The Model Curse Strikes Again!

The curse of Models have struck again! And apparently government based models has been alleged as a vital contributor to the massive oil spill in Gulf of Mexico in the US!

Here is the Wall Street Journal, (hat tip Russ Roberts)

``BP PLC and other big oil companies based their plans for responding to a big oil spill in the Gulf of Mexico on U.S. government projections that gave very low odds of oil hitting shore, even in the case of a spill much larger than the current one.

``The government models, which oil companies are required to use but have not been updated since 2004, assumed that most of the oil would rapidly evaporate or get broken up by waves or weather. In the weeks since the Deepwater Horizon caught fire and sank, real life has proven these models, prepared by the Interior Department's Mineral Management Service, wrong... (emphasis added)

As Friedrich Hayek once wrote, "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

How true.

Malicious Propaganda- "Shocking News From The World BANK"

Many Filipinos simply adore political rubbish.

Since this is the 3rd time that I received this silly propaganda called the "Shocking News From The World BANK - MUST read by all Filipinos" might as well expose it for its fraud.

Yes, google search reveals of 7,900+ related post, which means many have thought this as pertinent to unfortunately publish it (how nonsense can be so pervasive).

The message goes:

The Financial Analyst of World Bank would like to inform each and everyone of you that the present currency exchange rate of US Dollar to Peso is actually $1 = P52. Your government is manipulating the exchange rate for some years now. It is very much improbable and impossible that the Philippine Peso is appreciating compare to Euro, British Pound, Rials, and any other foreign currency. Even your ASEAN neighboring countries are suffering from the Global Crisis. Singapore , a developed country is affected by depreciation of their currency what more of your country?

We admire you for your hard work but we also pity you for having such a very corrupt government that is taking advantage of your hard earned money.

The ARROYO ADMINISTRATION is blatantly milking each and every OFW's all over the world of billions of pesos for its own greedy, selfish ends. Investigations reveal that this milked money from OFWs will be spent to BRIBE not only PGMA's pet CROCODILES in CONGRESS but some in the SENATE as well for her to PERPETUATE IN POWER BEYOND 2010. The rest would be deposited to the family's SECRET ACCOUNT in Switzerland .

Another money-making scheme is the LOTTERY DRAWS. Filipinos should be aware that all LOTTO DRAWS are orchestrated, and big money goes to the two sons of the lady president. Recent example is the SUPER LOTTO 6/49 draw, where supposedly two individuals from Luzon won. Do you know WHO these individuals are? It's Mikey and Datu, who else? One might ask how can the draw be rigged when it is being televised in front of millions of viewers. The answer is simple. As you all know, all bet combinations are being entered into PCSO's main data base as it is on-line, therefore, it is easy to determine which combinations were NOT betted upon. If they want to raise big money, no winners will be declared until the JACKPOT reaches sky-high because they could dictate the outcome at will. When it's "HARVEST TIME", viola, there would be "winner or winners" and the process repeats all over again. One might ask how this is being done. One insider told our investigators that actually the "DRAWN BALLS", six balls to be exact, are the only set which could fit into the transparent tube which sucks the balls up. All others are slightly bigger than the diameter of the tube which could not be distinguished by the viewers, therefore, there's no way they could be drawn! You Filipinos are being skinned alive, fried in your own fat and lard by your own government.

Outside the toxicity of personality based politics (or the vile focus on the past administration), the disinformation campaign represents a menagerie of fallacies.

We will just deal with the allegation of the Peso and Lotto.

1. like all markets, currency pricing is subject to demand and supply

2. all governments have been "intervening" in the currency markets (directly or indirectly-e.g. fiscal policies). Remember supply or currency issuance is monopolized by governments.

3. on intervention: currencies are being manipulated to "depreciate" and NOT to appreciate.

Around the world, mainstream thinking and politicians abhor 'strong' currencies. The main reasons are that weak currencies reflect on the continued financing of political activities, unsupported by the laws of economics (inflationism), by the political leaders.

Second, but of lesser importance is "export competitiveness"-the mistaken notion that the only way to grow an economy is by exports. We call this "mercantilism".

4. By appreciation, you'll have to unduly restrict supply of money in the markets. And this would create artificial mayhem or what is known as deflation (confiscatory deflation or government confiscating private property to collapse money supply). By doing so, such translates to a deliberate restriction in government expenditures, which ironically, would only cause an uproar among politicians and their cohorts.

Hence what is improbable and impossible is not for the Peso to appreciate, instead it is for politicians to refrain from inordinate spending!

5. Meanwhile, a currency is depreciated by means of printing money or increasing government financial liabilities relative to goods and services.

