Definitely Not a Reprise of 2008, Phisix-ASEAN Equities Still in Consolidation

Note: I am in a hurry so this week's outlook will be abbreviated.

This year’s top-notch performers among global stock markets[1] (based on year-to-date) accounted for biggest losers in the region this week: I am referring to ASEAN equities.

Correction and NOT a Reversal

ASEAN markets had recently been defying ‘gravity’ but as I noted last week[2] there seems to be signs of tightening correlations.

Over the short term or during past two months, the correlation of Phisix and ASEAN indices with that of distressed global equity markets have evinced formative signs of tightening or reconvergence.

As I have been saying, divergences in market performance may persist for as long as a global recession is not in the horizon.

One must remember that decoupling signifies as an unproven thesis that can only be validated during a full-blown crisis. It’s a theory that I have been sceptical of, considering the concurrent interconnectedness and interdependence of global economies.

So the previous downside volatility of the global financial markets appears to have been carried over during this week, which had adversely affected ASEAN markets.

Yet reports of China-led BRIC (Brazil, Russia and India) proposed rescue[3] of the Eurozone by buying of Euro bonds, and most importantly, the joint or coordinated liquidity infusions by major central banks[4] as the U.S. Federal Reserve, the Bank of England, Bank of Japan, and the Swiss National Bank through foreign currency swap lines or exchanging of an agreed amount of currencies (see the basics here[5]), underpinned a fierce rally in major global equity markets.

We seem to be witnessing another variety of quantitative easing (QE) or money printing measures at work.

Perhaps one unstated objective for the synchronized liquidity injections has been to finance $800 billion derivatives[6], where 40% of which has been accounted for by “equity” options, whose expiration on during last week would have reportedly triggered tremendous pressure on the marketplace. Also such interventions could have been meant to forcibly cover equity ‘shorts’ via the derivatives market which signifies another war against the markets and alternatively represents as policies aimed to bolster equity markets.

As I have repeatedly been pointing out, what I call as the Bernanke’s doctrine[7] has been about inducing a stock market boom that would serve as a wealth effect transmission to the economy.

Furthermore, the violent pendulum gyrations seen in the market breadth[8] of US markets resonates how today’s financial markets have behaving—boom bust cycles.

Essentially, emanating from the embers of the 2008 meltdown, global equity markets have increasingly been steroid dependent which means MORE boom bust cycles ahead.

Again as I projected last week

Friday saw big declines in Asian currencies as the US dollar fiercely rebounded over a broad number of major currencies. This US dollar rally may see an extension this Monday (unless there will be declarations for major actions by US and European policymakers over the weekend).

The unfolding crisis in the Eurozone has been prompting for short term funding predicaments that has led to liquidations across financial markets worldwide, including Asia.

This has been reflected on Asian currencies as well as the Peso.

This terse quote from a Bloomberg article summarizes the week’s action in Asia’s currency markets[9]

Losses for the won, rupee, ringgit and Taiwan dollar were the worst since mid-2010.

As with most of Asia, the Philippine Peso lost a hefty 1.91% over the week.

This Is NOT 2008, Redux

I would disagree to imputations that current environment is about rising risk aversion. Such description would likely apply to financial markets of crisis afflicted economies but not to Asia markets.

Proof?

The Euro debt crisis and fears of another recession has indeed been increasing overall market anxieties around, but for Asia such concern has been muted, relative to 2008.

The above graph of Credit Default Swap prices representing debt default risks of Asian sovereigns from ADB[10] shows that credit concerns in the region subdued.

In addition, net foreign trade in the Philippine Stock Exchange has been inconsequential despite emergent signs of selling pressures so far.

It could be that local investors may seem to have been more ‘traumatized’ (Post Stress Traumatic Disorder) by the last crisis to stampede into US dollars, relative to foreigners.

Moreover, while emerging markets in general have endured equity outflows from the recent volatility, this has partly been offset by inflows to the bond markets[11].

And there is even more evidence that risk environment has been conspicuously nuanced compared to 2008—the continuing lofty levels of prices of gold and other precious metals and even of oil.

Notice that the recent downside actions of the S&P 500 (SPX) has been accompanied by downswings of gold, precious metals (DJGSP) and oil (WTIC), yet the former two has basically risen above the levels from where the declines were triggered.

Furthermore, oil at $87 hardly accounts for a ‘recessionary’ environment.

And there have been some insinuations that bullion banks have been significantly hurt by the recent upsurge in gold prices, such that manipulation of the gold-precious metal markets downwards has been undertaken to ease on the losses of these banks under the camouflage of central bank actions.

