Thursday, November 05, 2009

Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble

The celebrity guru strikes again!

Mr. Nouriel Roubini, whose shot to fame and stardom came after accurately predicting last year's crisis and has been media's du jour favorite gloom spinmeister or otherwise known as "Dr. Doom", recently predicted that every assets, including commodities and emerging markets stocks are in a bubble!

Mr. Roubini's captivating 'one size fits all' theory for this forecast is based on the US dollar as the "mother" of all carry trade.

In a recent column at the Financial Times Mr. Roubini wrote, ``Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions."

Portraits from Bloomberg

Hence he predicts a massive recovery of the US dollar, as every asset class anchored to the carry trade collapses.


It would seem that the 2008 financial crash functions as Mr. Roubini's operating paragon from which this call has been predicated (Anchoring bias?).

Bloomberg recently interviewed commodity king Jim Rogers, who dismissed Mr. Roubini's prediction.

According to Bloomberg,

``Many commodities are still down from record highs and equity markets aren’t on the brink of collapse, Rogers, chairman of Singapore-based Rogers Holdings, said in an interview on Bloomberg Television today. The price of gold will double to at least $2,000 an ounce in the next decade, he said.

“What bubble?” Rogers said, when asked if he agreed with Roubini’s view. “It’s clear Mr. Roubini hasn’t done his homework, yet again.”

``Rogers countered Roubini’s arguments by saying that Chinese stocks and sugar, silver, coffee and cotton have all dropped from their historical highs by at least 50 percent.


A sample of commodities (sugar and cotton) cited by Mr. Rogers are far from their all highs, as seen from the chart above courtesy of Moore Research Center.

One must note that the above charts exhibits nominal and not inflation adjusted prices.


Again from Bloomberg, ``When asked if gains made this year pointed to a bubble, he said: “It’s not a bubble if something is up 100 percent this year, but down 70 percent from its high. That’s not a bubble, that’s a good year. That’s a great year. Maybe it’s too high for this year, but that’s not a bubble.”

``“I suspect it’s going to go over $2000 some time in the bull market, but depending on what happens in the world it could go much, much higher,” Rogers said. “The old high, back in 1980 adjusted for inflation, would be over $2000 now, just to get back to the old high. So we’ll certainly get there some time in the next decade.”

``“I don’t know any emerging market stock markets that are so high I’d call them a bubble,” Rogers said. “They’re certainly all up a lot, maybe they’re too high, but being too high is not a bubble for anyone who knows financial markets.”...

``In contrast to Roubini, Rogers said the only bubble he sees in the Western world now is in U.S. bonds."

You can watch the video of Jim Roger's interview here

Meanwhile Mr. Roubini countered Mr. Rogers' objection by saying that gold at $2,000 is "utter nonsense".

According to Bloomberg, ``There is no inflation or “near-depression” to drive gold prices that high, Roubini said today at the Inside Commodities Conference in New York. If a severe depression came to pass, with investors buying canned goods and hiding out in log cabins, “maybe you want some gold in that scenario,” Roubini said.

``“Maybe it will reach $1,100 or so but $1,500 or $2,000 is nonsense,” Roubini said. Gold rose to a record $1,098.50 today in New York on speculation that central banks and investors will purchase the metal to hedge against a declining dollar...

``“It is very hard to justify oil going from $30 to above $80 based only on the fundamentals of supply and demand,” Roubini said. Prices are “in part” a bubble, Roubini said.

``Roubini predicted in 2006 the financial crisis that spurred more than $1.6 trillion of credit losses and asset writedowns at global financial companies".

As you would note, media highlights on Mr. Roubini's favorable call but ignores his glitches and miscalls.

Earlier this year Mr. Roubini predicted stagdeflation, a continuing rout in asset markets including oil. According to Bloomberg (Jan 20th), ``Nouriel Roubini, the New York University professor who predicted last year’s economic and stock market meltdowns, said oil prices will trade between $30 and $40 a barrel this year.


“I see oil remaining throughout 2009 in the range of $30 to $40” a barrel, Roubini said in Dubai today."

In an earlier post we noted how Mr. Roubini hit only one out of several calls,see earlier post Wall St. Cheat Sheet: Nouriel Roubini Unmasked; Lessons, yet managed to harvest media's attention.

Going back to Mr. Roubini's theme of the US Dollar Carry. Here is why we are in the camp of Jim Rogers.

1. Past Performance don't guarantee future results.

Last year's carry trade paradigm had been based on financial institutions, such as the shadow banking system, and foreign banks (as Iceland and parts of Europe) which leveraged on the currency arbitrage.

Today, hardly the same parties or sector appear to be engaged in the said arbitrage activities considering their debilitated conditions.

Next, it isn't the carry trade that brought down the house in 2008, it was the US housing bubble. The carry trade only exacerbated on the downturn.

2. Barking At the Wrong Tree.

It isn't just private sector speculation as Mr. Roubini sees it, but governments' "speculating" as well.

