美股投资风险大幅提升

　　【财新网】（专栏作家 曹仁超）4月11日，周日。今年首季恒指跌4.1％、国企指数跌6.1％；1月底恒指曾较去年11月高点回落14％，之后才回升，主因 是去年8月开始人行逐渐收紧银根。虽然美股继续创新高，带动恒指2、3月份回升，却未能刺激恒指创新高。踏入第二季，人行会否继续收紧银根？由于担心内地 第二季CPI升幅可能达5％，估计人行由去年8月开始的货币政策维持不变，意味第二季恒指未有能力摆脱上落市。

国情不同政策各异

　　美国联储局的政策，可能已暗地里由过去的“通胀目标”（Inflation targeting）改为“资产目标”（Asset targeting），即美国房地产一天未止跌回升，宽松货币政策将继续保持。中国依赖出口，故通胀对中国经济不利；美国依赖消费，故楼价上升对经济有 利。中美两国国情不同，因此政策亦有异。香港股市夹在两者之间，不知如何是好。请不要忘记大方向，即2008年起美国已进入去杠杆化时期！

　　今时今日作为投资者，变得多疑是无可厚非，过去有多少次自己的资本被牢牢套住？例如1997年8月、2000年3月、2007年10月……。上 周美国十年期政府债券孳息率由2008年12月的2.05厘升至4厘，证明债券熊市已于今年1月中开始（美债牛市1981年中开始、美股牛市1982年8 月才开始；美股熊市2007年10月开始、美债熊市2008年12月才开始）。债券同股市方向不一定相同，例如五、六十年代；八十年代方向相同，是因为美 国经济由高通胀期走向低通胀期，此因素对两者皆有利。2009年起美债进入熊市，因人们发现美国政府未来无法削减开支，美国政府正透过增加负债去刺激经 济，上述举措对股市有利、对债市不利。如政府印刷2万亿美元钞票，可引发恶性通胀；反之，如政府只增加2万亿美元借贷，只会推高长债息率，情况有如九十年 代开始的日本。不过，2008年起美国家庭开始减债，由2007年负债占收入96％降至2008年的94％。美国人的储蓄率由2007年初0.1％一度升 到去年5月的6.7％，然后回落到今年2月的3.1％，估计未来将上升至7%至11％。

　　1997年中，我老曹认为香港黄金三十年（1967年至1997年）面临结束；但至今仍有不少人反对上述看法，尤其在2000年及2007年这 两年。十三年过去了，约60％投资者手上的投资项目仍未重返1997年8月水平（未计通胀）。在黄金三十年投资，可以讲不聪明的投资者都赚到钱（分别只在 多与少）。但过去十三年，在投资市场赚到钱的人渐少（约占40％）、蚀本者多（约占60％），类似情况仍会维持多三五七年。过去十三年中，只有1998年 中至2000年3月科网股热潮、2003年3月至2007年10月资产升值潮及2008年11月至2009年11月炒复苏概念才容易赚钱。经济变得如此杂 乱无章，赢家自然稀少。

　　自2000年起中国本土资源已无法满足出口需求，成为全球资源的大买家。以铁矿砂为例，全球海运量由2000年四亿五千万吨升到2009年九亿 吨，中国所占比重由2000年16％升到2009年70％。今年4月1日起每吨订价110-120美元，较去年升80％到100％，现货价更升至 153.6美元一吨（即第三季订价可能进一步上升）；反之，热轧钢每吨售价今年1月仍是530美元。中国面对原材料涨价但制成品售价升幅不大的困扰，钢铁 厂边际利润收窄。上述不是钢铁厂独有问题，铝厂亦早已面对。

中国贸盈进入收窄期

　　至于轻工业制品厂更为严重。例如2000年我老曹购买一部五十二吋Plasma超薄电视机，去年因老化而须更换。相同牌子，功能多了许多，但售 价由2000年12万元跌至去年2.8万元（同样在日本制造）。我老曹相信，中国制造业的美好时光早在2007年之前已结束。2009年起中国政府希望透 过房产、金融、消费等内需推动经济复苏，可维持多久（香港共维持了十二年）？中国能否由一个“生产者”转为“消费者”？

　　大家请记住，中国仍有六亿农民每月收入少于300元人民币。美国68％家庭是中产阶级，中国中产阶级人口却不足6.8％。中国的出口优势不是人 民币汇价偏低，而是工资仍低。但在一孩政策下，廉价劳工成本此优势已进入退潮期，内地十八岁至三十岁人口供应量正在减少；上述情况1981年亦曾在香港出 现过。换言之，中国开始进入工资急升期，令制成品不得不步台湾、南韩、日本等地区后尘，由劳工密集型走向资本密集型。内地劳工密集行业只有移向低劳工成本 的国家如越南、柬埔寨、巴基斯坦及印度等。未来中国外贸盈余将进入收窄期。

　　美国2010/11年度财赤估计高达1.6万亿美元，相等于GDP 12％（未来十年达9万亿美元）。去年美国人税后净收入较08年少3.7％，连续两年下跌。美国人重拾早已遗忘的储蓄习惯，故此低利率时代维持的日子应较 大部分人估计长，因美国需要低美元汇价去刺激出口。1980年里根上台后，透过减税刺激美国人借钱消费；到2010年美国已负债累累，美国人被要求重新努 力工作，奥巴马希望未来五年美国出口额上升一倍。美汇指数自2001年7月6日121点跌至2008年3月21日70.69（目前80.76)，已为出口 提供有利环境。面对中国消费市场正以年率14％速度上升，如人民币按年升值5％，美国出口情况更为乐观。

　　美国自从1937年采用凯恩斯理论后，便渐渐养成先使未来钱的习惯。虽然美国经济已是全球第一，但消费更劲，进入1970年变得入不敷支。过去 四十年美国差不多年年财赤及贸赤，以前曾赖日圆偏低，今天则赖人民币偏低，真正理由是美国人从出世那天开始已学晓先使未来钱，然后申请破产。美国3月份共 有14万9268人申请破产，较2月份升34％，较去年同期升23％，是2005年美国修改《破产法》（Bankruptcy Code Chapter 13）以来最多。在美国申请破产太易，是造成巨大贸赤的原因。不同民族性格，形成两国贸易差距不断扩大。

　　1997年8月起投资策略是“有胆博无胆”，例如1998年9月、2003年4月、2008年11月……这段日子可维持多久？亦是不知道，因为 愈来愈多人掌握其中窍门。

　　大部分股市评论员已沦为fortune-teller（算命佬），言论大都模棱两可，缺乏真知灼见。他们每天看茶杯里的“茶叶”，然后决定后市 怎么看，第二天又忘记自己昨天曾说过什么，人人都在胡言乱语。去年12月一份调查报告显示：公众人士对股市评论员信赖程度排名“倒数第二”（只略高于风水 师），实在令评股业者汗颜。以高盛为例，去年每股获利22.13美元，较2008年4.47美元上升395％．而税前利润87％来自炒卖 （trading）；2010年又如何？连大企业利润亦过分依赖炒卖，变成可预测性甚低。

　　15世纪初，哥伦布发现新大陆，并获南美土著Atahualpa族礼待，获赠黄金与白银。哥伦布回国后，西班牙派出战船攻打当地土人抢夺金银， 一年内西班牙利用一百五十四艘船每艘载回超过二百吨黄金或白银，相等于整个欧洲过去开采量的五倍。西班牙突然富甲天下，便购买意大利时装、法国工艺品、亚 洲的香料及瓷器，并兴建大量别墅、建立极之瑰丽的大教堂及最大的海军舰队。在如此挥霍下，西班牙当时通胀率竟达400％（黄金在西班牙有如贱泥）。不出五 十年，从南美洲抢回来的金银用得九九十十，法国因售卖工艺品给西班牙而日渐强大起来，西班牙进入没落期。

　　由于法国变得强大，路易十四穷侈极欲，兴建华丽的宫殿；路易十五更派兵参与美国内战，协助打败英军，令美国独立；到路易十六法国变得民不聊生， 引发法国大革命，拿破仑成为新贵。最后，法军给英国与普鲁士（后来的德国）组成的联军打败，英国海上称霸，普鲁士则在欧洲称雄。

