Don't bite the hand that feeds you

The following news release from Bloomberg highlights the wisdom in that old expression that one should never bite the hand that feeds you

Oct. 31 (Bloomberg) -- Warren Buffett’s Berkshire Hathaway Inc., the biggest shareholder in Coca-Cola Co. and Wells Fargo & Co., reduced its stake in credit-rating company Moody’s Corp. by 2.9 percent, the third cut in just over three months.

Berkshire sold 1.15 million shares and remains Moody’s biggest stockholder with 38.07 million, according to a regulatory filing yesterday. The stake sold for about $28.7 million, Berkshire said. The Omaha, Nebraska-based firm cut its Moody’s holding by 17 percent in July and 2 percent last month.

Moody’s, whose founder John Moody created credit ratings in 1909, is suffering from reduced demand for debt analysis after the economic decline curbed fixed-income issuance. The firm and rival Standard & Poor’s have been criticized by regulators and lawmakers for not foreseeing the wave in homeowner defaults that brought down the value of securities once awarded gold-standard AAA credit grades.

Moody’s fell 59 cents, or 2.4 percent, to $23.68 yesterday in New York Stock Exchange composite trading. It has slipped 20 percent in the past six months, trailing the 19 percent gain in the S&P 500 Index. Berkshire declined $1,180 to $99,000 and has gained 5.3 percent in six months.

Buffett didn’t respond to a request for comment e-mailed to his assistant, Carrie Kizer, after normal business hours.

High inter-market correlations and carry trade unwinding - e.g. $AUDJPY - disruptive to many asset classes

There has been a lot of commentary recently about the inverse relationship between the US Dollar and the S&P 500. What is perhaps more extraordinary from an inter-market analysis perspective has been the very strong correlation between one of the principal carry trade pairs - the Australian Dollar/Japanese Yen - $AUDJPY - and the MSCI Emerging Markets Index.



Using the daily changes in the exchange traded fund, EEM, and the daily changes in the North American closes for the cross rate, it is possible to derive the correlation coefficient value and the chart above shows the result of the linear regression from the beginning of January 2007 through the close on October 30, 2009. The coefficient of determination or R squared value for the relationship is approximately 0.62 which is one of the highest positive associations that I have encountered between a currency and an index.

An alternative way of considering the relationship is to normalize the paths taken by the two instruments using as an index base the values as of January 3, 2007, and placing the trajectories on the same 2 dimensional graph. The graphic below shows the remarkable extent to which the paths taken are correlated.



While correlations are interesting to observe there is often the implied question of so what?

This brings us to the takeaway proposition which is that the strength of the US dollar and perversely the Japanese Yen - which both, for different reasons, become the sought after currencies when traders/investors lose their appetite for risk - has a big impact on the attractiveness and viability of the carry trade. Put simply if the carry trade begins to lose its appeal - and both legs of (say) the Aussie/Yen trade are going in the wrong direction from the point of view of those long the carry trade - then there is a period of rapid unwind which can be very disruptive, especially for those asset classes which are being funded by financial engineering predicated on the carry trade.

Returning to the high R squared value - this has existed across the almost three year period under review and shows that when the currency pair drops so does the EEM.
In the last few sessions the currency pair has been exhibiting some erratic behavior which is of a hybrid nature - a roller coaster ride with spectacular waterfall like features for the passengers to really give them a good soaking.

As the carry trade loses its appeal so does the appetite for risk assets and this becomes part of the larger framework in which dollar strength - resulting not only from the actual unwinding of many other currency pairs but also from the flight to safety mindset - is not a positive for global equities.

Not so much

Until last week it seemed that the solution as to what to do with all of the jaw dropping amounts of "liquidity" being created by the world's central banks, was to buy Australian dollars.
Now, to quote Borat, not so much.

Niagara Falls - a new technical analysis pattern

The pattern above on the 4 hour chart for AUD/JPY might be best described as the Niagara Falls pattern. It arises when lots of fund managers all head for the same exit doors at the same time.

Central banks - meltups and meltdowns

This article captures the flavor of the inherent instability of the financial system better than most.

The past year has seen an unprecedented monetary stimulus unleashed on the world – although it is not quite true that we have never been here before. In 1990, in response to the savings and loan crisis, Alan Greenspan cut rates, committed to keeping them low, and freely supplied funds to US banks. Such policies are common to today’s quantitative easing programs – although, as Andrew Hunt Economics notes, they were not called QE at the time. It was, perhaps, half QE.

The result was a familiar “melt-up”. Banks borrowed from the Federal Reserve at 3 per cent, and bought longer-dated Treasuries that yielded twice as much. Thus recapitalised, they created further liquidity, engendering a rapid financial recovery. Equity markets soared, bond yields dropped, and emerging markets boomed. Recovery in the real economy followed three years after.