The recent sale of half of IMF's gold stash to India (Bloomberg) came as surprise to the market whom expected China to do the bidding.

To add China has been engaged in a buying spree of commodity assets globally as seen by the World Bank table above.

In short, the governments of emerging markets have in themselves been "speculating".

Of course we'd like to add that these speculative activities isn't myopically based on "animal spirits", because there are underlying geopolitical and monetary dimensions in these.

3. US dollar carry isn't likely to be a major factor.

Given the massive deficits and the monetary inflation engaged by the US, it would be naive or blind allegiance on the side of professional investors to discard the risks of higher interest rates by taking large positions for such arbitrage.

4. Money is neutral.

Mainstream always view money as a seeming constant where additional inputs of money are deemed as not to have an impact on the supply and demand balances. This is evident on Mr. Roubini remarks "very hard to justify oil going from $30 to above $80 based only on the fundamentals of supply and demand"

Mr. Roubini underestimates the impact of the global reflation efforts by collective governments on global economies. Moreover, Mr. Roubini reflects on the mainstream view which have been moored upon the US as still the key engine of global growth.

Yet apparently Mr. Roubini sees today's higher commodity prices as having little impact on inflation, he says, there ``is no inflation or “near-depression” to drive gold prices that high"


On the other hand, Bespoke Invest sees inflation on the horizon, ``Over the last ten years, trends in the CS have often preceded moves in the CPI. So when the net reading in the CS rises, increases in the CPI are typically not far off. Therefore, given that the net number of commodities rising in price is currently at +10 from a low of -15 in February, don't be surprised if upcoming inflation reports come in on the high side of expectations."

5. Wrong Models/Apples And Oranges

Gold isn't likely to rise during a deflationary depression (a view which Mr. Roubini leans on).

To argue for gold's strength on a Great Depression paragon misses the point that the US dollar then operated under a quasi gold standard. Thereby the rush to the US dollar equaled the rush to gold. That would be comparing apples to oranges today.

Gold doesn't serve as a medium of exchange for the consuming public today, but is still used as reserves by central banks. So gold's strength will be magnified by an inflationary depression and not during deflation.

In contrast to Jim Rogers who says Mr Roubini hasn't done his homework, Mr. Roubini's call would seem like an attention generating act.

An oversimplified theme which connects to the prevailing bias, appeals to the public. Publicity matters more than the content.

Wednesday, November 04, 2009

Warren Buffett's Inflation Hedge: A Pick And Shovel Commodity Play In Burlington

Warren Buffett bets "all in" with a railroad company, Burlington Northern Santa Fe

This news excerpt from Bloomberg, (all bold highlights mine)

``Warren Buffett’sBerkshire Hathaway Inc. agreed to buy railroad Burlington Northern Santa Fe Corp. in what he described as an “all-in wager on the economic future of the United States.”

``The purchase, the largest ever for Berkshire, will cost the company $26 billion, or $100 a share in cash and stock, for the 77.4 percent of the railroad it doesn’t already own. Including his previous investment and debt assumption, the deal is valued at $44 billion, Omaha, Nebraska-based Berkshire said today in a statement...

``Berkshire has been building a stake in the Fort Worth, Texas-based railroad since 2006 as Buffett looked for what he called an “elephant”-sized acquisition allowing him to deploy his company’s cash hoard, which was more than $24 billion at the end of June. Trains stand to become more competitive against trucks with fuel prices high, he has said."

The rail business will comprise Berkshire's second largest risk exposure after insurance

From Bloomberg, ``Burlington Northern, with pretax income of $3.37 billion on revenue of $18 billion last year, would be Berkshire’s second- largest operating unit by sales. The McLane unit, which delivers food to grocery stores and restaurants by truck, earned $276 million on revenue of $29.9 billion in 2008."

``Berkshire’s largest business is insurance, with units including auto specialist Geico Corp. Buffett, who is the company’s chairman and chief executive officer, has said he likes insurance because he gets to invest the premiums paid by customers until the cash is needed to pay claims. The insurance businesses last year collectively earned $7.51 billion on revenue of $30.3 billion."

``Buffett will use $16 billion in cash for the deal, half of which is being borrowed from banks and will be paid back in three annual installments, he told the CNBC. Berkshire will have more than $20 billion in consolidated cash after the purchase, he said...

Buffett's applies Ben Graham's Margin of Safety via a wide investing moatthrough privileges derived from regulation (more evidence on Mr. Buffett as political entrepreneur see previous post Warren Buffett: From Value Investor To Political Entrepreneur?)...

Again from Bloomberg, ``Buffett is increasing his stake in an industry that doesn’t have any competitors for certain types of freight. Federal law requires some chemicals to be moved only by rail.

``Railroads burn less diesel fuel than trucks for each ton of cargo carried, giving companies such as Burlington Northern and Omaha-based Union Pacific a grip on bulk commodities such as coal. That fuel-efficiency advantage also gives railroads a share of the profits from moving goods such as Asian imports of cars and other consumer goods sent to U.S. West Coast ports.