“神的眼泪”应该珍惜

　　不过，一山不能藏二虎，进入二十世纪，英德两国之争引发第一次及第二次世界大战；虽然两场仗都是英国战胜，但英国亦由此国力日衰，霸主地位由美 国取代，欧洲陆上称雄者则为苏联。1989年柏林围墙倒下，苏联解体，全球变成美国一国独大。德国经历两次大战后，不以武力去建立欧洲共同体，亦日渐强大 起来。

　　中国饱受列强百年侵略，到1978年实施改革开放政策，进入大国崛起时期。五百年西，五百年东。15世纪初由哥伦布发现新大陆开始的西方经济繁 荣期，至2000年美国科网股泡沫爆破，是否告一段落？中国由明朝开始由盛而衰，到1978年是否进入冒起期？

　　至于黄金，一如Atahualpa族所说，乃“神的眼泪”凝固而成，拥有后如不好好珍惜，将是诅咒多于欢乐。美国一度是拥有最多黄金之国，但 60年代开始日渐流失；1971年8月起美元不再兑换黄金后，美元在四十年内失去96％购买力，过去四十年所谓“资产升值”，其实是美元购买力下降的结 果。反之，德国同中国手上黄金则日渐增加。

　　过去美元购买力下跌速度如何？以寄一封信为例，1960年在美国要邮票3美分，1990年要25美分，现在则要45美分，即费用上升十五倍。再 以美国房屋为例，1970年2.66万美元一间，1980年7.66万美元，现在26.66万美元一间，1970年至今升值十倍（香港1970年至今楼价 上升三十倍）。美元购买力自1970年起以每年3％速度流失（70年代较快，80年起已降至每年2％）。

　　道指自去年3月起出现连续十三个月上升，代表美国企业未来三至九个月情况较去年好，但这只是告诉大家2010年没有Double Dip，而非另一繁荣期开始。两年期TIPS（Treasury Inflation-Protected Securities）只有1.56厘，较08年6月的2.92厘进一步回落，OECD 三十个国家2月份平均核心通胀率只有1.5％。美国CPI估计将进一步回落至0.3％，欧元区则为0.2％，因为我们已进入“低利率、低通胀率、低GDP 增长率、高失业率”，即所谓“三低一高”时代。

美股投资风险大幅提升

　　美国GDP由1960年5210亿美元升至2009年14.2万亿美元，过去五十年美国表现的确出色，未来又如何？会否一如1990年起的日 本，进入每年GDP只有1％到2％增长期？美国就业人口由1960年少于六千万，到2009年一亿五千万（仍有一千六百万人失业）。过去五十年生产力的提 升，令美国未来在创造职位方面愈来愈困难，因为今天服务业已占美国GDP 78.2％。美股经过去年3月至今上升，未来投资风险已大幅提升，回报率则大减。

　　1982年8月道指P/E只有六倍，2000年3月升至四十三倍，结束美股牛市。虽然2002年10月至2007年10月道指上升，但P/E最 高时亦只有二十八倍，2009年3月一度降至十五倍，然后反弹到2010年4月的二十二倍。如参考1966年至1982年大调整市，美股完成反弹后，应再 反复回落至2015至2020年才完成调整。未来五至十年美国进入“三低一高”时代，美股则进入低P/E时代。

　　1982年至2007年的香港经济转型期有美股大牛市配合；反之，2009年起的中国经济转型期，却须面对美国进入去杠杆化时代。因此，中国经 济转型相较香港艰辛许多。

　　历史证明，恒指平均P/E在十八倍至二十二倍结束牛市机会很大，平均P/E在八倍至十二倍则结束熊市机会很大。因此，历来便有十八倍P/E减持 论（即恒指P/E一旦高出十八倍便分段减持）及十二倍P/E增持论（即恒指P/E一旦低于十二倍便逐步增持）。■

　　本文由香港《信报》财经新闻提供，为方便普通话读者阅读，略有改动。“曹Sir智库”及“曹Sir金句”，请点击 http://www.hkej.com/template/cho/jsp/cho_main.jsp　　

The CDO unwind waiting to happen

Posted by Sam Jones on Oct 23 14:46.
http://ftalphaville.ft.com/blog/2008/10/23/17365/the-cdo-unwind-waiting-to-happen/

Are the days of CDO carnage behind us?
Apparently not. Bloomberg reported on Wednesday:
Oct. 22 (Bloomberg) — Investors are taking losses of up to 90 percent in the $1.2 trillion market for collateralized debt obligations tied to corporate credit as the failures of Lehman Brothers Holdings Inc. and Icelandic banks send shockwaves through the global financial system.
The article is referring to synthetic CDOs: that is, CDOs which are not backed by tangible collateral (RMBS, CMBS, for example) but CDS contracts which reference some form of collateral.
In this case, CDS on corporations.
All of which may sound dreadfully esoteric. Until you ratchet up the numbers. On Friday last week, Barclays analyst Puneet Sharma put out a report on a possible synthetic CDO unwind, and what can be expected to happen to the market as we move through a recession in the coming months.
In graph form, here’s what would happen to the ratings on prime and high-grade tranches of the trillion dollar synthetic CDO market:
Huge, disastrous downgrades: exactly mirroring the structured finance downgrades from ABS CDOs which have brought the financial system to its knees already. Don’t forget, moreover, that these CDOs aren’t backed by dodgy subprime collateral, but are supposed to reference the investment grade corporate world. More proof that it’s not the collateral which is to blame, but the structuring. The medium is the message, and all that.
We guess the impact of this might make itself felt in three ways:
Firstly, there will likely be the mark-to-market losses on the CDO notes themselves. As the Bloomberg article noted, in some cases this is equivalent to a 90 per cent loss on capital. The question here then, is who is holding these notes? Hedge funds were certainly big buyers of synthetic CDOs. But guess what – banks are also holders too. And by and large, banks synthetic corporate CDO holdings haven’t been written down.
Secondly, trouble in the synthetic CDO market will – just as with ABS CDOs – have huge regulatory capital impacts for banks. Shama at Barclays produces another set of graphs to demonstrate:
Downgrades of synthetic CDOs, in other words, will have a devastating caustic effect on banks’ capital ratios – with the potential to completely offset government recapitalisation actions.
Thirdly – crisis for synthetic CDOs will suck money out of the banking system in other ways. Synthetics are “unfunded”. In a normal asset-backed CDO, the cash raised from selling bonds is used to buy assets, but in a synthetic CDO, the cash raised from selling bonds is not used up front: as a protection seller, the CDO collects premiums on CDS contracts which only cost it money in the event of a default (when the CDO must make good on its protection). Of course, depending on what is happening to the spread on the various CDS contracts a synthetic CDO might hold, the CDO might also need to make margin calls. Here is a quick diagram of the generic structure:
The point here is that the “collateral” account of synthetic CDOs usually takes one of two forms: a bank deposit, or a similar cash-equivalent holding: a money market deposit, for example. As spreads widen, and collateral posting (the red line in this diagram) comes into force, synthetic CDO SPVs will be drawing money out of banks and money market funds to meet their obligations. Given that there are quite a few synthetic CDOs out there, the effect shouldn’t be too insignificant.______
There’s one other point too: synthetic CDOs almost always have a super senior swap written on them. You can see it in the above diagram, technically sitting “outside” – above – the structure. The swap effectively offers the arranging bank protection against its position. The question is, who writes these swaps? LSS conduits, for one (another layer of SPV fun – backed by CP), insurers do (monolines and AIG, for example) and other banks do.
Complicated all the above might be. The long and the short of it is that the synthetic CDO market has used derivative technology to build a huge amount of leverage. With recession now biting, the whole house of cards is dangerously close to collapse.
The CDS markets should feel the impact when it does. One way synthetic CDO managers can offset losses- or rather, crystalise them at acceptable levels – would be to buy protection in the market to sterilise their portfolios.

S&P’s CDO rating methodology is unpatriotic, outrage du jour

Posted by Tracy Alloway on Oct 07 16:47.