6. Peso appreciation is largely a global phenomenon-as the US dollar, the world's currency standard, is being debased- from quantitative easing, massive bailouts and deficit spending.

7. Since currencies are valued in pairs, or in terms of the other currencies, the strengthening of the Peso vis-a-vis the US dollar, suggest that the US government is manipulating their currency more than the Peso, by engaging in more printing money (inflationism).

8. For the paper money system, as history would show, is a race to oblivion. And we go by what I would call the Voltaire rule: Paper money eventually returns to its intrinsic value-ZERO.

9. Lotto has little (or insignificant) relevance to the strengthening of the Peso. Pagcor earns about $29 million a year a smidgen compared to the Philippine economy is $324 billion (PPP) or $160 billion (official exchange rate) according to the CIA.

From Pagcor's annual report

Therefore, Pagcor is a "state" business, whose income is derived from monopolistic revenues of gambling and gambling related activities less liabilities due to the winners (minus other related charges) --regardless of the personality/ies involved.

If there has been any shenanigans in the operations they are too minute to influence the Peso's activities.

10. Obviously, such unintelligent highly disoriented message isn't from a qualified financial analyst or importantly from the World Bank.

Beware of misleading mendacious politically colored missives like this.

Incredible Day In Sports

At Wimbledon. The longest (and the closest) ever 11 hour+ epic match in tennis (played in 2 days):

John Isner (USA, seeded 23rd) over Nicolas Mahut (France)

6-4, 3-6, 6-7 (7-9), 7-6 (7-3), 70-68

Incredible feat. See Here

Unintended Consequences Of America's Foreign Policy: Hydra Of Warlordism

Given the recent political controversy which resulted to the resignation of General Stanley A. McChrystal as commander of the US and coalition forces in Afghanistan, we came across an interesting insight which reveals of the unintended consequences from America's Afghan policy...the hydra of warlordism has been a product of American policies!!!

This from CATO's Malou Innocent. (Bold highlights mine)

The New York Times reports that congressional investigators have found mounting evidence that “American taxpayers have inadvertently created a network of warlords across Afghanistan who are making millions of dollars escorting NATO convoys and operating outside the control of either the Afghan government or the American and NATO militaries.”

The Financial Times broke this story back in March. But their most startling discovery was that after nearly a decade at war in Afghanistan, Washington still has no clue as to who its true enemies (and allies) are.

Many Americans would be surprised to learn that some prominent Afghan officials are in fact saboteurs of America’s presumptuous and dangerously quixotic nation-building endeavor, instituting policies that feed the insurgency’s momentum in order to get more economic assistance from the coalition. America’s Ambassador to Kabul, Karl W. Eikenberry, said as much last November. Eikenberry warned (of course, to no avail), that Afghan President Hamid Karzai, “continues to shun responsibility for any sovereign burden. . .He and much of his circle do not want the U.S. to leave and are only too happy to see us invest further.” [Emphasis added]

Karzai knows very well that once the conflict ends, his open aid spigot will dry up. Indeed, Karzai has become notorious for replacing and undercutting people in his government who become too well-liked and “clean,” fearing these officials will become more popular than himself. Such double-gaming leads us to Karzai’s younger half brother, Ahmed Wali Karzai.

I guess the US haven't learned from their regrettable experience with Osama Bin Ladin who allegedly had been an erstwhile ally of the CIA.

Maybe learning isn't the right word or phrase, maybe promoting vested interest is.

The huge amount earmarked for military expenditures seems like a compelling incentive for vested interest groups and the political bureaucracy to sustain such 'imperialist' policies in spite of the tremendous costs (needless deaths and corruption of society). As these signify political control over money and power.

Yet we are reminded of former US president Dwight Eisenhower's warning in his farewell speech, where he said,

"we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist. We must never let the weight of this combination endanger our liberties or democratic processes. We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together."

Global Price Earnings Growth (PEG) Ratios

For enthusiasts of financial ratio fundamentals here is a nice table depicting on the country price earning growth ratios (PEG), courtesy of Bespoke Invest.

The methodology, according to Bespoke Invest,

"The PEG ratio is used for individual stocks as a valuation measure that factors in growth rates. It is calculated by dividing the company's P/E ratio by its growth rate. Many investors would rather own a company with a high P/E ratio and an even higher growth rate than a company with a low P/E ratio and an even lower growth rate. A PEG ratio of one or less is typically viewed positively.

"A few years ago, we decided to apply the PEG ratio to various countries by dividing estimated GDP growth into the P/E ratio of the country's main stock market index. Many developed countries have low P/E ratios, but they also have low GDP growth, while developing countries may have higher market valuations as well as stronger GDP growth. Investors may find PEG ratios more useful than simple P/E ratios when determining asset allocations for various countries.

