The Word Became Flesh

A Season's Greetings...

John 1:14-18

And the Word became flesh and dwelt among us, full of grace and truth; we have beheld his glory, glory as of the only Son from the Father. John bore witness to him, and cried, "This was he of whom I said, 'He who comes after me ranks before me, for he was before me.'" And from his fulness have we all received, grace upon grace. For the law was given through Moses; grace and truth came through Jesus Christ. No one has ever seen God; the only Son, who is in the bosom of the Father, he has made him known.

Merry Christmas to ALL!

Filipinos Lead WTO Protests

Do you know that Filipinos make up a third of the protest groups in this week’s WTO conference in Hong Kong? According to an article written by Thingfish for netnewsasia, ``What was most striking though, was that of the 100 random protest groups we looked at, a third were from the Philippines. Add to that the several Hong Kong or regional bodies that are essentially Filipino pressure groups, and you’re looking at a very lopsided protest.”

With an infinitesimal share of trade relative to the world, it seems that we are getting ourselves an inordinate share of protesting. The same groups, the inveterate leftist and left leaning religious and environmental groups, leading the street protest against the administration are now seen in Hong Kong venting their perpetual ire. This character flaw is one of the many reasons why we remain chronically poor; our penchant for non-productive or even counterproductive activities.

Thingfish delivers the kicker ``Every day somewhere in the Philippines, someone is protesting against something. Protest is a national pastime. And perhaps that’s the real crowd-puller in Hong Kong this week: Filipinos just love a good protest.”

The Occam Razor's Principle in Explaining Gold's Rise

With gold prices soaring to a high of $540.2, the presumptive thought in every investors mind...“Why the sudden appeal of gold?”

Paul Kasriel, chief economist of Northern Trust, gives us the Occam Razor’s principle or “The principle of parsimony”...where “one should not increase, beyond what is necessary, the number of entities required to explain anything”...in short, it all boils down to a worldwide phenomenon called NEGATIVE REAL INTEREST RATES!

Mr. Kasriel sums it up with...``global investors are losing faith in, as Jim Grant calls them, faithbased paper currencies as a store of value.”

Quite a legacy indeed for outgoing US Fed Chief Alan Greenspan.

Philippine Peso Breaks to 2½ High! The Seen and Unseen Variables

As you probably know by now, the Philippine Peso surged to its highest level since June 2003 or a 2½ year high to Php 53.42 against the US dollar for an amazing gain of 1.36% over the week, essentially validating my contrarian forecast about a year ago.

Naturally, we have mainstream news accounts and their corresponding analysts piling over the reportage on what seems to be the stating the obvious....exploding overseas remittances. However, your prudent investor analyst who adopts the maxim of the illustrious economic journalist Frédéric Bastiat who declares “There is what is seen and the unseen”, which basically means an act or event as having been seen as the immediate cause to an effect but is not duly the underlying cause, in Bastiat’s words, ``When a man is impressed by the effect that is seen and has not yet learned to discern the effects that are not seen, he indulges in deplorable habits, not only through natural inclination, but deliberately.” In the context behavioral finance, Bastiat’s adage translates to what is usually deemed as ‘rationalization’ or an oversimplified explanation usually attributable to current events.

Figure 1, US Dollar/Philippine Peso Chart

In our Oct 17 to 21 edition, see US Tightening Affecting Global Financial Markets II, I wrote ``The chart above of the Philippine peso shows of the domestic currency appreciating after two rate hikes; on September 22^nd (red arrow) the Peso was at 56.24 while prior to Thursday’s rate hike the Peso was last traded at 55.71.” In short, the incipience of the peso’s appreciation was marked by a series of interest rates increases adopted by our own version of Central Bank, the Bangko Sentral ng Pilipinas, as shown in Figure 1.

Of course, this is NOT to discount the remittance factors which coincidentally accelerated during the period as promptly reported by Manila Times’ Maricel E. Burgonio last November 16^th, ``OFW remittances that month rose 28 percent to $941 million from a year ago. This led to a 28-percent growth in nine-month inflows to $7.9 billion from the $6.204 billion sent home in the same period last year.”