So far so good. Then came the meltdown. Greenspan started to tighten in 1994. But because banks were so highly leveraged to government debt, this produced a bond market rout. The price of 10-year bonds collapsed, yields soared, liquidity was sucked out of the system and the recovery stalled. Emerging markets suffered particularly: Mexico’s Tequila Crisis followed in December.

Might history repeat itself? Israel, Australia and Norway have already raised interest rates; India, Brazil and South Korea are forecast to follow shortly. Markets are not predicting the US, UK or eurozone to raise rates while recovery remains so weak. Meanwhile, banks are loading up on government debt.

This is partly because they want to ride the yield curve, as in the past. But regulators also want them to hold more “high quality” liquid assets. Coincidentally, governments also need to fund their budget deficits. Indeed, to raise their bond holdings to historic levels, Credit Suisse estimates eurozone and UK banks have to buy another €600bn of government debt. The irony is that when rates do rise, the 1990s example suggests the subsequent bond sell-off could be huge, so re-creating the kind of problems policymakers are now trying to prevent.

The UK economy- some ironic possibilities

The following are some musings on the UK economy prompted by an adage that seems quite appropriate for our times of thinking the unthinkable.

1.The UK public finances are in dire straits with a likely deficit this year well in excess of £200 billion and with red ink as far as the eye can see. It seems highly likely that within the next three or four years outstanding public debt will exceed 100% of GDP.
2. The UK is still in recession with a -0.4% GDP reading for Q3, 2009
3. The fact that the UK faces a national election within the next nine months means that there is no immediate political will to address the problem or even to spell it out to the electorate.
4. The markets are expected to fund the deficit through the continued purchase of gilts despite the fact that the Bank of England has indicated that it is winding down its Quantitative Easing program.
5. Sterling recently has exhibited as its default mode a tendency for sudden plunges against other major currencies.
6. A recent posting here reveals that the price of gold as expressed in terms of a variety of currencies showed that holders of the UK currency had lost the most purchasing power vis a vis the precious metal over the last five years. The real point of this is to highlight that the UK economy has historically been more inflation prone than many others.
7. Could the UK government - whatever flavor it takes after June 2010 - be faced with the awkward choice of having to approach the IMF for an emergency loan to bail out the gilts market and prevent a collapse in sterling, or to adopt the euro to seek some safety under the umbrella of a more globally acceptable currency?
8. Will Tony Blair, as the possible new President of the European Union, find that he has been provided with the unique destiny of rescuing the UK economy by facilitating the early adoption of the euro in place of sterling?

Mortgage backed securities - even more vaporware than thought

The New York Times for October 25, 2009 has a fascinating article about the likelihood that a considerable number of homes in the US do not have valid mortgage documentation. In the super hurry to securitize anything and everything it appears that the collateral packaging wizards have been remiss in maintaining adequate paper trails and back up documents on many of the properties covered under MBS's etc.

This adds another dimension to the financial black hole story. Not only do we have no idea what is the real mark-to-market value of products resulting from mortgage backed securitizations, but, even more bizarrely, the banks may not literally know what properties are actually covered under such contractual packages.

One surprising smackdown occurred on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

So the ruling may put a new dynamic in play in the foreclosure mess: If the lender can’t come forward with proof of ownership, and judges don’t look kindly on that, then borrowers may have a stronger hand to play in court and, apparently, may even be able to stay in their homes mortgage-free.

The reason that notes have gone missing is the huge mass of mortgage securitizations that occurred during the housing boom. Securitizations allowed for large pools of bank loans to be bundled and sold to legions of investors, but some of the nuts and bolts of the mortgage game — notes, for example — were never adequately tracked or recorded during the boom. In some cases, that means nobody truly knows who owns what.

Goldman Sachs = "hybrid hedge fund and bookie"

Close inspection of the graphic above really tells you all you need to know about the much heralded "super-talent" on Wall Street. The large red columns on the chart shows us just how much of Goldman Sachs' revenues come from trading its own capital. When I say its "own" capital this has to be seen in the context of that wonderful sleight of hand of modern capitalism - when times are good banks will vigorously protest how they are putting their own capital at risk and deserve to be compensated mightily; when times are not good, they will quietly use the public's capital to play with, but still make the case that they need to be rewarded generously in the interests of maintaining "orderly" markets.

In 2007, when capital markets were extremely cooperative the red column put in a rather staggering peak performance. 2008, which some may recall was a little more troublesome for markets in general, saw the red column drop back substantially.

Questions might legitimately be asked as to just how far the 2008 column might have dropped, even below the zero axis, if it had not been for the kindness shown by Secretary Paulson in making AIG's obligations to GS whole, rescuing the bank with $10 billion of taxpayers' money, fast-tracking the conversion from investment bank status to commercial bank status, and in essence providing a gigantic safety net under the financial system.