And Bespoke's outlook,

``Russia and China have the lowest country PEG ratios at 1.86 and 1.90, respectively. Russia has a very low P/E at 8 and decent estimated GDP growth at 4.3%. China, on the other hand, has a rather high P/E ratio at 19.24, but its GDP growth is also very high at 10.10%. The US is right in the middle of the pack with a PEG of 5.07. Our neighbors to the south rank just above the US with a PEG of 3.85, while our neighbors to the north rank just below the US at 5.67.

``The US does have the best PEG ratio in the G-7, so US investors looking for developed country exposure might be better offer staying right at home. European countries have exceptionally high PEG ratios because of their mediocre valuations and low growth rates. Australia and Spain both have negative PEGs -- Australia because it has a negative P/E and Spain because it has negative GDP growth."

Here is Asia's country financial metrics equivalent based on the table from ADB's Capital Market Monitor.

The table was updated last April, however with little changes in the marketplace (this view is based on the Philippine setting) the estimates should be relevant.

And here is the expected annual economic growth for Asia, again based on ADB's estimates.

Applied to the Philippines, since the estimated GDP number is 4.6% for 2011, then at 14.7 PE ratio as of April, thus PEG is at 3.2.

Since PEG is a relative measure, this makes the Philippines 'pricier' relative to her Asian peers but more 'affordable' relative to developed economies. Therefore, cheap or expensive depends on which country is used as basis of comparison. In behavioral finance, this is called the "contrast principle".

Currency Values Hardly Impacts Merchandise Trade

In the eyes of the mainstream the only way to generate export growth is to devalue a currency or impose punitive tariffs on trade partners whom are deemed as 'currency manipulators'.

Yet, facts belie these misguided conventional beliefs.

Referring to the above charts, analyst Howard Simons argues, (bold highlights mine)

``First, three-quarters of the import weights and two-thirds of the export weights derive from five sources: China, Canada, Mexico, Japan, and the eurozone; the others will be aggregated for visual clarity. Let’s take a look at the imports first.

``The most prominent development over time has been the seizing of market share by China from Japan and Canada. Mexico’s share expanded after the passage of NAFTA, but it has stagnated in recent years as maquiladora plants have become uncompetitive with Asian exports. In economic terms, Mexico now is exporting labor, a factor in production, as it has lost a competitive advantage in the production itself.

``On the export side, China is displacing Japan as a customer of the US. Exports to both Mexico and Canada expanded after the passage of NAFTA, as have exports to “all-others;” this category includes important growing customers such as Brazil, India, the Middle East, and the Asian periphery.

``What is or should be striking in the pictures above are the rather constant weights for the eurozone. Given the euro’s prominence for financial flows and for traders, and given its outsized 57.6% weight in the dollar index, you might think all of the changes over the years in the rates between the dollar, the euro, and its predecessors would lead to substantial changes in trade weights.

``The US and the eurozone have structurally similar economies and factors of production. As a result, we trade in similar goods where differences in customer tastes and small quality differentials mean more than price. Moreover, much of the trade between the two zones is inter-subsidiary and represents a transfer."

True enough, (chart courtesy of netdania) despite the Euro's 5 year uptrend, this has hardly affected the trade weightings of the Eurozone vis-a-vis the US.

In addition, many other factors also seem to impact trade more than currency values, such as Free Trade Agreements, differentiation of goods, transfer pricing from inter-subsidiaries, and etc...

In other words, currency values hardly is the major factor that influences trade balances.

I'd like to interpose another perspective--how did the Euro become an export giant, in spite of the currency's elevated valuation levels?

Analyst Martin Spring enumerates the strength of Germany as the Eurozone's driver: (all bold emphasis mine)

-Germany is a hugely powerful exporting power, only recently overtaken by China, and still a far bigger exporter than the US or Japan. This year it is forecast to have a foreign trade surplus of $187 billion, not far behind China’s $219 billion.

-Despite some of the highest labour costs in the world, it has high productivity to match them.

-Due to the cohesion that comes from good employer-employee relationships, manufacturing industry has the flexibility to meet adverse circumstances. In the global recession it has kept growth in unemployment to just half a percentage point through measures such as pay cuts and state-subsidized short-time working.

-Instead of looking to currency depreciation to ease its problems, it survived the period of a strong euro by meeting competition head on. The OECD, in its latest economic survey, says the nation used the adversity to spur innovation, make allocation of resources more efficient, and invest strongly in advanced production techniques.

-Its companies have diversified internationally and outsourced to low-cost countries – about half the added value of exports is now produced abroad.

