Is the Swiss Franc Better than Gold?

For the Economist the answer seems to be a yes

WHEN the going gets tough, investors buy two assets: gold and the Swiss franc. Gold's all-time peak in real terms was in 1980 when inflationary fears were particularly intense. That followed a long period of Swiss-franc strength in the 1970s, which forced the government to impose negative interest rates in a bid to dissuade foreigners from opening bank accounts in the currency. With investors now worried about European sovereign debt and the crisis over the American debt ceiling, it is not surprising that both assets are popular again. Gold has been hitting nominal highs, while the Swiss franc has reached a record in real trade-weighted terms (ie, against the country’s trading partners). The Swiss have both a fiscal and a current-account surplus, a low inflation rate and a relatively low debt-to-GDP ratio.

The Swiss Franc-gold correlation seems to be playing out a cycle.

In the two decades of the gold bear market during the early 80s until the late 90s, the Franc (CHF) has substantially outperformed gold. The middle green circle highlights this phenomenon by exhibiting the widest variance.

However, the recent rally in gold prices has been closing this gap, as shown by the gold ellipse on the right.

In the early 70s we saw a similar gap-closing dynamic by gold. This eventually culminated with gold topping out in the early 80s (red oblong-left).

It can be argued that based on the above chart, where in the stretch of 4 decades the Franc (CHF) has predominated gold, the Swiss currency has indeed been a ‘better’ safehaven option.

And a major additional reason, which the Economist above didn’t cite, is that Switzerland has the largest gold reserves per person (shown below)

Chart from the Economist

In short, the strength of the Franc can partly be attributed to its gold reserves.

Nonetheless, it is unclear if history would repeat or rhyme.

Given that the Swiss Central Bank has shown to be equally susceptible to inflating their currency, as recently prompted for by the Greece crisis, and like any nation operating on the central bank system, I am doubtful of the Franc-gold correlation “returning to the mean”.

This would depend entirely on monetary politics or how the Swiss Central Bank -government would respond to the unfolding events

The gap-closing trend by gold relative to the Franc, as indicated above, can be seen more clearly in this 3 year chart from stockcharts.com.

Bottom line: Since I am leery of central banking whom are prone or inclined to use their vaunted weapon (of money printing), I’d stick to gold.

Post Script:

The Philippine Peso seems no match to the Franc. (chart from Yahoo finance)

This just exhibits how relatively more inflationary the Peso (undergirded by obnoxious Philippine politics) has been.

Quote of the Day: Problem Solving as an Enabling Force of Innovation

When we fight constraints and eliminate them, we often gain access to new insights, new productivity and new solutions. It also makes it easier to compete against people who don't have those constraints.

There's a useful alternative: embrace the constraints you've been given. Use them as assets, as an opportunity to be the one who solved the problem. Once you can thrive in a world filled with constraints, it's ever easier to do well when those constraints are loosened. That's one reason why the best filmmakers learn their craft making movies with no budget at all.

That’s from marketing guru Seth Godin.

I would further add that this would work best in a competitive decentralized profit and loss driven environment.

Graphic: World’s Largest Armed Forces

Because of the Spratly’s brouhaha, many Filipinos seem to be searching the web for the odds of winnability for the Philippines, in case of a military escalation that could lead to a war with China.

I think these people, whom have not experienced the horror of wars, seem to desire it, perhaps in the doltish presumption that any war won’t get them involved or that wars function as some form of sporting event.

In wars, the losers have always been the people, as both combatants and non-combatants get slaughtered, aside from the economic hardship, physical dislocation and the psychic or mental trauma that arises from such hellish events.

Worst, people from opposing camps shoulder the burden of paying for such outrageous exercise.

Yet if there are any winners, they have always been the politicians, who see people fighting and dying in their behalf and paying for their reckless adventures in the false name of nationalism.

This graphic from the Economist.

The above graph only shows that a war with China is suicidal.

The better alternative is to engage them in more trading activities that should ease geopolitical pressures. Trade and not war is the answer.

Quote of the Day: The Limits of Innovation

Advancement is limited only by the extent of individual creativity. A decade or two from now you will enjoy the fruits of someone else’s idea, that you yourself simply could not have imagined prior to its development.

