Archive for the ‘International’ Category

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Oil prices for 2012

Thursday, December 15th, 2011

Knowing how others are reacting to the market is sometimes the most effective approach to personal investing.   Right now oil traders/speculators have placed unhistorically large and polar opposite options and futures trades on oil reaching either $150/barrel or $50/barrel over the next year.   They are placing these trades based on tail risk (a really BIG bad or good outcome that is unlikely) in the oil markets for 2012.  It is not often that the market place has two completely different directional bets occurring simultaneously. 

Traders believing the turmoil in the Middle East will heighten (oil embargo from Europe on Iranian oil, Israel bombs Iran etc.) are in the $150/barrel camp.  On the opposite side of the spectrum are those in the $50/barrel camp; they are focusing on the collapse of Chinese growth (due to over indebted banks from real estate loans) and the collapse of the Euro and/or a major recession in Europe (caused by the austerity measures suggested by the Germans to get European countries back to fiscal prudence).  The options market has seen more protection/speculation for an increase than a decrease in oil prices (meaning buying protection/speculating on the downside is cheaper than doing so on the upside).   Since traders and/or speculators have placed such huge bets on these two potential oil price outcomes, any changes in oil prices will be magnified.

Bottom line:  Investors should be prepared for major swings in oil prices, up and down, and have plans on how this will affect their portfolios.

Always Asking, Never Assuming™

Christopher Holtby

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Canada and Sweden: Examples of a bank crisis

Monday, November 15th, 2010

In the 1990′s, Canada and Sweden experienced a bank crisis and relatively severe currency problems.  Fast forward 20 years, both countries have emerged from the US credit crisis intact, stable and growing.  Although, there are signs of an overheating Canadian residential real estate market causing the Bank of Canada to raise rates by 1% in 2010.

In the 1990′s, the beginning and end to Canada’s and Sweden’s bank crisis took roughly the same path: Stage 1: Bank crisis; Stage 2: Corporations react by cutting expenses and strengthening their balance sheets; Intermission; Stage 3: Households cut back on spending, increase savings, and pay down their debt; Time passes; Stage 4: Government makes structural, painful adjustments for the economic recovery.  Sound somewhat familiar?

Regarding the US, the wild card is how the speed and strength of household adjustments can occur when Washington keeps giving the electorate short-term candy reforms.  Reforms which would promote long-term growth require pain of some type. Post World War II recessions were not caused by an over-leveraged economic system.  For example, no post WWII recession had households paying down debt by such large amounts as today (i.e. household debt decreased $374 billion since 2Q2008).  The four pillars of a typical post WWII recovery had one of the following: consumer spending, employment gains, revival in residential construction, and ending of inventory liquidation.

Bottom line: The Federal Reserve cannot solve our current problems with monetary solutions if the Legislative and Executive branches of the US government do not make structural sound reforms.  The history of Canada and Sweden in the 1990′s gives the investor a sense of what is necessary.

Always Asking, Never Assuming™

Christopher Holtby

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The story behind the US trade deficit

Tuesday, October 12th, 2010

The US trade deficit rose from $42 billion in May to $50 billion in June (numbers not seen since summer of 2008).  Trade deficits rise for two reasons: consumers are spending more or adjustments to the international trade imbalances between surplus and deficit countries via currency/interest rate differentials or manipulations.

Over the last 20 years the world has been separated into surplus and deficit countries.  Japan, China and Germany are leading surplus countries.  America, UK, and most of Europe are leading deficit countries.  The surplus countries are dependent on these surpluses for economic and employment growth.   The recent credit crisis stressed this relationship between surplus and deficit countries.  Households in deficit countries are lowering their consumption, increasing their savings.  This has forced surplus countries to use unconventional tools to maintain the status quo for their countries excess capacity to be purchased by the households of the deficit countries.

Germany has reported huge surplus numbers since the decline of the Euro.  China has offset the rise of the Renminbi with cheap credit to the countries banks thus protecting China’s surplus numbers.  Europe’s deficit countries have had a difficult time raising debt, making them a less relevant recipient of the surplus countries destination of their excess capacity.  Global trade must balance.  The US, with it’s flexible and open financial markets, will likely absorb the majority of this adjustment to balance the global trade equation.

For example, China has been buying Japanese Yen instead of US dollars as part of the goal to make Japanese exports relatively more expensive than Chinese exports (or least the Japanese components).  Japan understanding the importance of exports to it’s economic model has been attempting to neutralize these effects.

Bottom line:  US households are de-leveraging.  The US deficit is increasing.  Surplus countries, focused on their economic growth, believe the US Executive and Legislative branch will not make structural changes to disrupt their economic model of the US absorbing their excess capacity via currency manipulations (e.g. what they produce and export).  Trade wars occur when one party believes their economic model is at risk.  Whether we reach such point is unknown, but the risks are building.