-Although Germany does, like so many countries, have a problem of high and growing public debt, it is at last addressing that problem decisively. Over the 2008-2012 period, despite the biggest stimulus programme in Europe, its debt is forecast to grow by only 17 percentage points, compared to 22 per cent in France, 33 per cent in Greece and the US, 34 per cent in the UK and 39 per cent in Japan.

-The Economist says Germany “no longer suffers from an arthritic labour market, an obese state or a suffocating tax burden.”

-At the core of the engineering sector that is the cornerstone of the nation’s industrial economy are thousands of dynamic Middelstand enterprises (small and midsized firms, often family-owned) that export almost 80 per cent of their production, selling not only highest-quality machines, but also the panoply of expert support services that go with them.

-Germany is a world leader in fields such as automotive technology and renewable energy. It can sell machinery in China at four times the cost of Chinese competitors’.

All these can be summed up into competition, division of labor, competitive advantage and high level of entrepreneurship. In short, Germany's export powerhouse came about from fundamentally embracing free market principles and not from devaluation and closed door isolationist policies.

This bring us to the surprise announcement by China to gradually allow her currency to rise. Will these alleviate the so called global imbalances?

In 2005 the yuan appreciated by 9.8%, yet there has hardly been any improvements in the trade balance (deficit) standing of the US vis-a-vis China, as shown in the above chart.

And the narrowing of the trade gap in 2008 can't be attributed to the rising Yuan, because the world suffered from convulsions of the 2008 financial crisis, which had been a far larger factor.

Besides, China then repegged her yuan to the US dollar at the onset of the crisis (also shown above-chart courtesy of Northern Trust).

So the answer is a NO--the appreciation of the yuan is unlikely to make a significant dent to the US deficits. Moreover, for as long as the US dollar is the de facto medium of account "currency standard" for global trade, the US is likely to maintain huge deficits.

However for China it could be a different story.

China's surpluses could narrow, not because of the appreciating yuan, but because of policies aimed at shifting internal dynamics.

According to Northern Trust's Paul Kasriel,

``Now, I do believe that the rate of increase in China's trade surplus will be slowing in the coming years, but not primarily because of an appreciating renminbi. But rather because rising incomes among Chinese households will lead to increased discretionary spending by them. Also, in order to keep the population relatively happy, Chinese politicians will re-allocate government spending more toward services and infrastructure spending to benefit households rather than export industries."

Bottom line: currency values signify only as one variable out of the many that influence trade activities. Therefore tunneling on the "currency" valve as means to rebalance trade by indirect (inflationism) or direct protectionism is not only fallacious and deceptive but also unwarranted.

Borrowing Howard Simons conclusion, ``the world’s protectionists are better at making noise than making sense".

Does Macro Economics Matter?

In an article, "What's the Point of Macro?" Societe Generale Dylan Grise remarked,

``So my advice to anyone about to embark upon Einhorn's path of using macro to "actively manage your long-short exposure." is to think long, hard and honestly about what your sphere of competence actually is." (thanks to my dear friend Mr. Laird Smith)

If importation of product X is my business, and suddenly our government prohibits the imports of this item and its related lines, then what's the effect to my business? Obviously I'd have to either shift to other products where imports are allowed or close shop! [yes my dad suffered from this predicament nearly 30 years ago]. In short, business conditions respond to macro policies.

Thus my corollary: The more the government intervenes in the marketplace, the more macro perspective becomes relevant, and vice versa, in determining the viability of investments.

Put differently, the usefulness of the macro perspective relative to risk-reward tradeoff depends on the expected level or degree of government interventionism or inflationism.

As a caveat, while macro does matter, we shouldn't ignore the micro developments. Importantly, we should NOT depend on mathematical formalism to make macro appraisals.

Thought Of The Day: The Keynesian Circular Thought Process

This quote from Professor William Anderson

"In the world of Keynesian economics, there really is no individual behavior that is purposeful. People don't "spend" because they believe that the purchase of a specific good or service will make them better off, but because they are "buying back the product" they have produced as workers.

"This is what one might call circular logic, and it reminds me of the imaginary exchange that Professor Israel Kirzner used to explain the circular flow of Keynesianism:

"FIRST PERSON to SECOND PERSON: Why do you eat breakfast?

"SECOND PERSON: So I can go to work.

"FIRST PERSON: Why do you go to work?

"SECOND PERSON: So I can eat breakfast.

The Road To Serfdom In North Korea

Max Borders at the Washington Examiner enumerates the "vital concepts" from Friedrich Hayek's legacy "The Road To Serfdom" which most recently hit the top spot in Amazon (due to Glenn Beck's promotion).