So, while the future is not necessarily picturesque, neither is it as dark as some people suggest it may be. We live in an age that places a premium on knowledge. This represents a giant step forward.

This is from Jonathan M.F. Catalán at the Mises Blog with bold emphasis mine. Mr. Catalán seems to be on a roll with a series of impressive articles as this

Bottom line:

For as long as people are allowed to unleash their creativity on the marketplace, innovation and economic progress will continue in spite of government intrusions

Free Education Now A Reality

I have been saying that the internet would enable free markets to provide free education. This is now a reality. And this will radically reshape the education industry which has been founded on the industrial era template.

The ball just got rolling with University of People. (pointer to Jeff Tucker Mises Blog)

University of the People (UoPeople) is the world’s first tuition-free online academic institution dedicated to the global advancement and democratization of higher education. The high-quality low-cost global educational model embraces the worldwide presence of the Internet and dropping technology costs to bring university-level studies within reach of millions of people across the world. With the support of respected academics, humanitarians and other visionaries, the UoPeople student body represents a new wave in global education.

UoP’s Mission

University of the People (UoPeople) is a non-profit organization devoted to providing universal access to quality, online post-secondary education to qualified students.

The vision of University of the People is grounded in the belief that universal access to education is a key ingredient in the promotion of world peace and global economic development.

Spiraling costs of industrial era education is about to crater, whether in the US or in the Philippines. And so will public (tax payer funded) education. Credentialism via certification will likewise be transformed.

Urbanization and the Knowledge Economy

Investing guru Templeton’s Mark Mobius, reflecting on the mainstream view, believes that “Urbanization” will drive emerging market investments. ADB, for instance, has a literature on managing Asian cities here

Mark Mobius writes, (bold emphasis mine)

Over the next few decades, I believe we are likely to see an increase in several types of infrastructure investments due to rapid urbanization, which drives the increasing global demand for resources, mainly from emerging markets. I expect there will likely be many opportunities, particularly in the energy and materials sectors. Rapid urbanization in emerging markets, driven by rural populations migrating to cities in search of work and better opportunities, has put pressure on resources and prompted governments to pump money into a range of urban infrastructure-related sectors such as housing, transportation, sanitation, water, electricity and telecommunications.

I am a skeptic of the urbanization theme.

That’s because urbanization oversimplifies on the evolving trend of the global economic structure. Urbanization puts emphasis on past economic (industrial age) paradigms which it assumes will be carried forward.

Urbanization basically neglects the rapidly growing contribution and the deepening of the knowledge economy which has been reconfiguring people’s lifestyle and commerce.

Essentially urbanization focuses on the economies of scale from concentration and centralization, whereas the knowledge economy has been decentralizing socio-economic activities as a consequence of decreasing trend of communication, connectivity and transaction costs.

The Wikipedia explains the forces of the Knowledge Economy,

there are various interlocking driving forces, which are changing the rules of business and national competitiveness:

-Globalization — markets and products are more global.

-Information technology, which is related to next three:

Information/Knowledge Intensity — efficient production relies on information and know-how; over 70 per cent of workers in developed economies are information workers; many factory workers use their heads more than their hands.

New Media – New media increases the production and distribution of knowledge which in turn, results in collective intelligence. Existing knowledge becomes much easier to access as a result of networked data-bases which promote online interaction between users and producers.

Computer networking and Connectivity – developments such as the Internet bring the "global village" ever nearer.

As a result, goods and services can be developed, bought, sold, and in many cases even delivered over electronic networks.

I would add that increasing specialization will hallmark the knowledge economy. And specialization will diminish the economics of urbanization.

The changing nature of work can be exemplified by the telecommuting jobs, which have been rapidly growing.

These jobs are based on the web, are flexible and are not location sensitive (working from home, or elsewhere).

Wikipedia estimates

that over fifty million U.S. workers (about 40% of the working population) could work from home at least part of the time, yet in 2008, only 2.5 million employees (not including the self-employed) considered their home their primary place of business.

Occasional telecommuters— those who work remotely (though not necessarily at home) —totaled 17.2 million in 2008.

Very few companies employ large numbers of home-based full-time staff. The call center industry is one notable exception to this; several U.S.-based call centers employ thousands of home-based workers. For most employees, the option to work from home is granted as an employee benefit; most do so only part of the time.

