Confiscatory Deflation and Gold Prices

This is a reply to an objection

Gold’s rise represents:

1. fear of bank failure.

My reply

With all the money being sunk into the banking system of major economies, such observation omits the current evidences that abounds (from ECB’s $1 Trilion QE, Fed’s explicit guarantee and rollover of principal payments, SNB’s and Japan’s currency interventions and bans on short sales by 4 European nations plus Turkey and South Korea)

This of course doesn’t even include the money spent for the bailouts during the 2008 crisis where the Federal Reserve audit revealed $16 trillion issued to foreign banks and or previous estimates of $23.7 trillion exposure of US taxpayer money to save the systemically important or ‘too big to fail’ banks and other politically privileged companies.

As one would note, people stuck with an ideology will tend to dismiss evidences even if these have been blatantly “staring at their faces’.

2. concerns of the "Pesofication" of hard currency accounts

My reply

Assumptions that government’s may confiscate deposits or prevent withdrawals like the Argentina crisis (1999-2002) does not translate to an increase of demand for gold, for the simple reason that such government policies promote deflation.

Austrian Economist Joseph Salerno calls this ‘Confiscatory Deflation’

Mr. Salerno explains (bold emphasis mine)

As a result, Argentina's money supply (M1) increased at an average rate of 60 percent per year from 1991 through 1994. After declining to less than 5 percent for 1995, the growth rate of the money supply shot up to over 15 percent in 1996 and nearly 20 percent in 1997. In 1998, with the peso overvalued as a result of inflated domestic product prices and foreign investors rapidly losing confidence that the peso would not be devalued, the influx of dollars ceased and the inflationary boom came to a screeching halt as the money supply increased by about 1 percent and the economy went into recession. Money growth turned slightly negative in 1999, while in 2000, the money supply contracted by almost 20 percent.

The money supply continued to contract at a double-digit annual rate through June 2001. In 2001, domestic depositors began to lose confidence in the banking system, and a bank credit deflation began in earnest as the system lost 17 percent, or $14.5 billion worth, of deposits.

On Friday, November 30, alone, between $700 million and $2 billion of deposits--reports vary--were withdrawn from Argentine banks. Even before that Friday bank run, the central bank possessed only $5.5 billion of reserves ultimately backing $70 billion worth of dollar and convertible peso deposits. President Fernando de la Rua and his economy minister, Domingo Cavallo, responded to this situation on Saturday, December 1, announcing a policy that amounted to confiscatory deflation to protect the financial system and maintain the fixed peg to the dollar.

Specifically, cash withdrawals from banks were to be limited to $250 per depositor per week for the next ninety days, and all overseas cash transfers exceeding $1,000 were to be strictly regulated. Anyone attempting to carry cash out of the country by ship or by plane was to be interdicted.

Finally, banks were no longer permitted to issue loans in pesos, only in dollars, which were exceedingly scarce. Depositors were still able to access their bank deposits by check or debit card in order to make payments. Still, this policy was a crushing blow to poorer Argentines, who do not possess debit or credit cards and who mainly hold bank deposits not accessible by check.

Predictably, Cavallo's cruel and malign confiscatory deflation dealt a severe blow to cash businesses and, according to one report, "brought retail trade to a standstill." This worsened the recession, and riots and looting soon broke out that ultimately cost 27 lives and millions of dollars in damage to private businesses. These events caused a state of siege to be declared and eventually forced President de la Rua to resign from his position two years early.

By January 6, the Argentine government, now under President Eduardo Duhalde and Economy Minister Jorge Remes Lenicov, conceded that it could no longer keep the inflated and overvalued peso pegged to the dollar at the rate of 1 to 1, and it devalued the peso by 30 percent, to a rate of 1.40 pesos per dollar. Even at this official rate of exchange, however, it appeared the peso was still overvalued because pesos were trading for dollars on the black market at far higher rates.

The Argentine government recognized this, and instead of permitting the exchange rate to depreciate to a realistic level reflecting the past inflation and current lack of confidence in the peso, it intensified the confiscatory deflation imposed on the economy earlier. It froze all savings accounts above $3,000 for a year, a measure that affected at least one-third of the $67 billion of deposits remaining in the banking system, $43.5 billion in dollars and the remainder in pesos.

Depositors who held dollar accounts not exceeding $5,000 would be able to withdraw their cash in twelve monthly installments starting one year from now, while those maintaining larger deposits would not be able to begin cashing out until September 2003, and then only in installments spread over two years. Peso deposits, which had already lost one-third of their dollar value since the first freeze had been mandated and faced possible further devaluation, would be treated more liberally. They would be paid out to their owners starting in two months, but this repayment would also proceed in installments. In the meantime, as one observer put it, "bank transactions as simple as cashing a paycheck or paying a credit card bill remained out of reach of ordinary Argentines."

