December 2009 - Posts
Please, click here to read this article in pdf format: december-24-2009
Below is the first chart that I included on my first letter, back on April 14th (refer: www.sibileau.com/martin/2009/04/14 , “Remembering Harberler: The price level may be a misleading guide for monetary policy”).
I think this chart says it all. Back in April, the spill over from the
Treasuries and Agency debt/Mortgages markets was just beginning. As I
foresaw, quantitative easing policies worldwide lifted commodities,
taking oil to $80+/bbl and gold to $1,226/oz, and stocks, with for
instance, the S&P500 reaching 1,120 yesterday.
Further, in the spring, we heard economists all along say that the
markets were overvalued, that a second dip was on its way. All along, I
stuck to my thoroughly explained thesis. I also thoroughly explained
why the mainstream theses (i.e. David Rosenberg’s:” Reversible rally or reflexive rebound?” Bank of America’s Morning Call Note, April 20th, 2009) was wrong (For instance, also refer to my critic on Krugman’s view: “Why should we see lower lows in stocks and wider wides in credit?”, www.sibileau.com/martin/2009/05/19 ).
Entering 2010, we will reach stage no.4 shown below, where we should
see an increase in prices for capital goods and raw materials, as well
as the price of the companies that supply them. The tap feeding the
waterfall will have shut for the most part, but the spillover effects
from tighter spreads in credit will keep feeding a rally in stocks,
along with M&A deals, increasing the leverage of companies. As the
text for stage no. 4 reads, we will tell ourselves that companies
cannot justify their investment levels, and we will not be able to come
to terms with P/E ratios. This will only be the beginning of mankind’s
greatest illusion or economic delusion. It won’t be nice, because along
the way, the head of sovereign defaults will raise its ugly head. Get
ready, but in the meantime, profit from the spillover effect. On this,
please refer to my letters earlier this month.
Finally yet importantly, I would like to wish everyone a healthy and
prosperous 2010. It has been a pleasure writing “A View from the
Trenches” and exchanging intellectually challenging correspondence with
many readers. This is the final letter of 2009. “A View from the
Trenches” will be published again on January 4th, 2010.
Martin Sibileau
![]()
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: december-22-2009
Before we go on to discuss the latest development, I invite you to refer back to my letter from May 26th, 2009 (www.sibileau.com/martin/2009/05/26 ,
“A short description of the process”). In that letter, I laid out the
main drivers of the adjustment process, after the monetary expansion.
Given the market action in December, I think it is worth reviewing
these comments.
Apart from the international coordination in monetary policies and
globalization of production chains, there really isn’t anything new
that a good macroeconomics book will not tell you. We witnessed a full
transfer of private deficits to the balance sheet of governments. On
top of that, governments were already running their own deficits and
now, with the assumption of liabilities from the private sector and the
fall in revenue, they will have to either reduce spending or increase
taxes. And they will of course increase taxes. They will tax us to
death: They will tax more of your income flows, they will tax your
savings flows and your wealth no matter where you store it. And should
citizens of the world decide to store it in gold….they will see it
confiscated by their governments. The sooner this happens, the faster
we will be better off. It is like a vomit… you feel much better after
it and there is no point in delaying it.
In the meantime, the government that is best equipped to handle its
deficits is of course the US government, because of the international
reserve status of its liabilities, in which its debt is also
denominated. The market is now discriminating sovereign risk and sees
the US as the lesser of all evils. It buys USD accordingly not because
it loves USD, but because it hates Euros and gold, the two alternatives.
The cycle where US yields are to rise within a steepening move
kicked off, and in full force. Some analysts disagree with me, and
believe that the fall we witnessed yesterday in the 30-yr Treasury
(dropping to 96+ from 99) is explained by the illiquidity proper to
this short week. It is true, volume in Treasuries yesterday was below
average (73%) but you would have to be naive to miss the trend
triggered since the end of November. As well, in corporate credit, we
saw the CDX IG13 Index (tracks the credit default swaps of a pool of
125 liquid North American investment grade companies) compress to
85.5bps, from the 90+ we had only a week ago.
Within a steady low-interest-rate environment and ongoing
quantitative easing policies, higher sovereign yields and lower
corporate credit spreads will be positive of USD equities and negative
for gold. As you can see below (Source: Bloomberg), I have included
today two charts. To the left, we have crude oil, in 2008, when it
began to fall until it reached $32/bbl. To the right, we have gold, in
USD/oz. The two charts look very similar and give me horribly ominous
feeling on gold.