Here’s a vitriolic demonstration of the current dilemma facing the ratings agencies.
Having been accused of ratings puffery — not being realistic or pessimistic enough when they first evaluated structured assets like collateralised debt obligations – the agencies are now being accused of being too bearish. To wit: the latest HCM Market Letter’s comments on Standard & Poor’s (H/T Sam Jones).
First, a bit of background:
On Sept. 17, S&P published a revised methodology for CDOs — the slice and dice securitisations backed by mortgages or other debt – after having flagged its revision proposal since at least March. The rating agency said the new methodology would affect nearly 5,000 deals, mostly based on corporate loans and worth about $578bn. Outstanding synthetic CDOs would likely get a downgrade of four notches, S&P said at the time. The upside was that CDOs which received triple-A ratings under the new criteria had to be able to withstand Depression era-esque default rates.
A fair trade-off? Not according to some commentators.
Here are the relevant excerpts from that HCM letter (emphasis ours):With this announcement, S&P accomplished several things. First, the revisions constitute an admission that its prior ratings were based on profoundly flawed intellectual assumptions and ratings models. Unfortunately, they have replaced their original mistakes with equally serious ones. Second — and most important from a systemic standpoint — the revisions effectively hammer the final nails into the coffin of the securitization of corporate debt. Third, with these revisions S&P unilaterally changed the rules governing hundreds of billions of dollars of Collateralized Loan Obligations that were issued over the past few years. It did so without giving investors in these transactions any right of appeal, or any recourse to recover their potential losses. Investments were made based on earlier ratings which arguably constituted an implied promise by the ratings agencies to maintain the original set of assumptions underlying their ratings. By unilaterally changing these assumptions to account for the first time for Black Swans, S&P has broken its compact with the entire financial world that came to rely on its ratings. This post hoc approach reflects extremely poorly on the intellectual abilities of the credit rating agency.
Err, ouch.
If that wasn’t enough, though, HCM are also accusing S&P of being ignorant of the current economic environment:Fifth, S&P is effectively raising the cost of capital for less than investment grade companies that are already suffering from a dearth of available capital sources. Moreover, it is doing so after credit conditions have improved. While the rating agency is a private sector entity, it has enjoyed the imprimatur of the Securities and Exchange Commission that requires so many areas of finance to rely on its ratings. Moves like this, which are dressed up in intellectual clothing but are little more than ex post facto attempts to correct its prior mistakes, have large systemic effects. The problem is that these systemic effects are being inflicted by an organization that has surrendered any claim to intellectual legitimacy by its prior errors. Moreover, it is compounding those errors by making changes to its ratings assumptions that fly in the face of current data that suggests that corporate credit conditions are improving, rendering its heightened default scenarios highly unlikely to occur and unsuitable for application to these structured credit products.
And what’s more, S&P’s actions pose wider problems for collateralised loan obligations — a type of CDO which securitises commercial loans:The tragedy is that S&P’s recent move suggests that they are being permitted to stick it to investors again. The rating agencies fail to understand that corporate loans are different from bonds or mortgages. Instead, they are applying the same standards they erroneously applied to Collateralized Mortgage Obligations and Collateralized Bond Obligations to Collateralized Loan Obligations. As a result, they are downgrading CLOs and limiting their ability to provide capital to less than investment grade companies in an already difficult financing environment. They are doing this without regard to the consequences of their actions, which is to render financing harder to come by for viable companies that need access to capital. Despite improved credit conditions, less-than-investment grade companies remain faced with the same situation that they have always faced, i.e., the rationing of credit. Banks long ago exited the lending business in favor of the originate-and-distribute model, and in the aftermath of the crisis have little desire to add assets to their balance sheets. As Chart 1 on the previous page illustrates so graphically, the banks are still in the process of exiting the lending business and nobody appears to be filling the gap. One of the last men standing to purchase less-than-investment grade securities in large volumes were CLOs, and an increasing number of these are being frozen out of the market by these downgrades just as market conditions are improving. This is directly contrary to the efforts the Obama Administration is making to encourage lending, and is another reason why credit agencies should be subject to far stricter regulation in view of the damage they have already done and continue to do.
Woah — downgrading CDOs/CLOs is now unpatriotic and against Obamanomics?
Evil ratings agencies. Perhaps we can have a McCarthy-style witch hunt to purge them of their new-found realism bearishness soon.
Or maybe just another ratings flip-flop.
Related links:Hedgie adventures in pop history; hyperbole. Redux – The Long RoomCDOs, a tendency to liquidate – FT Alphaville`Race to bottom’ at Moody’s, S&P secured subprime’s boom, bust – Bloomberg

As Currencies Collapse, What Do You Do?

By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens." - John Maynard Keynes

For the record, I believe John Maynard Keynes is one of the top-ten most evil human beings ever to have walked the earth, but I am thrilled to see that he at least admitted his theories amount to no more than legalized theft. And I know many of you will point out that I have used this quote several times in the last year. And it may trouble you to know I’ll probably continue to use it now and then, just to remind the Keynesians of the world that even the author of the theories they hold so dear considered them to be immoral. Of course, I’m presuming Keynes believed theft is immoral. I never spoke to him. So I can’t say for sure.

In the last several trading days, I've been watching the dollar strengthen, which, if you've been reading my articles, doesn't make a lot of sense -- at least not on the surface. The Fed (and every other major central bank) is creating currency and easing credit more than ever in history, and that, by definition, is inflationary. Remember what I’ve said so many times: inflation is not defined as rising prices; inflation is an increase in the amount of currency and credit available. Rising prices result from inflation. So if there are more dollars in the economy right now than ever before in history, shouldn't prices be rising? Further, as long-term Treasury yields increase -- as they have been over the last year -- doesn't this offer further evidence that rates are on an upward trend? And if they are going higher, as the cost of borrowing increases, won’t that cause hurdle rates to move higher, as well? (A hurdle rate is the rate at which managers and/or investors decide for or against an investment. If, for example, the hurdle rate is 12%, then any projected rate of return below 12% is rejected as an investment.)

But the dollar is stronger for now, and below is a video analysis of a chart that bears out yet more possible gains from the greenback – at least in the short term. The chart also serves as a good example of why I am not a technician, and why I don't use charts for anything but confirmation of trends.

It seems to me, however, as though there are two very strong long-term forces threatening to send rates and prices higher:
1. Unprecedented printing and easing of credit.
2. A diminishing appetite for U.S. debt.
Let me ask you this: would you loan money to any entity at less than 5%, knowing the entity’s credit was bumping against its ceiling, and that its earning-power had been severely crippled? I know I wouldn't. But somebody has been buying Treasuries, and I think those "somebodies" are starting to realize just exactly how stupid that sort of behavior is.

Consider these comments Friday, 12/18/09, from Zhu Min, deputy governor of the People's Bank of China:
“The United States cannot force foreign governments to increase their holdings of Treasuries," Zhu said, according to an audio recording of his remarks. "Double the holdings? It is definitely impossible.”
"The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world," he added. "The world does not have so much money to buy more US Treasuries."
What if sovereign nations are slowly beginning to curtail their purchases of U.S. Treasuries? Might that not account for the rise we’ve seen in yields over the last year? “Man-of-the-year” Bernanke says he’s going to hold down the long-end of the yield curve, but that hasn’t been working so well for him; it’s hard to keep rates down when the global economy no longer wants your debt.

But let’s take it a step further: what if, say China, suddenly noticed that the U.S. government really isn’t all that credit worthy anymore. And what if about a year ago, China recognized that long-end prices were at historical highs, and yields were at historical lows. What would China likely do? Right. They’d slowly start selling – or at least start minimizing purchases. And what would happen to bond prices? They’d fall. And how about those yields? Yep. They’d start creeping up.

I know what you’re going to say: foreign nations hold only a relatively small percentage of U.S. debt. So what? That certainly doesn’t mean foreign nations are the only investors in the world who recognize what is happening to United States credit. Treasuries are not the safe-haven they once were. More often than not these days, they move in tandem with the stock market! What kind of behavior is that for the so-called “risk free rate of return?”
Here’s the part most people don’t think about, however: if foreigners are slowly cashing in U.S. bonds, what happens? Effectively, they sell bonds, and they buy dollars. And until they convert those dollars to some other asset – whether a currency or some commodity – the dollar will strengthen. But how long with these foreigners hold on to greenbacks? My guess is not long, and I’m willing to bet the recent dollar rally is going to be very ephemeral.