Mr. Lenicov openly admitted that this latest round of confiscatory deflation was a device for protecting the inherently bankrupt fractional reserve system, declaring, "If the banks go bust nobody gets their deposits back. The money on hand is not enough to pay back all depositors." Unlike the bank credit deflation that Lenicov is so eager to prevent, which permits monetary exchange to proceed with a smaller number of more valuable pesos, confiscatory deflation tends to abolish monetary exchange and propel the economy back to grossly inefficient and primitive conditions of barter and self-sufficient production that undermine the social division of labor…

Unfortunately, things were to get even worse for hapless Argentine bank depositors. After solemnly pledging when he took office on January 1 that banks would be obliged to honor their contractual commitments to pay out dollars to those who held dollar-denominated deposits, President Duhalde announced in late January that the banks would be permitted to redeem all deposits in pesos. Since the peso had already depreciated by 40 percent against the dollar on the free market in the interim, this meant that about $16 billion of purchasing power had already been transferred from dollar depositors to the banks.

Prices of gold vis-à-vis the Argentinean Peso only surged after the Argentine government allowed the Peso to be devalued.

Chart from Nowandfutures.com

Devaluation had been the outcome of an explosion of money supply

Chart from Nowandfutures.com

As the bust cycle of the imploding bubble culminated (explained above by Dr. Salerno above) inflation fell (see red ellipse below).

Chart from tradingeconomics.com

More of the Argentine Crisis from Wikipedia,(bold emphasis mine)

After much deliberation, Duhalde abandoned in January 2002 the fixed 1-to-1 peso–dollar parity that had been in place for ten years. In a matter of days, the peso lost a large part of its value in the unregulated market. A provisional "official" exchange rate was set at 1.4 pesos per dollar.

In addition to the corralito, the Ministry of Economy dictated the pesificación ("peso-ification"), by which all bank accounts denominated in dollars would be converted to pesos at official rate. This measure angered most savings holders and appeals were made by many citizens to declare it unconstitutional.

After a few months, the exchange rate was left to float more or less freely. The peso suffered a huge depreciation, which in turn prompted inflation (since Argentina depended heavily on imports, and had no means to replace them locally at the time).

The economic situation became steadily worse with regards to inflation and unemployment during 2002. By that time the original 1-to-1 rate had skyrocketed to nearly 4 pesos per dollar, while the accumulated inflation since the devaluation was about 80%; these figures were considerably lower than those foretold by most orthodox economists at the time. The quality of life of the average Argentine was lowered proportionally; many businesses closed or went bankrupt, many imported products became virtually inaccessible, and salaries were left as they were before the crisis.

Since the volume of pesos did not fit the demand for cash (even after the devaluation) huge quantities of a wide spectrum of complementary currency kept circulating alongside them. Fears of hyperinflation as a consequence of devaluation quickly eroded the attractiveness of their associated revenue, originally stated in convertible pesos. Their acceptability now ultimately depended on the State's willingness to take them as payment of taxes and other charges, consequently becoming very irregular. Very often they were taken at less than their nominal value—while the Patacón was frequently accepted at the same value as peso, Entre Ríos's Federal was among the worst-faring, at an average 30% as the provincial government that had issued them was reluctant to take them back. There were also frequent rumors that the Government would simply banish complementary currency overnight (instead of redeeming them, even at disadvantageous rates), leaving their holders with useless printed paper.

Bottom line:

The above experience from Argentina’s crisis shows that when government adapts policies to confiscate private property through the banking system, demand for gold does NOT increase or gold prices don’t rise.

It is when the Argentine government decided to devalue and inflate the system where gold prices skyrocketed.

Both confiscatory deflation and the succeeding inflation lowered the standard of living of the Argentines. The antecedent to the above events had been a prior boom.

In short, policies that promote boom-bust or bubble cycles represent as net negative to a society and even promotes more interventionist policies that worsens the prevailing social predicaments.

Lastly record gold prices today points to inflationism NOT confiscatory deflation.