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: december-18-2009
The world seems to have radically changed in the past sessions and
it is important not to lose track of the fundamental logic that was
behind the action in 2009 and will possibly be in 2010. Briefly, in
2007/8 we had “liquidity issues” in an overleveraged world that had
misallocated resources into real estate. The issues were eventually
“taken care of” by the intervention of central banks. Damage was
nevertheless caused, in my view, due to a delayed the intervention,
with the political transition from the Bush Administration to the Obama
Administration (or more precisely from H. Paulson to T. Geithner).
After that delay, the quantitative easing programs gained full speed
and we won the rally of 2009.
In the face of Greece’s downgrade and the surprise of the US labor
market stats yesterday (jobless claims at 480k vs. consensus of 465k),
why will liquidity be an issue again? What makes you think that this
time the situation will be different? Political struggles within the
Euro zone?
The Fed reiterated only a day ago (and for the 100th time) that it
intends to leave the Fed funds rate at a low level for an extended
period. Perhaps that clarity was lacking with respect to the European
Central Bank but now, after the mess in the so-called peripherals
(Ireland, Portgual, Spain, Italy, Greece), we may have clarity sooner
rather than later.
Therefore, it is starting to be evident (at least to me) the Fed and
the European Central Bank would (or should) maintain an accommodative
approach, also in 2011. However, according to our Thesis No. 2 on gold,
under such coordination, gold should underperform (see: www.sibileau.com/martin/2009/04/21 ). On December 7th (see: www.sibileau.com/martin/2009/12/07 ,
“Gold is put to the test”) I wrote about this and so far, the market is
telling me I am right. However, I want to wait until January to reach a
conclusion and I sincerely hope I am wrong on this one…
On the other hand, if the monetary accommodation takes place, risky
assets should continue rallying, which would suggest that December 2009
might, in hindsight, look like a buying opportunity months from now.
But the move in the USD was very violent and very strong, and it
certainly takes a leap of faith to focus on the big picture for 2010
and to stick to the logics of liquidity (low rates) and non-neutrality
of monetary and credit expansions.
I want to be constructive. Following the scientific method of
empirical falsification (http://en.wikipedia.org/wiki/Falsifiability ),
I will stick to what has worked. I will not be bearish until I see that
demand for liquidity is not met by supply. So far, it has been met.
With all the turmoil, all the noise of the last days (I call it noise
because except for the labor stats, everything else was not
surprising), the 3-mo Libor – Overnight Index Swap spread is still at
record lows, below 10bps. In addition, the trend in corporate credit is
still that of spreads compression.
Lastly, with all the activity in sovereign risk, an interesting
“convergence” in sovereign spreads may occur within the European Union.
Given that the base hypothesis here is that the Union will not break,
its main contributors (France, Germany, Netherlands et al) should end
up bailing out the peripherals. Under that scenario, the credit default
swap of the big brothers should widen, while that of the peripherals
would tighten (in the long term), converging towards a new equilibrium,
consistent with a new NOMINAL rate of interest for the Euro. The quote
from Keynes above continues to be prophetic and eternal.
“…And when output has increased and prices have risen, the effect of this on liquidity-preference will be to increase the quantity of money necessary to maintain a given rate of interest…” (J. M. Keynes, “The General Theory of Employment, Interest and Money”, Chapter 13, Section III, 1936).
Please, click here to read this article in pdf format: december-17-2009
I thought that as the end of the year approached, things were going
to get boring. Nothing could be farther from the truth. With most
analysts agreeing on the future path of interest rates (first half of
2010 unchanged but stimulus programs are unwound, second half of 2010
rates begin to raise, except in the US. US yields however increase),
there is still confusion around the impact on different markets. In
addition, we see markets are paying more attention to fundamentals.
Yesterday both the consumer price index (1.8% yoy, as expected) and
crude oil inventories (-3.7MM vs. -2MM expected) suggested that we are
getting closer to the end of cheap money…On this basis, the US yield
curve continued to steepen with stocks selling and the USD
appreciating. Oil reached +$72/bbl from its previous $69.87 close.