Just as investors have started to realize that Treasury yields and prices are unsustainable at these levels, they will soon realize that the dollar is no longer the store of value it once was either. It cannot sustain its status as the world’s currency reserve. With the massive amounts of debt the U.S. has piled up, along with the unprecedented number of dollars now printed and floating in the system, public perception of the dollar is about to change. And there may be one more surprise coming that most people aren't anticipating: it is very likely that many of the world's largest oil-producing countries may soon begin transacting in some currency other than the dollar.

Where to Invest Now?
Stocks? I continue to say absolutely not.
For over a year, I've argued that stocks would recover, and then trade sideways to down for a very long time. I've also suggested that there is a possibility that stocks might even continue to climb, but not until inflationary price pressure begins to accelerate.
My argument is that no matter what stocks do, they will fail to outperform general price increases deriving from inflation.

So if you believe the dollar is heading south, where do you put your money? Should you short the dollar? Or perhaps you should go long the euro? I don't think either is a good investment; most currencies in the world are going to lose value as governments print their way out of this mess. Even the Swiss -- traditionally the most fiscally responsible government on earth -- are getting on board.

I think the Euro could be a moderately good short- to medium-term trade. One of the euro's strengths is that the European Union doesn't issue debt (at least for now), and so its monetary policy isn't heavily reliant on that component -- the way U.S. is. At least from the debt perspective, the euro isn’t as affected by the debt component, and so the world may well shift away from the dollar to the euro as its global currency reserve.

Or maybe the Chinese will get their wish, and SDRs will replace the dollar. Who knows? And who cares? Any fiat currency that replaces the dollar is going to have just as many problems. Remember the European Union's currency printing presses are in high gear too – along with everyone else’s. The only thing that’s going to stop the pattern of violent economic gyrations we’ve seen in the last century is the decriminalization of private competing currencies, backed by commodities – most likely precious metals.

So if all fiat currencies are going to fall simultaneously, what will they be falling in relation to?
The answer to that is simple: commodities. And that's where I’m putting my money. I still believe energy, agriculture, and metals are going to be sure winners; I’m especially bullish on silver right now, but when inflation really starts to hand us higher dollar-based prices, I think investor psychology will head toward gold because it is by far perceived as the most stable, long-term store of value in the world -- as it has been for thousands of years.
There are some people who believe gold and oil are going lower -- and by extension, that the dollar is going higher. I obviously disagree with that position -- as I said earlier -- before I expound, here are two bearish video counterarguments to my thoughts on gold and oil, respectively.

Both gold and oil -- and especially gold -- have ridden out economic historical crises extremely well. They don't just keep up with inflation-driven prices -- they outpace them. As such, since there's no question in my mind that the profligate global printing of currency and easing of credit are going to drive prices higher -- on an unimaginable scale. And while the above short-term outlooks may be useful in their capacities, my long-term outlook remains exceedingly bullish.

Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies

Why market sentiment has no credibility

By Robert Skidelsky
Published: December 22 2009 20:30 Last updated: December 22 2009 20:30

It is not surprising that Britain’s largest economic downturn since the war should have seen the largest ever peacetime government budget deficit. By the end of this year Britain’s output will have fallen by about 5 per cent since the crisis started; in the same period the budget deficit will have risen by between 5 per cent and 8 per cent of output. Arithmetic so simple that even a child can understand it: smaller output, smaller revenues, larger deficit. And the corollary: larger output, larger revenues, smaller deficit.
The deficit for 2009-10 is projected to be £178bn (€200bn, $287bn), about 11 per cent of gross domestic product. There is some dispute as to how much of this is “structural” and how much “cyclical”. The “structural” deficit is the gap between government revenue and spending that will have to be closed by higher taxes or lower spending. The “cyclical” deficit is the gap that will automatically disappear when the economy has recovered. Those who say the downturn has added 8 per cent rather than 5 per cent to the deficit argue the recovered UK economy will be smaller than the pre-recession one, hence the recovery will leave a gap of £132bn rather than £100bn. Whatever the right number, no one doubts that there will remain a sizeable fiscal problem, even after the downturn has been reversed.
But why has the financial press been almost unanimous in condemning the modest pre-Budget measures announced by Alistair Darling, chancellor of the exchequer, to protect total spending in the face of a massive collapse of private demand? Why are the markets howling for “fiscal consolidation” now – ie cutting fiscal support to the economy immediately – when it has plainly not yet recovered?
To understand “market sentiment”, one has to go back to two ideas in the minds of most financial analysts which almost unconsciously shape their arguments. The first is the belief that economies are always at full employment. The second is the belief that even if they are not (obviously contradicting the first), they very soon would be if only governments would stop bailing them out.
The first is perhaps the most pervasive. It takes the form of denying that there is an output gap. That is, at all points in time output is no more or less than what the economy is able to produce. If this is so, government attempts to close an imaginary output gap by running a deficit will either take money better spent by the private sector or be inflationary. (Output-gap deniers always see the microbe of inflation in the air.) Either way deficits are bad, which is why “fiscal consolidation” needs to happen immediately. In the early days of the crisis this deep theoretical commitment to the existence of continuous full employment was temporarily overcome by common sense. But as the fear of apocalypse receded normal intellectual service was resumed.
The more cautious version of “output gap denial” is the view that the pre-crisis level of output was the result of bank-financed debt, and that much of it went for good with the credit crunch. Public finances cannot rely on a recovery of output to produce a stream of revenue to reduce the deficit because – wait for it – there is little or no output to be recovered.
Even the normally sober Martin Wolf has fallen for this line (FT, December 16 2009). The pre-crisis UK economy, he says, was a “bubble economy”. The bubble made UK output seem larger than it actually was! This is old-fashioned Puritanism: the boom was the illusion, the slump is the return of reality. However, experience of past recessions suggests that, once the corner is turned, output recovers vigorously from slump conditions (as do prices). Between 1933 and 1937 the UK economy expanded by 4 per cent a year, much higher than its “trend” rate of growth. Yet in 1931 orthodox economists were denying there was an output gap at the bottom of the greatest depression in history.
The second theoretical commitment of most financial analysts is that economies, if disturbed, revert quickly back to full employment if not further deranged by government actions. Thus contrary to the commonsense view that massive government intervention last autumn stopped the slide down to another Great Depression, the new conservative commentators (having got their breath and confidence back!) now argue that ill-conceived government measures have stopped, or are hindering, the natural recovery mechanisms.
For example, it is argued that massive government borrowing is keeping yields higher than they would otherwise be. Thus government efforts to stimulate spending have the effect only of retarding a natural fall in the rate of interest. If its borrowing is not rapidly reduced there will be a “gilt strike” – investors will demand higher and higher prices for holding government paper. Faced with the evidence that, despite increased government borrowing, gilt yields have been at a historic low, the critics say that this is only because the gilts are being bought by the Bank of England. Once the Bank stops buying government debt, interest rates will shoot up.
A parallel argument is that the expansion of the fiscal deficit is preventing a natural fall in the exchange rate sufficient to boost exports. The tortuous logic seems to be that “fiscal consolidation” will cause the rate of interest to fall and the fall in interest rates will cause the exchange rate to fall, thus increasing the demand for British exports. It is often alleged that something like this happened in 1931 when Britain left the gold standard for the last time.
Empirical evidence supporting the view that cutting the deficit causes the exchange rate to fall is very thin. A 1997 study by the International Monetary Fund showed that in only 14 out of 74 studied instances did fiscal consolidation promote a recovery via a fall in the exchange rate. In all the other cases fiscal policy either had no discernible exchange rate effect or it was the expansion of the deficit that caused the exchange rate to fall.
This only confirms what common sense and elementary Keynesian theory would lead one to expect. In a slump there is no natural tendency for the rate of interest to fall, because people’s desire to hoard money is increasing. So printing enough money to “satisfy the hoarder” is the only way of getting interest rates or the exchange-rate down.
But, of course, there is always “market sentiment” to fall back on. The government must cut its spending now, because this is what “the markets” expect. These are the same markets that so wounded the banking system that it had to be rescued by the taxpayer. They are now demanding fiscal consolidation as the price of their continued support for governments whose fiscal troubles they have largely caused.
Why on earth should we take this market sentiment any more seriously than that which led to the great debauch of 2007? Markets, it is sometimes said, may not know what they are talking about, but governments have no choice but to do what they tell them. This is unacceptable. The duty of governments is to govern in the best interests of the people who elected them not of the City of London. If that means calling the bankers’ bluff, so be it.