From Mr. Borders:

Spontaneous Order - Complex society and open markets cannot be planned. Period. Human beings just ain’t smart enough. Instead, the extended order emerges - unplanned and undesigned - due to humans interacting in complex ways according to simple rules. These rules do not specify certain social ends, but rather bring order to the diverse ends of billions of people pursuing happiness.

The Knowledge Problem - It is impossible for a single mind or group of minds to predict, plan or control the innumerable inputs, outputs and actions in a market. Instead, knowledge is dispersed among billions of people. Entrepreneurial opportunities are seized by individuals with particular, local insights, and/or expertise in some specific area the bureaucrate cannot possess.

Price System - Entrepreneurs also respond to information flows communicated through the price system. Bureaucratic control of an economy is impossible due to the loss of information communicated through prices, and due to the inability of one to gain the right kinds of information at the right times and right places. “Prices are signals, not marching orders.”

Competition as a Discovery Procedure - The circumstances of time and place are critical to the success of competitive market actors. The idea that we can aggregate economic data - like macroeconomic data - in order to say something meaningful about how things should to be coordinated is, well, a bad idea. Competition among market actors looking for opportunities to offer a previously unnoticed value to consumers is basically crowd-sourcing value creation. Innovators compete, you win."

And a fantastic example of how a society operates without or with little of these elements is North Korea.

This from the Washington Post, (all bold highlights mine)

Bowing to reality, the North Korean government has lifted all restrictions on private markets -- a last-resort option for a leadership desperate to prevent its people from starving.

In recent weeks, according to North Korea observers and defector groups with sources in the country, Kim Jong Il's government admitted its inability to solve the current food shortage and encouraged its people to rely on private markets for the purchase of goods. Though the policy reversal will not alter daily patterns -- North Koreans have depended on such markets for more than 15 years -- the latest order from Pyongyang abandons a key pillar of a central, planned economy.

With November's currency revaluation, Kim wiped out his citizens' personal savings and struck a blow against the private food distribution system sustaining his country. The latest policy switch, though, stands as an acknowledgment that the currency move was a failure and that only capitalist-style trading can prevent widespread famine.

"The North Korean government has tried all possible ways [for a planned economy] and failed, and it now has to resort to the last option," said Koh Yu-hwan, professor of North Korean studies at Dongguk University in Seoul. "There's been lots of back and forth in what the government has been willing to tolerate, and I cannot rule out the possibility of them trying to bring back restrictions on the markets. But it is hard for the government to reverse it now."

Because North Korea operates in secrecy and isolation, outside observers rely on informants and accounts from defectors. In this case, experts agree that the food shortage is dire. Several analysts who monitor and travel to North Korea said that in recent weeks, Pyongyang has abandoned almost all its rules about who can spend money and when. That would seem to indicate that Kim -- who once equated free-market trading with "egotism" and a collapse of social order -- now wants to rehabilitate the markets damaged in November...

``In the mid-1990s, amid a total collapse of the central planned economy, somewhere between 3 and 5 percent of the population -- perhaps 1 million people -- died of starvation. Meanwhile, North Koreans increasingly turned to small markets for trading and buying supplies."

Bottom line: The Road To Serfdom is about shortages, death and poverty. Even the North Korean leadership now recognizes that they can't subvert economic laws.

(hat tip Greg Ransom)

What Gold’s Latest Record Prices Mean

``The struggle against gold which is one of the main concerns of all contemporary governments must not be looked upon as an isolated phenomenon. It is but one item in the gigantic process of destruction which is the mark of our time. People fight the gold standard because they want to substitute national autarky for free trade, war for peace, totalitarian government omnipotence for liberty.” Ludwig von Mises

A major trait of bullmarket is, whatever assets we sell today will climb higher tomorrow. This implies that the most regrettable course of action in a bullmarket is to sell.

And one great example would be the gold market. Gold just set a new record in terms of nominal high (see figure 1).

Figure 1: Netdania.com[1]: Gold’s Stairway To Heaven

The monthly chart reveals that gold prices have been in a bullmarket since 2000. While true enough, there have long periods of consolidation, the general trend over the last decade has been up.

And importantly, contrary to those who allege that gold functions as safehaven during recessions or during the “deflation-symptom” crisis similar to the Bear Stearns-Lehman episode of 2008, evidence has shown otherwise—gold fell during the previous two recessions of 2001 and 2008 (see black channel lines)!

Alternatively, the most recent record run only implies that the fresh milestone high, established last week, DOES NOT presage of any forthcoming market crashes or “double dip” recessions. And if gold serves as a lead indicator as previously discussed[2], then the likelihood is to see reanimated activities in global risk markets.