``From ships, containers are loaded onto railcars to be hauled to so-called intermodal terminals, where they’re transferred to trucks for the final leg of their journey."

Finally, Warren Buffett's bet on the railroad industry seems like a pick-and-shovel (indirect) play on commodities or a massive bet on inflation.

According to wikipedia.org, ``Railroads carry a wide variety of commodities, coal being the most single important commodity. In 2006, coal accounted for 21 percent of rail revenue. Coal accounts around half of U.S. electricity generation. Other major commodities carried include chemicals, grain, non-metallic minerals, lumber, cars, and waste materials."

Burlington biggest carload is in coal (energy), which constitutes over 50% of the total and appear to compliment his MidAmerican Energy exposure while, chemicals and motor vehicles make up only 2% and 8%, respectively according to the company's site.

This means commodities with over 80% share of the company's freight cargo comprise is the main business for Burlington.

In other words, Mr. Buffett bets $44 billion on inflation. Action, indeed, speaks louder than words.

The Wal-Mart Effect: Wal-Mart Stores and Economic Growth

An article from Foreign Policy suggests of a strong correlation between the existence and growth of Wal-Mart Stores and national economic growth.

Justify FullThis from Foreign Policy (all bold highlights mine)

``When India's first Wal-Mart opened this summer in Amritsar, the response was mixed, with detractors fearing that big-box stores would eventually crowd out India's fabled "wallah" culture. What no one remarked on, however,
was that Wal-Mart's debut in a country is a bellwether for future growth. Indeed, Wal-Mart has started operations in 15 countries since 1991, and 13 of them have had boom economies, with an average of 4.4 percent annual growth since Wal-Mart arrived. Over the last five years, the economies of Wal-Mart countries outside the United States have grown 40 percent faster than the world average.

``So what's going on? Does the ability to buy giant bags of Froot Loops at cut-rate prices inspire economic growth?
More likely, Wal-Mart is simply a smart, cautious investor. "Wal-Mart chooses to go places with a sizable middle class," says Nelson Lichtenstein, a historian who just published a book on Wal-Mart's rise. And Wal-Mart's attention to middle-class growth could pay off for the company in the future.

``The portion of the
global middle class that lives in the developing world should rise from 56 percent in 2000 to 93 percent in 2030, according to the World Bank. Next up for the Wal-Mart effect, Lichtenstein says: Russia and Eastern Europe. Picture the new global bourgeoisie outfitted with cheap hibachi grills, extra-durable puppy toys, and energy-efficient minifridges, and you've got a glimpse of the coming Wal-Mart revolution."

Additional comments:

The article focuses mostly on the demand side perspective: global middle class growth.


Here is our complimentary view from the supply side:


Since Wal-mart offers international products at the most affordable prices, this indicates that consumers have more options to choose from, and is likewise backed by greater purchasing power from competitive pricing, i.e. more products that can be bought.


Since Wal-mart offers its consumers access to the world products, this also implies that global competition enhances pricing, product quality and the pool of products available for sale.


This also means an expanded internationalization of trade.


In short, the Wal-mart effect can be construed as representative of the globalization dynamics.
(Hat tip: Mark Perry)

Jim Chanos: 10 Lessons From The Financial Crisis That Investors Have Already Forgotten

Here is the presentation recently given by Hedge Fund wizard Jim Chanos at the University of Virginia's Value Investing Conference and the Yale School of Management's Leadership Forum.
09/10/22 Chanos Virginia Value Investing Conference Presentation

Tuesday, November 03, 2009

Proof Of Currency Values Aren't Everything: The Euro

Here is more evidence that "currency values aren't everything".

This from
Bloomberg's Chart of the Day, ``The euro’s surge against the U.S. dollar won’t hinder Europe’s recovery from the worst recession in 60 years because revived global trade will blunt the impact of a stronger currency, the Royal Bank of Scotland Plc said.


More from Bloomberg, ``The CHART OF THE DAY shows that euro-area export-related orders rose in October for the seventh time in eight months, according to data compiled by Markit Economics. The gain came even as competitiveness was hurt by the euro’s 17 percent advance in the same period."

“The impact of world trade on euro-area gross domestic product is more than three times larger than that of exchange- rate movements,” said Silvio Peruzzo, an economist at RBS in London. “In the euro area, world demand matters more than the currency.”

Additional comments:

-the purchasing power of a currency is determined by the supply and demand for money. This means that when a currency's domestic purchasing power is on a decline this should be likewise reflected on the relative decline in exchange rate.

-as we discussed in Asia: Policy Induced Decoupling, Currency Values Aren’t Everything, The Evils Of Devaluation, and Bernanke’s Devaluation Is About Debt Deflation, Tenuous Link Between Weak Currency And Strong Exports, it is the markets that matter most.

-Modern markets are complex and are structured in niches. This also means that markets have varying price sensitivity.

