Friday, November 17, 2006

Nasty Brutish and Short

EUR/USD 1.2792 Hi 1.2800 Low 1.2762
USD/JPY 118.05 Hi 118.48 Low 118.04
AUD/USD 0.7655 Hi 0.7679 Low 0.7643
EUR/JPY 151.02 Hi 151.34 Low 150.99

Well we are all shocked and horrified that the U.S. Residential Property Market is disappearing into a black hole. We had hoped that the merest whiff of a possibility that the FED may at some point stop PAUSING and go with EASE would be enough to stop that house of cards from imploding. Today's data quashed those flimsy hopes.

But still we can keep our hopes alive in other areas. The Democrats have taken back both houses, George W. is making noises about working with the Democrats and bi-partisanship (just like he did right at the beginning of his so-called mandate) and this means that really the U.S. is going to do something about peace in the Middle East and get out of Iraq.

Only not really. No-one seems to have explained this to George W., who may well be a down-home guy out of his depth in Washington, but he is also a seriously delusional President who seems to really believe that he takes his orders directly from God. Still, hope springs eternal. And his latest on Iraq can be summed up thus: "We are not leaving." Oh no, God forbid. The U.S. is not leaving and is gearing up to increase troop levels and to underline its committment to the Iraqi occupation. So you may as well count more money down the drain right now, more lives lost and more destruction. We have another two years of this. Just think how much money has been spent already. Then double it.

And then we have the Stock Market which, hey while the USD was rallying on the back of some vague remarks by some FED personage or other to the effect that inflation is a problem and so we may have to HIKE, was going hell for leather (well not really, but there was a rally and records) on the back of the hope that there would be an EASE some time in the future. And this EASE would, of course, save the U.S. economy from falling into a black hole, never to be seen again.

Only NOW we are told that no-one is actually buying the Stock Market. Capital Inflows into the U.S. Stock Market these past few months have actually been negligible.


Yes, that's right negligible. So the explanation (now you are going to love this) is that Hedge Funds have been "caught short" since the Summer and have been forced to cover and this is what is causing the buying in U.S. Stocks.

OK. So it's not the PPT doing George W.'s dirty work before the election, it's the Hedge Funds. Caught Short. Now you only have to look at what is happening to commodities to know that when the Hedge Funds of the world get caught anything then the price action is, to misquote Hobbes: nasty, brutish and short. It's not the type of price action we have been seeing on the U.S. Stock Market over the past few months. Hedge Funds may have been buying but that wasn't short covering we have been seeing. Therefore the Hedge Funds aren't "caught short" if anything they are NOW long. Think about that. These guys haven't exactly proved themselves Masters of the Universe and they are long U.S. Stocks at a time that the U.S. economy is tanking, the Japanese economy looks like its struggling and greater minds are talking about an imminent slowdown in China. Essentially what we have here is a global economic slowdown and our friends, the Hedge Funds of this world, are LONG.

Sounds like a sell signal to me.

While Commodities dive on the back of the idea that the Global Economic Recovery may be stalling, stalled, is in serious trouble, the USD has remained steady, rallied a little even. The USD has taken its queue not from the data, oh no, but from comments by FED officials to the effect that the fight against inflation is "not over yet". If that strikes you as a slightly flimsy basis for a USD rally, which it is, then start selling USDs now. Because the FED is not going to hike any time soon.

OIL 55.60
GOLD 618.50

Commodities are taking a dive as the Hedge Funds of the world scramble for the exits now that it has become clear that there is a Global Economic Slowdown underway. This has taken some of the shine off GOLD. But not as much as could have been expected. Indeed, with the USD likely to see further selling interest the case for GOLD remains fairly solid. We may see USD 600 in the short term and even USD 580 is a possibility but the search for an alternative to the USD will continue to underpin the positive performance of GOLD for some time yet.

The OIL price is much more dependent on demand so the potential for further declines remain. Debt bubbles are popping all over the place and this will undoubtedly have an impact on global economic growth. A great deal of the good news is already priced into the OIL market. OPEC really has its work cut out for it here. Unless George W. actually succeeds in starting another war in the Middle East, the risk for the price of OIL remains to the downside.

