Mission Impossible...Accomplished?! Thanks To Surplus Liquidity...

``If you’re just in it for the money or you view the market as a way to get-rich-quick, you’ll never have the urge to examine your mistakes. You’ll keep falling into all the common traps... reaching for the moon, not cutting losses, and over trading. Sooner or later you’ll blow up.” Tom Dyson, Daily Wealth

Life’s little miracles. For the longest period, the market seems so intricate to read or comprehend and at the next it seems so simple; everything seems to fall into places as if by design. In another instance of serendipity, in this game of chance, how fortunate of me to have the market play out the route of history. And from history your analyst appears to have captured these observable patterns in a bottle. In my March 20 to March 24^th edition, (see From Theme Based to Momentum Investing; It’s Horse Racing Time), these previous patterns were used as basis for my projections, particularly two invariable targets, namely the Phisix benchmark (2,457) and a defined time frame (early May).

Here is what I wrote then (emphasis added)...

``Of course, we understand that history does not necessarily repeat itself but it may rhyme. I have dealt on this last year (see November 7 to 11 Market Timing: Preparing For the Christmas Rally) but the Phisix failed to breach the critical threshold level. With this NEW episode, the pattern may have the chance for it to hold.

Now the table below shows of the 5 past runs.

Start	End	Months	Troughs	Peaks	Points	in %
29-May-03	4-Jul-03	1.5	1048	1308	260	24.81
1-Sep-03	4-Nov-03	2	1192	1432	240	20.13
27-Nov-03	23-Jan-04	2	1313.98	1565.56	251.58	19.15
26-Aug-04	4-Oct-04	1.5	1547.35	1853.29	305.94	19.77
16-Dec-04	8-Mar-05	2.6	1804	2172	368	20.40
24-Feb-06	????		2047.62

Table 1: Observable Patterns

“During the previous winning streaks, two patterns clearly emerges. One, the Phisix has returned by about 20% on the average and second, the average time frame of a run is about 2 months before it expires or goes to a pause.

“So if we take the February 24^th low as a starting point of the present run then 20% returns would be equivalent to 2,457 for the benchmark index. Presently that means an upside of about 11%. By Phisix, we mean the heavyweight component issues such as PLDT, SMC, Globe, BPI, Ayala Land, Ayala Corp, Metrobank, SM Primeholdings, SM Investments, Jollibee Foods and Petron Corp could be expected to have a return of 11% on the average (some above, some below) IF the pattern holds true. Second, if two months will be the reckoning period for the prospective upside steak as in the past, then we could be looking at the end of April to early May for the Phisix to possibly peak out.”

As of May 5^th or Friday’s close, the Phisix leapt over and above my target at 2,457 to 2,470! Talk about sheer providence or LUCK!

Well, over the week, the Philippine benchmark posted the best gains among Asian bourses up 8.8% to a seven-year high (you know that...it’s splashed all over media!!!), while recording a 17.85% return on a year to date basis.

Yes, I have read and heard a mouthful as to the supposed causality behind the Phisix recent success, and am delighted to see SOME of my contemporaries seeing the daylight among the clutter of balderdash.

You’d be surprised to learn that compared to the nascent phase of an advancing Phisix in 2003 to 2004 which had been dominated entirely by foreign money, last week’s abbreviated trading week recorded vivacious trading activities by the local investors quite similar to the developments seen in early 2005, which pumped up the market’s turnover even if we exclude the huge cross transaction of Mr. Enrique Razon’s buyout of ANSCOR’s holding in International Container Terminal .

Put bluntly, this time around, the hefty gains that you see in the Phisix had not been limited to foreign portfolio flows, as local investors have initiated sizeable participation over the buying activities in the broadmarket, lending credence to my theory that local investors have been shifting to reinvest into local currency based assets on the basis of better profit returns opportunities comparable to previously parking their ‘savings’ into US dollar denominated ones. Needless to say, the Peso’s rise had been one of the major subliminal psychological triggers for local investor to the join the ongoing rush to accumulate equity assets listed in the Philippine Stock Exchange.

However, as in the previous runs since the Phisix cyclically reversed in 2003, foreign portfolio inflows have been the leading exponent of equity accumulations, despite the mephitic political mileu and this run makes it no different. Portfolio flows have reached a March 12, 2005 high of over P 3 billion pesos or in just four days where foreign inflows contributed to about 17% of aggregate turnover at P 3.013 billion. As usual, these torrential deluges of foreign capital are symptomatic of global excess capital seeking for profit opportunities or “money chasing too few profits”. Wayne Arnold of the New York Times captures our thoughts in his article, ``Turmoil in Asia Doesn't Dent Investors' Enthusiasm for Its Markets” (emphasis ed.)..

In the Philippines, the president is facing protests and accusations of corruption after warning in February that elements of the military were planning a coup d'état. Yet foreign purchases of Philippine stocks are at five-year highs, the benchmark index is up 3.4 percent and the Philippine peso has appreciated about 8 percent. To some extent, this remarkable sangfroid with regard to Southeast Asia stems from a faith that political turmoil is not undermining economic growth. But economists and analysts say there is a bigger factor: a glut of global savings that is making cheap capital available to both heavily indebted rich economies and riskier developing countries. The resulting avalanche of global investment capital has become largely impervious, they say, to the political risks that often buffet Southeast Asia's accident-prone economies.

Let me remind our readers that the fabulous developments on the Phisix essentially reflects on a belated move by our equity benchmark relative to its peers similar to the latest outburst by the Philippine Peso.

...and the Falling US Dollar Index For a Rising Phisix, Albeit Caution is Warranted

``Successful investing doesn't require above-average intelligence because it is not an intellectual challenge; it is an emotional one and, I believe, it is a challenge most of you are capable of meeting head on and winning. If there's anything 'clever' about what I do, it is recognizing what works and ignoring what doesn't.”-Mark Shipman: The Next Big Investment Boom

Going back to the equities markets; to broaden your perspective, you must be enlightened that today’s activities have NOT BEEN limited to the country but is seen in most parts of the world through major benchmarks.