At the start of the year, we were told that gold wouldn’t generate investor appetite as the menace of “deflation” continues to lurk around the corner. We even read predictions stating that gold would fall back to the $800 levels[3] way until last month[4].

However, as we have always been saying--in a world of central banking, deflation is no more than a bogeyman to rationalize more inflationism, which central bankers are likely to accommodate. After all, inflation is ALL about politics. And central bankers, in spite of their supposed “independent” role, have been the main conduits in financing government expenditures. Thus all talks of “independence” are mostly demagoguery. Fact is, global banking regulations, as the Basel Accords, have all been skewed to accommodate government expenditures[5].

Of course, one major bullish factor about gold is that mainstream STILL doesn’t get it; gold isn’t just an inflation hedge, nor is it about alternative assets[6]. It’s also been starkly misguided to impute ‘conventional’ financial valuation metrics to gold when this doesn’t apply. It’s even myopic to calculate or value gold prices premised on commodity usage. And it is also faulty to appraise gold based on global mining output. Since gold isn’t being consumed, incremental additions to the above ground supplies by existing mines hardly determine the pricing model (see previous discussion[7]).

In a decadent world of fiat money, where money printing to fulfil specific political agenda have been the most convenient route resorted to by political leaders everywhere-for the simple reason that the ignorant masses hardly understands how such surreptitious redistributive activities influences their lives- gold seems to be re-establishing its role as ‘money’.

Therefore, gold’s ascendant trend in ALL currencies have simply been manifestations that demand for gold has been transforming from mere “commodity” (jewelry and industrial usage) to “money”.

Gold is being held as reserve asset not just by the central bank, but importantly by the general public. Gold’s increased function as “reservation demand” is what usually the mainstream sees as “speculation” or “speculative hoarding” or “investment demand”.

Otherwise said, money’s “store of value” is increasingly being factored into gold prices (unit of account). Hence, relative to gold pricing, this implies that reservation dynamics or the reservation model (and not consumption model) determines gold valuations or that the exchange ratio or monetary valuations relative to fiat currency applies-- where valuations are determined by the expected changes in relationship between the relative quantity of, and the demand for, gold as money vis-a-vis paper currencies.

And possibly one day, such transformation would include the deepening of “exchange demand” or gold as ‘medium of exchange’ (see previous discussion[8]). Proof of this has been the emergence of Gold ATMs in Germany[9] and in Abu Dhabi[10].

All these, of course, are ultimately dependent on the stimulus-response and action-reaction of global political leaders on the swiftly evolving political, economic and financial sphere.

And thus, periods of weaknesses, whether from recessions or from consolidations (in technical or chart lingo the “energy fields”), has served as buying windows rather than selling opportunities.

Yet for those whom have remained sceptical and or earnestly drudge to market “timing” gold’s prices, they usually end up chasing gold prices higher-- buy high and sell low.

And this is especially brutal to those in constant denial of gold’s ascendancy; they have entirely missed out the rally for ideological reasons, and vent their frustrations by continually disparaging such developments. The odd thing is that this has already been a 10-year market process.

Yet since gold rise has been threefold, all errant attempts to “time” the market has resulted to lost or missed profit opportunities.

As the legendary trader Jesse Livermore expressed by Edwin Lefevre in the classic must read for any serious investors, “Reminiscences of a Stock Operator”,

``Disregarding the big swing and trying to jump in and out was fatal to me. Nobody can catch all the fluctuations. In a bull market your game is to buy and hold until you believe that the bull market is near its end. To do this you must study general conditions and not tips or special factors affecting individual stocks.[11]”

In short, the best returns emanate from long term investments.

---

[1] Netdania.com, Forex charts

[2] See Why The Current Market Volatility Does Not Imply A Repeat Of 2008

[3] Yahoo. Finance, Gold Is "Fairly Expensive," Could Fall to $800 If Fed Moves, Midas Fund Manager Says, January 22, 2010

[4] CNN.Money, The coming gold bust

[5] See The Myth Of Risk Free Government Bonds

[6] Reuters.com, US gold sets record, ends strong as alternate asset

[7] See Gold As Our Seasonal Barometer

[8] See Financialization of Commodities: Boon Or Bane?