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Thursday, November 16, 2006

Magical Thinking Applied to Economics

EUR/USD 1.2801 Hi 1.2842 Low 1.2793
USD/JPY 118.04 Hi 118.32 Low 117.74
AUD/USD 0.7685 Hi 0.7699 Low 0.7642
EUR/JPY 151.13 Hi 151.48 Low 151.08

We live in a world where some people actually believe that if they rearrange the letters of their names the entire course of their lives will be changed. So it shouldn’t really surprise me that this magical thinking extends to the field of economics, which is after all mostly guff and spin. But still it does surprise me. Most economists I know wouldn’t be able to run a business if they tried very hard and they certainly don’t have what it takes to run an economy but these are the priests of the New Age and we go to them, and our Central Banker friends, and ask for tokens to keep the bad spirits away.

What exactly is the RIGHT official cash rate, we enquire? What is the correct exchange rate? What is the right ratio of Government Debt to GDP? And these numbers, once established to the satisfaction of the priesthood, we take away with us. We applaud when Central Bankers fight their way to achieving the right numbers. We applaud when the Government announces the right bottom line. And if, by some sad chance, the numbers are not as they should be then everything suddenly becomes very dark.

The central premise here is that if we can just get the numbers right, an inflation rate which is where it should be, exchange rates right on the button, official cash rates which are not too hot, not too cold, then we don’t really have to worry about anything else. Our job is done, the Gods of the economy have been sated. We no longer have to worry about infrastructure or education or crime or how we allocate resources, productive investment or indeed anything. We can in fact all go off to the beach safe in the knowledge that the dark forces of the world are being kept at bay because our friends at the Central Banks have found the right numbers. Dumb, crazy, intellectually lazy ideas are part of how we live now.

The idea that a healthy economy requires continual work to keep things ticking along, that we can not afford to neglect public infrastructure, or private investment, that we must maintain what has been created and look to improve our productive capacity over time with well thought out investments is simply too complex. Predicting the numbers and watching the numbers has become what the economy is really all about. And what are the numbers telling us right now?

Well the news is bad, which means it’s good. The U.S. Consumer seems to have fallen down a well. Retail Sales numbers released this week were considerably below expectations. What’s more previous results were revised DOWN, by a lot. Overall, even with the FED in PAUSE mode, there isn’t much sign that Mr. Joe Average is getting ready to whip out his credit card any time soon. This week’s PPI and CPI data told a similar story: there is not enough strength in domestic demand in the States to allow prices to rise. And they’re not. They are falling.

Some of this has to do with the correction in OIL and commodity prices which has been registered recently and a lot of this has to do with the inability of U.S. business to shift inventory without cutting prices. And this is not just impacting the Residential Real Estate Market.

So, the upshot? Well we have a FED in PAUSE mode with little likelihood of a RATE HIKE any time soon. And so, with no room for a HIKE, the market is waiting for a signal that RATES will fall. The idea that the PAUSE will continue indefinitely is not really on the agenda. This is not a USD bullish development. Indeed, the recent short term USD rally seems pretty close to being over and we can all put our SELL USD hats back on.

The state of the U.S. economy and the implications for the FED FUNDS rate has comforted the Stock Market bulls. The idea, of course, is that the only thing which counts is whether the FED is going to hike, pause or CUT. And cut is winning. The fact that U.S. companies may see their profit margins eroded by weak domestic demand is not a concern right now, though historically it is hard to make a case for rising Stocks at a time of economic retrenchment. For now the Stock Market bulls are going to see how far they can push this, secure in the knowledge that the high priests at the FED will do what they have to with interest rates and that will be sufficient to cure all the U.S.'s economic ills. Well it worked for Japan, no actually it didn't. Oh well never mind. If fiddling with Cash Rates doesn't work maybe we can rearrange the letters of "Federal Reserve" and that will make everything better.

OIL 59.21
GOLD 627.40

With the USD back under a cloud, the GOLD bulls are back. We still have a way to go before we test recent highs. We need to see significant USD weakness and ongoing and more aggressive DIVERSIFICATION out of USDs by Central Banks before this trend really takes off. Some suggest that both are simply a matter of time.

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Tuesday, November 14, 2006

The Warm Post-Election After Glow

EUR/USD 1.2825 Hi 1.2845 Low 1.2800
USD/JPY 117.62 Hi 118.20 Low 117.40
AUD/USD 0.7652 Hi 0.7666 Low 0.7618
EUR/JPY 150.85 Hi 151.38 Low 150.57

Positive GDP data released in Japan overnight, together with the growing consensus that Japan may just lift its Cash Rate to 0.5% at some point over the next three months, hasn’t really done a lot to help YEN bulls, or USD bears for that matter. There is a tug of war going on. Is the U.S. economy in trouble? Yes. Is it in bigger trouble than the Japanese economy? Probably yes, but it’s hard to tell. Will the BoJ move before the FED? Again yes, but it’s not a slam dunk. Yet.

