso over the 5 years period, with the Philippine Peso’s current belated rally providing for a countertrend rally but have not broken the main trends, i.e. Philippine Peso depreciates against “competitor” currencies. While following the debt default of Argentina in 2001, the Peso is just about neutral relative to the Argentine’s Peso.

Ergo, the firming of Brazil’s currency as well as by our neighbors’ demonstrates that the Philippine Peso has lagged the marketplace for quite sometime, thereby its present appreciation has not had a substantial material effect, thus far, on the so called “export competitiveness”. If taken at a converse perspective, since the Peso has depreciated largely against its “competitors” over the longer period, then presumably given the single dimensional focus on the “price component” as manifested by the underlying currency, then we should have gained “export” market share, bilaterally or through the world market, at their expense. But have we done so? Nicolas Taleb in his book Fooled by Randomness promptly explains, ``but economics is a narrative discipline and explanations are easy to fit retrospectively”.

Moreover, present world conditions highlights the increased dimensions of globalization as manifested by expanded linkages through trades, economic and financial integration can now be seen through the attempt to integrate the region’s monetary system whose possibility I discussed three years ago (see September 15 to 19, 2003 edition, the Emerging Asian Economic Bloc). According to Shehla Raza Hasan writing for the Asia Times Online notes that ADB plans to revive the adoption in June of the ACU (Asian Currency Unit) or the ``notional unit of exchange based on a "basket" or weighted average of currencies used in the 10 member states of the Association of Southeast Asian Nations plus South Korea, China and Japan”, for purposes of a single common currency to bolster the region’s capital markets, economic integration and cross border transactions. With the region’s growing realization of the need for an alternative form of currency, it is a wonder why too much effort have been spent looking for solutions that ran backwards. Interestingly, have not the G-7 in their latest communiqué, exhorted Asian nations to allow for “greater flexibility of exchange rates”? Posted by Picasa