As I wrote before, in 2010 I expect a higher USD and higher stocks
with higher yields in Treasuries. However, yesterday after the FOMC
statement, the activity in the Treasuries and stocks markets seemed to
refute this thesis. The statement was nothing new, with the repeated
“exceptionally low rates for an extended period” phrase. This was of
course interpreted as a validation of future inflation, and the 30-yr
Treasury plunged. So did the S&P500. However, equities (+0.11%) and
yields managed to end almost flat. At the end of the session, the USD
was losing strength. I think it may be too early to reach conclusions
here, but I took note of it. The same can be said about gold, which I
found erratic. Was it related to the fall of the Euro and the Yen
(after the Nikkei reported that the Basel Committee on Banking
Supervision had decided to delay enforcement of stricter capital
requirements for Japanese banks)?
Lastly, in our letter from yesterday, I incorrectly compared the
situation in Greece with that of Argentina. Although it is true that in
both countries the governments “stuffed” local banks with their own
debt, the comparison is not correct. In Argentina, the financial system
was totally compromised, because the peso was under a convertible (with
the USD) system, where the Banco Central had given up the ability to
act as a lender of last resort. In Greece, the situation is radically
different. The EUR2BN private placement that was announced yesterday is
nothing else but an undisclosed tax on Euro zone taxpayers, to
subsidize Greece’s fiscal deficit. Greece cannot get a direct subsidy,
but the banks that took on the government debt have access to liquidity
facilities from the European Central Bank. Thus, the 250bps spread on
Euribor charged for the issuance was an arbitrage on taxing
jurisdictions, earned by the shareholders of the respective lenders and
in a more diluted way, by Greece citizens too. The “white glove” move
was subtle, beautiful and simple, with no direct impact on the foreign
exchange markets.
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
"…And when output has increased and prices
have risen, the effect of this on liquidity-preference will be to
increase the quantity of money necessary to maintain a given rate of
interest…” (J. M. Keynes, “The General Theory of Employment, Interest
and Money”, Chapter 13, Section III, 1936).
Please, click here to read this article in pdf format: december-16-2009
All of a sudden, the world seems to be paying attention to
fundamentals, rather than liquidity. It is strange, because I think
that there is widespread consensus that liquidity or the lack thereof
will play in 2010 a role as important as it did in 2009.
Yesterday, the markets traded on the Producer Price Index (PPI),
which surprised to the upside, with a 2.4% change year over year. When
you think about all what happened in 2009, including the first three
months, a positive change of this order seems relevant, at least before
revisions. On that note, the market sold the long end of rates, the USD
appreciated and stocks had a range bound session, closing down (S&P
1,108pts or -0.55%). The 2Y10Y curve steepened +3.5bps. Investors
immediately associated this reading of the PPI with inflation and crude
oil could reach again the $72/bbl level.
On my preceding two letters, I proposed shifting in 2010 to USD
denominated assets, favoring equities as an asset class. I do not like
thinking this way, but I have no choice.
In the interest rates markets, there could be two drivers. The first
one would be the credit multiplier in action, as activity and lending
pick up. The second one could be an increase in rates, either directly
caused by central banks or by an oversupply of sovereign debt. These
two drivers would continue to compress corporate spreads and, given the
perception of lower default risk, investors would have to shift their
monies to equities, if they need higher yields. At the same time, with
the increase in lending and spread compression, companies may seek
alternative sources of capital (dynamic), as well as capital structures
(static). This could be achieved via equity buybacks, with debt. In a
way, the financial sector is leading this trend, as financial
institutions have been repaying TARP funds.
Simultaneously, with the increase in rates, the USD would become
more attractive, ceteris paribus and a flow of foreign capital would
return to the US to further fuel the spread compression in corporate
credit. In summary, the problem with this picture is that debt is
cheap. I call this a problem because it shows that we would be printing
our way out of the mess triggered in 2007. Debt has to be expensive, in
order to avoid this. How can you make debt “expensive”, or at least
stop it from cheapening? With central banks selling assets, touching
relative prices in the same fashion they did back in the spring of
2009. Will they do it? I hope for the best, but fear the worst.
Having said this, I must now dig deeper and ask myself what
assumptions are behind this logical thread. The first one is the
assumption of “stability” in benchmark, sovereign rates, with
independent central banks. This means that there will be enough demand
for both sovereign and corporate debt. This assumption is always
challenged. Yesterday, for instance, we learned that the Government of
Greece did a EUR2BN private placement with five local banks (National,
Alpha, Piraeus, EFG and Imi) at 250bps over 6-mo Euribor. This is very
serious and I am surprised to see that the Euro still trades at
USD1.45+. The last time I saw a government placing (forcing) debt among
local banks was in Argentina, before 2001. The other important
assumption here is that as activity picks up, commodities, raw
materials or wages (in Emerging Markets) do not rise. I am not too
comfortable with this notion for now.