At the magnitude of today’s firming of our local currency, it would probably require remittances to grow by about 40-50% to drive the Peso to its current levels. Nonetheless, we should not forget that the remittances have been growing all year round yet the Peso hovered within the 56 to a US dollar levels in about 27% of the year! Particularly in July to September which was largely ascribed to political instability concerns arising from the Garci wiretapping scandal.

My bullish case for the Peso has mainly been predicated in the context of macro developments, particularly of surplus global liquidity, expanding trade, financial marketplace and economic integration. In short, the globalization of the economic and financial spheres has expedited the gradual leveling off in the purchasing power differentials underpinning today’s macro evolution.

If you think that the Philippine Peso’s 1.36% advance was enough to make this week’s cynosure, then you must be apprised that it was Indonesia’s rupiah that took the spot light up by more than THREE percent!!

Let us take it from the report of Bloomberg’s Christina Soon (emphasis mine), ``The rupiah surged 3 percent this week to 9,700 against the dollar, the biggest weekly gain since the period ended July 19, 2002. The currency yesterday climbed as high as 9,615, its strongest since June 20...The rupiah yesterday climbed to the strongest since June 20 after the central bank this week raised its benchmark interest rate for the sixth time in four months to slow inflation. Higher rates boost returns investors get for holding Indonesian assets. A new cabinet that was put into place this week also fueled expectations the government can attract more investment.”

Figure 2 Indonesia’s Rupiah as of November 18^th close, courtesy of Ed Yardeni (www.yardeni.com)

Indonesia’s rupiah has been on an uptrend after an overshoot to the downside during the selling frenzy in the wake of the 1997 Asian Crisis (see Figure 2). Since, the Rupiah has gradually gained some of its lost ground and used the recent Cash Yield spreads as a pretext for portfolio inflows.

It has not been different from South Korea’s won which advanced by .4% over the week mostly due to an almost ‘coordinated’ movement in the REGION’s currencies. A continuation of Bloomberg’s Ms. Soon report notes that (emphasis mine), ``South Korea's central bank on Dec. 8 unexpectedly raised its benchmark interest rate as an accelerating economy threatens to spur inflation. The bank lifted the rate to 3.75 percent from 3.5 percent. The National Statistical Office on Dec. 8 said its consumer confidence index rose to a six-month high in November. Fund managers based outside Korea bought a net $226.2 million of the nation's shares this month through yesterday, according to stock exchange data.”

Figure 3 South Korea’s won as of November 18^th close, courtesy of Ed Yardeni (www.yardeni.com)

The Korean Won also a victim to the 1997 Asian Crisis presently shows of a steady and robust rebound (see Figure 3) in the wake of the downside overshoot. Again, perceived interest rate premiums have been spurring its present currency gains!

Ms. Soon notes of the gains of the other regional currencies such as Thai Baht (+.3%) to 41.28, Singapore dollar (+.06%) to $1.6827 and the Taiwan dollar to $33.517. Formerly US dollar pegged currencies were also up, the Malaysian ringgit (+.24%) to $3.77 and China’s renmimbi (+.05%) to 8.0765.

Aside from remittances Ms. Soon also notes of the other currency analysts views of growing spread differentials for the Philippine currency responsible for its current gains, ``The currency yesterday extended gains to a 29-month high after a report this week showed inflation rose at the fastest pace in three months in November, stoking speculation of an interest-rate increase next week....The consumer price index advanced 7.1 percent from a year earlier, up from 7 percent in the previous two months, the National Statistics Office said on Dec. 6. The currency added 1.4 percent through the end of October after Bangko Sentral ng Pilipinas lifted its key interest rate on Oct. 20 to curb inflation from higher fuel prices. The bank on Nov. 17 kept its key interest rate at 7.5 percent.”