Cartoon of the Day: Different Types of Looting

This caricature below is almost an exact depiction of what’s been happening around the world today. (hat tip Mises Blog Jonathan Catalan and Salt Lake Tribune]

Global Equity Meltdown: Political Actions to Save Global Banks

“However, hanging onto money is highly risky in a time of monetary inflation. The security-seeker does not understand this. Keynesian economists do not understand this. Politicians do not understand this. The result of inflationary central bank policies is the production of uncertainty in excess of what the public wants to accept. But the public does not understand Mises' theory of the business cycle. Voters do not demand a halt to the increase in money. It would not matter if they did. Central bankers do not answer to voters. They also do not answer to politicians. "Monetary policy is too important to be left to politicians," the paid propagandists called economists assure us. The politicians believe this. Until the crisis of 2008, so did voters.” Professor Gary North

Local headlines blare “Global stocks gyrate wildly; sell-off resumes in markets”[1]

To chronicle this week’s action through the lens of the US Dow Jones Industrial Average (INDU), we see that on Monday August 8th, the major US bellwether fell 635 points or 5.5%. On Tuesday, the INDU rose 430 points or 4%. On Wednesday, it fell 520 points 4.6%. On Thursday, it rose 423 points or 3.9%. The week closed with the Dow Jones Industrials up by 126.71 points or 1.13% on Friday.

All these wild swings accrued to a weekly modest loss of 1.53% by the Dow Jones Industrials.

Some ideologically blinded commentators argue that these had been about aggregate demand. So logic tell us that aggregate demand collapsed on Monday, jumps higher on Tuesday, tanked again on Wednesday, then gets reinvigorated on Thursday and Friday? Makes sense no?

How about fear? Fear on Monday, greed on Tuesday, fear on Wednesday, and greed on Thursday and Friday? Do you find this train of logic convincing? I find this patently absurd.

Confidence doesn’t emerge out of random. Instead, people react to changes in the environment and the marketplace. Their actions are purposeful and seen in the context of incentives (beneficial for them).

And that’s why many who belong to the camp of econometrics based reality gets wildly confused about the current developments where they try in futility to fit only parts of reality into their rigid theories.

And part of the realities that go against their beliefs are jettisoned as unreal.

So by the close of the week, these people end up scratching their heads, to quip “weird markets”.

Weird for them, but definitely not for me.

Political Actions to Save the Global Banking System

Yet if there has been any one dynamic that has been proven to be the MAJOR driving force in the financial markets over the week, this has been about POLITICS, as I have been pointing out repeatedly since 2008[2].

I am sorry to say that this has not been about aggregate demand, fear premium, corporate profits, conventional economics or mechanical chart reading, but about human action in the context of global policymakers intending to save the cartelized system of the ‘too big to fail’ banks, central banks and the welfare state.

As I pointed out last week[3],

Important: The US has been downgraded by the major credit rating agency S&P after the market closed last Friday, so there could be an extended volatility on the global marketplace at the start of the week. This largely depends if such actions has already been discounted. The first thing on Monday is to watch Japan’s response.

The S&P’s downgrade tsunami reached the shores of global markets on Monday, where the US markets crashed by 5.5%.

It is very important to point out that the market backlash from the downgrade did NOT reflect on real downgrade fears, where US interest rates across the yield curve should have spiked, but to the contrary, interest rates fell to record lows[4]!

And as also correctly pointed out last week, the US Federal Reserve’s FOMC meeting, which was held last Tuesday, introduced new measures aimed at containing prevailing market distresses.

The FOMC pledged to:

-extend zero bound rates until mid-2013, amidst growing dissension among the governors,

-maintain balance sheets by reinvesting principal payments of maturing securities,

and importantly, keep an open option to reengage in asset purchases[5].

Some have argued that the Fed’s policies has essentially been a stealth QE, as the steep yield curve from these will incentivize mortgage holders to refinance. And this would spur the Fed to reinvest the proceeds.

According to David Schawel[6],

A surge of refinancing will reduce the size of the Fed’s MBS holdings and allow them to re-invest the proceeds further out the curve

The Fed’s announcement on Tuesday, basically coincided or may have been coordinated with the European Central Bank’s purchases of Italian and Spanish bonds or ECB’s version of Quantitative Easing. The combined actions resulted to an equally sharp 4% bounce by the Dow Jones Industrials.

Mr. Bernanke has essentially implemented the first, “explicit guidance” on Fed’s policy rates, among the 3 measures he indicated last July 12th[7].

The resumption of QE and a possible reduction of the quarter percentage of interest rates paid to bank reserves by the US Federal Reserve signify as the two options on the table.

My guess is that the gradualist pace of implementation has been highly dependent on the actions of the financial markets.

I would further suspect that given the huge ECB’s equivalent of Quantitative Easing or buying of distressed bonds of Italy and Spain, aside Ireland and Portugal, estimated at US $ 1.2 trillion[8], team Bernanke perhaps desires that financial markets digest on these before sinking in another set of QEs.

And to consider that US M2 money supply[9] has been exploding, which already represents a deluge of money circulating in the US economy, thus, the seeming tentativeness to proceed with more aggressive actions.