Always Asking, Never Assuming™

Christopher Holtby

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Devaluation of one’s currency and gold

Tuesday, September 28th, 2010

Not since the 1930′s has the world seen developed and developing countries either blatantly devaluing their currencies (Switzerland 2009, Japan 2010) or attempting to debase their currencies (US and UK 2010).  There is more to this story than most people expect, which I will explore in latter postings.

In the 1930′s, the major countries of the world, based the value of it’s currency against a fixed exchange price to gold.  The effect of this policy, in a period of decreasing private demand (another term for a recession or depression), magnified the effects of deflation as the government could not ”print money” due to the gold/currency fixed rate (the central bank could not print money that is linked to a  corresponding value of gold).  Beginning with Spain (1927) and ending with France (1937), countries de-linked their currencies to gold, allowing the central bank to devalue their currency (i.e. print money).  In the US, this allowed the Roosevelt administration to “pump” money into the system as the household and corporate sector demand evaporated.  The 1930′s showed that when all countries de-value at once, little was gained in relative international trade competitiveness.  The only real result was political tension and foreign-exchange rate uncertainty.

Fast forward 70 years.  Today, the daily foreign exchange market of roughly $4 trillion makes moving foreign exchange markets more difficult.  Printing money to devalue one’s currency needs to be done in massive amounts.  Switzerland gave up the attempt to de-value it’s currency last year after the intervention involved 40% of it’s GDP.   There is a struggle between the surplus countries keeping their currencies artificially low and deficit countries choosing to rectify their deficit positions.

Bottom line: Every country cannot have a surplus account because for every net exporting country there has to be an offsetting net importing country.  A currency cold war, of sorts, has begun between the surplus and deficit countries.

Always Asking, Never Assuming™

Christopher Holtby

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Multi-tasking

Thursday, June 10th, 2010

Men can’t multi-task.  Markets can’t either.  That makes investing frustrating.  There are risks (that can be statistically measured) and uncertainties (which cannot be measured) lying below the surface that affect either short, intermediate or long-term investment valuations.  How you juggle those issues is why I have a job.

The U.S. saved Europe from Hitler and Japan from Emperor Hirohito.  The Marshall Plan financed the re-building of Japan and Europe.  Now Europe and Asia want the U.S. to “bail” them out again.  Europe is focused on tightening fiscal policies, which will reduce their domestic demand and lower their currency further, making their exports more competitive.  Asian economies are holding their currency values down, which makes their exports cheaper in comparison to the U.S.  These two regions will run large current account surpluses (e.g. look at Swiss National Bank actions to hold down the Swiss Franc value).  Global trade is a zero sum game.  The U.S. would de facto accept a stronger currency, much larger budget deficits, and lower private savings.

The G20 meet in Toronto in late June.  Earlier communique from the G20 talked of a re-balancing strategy, where global growth occurs without re-enforcing the current large trade imbalances between Asia, Europe and America.  Talk is cheap.

If the imbalances become worse because of the Asian and European strategies, the U.S. dollar will become very over-valued and cause a larger budget deficit (e.g. foreigners will buy U.S. Treasuries to finance their growth).  The long-term risk would be an attack on the weakened financial condition of the U.S. as Europe regains it’s attractiveness to global investors, and Asian economies mature and domestic demand grows rapidly.

Bottom line:  What could happen might not happen.  This problem is like a slow moving train which is far, far off into the distance whose direction could change at anytime.  It would be wise to weigh your non-U.S. dollar exposure against the maturity of liabilities.  It would be wise to not create a directional bet in your portfolio.  Monitor trade imbalances between relevant countries.

Always Asking, Never Assuming™

Christopher Holtby

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Country risk and international/emerging market investments

Monday, February 15th, 2010

Beginning with the creation of the European Union through the Maastricht and Lisbon Treaties, a generation of investors no longer worried about European country risk.  German bonds and Greek bonds traded within a few basis points of each other up to late 2007/early 2008.  Economic historians will point to the periods between 1946 and 1999 as being very challenging.  Deciding which European countries to invest in and how was tough.  You had the Club Med countries experiencing several periods of currency devaluation.  The markets provided guidance on the risk between these European countries with credit spread differentials on corporate and government debt.   Since the creation of the European Union, German and Greek bonds traded based on interest rate differentials.  No longer.  They now trade based on credit differences.  Risk and return eventually come back into balance.  The only question is when.