Sunday, November 01, 2009

5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

``The next bubble in asset markets will not be in the West but in emerging Asia, led by China. The irony is that the more anaemic the Western recovery proves to be, the longer it will take for Western interest rates to normalize and the bigger the resulting asset bubble in Asia. Emerging Asia, not the U.S. consumer, will be the prime beneficiary of the Fed's easy money policy.”- Christopher Wood, Is the U.S. Economy Turning Japanese?

In this issue:

5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

The Cost of Self Esteem

5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

1. Reflation Trade Has Been A Crowded Trade

2. No Trend Goes In A Straight Line

3. Markets Have Been Liquidity Driven

4. Tightening Trial Balloons Responsible For Recent Shakeup

5. Nothing But A Head Fake Signaling

In a recent commentary marketing guru Seth Godin asked ‘Why do people celebrate Halloween?’

His answer, ``Because everyone else does….Most of what we believe is not a result of direct experience (ever seen an electron?) but is rather part of our collection of truth because everyone (or at least the people we respect) around us seems to believe it as well.” (bold highlights mine)

Let me add, for many, there is that need to be seen as conforming to traditions (social status), aside from the need to use such opportunities for networking.

Mr. Godin concludes that “social constructs” drive people to behave in traditional ways. In behavioral finance or economics, such traditionalism represents as the “comfort of the crowds” or the Bandwagon Effect or the Herding instinct.

In other words, it isn’t much about rationality vis-à-vis irrationality or evidence against theory but social impulses predicated on assumed experiences that motivates people’s actions to observe traditions.

The Cost of Self Esteem

In the marketplace, mainstream behavior represents the same dynamics-traditionalism, where the underlying assumption is that the consensus mindset applies as the self-evident truth, regardless of proofs.

For instance, interventionists or inflationists or the left predominantly use industrial era metrics to justify government interventionism in a world evolving around the “information age” whose platform is principally structured upon the twin forces of globalization and competition inspired technological revolution.

By postulating that today’s economic landscape as dissimilar compared with the configurations of the past, they argue that markets have been failing and thereby justify more intervention by the government via inflation (fiscal deficits, centralization, price controls, devaluation and so forth…) or increased regulation.

Moreover, the same line of thinking pervades the mainstream mindset when traditionalist fundamental models appear to be ‘foisted upon’ the public in the hypothesis that markets have been operating under “normal” or basic law of scarcity conditions, when the reality is that governments have been the markets!

For instance, some has sternly argued that can’t consumer price inflation can’t occur when unemployment is high. Yet, Iceland seems to be a real life example debunking such unrealistic model [see Iceland's Devaluation Toll: McDonald's].

In other words, the conventional approach have been to read and interpret the market or the global economy as operating under assumed models with historically similar dynamics, when the reality is ‘this time is different’ or that we are operating under uncharted territory.

Mr. Doug Noland in his Credit Bubble Bulletin hits the nail on the head in arguing that today’s economic environment is starkly different from any previous conditions we have ever seen, ``the unfolding reflation will be altogether different than previous reflations. The old were primarily driven by Fed-induced expansions of U.S. mortgage finance and Wall Street Credit. Our mortgage industry, housing and securitization markets, and Bubble economy were at the epicenter of global reflationary dynamics. The new reflation is fueled by synchronized fiscal and monetary stimulus across the globe. China, Asia and the emerging markets/economies have supplanted the U.S. at the epicenter. U.S. housing is completely out of the mix. Those fixated on old reflationary dynamics look today at tepid U.S. housing markets, mortgage loan growth, consumer spending, and employment trends and see ongoing deflationary pressures. The Fed is wedded to the old and is positioned poorly to respond to new reflationary dynamics. A stable dollar used to work to restrain global finance – hence global inflationary forces. The breakdown in the dollar’s stabilizing role has unleashed altered inflationary dynamics – forces that the Federal Reserve disregards.” (bold emphasis mine)

So why is it difficult to change peoples’ thinking even when presented by strong evidences?

Based on social constructs, Professor Arnold Kling of EconoLog argues that change comes at the cost of “acknowledging a loss of status” or “loss of group identity”.

This implies that self esteem derived from social linkages account for as one of the basic human needs, which can be seen in the order of values as framed by Maslow’s hierarchy of needs (see figure 1)



Figure 1: Wikipedia.org: Maslow’s Hierarchy Of Needs

According to Wikipedia.org ``Maslow's hierarchy of needs is predetermined in order of importance. It is often depicted as a pyramid consisting of five levels: the lowest level is associated with physiological needs, while the uppermost level is associated with self-actualization needs, particularly those related to identity and purpose.”

In short, one of the major costs or barrier or resistance to change dynamics of changing people’s thinking is self esteem. Professor Kling suggests, ``On political issues, I think that it is harder to change the mind of someone who is highly educated than someone who is not. The highly-educated person is more likely to have his sense of status and identity tied up in his political beliefs. He is more likely to have a made a larger investment in finding facts and theories that confirm his beliefs.”

