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Poisoned Blade

“Neither a borrower, nor a lender be; for loan oft loses both itself and friend.”
-William Shakespeare
 
That quote, of course, comes from Hamlet – Shakespeare’s longest tragedy. It’s a story that continues to be interpreted from many perspectives, despite it being over 400 years old.
 
Wall Street is all about storytelling. The story of the US Dollar serving as the world’s said “reserve currency” is roughly 1/10th of Hamlet’s in age. Since President Nixon abandoned the Gold Standard in 1971, plenty a leveraged loan banker has been paid to create limitless credit on the Buck’s back. Those bankers, by the way, include the central banking kind over at the US Federal Reserve.
 
Now we can all wake-up this morning and inspire something along the lines of Claudius’ murderous plot, or we can look at the US Dollar hitting new lows this morning for what it is – a credibility crisis that has gone global. One that’s been proactively predictable, for months…
 
One of the Harvard economic historians whom I respect, Ken Rogoff (former Chief Economist at the International Monetary Fund), said in a Bloomberg interview last week that,
“If the Obama Administration fails to rein in the long-term budget deficits, the dollar is set to decline for decades.”
 
As in all Shakespearean tragedies, there are multiple plots. The story of the Burning Buck has many. Rogoff’s basic point is grounded in US Fiscal Policy, but there are many others. This blade has already been poisoned. It is doused in US Debt.
 
Since Friday, here are The New Realities that have knocked the US Dollar down to fresh year-to-date lows:
 
1.      The Fed’s Balance Sheet expanded for the 4th consecutive week to $2.09T (that’s a “T” as in TRILLION; up $1.2T year-over-year!)

2.      The United Nations is calling for a new Breton Woods agreement this morning (i.e. a new world currency reserve system)

3.      The Gold price has shot above $1006/oz; meanwhile the US Federal Reserve keeps monetizing its debt and maintains ZERO interest rates

 
Last week, I started to get antsy about the US Dollar threatening to breakout from an immediate term TRADE perspective. The two-day move that got the US Dollar Index above my critical breakout line of $78.52 didn’t hold however. Now we’re right back to digging Ophelia’s grave. The US Dollar is once again broken across all 3 of our investment durations (TRADE, TREND and TAIL). Importantly, the breakdown through the $78 line has only been sustained 1 time in the last 38 years – in Q3 of 2008, right before we crashed.
 
The difference between the US stock market understanding that $150/barrel oil was bad for 70% of America’s GDP (Consumer Spending) last year, and this year’s setup is that there is that other dominating global macro factor accelerating – Chinese demand.
 
In sharp contrast to the Q3/Q4 2008 slowdown in China associated with the Olympics, this year we are seeing reported Chinese growth rip the rims right off of those Olympic basketball court hinges. Overnight, Chinese auto sales were reported up huge. At +90% year-over-year growth, that was almost 900,000 cars they sold. I know the “China is crashing” crowd wants to believe that China is making up these numbers. I wonder what Horatio would think of these tales…
 
On Friday, the Chinese also expanded both institutional fund flows and liquidity for foreign investors. Rather than having to be locked up for 1-year, China is allowing for 3-month liquidity on foreign funds and also expanding the size of funds by 20-25%. This, of course, is good for the fledgling Chinese stock market. Don’t forget that 60% of daily trading there is still retail!
 
Chinese stocks closed up for the 5th consecutive day, adding another +1.7% to the Shanghai Composite’s impressive YTD gain of +61%. We’re long the less volatile H-shares via the EWH (Hong Kong ETF). The Hang Seng took the Chinese auto sales news very kindly and shot up another +2.1% last night, taking it within 5 points of its YTD high. I don’t think Asia’s bull market in equities could care less about what our squirrel hunter extraordinaire, Timmy Geithner, says about America being the world’s financial “reserve” leader by the way.
 
After the long weekend, no matter where you go this morning, here we are. The two global macro factors that matter most remain:
 
1.      Chinese Demand

2.      The US Dollar

 
However tragic it may feel to hear that the world doesn’t look at America or her currency as it once did, it’s time to accept this for what it is. America’s Hamlet has been pierced by the poisoned blade of leverage. We’ve seen this fatal fencing match play out in slow motion. This is no time to pretend that these blades of currency devaluation aren’t real.
 
My immediate term TRADE support and resistance levels for the SP500 are 1007 and 1041, respectively. The US Dollar breaking down puts that topside target in play.
 
Best of luck out there today,
KM
 


LONG ETFS

VXX – iPath VIX We bought volatility on its lows on 9/3 ahead of last Friday’s employment report.

XLU – SPDR Utilities We bought some low beta dividend yield on its lows on 9/2. Utilities traded down 1% and they should act ok during stagflation fears.  

XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

EWH – iShares Hong Kong
The current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.  