One great aspect of capitalism is that it allows a society to get richer (source: Schumpeter).  Capitalism also brings about creative destruction.  The global stock and bond markets are in this current phase.  I experienced such a phase in Canada during the late 1980s through the mid-1990s (family businesses and investments).   There is opportunity in a crisis.  There is also the need to ensure one’s assets are intact at the end of the crisis or the creative destruction phase.

Money managers will need to avoid the pressure thrust upon them from pension consultants and the like over the last 25 years to base their country weightings on the EAFE Index.   Sometimes it makes sense to have a zero weighting to Japan (currently a 23.5% weighting in the MSCI EAFE Index).

Bottom line: Stock picking, not country allocation, has historically provided a balanced risk/return trade off.  Policy/political risk during a creative destructive phase is very real (US is especially included in this category).

Always Asking, Never Assuming™

Christopher Holtby

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Internal disagreement with Beijing

Tuesday, December 22nd, 2009

Because of China’s current and future influence on global economics and finance, it seemed wise to spend a few weeks researching China’s operational and structural issues.  The butterfly effects from China have global investment knock-on effects.  There will be a series of forthcoming blogs stemming from my research. 

Any emerging country needs to have an industrial base.  Generally, the steps are: 1) build, 2) organize, and 3) run efficiently.  Over the last 20 years there has been a struggle between the central planners in Beijing and the provincial entrepreneurs over the vision for and implementation of an industrial base.  Beijing wants to create an industrial base that is organized and efficient (e.g. capital and human resources).  The provincial entrepreneur wants to make money without any thought given to the grand schemes coming from Beijing.

Right now, China’s steel industry is the largest in the world.  The excess steel production in China is greater than the total steel production of Japan (world’s 2nd largest producer).  China is the world’s largest producer of cement, plate glass, coal chemicals, crystalline polysilicon, wind power equipment, ships, crushed soybeans and fertilizer (source: Urandaline).  40% of the world’s capacity of crystalline polysilicon, a key ingredient in solar cell production, is in China, with enough production capacity to supply the world 2x over (low-cost solar panel prices have dropped 85% in 9 months).  In 2007, Beijing wanted to close inefficient and polluting small smelters, so they raised the required capacity minimums.  The smelters just produced more, thus thwarting Beijing’s goals.  Private industrialists work closely with local and provincial officials who want tax revenue.  For example, in western China, local governments have welcomed new aluminium and ferroalloy facilities, even though Beijing has warned that excess capacity will lead to bankruptcies.

The ability of China to export their excess capacity from their industrial base requires external demand for that excess capacity.  The Euro zone and America’s demand for China’s excess capacity is slipping rapidly, as those economies re-calibrate to their new deleveraged, slow-growth economies.  Razor-thin margins on China’s overcapacity will lead to bankruptcies and low quality products (remember the lead toys from China?).  Except for a few industries (cement and steel), Beijing has not followed through with punitive action for those provinces supporting over-capacity in a range of industries.  Investors (mostly local banks fed by state banks) do not forsee any penalties and will keep snubbing their nose at Beijing until something changes.  This means that China is creating an industrial base that is fragmented and inefficient.  An inefficient allocation of capital means low returns.  Low returns are not how growth is maximized.  However, Chinese politicians and entrepreneurs are quick learners and will eventually correct this current path.  The timing is the unknown. 

Bottom line:  China’s economy is subject to the same economic rules as all other economies.  

Always Asking, Never Assuming™

Christopher Holtby

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Iran and you

Tuesday, December 15th, 2009

Financial markets and investors view geopolitical events as odd, almost non-important events.  The number of variables influencing geopolitical outcomes are so numerous that no computer program currently exists that can create a reliable bell-shaped curve of probable outcomes.  As we read about and consider various geopolitical outcomes, our minds hurt thinking about the variations and influencing factors.

Iran is focused on regime survival.  It has learned from North Korea that possessing nuclear weapons almost guarantees regime survival (US does not want to destabilize North Korea).  It is widely believed that Iran is close to nuclear capability, but it is unknown how close they are to a nuclear weapon.  Iran is a Shiite Muslim country, whereas Saudi Arabi is a Sunni Muslim country.  As we have learned in Iraq, these two arms of Islam do not get along (see current fight in Yemen between these two Islamic factions). 

After the summer 2008 election in Iran, which resulted in protests and riots, the Iranian government was able to shut down most modern forms of communication within Iran (Twitter, Facebook, cell phone, etc.).  During one of the protests, there were chants of  ”Death to Russia”.  This was odd, as the normal chants are for the destruction of America, Israel, Great Britain, and sometimes France, but Russia?  Analysis has found that Russian intelligence provided the technology to the Iranian regime to shut-down communication systems during the summer 2008 riots.  Russia has also built rail systems to transport gas to Iran in the event of an embargo from the West.