Lord Skidelsky is emeritus professor of political economy at the University of Warwick. His latest book Keynes: The Return of the Master was published in September

Securitisation rules

Published: December 21 2009 09:26 Last updated: December 21 2009 09:26

Grappling with unintended consequences is like stuffing the proverbial genie back in its bottle. Accounting rule changes in June, which will see US banks bring securitisations back on balance sheet at the turn of the year, prompted concerns that those assets could be commandeered by the Federal Deposit Insurance Corporation as part of resolving bank failures. Loss of so-called “safe harbour” protection, warned rating agencies, could mean downgrades of bank-originated securitisations and deter new issues. So this week, the FDIC confirmed that assets securitised before the end of March would remain safe from seizure. Meanwhile, it wants feedback on possible rules that would determine whether future deals are protected.
Rather by the backdoor, then, the FDIC adds another voice on reform of securitisation markets. Coordinating its elaborate list of possible conditions with the US legislative process is a priority, as should be ensuring consistency internationally. Differing standards could drive securitisation activity from deposit-takers to non-bank or non-US institutions. The preliminary nature of the FDIC’s thoughts reflects, too, some disagreement between regulators, meaning an extension to the March deadline appears likely. Prolonged uncertainty is not ideal. But for consumer credit-backed securities, at least, the FDIC’s possible rules chime with what has been proposed elsewhere.
However, new FDIC suggestions – which may be restricted to only residential mortgages – include a six-tranche limit in capital structures, a requirement to hold loans for 12 months before they are securitised, and a portion of deal fees paid over time. True, the mortgage-backed securities market spawned the most complex structures and worst performance of pre-crisis issuance. But these strictures could make securitisations less viable in a market that, still, remains closed. They also smack of rear view regulation, before the new rules are in place to prevent the next one.

Valuation fundamentals

Published: December 22 2009 09:35 Last updated: December 22 2009 10:09

Like death, investment fundamentals matter but are often forgotten or ignored, pushed aside by the immediacy of day-to-day living. This approach can bring happiness for years – until a life or death moment intervenes. Late last year was just such an occasion. But, since March, asset classes from stocks to commodities have soared again. Are investors deluding themselves once more?
Take bonds. Their valuation depends on the outlook for growth, inflation and, where applicable, quantitative easing programmes. A useful way for investors to think about bonds is to compare nominal yields today with historic real yields to see what expectations for inflation are spat out. For example, Merrill Lynch believes that over the past 300-odd years, real bond returns in the UK have been about 3 per cent. That means those holding 20-year gilts with a nominal yield of 4.2 per cent expect inflation to stay about 1 per cent for two decades. That’s a big call. Most other bond markets are supported by similarly low expectations for long-term inflation.

Then there are equity markets. Here it is best to use long-run, adjusted earnings based valuations, or methodologies comparing prices to real assets, such as replacement ratios. On such measures, US stocks are now almost 50 per cent overvalued, according to Smithers & Co. Unfortunately, historical data are less reliable for other equity markets, but most also look expensive on this basis, albeit to a lesser extent.

Finally, commodities and property. For the former, price rises have outpaced absolute improvements in global industrial production. The fundamentals for certain housing markets, however, look good. In the US, for example, values relative to disposable income are well below trend having fallen by more than a third. House prices are ticking up again across the globe, although the commercial sector remains soggy. Investors should not get carried away, but compared with other asset classes at least, fundamental valuation metrics suggest bricks and mortar are not the stupidest things to buy right now.

Hamp, what is it good for?

Posted by Tracy Alloway on Dec 22 11:26.

In addition to the difficulty of converting temporary mortgage modifications into permanent ones, one of the big question marks hanging over the US Treasury’s Home Affordable Modification Plan is the redefault rate. That is, the percentage of homeowners who redefault on their modified mortgage.
FT Alphaville has mentioned before that in cases of severe negative equity, it might make more sense for a homeowner to make a couple of Hamp-reduced interest payments on his or her mortgage and then walk away. The US Treasury hasn’t given an official default rate for the programme yet, but figures like 25 per cent and 50 per cent have been bandied about.
In their US Securitised Product Outlook for 2010, however, Barclays Capital take a slightly more negative outlook on the redefault rate. It might be better than previous mortgage modification plans — but it’s still likely to be pretty dismal, they say:
Re-default performance for loans modified in Q3 08 has been dismal, with more than 60% relapsing into deep delinquency already. However, HAMP has been more aggressive than earlier mods – reducing borrower payments by 30-40%, compared with earlier modification efforts that typically reduced monthly payments by 15-20%. As Figure 6 shows, higher payment reductions reduce re-default rates, but only by 5-10% for that magnitude of payment change . . .
On the flip side, HAMP does not address the issue of negative equity, which is one of the primary drivers behind default . . . Taking these factors into account, we expect overall HAMP re-default rates to show not more than a 10-20% improvement over the default rates seen in past mods.
With the redefault issue then, plus the conversion rate for permanent modifications and various servicer problems, BarCap thinks we’ll see some sort of revision or significant tweaking of the programme.
Possible changes could include further streamlining the documentation requirement for Hamp applications, creating a lower debt-to-income target or second-lien programme, or, perhaps most significantly, starting principal forgiveness instead of just forbearance.
Here’s a summary:
Finally, watch out for new policy changes from Washington on the mortgage front. If HAMP does not work well (as we expect), and foreclosures keep rising, Congress might revisit some of the more radical suggestions from earlier this year, such as cram-downs, forced debt forgiveness, etc. On the agency MBS side, one tail risk is the prospect of an off-market, low mortgage rate provided by the government. MBS investors fearful of this shift compressed the coupon stack sharply in Q1 09 – if such an off-market rate is actually offered by the government, it could greatly hurt premiums and, thus, all agency MBS valuations
. . .
A greater share of debt forbearance mods would lead to upfront losses on the pool, in turn leading to higher initial [constand default rates]. However, since debt forgiveness mods typically perform better than comparable rate reduction mods, re-default rates would be lower (Figure 27). Higher losses upfront on the forgiven amount would imply that subordinates would be written down faster on subprime deals, causing crossover to occur sooner. This would benefit the second and third cash flows at the expense of the first cash flow bond as the principal waterfall switches from sequential to pro rata.
Given all of the above, readers might well be scratching their heads as to what the Hamp is actually good for. And on that point Barclays is very clear — shadows and cans:
To be clear, the modification program (HAMP) is not a silver bullet. As Figure 6 shows, historical re-default rates for all types of modifications are high – HAMP should be better, but not hugely so. But the process of modification buys time. It increases the number of months between the borrower turning delinquent and the home hitting the market. This is shown in the REO (real estate owned) line in Figure 5; even as foreclosures keep rising, the REO bucket has gone down. So kicking the foreclosure ‘can’ down the road has helped prices stabilize.
Intuitively, if there are millions of foreclosures to still work through the system, it is better to spread them over a few years than have them hit the market in six months – this prevents prices from over-correcting to the downside. And with the Administration focused on modifications, we expect long delinquency-to-liquidation timelines to help home prices.
As a result, our forecast calls for prices to drop 8% from current levels, before stabilizing in Q2 2010. The macro impact of this decline should be muted. After all, a house worth $100 is now worth $67 (prices have fallen around 33% from peak in Case Schiller). A further 8% decline from current levels is simply another $5.3. As every month passes without a sharp increase in the REO bucket or a sharp drop in home prices, the tail risk posed by housing declines ever so further.