CYB – WisdomTree Dreyfus Chinese Yuan
The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP – iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

 
SHORT ETFS
 
DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

LQD – iShares Corporate Bonds Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


THE MACAU METRO MONITOR

MACAU CASINO OPERATORS LOOK SET TO PULL ACES FOR REST OF YEAR scmp.com

Macau’s casino revenue is growing again, with August being a particularly impressive month.  With trough compares for the rest of the year, many are predicting soaring growth figures in the coming months.  The financial crisis, Beijing’s visa restrictions, and a credit crunch among VIP junket operators all contributed to the steep fall in earnings by Macau operators last year. 

Cost cuts implemented by most casino operators have been effective; the companies are far leaner than before.  With speculation mounting that visa restrictions will be relaxed this month, and upcoming calendar catalysts (such as the eight-day Golden Week holiday to mark China’s 60th National Day) boosting traffic, there could be significant mass market growth in the coming weeks and months.

 

HO SAYS “UNCLEAR” FACTORS OF FINANCIAL CRISIS STILL AFFECT MACAU macaunews.com.mo

Macau’s Chief Executive Edmund Ho Hau Wah warned on Monday that the public should remain cautious given the “unclear” factors of the financial crisis still affecting Macau.  The remarks were made prior to his attendance at the 13th China International Fair for Investment and Trade in Xiamen. 

Ho was quoted as saying, “different indices…show that the situation is not too bad, but unclear factors do exist, so we still need to make full use of all types of support the central government has given us, and maximize our efforts to promote economic development and guarantee employment and people's livelihood, efforts that will not be neglected."  Ho’s term ends on December 19th, 2009.

 

GRAND HYATT MACAU AT CITY OF DREAMS OFFICIAL OPENING SET FOR SEPTEMBER 29, 2009 reuters.com

Melco Crown Entertainment, LTD today announced that Grand Hyatt Macau will open on Tuesday, September 29, 2009.  The property adds approximately 800 guest rooms to City of Dreams and offers spectacular views over the City of Dreams resort or the west bank of the Pearl River.  According to Lawrence Ho, Co-Chairman and CEO of MPEL, “Grand Hyatt Macau is set to become Macau’s most sophisticated luxury conference and special events venue”.


THE WEEK AHEAD

The week of the 8th through the 11th, though shortened by the holiday, will not be without some major economic data releases. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

Tuesday September 8

 

North America: Weekly ABC Consumer Comfort index data will be released on Tuesday. The Treasury will hold a 3 year note auction at 1 PM while the Federal Reserve will release Consumer Credit figures for July in the evening. July Building Permits will be released in Canada.

 

Europe: Germany will see the release Current Account, Trade and Industrial Production Data for July on Tuesday morning while in the UK Industrial and Manufacturing Production data for July will also be announced.

 

Asia: In Australia, Retail Trade and Housing Finance figures for July will be issued.

 

Wednesday September 9

 

North America:  Weekly MBA Mortgage application data will be released on Wednesday morning, as will EIA oil gas and distillate stock levels as well as ICSC and Redbook figures which were pushed behind one day by the holiday. At 1 PM the Treasury will auction 10 year notes while at 2 PM the FOMC Beige Book will be released. We will be anxious to hear the comments of Chicago Fed Governor Evans when he addresses the Council on Foreign Relations on Wednesday morning as part of an event titled “The Great Inflation Debate".  August Housing Starts will also be published in Canada on Wednesday morning.

 

Europe: German CPI for August will be issued on Wednesday morning with a 7 Billion Euro 2 year Schatz offering will be held at 5:15 AM. In the UK, Trade Balance data for July will be also issued.

 

Asia:  In Japan August CPGI and July Machinery Orders will be released on Wednesday morning. In the Evening South Korea will release August PPI and Australian August Unemployment data will also be released.

 

Thursday September 10

 

North America:  Census Bureau Goods and Services Trade data for July will be released on Thursday, while Weekly Initial Claims, EIA Natural Gas Stock and Fed M2 figures will be also be released through the day at their normal times. At 1 PM, the Treasury will auction 30 year bonds. Thursday morning will see BOC rate announcements and Merchandise Import and Export data for July released in Canada

 

Europe: In France Industrial Production, Manufacturing Production and Trade Balance data for July will be issued on Thursday morning while august CPI will be issued in both Sweden and Norway. Final Q2 GDP, Consumption, Investment and Trade data will also be released in Italy.

 

Asia:  Indian Weekly Wholesale Inflation figures will be released on Thursday. Japanese Q2 GDP will be released at 8 PM while, later that evening, a slew of critical data will be issued in China including August Exports, Imports, Retail Sales, CPI, PPI, M2 and Industrial Output. We have been writing frequently about the changing nature of internal demand in China, but Export data will be of special interest to us this month as we look for signs that recovery abroad (particularly in the EU) is being felt by Chinese companies.

