Global Investing

The Big Five: themes for the week ahead

Five things to think about this week:

Q3 – CLUES AND CUES
- Global equity markets started the quarter positioned for economic stabilisation after a strong Q2 performance but, even so, EPFR data shows less than a third of the cash that flooded into money market funds in 2008 has exited in the year to date. The Q2 reporting season, which is about to kick off (Alcoa out this week), will show whether there are reasons for investors to draw down their cash holdings further. The U.S. data that came out before the long July 4 weekend held more negative surprises than positive ones, and macroeconomic confirmation of recovery will be needed to tempt more wary investors into equities.

BOND YIELDS
- Benchmark U.S. and euro zone bond yields broke lower after the U.S. non-farm payroll data but the VIX hit some of its lowest levels post-Lehman and a recent compression of intra-euro zone spreads has yet to go markedly into reverse. Which of these trends turns out to be sustainable will become more evident in the next few weeks, particularly as U.S. supply resumes this week with TIPS, 3, 10, and 30 year auctions.

L’AQUILA SUMMIT
- The slow-burning international reserve currency debate could pop up at the G8/G8+5 big emerging powers summit in Italy this week. China’s public stance is that it is not pushing the issue but Beijing also reckons a debate on this would be normal at such a forum. It is unclear if any final statement will mention it in a way that would rattle FX markets. But sideline comments on the debate will be closely watched and particular focus will be on which countries, if any, would be willing to join China, Brazil and Russia in their commitment to buying the IMF SDR notes — for which crucial groundwork was laid down this week.

FOLLOW THE MONEY
-  Questions remain over what use is being made of the 442 billion euros ($619.6 billion) of ECB one-year money that was pumped into the market. A spike up in overnight deposits clearly suggests banks are continuing to park a significant proportion of that cash at the ECB. Any swings in that data will be closely watched for signs that the money could be put to work in other parts of the rate/fixed income market — or maybe even filter through to the economy in the form of lending. The BOE will also be in focus, with clues sought on the outlook for its QE strategy.

COMMODITY RISKS
- Commodity price volatility looks to be on the cards. A rally in industrial raw materials risks tapering off unless a stronger economic rebound materialises soon, both in big emerging economies and their developed counterparts. For soft commodities, the focus is increasingly turning to the potential impact on harvests from El Nino weather patterns that are developing. Investors will have to decide whether they would be better off exposed to stocks linked to the metals/minings, which will at least earn dividends, or to the commodity itself — or neither. As for any spike up in food prices, the fallout would be even wider at the current economic juncture, and complicate both policy and investment decisions.

The Big Five: themes for the week ahead

Five things to think about this week:

EYE ON CENTRAL BANKS
-  Investors will be on the lookout for any further signals on quantitative easing when the European Central Bank and the Bank of England announce their decisions on Thursday. Analysts see the ECB leaving rates on hold but pushing ahead with and possibly extending a plan to buy up to 60 billion euros in covered bonds. The focus will also be on growth forecasts for the next year and the message they send about the pace of any recovery.

COMMODITIES SUPERCYCLE, CYCLICAL SURGE
- Oil prices are nearly double their four-year low set in December and the Baltic Dry Index, which tracks rates to ship dry commodities, has risen more than 300 percent since the start of the year. Coupled with a weakening dollar, investors might be bracing for the return of the supercycle in commodities. The resultant inflationary pressures could push investors away from government bonds and into the arms of equities.

EMERGING DISCONNECT
- High-yielding emerging market currencies remain weak, weighed down by poor domestic growth prospects even as emerging equities rise along with their developed market peers, buoyed by hopes of a global economic recovery. The disconnect is likely to persist with governments, particularly in emerging Europe, looking likely to lower interest rates further.

Big Five

Five things to think about this week:

VALUATIONS
- The MSCI world stocks index has rebounded 37 percent since March, the VIX fear gauge has hit its lowest level since September 2008, and positive earnings surprises in Europe are marginally outstripping negative ones. But there are serious questions over the equity market’s ability to sustain its rise.

MACRO SIGNALS
- Trade data from the U.S., Canada and the UK, all out in this week, will be combed for signs of any recovery in global commerce. Also due are flash GDP data from the euro zone, industry output for the U.S., France, Italy, the euro zone and the UK, and Japan machinery orders.  
  
QUANTITATIVE EASING
- The ECB has finally shown willingness to deploy unconventional easing measures but it’s hard to judge the success of such steps. Narrowing credit spreads, stock markets’ bounce and gains in emerging market assets all show efforts to restore confidence in the financial system are having an effect. But if getting and keeping bond yields down is the yardstick for success, it’s unfortunate that 10-year UK and U.S. government bond yields are back up to levels seen before the announcement of quantitative easing in those countries. And diminishing returns on further balance sheet expansion raise questions over how much more money central banks can print before inflation fears start to preoccupy policymakers and markets.
  