`Real estate owned’ means the properties owned by banks and mortgage companies — the stuff we call `shadow housing inventory‘ since it’s not included in official measures of unsold housing inventory.

Related links:
FT Alphaville coverage of HampWill the groundhog see a shadow housing inventory? – WSJ Developments
Mitchell a key vote in cramdown battle – Phoenix Business Journal
OCC and OTS: Foreclosures Increase, but HAMP Mods Performing Better – HousingStorm.com

[Outlook 2010] Saxo's outrageous predictions for 2010

Posted by Izabella Kaminska on Dec 17 09:50.

Every year Saxo Bank comes out with a list of 10 outrageous predictions for the year ahead.

Previous predictions from the bank have included Ron Paul being elected US president, crude crashing to $25 per barrel and Chinese growth hitting zero.

Without further ado then, we present Saxo’s latest outrageous predictions for 2010:

1)Bunds yields will fall to 2.25%
Deflationary forces and excessive monetary policy will lower the yield on Bunds and other sovereign fixed income when the government fixed income traders refuse to buy into the “growth story” that is being told by the stock market. We believe that the German 10-Year Government Bond could be forced from 122.6 to 133.3 by the end of 2010 in a general flight to quality.

2) VIX will fall to 14
The markets are showing the same kind of complacency towards risk as they were in 2005-06. Although the VIX has been trading lower since October 2008, this could bring the VIX down from 22.32 to 14 as trading ranges narrow and implied options volatility declines.

3) CNY (China Yuan Renminbi) will be devalued by 5% vs. USD The efforts of Chinese authorities to stem the credit growth and avoid bad loans, combined with the creation of several growth bubbles could ultimately reveal the Chinese investment-driven growth as being deficient. The massive, Chinese spare capacity and the economic backdrop could be a deciding factor in devaluing the CNY vs. the USD.

4) Gold will fall to $870 in 2010 but will rise to $1500 in 2014
A general strengthening of the USD could break the back of the recent speculative element in gold. Although we are long term bullish on gold (believing it will reach $1500 within five years), this trade seems to have become too easy and too widespread to pay out in the shorter term. A serious correction towards the $870 level could shake out the speculative community while keeping the metal in a longer term uptrend.

5) USDJPY to reach 110
Although the downturn in the USD is rooted in irresponsible fiscal and monetary policies, we believe that the USD could snap back at some point in 2010 because the USD carry trade has been too easy and too obvious for too long. At the same time, the JPY is not reflecting economic reality in Japan, which is struggling with a huge debt burden and ageing population.

6)Angry American public to form third party in the US
The anti-incumbent mood is approaching 1994 and 2006 levels as a result of bail-outs and general disapproval of both the big parties. A demand for real change among American voters could propel a third new party to become a deciding factor in the 2010 elections.

7) The US Social Security Trust Fund will go bust
This is not so much an outrageous claim as an actuarial and mathematical certainty. The outrageous part is that social security taxes and contributions have been squandered for so long. 2010 will be the first year where outlays for the non-existing trust fund will have to be part-financed by the federal government’s General Fund. I.e. the budget trick, in reality a “fund” without funds, will be visible for the first time. Part of the social security outlays will have to be financed by higher taxes, more borrowing or more printing.

8)The price of sugar will drop one third
Despite a recent spike in prices caused by Indian drought and above average rainfall in Brazil, the forward curve already indicates considerable downside beyond 2011 so a return to more normal weather conditions in 2010 would make sugar one of the less inspiring commodities. Furthermore, the higher price of ethanol (which is correlated to the demand for sugar) has made both Brazil and the US lower the ethanol content of gasoline by five percentage points, consequently lowering the demand for sugar.

9) TSE Small Index will rise by 50%
Small cap firms have been underperforming the Nikkei, but their fundamentals indicate this is a “bargain index” compared with its large-cap peer. With a price/book ratio of only 0.77 and only about 12% of the index consisting of financials, we know no other index this cheap. Positive GDP figures in 2010 could very well make this index a surprise to the upside.

10) US trade balance will turn positive for first time in 34 years
Last time the US trade balance was positive was briefly in 1975 after a large drop in the USD following the aftermath of the oil crisis. The USD has now become cheap enough again to stimulate US exports and punish imports. The trade balance has already improved somewhat but change takes time and once it has momentum we would not rule out a positive US trade balance for one or more months of 2010.

To compare and contrast with how they fared before click here.

Article Series - Outlook 2010

1. The deluge begins
2. Deutsche Bank ponders all things sovereign
3. Goldman sees 2010 as 'exciting, with risks!'
4. Goldman Sachs up 12-mth gold forecast to $1350/toz
5. JPM targets 20% gain for Euro equities
6. Thundering Herd bullish on Euro equities
7. How will analysts fare?
8. Moody's sees sovereign states a-suffering
9. 10 surprises from UBS
10. Chasing the rally into the New Year
11. Saxo's outrageous predictions for 2010
12. Ten tweets from Wilmot

How the IRS sort-of-saved Citi

Posted by Tracy Alloway on Dec 17 13:35.

Who says the IRS isn’t, umm, understanding?

The US tax authority exempted the Citigroup, and some other bailed-out companies, from rules which would otherwise have led to the troubled bank losing $38bn worth of tax credits.

Citi had planned to repay the US government’s Tarp stake, and under IRS regulation, companies that encounter a change in ownership lose these tax credits. The rule is designed, according to the IRS, to prevent profitable companies from buying loss-making ones to evade taxes.

The rule-change has nevertheless raised eyebrows. From the Washington Post on Wednesday:

The federal government quietly agreed to forgo billions of dollars in potential tax payments from Citigroup as part of the deal announced this week to wean the company from the massive taxpayer bailout that helped it survive the financial crisis.

The Internal Revenue Service on Friday issued an exception to long-standing tax rules for the benefit of Citigroup and a few other companies partially owned by the government. As a result, Citigroup will be allowed to retain billions of dollars worth of tax breaks that otherwise would decline in value when the government sells its stake to private investors.

The “quietly agreed to forgo billions of dollars in potential tax payments” is a bit of a red herring, bit it has sparked quite a bit of outrage from the Washington Post’s taxpaying readers (all available for perusal on the paper’s dot.comments blog).

The issue here is that these tax credits — Deferred Tax Assets (DTAs) — make up a significant proportion of Citi’s capital. Yanking them because of a change in ownership, one caused by the bank repaying the Tarp no less, would have defeated the purpose of them paying back the Tarp in the first place, and probably ended up costing the US taxpayer more US taxpayer in terms of lost Tarp monies and potential support costs.

Reuters columnist Rolfe Winkler, who’s been following the Citi capital debate for some time now, posted a good illustration of the problem:

To be sure, there’s a degree of moral hazard involved here. The US government has just changed the rules to reflect very specific circumstances, with the effect of, as one Republican staffer put it “[inflating] the returns that they’re showing from the Tarp.”

The market’s not stupid, however. It knows Citi still has problems — notably it could still lose some of its DTAs if there’s a regulatory crackdown, or if the bank’s future profitability is less than expected. That’s one of the reasons DTAs make such shoddy capital — they’re only really useful when a bank is making (enough) money.

In any case, Citi’s Tarp repayment fittingly fell through on Wednesday after investors demanded a lower price ($3.15) for the stock than the government paid ($3.25) when it acquired its stake.

Related links:
Citigroup’s share sale under fire – FT
What’s up with Citigroup? – The Baseline Scenario
The rise of deferred tax assets in Japan – University of Chicago paper (via SSRN)

Digesting the Basel reforms

Posted by Paul Murphy on Dec 17 18:17.

The latest Basel proposals for the banking sector were released on Thursday, and they are not going down well.

Here’s a snap summary from the banks team at Credit Suisse:

The Basel Committee has published its latest thoughts on capital and liquidity. We are still digesting the main implications of this, but at first read it looks pretty punitive on the sector. In particular, the new definitions of common equity tier 1 appear to take a very hardline with the majority of deferred tax assets, insurance equity capital, excess expected losses, unrealised debt losses, minority interests and pension fund liabilities being deducted. Other supervisory deductions will get a 1250% risk weight on these proposals. The calculation of counterparty credit risk also seems to be changing markedly. The liquidity document seems less surprising with the broad thrust being an increase in Government bond holdings and a reduction in short-term wholesale funding which we have written about extensively before.