Finally, the main issue here is that I think that we are heading
towards this cycle of higher rates, lower spreads, higher equities and
higher USD, which is not sustainable in the long term, unless as I
said, central banks engage in “asset management” (asset sales). This
should keep volatility floored at a certain level and should prove a
formidable challenge on gold bulls.
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
“…And when output has increased and prices
have risen, the effect of this on liquidity-preference will be to
increase the quantity of money necessary to maintain a given rate of
interest…” (J. M. Keynes, “The General Theory of Employment, Interest
and Money”, Chapter 13, Section III, 1936).
Please, click here to read this article in pdf format: december-15-2009
The big news yesterday was the $10BN bailout of Dubai World by Abu
Dhabi, through a Financial Support Fund. However, on the other side of
the emerging markets spectrum, Mexico’s sovereign debt rating was cut
one level by S&P to BBB from BBB+.
All in all, the general picture is of even higher liquidity. The
3-mo Libor -OIS spread reached another record, falling to 8.78bps. In
corporate credit, the IG13 Index (125 investment grade names from North
America) fell to 91.5bps, getting us closer to a 2010 that may see a
huge wave of capital structure financings, where firms minimize their
cost of capital.
Thanks to the news out of Dubai, gold managed to close higher at
$1,124/oz, after having fallen as low as $1,110/oz. The intraday chart
below on gold (source: Bloomberg) is very descriptive. Thus, I invite
you to go back to my comments of Nov 27/09 (refer: www.sibileau.com/martin/2009/11/27
, “Some thoughts on Dubai”), when according to our Thesis No. 2 (on
gold) the fact that gold had not rallied when the news of the debt
restructuring went out, suggested that a “timely hand” was on its way.
We wrote that that suggestion was “inductive” and flawed, but we
acknowledge it anyway, with the caveat that it was too early to draw
conclusions. Well, the timely hand came and gold is now a bit more
stable. Why is it not rallying? Because of the widespread perception
(or knowledge?) that interest rates are on their way up in 2010. On the
other hand, sovereign risk seems to be well contained, after so many
negative news out of emerging markets and Europe failed to disturb the
status quo, with a Euro still surviving the storm.
This last point (interest rates increase) brings me back to a point I made last Friday (www.sibileau.com/martin/2009/12/11
), when I wrote: “…All one can ask for is consistency, and so far, we
have not seen it (…)I am confident we will see effective policy action
on all of these fronts. But, muted volatility? I don’t think so (…) On
this basis, in 2010 I am tempted to slowly shift my investments to USD
denominated assets and give equities a chance (I see credit/fixed
income a bit rich vs. equities)…”
Interestingly enough, Mr. Gartman arrived to the same conclusion, in
his note (see “The Gartman Letter”, Dec 14/09) published yesterday. I
do not know whether that is a good thing. Briefly, this is the line of
reasoning: As liquidity continues to flood the market, credit spreads
will continue to compress, reaching a point where investors will need
to exit credit into equity, to earn higher returns. To me, I think the
story is not so much demand driven. I think equity will appreciate to a
good extent because of supply factors, one of which is the capital
structure changes that will take place as the cost of debt falls (i.e.
equity buybacks). But I will elaborate more on this tomorrow, because
the analytical framework behind this story is full of inconsistencies.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
“…And when output has increased and prices
have risen, the effect of this on liquidity-preference will be to
increase the quantity of money necessary to maintain a given rate of
interest…” (J. M. Keynes, “The General Theory of Employment, Interest
and Money”, Chapter 13, Section III, 1936).
Please, click here to read this article in pdf format: december-14-2009
We finished last week with a steeper yield curve and tighter
corporate spreads. This is consistent with the chart below (source:
Bloomberg), our already famous 3-month Libor – Overnight Index Swap
spread. The chart shows how the cost of renting bank balance sheet has
been steadily declining. It declined in the face of Dubai’s debt
restructuring. It declined even as Greece and Portugal are threatening
the Euro and it declined with the ratings downgrade of the State of
Illinois.