Figure 3: MSCI Emerging Free and the Dow Jones 1800 Asia Pacific Index

World markets are being driven to record highs following the expectations of “stimulative” monetary conditions from signals that the US FED maybe going into a “pause” (discussed last week).

Markets in the US (2000-2001 high), Europe (2001 high), in Latin America and Asia have been treading in fresh watermark highs as reflected in Figure 3, the MSCI Emerging Free Index and the Dow Jones 1800 Asia Pacific Index. This shows that Emerging market bourses, such as Brazil, Mexico and India have set new record territories which bolstered the Emerging market benchmark, while Asia’s index likewise being buttressed by record gains in Singapore, aside from near record territories by other Asian bourses as Australia, Taiwan and etc. Bloomberg’s Chen Shiyin reports, ``The Morgan Stanley Capital International Asia-Pacific Index, a dollar-based index that tracks shares in 14 markets across the region, added 2.7 percent to 140.75 this week, surpassing the previous all-time high of 140.41 set on Feb. 23, 1989. All 10 industry groups that make up the measure advanced.”

Figure 4: US Dollar Index Loss; Phisix Gains

As explained last week, the falling US dollar trade weighted index has had a “stimulative” aftereffect to emerging market assets. As such we have been seeing an accelerated increase in the prices values of world equity indices, as well as in commodities to emerging market equities.

In particular, I have noted that the Phisix experienced its cyclical reversal when the US Dollar index peaked in 2003 backed by the Fed’s flooding of the global marketplace with superfluous liquidity to arrest any prospects of deflation. The Phisix climbed at the back of intense foreign buying then until early 2005 as foreign money played the US dollar diversification theme.

For most of 2005, as the US dollar recovered on the premise of interest rate/yield differentials while the Philippine market practically stood still or traded rangebound. As shown in Figure 4, the mid April collapse of the US dollar index has been inversely associated with a positive reaction from the Phisix once again bolstered by foreign portfolio flows.

What this basically shows is that the Phisix appears to have a strong negative correlation with the US dollar index. A weakening US dollar appears to feed upon the appetite of foreign portfolio flows into Philippine assets.

Figure 5: Phenomenal Growth of Commodity derivatives

As a measure to the exponential growth of world surplus liquidity contraryinvestor.com shows us of the bulging commodities trade underpinned by exploding derivatives held by US banks!

While global monetary authorities have the power to control the liquidity valves, as to where it flows is practically beyond their reach. Here the authors of contraryinvestors.com suggest that to profit from present liquidity flows simply means to “follow the money” (emphasis mine),

``...whether the Fed is willing to admit this or not, it has become the servant to the hedge fund managers, the prop desk traders, the structured finance masters of the universe, etc. Under this set of circumstances, our best near term investment returns lie where these aforementioned allocators choose to position the Fed liquidity largesse at any point in time. And that's currently in the hard asset complex. Simple enough? Until these forces or dynamics change, we need to stay long energy, long equities benefiting from higher commodity prices, in short duration fixed income if at all, as well as long precious metals.

In short, it would be hard to call for on an interim “top” on the present momentum of the Phisix yet, if the US dollar index continues to fall on the back of increased “stimulative” conditions that has prompted for augmented inflationary expectations. Further as the financial sector liability expansion continues to feed on inflating assets and or asset markets worldwide, heightened speculative leveraging creates their own source of liquidity...

Nonetheless, the world financial markets appears to be too complacent, wearing rose colored glasses...and a word of caution from Dr. Marc Faber...``Right now, risk appetite is at an extreme and everybody is bullish about something. Investors are also extremely optimistic about the global economy. Hence the significant rise in commodity prices. However, given tighter international liquidity and weakness in U.S. housing, and the potential for equity markets to undergo a nasty correction in the next three to six months, the global economy could — for a change, after having surprised on the upside for the last three years — disappoint. If such a scenario were to play out, U.S. bonds could rebound, while industrial commodities and precious metals could sell off. Therefore, short bond positions should be covered, and traders might consider buying ten-year treasuries at yields above 4.80%.”

In short, be wary of a short term jolt. Keep your mental stops on.

Improving Your Portfolio Returns by Seeing the Unseen

``There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!”- Edward Lefèvre, Reminiscences of A Stock Operator

I have been requested by some to help improve on their portfolio returns, something which I have been attempting to do through this newsletter since 2002. Let me reword, the reason for this newsletter is to help you identify and act on investment themes or trends with an objective to attain returns greater than what is offered by the respective benchmarks in the marketplace. Unless you obtain the services of a portfolio manager, which I highly recommend for the purposes of specialization, the task to improve on your portfolio essentially falls on you, as the investor/prospective investor.

However, as stated in numerous occasions investing is fundamentally or most importantly psychological more than anything else, in contrary to what is commonly known or assumed. In the words of author Edward Lefèvre in his investment classic (said to have written on the account of the legendary trader, Jesse Livermore), Reminiscences of A Stock Operator (emphasis mine), ``But not even a world war can keep the stock market from being a bull market when conditions are bullish or bear market when conditions are bearish. And all a man needs to know to make money is to appraise conditions.” If you have noticed, appraising psychological conditions that constitute the cycles have been the focal point of this outlook since I began this lowly information crusade. All other concerns have remained subordinate. And this applies not only to the stock market but to all aspects of the financial markets as well.

Moreover, investment forecasting is NOT a practice thaumaturgy (performance of magic or miracles). In alot of instances I found it intensely difficult and even frustrating to preach about absolute returns, when expectations of me are usually predicated on short term moves. I found a passage from Mr. Lefèvre’s book applicable to my plight (emphasis mine)...

``I NEVER hesitate to tell a man that I am bullish or bearish. But I do not tell people to buy or sell any particular stock. In a bear market all stocks go down and in a bull market they all go up...I speak in a general sense. But the average man doesn’t wish to be told that it is a bull market or a bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn’t even wish to think. It is too much bother to have to count the money that he picks up from the ground.”

Essentially this is what the public fails, if not refuses, to understand; that cycles caused by psychological shifts by the investing community underpin the marketplace. While there maybe sizeable accounts of randomness or “noise” on its daily activities, fundamentally, markets, like any aspect of our corporeal life operates under cycles.