Wednesday saw market jitters rear its ugly head, as rumors circulated that France would follow the US as the next nation to be downgraded[10]. The US markets cratered by 4.6% anew.

On Thursday, following an earlier probe launched by the US Senate on the S&P for its downgrade on the US[11], the US SEC likewise opened an investigation to a possible insider trading charge against the S&P[12].

Obviously both actions had been meant to harass the politically embattled credit rating agency. The possible result of which was that the S&P joined Fitch and Moody’s to affirm France’s credit ratings[13].

To add, 4 Euro nations[14], namely Italy, Belgium, France and Spain has joined South Korea, Turkey and Greece[15] to ban short sales. A ban forces short sellers to cover their positions whose buying temporarily drives the markets higher.

These accrued interventions once again boosted global markets anew which saw the INDU or the Dow Industrials soar by 3.9%.

Friday’s gains in global markets may have been a continuation or the carryover effects of these measures.

Unless one has been totally blind to all these evidences, these amalgamated measures can be seen as putting a floor on global stock markets, which essentially upholds the Bernanke doctrine[16], which likewise underpins part of the assets held by the cartelized banking system and sector’s publicly listed equities exposed to the market’s jurisdiction.

Thus, like 2008, we are witnessing a second round of massive redistribution of resources from taxpayers to the politically endowed banking class.

Gold as the Main Refuge

AS financial markets experienced these temblors, gold prices skyrocketed to fresh record levels at over $1,800, but eventually fell back to close at $1,747 on Friday, for a gain of $83 over the week or nearly 5%.

From the astronomical highs, gold fell dramatically as implied interventions had been also extended to the gold futures markets. Similar to the recent wave of commodity interventions, the CME steeply raised the credit margins of gold futures[17].

We have to understand that gold (coins or bullions) have NOT been used for payments and settlements in everyday transactions. So gold cannot be seen as fungible to legal tender imposed fiat cash (for now), even if some banks now accept gold as collateral.[18]

In an environment of recession or deleveraging—where loans are called in and where there will be a surge of defaults and an onrush of asset liquidations to pay off liabilities or margin calls, fiduciary media (circulating credit) will contract, prices will adjust downwards to reflect on the new capital structure and people will seek to increase cash balances in the face of uncertainty—CASH and not gold is king. Such dynamic was highly evident in 2008 (before the preliminary QEs).

Thus, it would signify a ridiculous self-contradictory argument to suggest that record gold prices has been manifesting risks of ‘deflation’.

Instead, what has been happening, as shown by the recent spate of interventions, is that for every banking problem that surfaces, global central bankers apply bailouts by massive inflationism accompanied by sporadic price controls on specific markets.

Alternatively, this means that record gold prices do not suggest of a fear premium of a deflationary environment, but instead, a possible fear premium from the prospects of a highly inflationary, one given the current actions of central banks.

This panic-manic feedback loop or in the analogy of Dr. Jeckll and Mr. Hyde’s “split personality” which characterizes the global markets of last week has been materially different from the 2007-2008 US mortgage crises.

Not only has there been a divergence in market response across different financial markets geographically (e.g. like ASEAN-Phisix), the flight to safety mode has been starkly different.

The US dollar (USD) has failed to live up to its “safehaven” status, which apparently has shifted to not only gold but the Japanese Yen (XJY) and the gold backed Swiss Franc (XSF).

It’s important to point out that the franc’s most recent decline has been due to second wave of massive $55 billion of interventions by the SNB during the week. The SNB has exposed a total of SFr120 billion ($165 billion!) over the past two weeks[19]. The pivotal question is where will $165 billion dollars go to?

Bottom line:

This time is certainly different when compared to 2008 (but not to history where authorities had been predisposed to resort to inflation as a political solution). While there has been a significant revival of global market distress, market actions have varied in many aspects, as well as in the flight to safety assets.

This implies that in learning from the 2008 episode, global policymakers have assimilated a more activist stance which ultimately leads to different market outcomes. Past performance does not guarantee future results.

The current market environment can’t be explained by conventional thinking for the simple reason that markets are being weighed and propped up by the actions of political players for a political purpose, i.e. saving the Global Banks and the preservation of the status quo of the incumbent political system.

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[1] Inquirer.net Global stocks gyrate wildly; sell-off resumes in markets, August 12, 2011

[2] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?, November 30, 2008

[3] See Global Market Crash Points to QE 3.0, August 7, 2011

[4] See Has the S&P’s Downgrade been the cause of the US Stock Market’s Crash?, August 9, 2011

[5] See US Federal Reserve Goes For Subtle QE August 10,2011

[6] Schawel, David Stealth QE3 Is Upon Us, How Ben Did It, And What It Means Business Insider, August 9, 2011

[7] See Ben Bernanke Hints at QE 3.0, July 13, 2011

[8] Bloomberg, ECB Bond Buying May Reach $1.2 Trillion in Creeping Union Germany Opposes, August 8, 2011

[9] FRED, St. Louis Federal Reserve, M2 Money Stock (M2) M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs). Seasonally adjusted M2 is computed by summing savings deposits, small-denomination time deposits, and retail MMMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.