The message is clear. For new government debt issuance, the market
demands more and the curve will steepen. But the effect of liquidity is
still significant and perhaps even increasing, because last Friday, the
3-month Libor – Overnight Index Swap spread reached 9+bps, a record
level that we had not seen since 2006. Under these conditions, 2010
should be a year of changes in the capital structure of firms, with the
continuous deleveraging and search for lower cost of capital
structures, including mergers. Perhaps that is enough to avoid
deception.
As we wrote on Friday, we may see a shift of consequence in 2010, to
give the market a signal that fiscal deficits are manageable,
sustainable. If this shift is successful, the $1,226/oz level that we
saw in gold only days ago will prove a formidable top.
A final thought here. Every analyst agrees with the view that, given
the severe slack in the world, inflation in the developed world, as
measured by the Consumer Price Index, will not be a problem in 2010-11.
It is true. Consumer prices will not increase in the short term. But
asset bubbles have been a reality during the last decades, even if
consumer prices have not been a concern. Yet, the dotcom bubble morphed
into a real estate value, which morphed into a commodity bubble, etc.
etc., which makes me think that if you consider inflation “the” problem
and describe it within the narrow definition of a consumer price index,
you lose sight of the main problem. The main problem is that in the
last decades, resources have not been allocated to efficient use,
addressing authentic demands, because of the continuous distortion in
relative prices, caused by active monetary policy. In the next years,
the scale of these policies will keep growing, making matters worse. If
labor markets are flexible, the unemployment rate may not be severe.
But I believe unemployment will be more resilient than expected.
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
“…And when output has increased and prices
have risen, the effect of this on liquidity-preference will be to
increase the quantity of money necessary to maintain a given rate of
interest…” (J. M. Keynes, “The General Theory of Employment, Interest
and Money”, Chapter 13, Section III, 1936).
Please, click here to read this article in pdf format: december-11-2009
It seems that in the last 24 hrs, the world has put the ongoing
confusion in perspective, and become a bit more optimistic on the
outlook for 2010. At “A View from the Trenches”, we remain optimistic.
Too many times, we have written that liquidity remains intact and that
as long liquidity is not affected, the rally will continue.
Now, although liquidity is out there, the underlying force behind
it, fiscal deficits, is also alive. From the research that I read and
comments that I heard in the last days, I feel analysts are
underestimating this issue. There is a widespread expectation that
volatility in 2010 will be more muted. But if the growing trend in
fiscal deficits is to be broken, something of consequence needs to
happen. And when something of consequence happens, expectations must be
reassessed, which hardly represents a picture of muted volatility.
Thus, for me to remain bullish entering 2010, I need to see that the
fiscal gap is manageable, that it is not a problem, because if it is,
things are going to spiral out of control and rather swiftly.
All one can ask for is consistency, and so far, we have not seen it.
Next year will give us an environment with a US Treasury issuing more
debt (and with longer average duration), with a still unsolved demand
for Agency debt (once the Fed stops its bid in Apr/10), with the Euro
zone falling into pieces, and with creditor countries in Asia
exacerbating the USD peg. This is barely a picture of muted volatility
and higher valuations…
I am confident we will see effective policy action on all of these
fronts. But, muted volatility? I don’t think so. I am also confident
that there will be further monetary coordination in 2010, and
consequently, I believe gold could underperform, according to our
Thesis No.2. On this basis, in 2010 I am tempted to slowly shift my
investments to USD denominated assets and give equities a chance (I see
credit/fixed income a bit rich vs. equities).
Below, I show a chart (source: Bloomberg) with the US Treasuries
(Active) yield curve. You can see the steepening move since the
beginning of December. Please, do not ignore it. It will be a move of
consequence.
Martin Sibileau.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
To the risk of sounding like a broken record, let me repeat that back on September 2nd, I wrote that:
“…emerging markets are the Achilles’ tendon… We can perfectly
see a G-8 central bank coordinate assistance with another G-8 member,
but investors are wondering who is going to pay the bill, if a fiscal
problem unfolds in an emerging market. The IMF? Maybe, but given that
history suggests otherwise, the onus is on policy makers…” (www.sibileau.com/martin/2009/09/02 ).
And that on September 3rd, I suggested that:
“…A run against an emerging market’s currency would not
necessarily be supportive of the USD, if the same is triggered by a
wave of defaults affecting the country’s financial system. It could
potentially be supportive of gold, if the big guys (G-8 countries)
don’t lend a timely hand…” (www.sibileau.com/martin/2009/09/03 ).