What am I driving at? The US dollar’s sterling gains this year relative to its major trading partners has been primarily prompted by the view of better returns relative to currency yield spreads as a result of the 12 ‘measured’ increases by the US Federal Reserves on its interbank lending rate from 1% to 4.0% with another rate increase anticipated this Tuesday, December 13th. To quote the IMF’s December 2005 Financial Market Update (emphasis mine), ``The U.S. dollar appreciated as growth and interest rate differentials remained in favor of the United States and outweighed concerns over structural weaknesses, leading to robust investment inflows. Foreign demand for U.S. dollar financial assets, particularly bonds, remained in excess of amounts needed to finance the country’s current account deficit...Emerging market bond spreads tightened to record low levels on improving fundamentals and the search for yield.”

In other words, today’s $1.9 trillion daily traded currency markets are obsessed with the chase for yields emanating from a glut of credit and money, prompting portfolio flows into currencies that maintains a prospective positive cash premium spread relative to comparable anchor currencies, such as the US Dollar, Euro or Japanese Yen. This spread arbitrage is widely known as the ‘Carry Trade’. Hence, the Philippine currency is NOT exempt from trading strategies assimilated by portfolio managers and thereby derives its strength LESS from the ‘seen’ remittance flows but mainly from the ‘unseen’ portfolio flows. Empirical evidence such as the declining peso denominated and dollar denominated sovereign bond yields suggests of indicators supportive of this view, i.e. being investor supported and so as with partial signs into the Phisix based on net foreign buying~ in spite of present consolidation.

However, this yield spread arbitrage trend is unlikely to persist once the US Federal Reserves ceases its interbank rate increases which may come into fruition by early 2006.

This is NOT to say that the Peso’s recent climb would reverse under such scenario, but rather once the structural infirmities of the US dollar would come into full view, as in 2002-2004, what could be expected in the currency marketplace would be a refocus on the present state of underlying fundamentals moored on growing intra-region economic and financial ties and the individual performance of emerging market economies.

Figure 4, Emerging Market and Global Yield differential spreads courtesy of IMF/JP Morgan and Merrill Lynch

As the recent IMF Financial Market Review (see Figure 4) notes (emphasis mine), ``Despite the rise in short-term rates in the United States, emerging markets have proven remarkably resilient to a variety of shocks, with emerging market external bond spreads falling to all-time lows. This resilience has been fostered by significant improvements in fundamentals, with emerging market countries having significantly reduced public debt-to-GDP ratios since 2002 due to strong economic growth, appreciating currencies and, in many cases, strong primary fiscal surpluses. Furthermore, external financing requirements for emerging market sovereigns and corporates have continued to decline as commodity prices rise and global growth boosts remittances from overseas workers.”

In short, the US dollar bear market in 2002- 2004 helped boosted fundamentals of emerging market assets particularly relative to sovereign and corporate bonds and had been doing so despite the recent rally seen with the world’s anchor currency. The realignment towards the purview of fundamentals from the yield perspective could help propel the Peso to maintain its momentum for further MODERATE gains in the coming year/s.

One must be reminded that the PESO has LAGGED the region such that today’s outperformance could be construed as simply a classic case of cyclical recovery.

In the present global economic milieu, immense disparities of purchasing power between developed and emerging market economies have created substantial economic opportunities for trade, service, goods production/manufacturing and financial exchange arbitrage, largely fueled by the web enabled technological revolution in information and communication services. The offshoot of this phenomenon has been to facilitate wealth redistribution to emerging market economies. It is for this reason why global capital flows are expected to continue to take advantage of Asia’s rapidly expanding economies, swelling consumer class backed by young demographics and fast developing markets.

For instance, the Philippines is ranked among the lowest in terms of Purchasing Power Parity (PPP) as measured by the Economist’s Big Mac Index as of June 9^th (Peso at 54.95 or higher prior to the article’s composition). In US dollar terms a Big Mac cost $1.47 in the Philippines compared to $3.06 in the United States, $1.54 in Hong Kong, $2.34 in Japan, $1.53 in Indonesia, $2.17 in Singapore, $2.49 in South Korea, $2.41 in Taiwan and $1.48 in Thailand. Whereas the pegged currencies then of China and Malaysia (scrapped July 21^st) where at $1.27 and $1.38, respectively. Essentially, this ‘PPP undervaluation’ could be one of the principal reasons behind the Business Process Outsourcing (BPO) as well as the Shared Service and Outsourcing (SSO) boom we are seeing at present (see November 14 to 18 edition: Age Of Internet Boosts Domestic Economic Environment) and a foundation for the Peso’s sustained recovery (barring further governance lapses or political instability).