Rolfe Winkler in his blog at Reuters captures the flavor of Goldman's business quite well with this remark.

It’s a hybrid hedge fund and bookie, with an investment bank and asset management business thrown in for good measure.

All that I would add to the suggestion regarding its role as bookmaker is that GS is in the unenviable position of knowing that it can rely on laying its riskiest bets off to Tim, Larry and all their other chums and ex employees in Washington.

The part that I think irks most of us is the notion that bankers as punters are essentially counting on liquidity and favorable trading conditions. A cynic might even suggest that it is in fact the government's mandate to GS to provide the requisite support to create such conditions. They feel fully entitled to eye-watering compensation when times are good, and, the most generous welfare programs in the history of humankind when markets run into a spot of bother.

Let's allow Mr. Winkler to have the last word as he has mustered the energy to raise some pertinent further issues. However, I am afraid they will almost certainly go into that great black hole of silence and meet with no response from those who should be required to address them.

With that in mind, one is left to wonder whether Goldman was really worth saving last year. What have taxpayers received for $50 billion worth of cash and guarantees, for giving Goldman access to the Federal Reserve as its lender of last resort?

Saving Goldman was largely about saving the derivatives market, which is so big and unstable that the death of one counterparty could mean the death of all. With big commercial banks like JP Morgan Chase in deep, saving the derivatives business was as much about protecting depositors and maintaining the integrity of the payment system as it was derivatives themselves.

Many of us didn’t like it — we thought banks like Goldman should have been recapitalized the right way, by wiping out shareholders and forcing subordinated creditors to eat their share of losses. But that ship has sailed. We socialized the risk while privatizing the profit because we were told we had no other choice: The government had to guarantee the biggest banks’ liabilities because they were too unstable to survive bankruptcy or FDIC receivership.

If that’s true, why haven’t we seen any substantial reforms to reduce systemic risk? Congress is kicking around new resolution authority to help resolve failed systemically-important banks. But the goal should be reducing systemic risk to begin with. Yet serious reform of the derivatives market — something that would reduce its size significantly — is nowhere on the radar.

Truth and consequences

“The greater the lie, the greater the chance that it will be believed”.
“The surest way to remain poor is to be honest”

No attributions will be supplied for either of these citations but they are symptomatic of an age in which spin is the force majeure.

High beta stocks appear to be stalling

The high beta index, the Russell 2000 (RUT) could be stalling at current levels and notably has failed to make a comparable push this week to that which has been seen on the DJIA and S&P 500.
The index has certainly been very user friendly during the most lively part of the rally since July but the high beta stocks are not the best place to be if, and when, a corrective episode arises.

Keeping Mr Ratigan "on message"

In this Huffington Post article yesterday, Dylan Ratigan (ex CNBC TV journalist and now host of MSNBC's Morning Meeting show) is remarkably candid about the modus operandi of certain Wall Street activities, especially the over the counter versions of credit default swaps.

The key to success here is that when there is a default or claim against that so-called credit insurance -- the banks keep all the past payment -- and the taxpayer under threat of collapse pays off the claims while getting nothing in return.

This quite simply, is a brilliant way to steal our money.

Now this method of "business" is only possible if the government continues to allow these crooked insurance contracts to be written in secret, allows them to hold little or no money in reserve for payment and allows them to sell enough coverage on enough vital national assets that if there is a default -- the taxpayer has no choice but to pay.

Needless to say, J.P. Morgan & Co. has never had more revenue and the Goldman Sachs bonus pool has never been bigger.

Considering the $23.7 trillion of taxpayer money being used to support these Corporate Communists one would hope they could at least make a few billion in profits with it. In context, making a few billion risking a few trillion is a rather pathetic return after all.

Perhaps, in order to keep Mr. Ratigan more "on message", Rupert Murdoch should have a chat with him about a much more lavish broadcasting deal with more avenues and career opportunities within his other "entertainment properties".

Two nations with most developed financial services sector show most currency debasement over last 5 years

The graphic above shows an index for the price of gold as measured in each of five currencies where the base level for the index was set five years ago.

Perhaps not surprisingly the two nations with the most highly developed financial services sectors are showing (according to the benchmark of gold purchasing power) the most debasement of their currencies.

Holders of sterling now have the dubious distinction of finding that it takes £2.75 to pay for the same amount of gold that would have only cost £1 in October 2004. The UK is also within a few pence of equaling the highest price that gold has ever been in terms of its currency.

The US actually has the highest dollar price for gold that has been seen historically - indicated by the fact that the dark blue line on the chart is at its highest level. However in comparison with the UK where it takes 2.75 times as much currency to buy the same amount of gold as it did five years ago, the holders of US dollars only have to part with about 2.35 times as much as they did five years ago.