 

Friday September 11

 

North America: August Export and Import Price data will be released at 8:30 AM on Friday, while preliminary Michigan Sentiment figures for September will be published at 9:55 and Wholesale Inventory data for July will be released at 10.  At 2 PM the Treasury Budget for August will be announced. In Canada new Home Price Index levels for July will be released.

 

Europe:   Swedish Q2 GDP will be announced on Friday morning. CPI figures for August will also be released in Spain while in the UK PPI for August will be announced. In Italy, Industrial Production figures for July are scheduled for release.

 

Asia: Japanese Consumer Confidence for august will be issued on Friday morning, as will Indian Industrial Output data for July.

 

 

Andrew Barber

Director

 

 


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Heavy gov't borrowing, inflationary policies to cut bond prices


The TWIB of Energy

This Week in Baseball, or TWIB, is the weekly T.V. show that provides an overview of what has transpired in the baseball world over the past seven days.  It is a must view for any real baseball fan.  The Department of Energy of the U.S. Government is an incredible source for primary information about both domestic and international energy markets.  The Department of Energy also writes a weekly overview which is called TWIP, or This Week in Petroleum.  While much less sexy that TWIB, TWIP is a must read for those following the energy markets.  Every week we find a couple of interesting nuggets in TWIP and this week was no different.

 

As it relates to greenhouse gas emissions, TWIP noted this week that Energy Information Administration is going to start publishing greenhouse emission data on a monthly basis due to increased demand for this data.  They also highlighted a few facts from the 2008 report, which was just released.  Most notably was the following quote:

 

“The August 2009 STEO expects that the economic downturn, combined with a significant switch from coal to natural gas as a source of electricity generation in some U.S. regions, will lead to a 5-percent decline in energy-related CO2 emissions in 2009. In 2010, CO2 emissions from fossil fuels are forecast to increase by 0.7 percent, due to an improving economy (see Figure 2).”

 

This is probably a headline that most environmental groups won’t have us focused on, but it is noteworthy that greenhouse gases will be down almost 5% from 2009.  Obviously this is partially due to the economy, but, as noted above, we are also starting to see a real impact from the transition from coal to natural gas.  This is a key longer term trend for natural gas demand that we need to keep front and center, especially as the news around natural gas is currently overwhelmingly bearish and any incrementally bullish data points could change the tone of that market.

 

Another interesting data point was related to the pricing of gasoline and diesel.  Both gasoline and diesel are well below last year’s prices.  Diesel is currently priced at ~$2.67 per gallon, which is $1.45 below last year’s price.  While gasoline is priced at ~$2.61 per gallon, which is $1.07 below year ago prices.  From a consumer spending perspective though, as Howard Penney has been highlighting, there has been a dramatic increase year-to-date of both gasoline and diesel prices.  On the margin, this has obviously tightened the consumer’s ability to spend since the beginning of the year.

 

The final noteworthy data point was related to the inventory data.  On aggregate petroleum inventories remain above their five year average and above year ago levels.   Crude oil inventories are slightly above the five average and gasoline inventories are slightly below, but distillate inventories are still dramatically above year ago levels and the five year average.  In fact, distillates (primarily diesel and heating oil) are at almost 50 days of supply versus 30 days from a year ago.  The implications of this oversupply is likely negative for the margins of refineries in the intermediate term.

 

 

Daryl G. Jones
Managing Director
 


HEAD IN THE STARS

Research Edge Position: Short Japanese equities via EWJ

 

The wife of presumptive DPJ Prime Minister  Yukio Hatoyama has been receiving heavy media coverage in the west in recent days, with special attention being paid to her  belief that she was abducted by aliens in her sleep and transported to another planet.  Unfortunately for Japanese taxpayers, our initial read on the economic measures being pushed by the victorious Democrats after their historic win is that Mrs. Hatoyama may not be the only member of her household with a head in the stars. 

 

With pre-election proposals that ranged from cash incentives to induce more couples to have babies in an attempt to stem the generational tsunami about to blast the Japanese pension system to reductions in highway tolls to get people on the road and spending, we anticipate that the new government will accelerate the growth of domestic Japanese government debt and accomplish little.    Although the DPJ hasn’t even taken office yet the writing already seems to be on the wall; the fundamental weaknesses in the fabric of the Japanese economy have yet to be addressed meaningfully by  leadership of either party. 

 

Our strategic thesis on Japan is long, involved and makes for depressing reading. Our tactical thesis on Japan is short, simple and makes for some  good trades: Yen UP/Stocks Down. In the first chart below we have illustrated this relationship over a three year horizon. In the second chart we have illustrated the way our models line up in the near term for the Nikkei.  We are currently short Japanese equities via EWJ and may have gotten in a little too early –but there is nothing but downside from here as far as we can tell barring a declining Yen.

 

Andrew Barber

Director

 

HEAD IN THE STARS - abj1

 

HEAD IN THE STARS - abj2

 

 


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