In 2009 the Office of Personnel Management reported that approximately 102,000 Federal employees telework.

In the next three years, public and private sector IT decision makers expect telework to increase by 65% and 33%, respectively.

I, for one, am a Philippine based telecommuter.

As society evolves towards the knowledge economy, the incentive will largely focus on diversity dynamics from localized knowledge and commerce.

A study from McKinsey Quarterly seems to validate this perspective as local champions have been outperforming multinationals

we have found that high-performing global companies consistently score lower than more locally focused ones on several critical dimensions of organizational health—direction setting, coordination and control, innovation, and external orientation—that we have been studying at hundreds of companies over the past decade.

That’s how the knowledge economy has been changing the nature of commerce and will continue to do so.

So while I agree that infrastructure will highlight growth of emerging markets because of increased economic freedom and greater degree of free trade, emphasis on urbanization should translate to a lot of misdirected resources—yes they account for as emerging bubbles similar to China’s ghost cities and Potemkin Malls

If free markets will determine where infrastructure trends are headed for, then a more widespread development that caters to the growing forces of technology enabled specialization and diversity should be expected.

Government sponsored urbanization, thus, represents a symptom of bubble cycles at work.

In Venezuela, Price Controls have Resulted to a Shortage of Doctors

In Venezuela price controls has not only brought widespread shortages in many goods at worst it has been causing doctors to flee.

From the eloquent Mary O’ Grady of Wall Street Journal

Yet it is in health care where Venezuelans are feeling the inflation pain most. Hospital services are up 39.7% year over year, doctor and paramedic services are up 21.5%, and the cost of medicines and medical equipment has risen 17.4%.

These cost increases refer, of course, to private clinics and goods that are not subject to price controls. Wherever prices can't be raised, both quality and supply are deteriorating rapidly...

In its 2010 annual report, the ministry of health acknowledged the shortage of doctors, particularly in specialties such as anesthesiology, neonatal care, cardiovascular surgery, neurosurgery and child cardiology. Private hospitals are also deteriorating now as the poor turn up for care with government medical insurance, but the insurer doesn't fulfill its obligation to pay.

The government has admitted that a large number of doctors have fled, but it says it's not worried. More than 25,000 Venezuelan students are now enrolled in Venezuela's new Bolivarian medical schools or in medical schools in Cuba. Unfortunately the curriculum is not public, and Venezuelans are worried that the students spend more time studying revolutionary politics than anatomy. Mr. Chávez seems to understand this, if nothing else. His surgeon hails from Spain

That’s the magic of socialism: equality in hardship.

Video: Understanding Human Action (Praxeology)

Here is a short video explaining human action (praxeology) [sourced from Mises Blog]

From Ludwig von Mises (bold emphasis mine)

Choosing determines all human decisions. In making his choice man chooses not only between various material things and services. All human values are offered for option. All ends and all means, both material and ideal issues, the sublime and the base, the noble and the ignoble, are ranged in a single row and subjected to a decision which picks out one thing and sets aside another. Nothing that men aim at or want to avoid remains outside of this arrangement into a unique scale of gradation and preference. The modern theory of value widens the scientific horizon and enlarges the field of economic studies. Out of the political economy of the classical school emerges the general theory of human action, praxeology. The economic or catallactic problems are embedded in a more general science, and can no longer be severed from this connection. No treatment of economic problems proper can avoid starting from acts of choice; economics becomes a part, although the hitherto best elaborated part, of a more universal science, praxeology.

Quote of the Day: Is Expertise Posture or Knowledge?

Another thought provoking article from my favorite marketing guru Seth Godin [bold emphasis mine]

What I discovered, though, was that domain knowledge, edge to edge knowledge of a field, was incredibly valuable. It helped me understand where the edges were, and it gave me the confidence to be selective, to develop a taxonomy, to see what was going on.

As the deluge of information grows and choices continue to widen (there's no way I could even attempt to cover science fiction from scratch today, for example), it's easy to forget the benefits of acquiring this sort of (mostly) complete understanding in a field. I'm not even sure it matters which field you pick.

Expertise is a posture as much as it is a volume of knowledge.