[10] The Hindu, Fears of France downgrade trigger massive sell-off in Europe, August 11, 2011

[11] Bloomberg.com U.S. Senate Panel Collecting Information for Possible S&P Probe, August 9, 2011

[12] Wall Street Journal Blog SEC Asking About Insider Trading at S&P: Report, August 12, 2011

[13] Bloomberg.com French AAA Rating Affirmed by Standard & Poor’s, Moody’s Amid Market Rout, August 11, 2011

[14] USA Today 4 European nations ban short-selling of stocks, August 11, 2011, see War against Short Selling: France, Spain, Italy, Belgium Ban Short Sales, August 12, 2011

[15] Business insider 2008 REPLAY: Europe Moves To Ban Short Selling As Crisis Spreads, August 11, 2011, also see War Against Market Prices: South Korea Imposes Ban on Short Sales, August 12, 2011

[16] See US Stock Markets and Animal Spirits Targeted Policies, July 10, 2010

[17] See War on Gold: CME Raises Credit Margins on Gold Futures, August 11, 2011

[18] See Two Ways to Interpret Gold’s Acceptance as Collateral to the Global Financial Community, May 27, 2011

[19] Swissinfo.ch Last ditch defence of franc intensifies, August 10, 2011

How Reliable is the S&P’s ‘Death Cross’ Pattern?

Mechanical chartists say that with the recent stock market collapse, the technical picture of the US S&P 500 have been irreparably deteriorated such that prospects of a decline is vastly greater (which has been rationalized on a forthcoming recession) than from a recovery. The basis of the forecast: the Death Cross or ‘A crossover resulting from a security's long-term moving average breaking above its short-term moving average or support level[1]’.

First of all, I’ve seen this picture and the same call before.

In July of last year, the S&P also experienced a similar death cross. Many articles emphasized on the imminence of a crash[2] that never materialized.

Secondly, I think applying statistics to past performances to generate “feasible” odds on a bet based on the ‘death cross’ represents as sloppy thinking

To wit, betting based on a ‘death cross’ signifies a gambler’s fallacy or fallacy committed when a person assumes that a departure from what occurs on average or in the long term will be corrected in the short term[3].

A coin toss will always have a 50-50 head-tail probability distribution. If the random coin toss exercise would initially result to string of ‘heads’ outcome, the eventual result of this repeated exercise would still result to a 50-50 outcome or a zero average, as shown by the chart below.

As the illustrious mathematician Benoit Mandelbroit wrote[4],

If you repeat a random experiment often enough, the average of the outcomes will converge towards an expected value. With a coin, heads and tails have equal odds. With a die, the side with one spot will come up about a sixth of the time

Applied to the death cross, we see the same probability 50-50, because each event from where the ‘death cross’ appears entails different conditions (finance, market, politics, social, cultural, even time and spatial differences and etc), as earlier argued[5]. It would signify a sheer folly to oversimplify the cause and effect order and speciously apply odds to it.

Proof?

One would hear proponents bluster over the success of the death cross in 2000 and 2007. Obviously the hindsight bias can be very alluring but deceptive. The causal relationship which made the ‘death cross’ seemingly effective in 2000 and 2007 for the US S&P 500 had been mostly due to the boom bust cycles which culminated to a full blown recession or a crisis during the stated periods.

The death cross was last seen in July of last year (green circle above window), but why didn’t it work? The answer, because the death cross had been pulverized by Bernanke’s QE 2.0 (see green circle chart below). When Mr. Bernanke announced QE 2.0, the ‘death cross’ transmogrified into a ‘golden’ cross!!! This shows how human action is greater than historical determinism or chart patterns.

Many mistakenly think that chart patterns has an inherently built in success formula which is magically infallible, as said above, they are not.

Third, not all market crashes has been due to recessions.

The above illustrates the crash of 1962 (upper window) and 1987 (lower window)[6]. This is obviously unrelated to the death cross, however the point is to illustrate that not every stock crash is related to economic activities. The recent crash may or may not overture a recession.

Bottom line: The prospective actions of US Federal Reserve’s Ben Bernanke and European Central Bank’s Jean-Claude Trichet represents as the major forces that determines the success or failure of the death cross (and not statistics nor the pattern in itself). If they force enough inflation, then markets will reverse regardless of what today’s chart patterns indicate. Otherwise, the death cross could confirm the pattern. Yet given the ideological leanings and path dependency of regulators or policymakers, the desire to seek the preservation of the status quo and the protection of the banking class, I think the former is likely the outcome than the latter.