COMMODITIES
- Confusion over the reasons for the commodities rally has reduced the usefulness of commodities prices as indicators of the industrial outlook. An apparent economic recovery in China has helped to boost the CRB commodities index by 21 percent from February’s lows. But how much does the rise reflect a change in supply/demand for commodities, and how much is it simply due to idle money flooding back to unstable markets? Similarly, why has spot gold remained strong above $900 as jitters over the financial system decrease? Gold could be reflecting expectations that recovering economies will boost physical demand for the metal, but it may also be responding to fears of currency debasement after central banks’ radical monetary easing.

EMERGING MARKETS 
- Rising commodity prices and an easing dollar have offered a perfect environment to re-enter emerging markets. The coming week’s  EBRD meeting will focus attention on central and eastern Europe and how it is coping with a nasty period of refinancing (albeit less dire than the IMF initially estimated).

from Commodity Corner:

Correlation Between Oil and Equities Markets

oil-vs-stock-market

Oil prices have been trading in an unusually strong positive correlation with equities markets over the past few months on hopes that signs of an economic recovery could mean a boost for energy demand.

But with oil and product inventories swelling and little sign of demand improving in the United States and other big developed economies, analysts warn that the linkage may be hard to maintain, especially if U.S. motorists cut back on vacations this summer.

Greenland – new and poor country?

Greenland, an arctic island with a population of 57,000, voted for self-governance from Denmark in a referendum on Tuesday. The “Yes” camp won an overwhelming 75 percent of the vote.

Shrimp and halibut fishing and tourism form the backbone of the economy but the island is rich in minerals and its waters may hold vast hydrocarbon reserves.

The resources setting is very much like one of Iceland, although Greenland – made up mostly of Inuit people who live in small, isolated villages – does not have a huge banking sector. (Neither does Iceland these days, some might argue.)

Hedge funds and commodities find interest cooling

rtr1w493.jpgIt was not so long ago that hedge funds and commodities were the two red hot areas to invest in.

The credit crisis has shown that investor interest can quickly cool.

Many hedge funds betting on a so-called “super-cycle” have been caught out by a sharp pullback in commodities after a five-year bull market and are now facing the task of soothing anxious investors.

One of those to have suffered – hedge fund firm RAB Capital - is trying to strike a bargain with investors in its flagship Special Situations strategy, which has plunged 48 percent year-to-date after some bad bets on mining stocks plus a high-profile mistake at Northern Rock.

Commodities hedge funds feel the heat

rtx7ukh.jpgThe heat is on for hedge funds with commodities bets.

Earlier this week Ospraie Management told investors it is shutting its flagship fund after it plunged 27 percent in August. The fund’s energy and commodities stock positions fell as investors worried if a global economic slowdown will mean less demand for resources.

And now RAB Capital’s Philip Richards is giving up the CEO role to focus on his funds after an awful period of performance for his once high-flying Special Situations fund.

Losses on small-cap mining stocks, as well as its high-profile error in buying into troubled bank Northern Rock, meant its listed feeder fund fell 38.1 percent from the start of the year to Aug. 21.

Barrels and ounces

The price of oil was falling sharply on Tuesday after traders stopped worrying about former Hurricane Gustav’s winds, but by at least one calculation it remains very pricey – that is, its link to the price of gold.Some market watchers argue that there is a long-term relationship between the prices of the two commodities. Roughly speaking, this theory would have 10 barrels of crude oil costing the same as one ounce of gold.  Back in March, for example, gold hit a record of $1,030 an ounce and a barrel of oil brought around $105.Oil

By July, however, gold had fallen and oil had risen to the extent that the ratio was not 10 to 1, but 5.9 to1. Some argued at the time that hedge funds noticed this and began to short crude. With the latest tumble, oil is about 27 percent below its high. But against gold, the ratio is still at 7.4 to 1.

The problem is that gold won’t stop falling either, which rather undermines the ratio theory. Perhaps it is all just hooey. If it is not, however, oil would have to dive another 25 percent to reach equilibrium of $79 a barrel against today’s gold price.

Using terrorism to gauge oil’s impact

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Do oil price spikes cause recessions? It is a controversial question and one that is very much a propos. It is all very chicken-and-egg, of course. If oil is soaring because of overheating economic demand, is it the demand or the ensuing rise in oil prices that causes the crash?

 oil1.jpg

Britain’s Centre for Economic Policy Research has had a go at trying to answer this with a report written by Natalie Chen and Andrew Oswald from the University of Warwick and Liam Graham from University College London. The twist was that the academics used terrorist incidents as an instrumental variable. Roughly, they looked at the impact of a sharp rise in oil prices on the profitability of various industries. By using terrorist events, they stripped out macroeconomic drivers and focused on something that was separate from the business cycle.

Steelmakers show industrial Germany is weathering downturn

steel2.jpgIt’s not all doom and gloom — just ask steelmakers.

Germany’s ThyssenKrupp and Salzgitter have both raised their profit forecasts, fuelled by demand from fast-growing China, India and Russia. Profits are soaring on sky-high prices for rolled and flat steel.

Both companies are cashing in on growth outside Europe, and they join Hochtief and Kloeckner who this week also showed that industrial Germany is insulated against a global economic slowdown.