Reading every single trade journal, for example, or understanding the marketing, engineering and sales of your field--there are countless ways to go deep instead of merely paying lip service to the current flavor of the moment.

To me, the importance of domain knowledge (specialized) is especially relevant for those in the financial markets (or in stock markets).

Instead of acquiring the necessary ‘signals’ that could deliver the ‘edge to edge knowledge’, most get lost in the din or cacophony of ‘noises’, which Mr. Godin describes as the “current flavor of the moment”.

The latter can be characterized by the pervasive use or application of cognitive biases and logical fallacies, except that they are masqueraded in numerical or technical methodologies which are completely dependent on past or historical activities or on some presupposed constants which operates on aggregated formulas.

Popular or consensus wisdom usually represents what Black Swan theorist and author Nassim Taleb calls as the negative knowledge (wrong and doesn't work).

For many, thus, expertise signify more as social signaling (posturing or seeking social acceptance) and or “telling people what they want to hear” but predicated on certain technically based paradigms which produces an aura of supposed superiority rather than representative of the true domain knowledge.

We should learn how to separate the proverbial “wheat from the chaff”

James Grant on Faith based Paper Money and the Gold Standard

Wall Street Journal’s Holman W Jenkins Jr. interviews James Grant (hat tip Laird Smith) [bold emphasis mine]

The gold standard, he says, citing the "late, great" libertarian economist Murray Rothbard, was the "people's system. If you didn't like the currency, you could exchange your paper for gold and that sent a message."

More from Mr. Jenkins interview of James Grant

The "fiat" dollar, he adds ruefully, "is one of the world's astounding monetary creations. That a currency of no intrinsic value is accepted as money the world over is an achievement that no monetary economist up until not so many decades ago could have imagined. It'll be 40 years next month that the dollar has been purely faith-based. I don't believe for a moment it's destined to go on much longer. I think the existing monetary arrangements are so precarious, so ill-founded and so destructive of the economic activity they are supposed to support and nurture, that they will be replaced by something better."

How exactly the transition to a new gold standard might take place is a puzzle, but Mr. Grant says he's seen many "impossible" things come to pass in his career. A certain "social spontaneity" might take a hand. He points to GLD—the ticker symbol for an exchange-traded fund whose gold holdings now make it equivalent to the world's 10th largest central bank. "At the margin," he says, "people are registering dissent from the judgment of our central bankers by bidding up the price of gold."

Read the rest here

Chart from Sharelynx/goldchartrus.com

Anyone who thinks that today’s economic climate poses little risk for dramatic transitions in today’s monetary architecture should look at my post below on Dead Currencies.

They are likely to be overestimating the strength of today’s system which have increasingly been based on serial bailout policies, especially in developed economies.

Once the tipping point from the accretion of political mistakes have been reached, we are likely to see a hastening of the implosion of today’s money system.

And as a popular Wall Street maxim goes:

Past performance does not guarantee future results.

As for the return of the gold standard, that’s something unclear for now. But as history has shown, economic forces could compel us to drastically embrace this option once the motion of monetary collapse becomes entrenched and accelerates.

Gold and the precious metal group, based on the price trends relative to the incumbent 'faith based' currencies of major economies, seem to be showing their revitalized role as man's default currency or the public's dissent over the judgment of central bankers as Mr. Grant rightly observes.

Ultimately, the fate of our currency system depends on the direction of monetary politics which constitutes a substantial tail risk that the mainstream continues to ignore.

Graphic: Dead Currencies

Below is a deck of pictures, courtesy of Casey Research, showing various currencies from different parts of the world that have expired or have been abandoned.

It is foolish or naïve, for some, to believe that political actors willed or deliberately engineered the demise of these currencies, or that these have been the responsibility of the private sector.

Instead, the spate of currency extinction overtime signifies as the outcome of a series of actions undertaken by political leaders which essentially collided with economic reality and failed.

In other words, hyperinflation or war, which had been mainly responsible for the demise of most of these currencies, represents as the unintended effects from the desire to preserve or expand of political power by incumbent political leaders during their era.

As the great Ludwig von Mises reminds us, (bold emphasis mine)

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them.

Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German Mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last forever.