As Goldmoney.com Alasdair Macleod writes[12],

In common with dealers and market makers in all markets, bullion traders run short positions in bull markets. The turnover on the bullion markets is massive, and a dealer active on behalf of its customers and its own trading book can make substantial dealing profits. So long as those profits exceed the losses on their short positions, all is well. This is why the greatest threat to the bullion market is not the bull market itself, but prices rising too rapidly.

In the last two months, the market for gold has been particularly strong, erasing trading profits for many bullion dealers. Central bankers see this as the result of financial flows building due to the difficulties in the euro area. The targets for these flows out of the euro are the Swiss franc and gold, so the SNB’s move is designed to take the heat out of both of them.

The whopping $2 billion trading losses racked up by Swiss bank UBS[13] from supposedly unauthorized trade by a ‘rogue’ trader, Kweku Adoboli, has allegedly been due to voluminous exposure in “shorting” silver[14].

All machinations to manipulate the metals market will prove to be a temporary event. We should see metals rally significantly in the light of intensifying interventions (via assorted money printing measures) in the marketplace.

With the team Ben Bernanke meeting this week (September 21^st) for an extended 2 days[15], we should expect Operation Twist, a pioneering measure telegraphed by Mr. Bernanke in his last speech[16], which aims to lower interest rates on the longer duration securities, to be formally in operation.

This could be backed by another formal QE 3.0 or by a significant interest rate cut on excess reserves (IOER) meant to disincentivize banks from parking their excess reserves at the Fed.

And considering that much of the developed world has been already been immersed into various forms of QE, we should expect improvements in global equity markets that should filter over to ASEAN markets.

Again, to repeat, this has NOT been 2008. There are hardly signs of deflationary risks that warrant an increase of cash holdings. In the US, money supply has been rampaging along with improving signs of credit conditions[17]. Elsewhere, we should expect policy directions towards an accommodative stance by keeping current levels of interest rates or perhaps even by lowering policy rates.

Central bank activism essentially differentiates today’s environment from that of 2008.

PSE Still in Consolidation Mode

The local market has indeed been under pressure, but again there have hardly been signs of major deterioration.

True, every sector has been marked by declines this week with the ALL sector suffering the largest loss due to Manulife (-6.02%).

Mining, being overextended, suffered most from last week’s profit taking. Again I view this as a fleeting event.

The Phisix has been rangebound. However, trading indicators seem to suggest of partially oversold conditions (MACD). This implies that a rebound could be in the offing.

And peso volume has been dropping as the Phsix consolidates. This serves as indication of the diminishing strength of sellers.

Market internals, despite last week’s significant profit taking, has not materially deteriorated.

If US markets will continue to rebound, then we should see the current consolidation trend in the Phisix to segue into an ascending trend.

I would certainly watch the US Federal Reserve’s announcement and the ensuing market response.

If team Bernake will commence on a third series of QE (dependent on the size) or a cut in the interest rate on excess reserves (IOER), I would be aggressively bullish with the equity markets, not because of conventional fundamentals, but because massive doses of money injections will have to flow somewhere. Equity markets—particulary in Asia and the commodity markets will likely be major beneficiaries.

As a caveat, with markets being sustained by policy steroids, expect sharp volatilities in both directions.

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[1] See Global Equity Market Performance Update: ASEAN Equity Markets as co-Leaders, September 13, 2011

[2] See Phisix-ASEAN Equities: Staying Afloat Amidst Global Financial Market Hurricane, September 11, 2011

[3] See BRICs Mulls Bailout of the Eurozone September 14, 2011

[4] See Hot: Major Central Banks to Jointly Offer US Dollar Liquidity, September 15, 2011

[5] See How Does Swap Lines Work? Possible Implications to Asia and Emerging Markets, October 30, 2008

[6] Naked trader.com Almost 40% of S&P 500 Options Expire Sept. 16, JPMorgan Says

[7] See US Stock Markets and Animal Spirits Targeted Policies, July 21 2010

[8] See US Equity Markets: Signs of Intensifying Boom Bust Cycles, September 17, 2011

[9] Bloomberg.com Asian Currencies Fell in Week on Concern Europe’s Debt Crisis Will Worsen, September 17, 2011

[10] Asianbondsonline.org Emerging East Asia CDS - Senior 5-year

[11] Wall Street Journal Emerging Market Local Currency Bonds Funds Continue To Draw Money, September 16, 2011