Albeit I would caution you from adhering to some outlooks that give emphasis to simply technical dimensions in predicting the future directional values of the Peso. One must be reminded that economic construct of the Philippines is far distinct than its neighbors to assume a corollary.

However, going back to fundamental potentials, Goldman Sachs which four years ago, predicted the rise of the “BRIC”, the Brazil, India, Russia and China emerging market paragons with potentials to become significant economies relative to the world have now added its next eleven candidates to its roster.

Bloomberg Asian analyst William Pesek quotes Mr. Jim O'Neill, London-based head of global economic research at Goldman Sachs, dubbing the next generation of potential BRIC’s as ``Next Eleven, the list includes Bangladesh, Egypt, Indonesia, Iran, South Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey and Vietnam” based from the criteria which includes “macroeconomic stability, political maturity, openness of trade and investment policies and quality of education.”

Of course, this sanguine outlook does not presume or gloss over risks or incidences without any road bumps. As mentioned in the past, the present macro risks includes the sharp unwinding of intrinsic imbalances such as a sharp slowdown in the Chinese economy, a real estate led consumer retrenchment in the US, a collapse in the value of the Japanese Yen, a US dollar crash, a trade war or wave of protectionism, surge of consumer price inflation...among the others that may lead to unnerving investors, a possible liquidity crunch or portfolio outflows and reverse the pervasively positive sentiment for the region and its asset classes.

The risks could also be insulated in nature with regards to the domestic arena, particularly political destabilization and possible governance or policy lapses that could derail the semblance of progress as evidenced by the positive gains evinced by domestic financial assets.

World’s Mountain of Debts, The Bullion Crosses the Maginot Line

``The fundamental question is whether a central bank can manage the supply of money and credit better than the free market otherwise would. We shouldn't kid ourselves about the true nature of the Fed, which is inherently incompatible with real free market capitalism. Centralized planning of the money supply is a form of economic control that significantly affects prices, wages, and production levels.”-Congressman Ron Paul

If inordinate liquidity drives the global equity assets, various carry trades and the creation of myriad financial claims intermediaries have likewise spawned rising asset classes on a global scale.

To show you the collective thrusts of global governments underpinning the present inflationary cycle we note that government printing presses have been in full throttle cranking out eye boggling debts in an effort to appease short term demands by voters and investors alike. With the advent of paperless electronic money, today’s money system is produced by simply pressing on a single button.

Analyst David Fuller of Fullermoney.com says that the reason why all central banks are flooding the money system with paper money is because:

1. No country wants a strong currency due to globalization's competitive pressures.

2. They still fear deflation more than inflation.

3. They believe that they can get away with printing money because wage pressures are muted while China and other developing countries keep the cost of manufactured goods down.

Of course one cannot discount that given the high leverage of the today’s monetary system, the only way out of the debt cycle aside from debt repudiation is to invariably print more money to drive down the value of their currencies which they will use to pay back creditors!

Debt Pyramid Courtesy of Larry Edelson for Safe Money/Weiss Inc.

``Where you find major debt excesses — that’s where you can also expect the greatest pressures on governments to generate more inflation.” notes Larry Edelson of Weiss Inc.. Mr. Edelson enumerates the geographical breakdown of private and public debts into the following:

Europe: $2.6 trillion

Asia (excluding China): $747 billion

Latin America: $760 billion

Third-world countries overall: Some estimates place third world debt at $2.1 trillion.

In the USA: Over $39 trillion. That’s more than $141,000, for every man, woman and child.

To consider these are interest bearing debt instruments which does not include:

the derivatives market which in the US alone stand at $96.2 trillion (Comptroller of the Currency).