When commentators refer to the unfortunate plight of dollar based asset holders they should also keep in mind that the Brits have haplessly managed to outperform them over the most recent five year period.

Australian Dollar moves into area of previous strong support/resistance

The current view on the weekly chart for $AUDCHF shows that the Aussie dollar is moving higher into an area where strong trend-lines indicating support/resistance are likely to come into play.

A note on irony

Irony is the preferred tool to be used in framing those comments which the author does not expect to be correctly understood in real time.

Diversifying away from US dollar dependency - no more hurry up and wait

The report yesterday in the UK's Independent newspaper by Robert Fisk triggered several slightly bizarre reactions which ranged from brandishing the respected reporter as a conspiracy nut to dismissing the allegations as not very useful since Mr. Fisk is not by training an economist. (Actually I would have thought that was to his credit).

What was questionable about the Independent article was the emphasis that was placed on the notion that pricing oil in another currency than US dollars was really the thin end of the wedge which will lead to a phasing out of the greenback's role as the global reserve currency.

The problem with that part of the story is that it was not news, and nor does the pricing of oil really address the core issue which is the appetite that foreigners will have for dollar denominated securities, and in particular US Treasuries. I have expressed views on the unsettling implications of relying solely on the US dollar as the global reserve currency several times before including here, in this article , and also here.

As is often the case the Daily Telegraph's Ambrose Evans Pritchard has a good piece on the issue.

Beijing does not need to raise money abroad since it has $2 trillion (£1.26 trillion) in reserves. The sole purpose is to prepare the way for the emergence of the yuan as a full-fledged global currency.

"It's the tolling of the bell," said Michael Power from Investec Asset Management. "We are only beginning to grasp the enormity and historical significance of what has happened."

It is this shift in China and other parts of rising Asia and Latin America that threatens dollar domination, not the pricing of oil contracts. The markets were rattled yesterday by reports – since denied – that China, France, Japan, Russia, and Gulf states were plotting to replace the Greenback as the currency for commodity sales, but it makes little difference whether crude is sold in dollars, euros, or Venetian Ducats.

What matters is where OPEC oil producers and rising export powers choose to invest their surpluses. If they cease to rotate this wealth into US Treasuries, mortgage bonds, and other US assets, the dollar must weaken over time.

"Everybody in the world is massively overweight the US dollar," said David Bloom, currency chief at HSBC. "As they invest a little here and little there in other currencies, or gold, it slowly erodes the dollar. It is like sterling after World War One. Everybody can see it's happening."

What I find most unsettling about the way in which many pundits continue to dismiss the de facto decline in confidence in the US dollar is the the highly complacent notion that policy making with respect to the state of the US public finances is fundamentally a domestic, Washington based, matter. Until the global financial system has moved further along the path of diversifying itself away from dependence on a single reserve currency, the trillions of dollar which are piling up on the public balance sheet in the US are not issues which can be decided upon by interest groups, politicians and a central bank in Washington acting only with regard to their domestic agenda.

A crisis in confidence in US government securities, brought on by the ongoing attrition in the dollar as a store of value, would lead to an avalanche of liquidations which would completely overshadow the near meltdown of last October.
In the dire circumstance where there is a serious questioning as to whether to continue to prop up an asset class which has passed its "sell-by" date, cleverly chosen phrases from Messrs Bernanke and Obama about further guarantees, underwritten by US taxpayers, would be unlikely to restore calm and appease anxious foreign sellers of US securities.

The time to move forward on further reserve currency diversification is sooner rather than later and the gold market is now sending that message loudly and clearly.

U-6 employment statistic in the US at 17%

The US employment data statistics make for sober reading. Here are some comments from Mike Shedlock's blog in reference to the table above.

The official unemployment rate is 9.8% and rising. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6.

As can be seen the U-6 number currently stands at 17% which gives a better estimation of the extent of under-utilization of the US labor force (and the concomitant hard times) than the U-3 statistic.

Japan's Nikkei breaks below key levels

In Asian trading on Friday October 2nd, 2009 the Nikkei 225 broke below two major support levels as the chart above reveals. The index completed its move below all three key moving average levels with a close below the 200 day EMA (the green line on the chart). In addition there is a clear violation of the uptrend line through the lows since the March bottom.

If the yen continues to strengthen against the US dollar, and if US consumers continue to lose jobs, the outlook for the Nikkei increasingly looks like a prolongation of its 20 year bear market.

On the subject of US non-farm payrolls it is worth noting that if the one million plus workers that have "left" the US labor force since May (i.e. they are too discouraged to look for work and drop off the official statistics) were added back into the unemployment figure the U3 percentage would be 10.4%.

For a good discussion of the real way to look at the US employment data the following article is recommended.