And accordingly, as stated above, in most instances, similar to the narrative of Mr. Lefèvre, I find that the average investors indeed want something for nothing, such that in most cases, I am often expected to deliver short term winning formulas or a nostrum which essentially is a deliverance from one’s “gamblers’ ticks”.

And this is where the stock touts as seen in most conventional brokers and their coterie of analysts thrive, by mostly advancing PAST information and projecting them into the future. By deluging you with stock particulars, they induce you to trade frequently, which basically go against the goal of achieving above average returns, in the treasured words of the Oracle of Omaha, Mr. Warren Buffett, ``For investors as a whole, returns decrease as motion increases.” These stock touts often cannot distinguish the proverbial ‘forest from the trees’ simply because it is not their interest to do so. Their revenues models are not derived from bolstering your returns but from churning transactions.

Further, by pounding on you with past financial details aggravated by the “implied effects” of current events, they foster upon the public the fundamental foibles of the average investors; the mental short cuts or “heuristics”, namely the survivalship bias, overconfidence, anchoring, Loss Aversion/prospect theory, framing, mental accounting/rationalization, Regret theory and the comfort of the crowd/fallacy of the typicality (see August 18 to 22, 2003, Stock Market 101 on Cycles, Investor Psychology and Behavioral Finance). For instance, journalists from the mainstream media are wont to paint the picture (“framing”) abetted by the experts, during days when the markets traded lower as oil prices coincidentally goes up, of a causality based on oil price movements on the market. Sounds familiar no?

Figure 1 Dow Jones World Stock Index (black line) and the WTIC Crude benchmark (red line)

Say it isn’t so! The Picture is a fact as Ludwig Wittgenstein, Austrian-British philosopher once wrote; the three year chart of Crude Oil West Texas Intermediate (WTIC) and the Dow Jones Word Index certainly disproves such assertion so far. Yet, as mentioned above, you would hear commentaries flooding allover mainstream media from the so called experts to the lay persons of the highly touted “inverse correlation”. Such is an example of mental short cuts called as the fallacious “rationalization” of events to the markets. ``Either they're trying to con you or they're trying to con themselves.” observes Warren Buffett on financial analysts.

This is not to suggest that such correlation will be perpetual. A correlation is a correlation until it is not. For me, the reasons why oil and global stock markets have shadowed each other are due to the following:

One, oil has not yet crossed the ‘threshold of pain’ as to drain liquidity away from the financial system.

Second, speaking of liquidity, inordinate amounts of money and credit has been flooding the global financial system, causing the purchasing power of fiat currencies to fall against assets or, as seen on a mirror viewpoint, excess money have been simply chasing for yields, driving a diverse range of asset prices higher...including oil.

Figure 2: Gavekal Research: US and Japan Dumping Money in to the System

Figure 2 from Gavekal Research shows that the Japanese monetary base has been allowed to double in very short periods of time or in about three years, thrice since 1971. In fact, according to Gavekal Research, the Japanese Monetary base is currently even larger than the US! They are suggesting that the gradual reversal of the current monetary Quantitative Easing (QE) policy and the prospective lifting ZIRP (Zero Interest Policy) could lead to a possible meltdown in global bonds bolstering my case (see March 27 to 31 edition, Listen To Your Barber On Higher Rates and Commodity Prices!), as exported Japanese capital ($1.8 trillion!!!...or about 15% of US GDP or 3% of US assets) may find its way back home. But that is another story for our future outlook.

Lastly, the synchronized movements of oil prices and equity assets could be reflective of a global economy running on full throttles.

So essentially, it does not necessarily follow that high oil prices would lead to a lower market, as the causal association has rather been flimsy or outright tenuous, for the time being. In fact based on the historical data, as shown by Figure 1, it could be said of the reverse; particularly higher oil prices have led to higher markets values for equity assets or in a different plane, higher assets values for global equities have led to higher oil prices! Take your pick.

Going back to the main issue, it is also in the marketplace where such inferences (the act of deriving a logical conclusion from a premised believed to be true), assumptions (something accepted as true without proof) and cognitive illusions (illusion of knowing) are largely utilized by the average investors as basis for their decisions, the major attributes of investor losses. Unless one learns how to separate the “chaffs from the grains”, when the tide goes out one will learn who’s been swimming naked or who’s been surfing on plain ol’ Lady Luck.

You see, rising markets breeds many soi-disant geniuses. Rising markets will similarly lead to investor overconfidence. And since markets operate on cycles this means that many of the late comers and their attendant ‘genius’ experts will get burned arising from sheer imprudence or recklessness in the future as the cycle turns. Count that as a fact, it always does. Greed, Fear and Hope always dominates the market, as it has been, since time immemorial. As George Santayana wrote in The Life of Reason, ``Those who cannot remember the past are condemned to repeat it.”

I have dealt frequently with the unseen variables over the mostly macro facets and on some domestic economic and financial market issues. The information I have imparted to you have not been conventional, yet, they would appear to have validated my prognosis over time’s progression. I know it could have been outright serendipity or just plain luck. But at least, I am pleased to have been fortunate or blessed enough to have rightly called on the major turns or inflection points in the financial markets, be it the Phisix, the Peso, the Mining index/industry, the US dollar, Gold or commodities. Thank you, Lord.

Yet, all these could also have been a matter of visual processing, or the sequence of steps that information takes as it flows from visual sensors to cognitive processing (wikepedia.org), at the margins. The picture below (Figure 3) is a test of your visual processing, something which is commonly applied to investing.

Figure 3: Visual Processing Test, from Robert Ringer of Early to Rise

According to Mr. Ringer, If you are able to spot the object above then your visual processing is probably good. If you can’t get it, then try rotating the picture clockwise or look at it on a landscape format. If you are still having a hard time figuring it out, then probably it is an indication that you have probably some difficulty with your visual processing.

This isn’t an abstraction or illusion, it’s an actual picture. It’s actually a picture of a cow or of a cow’s face.

The point is, to quote Mr. Robert Ringer, ``we often look directly at things, yet still do not see them.”