[9] See Creative Destruction: Electronic Payments Over Cash And Checks

[10] Financial Times Blog, Abu Dhabi’s gold ATM machine a sign of more opulence to come, May 13 2010

[11] Lefevre, Edwin, Reminiscences of a Stock Operator p.76 John Wiley and Sons

Buy The Philippine Mining Index And ASEAN Bourses On Record Gold Prices

``In all countries and all civilizations, two commodities have been dominant whenever they were available to compete as moneys with other commodities: gold and silver. At first, gold and silver were highly prized only for their luster and ornamental value. They were always in great demand. Second, they were always relatively scarce, and hence valuable per unit of weight. And for that reason they were portable as well. They were also divisible, and could be sliced into thin segments without losing their pro rata value. Finally, silver or gold were blended with small amounts of alloy to harden them, and since they did not corrode, they would last almost forever. Thus, because gold and silver are supremely "moneylike" commodities, they are selected by markets as money if they are available. Proponents of the gold standard do not suffer from a mysterious "gold fetish." They simply recognize that gold has always been selected by the market as money throughout history.”-Murray N. Rothbard

Aside from the lessons of how to treat bullmarkets, there are two factors to ascertain or discover from gold’s rise:

One: To identify bullmarkets pertinent to gold’s actions and

Second: The possible implications of the gold’s resurgence to domestic gold and metal mining related issues.

The Relevance Of Gold-ASEAN Bull Markets

The Phisix and most of Asian stock markets are in a bullmarket. That has been a mantra of ours for the longest time.

In the fullness of time, perhaps the 2008 US housing bubble crisis will be portrayed as an intermission to the current phase of the bullmarket cycle.

No, relative economic success isn’t the main force that will fuel this boom, although this will be the “rationalization” or “justification” which mainstream will obviously utilize.

Instead what will drive this boom is the global bubble cycle (or what can be described as the Austrian Business cycle) that continually plagues the present state of the markets. Such cycles signify as the consequences of the world inflationism or the mainstream’s “central banking-fractional reserve-deficit spending” policy framework.

Since money isn’t neutral and where collective money printing would impact relative assets relatively, the likely magnet for the tsunami of “counterfeit” money (money from thin air and are unbacked by real savings) are sectors or nations that has eluded from developing bubble conditions during the last bubble cycle. In other words, where the supply side hasn’t generated excess capacity or malinvestments, “speculative” money is likely to flow or get funnelled into these focal areas.

They will be embraced as a surge in domestic consumption, swelling middle class, wealth transfer, demographic dividends, urbanization and alot of many other pretexts for a boom, but eventually like all bubble cycle most of these will be exposed as tomfoolery or a scam. That’s because the forces that would underpin such booms will likely be characterized by ballooning domestic credit, in households or corporate or both, and by leveraged international money flows.

Though, of course, one big factor which we cheer of is the broadening of economic freedom in many emerging markets, as seen by growing globalization of trade, investments and labor.

However, economic freedom is diametrically opposed to inflationism. Hence, two forces are fiercely counteracting or grinding upon each other. And economic freedom would have to endure from the ordeals of the volatility elicited from the falsified pricing mechanism in the marketplace derived from the current collective interventionist policies. Remember, all current actions have future consequences. Economic freedom thus is a long term proposition in the face of the adversarial forces of hidden taxation.

And it would be an irony to say that rising gold prices seem to be a “boon” to stock markets and other financial assets or the economy. That’s because rising gold prices exhibits the pathology of the endemic nature of the political agents to debase currency for political goals. The reason why rising gold prices appears as a benediction for the markets today is due to the “sweetspot” of inflation[1]- as seen by low interest rates and tolerable instances of inflation.

As Friedrich August von Hayek explained, (bold highlights mine)

``Now the chief effect of inflation which makes it at first generally welcome to business is precisely that prices of products turn out to be higher in general than foreseen. It is this which produces the general state of euphoria, a false sense of wellbeing, in which everybody seems to prosper. Those who without inflation would have made high profits make still higher ones. Those who would have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom. There is a general excess of demand over supply-all is saleable and everybody can continue what he had been doing. It is this seemingly blessed state in which there are more jobs than applicants which Lord Beveridge defined as the state of full employment-never understanding that the shrinking value of his pension of which he so bitterly complained in old age was the inevitable consequence of his own recommendations having been followed.[2]”

ASEAN’s Bullish Momentum

This welcome phase can vividly be seen in Figure 2.

Figure 2: Bloomberg[3]: Blossoming Bull Markets In ASEAN?

For major ASEAN nations, the marketplace seems ripe for a raging bull.

Indonesia’s Jakarta Composite Index (green line) has already transcended its 2008 high (!!), while the Philippine Phisix (yellow line), Malaysia’s KLCI (red line) and Thailand’s SET (orange line) are all within spitting distance.

If all four benchmarks manage to surpass their 2008 highs, then I’d presume that the region’s bubble cycle could only accelerate.

And following the recent market stresses within the EU zone where the European Central Bank (ECB) has already reactivated their own version of quantitative easing, coupled with the soon to be operational European Financial Stability Facility (EFSF), a combined €750 loan facility from the (€440 billion) EPSF, the IMF (€ 250 billion) and the European Financial Stabilization Mechanism (€ 60 billion), aimed at “providing financial assistance to Eurozone states in difficulty”[4], monetary conditions among major developed economies are likely to be very accommodative for an extended period especially in the light of Asian conditions.