Yesterday’s panic on the health of emerging markets should force us
to reconsider the problem at hand, at a higher level. Thus, let’s gain
some perspective here. Let’s not drown in a glass of water. Europe will
not risk its monetary union on the fiscal situation out of Greece or
Portugal. In fact, is this any surprise? Has it not been decades since
these, now so-called “peripheral” countries, have been running debt
sustainability problems? Certainly, downgrades affect investment flows
in the short term, but my view here is that it will only be temporal.
On the same note, does anyone doubt that institutions affected by the
Dubai restructuring will not have access to liquidity lines, if needed?
The 2009 story was all about injecting liquidity to avoid another
depression, and it worked. If it worked, there will be more of it in
2010, if needed.
The existing monetary policies were first proposed by Keynes, who wrote the following on the same:
“…when output has increased and prices have risen, the effect of
this on liquidity-preference will be to increase the quantity of money necessary to maintain a given rate of interest…” (General Theory, Chapter 13, Section III)
I am convinced that when this whole exercise in monetary policy is
over, we will need a much larger quantity of money to maintain
back-to-normal interest rates. How do we get there? Bernanke himself
reminds us of the road chosen every week: Maintaining rates at a low
level for an “extended period”. I see no reason to not take Ben’s word
at par here.
In conclusion, I will go on record here saying that when this
confusion triggered by concerns on the future of “peripherals” as well
as end-of-year technicals disappears, we will look upon these days as a
time of opportunity. When will the confusion bottom out and disappear?
I have no clue. It will vanish when it will vanish. Sometimes, it is
best to leave things as simple as that.
Lastly, should the world collectively coordinate a 2010 of low rates
to thwart prospective liquidations in emerging (and perhaps
not-so-emerging markets too), gold will underperform, if our Thesis
No.2 is not refuted.
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
We closed tighter in credit yesterday, with the IG13 index (tracks
the credit spread of 125 North American investment grade firms) losing
about 2 ¼ bps intraday. It seems that credit is “getting it”, while
equities and commodities are struggling.
What is credit getting? That liquidity is available and will be
available for a long time. But, to be fair, the relationship between
credit spreads and liquidity is very straightforward, very simple. It
is certainly not that simple with equities and commodities, because
inflation is a non-neutral monetary process, where the prices of assets
do not change simultaneously (i.e. not simultaneously, as the
mainstream theory states).
However, the world is worried about a potential sudden decrease in
liquidity. On this front, I am only concerned about the situation in
Europe. In the sovereign risk market, players in the Euro zone are
starting to distinguish between the strong countries and “peripherals”.
I really do not know whether there are in fact any strong countries, to
begin with. Nevertheless, let’s accept the distinction… Greece is of
course a peripheral, together with Portugal, which yesterday morning
was put on negative watch, for downgrade, by S&P. It is not clear
yet what would happen, should any of these “peripherals”, which include
Italy, engage in an upward deficit spiral. I doubt we would get to that
point because these countries would neither leave the Euro zone to
practice a debasement of their own currencies nor would the European
Central Bank deny liquidity lines for their respective deficits.
Therefore, the Euro loses ground, and this is more evident when one
sees the cross with the Canadian dollar: In the last two sessions, the
Euro has lost 3 cents against the CAD.
Thus, while we are led to believe that Europe practices some sort of
restraint, the opposite is certainly taking place in the export
countries of Asia, awash with liquidity that looks for yield. As you
can see, in perspective, the slow but certain debt deflation (or
inflation) is taking place worldwide. Should we believe then the
market, when it implicitly expects things to get tougher?
The US yield curve has steepened significantly since the end of
November, but Fed’s Bernanke repeated yesterday, in a speech to the
Economic Club of Washington, that “…interest rates are likely to remain
low for an extended period”, and that “the U.S. economy faces
formidable headwinds, including a weak labor market and tight credit
that are likely to produce a moderate pace of expansion…” I agree on
the diagnosis, but disagree on the medicine. However, I am more
inclined to believe Mr. Bernanke than those who didn’t believe him and
let gold drop to below $1,150/oz.
These are times of confusion and I will wait until January to make a
strategic allocation of my capital, when I have more clarity and less
end-of-year noise.
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
It’s Monday morning and I expect that you will have already digested
Friday’s action, that you will have had enough time during this weekend
to think over what just happened two days ago.