Reuters: Commodities hold key to economic power

According to Pratima Desai of Reuters, ``Raw material resources will determine country rankings in the world economic pecking order in years to come as strong demand and limited supplies ensure commodity prices hold their upward trajectory.”

"But in the main, investments will be concentrated on things to do with commodities, whether they be stocks, bonds or currencies such as the Canadian or Australian dollars." Notes David Murrin, chief investment officer at hedge fund Emergent Asset Management.

Oops, Record High Oil Prices Means Higher Mining and Oil Stocks!

I have to admit, the recent “euphoric” bouts of buying activities in the mining and oil sector has given me some apprehensions about a possible “top”. In fact, I’ve taken such opportunities to liquidate some of my trading positions. Yet it appears that the gravity defying momentum of oil and mining stocks appears to remain solid amidst an overbought backdrop.

Technicians or price action watchers known as Chartists have been blown off by the recent surge. Most of them have sold out or have been left behind, following the two week frenetic run, where the Mining and oil index have gained by almost 1,000 points or about 25% (and is up about 77% up from the first week of the year). Such is the flaw of trying to “time” the markets, because markets can remain irrational than one can remain solvent to paraphrase the preeminent economist John Maynard Keynes.

Nonetheless, in the past three trading sessions, from April 11-17, the Mining and Oil Index took the top spot in terms of Peso trading volume relative to the different sectors! Moreover, the mining and oil index appears to have generated its distinct sentiment relative to that of the Phisix. Put differently, the performance of the sector has been independent to that of the Phisix. Apparently, these are seminal manifestations or indications of the times to come.

At present, the Mining and oil index appears to be at still overbought levels, hence, a trading sell, in my view. However, despite the overbought conditions, one may be compelled to buy back ASAP due to Friday’s noteworthy surge to nominal RECORD highs by the world oil benchmarks, the West Texas Intermediate Crude (WTIC), as shown in Figure 1, and the Brent Crude, accompanied by a broadbased metal rebound. In New York, WTIC closed at $75.15 per barrel while Brent crude closed at $74.56 in London.

Figure 1: WTIC Crude courtesy of stockcharts.com

Of course, rising crude also translates to rising prices in other commodities. After a severe one-day profit taking last Thursday, Copper and Gold staged a dramatic reversal on Friday with Copper on a FRESH RECORD high, up 11.38% for the week to $3.0985 per pound! Gold, the metal sibling of oil, likewise stormed back to over $630 per oz also at milestone highs!

One has to keep in mind that rising commodity prices could be indicative of declining values of Paper based money or the present US dollar standard system. Even the proponents of deflation have now been raising concerns about the attendant emerging incidence of growing inflation.

You see by theory, paper based money and credit can be issued infinitely relative to the finite supplies of commodities, ergo, too much supplies means falling values of paper money or as manifested in the present case, the surge of commodity prices. For instance, while media has noted of rising Gold prices quoted in US dollars, what has not been said is that Gold has surged across the spectrum of major Fiat Currencies, as shown in Figure 2. Even against the top performing Canadian dollar, Gold still asserting domination.

Figure 2: Gold Surging against the Canadian "Loonie" Dollar and the Japanese Yen (courtesy of Fullermoney.com)

This means that global investors have been slowly monetizing gold as an alternative currency, something we have argued about since 2003. The public has taken gold as a safehaven against the loss of purchasing power by the overissuance of paper based money and credit.

Now, since the locals have gradually imbued of these developments and learned how to price mining and oil stocks with that of its underlying products; with the present surge in commodity prices, you can expect another round of frenzied buying frenzy at the Philippine Stock Exchange next week.

Notwithstanding, the nominal record high set by Crude Oil prices, aside from the inflationary manifestations, are also about investment cycles and geopolitical considerations, something we discussed last May 2 to 6, 2005, The Cure Is Worse Than The Disease. One can expect that, with the present imbalances that have led to a tight margin exacerbated by present geopolitical conditions, these are recipes for new RECORD oil prices...Think $100 per barrel!

For instance, the 15 permanent and elected members of the United Nations Security Council are scheduled to meet on April 28 at its New York Headquarters. The US and Britain have been rallying for support on tougher actions against the largely defiant Iran. A sanction against Iran could be imposed and the drums of war can now be heard from a faint distance.

We must not forget that an estimated 743 billion barrels (see Figure 3) or over 66% of accrued world oil reserves are held by the Mid-East countries. Such that any military conflict or escalating unrests, e.g. Iraq’s majority Shia is supported by Iran, in the region could affect or risks cutting off or destabilizing the world’s oil supply link.

Figure 3 Distribution of World’s Reserves courtesy of Martin Weiss of Money and Markets

Furthermore, any events that may lead to the closure of Strait of Hormuz (see Figure 4) where 40% of the internationally traded oil’s passes through could cause an oil price spiral to over $100 per barrel!

Figure 4 Strait Of Hormuz courtesy of globalangst.blogspot.com

Notwithstanding you have further tensions in Nigeria, Chad, and Latin American States as Venezuela. Aside, you have news about the declining or “peaking” of oil output from major oil field as the Burgan oilfield in Kuwait, and the second largest producing oil field in the world, the Canterell oilfield in Mexico. In short, whether you believe about the Peak Oil theory or not, present demand and supply conditions are so tight that any incidences or events that may snap or tilt the present imbalances may lead to spiraling oil prices! The greater risks is for an upside rather than a downward move for oil.

To repeat the my above quote of Albert Einstein “We must learn to differentiate clearly the fundamentally important, that which is really basic, from that which is dispensable, and to turn aside from everything else, from the multitude of things which clutter up the mind and divert it from the essential.” What is essential to understand with the current developments is that the publicly listed oil companies act an insurance against any risk of an oil price shock which may worsen as geopolitical conditions have been threatening to escalate. Put bluntly, it pays to be invested in oil explo companies as an insurance against escalating oil prices.

Since oil exploration and production companies have existing reserves, even when most of them are not operational, rising prices of oil would translate to an increase of their asset values and should likewise be reflected in the share prices.

As discussed last year see August 1 to 5 edition, Hidden Wealth in Philippine Black Gold Stocks, oil stocks remained at the fringe for quite a time until its recent renaissance.