And such disparate circumstances are likely to engender and amplify arbitrage or carry trade opportunities.

In the Philippine Phisix, market internals appear to be suggestive a looming major upside thrust (see figure 4)

Figure 4: PSE: Phisix and Advance-Decline Spread

The Advance-Decline spread (lower window) which is the daily tally of advancing issues less declining issues or a measure of market breadth or sentiment seems to be on the mend as the Phisix approaches its 29-month resistance levels (Upper window).

If the Phisix is to successfully breach the present resistance levels at about 3,350, we are likely to see a tight advance decline spread similar to the March-April pattern.

And if the present momentum extends, it won’t be far fetch that a test of the 2007 high at the 3,800 level will be the next topic of our discussion.

Meanwhile, the other major force, which we earlier we pointed out[5], is the potential ‘sustained’ rally in the Euro-US Dollar.

Philippine Mining Index Due For Yearend Fireworks

The other area which is likely to benefit from rising Gold prices is none other than the mining issues (see figure 5).

Figure 5 stockcharts.com: Gold and Global Mining Stocks

As gold has reached a new milestone, the benchmark of global mining stocks continue to trail or lag.

Of course, not all mining companies are created equal. And that’s the reason why I chose the Dow Jones US Mining (DJUSMG) and S&P/TSX Global Mining Index (SPTGM) to compare with gold. The activities of the general mining issues should smooth out the activities of gold miners (lowest pane; DJAPRT Dow Jones-UBS Precious Metals Total Return Index[6])

Dow Jones US Mining represents select US based gold and coal stocks[7] while the S&P/TSX Global Mining Index[8] is a global bellwether of Aluminium, Diversified Metals, Gold and Precious Metals and Coal and Consumable fuels. Both indices, while lagging, appear to be advancing. If the past will reprise, then the component issues of both benchmarks are going to do alot of serious catching up. But again, the performances of coal, industrial metals and others haven’t matched the performance of gold miners. Yet if we are right and eventually inflation accelerates then all these will rise, but the degree of increases will likely be different.

How should these apply to the local mining index?

The Philippine mining index is essentially a gold mining index with about two-thirds of the index weightings based on gold miners. The balance is distributed between coal (Semirara about 14% of the index as of Friday’s close), industrial metals (NIHao Mineral Resources 3.2%, Geograce 3.4%, and Atlas Consolidated 9.43%-Atlas is most diversified since it has also gold and silver) and oil (Oriental Petroleum 3.13%).

Figure 6: Philippine Mining Index And GOX

This suggests that like Dow Jones US Mining, the local mining issues appear to be far underperforming both Global diversified mining (as shown above) and conspicuously the gold miners see figure 6. Year to date, the local mining index is down 17.54% even as the Dow Jones Mining is up 3.07%.

Meanwhile, another US gold miner index, the CBOE Gold Index (gold line) seems hardly correlated with our local index or with gold related mining issues within the index. The GOX is up 10.6% on year to date.

The chart above consists of the top 5 mining issues in terms of capitalization, particularly Philex (red line), Semirara (green), Lepanto (orange), Atlas (black) and Manila Mining (violet). Since Philex made a spectacular nearly fourfold rise late last year, the Philippine Mining appears to be more inclined to reflect on Philex’s movements, given that Philex has about 43% of the index market cap.

Nevertheless, while there is no clear relationship between the US GOX and local mines to the upside, they have almost been as one to the downside during the Lehman collapse in 2008.

However one interesting observation is that the gist of the runs of many mining issues seems to occur during the last semester of the year, in 2006-2007 and in 2009. Of course this excludes the shock of 2008.

Hence, it is my impression that given gold’s recent fresh highs, combined with other factors mentioned above, along with seasonal and rotational effects, my next bet is that the far oversold mining index is likely to make a dramatic encore by the yearend.

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[1] See Inflation’s Sweet Spot Augur For A Gold Breakout And Global Equity Market Rally, February 28, 2008

[2] Hayek, Friedrich August Can We Still Avoid Inflation? The Austrian Theory of the Trade Cycle

[3] Bloomberg.com, World Index

[4] Wikipedia.org, European Financial Stability Facility (EFSF)

[5] See Buy The Peso And The Phisix On Prospects Of A Euro Rally

[6] iPathETNs, Dow Jones-UBS Precious Metals Total Return Index

[7] Wikinvest.com Dow Jones US Mining

[8] Standard And Poors, S&P/TSX Global Mining Index