The release of US labor market data gave a final touch to the
discussion over whether there is or not an ongoing recovery, with weak
consumption. The so-called and feared jobless recovery, where
consumption would remain weak as unemployment remained high, seems to
have faded in the mind of investors. With this, the expectation of “low
rates for longer than expected” seems to have muted into a “low rates
for a certain and limited period”. Gold sold and sold dramatically,
dropping from $1,226/oz intraday Thursday to $1,049 intraday Friday. Of
course, the S&P TSX Composite Index (Canada) took it on the chin.
Today, instead of giving answers, I want to suggest some observations that bring up what I think are relevant questions:
-Interestingly enough, the Euro lost against the Canadian dollar on
Friday. At the close of Thursday, a Euro bought 1.5910 CAD. At the
close of Friday, a Euro bought 1.571. However, European equity markets
had gained over 1%, while the S&P Toronto Stock Exchange Composite
Index had lost -1.08%. If we remember that on Thursday, the European
Central Bank had decided to leave interest rates unchanged… What do we
make of this?
-Gold held very well immediately after the announcement that Dubai
was considering restructuring the debt of Dubai World. Yet, some mildly
positive news out of the US labor market sent gold 5% down intraday on
Friday. At “A View from the Trenches”, I have held that gold’s price
has been a function of the degree of coordination in global monetary
policy. But, we can still ask ourselves if gold is actually a hedge
against inflation or against chaos…
The US yield curve steepened on Friday, signaling “wise” money is
getting ready for a change. If commodities sold off on Friday on fears
of an earlier than expected increase in interest rates, why would that
negatively have affected the Euro? Would Europeans not happily increase
rates too?
From a fundamental perspective, the disparity in the USD and Euro
outlook can only be justified if one assumes that productivity
increases will match interest rate increases better in the US than in
the Euro zone. Note that I did not say that productivity would change
faster or slower in the US vs. Euro area. I said that the changes in
productivity would match better the changes in interest rates in the
US, rather than in Europe. Now…how true is this statement? Is the US
increasing productivity or is the USD only lagging other currencies,
given that it had been massively oversold? There are problems in the
Euro zone, with countries like Greece, whose fiscal deficits are
unsustainable…But we could also talk about California. How can we
blindly adhere to a fundamental view these days? How can we ignore the
technical damage done to gold on Friday?
The end of the year approaches and I do not think we can see
catastrophic moves. I will wait and see. But come January, and you’d
better be ready to fly low, because it will be open season…
One last thought:
In 2009, Gold was NOT profitable when there was global coordination
to lower rates. Gold became profitable when the coordination broke,
with central banks keeping rates low, while others increased them. If
the Fed started to increase rates sooner than later, would that
increase be “coordinated” with other countries? I think the answer is
yes, but not because the Fed sought to coordinate, but because the rest of the world would play along. According to our Thesis No. 2, with this coordination, gold should underperform. Thesis No. 2 is being tested right now.
Martin Sibileau.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
I know I could start discussing the macroeconomic data releases from
yesterday, or the news out of Venezuela, where it seems banks may be
nationalized, or the follow up on Dubai, or gold going beyond
$1,200/oz. But such news would only be…well, they would be news which
are available elsewhere to read. My wish is always that this letter can
add value by providing unique insights.
On this note, I think it was of particular interest to read
yesterday that Jeffrey Lacker, president of the Federal Reserve Bank of
Richmond, said during a press conference after a speech to the
Charlotte Chamber of Commerce that to his mind “…a natural place to
start is asset sales…”. Mr. Lacker’s view is that the Fed should start
removing the ongoing monetary stimulus by selling the mortgage debt it
is STILL acquiring. Of course, he had to address investors concerned
that such a move could work against the fragile recovery. Mr. Lacker is
not alone here, for Mr. James Bullard (St. Louis Fed) shares his views.
Nevertheless, still the majority of Fed officials seem to prefer to
either raise the interest rate on bank reserves, or drain reserves.
Mr. Lacker mentioned this option yesterday. However, the readers of
“A View from the Trenches” are ahead of the curve, for on November
24th, I introduced Thesis No. 3 (“Introducing Thesis No. 3” www.sibileau.com/martin/2009/11/24 ), which I further wrote about on November 26th (“Witnessing the impact of excess supply of liquidity” www.sibileau.com/martin/2009/11/26 ).