And another thing, we humans are predisposed to look for patterns even when non-exist, that’s a result of our legacy or inheritance from hunter gatherer ancestors’ genes whom looked for patterns in the environment for survival or risked being eaten alive by predators. This behavioural tendency is called clustering illusion[7]. A cognitive bias which we should keep in mind and avoid in this modern world.

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[1] Investopedia.com Death Cross

[2] The Economic Collapse Blog, The Death Cross: Another Sign That We Are On The Verge Of A Recession?, July 5, 2010

[3] Nizkor.org Fallacy: Gambler's Fallacy

[4] Mandelbrot, Benoit B The (mis) Behaviour of Markets, Profile Books p.32

[5] See The Causal Realist Perspective to the Phsix-Peso Bullish Momentum, July 10, 2011

[6] About.com Stock Market History

[7] Wikipedia.org Clustering illusion

The Remarkable Phisix-ASEAN Resiliency Amidst the Global Financial Storm

“Keynesians tend to assume that government spending has a big positive effect on economic growth. Others disagree. But if the impact of increasing government spending is large, then the impact of removing it is also. So policy makers better be sure that the boom is around the corner. And all these are just short-run considerations. Here's the real dirty secret of Keynesian policies: They are sure to have a negative effect in the fullness of time.” Kevin Hassett

So how has the global markets affected ASEAN benchmarks and Philippine Phisix during last week’s furor?

ASEAN’s Gradual Discounting of Global Equity Market Meltdown

Except for Monday and Tuesday, where the bears launched a ‘blitzkrieg’ that has resulted to two day cumulative loss of 6.3%, broken down to 2.3% and 4% respectively, the diminishing marginal (time) value of information has stunningly prompted for an exceptional performance by the Phisix and the ASEAN region.

Astonishingly, the Phisix has managed to shrug off or IGNORE the 6% loss by the US last Thursday and went on to even close marginally higher[1]!

The recovery during the last three sessions of the week accrued to a net loss of 2.61% by the Phisix, still significant but the figures hardly reveal everything.

The actions of the Phisix basically have been identical with most of our neighbors.

Except for Indonesia (JCI) which saw a measly .79% decline for the week and while the Phisix (-2.61%) and the Thailand’s SET (-2.86%) fell by more than the US, the latter two still posted positive returns on a year to date basis, respectively 2.87% and 2.84%. Only Malaysia which fell by 2.67% over the week, has been down by 2.3% on a year to date.

Yet there are some noteworthy developments here and in the region:

1. Again Indonesia, Thailand, and the Philippines remain on the positive territory, despite the global meltdown. Only Malaysia among the ASEAN tag team has been on the negative.

2. Regional volatility appears to be decreasing even as global markets continue to roil.

If such trend should persist then convergence in the performance of ASEAN bourses could deepen or could reflect on higher correlations of emerging Asian equities.

The statistical correlations may seem ambiguous, but from the above charts courtesy of the ADB[2] we can see how least correlated we are with US equities in relative terms.

Among ASEAN bourses only Malaysia has had above half a percent of correlations (left window). Indonesia (.38) has the least correlation followed tightly by the Thailand (.39) and the Philippines (.4).

So well into 2011 the correlations have tightened among ASEAN bourses which have also been reflected on the right window (emerging Asia-emerging Asia correlations, green line). Whereas correlations of emerging Asia with the US has clearly departed or has significantly diminished, where previous correlations .62 in 2009 has recently been only .46.

The implication is that global or US investors who seek to diversify away from high correlations performance with US assets may likely consider Emerging Asia or the ASEAN region as an alternative.

This is why the recent US downgrade is unlikely a net negative for Phisix or the ASEAN region as global diversification play could be a looming reality.

And this could also be why regional policymakers appear to be “bracing” for a possible onslaught of foreign capital flows[3].

3. Domestic participants appear to be learning how to discount events abroad.

In the Phisix, the seeming resiliency from the recent global market rout has primarily been an affair dominated by domestic participants.

Net daily Foreign trade (averaged on a weekly basis) exhibits net outflows last week (left window). Nonetheless, total outflows have yet to reach the May levels, in spite of this week’s dramatic volatility. This has likewise been reflected on the Philippine Peso which was nudged lower (.14%) to close at 42.64 to a US dollar this week.

The share of foreign investors to total trade has spectacularly declined as domestic investors has taken over or dominated (right window) trading activities. Local investors accounted for about 65% of this week’s trade.