I Told You So Moment: The Phisix At Milestone Highs

First they ignore you, then they laugh at you, then they fight you, then you win- Mahatma Gandhi

It’s not that we didn’t see this coming, the Philippine Phisix closed this week at a milestone record nominal HIGH at 4,458.

For me, this signifies another “I told you so” moment, as cynics both from the mainstream economics and the mechanical charting camp have mistakenly stated that this won’t be happening soon.

Epic Breakout on a Divergent Marketplace

Yet such monumental breakout came amidst a wobbly and seemingly discordant global equity market.

It’s not that this epic moment has been isolated or represents a unique trait seen exclusively to the Phisix only, but rather, the ASEAN majors have been one of the best performing equity markets of late. In short, as I have repeatedly been pointing out, this has been a regional dynamic.

By our latest reckoning, the Philippines along with Indonesia, Malaysia and Thailand have been in the top 20[1] among the 78 bourses worldwide.

The abbreviated price actions of the FTSE ASEAN 40 (ASEA) Exchange Traded Fund [ETF], which is a newly constructed bellwether, exhibit this new height.

This has happened as most of Asia seems on the upside, as represented by the Dow Jones Asia Pacific index (P1DOW). Meanwhile, the US S&P 500 (SPX) seems edgy, but still has been manifesting upward inclinations.

Only the European benchmark (stoxx 50) appears to be the odd man out, considering the festering debt crisis which seems to be spreading to the PIIGS.

And nowhere has this seeming exceptional deviation by the ASEAN majors imply of “decoupling”.

As the charts above from CLSA/Businessinsider indicate[2], over the past two decades returns of Asian bourses have been converging.

This gives credence to my repeated assertions[3] that in the world of globalization, the correlation of global equity markets have been tightening.

Yet to view performance digressions as “decoupling” risks false and misleading interpretations of events that may result to wrong prognosis, overconfidence and consequent errant actions that could lead to monetary and psychic losses.

One would further note that divergent actions occur mostly during crisis or recessions, as in the Asian crisis of 1997, the dot.com bust in 2000 and the US mortgage bubble crash of 2008. However, the boom phase of a bubble cycle tends to show signs of re-convergence.

Not every of the market signals I earlier alluded to[4] participated in the confirmation of the local boom. Europe’s ongoing crisis has partly taken some steam off from the global equity market re-convergence.

If there is any lesson from the above, it is that the local and ASEAN boom would likely become stronger if global equity markets would act in consonance. Oppositely, a further widening of divergences would put to doubt the string of current advances.

Gold-Phisix Correlation Redux

There is another noteworthy development that needs to be emphasized, as the Phisix and ASEAN bourses have reached record territories, so has gold prices.

As I previously wrote about how gold’s price actions seem to lead the Phisix[5],

The implication is: for as long as the trend of gold prices remains to the upside, the Phisix will likely follow unless domestic factors become powerful enough to impel a disconnect.

Prices of gold have served as reliable barometer so far.

Alternatively, this also means that accrued corporate earnings or micro economics or mainstream’s macro views can hardly explain this phenomenon.

Consumption demand, which has been the popular perspective, can hardly explain the broad based increases in commodity prices along with equity prices.

Of course correlation does not imply causation or that there presents no causal relationship between gold and the Phisix.

The point is: both gold and the Phisix account for as symptoms of an underlying pathology, which has largely been an unseen factor.

Again correlation does not represent causation. Yet the degree of correlation may vary according the causal relationship dynamics that underpins these markets.

In my view, I see this relationship anchored on the unfolding (Austrian) business cycle or bubble cycle fueled by monetary policies.

And the political process in fostering such boom phase of this bubble cycle has clearly been at work.

In the US, Federal Reserve chairman Ben Bernanke recently placed the QE 3.0 option on the table[6] partially confirming my forecasts[7].

Although Mr. Bernanke partly backtracked[8] from his earlier stance by stating that while QE 3.0 is in the cards it will not be used soon.

I see this as part of the mind conditioning-communication tactical tools used by the central bankers (or the signaling channel) to influence market expectations (aside from indirect market interventions).

The important point is that the Fed seems to be projecting the idea of renewed access to QE which is a sign of imminence. The question isn’t about an IF, but rather a WHEN.