For the week, local investors bidded up domestic oil companies as Oriental Petroleum (+33%), Philippine Overseas (+29.03%) and PetroEnergy (+82%). With oil prices carving out new highs, one can expect these companies to shadow oil prices and similarly outperform together with the movements of their siblings, the mining stocks.

As for me, I would be compelled back into the market given the present circumstances regardless of what the technical indicators say. Besides since commodities are presently in a bull market, any mistakes should easily be covered, to quote the veteran Richard Russell, ``A bull market tends to bail you out of all your mistakes. Conversely, bear markets make you PAY for your mistakes.”

For one to achieve outsized returns, it takes to know WHEN to have the fortitude to take the necessary risks. And Time is NOW!

Philex and Copper: Testing the Limits!!!

Interesting times indeed. Defying gravity and chart indicators, the exemplary strength exhibited by Philex has been simply amazing. Aside from leading the Mining index, its present price dynamics has now turned parabolic!

Figure 1: Philex B

In trying to figure out why Philex has behaved in such bizarre manner, your analyst stumbled on a paragon that appears to resemble its present comport. Philex’s major product Copper has likewise done an equally breathtaking stunt! A historical record run out of severe fundamental imbalances....

Figure 2: Copper Prices courtesy of stockcharts.com

Notice that while copper has consolidated sometime February, Philex, after having peaked in January, has basically mimicked its moves with both breaking out of the area of indecision by March to carve fresh record heights.

In short, Philex has been priced by the market, thus far, as a proxy to copper such that for as long as copper continues to defy gravity, outperformance from the Philex can be expected should the correlation persist. As the illustrious John Maynard Keynes once said, the market can remain irrational longer than you can remain solvent.

Philippine Mining Index; We’ve Only Just Begun!

``The best investment opportunities come from an asset class where those who know it best, love it least, because they have been disappointed most.” Donald Coxe, BMO Financial Group

I smell sweet absolute vindication. Since my Rip Van Winkle in Gold series in 2003, I have fulfilled partial projections (such as Philex “A” a mere 15 cents away from its 1987 high of 3.30), I predicted that all, if not most, previous highs of publicly listed mining issues would be topped and that the Mining index would surpass its 1987 high (see October 11 to 14, 2004 Philippine Mining Index: The March to 9,000-levels)!

Today, since the euphoria brought about by the Supreme Court’s ratification of the Mining Act in 2004, it appears that the mining index has gotten its second wind with an industry-wide charge lifting the mining index close to its 2005 high.

My conviction is that the Mining/extractives industry (including oil) would generate the best returns simply stems from the following premises:

One, it has been a global trend. The measures of the industry are on a macro aggregate basis and not on a localized scale.

Second, the industry comes from a very low base. The mining industry has been depressed by over a decade. The huge surge in commodity prices worldwide represents imbalances in the demand-supply equation that necessitates our resources to be tapped or brought on stream to meet existing deficiencies. According to an industry official, of the 9 million mineral rich hectares only 1.4% of the potential mining sites have been covered by permits! In short, risks have been basically limited relative to the commodious upside potentials.

Third, the investment cycle for the industry has just turned in to its favor or the commodity cycle is at its pristine state yet.

Aside from demand growth emanating from the rapidly expanding emerging market economies at the margin, increasing investment and speculative activity has exacerbated the present cycle, according to analyst Martin Spring, ``One indication of this is that investment in commodity index funds has risen from less than $30 billion to an estimated $80 billion currently, and is forecast to reach $140-150 billion by the end of next year.”

Moreover, there is the supply side underscored by plunging inventories, according to Donald Coxe of BMO Financial Group who writes in his Basic Points, ``The next years of this bull market will be driven by the Supply Side.”

Infrastructure bottlenecks highlighted by the shortage of manpower (mining engineers, geologists and etc.), and materials (tires, rigs, et. al), rising costs (wages, cost of materials and interest rates!), reserves coming from politically risky zones (To quote Mr. Coxe, ``As for those billions of tons of ore in potential greenfield projects, they are scattered across the globe, mostly in Third World locations, and mostly in politically risky Third World locations, such as the Congo.”), severe undercapitalization or lack of investments (According to Mr. Coxe, ``The industry is consolidating rapidly, not growing rapidly”~ which means mining and oil companies have been tethered by the ‘rear view mirror’ syndrome or the fear that “good times may not last”), environmental restrictions and political interference. What took a new mining project to open or operate in 5 years has now been extended by about 8 years. So the good times are about to continue rolling. Again quoting Donald Coxe (emphasis mine), ``At current consumption growth rates, the world is going to need major new supplies of copper, zinc, lead, tin, aluminum, and nickel by the end of this decade.”

Finally and most importantly is that the industry has the CRITICAL MASS to attract foreign investments and contribute to the development of the domestic economy. According to analyst Doug Casey, the country is ranked second in gold reserves, third in copper and sixth in chromite.

Figure 1 Philippine Mining Index and the CBOE GOX index

The Chicago Board Options Exchange Gold index (GOX) a benchmark comprising several key mining issues has been on an uptrend since end 2000, as shown in Figure 1 (Blue line and blue arrow). While the Philippine mining index has started its ascent in only at the end of 2003! In short, a THREE years lag! CBOE’s GOX has returned 5x compared to the local mining index which is up only 3x!

I got scoffed at, laughed at and ridiculed when I preached this contrarian investment theme about 3 years ago. Such denials came from some clients and friends until even last year especially after the initial bout of euphoria failed to sustain its rise. To quote IBM founder Thomas J. Watson, Jr. ``There's a fine line between eccentrics and geniuses. If you're a little ahead of your time, you're an eccentric, and if you're too late, you're a failure, but if you hit it right on the head, you're a genius." It certainly proved difficult to be seen as an eccentric, when the public’s inclination is to assume of the short term perspective.

Albeit, I understand how investment mavens Jim Rogers and Dr. Marc Faber felt, having preached the same theme earlier or since the late 90s (Warren Buffett bought his 130 million ounces of silver in 1998!). Now it looks as if it is payback time, as the commodity theme gets conspicuously diffused into the public psyche!

Figure 2: From Denial to Gradual Acceptance?

