In this Week’s Issue: Aug. 19, 2011
• Spot Gold reached yet another all-time above of $1,875 an ounce (Reuters)
• Philadelphia Fed Factory-sector index of general business activity fell to -30.7 in August (WSJ)
• Fitch Ratings kept the U.S. debt rating at AAA and said the outlook was stable (Economist)
• U.S. CPI increased 0.5% in July on a seasonally adjusted basis (BLS)
• U.S. leading economic index increased 0.5% in July to 115.8 (Conference Board)
• Average rate on 30-year fixed mortgage falls to 4.15%, lowest on records since 1971 (AP)
• U.S. benchmark 10-year note yields fell below 2% for the first time on record (AP)
• U.S. industrial production rose 0.9% in July, industries used 77.5% of their capacity (WSJ)
• Eurozone GDP growth fell more than expected to 0.2% on a quarterly basis from 0.8% in Q1 (WSJ)
• Germany’s GDP expanded just 0.1% in Q2 from Q1, missing forecasts by 0.5 % (Reuters)
• Fitch Ratings said affirmed the United States’ top-notch credit rating at AAA (Reuters)
• ECB spent record $32 billion buying bonds to prop up Italy and Spain (AP)
• Japan’s Q2 GDP shrank 1.3% y/y, half the expected decline of 2.6% (Reuters)
It has been a wild ride this summer. Don’t we all wish we had followed the old rule “Sell in May, then go away?” As we’re trying to put these markets swings into context, I can’t help but thinking that the “New Normal” has actually arrived and is now showing its ugly face. Here are a few snapshots of how the new normal has been ravaging across the financial markets.
Continued Dollar Weakness
Choppy Stock Markets
Then again, beauty is in the eye of the beholder and while most of us may require an extra dose of Dramamine, the risk seekers thrive in this market. A number of hedge funds have been raking in profits trading these wild market swings aggressively. Day trading however is an activity that, just like the driving stunts on auto commercials, should be left to professionals only. For most of us it felt safer to embark on the ultimate risk-management tool: stay on the sidelines and watch, hence the renewed flight toward safety evident in new record highs for gold prices and treasuries.
Although we have been hearing this for quite some time now, both asset classes are now showing more signs of being in bubble territory. Whether we are still at the beginning or near the end of a bubble remains the topic of dispute. Much depends on how fear continues to spread through the financial markets. To get a sense of what I would consider market distortions, please review the chart below showing the S&P 500 valued in Gold. In March 2009, the S&P 500 fell to a low of 666.79 which resulted in a value of 0.70 in relation to Gold. We have fallen far below that level in the past couple of weeks, perhaps a symptom of US$ weakness more than anything else. After the Federal Reserve’s announcement to keep interest rates at record low levels for at least another two years, Dollar depreciation seems inevitable and hardly anyone disputes that the Dollar will continue to decline (which is a problem in itself by the way). With regard to the chart below in terms of what may be an oversold market condition, it forces me to ponder the following question: Are we more comfortable putting our faith in a shiny metal or is there more value in letting some of the smartest and brightest (perhaps also greediest) business executives figure out how to allocate capital most efficiently? Initially, I may be wrong leaning towards the latter but it seems to me that in the long run, companies will be more likely to figure things out and outpace the rush towards Gold.
China’s Redback & Dim Sum Bonds
As a lover of Chinese food, I immediately got excited when the words “dim sum” appeared while browsing through an article in the Economist. Dim sum in this case however, referred to the financial instruments nicknamed “dim sum bonds,” which are securities denominated in the Chinese Yuan, but sold in Hong Kong where dim sum is a local delicacy.
Finding more evidence of the “New Normal,” we previously examined how Brazil and China started to settle their trade balances directly rather than via the U.S. Dollar. China has begun to encourage other countries, such as oil-rich Venezuela, to settle their trade balances in Yuan as well. At the same time, issuance of Chinese Yuan denominated bonds have begun to take shape as well. Please consider Redback and forth: The yuan is flowing beyond China’s borders—and back again. Despite increased efforts by China to slowly transform its currency and financial markets into playing center stage in global finance, the Chinese government remains extremely obscure as to how it intends to achieve this goal. Clearly, not all of their efforts have the intended outcomes as the Economist article concludes:
Foreigners will be keen to acquire yuan, and reluctant to part with it, for as long as they think it is artificially cheap.
Ironically and perhaps a sign of hope for U.S. investors, at the moment, there is still no way around the greenback. The fate of China’s currency as well as its economy remains deeply dependent on the fate of the U.S. economy and the Dollar. But China’s current dim sum efforts give a tiny preview of things to come. The stakes are high, the path is unclear, and there are numerous hurdles before China can transform itself into a thriving financial market; they still have years, perhaps decades to go. In the meantime, my my immediate (culinary) future becomes increasingly clearer: Dim Sum this week-end!
Good luck and good investing!
Clemens Kownatzki, MBA is an adjunct professor of financial risk management at the Graziadio School of Business and Management, as well as the founder and CEO of FX Investment Strategies, a Registered Investment Advisor. In addition to running his investment advisory firm, he is a contributing author at SeekingAlpha.com and BusinessInsider.com. He also authored the book, Money Music 101, available on Amazon and Kindle, in addition to publishing the popular investment blog www.fxinvestmentstrategies.com along with a weekly newsletter.Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration. Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.