And the commodity markets seem to have been affirming such expectations. Even the perennial laggard Natural Gas (NATGAS) appear to be on the rise. Silver, oil (WTIC) and the CRB Reuters (CCI) have been on climbing higher, despite the string of recent interventions.

Of course I don’t think Mr. Ben Bernanke would automatically employ QE or its variant, that’s because QE is a political tool designed at attaining political ends.

QE 3.0 will likely be tied to the congressional vote on the US debt ceiling, the deadline[9] of which is on August 2^nd is fast approaching.

The political pressure to raise the debt ceiling continues to intensify as major credit rating agencies as the S&P and Moody’s has warned of a possible downgrade[10] if a deal won’t be reached.

Higher prices of Credit Default Swaps (CDS)—an insurance against default risks—on US sovereign debt (see left window below[11]) has been attributed to the recent political impasse.

Although in perspective, the rising prices of US CDS can be seen amidst a backdrop of general concerns over credit risks for most of the world[12] (including the Philippines which is two notches below the US), but especially for many European countries over a one month frame. In short, politicking may have led to the misplaced focusing effect for many politically blinded observers.

The above reveals that the causation link of higher US CDS prices and political stalemate over the debt ceiling seems unclear.

The other major factor that could prompt Ben Bernanke to reactivate QE 3.0 soon is if the debt crisis in the Eurozone escalates to the point of putting US banks at risk. As pointed out in the past[13], QE 2.0 has reportedly benefited foreign banks or had been used as an indirect channel to conduct bailouts of Eurozone banks through the Eurodollar market.

I wouldn’t know which of these events would prompt Mr. Bernanke to trigger the next version of QE, but one thing is certain, given the trillions of bailouts thrown to US banks (demonstrated preference or actions as proof of the order of priorities), combined with ideological or doctrinal leanings and path dependency, plus reluctance to adapt fiscal discipline as the necessary path for reform, all these point towards the QE option to secure or safeguard the tripartite government-banking system-central bank political structure.

All these imply that monetary accommodation will prevail over marketplace for a longer period of time which should support the current risk environment.

And given that the global transmission of credit easing (QE) policies and artificially suppressed interest rates everywhere would have different impacts on different asset classes, the gold-phisix correlations, unless the latter would be influenced more by domestic factors, will likely be sustained.

Market Breadth and Internals Point to Further Strength

Since financial markets are driven by psychology, underpinned by the above forces, people’s outlook can be measured from actions being undertaken from different financial market indicators.

The milestone breakout by the Phisix has been bolstered by the broader market.

Market breadth has been broadly positive as all sectors posted gains (left window).

Again the Philippine composite has been elevated by mostly the mining sector followed by the financial sector, particularly led by Metrobank [PSE: MBT].

Advance decline spread (weekly basis) has likewise turned significantly positive (right window).

Market internals have also demonstrated broad bullishness.

Average daily trades (weekly basis) and daily number of issues traded (weekly basis) has dramatically improved.

While no trend goes in a straight line, such congruent positive actions are likely signs of continuity. Importantly, such trends could reaccelerate.

Philippine Peso Driven by Portfolio Investments

This week the Philippine Peso has partially departed from its tight correlation with the Phisix.

The monumental advance of the Phisix saw the Peso soften instead. The Peso seems to reflect more on the region’s actions than to confirm the Phisix’s vigorous advances. Or maybe currency intervention by the local central bank could also be a factor.

Although one week does not a trend make, I think that the Peso should eventually make more confirmations of the actions of the Phisix and vice versa.

As I keep saying[14],

this has been premised mostly on the favorable relative demand for Peso assets, aside from the lesser inflationary path by the Peso based on the supply side.

There is no proof stronger than this.

The chart above from the World Bank[15] and yahoo finance shows that Philippine Peso has hardly been driven by remittances, which has been peddled by the mainstream, but by virtue of correlations based causal logic the net capital flows (manifested mostly by portfolio investments).

For as long as the net capital flows (again mostly by portfolio investments) continue to expand, some of which will be evidenced in the actions of the Philippine Stock Exchange, we should then expect that this would be reflected on a rising Peso.

Bottom line: Again momentum, via various market signals, favors the confirmation of this week’s epic breakout.