The story which is making the rounds at the moment is that, despite the Real Estate Meltdown, the U.S. Consumer is alive and kicking. Which may or may not be true. Data scheduled to be released today in the States will be poured over for signs that the U.S. Consumer can and will keep the U.S. economy, and by extension the Global Economy, ticking over. While cheaper OIL prices, stable interest rates and some election generated optimism may give the U.S. Consumer a short term boost, longer term the weight of accumulated debt will be felt.

There is a warm glow about what is happening in the States right now. A lot of people are cheering because Donald Rumsfeld has left office, because the Democrats took both houses in the elections and the idea is that something has turned the corner, in a positive way. The semi-official view of U.S. politics is this: George W. Bush is not really in charge, he is just a puppet-type figurehead. The real power behind the throne is/was in the hands of the Neo-Cons. According to this logic once these Neo-Cons were neutered, or removed from office, as Rumsfeld has been, then the U.S. Government will return to “normal”. The idea here is that George W. Bush is not really the architect of the War on Iraq and he is just some kind of down-home guy who is out of his depth in Washington. There doesn’t seem to be much justification for this belief. George W. is still President and he still has a very clear political agenda, which has had so far a lot of unfortunate consequences, particularly for the unarmed citizens of Iraq and for U.S. home owners. The upshot is that the belief that the removal of some of the dark forces behind the throne will fix the problem is probably a trifle optimistic.

What is significant in the recent election results though is that with the return of the populist politics the downward trajectory in U.S. Wages is probably over. There is a limit to how far you can squeeze wages. We have already seen the start of this in the recent GDP figures. Private Sector Wages and Salaries rose 8.5% in Q3.

Indeed, a great deal of the so called surge in U.S. Productivity in the past couple of decades was really the flip side of the squeeze of Labour costs. There are essentially two ways you can increase productivity: invest in whizz bang technology and education so that your Labour Force produces more with less or force down the Cost of Labour. The U.S. basically took the second option. But there is a limit. And if something has turned the corner in the U.S. that’s it: the Wages Share of GDP is more likely to rise than fall from here on in. And that means Corporate Profits will be squeezed. Though the Stock Market bulls aren't talking about that. Not now.

What’s more Wages rises are a no-no in Central Bank land. The price of everything can double and that’s OK but that doesn’t mean that the average Joe will be allowed a Wages rise sufficient to keep paying the bills. If that happens our unelected officials in Central Bank land start muttering darkly about secondary-round inflation. So if you don’t want to see rates rise keep fighting off those Wage rises. Let them eat cake.

In short, more populism in Washington means a greater likelihood that the FED may have to raise rates at some time in the future. So pay careful attention to the Inflation numbers which are also due for release today. Any sign of inflationary pressures and the very recent recovery in the USD could find further legs. This is a short term trend, but a trend nevertheless.

OIL 58.36
GOLD 625.10

Over at Morgan Stanley Stephen Roach is going with his: China slowdown story. And that story might be the big surprise going in to 2007. While the market is still broadly bullish on commodities, world growth and, well, pretty much everything, Commodity Markets are showing signs of stress.

And the big Commodity Market currency, which was supposed to rally on the back of interest rate differentials and commodities is under pressure. As global economic growth continues to slow that story is likely to get more press and the AUD, which doesn’t really have anything going for it except short term speculative buying interest, is unlikely to be much of a positive story in 3 months or so. At which point you can expect more headlines about unfortunate International Trade statistics, Foreign Debt, Current Account Deficits, the Australian drought and slowing domestic economic activity. Selling the AUD against the JPY and the EUR and the USD are all likely to pay dividends. Though the carry, of course, will be negative. Slightly less against the USD.

While Commodity prices as a whole remain under pressure, the case of OIL and GOLD continue to respond to slightly different stimulus. Strange things are happening in the Middle East. There have been resignations from the Government in Lebanon, Iran and Israel are one again trading veiled threats. Nothing positive is happening in Iraq and nothing positive is likely to happen there for quite some time. Tony Blair may be trying to revive his political legacy by brokering some kind of a Peace Accord but so far his success has been zippo. And that goes right from the start of his mandate, so there is no particular reason to believe that he has suddenly found the way forward.