I have been saying that the financial markets are fundamentally psychological more than anything else, such that investment themes permeate through the public via several stages. The boom bust stage cycle as defined by billionaire philanthropist George Soros as 1) The unrecognized trend, 2) The beginning of a self-reinforcing process, 3) The successful test, 4) The growing conviction, resulting in a widening divergence between reality and expectations, 5) The flaw in perceptions, 6) The climax and finally 7) A self-reinforcing process in the opposite direction.

With indicators such as business headlines ``Stocks at Par with Gold price trend”, faddish analysts taking up the Bullish outright “buy” calls from previously “speculative” buy calls on mining issues and local buying amidst foreign selling yet propping up price levels to 1987 highs (particularly in Philex Mining), it appears that we are in at the stage 2 “The beginning of a self-reinforcing process” gradating into the stage 3 “The successful test” of the Soros cycle. In short, from the fringe our investment theme has slowly evolved to the social convention or is, in other words, turning mainstream! From one the songs of the late Karen Carpenter, We’ve only just begun!

Figure 2 shows of the recent major or deep corrections in the mining index (blue arrows) have signified the massive denials by the public on the recrudescence of the once downtrodden industry. Yet despite such rabid denials your prudent analyst/investor remained steadfast, as British author Aldous Huxley once wrote, “Facts do not cease to exist because they are ignored.”

Today, the technical picture manifests of a gradual improvement in the investing public psyche as exhibited by our favorite pattern the “J.LO” bottom (named after actress Jennifer Lopez). Moreover, corrections or counter trend moves has been to a lesser degree compared to the previous.

Figure 3: The Big Picture! Massive JLOs!

Figure 3 shows of the Mining index since 1958. The highest the Mining index has reached was in 1987, which paradoxically was counter to the rapidly declining prices of commodities then. Today, the rise of the mining index has coincided with the spectacular jump in commodity prices see Figure 4, meaning that the global investing dynamics has filtered into the pricing of domestic mining stocks in anticipation of its renascence.

And since commodities operate under an investment cycle like any other industries, its record high prices driven by asymmetries in the marketplace are bound to remain in place for sometime; possibly a decade or more, although NOT in a straight line.

Some market participants or prospective participants deem analysts ‘can read the future’ or the ‘investing public’s mind’. Conventionally, they ask for a specific date or time frame, normally a short time at that, when considering to jump into the marketplace. Let it be known that we (analysts) do not control the market and are not clairvoyant nor are we psychic; we operate on the realm of probabilities and possibilities.

Figure 4: courtesy of Martin Weiss, Money and Markets

Finally, I’d like to warn you that the frenzied rally in the mining index indicates that some index members, in particular the apparent leader Philex Mining has been into deep overbought territories for sometime and could see some correction anytime soon. With faddish analysts throwing a buy call on the issue, we take such signs of bullishness as indicators of near ‘tops’. One analyst in the print media made a similar call last January 25^th 2005, in the heat of the Mining run spawned by the Supreme Court ruling and in less than a month the mining index collapsed following such euphoria.

While I remain bullish on the industry over the long term, there would be a better time to accumulate at much attractive prices than today. BMO’s Donald Coxe makes a worthwhile recommendation to the public (emphasis mine), ``The longer-lived the reserves, the more a company is worth. A deep value investor should not price these stocks primarily on their current p/e ratios, but on the values deep in the ground that will be realized over coming years—and coming generations.”

Figure 5: Courtesy of Adam Hamilton’s Zealllc.com

As a final reminder, contrary to the pabulum spouted by conventional analysts, mining stocks are less valued by P/E ratios as shown by sky high P/E valuations in Figure 5 by mining stocks components of the Amex Gold bugs HUI and the Philadelphia Gold Silver XAU, but by operating leverages and reserves.

Have a great holiday!

CBS Market Watch: Gold hits $600 an ounce

Gold hits a milestone!

NEW YORK (MarketWatch) -- Gold futures powered higher early Thursday, setting a fresh 25-year high at $600 an ounce, pulling other metals to multiyear levels and helping copper to a new all-time high.

"Gold is exploding and silver isn't far behind," said Kevin Kerr, trader and editor of Global Resources Trader, a newsletter published by MarketWatch, the publisher of this report.

Gold for June delivery rose to $600 an ounce in official trade on the New York Mercantile Exchange, having earlier hit a high of $601.90 in electronic trade.

Silver traded at a new 22-year high of $12.01 an ounce, after peaking at $12.08 in electronic trade.

The metal has rallied sharply in recent weeks as excitement has built about the pending launch of a silver exchange-traded fund, that's expected to boost physical demand for the metal.

Copper was last up 2.20 cents to $2.618 a pound, after trading at a new record of $2.621 in official trade and $2.64 a pound in electronic trade.

Platinum rose $17.40 to $1,098 an ounce and palladium was up $13.35 at $356 an ounce.

The ``Philippine Mining Industry's Inevitable Rise” Watch

I have recently argued that geopolitical developments would be shaped by resource based securitization. Some events leading towards the validation of these assumptions...

1. Recently, Zimbabwe has attempted to nationalize its mining industry. According to a report by Diamonds.net, ``Under intense pressure from South Africa's mining houses and the International Monetary Fund (IMF,) the Zimbabwe government has been forced to backtrack on its proposal to nationalize mines in the country.”

2. According to a Bloomberg report, Cia. Vale do Rio Doce, the world's largest iron-ore producer said the amount of mining exploration and investment in South America may be overtaken by spending in Asia as companies are lured by the prospect of bigger finds. Asia accounted for 17 percent of global investment in mining exploration last year, from 8.7 percent in 2001, Fabio Masotti, Vale's head of exploration for Asia and Oceania, said at the three-day Annual Asia Mining Congress in Singapore. This increase occurred in the face of ``restrictive mining laws, red tape, social and economic instability'' in many Asian countries, Masotti said in a speech. Rio de Janeiro-based Vale has budgeted $180 million for exploration this year, with more than half of it to be spent outside Brazil, said Masotti.