This applies not only to politics but likewise to other aspects such as economic or social dimensions.

So what has this got to do with today’s market actions or more particularly today’s market slump?

A whole lot.

The “desperately seeking normal” camp or those “fixated on old reflationary dynamics” as distinguished by analyst Doug Noland, has interpreted the recent plunge in global markets as a semblance of vindication of the “ongoing deflationary pressures”.

Where they have been mostly wrong throughout the recent episode, fleeting market signals that appear to validate their supposition may otherwise be construed as “even a broken clock is right twice a day”.

5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

We see five factors why today’s market slump isn’t the scenario from which the desperately seeking normal camp expects.

1. Reflation Trade Has Been A Crowded Trade

There is a limit on how much a rubber band’s elasticity can be stretched before it snaps or the breakage of the so called “cross links”. The degree of elasticity depends on the basic dimensions and the quality composition of the rubber band.

Applied to the markets, there is also a limit on how markets can be manipulated or a maximum elasticity on how markets can accommodate extreme sentiment. This applies even across varying time dimensions, which means that even as fundamental imbalances of inflation are being built globally over the long term, strains from one sided or popular trades can be vented to reflect on an interim “breakage of cross links” or snap backs. Hence, long term or secular trends will always be spliced with intermittent countertrends.

In the context of the US dollar Index, which have been the foundation of today’s reflation dynamic, the recent rebound amidst the hefty decline in global markets epitomizes the interim crowded traded snap back (see figure 2).


Figure 2: US dollar Commitment of Traders and US dollar Index

The chart from futures.tradingcharts.com demonstrates on the crowded trade phenomenon where non-commercial positions (banks, hedge funds, or large speculators) have overwhelmingly shorted the US dollar, as shown by the blue vertical lines. Commercial positions (red lines) are the end users (as importers or exporters) who apply currency hedges.

In the most recent past, each time US dollar short contracts reached the -19,200 level, the US dollar “recoiled” (June and August). Today, large speculator short contracts have vastly broken below said levels. And this signifies the crowded trade.

Alternatively this means that as the US dollar rebounded, carry trades based on the US dollar may have all been closed which oppositely results to the steep drop in so-called risks assets.

2. No Trend Goes In A Straight Line

When we say long term or secular trends will always be spliced with intermittent countertrends it simply means that markets don’t move in a linear fashion.

In other words, there is a distinction between secular trends and countertrends or a difference between the short-term and the long term.

Confusing one for the other could risk a disastrous portfolio.

Today’s massive asset speculations have resulted to overextended markets as in the case of the US (see figure 3)


Figure 3: Chartoftheday: Extraordinary Bear Market Rally

Chartoftheday.com sees an exceptional episode in today market action by the Dow Jones Industrials from whose chart ``illustrates the duration (calendar days) and magnitude (percent gain) of all significant Dow rallies that occurred during the 1929-1932 bear market (solid blue dots). For example, the bear market rally that began in November 1929 lasted 155 calendar days and resulted in a gain of 48%. As today's chart illustrates, the duration and magnitude of the current Dow rally (hollow blue dot labeled you are here) is greater than any that occurred during the 1929-1932 bear market.”

It is quite obvious that the referenced site is biased towards the “old reflation model” with their view predicated on a bear market rally, and perchance, expects the US markets as in a path towards the Great Depression levels.

Unfortunately, using the basic metrics of the monetary standards alone, where the Great Depression was anchored to gold while today operates on a pure paper ‘US dollar’ standard, comparing the Great Depression with today would fundamentally be immaterial.

Nevertheless today’s significant correction amidst the vastly overstretched or overbought market denotes of a “normal” corrective phase of market dynamics.

While we haven’t bullish with the US markets, we can’t also be equally bearish for the simple reason that we see the US government as supporting their asset markets as a priority over the other areas of concern. As 2008 meltdown has shown, the survivability of the US dollar standard depends on the Federal Reserve’s key agents, the US banking system.

This is a fundamental variable that can’t seem to be comprehended by the consensus.

3. Markets Have Been Liquidity Driven

As earlier noted, another outstanding fallacy utilized by the old reflation model or desperately seeking normal camp is to extrapolate conditions of the yesteryears through traditional metrics to project a preferred or biased scenario.

For instance we noted that the humongous profits reaped by ‘Too Big To Fail banks’ have been fundamentally derived from trading [as previously discussed in What Global Financial Markets Seem To Be Telling Us]

This seems to have confounded mainstream analysts like MSN’s Jim Jubak who recently wrote, ``What's really disturbing to me, however, is that the model is relatively new, even at Goldman Sachs, and current financial policy is pushing Goldman and JPMorgan Chase to even more extreme versions of the "bank as trader" model.” (bold emphasis mine)

But of course, the “bank as trader” represents as the du jour model.