[12] Macleod Alasdair Central banks and the gold price goldmoney.com September 11, 2011

[13] Washington Post, UBS says rogue trader caused $2 billion loss, September 15, 2011

[14] Keiser Max BREAKING: UBS rogue trader was trying to exit a naked silver short…. [UPDATED], maxkeiser.com September 15, 2011

[15] IBTimesFX The Week Ahead September 16, 2011

[16] See US Mulls ‘official’ QE 3.0, Operation Twist AND Fiscal Stimulus, September 9, 2011

[17] See US in a Deflationary Environment, NOT! (In Charts) September 16, 2011

US Federal Reserve Gambles With Untested Policy Tool: Paying Interest On Bank Reserves

Utilizing the “untested” policy tool of paying interest on bank reserves, the US Federal Reserve seems to be gambling away the US economy as well as the worlds’.

This Bloomberg article is a mouthful. (bold highlights mine)

Federal Reserve officials are staking their inflation-fighting credibility on an untested tool: the power to pay interest on bank reserves.

Congress granted the Fed this ability in 2008, and Chairman Ben S. Bernanke, Vice Chairman Janet Yellen and New York Fed President William Dudley have all cited it as a main reason why they’ll be able to keep the U.S. economy from overheating after pumping record amounts of cash into the financial system. Raising the rate, currently at 0.25 percent, is intended to entice banks to keep their money on deposit at the Fed instead of loaning it out and stoking inflation.

With the benchmark overnight lending rate trading at 0.1 percent, less than half the deposit rate, it isn’t clear how much control the central bank can exert over borrowing costs by raising the interest on reserves, said Dean Maki, chief U.S. economist at Barclays Capital. Internal critics also have cast doubt on the tool’s effectiveness. Philadelphia Fed President Charles Plosser said last month it isn’t a cure-all because it doesn’t address the need to shrink the central bank’s balance sheet and reduce the amount of reserves in the system.

“There is some concern in markets about whether the Fed will keep inflation under wraps as it goes through this exit strategy,” Maki said in a telephone interview from his New York office. “It’s unknown exactly what interest on reserves does to the economy.”

Cash in the banking system has ballooned since the credit crisis began in 2007, when the Fed embarked on its unprecedented monetary accommodation, which includes two bond-purchase programs that have swelled the central bank’s balance sheet to a record $2.69 trillion...

The amount of excess reserves climbed to $1.47 trillion this month from $991 billion at year-end and $2.2 billion at the start of 2007, Fed data show.

The Federal Open Market Committee begins a two-day meeting tomorrow and will decide whether to continue with its planned $600 billion of bond purchases through June.

The effectiveness of using interest on reserves, or IOR, as a main policy tool may depend on how closely the federal funds rate, or overnight inter-bank lending rate, follows its movements. The Fed has kept its target for the fed funds rate at zero to 0.25 percent since December 2008.

“The big unknown is how tight the spread between the IOR and effective fed funds rate will be,” said Dino Kos, a managing director at economic-research firm Hamiltonian Associates Ltd. in New York. “If the fed funds rate trades at a stable, and preferably narrow, discount to the IOR, then tightening policy through the IOR is doable. But a wide and unstable spread undermines the strategy.”

More...

The Fed probably would like to mimic the so-called corridor system in Europe, where the deposit rate acts as a floor to the overnight lending rate, according to Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. The U.K. central bank’s benchmark, now at 0.5 percent, is the rate it pays on the reserves it holds for commercial banks. That’s below the overnight sterling London interbank offered rate of 0.57 percent.

The Frankfurt-based European Central Bank pays a rate on the deposits banks park with it overnight. The ECB raised this rate a quarter point to 0.5 percent on April 7, the same day it increased its benchmark refinancing rate by the same margin to 1.25 percent...

Before the Fed boosts the deposit rate, it likely will use reverse repurchase agreements and its new Term-Deposit Facility to gain more control over the federal funds rate, Stanley said. He predicts the Fed will raise rates as soon as November, which he said is an “aggressive” time frame that reflects his concern inflation will accelerate.

In a reverse repo, the Fed lends securities for a set period, draining bank reserves from the financial system. At maturity, the securities are returned to the Fed, and the cash goes back to the primary dealers.

Stanley said he’s skeptical these transactions can operate at a scale big enough to suck sufficient cash from the system to control the federal funds rate. The rate fell as low as 0.08 percent on April 13 after the Federal Deposit Insurance Corp. began adjusting calculations of U.S. banks’ deposit-insurance fees this month to cover all liabilities instead of just domestic deposits.