Overall, we believe this is negative for the European banks sector. Timeline for implementation isn’t until 2012, with grandfathering arrangements thereafter, but the market is likely to look through this and penalise banks which rely heavily on DTA, pension fund add backs, and financial subsidiary capital in our view.

For individual banks, we need to do more work, but our first read is that UK banks, in particular LBG and RBS look substantially exposed (see our research pre-empting this two weeks ago). But this will affect most European banks as well. For example, the French banks have 6-22% of equity tier 1 capital from minorities. Consider also that Credit Agricole and Natixis are potentially exposed due to the listed entity owning 20-25% of their own retail networks with the associated deduction 50% from tier 1 and tier 2 – the rules might not apply here but could create uncertainties until decisions are made in 2010. Another example is Dexia with an equity tier one ratio at 10.8% but below 5% if the €8.8bn of unrealised negative AFS currently not deducted is applied to tier 1. Other regions, like Scandinavia and Italy are arguably less exposed given tier 1 definitions are already prudently struck.

Of course, these are still proposals and there’s a lot of detail still to emerge. There might also be national discretions, although the aim of this in part seems to be to remove those. One need only look at the Australian banks, several of which would report equity tier 1 ratios 200bps higher were they to adopt UK FSA standards. But generally speaking, the definitions are tightening up for all. Of course, the BIS might apply relatively low equity tier 1 minima, in line with tighter definitions. The question then is whether the market would accept lower headline numbers, or still push for relatively high (e.g. 8-10%) ratios on the new definitions. At the very least, the BIS’ starting point seems to be a relatively hardline approach to new capital and liquidity definitions – and hence we would view this negatively for the sector as a whole.

The real sticking point here seems to be changes to the definition of Tier 1 equity. Minority interests no longer apply, unrealised losses (and gains) must be taken into account, the use of deferred tax assets is largely ruled out and there are stringent new rules proposed for the related treatment of pension fund deficits. In short, banks’ core equity is going to have to get a lot purer.

Also, at the Tier 2 level, it looks like banks will be kissing goodbye to the upper and lower divisions.

There are some very complex changes to the treatment of counterparty risk, including the charming concept of “wrong way” risk, and also alterations to calculations like the probability of default, which in future will include the important caveat: in a downturn.

Meanwhile, on the liquidity front, the proposed framework here is broadly as expected, with banks being required to hold significantly more government bonds on their books.

Here’s some more from Credit Suisse:

1. Liquidity coverage ratio. This new regulatory ratio aims to ensure adequate liquidity in the event of another market disclocation. It is meant to require a bank to maintain an adequate level of “unencumbered, high quality assets that can be converted into cash to meet its liquidity needs for a 30 day time horizon under an acute liquidity stress scenario”. The ratio is defined as:

· (stock of high quality liquid assets) / (net cash outflows over a 30 day time period), with a minimum of 100%.

With high quality liquid assets including Government bonds and covered bonds. This isn’t a major surprise and is effectively a similar definition to central bank eligible collateral pre-crisis. More surprising though is the regulator’s assessment of an extreme stress scenario:

· 7.5% of “stable” retail and small business deposits go in the first 30 days;
· 15% of “less stable”deposits, high net worth (uninsured) deposits and internet deposits;
· 25% of wholesale funding with a maturity of less than 30 days supplied by large corporate customers as part of an operational payments services float;
· 75% of wholesale funding < 30 days from large corporate customers other than as part of payment systems float;
· 100% of interbank funding with a maturity of less than 30 days.

2. Net stable funding ratio. This new regulatory ratio aims to “promote more medium and long-term funding of the assets and activities of banking organisations”. It is defined as:

· (available amount of stable funding) / (required amount of stable funding) with a minimum of 100%

The numerator of this ratio is roughly equivalent to “core funding”, as defined in the Reserve Bank of New Zealand regulations and in our recent note “More important than Tier One?”, 27 November. It is calculated using a weighting schedule as below:

· 100% of total tier 1 and tier 2 capital and preferred stock
· 100% of liabilities with a contractual maturity >1yr
· 85% of “stable” retail and small business deposits with maturity <1yr
· 70% of “less stable” retail and small business with maturity <1yr
· 50% of large corporate deposits with maturity <1>

plus

· 10% of all undrawn committed credit lines and overdraft facilities
· And a percentage of guarantees, uncommitted credit lines, letters of credit, potential money market mutual fund repurchase obligations etc, at local regulator’s discretion.

The denominator is calculated as a weighted sum of the asset side of the balance sheet:

· 0% weighting – cash, securities with a remaining maturity <1yr, interbank loans with a maturity <1 yr, securities held with an offsetting reverse repo
· 5% weighting – unpledged high-quality liquid securities (similar definition to central bank eligible collateral)
· 20% weighting – corporate bonds and covered bonds with a proven record of liquidity (ie, no major increases in repo haircut in the last 10 years)
· 50% weighting – other corporate bonds, gold, equities, loans to corporates with a maturity less than one year
· 85% weighting – retail loans with a maturity less than one year
· 100% weighting – all loans with maturity > one year, all other assets

All in all, the view seems to be that this is a tad more aggressive than forecast. According to back of an envelope calculations by Credit Suisse, the European banking sector as a whole will have an aggregate funding requirement of €1,100bn.

Credit Suisse says that is broadly as expected, but it still sounds like an awfully large amount of money.

Related links:
Bank capital rules face overhaul – FT
Strengthening the resilience of the banking sector – BIS
International framework for liquidity risk measurement, standards and monitoring – BIS

`There's no bubble in gold,’ CIBC says

Posted by Tracy Alloway on Dec 18 08:46.

The idea of a `gold bubble’ went stratospheric in recent days, as economist Nouriel Roubini blasted the “barbarous relic” and the gold bugs who followed it.

And indeed, on Thursday it seemed Roubini was somewhat vindicated, as the shiny stuff dropped below $1,110 for the first time since early November.

But there are (clearly) those who disagree with the gold bubble theory.

Wading into the debate on Friday, for instance, are the commodities analysts at Canadian bank CIBC, with a research note titled “Bubble, bubble, are we in trouble?” The subtitle, for those who can’t bear the suspense, is “Precious metals to continue their Royal Ascent”.

And the reasoning:

Gold has been exhibiting significant correlation to the U.S. dollar, yet we believe other fundamentals will support continued strong performance of the metal, including stronger investment demand, the market’s need for a safe haven investment, and the absence of growing mine supply.

. . .

The rationale for accelerated reactions to dollar-led gold price movement lies in the additional factors contributing to the strength in the metal. Currency movements may be important but they are not the only factor propelling the price of gold. Uncertainty of many factors has led to strong investment demand for the metal as one of the prime drivers to gold price increases. Whereas jewelry demand accounted for about 82% of metal purchases a decade ago, that figure has dropped with investment demand rising to as much as 73% of total demand in some recent quarters. Aside from the safety protection offered by bullion, we suspect that investors have sought to limit volatility within their holdings by diversification into traditionally counter cyclical vehicles such as gold.

The desire for diversification is not limited investors. In ever increasing amounts, Central Bankers have also joined the party that arguably they were responsible for its demise 12 years ago. Whereas back in 1997, there was selling pressure on bullion brought about first by the governments of the Southern Hemisphere (Argentina, Australia), followed by Switzerland, Netherlands and the United Kingdom, now there is net buying taking place among Central Banks. Key among the buying group of late is China and India. We think this trend to broader purchases by Central Banks will continue leading to a new source of demand that hitherto was a source of supply as Central Bank selling intensified at the turn of the millennium.

In the absence of growing mine supply, we anticipate that bullion will continue to perform well over the next few years and possibly longer. Short-term gyrations however will also be the norm and in the past two weeks we have seen what we consider to be a normal (and arguably healthy) correction to the upward phase of a continued long-term bull market for gold.

The bank is accordingly raising its gold price forecast for 2010 and 2011 from $1,100 and $1,200 an ounce respectively, to $1,200 and $1,400.