We should see the Phisix at 4,900-5,000 by the yearend barring any exogenous shocks.

---

[1] See How Global Equity Markets have Measured Up to the PIIGS Crisis, July 13, 2011

[2] Weisenthal, Joe This Is What Global Market Correlation Looks Like, Businessinsider.com, July 11, 2011

[3] See ASEAN’s Equity Divergence, Foreign Fund Flows and Politically Driven Markets, June 5, 2011

[4] See I Just Can’t Get Enough: Philippine Phisix Emits Intensely Bullish Signals, July 3, 2011

[5] See How External Forces Influence Activities of the Phisix, May 29, 2011

[6] See Ben Bernanke Hints at QE 3.0 June 13, 2011

[7] See Poker Bluff: No Quantitative Easing 3.0?, June 5, 2011

[8] See Ben Bernanke on QE 3.0: Not Now, But An Open Option, July 15, 2011

[9] Reuters.com Obama, lawmakers press ahead for elusive debt deal, July 16, 2011

[10] Bloomberg.com Moody’s Downgrade Warning Adds Pressure on U.S. Debt Deal, July 14, 2011

[11] Zero Hedge, US Default Risk Jumps To Highest Since February 2010 On Debt Ceiling Worries, July 14, 2011

[12] Bespoke Invest, Changes in Sovereign Debt Default Risk Over the Last Month, July 16, 2011

[13] See Political Interventions has Led to the Widening of Divergences in Global Asset Markets, June 26, 2011

[14] See I Just Can’t Get Enough: Philippine Phisix Emits Intensely Bullish Signals, July 3, 2011

[15] Worldbank.org, Generating More Inclusive Growth, Philippine Quarterly Update June 2011

Expect a Rebound from the Lagging Philippine Property Sector

Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production. Thus, the Misesian theory of the business cycle accounts for all of our puzzles: The repeated and recurrent nature of the cycle, the massive cluster of entrepreneurial error, the far greater intensity of the boom and bust in the producers' goods industries. Murray N. Rothbard

Two of last week’s cynosure or market darlings had been East Asia Power [PSE: PWR] on a mind boggling gain of 232%, and Boulevard Holdings [PSE: BHI] 31.4%.

PWR can now be considered as a property issue considering the takeover by Century Properties has been formalized[1]. Meanwhile, BHI’s rumored acquisition by another real estate giant has yet to be confirmed.

To me, these developments signify as writing on the wall.

Where the huge breakout by the Phisix has been validated by broad market based bullishness or a “rising tide phenomenon”, a confirmation or continuation of these upside biased actions on the Phisix would also mean rising prices of property issues.

During the recent phase of the bubble cycle, which began in early 2009, the property sector (top window, blue line) has mostly led or outclassed the Phisix. This seems in stark contrast to the financial sector (lower window, red line) which has mostly lagged the local benchmark.

The two large red circles I drew demonstrate the occasions where the Property sector has vastly outperformed the Phisix and the green circle which reveals that the roles have reversed.

This implies two possible scenarios:

-one, the lagging property sector could be an anomaly that would eventually revert to the mean, or

-two, the seeming laggard effect could be representative of a new trend.

The 6 biggest property sector according to their free float market cap weighting in the PSE Property basket are (in pecking order[2]): Ayala Land 35.96% [PSE: ALI], SM Prime Holdings 17.92% [PSE: SMPH], Belle Corporation 10.97% [PSE: BEL], Megaworld Corporation 7.91% [PSE: MEG], Robinson’s Land 7.66% [PSE: RLC] and Filinvest Land 5.01% [PSE: FLI].

The performances of the big six on a year to date basis in %:

Only BEL and SMPH posted gains so far, while the others remain in the red, with Megaworld suffering the most.

The massive divergence between the price actions of most of these property heavyweights and the Phisix is the reason why the property sector has conspicuously trailed.

Yet parsing on the recent price trends….

…I find that the returns on the table above haven’t been revealing exactly what has been happening.

Individual trends suggest that there has been an ongoing rotation; leaders BEL (blue) and SMPH (black candle) appears to be in consolidation whereas the laggards have all been ascendant, namely RLC (violet), ALI (red), FLI (orange) and Megaworld (green).