Yet banks have been the major beneficiaries of this grand experiment via massive ‘risk-free’ subsidies.

From the same article...

The overnight lending rate has traded below the interest rate on reserves for almost two years, partly because Fannie Mae and Freddie Mac, the mortgage-finance companies under government control, became “significant sellers” of funds in the overnight market and aren’t eligible to place cash on deposit at the Fed, according to a December 2009 research paper by the New York regional reserve bank.

The “theory” of interest on reserves is “proved wrong every day: Why would a bank ever lend at less than what they’re earning at the Fed?” Maki said. “There are more issues here than it sometimes is made to sound. Chairman Bernanke mentioned the Fed could raise rates in 15 minutes if they decided to, but it’s not clear they have that kind of control on the funds rate.”

Where Ben Bernanke cheerfully says that “Paying interest on reserves should allow us to better control the federal funds rate”, this looks more like blind optimism than a verified method.

Economic Policy Journal’s Bob Wenzel says that the FED pays “EIGHT times equivalent market rates when they keep the funds as excess reserves” and that this rate is also “more than eight times the rate on one-month T-bills” which is almost like “gifting banks $890 million every three months”

And it’s of no doubt why the financial sector continues to outperform.

Chart from Bespoke Invest

Nevertheless the continued interventions via manipulation of interest rates, the policy of quantitative easings and all other forms of monetary tools including the experiment of paying interest on bank reserves are likely to give us more uncertain outcomes through heightened volatility (bubble cycles) which should translate to even more interventionism.

Gold Fundamentals Remain Positive

``Gold, on the other hand, is a much-needed safeguard against the barbarism of monetary authorities. Historically, the international monetary system, imposed after World War II by the Bretton Woods agreements, gave the dollar a central role. It was considered "as good as gold" because it was the only currency that maintained a link with the yellow metal. Gold thus acted as economic actors' safety valve against American monetary authorities' abuse of inflationary expansion.” Valentin Petkantchin Gold and the Barbarians

I have always emphasized that gold has proven to be quite a reliable thermostat of the global equity markets[1].

Gold has not escaped the short deflationary episode in 2008 nor has it eluded the recession in the early 2008. Thus gold, as we have repeatedly argued here[2], isn’t likely to function as a deflation hedge for the simple reason that gold isn’t part of the incumbent monetary architecture unlike during the Great Depression days of the 1930s. In short comparing gold in the 30s and gold today would be like comparing apples to coconuts.

The implication of this is that a sustained fall in gold prices could suggest of contracting money supply or a resurfacing of recessionary (deflationary) forces. Thus, a sustained fall or a dramatic collapse of gold prices should be mean alarm bells for us.

As a side note, not all recessions have been deflationary as alleged by some, and this has been evident in the stagflation era of the 70s (see figure 4).

Figure 4: Economagic: Stagflation

In the 70s, even as the S&P 500 (green line) fell, the consumer price (blue line) index continued to surge. Meanwhile, precious metals (red line) peaked amidst the 1980 recession.

But of course, like money, gold is also subject to demand and supply balanced by prices. Thus given the 10 successive years of gains, gold is certainly not immune to plain vanilla profit taking.

The point is—we should ascertain if any fall in the price of gold constitutes structural or countercyclical forces at work.

Monetary Disorder Remains The Dominant Theme

When we learn that China intends to issue 1 trillion yuan ($151 billion) this year[3], the the Central Bank of Ireland is financing €51bn of an emergency loan programme by printing its own money[4] and that the US monetary aggregate M2 has been surging by biggest weekly amount since 2008[5], we don’t seem to see any substantial or structural changes that should impact the long term price trend of gold materially.

In short, global central banks continue to pump money like mad, and this should be bullish for gold.

Figure 4: St. Louis Federal Reserve: Bank Credit

To add, as I have rightly been predicting[6]; the steep yield curve would influence the US credit markets positively, though at a time lag, as I previously wrote “the US yield curve cycle has a 2-3 year lag period from which we should expect it to generate “traction” by the last quarter of 2010.”[7]

And they seem to performing as expected (see figure 4), as the US credit market appear to show signs of improvements.

The risk here is that with record “excess” bank reserves or banks' base-money holdings minus required reserves that is either held in their vaults or on deposit with the Federal Reserve, given the fractional reserve system, these reserves can multiply credit and money supply that may amplify or accelerate the rate of inflation.

In other words, even what may be read as a positive ‘economic’ sign could represent a prospective hazard—an offshoot to the previous policies.