And just in case you’re still concerned gold might be in something of a bubble:

We do not believe gold has experienced a bubble with the recent pullback of about 8% in prices, any more than the pullback in May-June of 2006 signaled the end of bull market for bullion. We continue to expect that investors will continue to add to positions or more likely start to build positions for gold exposure. It is our belief that at least in Canada, generalists are well underweighted gold equities relative to the 13% weighting of the precious metals sector on the TSX. For the rest of the world, the holdings are less than in Canada and therefore may also need to be adjusted upwards to compensate for higher risk levels for alternative investments.

And so, CIBC also presents the below three charts.

The first showing, the current bull run in gold (from the low in circa 1999, when the UK, err, sold off its reserves) against the 1970s/1980s bull run that started in 1972:

The second shows the current gold bull run against that widely-known bubble, the tech boom of the early 2000s. The trajectory is a bit, umm, different:

Not to worry though, CIBC says. The picture is still very different between gold equities:

Related links:
A golden sell-off – FT Alphaville
Gold retreats on talk of bubble – FT

Debunking carry-trade denial

Posted by Izabella Kaminska on Nov 25 11:00.

To carry trade or not to carry trade. That is the question.

In the last few weeks a host of different banks have stepped forward to question both the depth and degree of the current dollar carry trade. Among them have been Goldman Sachs, UBS and Barclays Capital – all claiming the risks of executing speculative dollar-funded carry trades still outweigh the potential returns, meaning the trade isn’t half as popular as the market is making out, nor is it contributing to any such thing as a global asset bubble.

Considering the above then it’s interesting that Sean Corrigan of Diapason Commodities does his best to prove the exact opposite in his latest note.

To do so, he provides some pretty compelling evidence given, as he states, hard numbers are impossible to come by.

Exhibit a) comes in the shape of the following chart:

As Corrigan explains (our emphasis):

The first (which we have adduced before) shows the uncanny correspondence between the outstanding stock of commercial paper issued in the US by foreign financial institutions with the inverse of the US dollar trade-weighted index since the crisis intensified last year (i.e, the greater the appetite for cash, the weaker the buck).

If we assume that the 25% fall in non-cash assets and the coincident and hugely disproportionate 150% increase in cash holdings experienced by foreign-related commercial banks in the US over the past year is a sign of a certain anal retentiveness re their basic role, qua banks, this suggests that CP is not being used to finance any active, economic purpose in the Land of the near-Free Loan itself – an inference further reinforced by the fact that domestic financial CP outstanding has plummeted to what is at least a 9-year low. Thus, the correlation between funding and forex hints that the raising of dollars for use abroad is indeed what is at work.

But that’s not all. Exhibit b) provides further evidence of how funds are flowing out of the US:

As Corrigan explains, the chart is drawn from monthly Federal Reserve figures showing the stock of US banking claims on — and liabilities to — foreigners which are payable in US dollars. These figures, he says, reveal a pattern of reduced foreign holdings of US assets alongside a roughly equal and opposite expansion of US lending to foreigners. Corrigan interprets that as follows:

…given the anaemic nature of the recovery in trade or, indeed, any form of business outlay, one presumes must be funding either government deficits or feeding the swelling bull market in — well, just about anything and everything, really.

Ever the Austrian, Corrigan is naturally compelled to warn about the consequences of such flagrant carry-trade practices:

One of the main evils of easy money — utterly overlooked by its ragbag of macromancer advocates — is that it leads to a gross mispricing — and hence an ultimate misuse — of capital. While the simple proportionality between a given stock of money and a general price level (whatever that really means) seems intuitive enough, the Gordian tangle of ceteris paribuses involved in that assumption make it harder to spot in practice. Much more critical, as we Austrians are ever keen to point out, is the malign effect on relative prices, rather than on average ones. This is especially true of the relation between the prices of present goods and the entrained future ones which comprise capital goods.

According to Corrigan, you see, one of the greatest perils of easy money is that it detaches capital asset prices from those of the underlying capital goods upon which they are supposed to represent claims (a bit like the disconnect we’re experiencing in the oil markets we would presume).

Hence, the big danger is that money printed by central banks has gone straight into the hands of buyers of capital assets rather than capital goods — especially as the latter is still largely fixed on reducing outlays.

Of course, as the former has a problem with holding cash in rising markets, it’s fair to assume a type of tangential fractional reserve process has been created in which every QE recipient inevitably tries to reduce their own cash ratio to an acceptable minimum. That ratio, by the way, falls ever lower as markets rally.

Quid pro quo, a dollar carry trade is very likely fuelling a global asset bubble after all.

Related links:
Debunking the size of the carry trade - FT Alphaville
Roubini: Mother of all carry trades faces an inevitable bust – FT

Introducing financial oil leasing

Posted by Izabella Kaminska on Dec 16 17:15.
The concept of ‘leasing’ commodities has been well established in the gold market for a while.
The lease rate for gold is derived from daily gold forward rates (GOFO) published by the London Bullion Market Association. You arrive at the rate by taking the GOFO rate — the rate at which dealers lend gold on swap against US dollars — from the day’s Libor rate.
The biggest lenders of gold have always been central banks, while gold producers have often been those most keen to borrow for the purpose of pre-selling bullion to cover operating and extraction costs.
But while there’s been much discussion about the financialisation of oil as an asset class, much less has been written about how that transformation would inevitably lead to oil becoming a leased commodity in the gold sense, too.
Among commenters who have observed trends on this front is Chris Cook — an avid watcher of crude and product market developments, a former director at the International Petroleum Exchange and regular FT Alphaville commenter.
As he explained in a recent comment on a post featured on The Oil Drum, where he also contributes (emphasis FT Alphaville’s) :
It was the Goldman Sachs Commodity Index (GSCI) fund – which had a high component of energy – which first introduced the concept of ‘hedging’ energy price inflation.
In other words, people became interested in off-loading dollar price risk in favour of taking on energy price risk. Anyone familiar with futures markets will see that this is directly opposite to the wish of producers wishing to ‘hedge’ energy price risk in favour of taking on dollar price risk.
The point is that the motive of investors in doing this is the complete opposite of speculation, and in my view, the wave of Exchange Traded Funds that have piled into the market are beneficial in the genuine liquidity they provide to the market.
Unfortunately it is they, rather than manipulative producers and speculator intermediaries who have been mistakenly pilloried as the culprits for the ‘Spike’.
Perhaps the most important recent development in recent years was the smart move by Shell in 2005 in entering into a joint venture with ETF Securities. What this enabled Shell to do was to put to work some of their idle capital sitting in the form of oil either in tank, or even in the ground (where storage is free). Essentially investors loan dollars to Shell, and Shell loans oil to investors.
And as Cook goes on, there may be a key macro economic consequence of all this that differentiates it to the gold scenario:
Other players were not slow to pick up on what Shell had done, and it is from this point on that we saw fund money – from 2007 on flying from financial market risk – pouring into the energy market facilitated by a great deal of hype, and an arbitrage taking place opaquely inside and by reference to the global market price set by the BFOE complex of contracts.
Since there are now only about 70 cargoes (of 600,000 bbls) a month coming out of the BFOE oil fields it will be seen that it does not take too much money on the part of anyone so minded to support the price, insofar as it was necessary – and it is of course the case that oil supply and demand are increasingly tight.
I think that some producers came to realise that oil is more valuable in the ground, and that it may be good business to support the price by influencing the BFOE price in a not dissimilar way to that in which the International Tin Council supported the tin price pre 1985 by buying in stocks of tin.
Oil producers’ motivation to do this redoubled after the financial crisis commenced and interest rates went essentially to zero – - the “zero bound”. Why produce oil and exchange it for financial assets yielding 0% ? Producers preferred to lease or lend their oil instead. At this point we were seeing not just oil but all commodities becoming detached from real world supply and demand, and the forward price curve in commodities began mirroring the yield curve.
All of which might help explain the perpetuation of the contango in the oil futures curve.
Related links:The business of oil leasing - FT Long RoomWas Volatility in the Price of Oil a Cause of the 2008 Financial Crisis? – The Oil Drum