3. Mexico might even attempt at denationalizing its oil industry! According to this Bloomberg report, ``Mexico risks a drop in oil output unless lawmakers allow for private investment in the industry, according to the chief executive officer of state-owned Petroleos Mexicanos, the world's third-largest producer.

``Pemex, as the company is known, will leave billions of barrels untapped in deep Gulf of Mexico waters and in a costly onshore field without partners to provide technology and share risks, said Pemex CEO Luis Ramirez Corzo. Mexican law allows only Pemex to extract crude and natural gas and to refine oil, barring companies such as Exxon Mobil Corp. and Royal Dutch Shell Plc from investing in the industry.

``The country since 1979 has pumped the majority of its oil from Cantarell, the world's second-biggest field by production, and reinvested little on other deposits, Ramirez said. With Cantarell supply declining for the first time this year, Pemex must emulate state-controlled companies such as Norway's Statoil ASA to drill in more remote areas.

``We're worried,'' Ramirez said in an interview from the 44th floor of Pemex's Mexico City headquarters. ``The problem is that today we have to begin making decisions that affect us 10 years from now.''

Listen To Your Barber On Higher Rates and Commodity Prices!

``If you don't know where you're going, you'll end up somewhere else.” Yogi Bera

Figure 4: Since 2004 Philippine (ROP) Sovereign Instruments have Soared!

A client asked me last week whether it would be more prudent to invest in bank products which invested mainly on ROPs instruments yielding a rate in the high 10s in percentage or the stock market. Naturally, I would have to admit that considering the equities market as my métier, I would be biased to answer in favor of the latter. As Warren Buffett once remarked, ``Never ask a barber if you need a haircut.”

Figure 4 courtesy of again of Asianbondsonline.com tells us that since 2004, benchmark coupon rates for ROPs have collapsed by about 40%. In short, ROPs have been on a BULL MARKET! Yet, much of these improvements I have likewise attributed to overflowing money and credit supply or the inflationary cycle adopted by global central banks since 2003 (discussed extensively in our November 14 to 18, 2005 Inflation Cycle A Pivotal Element to Global Capital Flows). I have argued that global investors has lumped the Philippines as part of the emerging market class, such that investing on the aforementioned rubric means a spillover to Philippine assets, thereby contributing to the conspicuous inflation of asset prices.

Now times have changed. Global central banks led by the US Federal Reserves has began to siphon off liquidity, since 2004, from the global financial marketplace as it hiked its interbank rate for the 15^th time to 4.75%. To wit, we have also reported of the recent rate hike undertaken by the Euro last December (with more forthcoming) and the end of the accommodative money policies in Japan with the end of the Quantitative Easing (QE) (see March 6 to 10 Rising US Yields; Japan’s End to Quantitative Easing).

In essence, we have concurrently a global trend of rising interest rates which does not bode well for our peso sovereign debt class. The Philippine 10-year US denominated instruments is merely 230.9 basis points away at 7.159% from its US 10-year counterpart at 4.85%. Such low spreads makes it unlikely for the Peso debt instruments to surge further, especially under the environs of constricting monetary conditions.

I have been expecting a divergence in the price performance among asset classes however since the Fed flushed the world with excess dollars in 2003, almost in synchronicity, global asset prices have risen across all spectrums.

Today, as the scaffolds of liquidity are gradually being withdrawn; it could be observed among the financial marketplace that some tolls are being exacted not in the equity or commodity markets but in the bond markets...

Figure 5: Lehman Bond Composite (Global) and the Salomon Brothers Emerging Market Debt Fund Inc.

As shown in figure 5 courtesy of stockcharts.com the Lehman Bond Composite – Global (red line), representative benchmark of global bonds and Salomon Brothers Emerging Markets Debt Fund Inc (black line) for emerging markets have been on a recent decline.

Figure 6: Dow Jones Corporate Bond Index (red line) and the Morgan Stanley Dean Witter U.S. Government Securities Trust (black line)

And it is almost across the board, as shown in Figure 6 Morgan Stanley Dean Witter U.S. Government Securities Trust, representative of US sovereign debt as well as the Dow Jones Corporate Bond Index, representative of corporate debts.

Moreover, if government trends are of any indication, the recent surprise delivered by Iceland’s central bank to raise interest rates by three quarters of percentage point may herald to similar activities in the financial marketplace, something unexpected by the conventional investors.

Since 2003, I have stated that rising gold prices have not been consistent with rising equity and bond prices as gold prices signify an increased degree of uncertainty (geopolitics, monetary, financial, or economic stress) and/or hallmarks of higher inflationary environment.

Figure 7 shows (courtesy of kitco.com and economagic.com) the correlation of rising gold prices in the past in tandem with rising interest rates (as shown in the lower window).

The recent surge of gold prices to a 25-year high alongside precious metal sibling silver, as well as record highs of other metals as copper, zinc (see Figure 8) and platinum, and even sugar to a 24 year high, has been accompanied by a breakout of the 10 year yield of the benchmark US Treasuries to its highest level since May 2004.

If past were to assimilate itself then we are off into seeing higher rates conflate with higher commodity prices (see Figure 9 represented by the CRB Reuters Index).

While bonds may not be the place to be, as higher inflation rates erodes yields or locking in at low rates would translate to capital losses, higher commodity prices equates to higher reserves valuation and increase in earnings for the extractive industries. Further, if eroding purchasing power brought about by monetary inflation is concerned, amidst a “stagflationary” environment, then in parallel to commodities, hard assets could be the place to be. In short, under the Philippine setting it’s best to stay invested with short term bonds or preferably long the stockmarket (mostly in real estate and mining/oil).

I guess its time to listen to your barber and have that haircut!

Phisix Breaks Out! It’s the Peso, stupid

``Efforts and courage are not enough without purpose and direction." - John F. Kennedy

After a long and tedious wait, finally that much awaited breakout!

Figure 1 Phisix Breakouts out of One Year Consolidation

Surging 2.7% for the week, the Philippine benchmark index posted cumulative gains of a noteworthy 5% over two consecutive weeks, to scale a 6 year high as of Friday’s close. The advances over the previous ten sessions represent the bulk of the 5.34% year-to-date advance for the Phisix.