Thus, the recent volatility in gold prices for me would account for profit taking and certainly not a reason to see a reversal.

Yet part of the recent fall in gold prices has allegedly been traced to a speculator-trader, who massively levered up on huge (long- short) gold positions, which turned out to be unprofitable and had been forced to liquidate.

The ensuing liquidation resulted to what the Wall Street Journal reports as the biggest single reduction ever[8]in gold contracts.

So with the possibility that this event may have already passed and or could have been discounted, gold could regain its lustre over the coming sessions.

Gold And The Web Enabled Middle East Political Revolutions

Friday’s huge rally in gold, which media attributed to Egypt’s worsening political crisis and had likewise been adduced to the heightened risks of a regional political upheaval—where dictatorships and the entrenched aristocracy appear to be facing a comeuppance from the long disgruntled populace, a revolution apparently enabled by the web[9] and partly triggered by surging food prices—appear more like rationalization.

Figure 5: Bloomberg[10]: Political Tremors In The Middle East

Although, stock markets in the Middle East had indeed been rattled by such fears (see figure 5).

Perhaps the embattled aristocracy could be scrambling to safekeep their wealth overseas by buying gold for laundering purposes or for absconding it, similar to reports where the First Lady of the deposed President of Tunisia was alleged to have fled with 1.5 tonnes of gold (worth $55 million)[11].

The spike in oil prices should be more of a natural side effect over concerns of supply side disruptions once political standoffs become exceedingly violent. But given that the political turmoil account for as domestic issues, I am sceptical over the prospects of prolonged violent stalemate.

For me, these so-called uncertainties are icing in the cake for gold.

Yet in my view, we should see these ongoing revolts as positive.

People appear to be emboldened in asserting their sovereignty over an increasingly derelict political structure built upon vertical hierarchies predicated on central planning and or political-economic fascism.

In short, the web has functioned as a pivotal instrument in counterbalancing or levelling or reducing the concentration of political power to a few or to the once powerful elite. The likelihood is that the rule of autocrats will be diminished, unless governments would be successful in introducing and imposing controls and censorship on the cyberspace.

With over 2 billion people now wired or connected online or “With the world's population exceeding 6.8 billion, nearly one person in three surfs online”[12], add to that the 5 billion mobile phone subscriptions or about 73% of the global population, it’s no wonder how the political playing field is being reconfigured to adjust to these new realities.

Governments in the future are likely to be more attuned to the public and would likely shed a lot of bureaucratic fats.

And these ongoing revolutions represent the aforementioned structural adjustments in the political process. Hopefully, these people power revolts will be alot less bloody than their counterparts in the early to mid 20^th century.

And if there should be any major force that could influence the current trend of gold it would likely be gold’s reversion to the new monetary framework which will likely be brought upon by people’s realization and intolerance of the abuses of central banking system.

So I unlike those who see a surge in the “event risks” from the current string of upheavals in the Middle East as a reason to sell, I see gold rebounding from these uncertainties, fed by the inflationism in central banks and eventually a rally in most of the global equity markets, including the Phisix.

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[1] See Gold As Our Seasonal Barometer, February 23, 2009

[2] See Gold Unlikely A Deflation Hedge, June 28, 2010

[3] People’s Daily Online Central bank to print 1 trillion yuan in paper currency, January 20, 2011

[4] Independent.ie Central Bank steps up its cash support to Irish banks financed by institution printing own money January 15, 2011

[5] Durden, Tyler M2 Surges By Biggest Weekly Amount Since 2008 As It Hits Fresh All Time Record, Zero Hedge, January 27, 2011

[6] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010, See What’s The Yield Curve Saying About Asia And The Bubble Cycle?, January 17, 2010

[7] See Trigger To The Inflation Time Bomb, October 7, 2010

[8] Cui Carolyn and Zuckerman Gregory Small Gold Trader Makes Big Splash, Wall Street Journal, January 28, 2011

[9] See The Web Is Changing The Global Political Order, January 29, 2011

[10] Bloomberg.com Bloomberg GCC (Gulf Cooperation Council) 200; The Bloomberg GCC 200 Index is a capitalization weighted index of the top 200 equities in the GCC region based on market capitalization and liquidity. The index was developed with a base value of 100 and is rebalanced semi-annually in April and October.

[11] MoroccoBoard.com Tunisia: Ex First Lady Absconded With 1.5 T Of Gold Bullions, January 17, 2010

[12] Physorg.com Number of Internet users worldwide reaches two billion, January 26, 2011