Other financial obligations not included are the US government’s future state welfare commitments in Medicare and Social Security to the tune of $20 TRILLION, according to the US General Accounting Office study.

With similar welfare obligations subscribed to by governments of major industrialized economies as Japan and Germany.

Obligations by private companies to guarantee mortgage/asset backed securities underwritten by agencies as Fannie Mae and Freddie Mac.

In short, the mountain of debt has become so pervasive that it adds up to about $200 trillion (see table beside) or about 3 times more than the world’s GDP!

So while the inflationary nature of central bankers mostly in cahoots with politicians have spawned rising assets values, it has also fostered a highly levered consumer demand and excess capacities in various other parts of the world.

Today, the global commodity cycle has likewise been an outgrowth of the inflationary tendencies of collective governments.

Gold, Economist John Maynard Keynes’ (the paramount icon of Central bankers and politicians) barbaric metal crossed the ‘Maginot line’ to close above the $500 threshold level and register a 22-year high at $503.3 per oz.! Other metals hit pivotal milestones, Silver at an 18-year high, copper and lead to FRESH record highs, aluminum to a 16-year high and zinc to a 15-year high! Even sugar hit a 9-year high while cattle futures hit a two year high.

30-year Gold Chart Pre-Breakout courtesy of kitco.com

Some central bankers as Argentina, South Africa and Russia have aired their intent to increase Gold into their reserves, while the opening of the Dubai Gold and commodities exchange has expanded investor’s access to commodities.

First, my predictions for gold to hit these levels at this time frame have been attained albeit we could see some profit taking in the near future following its extended rise. To share the observation of CLSA’s jetsetting analyst Chris Wood, ``It is also hard to escape the thought that gold might be rising in the short term for the simple reason that just about everything else has been rising too.”

Second, for as long as central bankers continue with their inflationary proclivities, fiat currency values of all cuts will continue to see massive depreciations of their intrinsic values relative to finite precious metals and other commodities, regardless of a hyperinflationary or a deflationary outcome.

Third, gold has cut a swath along major currency levels signifying a new phase in its bullmarket and underscoring my outlook (see September 12 to 16 edition Gold At Fresh 17 Year Highs; Currency-wide bullmarket begins!). To quote veteran analyst Richard Russell of the Dow Theory Letters and one of Wall Street top market timers,

``Gold has entered a new phase. This phase is characterized by gold separating itself from all paper currencies including the dollar. It's clear that something has changed -- that gold is now being accepted by sophisticated investors, not as a speculation, but as an alternative currency. Thus, over recent weeks while the dollar was strong, gold has continued to climb. Such action would have been considered almost impossible even a few months ago.

``Gold is now being accepted as the fourth currency along with the dollar, the euro and the yen. But there is a difference. Gold is also being recognized as the tangible currency and the ONLY SAFE currency. That gold pays no interest -- but is still at an 18-year high in terms of dollars -- is a testament to its value and safety in the eyes of sophisticated investors."

Fourth, rising gold prices across all major currencies are not merely signs of attendant inflation (expansionary money policies and NOT rising prices) but rather symptomatic of underlying monetary stress in contrast to what has been parlayed by mainstream media. While gold has risen alongside the US dollar in the interim, this does not mean that the US dollar’s woes are over (see above). Nor does Warren Buffett’s trimming of his anti-US dollar losses suggest that he capitulates! In fact, outgoing Federal Reserve Chair Alan Greenspan in his latest public appearance admonishes on the possible significant impact from the fiscal imbalances ``In the end, the consequences for the U.S. economy of doing nothing could be severe.''

Lastly, gold is now prominently featured as an alternative investment class which has slowly pervaded into the mainstream school of thought. Alongside most of the contrarian analysts, I believe that gold is in a fledging phase of its bullmarket cycle with conservative targets at $873 per oz (1980 nominal high) and about $1,800 (inflation adjusted) over the coming years. It is when mainstream bankers and hard core central bankers ‘capitulates’ or turn into the bullish gold camp when its climax would have been reached. As far as we are concerned the indicators of bullishness are still within the periphery.