Well, this isn’t exactly a surprising development since we have repeatedly delved on the possibility of this outcome over the past weeks, if not since late last year (see November 7 to 11 Market Timing: Preparing For the Christmas Rally). We have even taken as cue the movements of Indonesia’s JKSE (+.47%) in the previous edition!

Even amidst the most recent battering of the Phisix coincidental to the declines among contemporary emerging market indices, my forecasts for the Phisix remained steadfastly for the breakout, confidently banking on market cycles as basis for such gritty projections. As to whether the present breakout could simply be a headfake or the next leg up remains to be seen, however, signs are predominantly indicative for the latter to occur.

In contrast to the previous breakouts, which had been primarily driven by foreign money, today’s watermark activities could be characterized as being driven by a combination of more aggressive local investors and an equally optimistic foreign money. In fact, market internals reveal that the scope of foreign buying activities over the broadmarket has reached a March 2005 high! As an aside, net foreign buying constituted about 20% of accrued turnover at Php 1.273 billion.

It is safe to infer that the money flows from overseas investors into the domestic market could be consistent with the activities in the emerging market class. For the week that ended on March 22^nd, according to Amgdata.com, ``Excluding ETF activity, International Equity funds report net inflows ($854 Mil) to all Emerging and Developed regions.” Moreover, most Asian bourses registered advances for the week except for Sri Lanka, Thailand, Taiwan, South Korea and Hong Kong.

During the previous outlooks, I mentioned that the formative upside trends or the “successful breakouts” (see February 27 to March 3 edition, Bullish Signals from the Recent Rally) over the broadmarket indicated a psychological reversal by the locals whom have been sparingly bullish over the present advance cycle which incepted in the second quarter of 2003. The burst of activities from local investors have been conspicuously observed during the peak cycle of last year’s run, i.e. February to March.

Even prior to the present breakout, evidences abound that local investors’ activities have actually ramped up!

Figure 2: Ascending Number of Trades

As shown in Figure 2, the number of trades or the transactions consummated daily have been building up since the last quarter of 2005 until the present. The overall trend has likewise been on an upside since 2003. Please note that the spike or the record high number of transactions was recorded during the zenith of last year’s run from February to March. Present momentum tells us that we are about halfway from the previous peak. This suggests that as the market scales higher, activities are likely to reach or even surpass previous highs.

Figure 3: Issues Traded on an Uptrend

On a similar plane, we can observe that the number issues traded daily in the market also on an uptrend for both the long term (since 2003) and short term perspective (mid 2005) as shown in Figure 3 (the red arrow). Again similar to the number of trades, activities during the last quarter of 2005 have been markedly higher than the base prior to the February to March 2005 run up and continue to accelerate. Again, expect the number of traded issues to increase in magnitude or even possibly surpass the previous record highs as the Phisix lofts to higher grounds.

Now against the claptrap spouted by most conventional mainstream analysts/experts of improving micro aspects (there is no dispute that the micro environs has emitted signs of improvement but has not served as the driver!), your prudent investor analyst has pointed to the higher peso as the pivotal impetus for the psychological shift of the local investors as to being “positive” on the domestic market.

Again, using Bastiat’s law of the Unseen or in the words of the illustrious scientist Albert Einstein ``Not everything that counts can be counted and not everything that can be counted, counts”.

Figure 4: Peso’s Appreciation In September Coincides with Acceleration of Local activities

Now what appears to really count among the sundry of countable factors is that as the Philippine currency, the Peso begun its appreciation in September, activities in the market by the local investors, as demonstrated by the confluence of the rising number of traded issues and the daily transactions, have distinctively been on an uptick over the same period! In other words, the rising Peso has coincided with the growing activities of local investors over at the PSE.

The distinguished Austrian Economist Ludwig Von Mises argued that ``Human action is purposeful behavior” which means that people are generally moved by the judgments of value aiming at a definite end or that people act to attain their “perceived” interests. The Philippine Stock Exchange or the local equities market has evidently become an alternative avenue for local investors whom have found investing in the dollar denominated assets as a less appealing proposition. In short, local investors have been simply chasing for yields. Elementary my dear Watson!

One must remember that throughout the past decade, as the Peso depreciated amidst financial and economic turmoil, local investors have fundamentally fled from investing in local (peso) assets or (business) ventures and took the US dollar route as a haven for their savings. This essentially is known as “Capital Flight”.

In the past I mentioned that the domestic banking sector’s Foreign Currency Deposit Unit (FCDU) has been reportedly loaded with some $10.4 billion worth of dollar denominated investments lodged overseas by local resident investors, according to the Bangko Sentral ng Pilipinas as reported by the Philippine Daily Inquirer.

As the prospects of a firming peso/falling dollar and higher yielding rates for the domestic money market or fixed income units relative to US dollar based units gets to be entrenched upon the Filipino investor’s psyche, the odds are for a trend reversal of the past “Capital Flight”. You can expect a gradual repatriation of that $10.4 billion worth of locally owned dollar assets back to Philippine shores. Investments are likely to grow manifold in the form of expanded volume for the PSE (direction too!) as well as domestic fixed income securities, real estate and/or myriad business ventures or direct investments. This, notwithstanding, does not incorporate the unreported monies stashed overseas!

The logic is quite simple: Would you remain holding on to the US dollar or US dollar denominated assets when returns are falling? Would you not invest on a higher yielding currency?

So what your mainstream analysts deduces as micro improvements acting as drivers of the markets are essentially the consequences of ‘causality’. To reword the famous quote of author Harold Coffin, ``It’s the Peso, stupid.”

Because our goal is to always be ahead of the curve, understanding the drivers of the market is our main concern and acting on investments that are expected to respond or react to such trends and NOT training our eyes on relative effects. As the prominent economist John Maynard Keynes once said, ``Successful investing is anticipating the anticipations of others." We act on the anticipation of an emerging trend or surf on an existing wave/trend.

Again let me remind you that this is seen in the prism or through the looking glass of the local investors.

In essence, the rising peso has certainly provided the subliminal stimulus for local investors to ante up on the domestic equities market using news or current events as rationalization for such activities. As for the foreign money, it’s all about global liquidity and sentiment (STILL!).