I think the current trend of local bullishness can be buttressed by recent empirical evidence. Philippine bank lending in June has reportedly been strongly expanding[4]. Although official statistics say that most of the loan growth has been directed to ‘production activities’ led by power (62.3%) and financial intermediation (31.9%), I would surmise that many of these loans may have been redirected to the Phisix.

The Bangladesh stock market crash should be a noteworthy example to keep in mind where were substantial amount of bank loans had been rechanneled to the stock market. And when the government imposed tightening measures (both monetary and administrative), the Dhaka Stock Index collapsed[5]by about 40% in January of this year. Since, the Dhaka has hardly made a significant headway in recovering.

Nevertheless the Philippines maintains the steepest yield curve in Asia, which should even boost the appetite of banks to lend. This should serve as an impetus for the boom phase of the domestic business cycle which the Phisix seems to be part of the transition.

Importantly, policy rates remain very accommodative with only two marginal increases in the BSP’s policy rates as of June 2011. Meanwhile Indonesia’s rates are at record low (no wonder the outperformance).

Phisix and Market Internal Divergence

3. Market internals despite this week’s drastic swings has not been entirely negative.

Daily traded issues averaged on a weekly basis (left window) seem to validate the remarkable actions by local investors as this sentiment indicator continues to climb.

The advance decline spread computed on a weekly basis reveals of the same developments; lopsided lead by declining issues during the early selloff has partly been offset by the asymmetric difference by the advancing issues during days where the Phisix rebounded.

Proof of this week’s astounding resilience is that the early devastation from global market carnage hasn’t reached the intensity of the 1^st quarter storm marked by the Arab Spring-Japan triple whammy calamity selloffs.

In essence, the losses of the Phisix may have overestimated the actual actions in the general market or the Philippine Stock Exchange.

Said differently, the Phisix reflected on foreign outflows (selling of Phisix heavyweights) in contrast to the general market which manifested a much buoyant of local investors, an apparent divergence!

I argued of a potential ASEAN Alpha play at the end of July[6], here is what I wrote,

So it is unclear whether ASEAN and the Phisix would function as an alternative haven, which if such trend continues or deepens, could lead to a ‘decoupling’ dynamic, or will eventually converge with the rest. The latter means that either global equity markets could recover soon—from the aftermath of the Greece (or PIIGS) bailout and the imminent ratification of the raising the US debt ceiling—or that if the declines become sustained or magnified, the ASEAN region eventually tumbles along with them. My bet is on the former.

Therefore, I would caution any interpretation of the current skewness of global equity market actions to imply ‘decoupling’. As I have been saying, the decoupling thesis can only be validated during a crisis.

In the meantime, we can read such divergent signals (between ASEAN and the World) as motions in response to diversified impact from geopolitical turbulence.

For this week, the function of the Phisix (or ASEAN) as alternative haven has been demonstrably true for the domestic participants but unsubstantiated by foreigners fund flows.

My divergence theory seems as gradually being validated by the marketplace!

Again let me remind you, that divergence only thrives in a global scenario that doesn’t signify a real crisis or a recession, most likely from a global liquidity drain. For if the imminence of an overseas recession should emerge, we have yet to see how the local and regional markets would react.

Remember this is no 2008! This time the activist approach by the conventional ‘modern’ central bankers has been paving way for different outcomes on different markets.

Gold as Refuge, Also Played Being Out via Domestic Mining Issues

4. As Gold, the Japanese yen, and the Swiss franc has functioned as the du jour flight to safety assets during the current market distress, we seem to be witnessing the same phenomenon taking hold even in the local equity markets where gold mining issues have taken the center stage!

Whether from year to date (below window) or from last week’s amplified volatility, the market psychology of domestic investors on mining issues have ostensibly turned from the fringe to the mainstream.

One would note that in the sectoral charts above, Tuesday’s carnage only dented the mining sector (violent) which again found footing or used this decline as leverage to recoil higher. All the rest of Phisix (green) sectors, namely bank (blue), Commercial Industrial (grey), Holding (red), Services (light green) and Property (black candle), went in the direction of the mining sector but has been hobbled by the steep losses.

All I can say is that since the Philippines have NO physical markets for gold in terms of spot or futures or even Exchange Traded Funds (ETF), mining issues could have likely served as a proxy or representative asset.

That’s why in the face of the current market inconstancy or turbulence, despite the hefty gains, I would recommend a partial shift of asset exposures to gold mines as hedge. This is not a momentum play but rather a possible flight to safety move as we seem to be seeing here and abroad.

Conclusion

Mimicking the US Federal Reserve, my closing will be a reprise of my statement from last week[7] but with some alterations, enclose by brackets [ ]

The Phisix and the ASEAN-4 bourses have not been unscathed by the brutal global equity market meltdown.