That’s because the only significant alternative way to rehabilitate the US banking system’s balance sheet is to profit from trading. The industry has been hobbled by balance sheet impairments from the recent bubble bust and this has reduced their incentives to engage in the traditional model of lending.

And the only way to consistently profit from trading is to have an environment that will be conducive to this. And the only way to attain this is to create it. Hence, the US government has engaged in a decisive, massive, monumental and unprecedented scale of operations. The US government, according to Bloomberg, ``has lent, spent or guaranteed $11.6 trillion to bolster banks and fight the longest recession in 70 years, according to data compiled by Bloomberg. That’s a 9.4 percent decline since March 31, when Bloomberg last calculated the total at $12.8 trillion.” (bold highlight mine)

And this is why too the world appears to likewise adopt a seemingly complementary set of policies too.

This refusal to acknowledge the massive influence of government in today’s market system, results to this deep confusion between conventional models and evolving market realities.

Yet the ‘Bank As Trader’ model has been underpinned by the following sequence:

1. Taxpayers provide the Too Big To Fail banks with liquidity, loans, guarantees and equity.

2. Financial conditions has been stage managed by the US Federal Reserve via zero interest rate, quantitative easing, expansion of loan books of Fannie Mae, Freddie Mac and the FHLB, and through various programs where the US government acts as market maker (such as Term Discount Window Program, Term Auction Facility, Primary Dealer Credit Facility, Transitional Credit Extensions, Term Securities Lending Facility, ABCP Money Market Fund Liquidity Facility, Commercial Paper Funding Facility, Money Market Investing Funding Facility, Term Asset-Backed Securities Loan Facility, and Term Securities Lending Facility Options Program.)

3. Investment banks, hence, profit immensely from the spread generated by these manipulated markets.

4. The resultant handsome profits generated from these arbitrage opportunities prompts companies to deploy huge employee bonuses which prompts for an uproar from politicians and media over the ‘evils of greed’.

Incidentally, this brouhaha over greed is obviously a myopic distraction in the sense that pay and profits simply signify as symptoms of the main disease.

The underlying fundamental malaise is that the ‘bank as trader model’ has been a product of the collusion between the banking system and the US government to inflate the economy to the benefit of the elite bankers!

Nevertheless, the ‘Bank As Trader Model’ appear to synthesize with the overall the fundamental strategy employed by the US Federal Reserve to revitalize its banking system.

How?

1. By manipulating the mortgage markets and US treasury markets with the explicit goal of lowering interest rates, in order to ease the pressures on property values and to mitigate the losses in the balance sheets of the banking system,

2. By working to steepen the yield curve, which allows for conducive and favorable trading spreads for banks to profit and to enhance maturity transformation aimed at bolstering lending, and

3. By providing the implicit guarantees on ‘Too Big To Fail’ banks or financial institutions, this essentially encourages the revival of the ‘animal spirits’ by fueling a run in the stock markets. As we have noted in Investment Is Now A Gamble On Politics, 5 financial stocks otherwise known as the Phoenix stocks accounted for most of the trading volume last September.

In short, the recovery of the US banking and financial system has basically been entirely dependent on government actions via inflation.

One cannot simply read today’s markets without addressing the policy recourse or anticipating the prospective actions of the US government.


Figure 4: Liquidity Prompted Markets Equals Highly Correlated Trade

And the impact to the global marketplace has been the same dynamics: a high correlation of market activities.

The inverse correlation of US dollar vis-à-vis ‘risk’ asset markets (commodities and stocks) seems like a déjà vu. This should be music to the ears of the ‘desperately looking for normal’ camp.

However, this isn’t about traditional fundamental model, but about liquidity.

A rising US dollar signifies global liquidity contraction, as leverage in parts of the global financial system could have forcibly been unwinded. Moreover a spike in the VIX or volatility sentiment appears to be chiming with the underlying theme.

In addition, given the synchronous market actions brought about by a seeming reversal in liquidity dynamics, then the impact should be reflected on Asia over the coming sessions due to the recent strong correlation (Figure 5)


Figure 5: Money Week Asia: High Correlation Liquidity Driven Trade

According to Chris Sholto Heaton of Money Week Asia, ``the markets are generally highly correlated in terms of direction, with an R-squared value of 0.94 (the maximum is one, implying perfect correlation). In short, when Wall Street rises, Asia rises; and when Wall Street falls, Asia falls.”

In other words, Asian Markets may indeed fall from a US dollar rally over the interim. But this should be a short-term countertrend or a buying opportunity more than a secular trend as liquidity dynamics favor Asia and emerging markets/

4. Tightening Trial Balloons Responsible For Recent Shakeup

High profile and prolific investment strategist of CLSA, Mr. Christopher Woods in a recent opinion column at the Wall Street Journal basically echoed my observation, Mr. Woods wrote, ``The reality of an increasingly command-driven economy in America means that government policy is likely to become the key determinant of where investors should place their money.”

If the recent hyperactivity of the markets had been based on government policy to reflate the system, then the easiest explanation should be to attribute the recent correction as a reversal of the liquidity flows.