GOLD and OIL are only likely to follow the rest of the commodity market southwards if GEOPOLITICS does not return to the front pages any time soon. Oh, and if the present show of USD strength continues. Neither is a given.

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Sunday, November 12, 2006

Financial Shell Games

EUR/USD 1.2840 Hi 1.2900 Low 1.2826
USD/JPY 117.59 Hi 117.17 Low 117.92
AUD/USD 0.7676 Hi 0.7660 Low 0.7697
EUR/JPY 150.98 Hi 150.26 Low 151.46

There is an entire Doomsday Crowd waiting for cracks to appear in the USA and there is no shortage of pundits who suggest that everything in the USA will all end in tears very soon. Certainly economic management in the USA has been poor and it shows. We could line up all the data, from Construction Spending to Retails Sales and shake our heads about the poor financial position of that Great Consumer of Last Resort which America has come to represent to the rest of the world. Quite. But there are problems which are just as severe and entrenched in other parts of the world which are being entirely ignored. Indeed MOST financial newspapers and professional forecasters are either blithely nonchalant about the looming crisis or even more blithely bullish.

Think of a country where Household Debt to Income ratios are sitting somewhere around 150% and Gross Government Debt to GDP is currently sitting at around 170% with no sign of a coherent plan to address the problem.

Think of a country where the Central Bank has flooded the market with liquidity for the better part of a decade in the mad hope that simply printing money would solve all their problems. And PUNDITLAND has quietly endorsed this policy approach. Cheered even.

There have been no comparisons made with the doomed monetary policy of the Weimar Republic and the assumption has been widely accepted that fiddling with interest rates and printing money was the right approach to a domestic debt crisis brought on by excessively cheap money, which at the time was seen to be an appropriate response to the sharp adjustment in exchange rates imposed on Japan via the Plaza Accord. It's some kind of crazy loop.

In hindsight it seems so entirely crazy that printing money could be seen to be an appropriate response to real economic distress that it’s a wonder that anyone bought into the idea. But they did: in droves. In an era of new paradigms Japan was the ultimate new paradigm. First you fiddle with the exchange rate, then with interest rates, then everyone goes broke then you fiddle with interest rates some more and then, as a last resort, you crank up the printing presses and print money as fast as possible.

What’s more the story went out a couple of years ago that an economic recovery was in the offing in Japan and Offshore Funds rushed into the Stock Market. The stock market rallied over 2005 and the bullish pundits rejoiced. This year the major Stock Market Index is flat as a pancake and the economic data is starting to look very uninspiring indeed.

Japanese Household Spending
Japanese GDP
Japanese Profits and Stocks Disappoint

Japanese Machinery Orders Fall

But there seems to have been no adjustment in PUNDITLAND. Still nary a bearish call out there with regard to Japan.

What’s the deal? Does Mercantilistic Theory has everyone in thrall? As long as the Japanese International Trade Account is in Surplus then everything is just fine? The Japanese Trade Account is indeed one of the world's greatest economic success stories. But the Japanese capacity for financial management seems to be slightly less than brilliant. While the Japanese are diligently working away producing stuff to sell to the rest of the world the fruits of their industry seem to have been recklessly squandered. Or rather recycled into U.S. Treasuries. Which comes pretty much to the same thing.

It seems that Japan might have painted itself into something of a financial corner. So now we really get to test these new paradigms. What happens next? I have no idea. But if cracks start to appear in the Nikkei, as looks likely, it is unlikely that the U.S. Stock Market will keep rocketing skyward without a care in the world. The Japanese are, after all, providing the U.S. with what is essentially free money and they have been doing that for some time. But as the financial shell game winds up things could start to be just a bit tricky.

The Doomsday Crowd, bless their souls, should switch their gaze eastward. We have lots more data out of Japan this week. And the Nikkei is shaky. What this means for the YEN is uncertain, though more ugly economic noises and an exodus of Foreign Investors from the Japanese Stock Market are unlikely to provide room for a rally.

OIL 59.59
GOLD 629.50

GOLD is holding on. Should financial market shakes be added to all the other uncertainties out there, including Central Bank Diversification, then there is scope for more gains in the price of GOLD.

The OIL story is slightly more complicated. We have a potential global economic slowdown looming, rather closely, and the Republicans just got a good kicking which means that the situation in the Middle East is far from clear but there is potential, just potential, for LESS violence, which wouldn't be good for the price of OIL. It's a bit early to take a clear position on this one. So sit on sidelines and wait to see what gives.

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