On Nov. 24th, I wrote that: “…My view is that if Bernanke
follows Keynes, the Fed will withdraw liquidity in the quantities that
it sees in excess of demand (=excess supply). As long as it sees demand
for a certain quantity of liquidity, that quantity will not be reduced
and of course, further liquidity will not be provided. Let’s call this
Thesis No. 3…This view significantly differs from the
mainstream opinion, which holds that the Fed, once it starts unfolding
its exit strategy, will seek to return the level of bank reserves,
which are expected to rise to $1.35 trillion, to the historical average
of $10 billion (i.e. normal levels prior to the crisis; this strategy consists therefore in eliminating excess reserves)….”
And on Nov. 26th, I continued saying that: “…contrary to what many analysts predict, I
believe the Fed will not target a level of excess reserves. In my view,
it is more consistent with the policy developed so far to target a
level of “excess supply of liquidity”. The problem here is how to define “excess supply”…”
I cannot stress enough how important is for investors to understand
this difference. The consequences of one strategy or the other are
radically different (not necessarily opposed) and they will certainly
define who makes money and who loses it in 2010/11.
To that effect, I further said that: “…The important issue here is that if you want to be consistent all the way on this subject, excess supply is eliminated with asset sales, not necessarily with interest rate increases.
Please, take a good note of this. If you target excess reserves, you
can play with interest rates. If you target excess supply, you must
sell assets in the balance sheet of central banks. It makes sense. When
central banks buy assets, they inject liquidity that creates asset
bubbles. To keep them muted, central banks must sell assets.
Will central banks sell assets? Not initially, but eventually. Why
should we care about this? Because it should provide us with a good
tool to assess when the bubbles will go bust. You can trade gold accordingly!…”
…And since then gold rallied beyond $1,200/oz. in the face of
Dubai’s default and we started hearing Fed officials speak of asset
sales. Feedback here is very much appreciated.
(Note: “A View from the Trenches” will not be published tomorrow, Friday Dec. 4th).
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Yesterday, the barbarians crossed the Rhine, compromising the status
quo. With investors’ realization that the news out of Dubai has done
absolutely nothing to the general liquidity picture, they now know the
vulnerability of the system, and they go for more. When barbarians
crossed the Rhine in December 406 AC, their merit was underestimated,
because their crossing was more a reflection of Rome’s weakness than of
their own strength. Like then, the rally in risky assets these days is
underestimated, because its resilience is more a reflection of central
banks’ weakness (= flight out of debased currencies) than of its own
strength. Yet barbarians finally reached Rome, and I am very tempted to
say that they will also throw a significant challenge to central banks…
Who wins? The arm dealers. Who are the arm dealers? The gold mining companies.
Indeed, yesterday we learned that Dubai may restructure $26BN in
debt obligations and that there are liquidity lines ready for the local
financial institutions. We also learned that the Bank of Japan is ready
to inject more liquidity to the world, in the form of quantitative
easing. There are countries like Australia (and perhaps Canada soon)
that will not join the party and will keep raising rates (Australia did
so by 25bps yesterday, to 3.75%). China, well….China still has to make
up its mind…
On the other hand, there is widespread speculation on the financial
stability of Greece, given what seems to be its unsustainable fiscal
deficit. This is putting pressure on the Euro, which fell against the
Canadian dollar (commodity currency). On Friday, one Euro bought 1.60
CADs. Today, it buys 1.575 CADs.
Emerging markets continue to capture capital flows. In Latin
America, we have a new dictatorship in Honduras. In Venezuela, Chavez
continues to buy arms and threatens regional peace. Ecuador has
defaulted on its debt, like Argentina. Brazil goes as far as siding
with Teheran on their nuclear aspirations, to divide the Caracas –
Teheran axe. In Bolivia and Argentina (and perhaps soon Uruguay too),
capital is fought with vehemence by their respective leaders. However,
capital continues to flow in the region, discriminating and without
fear, into Colombia, Peru and Chile at unseen speed and levels. For the
first time in more than a year, even the Mexican Peso now trades below
the $13MXP/USD level.
This picture is only sustainable in the near term, and we should not
be surprised to see gold trade above $1,200/oz. This unprecedented
monetary expansion, as we wrote too many times, cannot and will not
bring economic growth. Therefore, at one point, equities will have to
reflect this reality. It would seem as if the corporate credit market
gets it. Since November, the compression in investment grade spreads
has been more muted than the rally in the S&P500, as the chart
below shows ( CDX IG 5-yr Series 13 index (white line) vs. S&P500
Index (orange line); source: Bloomberg). The VIX index (benchmark of
volatility in the S&P500) dropped dramatically yesterday, but even
its descent has been bumpy.
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.