Israel knows that two nuclear weapons could destroy roughly 70% of their population (source: Stratfor), making an Iranian regime with nuclear weapons untenable.  Russia wants NATO and the US to stop “messing” in their spheres along the old Eastern block.  Russia also wants Western capital.  Some 40% of the world’s oil flows through the Straits of Hormuz (source: Stratfor).  Iran has threatened to mine the Straits of Hormuz if anyone takes military action against it.

The “players” have three options: 1) buy off Russia, 2) carry-out strikes against Iran lead by the US, and 3) buy off Israel.  Nobody knows what Russia’s or Israel’s ”last minute” deal-making would look like.  Nobody knows the outcome.  Obama has promised Israel a 12/31/09 decision, which was extended from an early September 2009 decision deadline.

Bottom line:  For those having agility, geopolitical crises provide great opportunities.  It is not possible to model the various outcomes, with any degree of usefulness, of the current Iranian situation.  The world is a messy place.   

 

Always Asking, Never Assuming™

Christopher Holtby

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Is government debt the next subprime?

Sunday, November 29th, 2009

One of the non-government organizations I keep tabs on is the Bank of International Settlements (a central bank’s bank) based in Basel, Switzerland (established in 1930).  This organization is pivotal to how the Basel Accords are written and monitored by regulators and commercial banks around the world.  The most recent accord, Basel II, provides suggestions on banking laws and regulations in order to create an international standard.  Domestic bank regulators, such as the Federal Reserve, use these suggested rules when deciding on the capital requirements that their domestic banks need to protect against the types of financial and operational risks inherent in their business.  Having one set of rules allows JP Morgan Chase Bank to understand and feel comfortable trading and dealing with Ziraat Bank of Turkey (this is critical for global trade to exist).

Bank regulators worldwide are working on mechanisms that will help avoid another repeat of the 2007-2008 liquidity crisis in the international financial system.  As reported in the Financial Times and Bank of International Settlements, the focus has been on banks needing a greater allocation of their assets to “safe” investments such as government debt and government agency debt (in the US, that would be Treasury and agency bonds).  Last year, the banks held illiquid mortgage derivatives which created a solvency problem for the capital ratios (e.g. Lehman, Merrill Lynch, Goldman, Morgan Stanley, etc.).  Government debt is liquid (you can sell just about any amount at anytime with a very, very small spread between the bid price and the ask price).  The probability of outright default on government debt in the major developed countries seems very small.  However, those countries are currently issuing copious amounts of new debt without, as of this writing, instilling some sort of fiscal discipline. 

Investors in US government and sovereign bonds should watch how the new Basel II accord deals with the margin for error for price decreases of these bonds and the rules for capitalizing banks in general.

Bottom line:  There is no free lunch.  Hopefully, the next big crisis will take a few decades to arrive.   Being aware of the global financial “plumbing” system provides clues on leverage and the pricing of spread risk.  

[Disclaimer:  This posting should not be construed as a recommendation to purchase or to allocate money to bonds of any sort, nor is it providing specific investment advice.] 

 

 

 

Always Asking, Never Assuming™

Christopher Holtby

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Chinese Property and Stock Markets and Emerging Mkts

Friday, November 20th, 2009

As reported by Xinhua news agency, Fan Gang, the director of the National Economics Research Institute and a member of the monetary policy committee of the People’s Bank of China (China’s central bank), sees excessive liquidity, a devaluing US dollar, and extremely low interest rates as setting the stage for asset bubbles in the Asian emerging markets.   

The Chinese government has close links to and influence on the banking sector.   The banking sector becomes a de-facto arm for the Chinese government to influence the flow of credit in and out of the economy, which affects the pace of economic and employment growth.  The ultimate goal for Beijing is to provide stability for the majority of the Chinese population still living below the poverty line.

In 2009, the Chinese bank increased its loans to 33% of GDP, which is titanic number.  In February, April, May, July and August 2009, banks had surges of lending.  In March, June and September 2009, the banks reined in their lending, negatively affecting the ailing sectors of the economy.  This has caused a fiscal and monetary policy debate between the government and the banking sector on how to stabilize growth and employment using abrupt start/stop fiscal and monetary policy.  The Chairman of the Industrial and Commercial Bank of China believes asset prices are just recovering from recessionary levels, whereas the statements of the chief of China’s Bank Regulatory Commission show they are worried about loose liquidity creating asset bubbles (specifically real estate and stock markets).

Bottom line:  China has been a major contributor to global growth in 2009.  Historically, the peasants and politicians have ruled the direction for China.   Paying attention to Chinese fiscal and monetary policy is critical in order for investors to understand the knock-on effects for emerging market investments, commodity investments and  global growth.

Always Asking, Never Assuming™

Christopher Holtby

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