However, excluding Friday’s [Monday and Tuesday’s] emotionally charged fallout and despite the weak performances of developed economy bourses during the week, the Phisix and ASEAN bourses has managed to keep afloat and has even demonstrated significant signs of relative strength, signs that could attract more divergent market activities in a non recessionary setting.

As global policymakers continue to engage in a whack-a-mole approach to the acute problems facing the developed economies’ banking-welfare based government system, the path dependent solution, as demonstrated during this tumultuous week, has been the age old ways of printing money and selective price controls.

The same foreseeable actions can be expected over the coming days, more patchwork with unintended consequences overtime.

And the outcome to the marketplace should be variable as the current conditions reveal.

Lastly, downgrades for Asia and possibly for Europe which may have a short term effect on Asian assets should actually be a plus for the region over the long run. This is not only from the possible diversification move but also from real capital flows.

That is if we adapt relatively sounder money approach and embrace economic freedom.

However if we continue to act in concert with global policy trends then we could expect these downgrades to eventually export boom bust cycles anew to Asia.

---

[1] See Philippine Phisix: What An Incredible Turnaround! (Global Equity Markets Update), August 11, 2011

[2] Asian Development Bank Asia Capital Markets Monitor August 2011

[3] Bloomberg.com Asia braces for capital flows as currencies rise, gulfnews.com August 9, 2011

[4] BSP.gov.ph Bank Lending Continues to Accelerate in June, August 10, 2011

[5] See Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets, January 11, 2011

[6] See The Phisix-ASEAN Alpha Play, July 31, 2011

[7] See Phisix-ASEAN Outperformance Despite Global Meltdown, August 7, 2011

Quote of the Day: Path Dependency

From Professor Arnold Kling,

…most respectable people think that Bernanke and Paulson and TARP and such SAVED THE WORLD, and so that is now the model going forward for handling any situation involving shaky large banks.

Information Age Investing: Entrenching Technology Sector Leadership

Bespoke Invest shows us some very important developments in the US stock markets during the recent sharp volatility: Technology Sector’s market leadership has been intensifying

Bespoke Invest writes

As shown, the Technology sector, which was already the largest sector in the index, has seen the biggest gain in weighting since the bull market peaked. On April 29th, Tech had a weighting of 18.07%. As of now, its weighting is 19.06%. The gain in Tech is even more impressive because the only other sectors that have seen increases in their weightings since the bull market peaked are non-cyclical in nature (Cons. Staples, Utilities, Health Care, Telecom).

Additionally, the technology sector has been outpacing the industrials.

Again from Bespoke Invest

While Industrials have been slumping, the Technology sector has been ramping. Although there have been numerous calls to avoid the sector during this downturn, Tech stocks have been handily outperforming the market. In fact, heading into today, Technology was the least oversold of the ten sectors.

My thoughts

Recent volatility has been proving to be more of a shakeout than a genuine inflection point.

The underlying change of market leadership or divergent actions in the sectoral performances, which reveals of an ongoing rotation towards the technology sector, shows that this has not been a debt deflation driven financial market sell down, as global central bankers have been applying aggressive activists measures.

The gap in the market cap weighting of the technology and other sector has been widening. In the Philippines, the Mining sector has been assuming this role.

As I have been saying, as the information age deepens, the pie of the technology sector relative to the economy will continue to expand.

Global production process will continue to lengthen or experience enhanced specialization as more technology products and services will be offered and provided to the marketplace. Competition led innovation will be the major driving force for this dynamic.

People hardly notice that the internet search industry is one big example of this ongoing dynamic.

The technology market leadership dynamic will continue to be reflected on prices of technology equities, which should be expected to have a greater share in the US equity market’s sectoral weightings as time goes by.

Essentially, a bet on the information age should translate to a bet on the technology sector.

But as caveat, since policies of central bankers have led to periodic bubble cycles, the capital intensive technology sector could be in a formative bubble cycle process. Although I guess this has yet to reach a maturity phase.

Of course, US treasuries are the ultimate bubble in the US, which I think is in a near maturity or blowoff phase. The global bond bubble applies to many developed economies based on the 20th century designed welfare system.

And so goes the US treasury securities and other bond bubbles (EU, Japan), so with the US dollar and the US dollar system.

I’d stick to precious metals and the technology sector.

More Endorsement for the Prudent Investor Newsletters

Businessmirror’s prolific financial columnist John Mangun tweets last August 10^th,

I hardly open my twitter, but had to discover this from another reader. Thus my late reaction.

Anyway, my profuse thanks, John.

Follow John Mangun's twitter address here