So the rising tide has already begun to filter into the worst performers and we would likely see more of the same actions going forward.

With the steep local yield curve (left window) along with the domestic monetary environment operating on negative real interest rates (right window), which the World Bank chart confirms my earlier observations[3], foreign portfolio inflows should include not only investments in equities but also on real estate which should likewise get reflected on the Phisix Property index.

And the same forces are likely to also impel locals to get into a property acquisition binge.

A construction boom can be ubiquitously seen in the Metropolis as new buildings grow like mushrooms. Such anecdotal evidence appears to be confirmed by the reported $ 1.19 billion worth of real estate investments for the first 5 months in 2011[4].

And the property sector signifies as a capital intensive sector most receptive to the monetary policy induced Austrian Business Cycle.

To quote the great Murray N. Rothbard[5], (bold emphasis mine, italics original)

For businessmen, seeing the rate of interest fall, react as they always would and must to such a change of market signals: They invest more in capital and producers' goods. Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable now seem profitable, because of the fall of the interest charge. In short, businessmen react as they would react if savings had genuinely increased: They expand their investment in durable equipment, in capital goods, in industrial raw material, in construction as compared to their direct production of consumer goods.

Like the capital intensive mining sector, the domestic property sector will undergo a boom bust cycle phase.

Bottom line:

The lagging effect of the Property sector seems more of an anomaly than an evolving trend.

The breakout of the Phisix should be seen as a catalyst that could launch the next leg up for the property sector.

The upcoming rebound would not only close the underperformance gap but would also power this sector as one of the best performers.

The Philippine property sector as I earlier predicted will see a boom phase[6] (again barring any exogenous shocks). Real estate or property booms have traditionally functioned as the centrifugal force from a monetary induced bubble cycle. This has been very evident in China[7]. And likewise became the ground zero for the US mortgage-banking crisis[8].

Well it’s time to profit from the political folly.

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[1] Philstar.com Century Properties seals deal to take over East Asia Power, July 12, 2011

[2] based on Friday’s close and only considered weights of 5% up

[3] See Phisix: Negative Real Interest Rate and Stagflation Risks, June 12, 2011

[4] Philstar.com Surge in investment shows return of investor's confidence, July 2, 2011

[5] Rothbard, Murray N. The Austrian Theory of the Trade Cycle, Economic Depressions: Their Cause and Cure, Mises.org

[6] See The Upcoming Boom In The Philippine Property Sector, September 12, 2010

[7] See China’s Bubble Cycle: Shadow Financing at $1.7 Trillion, June 28, 2011

[8] See 2008 US Mortgage Crisis: The US Federal Reserve and Crony Capitalism as Principal Causes, May 31, 2011

Nassim Taleb on Dodd Frank’s OFR: Soviet Style Management

While rapid advancement of technology has been decentralizing or democratizing data and information flows, central planners dream of the opposite: centralizing these in an attempt to control the markets.

A recently enacted financial overhaul law, Dodd Frank has an offspring called the Office of Financial Research.

According to the Wall Street Journal Blog, (bold emphasis mine)

Dodd-Frank created the new semi-autonomous office to support a new council of regulators – the Financial Stability Oversight Council, or FSOC – that is charged with spotting and tamping down emerging risks to financial stability. The OFR has two key components – a data-collection arm that has broad power to request any kind of information from financial firms it deems necessary, and a research and analysis arm that to be focused on monitoring the financial system for risk and producing research to improve regulation.

Celebrity author and Black Swan expositor Nassim Taleb critiqued the framework of this new office. In a prepared testimony Mr. Taleb says that this represents

an attempt to create “an omniscient Soviet-style central risk manager.”

That’s because Mr. Taleb points out that quant models can’t capture real events

According to the same article, (bold emphasis mine)

In his testimony, Mr. Taleb said that “[f]inancial risks, particularly those known as Black Swan events cannot be measured in any possible quantitative and predictive manner; they can only be dealt with [in] nonpredictive ways.” He argued that trying to do what the OFR is designed to do could actually increase risks, in part by increasing “overconfidence” in the information’s ability to predict the next crisis.

Like all quant-econometric based models, they suffer from what the great F. A. Hayek calls as the knowledge problem as embodied by the quote below:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Most people hardly ever learn