However, what drives such motions? Could it be that monetary inflation hasn’t kept up with present price levels? Or has present price levels been too high for monetary inflation to support?

Or could it be that governments have suddenly rediscovered sound banking, where signs of bubbles may have prompted for active strategies to ‘exit’ from the today’s policy induced liquidity environment?

Aside from Israel and Australia, which had been the early birds in raising interest rates, Brazil followed suit with capital controls to stem foreign inflows, a week earlier.

Late this week, we find an eerie coincidence of central banks in a tightening mode.

Norway was the first European country to raise interest rates Friday, while India ordered its banks to keep more of its cash funds in government bonds, last Thursday.

In addition, four of the world’s biggest central banks signaled the end or the near end of their Quantitative Easing programs.

On Friday, the Bank of Japan announced that ``it will stop buying corporate debt at the end of the year, as central banks around the world phase out emergency measures taken at the height of the financial crisis” (Bloomberg).

Also last Friday, the US Federal announced that it has ``completed its $300 billion Treasury purchase program today amid signs the seven-month buying spree helped stabilize the housing market and limited increases in borrowing costs” (Bloomberg).

In addition, likewise on Friday, a former official of the Bank of England announced a prospective downscaling of their own Quantitative Easing program, ``Former Bank of England policy maker Charles Goodhart said the bank may scale back or pause its bond- purchase program next week as officials around the world start to pull back stimulus for their economies.” (Bloomberg).

The European Central Bank wouldn’t be left behind, again on Friday, ``European Central Bank council member Axel Weber signaled the bank may start to withdraw its emergency stimulus measures next year by scaling back its “very long- term” loans to banks.” (Bloomberg)

Articles like this also published last Friday (Financial Times) exacerbated on the uncertainty brought about by the changes in the direction in global central bank policies, ``As the Federal Reserve’s programme of buying mortgage debt edges towards $1,000bn this week, investors are starting to worry about what happens once the central bank starts to slow down and exit from this key plank of its monetary easing policy.”

Of course, Friday had been catastrophic for global equity and commodity markets. And perhaps, the ensuing selling pressure from these agitations may likely spillover to the coming sessions.

However, given the latest round of triumphalism from being able to pivot or manipulate markets higher enough to project an economic recovery, global governments seem to increasingly exude confidence over their actions, so as to embark on an audacious experiment to conjointly orchestrate an apparent end to the quantitative easing programs, in order to keep a rein on asset prices from spiraling higher.

Again this is new stuff for central banking: Concerted policies are seemingly aimed at nipping an asset bubble from its bud!

Nevertheless, this lamentably reflects on the artificial nature of today’s marketplace, as it has been primarily negotiated by global political and bureaucratic authorities.

This week’s violent reaction in the marketplace following the policy signaling ploy by key central bankers seems like trial balloons to test for market reactions.

It is likely that the corresponding events may prove to be knee jerk and temporary as the overall environment remains accommodative. Perhaps, central bankers have been heeding the PIMCO’s Paul McCulley advice when he recently wrote, ``that markets can stray quite far from “fundamentally justified” values, if there is a strong belief in a friendly convention, one with staying power. And right now, that convention is a strong belief in a very friendly Fed for an extended period. Thus, the strongest case for risk assets holding their ground is, ironically, that the big-V doesn’t unfold, because if it were to unfold, it would break the comforting conventional presumption of an extended friendly Fed.”

By trying to prevent a V-shape recovery as Central Bankers appears to have done, Mr. McCulley, banking on behavioral dynamics, suggests that markets can expect more of extended friendly policies from the Fed (and from other global central banks) which should prolong the rise in asset markets.

I wouldn’t share Mr. McCulley’s confidence though. His theory discounts the Ponzi dynamics required to maintain and improve on asset pricing.

What we seems certain is that volatility risks from bi-directional interventionist policies have been reintroduced and could be the dominant theme ahead of us.

However, it is my view that the upside risks as having more weight than the downside over the longer term, because the US government will likely sustain an implied “weak” US dollar policy.

Remember, with the goal to stabilize and promote interests of the banking system, as seen from Bernanke’s doctrines, the US will likely proceed with the devaluation path in order to reduce real liabilities via inflation.

Further, the Fed will likely work on normalizing its credit system by keeping the banking system’s balance sheets afloat with elevated asset prices from which the only recourse is to inflate the asset markets.

In the interim, markets can go anywhere.

5. Nothing But A Head Fake Signaling

In the US, the so-called exit from the Quantitative Easing seems likely a head fake move.


Figure 6: T2 Partners: Woes of Mortgage Markets Still Ahead

With the risks of the next wave of resets from the Alt-A, Prime Mortgages, Commercial Real Estate Mortgages, aside from the Jumbo and HELOC looming larger [as previously discussed in Governments Will Opt For The Inflation Route] (see figure 6), they are likely to exert more pressure on the banking system.

Resets of Alt-A mortgages will crescendo until the end of 2012. And as you can see the subprime is dwarfed by risk exposures from Alt-A, Commercial and the Prime Mortgage.

In addition, commercial mortgages which has a risk exposure of around $1 trillion, is more widely held by US financial institutions.

According to Wall Street Journal, ``In contrast to home loans – the majority of which were made by only 10 or so giant institutions – thousands of small and regional banks loaded up on commercial property debt. As a result, commercial real estate troubles would be even more widespread among the financial system than the housing woes. At the present, more than 3,000 banks and savings institutions have more than 300% of their risk-based capital in commercial real-estate loans.” (emphasis added)

So the Fed’s communiqué and the real risks appear to be antithetical. One will be proven wrong very soon.

In addition, the Fed has been actively trying to expand its power which at present is being heard by the US Congress.

Moreover, worries over the politicization of the Fed as a proposed law grants veto power to the Secretary of the Treasury over Section 13(3) emergency action by the Federal Reserve Board of Governors (David Kotok).

In short, there is little indication that the Fed has embraced a tinge of sound banking. Instead, all these could be read as growing signs of the politicization of the monetary policies.

As Murray N. Rothbard in Mystery of Banking wrote, ``When expectations tip decisively over from deflationary, or steady, to inflationary, the economy enters a danger zone. The crucial question is how the government and its monetary authorities are going to react to the new situation. When prices are going up faster than the money supply, the people begin to experience a severe shortage of money, for they now face a shortage of cash balances relative to the much higher price levels. Total cash balances are no longer sufficient to carry transactions at the higher price. The people will then clamor for the government to issue more money to catch up to the higher price. If the government tightens its own belt and stops printing (or otherwise creating) new money, then inflationary expectations will eventually be reversed, and prices will fall once more—thus relieving the money shortage by lowering prices. But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to “catch up” to prices, then the country is off to the races.”

At the end of the day, the policy path appears heavily skewed towards more inflation to insure against additional losses and to safeguard against renewed disruption in the banking system.


Saturday, October 31, 2009

Ron Paul On Michael Moore: Corporatism Not Capitalism Is To Blame

Congress Ron Paul responds to Michael Moore's criticism of Capitalism. (Hat tip: Marcaeld)

some noteworthy quotes...

-"it's a fallacy to say that you have a right to someone else's services...

-"you've a responsibility to take care of yourself, but you don't have a right to get something from government because government has nothing and so government has to take it from somebody and give it you, so its a failed policy, it is a form of socialism...

-"But he is complaining about it being part of capitalism, but this has nothing to do with capitalism, this is corporatism. The corporations run things, the drug corporations lobbyist, insurer's lobbyist...We have a system where money and bigness influences the government, but that's corporatism not capitalism.

-example of free market-medical tourism

-"pumping money into the system doesn't improve quality it increases prices"

-you either have government intervention to mess up the markets or you don't. You either believe in freedom and believe voluntary choices...

-"when something is free and you don't have it, it is irrelevant"


Friday, October 30, 2009

William Gross On The New Normal

Pimco's Bill Gross explains the "New Normal" at a recent CNBC interview


Stratfor Video: A Crisis in the Kremlin

Russia seems caught between the clashing interest of political interest groups and the economy.

Stratfor: "A plan to remake Russia's economy threatens to unleash political infighting in Moscow -- upsetting a balance that Prime Minister Vladimir Putin has worked to maintain. If the plan goes through, the implications for industry and investors could be profound." (Hat tip:
Stratfor & John Maudlin)

This is an example of the hazards from state capitalism...


Graphics: Are We Coming Out Of Recession?

Interesting graphics from mint.com.

Although this applies more to the US more than the world.

economy-1
Mint.com Personal Finance Software

"The US stock market is soaring, commodity prices are on the rise, and there are signs that consumer confidence is growing. Ask the US government if the recession is ending and you’ll hear a resounding yes as the Obama administration rushes to claim an early victory. Naysayers however point to the massive US debt and the 10% unemployment rate as signs that, even with the economic stimulus package, we still have a long way to go. Our info-graphics displays some leading economic indicators on the road to recovery."

Thursday, October 29, 2009

Decoupling In Foreign Direct Investments?

In the crest of the 2008 crisis, decoupling, for the mainstream, resonated as a fantasy or myth.

Well, for us the synchronization or "recoupling" then signified more of shock or an anomaly than of a secular trend.


Again we see another sign where emerging markets appear to be diverging from advanced economies in terms of Foreign Direct Investments.


According to the Economist, ``FOREIGN direct investment inflows will barely reach $1 trillion in 2009, a decline of more than half since 2007, predicts the Economist Intelligence Unit, a sister company to The Economist. And for the first time emerging economies will attract more than half of the global total. Flows to poorer economies, especially Asian ones, are proving more resilient than flows to rich economies which are suffering the worst recession in several decades." (bold emphasis mine)

In short, secular trends appear to be overpowering interim 'crisis based' dynamics.