David Fuller and Eoin Treacy's Subscriber's Comment of the Day.
Friday 3rd February 2012
Coggan: China Will Shape Next Bretton Woods Pact - This is an interesting column by Philip Coggan for Bloomberg. Here is the opening:
When the world economy heads into crisis, the international currency system often breaks down. This occurs either because debtors can't meet their obligations, or because creditors fear they are not being repaid in sound money. The first condition exists today in the euro zone; the second is likely to emerge in the China-U.S. relationship.
So how might these conditions change the system? Much discussion concerns whether the U.S. dollar will be replaced as the global reserve currency by the Chinese yuan or whether it will simply be one of a number of reserve currencies that includes the euro, yuan and yen.
As of 2010, about 60 percent of all foreign-exchange reserves were denominated in dollars, giving the U.S. currency a critical mass. Investors are still comfortable with holding it; despite the country's fiscal problems, in times of crisis, the dollar is regarded as a haven. It will take a long while for international investors to become confident that a Communist-led government will always respect their rights.
China's Enormous Economy
By 2020, if current trends are realized, China will become the world's largest economy. The nation's foreign-exchange reserves already give it significant power as a creditor nation. But even if foreigners wanted to hold yuan instead of dollars, there would be constraints on their doing so. And removing the constraints would probably cause the yuan to soar, something that the Chinese are keen to avoid.
So it seems unlikely that the next 10 years will see a yuan standard replacing a dollar standard. But might the present crisis conditions lead to some other sort of change? Might countries, for example, be driven to enter a new arrangement comparable to the 1944 Bretton Woods pact, in which the world's major industrial states agreed to adhere to a global gold standard to stabilize international currencies?
My view - This is interesting conjecture from Philip Coggan and while "crisis" has probably been the most frequently used descriptive word in economic reports since 2008, no one could seriously equate today's debt problem with the real crisis of WW2, which led to the Bretton Woods Agreement in 1944.
There is a fair degree of hyperbole in describing today's problems as "a global debt crisis" or "crisis of capitalism". Are the Asian-led growth economies in crisis? Obviously not. I would question whether the USA's consumer, state and central government debt burdens qualify as a genuine crisis, although they are certainly long-term problems. The Eurozone is in a crisis entirely of its own making but even this has probably passed its nadir now that the ECB is functioning as the lender of last resort.
I would also argue that there is no "crisis of capitalism", although capitalism is too often abused by the serious problem of low ethical standards.
I do not expect to see a new global currency system within the next decade. It would be almost impossible to agree upon and no government is seriously lobbying for a new Bretton Woods today. Instead, the world is still adjusting to the comparatively new and highly competitive world of globalisation. While sometimes controversial in the west, this has already proved to have far more advantages than disadvantages.
For evidence, just ask the hundreds of millions of people in the developing world who have emerged from poverty and into the middleclass during the last ten to twenty years. In the west, the results are mixed. Many people have seen their standards of living decline, at least temporarily, as the global playing field becomes more level. However the corporate Autonomies - successful multinational companies which have grown way beyond their home countries - have flourished as never before thanks to globalisation.
So if not a new Bretton Woods, what kind of a currency world are we likely to see over the next decade?
I think it will be multipolar, with four main reserve currencies - USD, EUR, JPY and CNY, in line with the size of their respective economies, or in the case of the euro, economic block which it represents. All are flawed, by definition as they are fiat currencies, and by current circumstances.
Of the USD, EUR and JPY, the greenback is clearly the most influential and most liquid, but it is a debtor currency, as is the EUR and while Japan has a trade surplus its govenment debt is enormous. The CNY is a creditor currency and while China has embraced command capitalism, its communist party rulers have yet to show any real interest in democracy.
On a long-term basis, the JPY's role as a reserve currency is likely to decline as the Japanese economy slips in the global GDP growth stakes. The EUR is still a political construct and an experimental currency, but it should survive so long as the will to hold it together remains, and even with slow growth Europe will still be a large economic block. The USD should retain its role as a haven currency in times of perceived crises, due to liquidity and also the stability of a mature democracy. The CNY's is certain to be an important reserve currency as it becomes fully convertible and China grows to become the world's largest economy. Eventually, I assume that the INR and BRL will become reserve currencies, provided that the economies of Brazil and India remain largely on a growth trajectory.
Last but not least, in a world of fiat currencies gold will remain a monetary currency in the eyes of many investors. As such, it will probably do best when short-term interest rates remain low, as is the case today in many countries.
Thank you for the excellent service. Can you refresh the beginner traders why you prefer to use 5-year weekly charts with a 200 EMA versus a 1-year daily charts?
My comment - Thanks for the feedback and a question of general interest.
Our preference for weekly over daily charts can be explained in one word - perspective. However, it depends on what you are doing. For instance, if day trading, heaven forbid because there would be little time for anything else, I would be looking almost exclusively at intraday tick charts. These enable one to scrutinise the market as if it was under a microscope and will show the same trends, congestion area trading ranges and trend endings as you see on longer-term charts.
Moving up the time scale, as a short-term trader meaning holding positions for a few days to several weeks, I would focus mainly on daily charts showing a year's history but I would also want to be familiar with the weekly chart for perspective.
As a medium-term trader looking to run trends while they persist, whether for a matter of weeks or months, I would be looking at both weekly and daily charts.
As an investor, I would be looking mainly at longer-term charts such as weekly 5-year and 10-year, and occasionally monthly charts of 20 to 50+ year's duration on semi-log scales for additional perspective. I would also look at daily charts for timing when adding to or lightening a core position. Similarly, I would use the 200-day MA on weekly charts, to see overextensions and mean regressions, adding to positions near the MA within trends and lightening when they become overextended relative to the MA.
Lastly, the most important buying opportunities occur when everyone is terrified following market plunges. As an investor or trader, picking up value stocks which are clearly overextended relative to their declining MAs is usually a good idea.
Today, I paid 2,288.50p and 2,291.00p, in two small top-up purchases, plus online dealing costs. RDSB currently yields 4.72% according to Bloomberg and the company recently announced that it intended to raise its payout this year.
For the record, my personal long-term stock market purchases last year were more RDSB, then the Aberdeen Asian Income Fund (AAIF LN (weekly & daily) last November. So far this year I have yesterday's and today's purchases.
"my understanding as reported in DEBKA is that both india and china will continue to buy oil from iran but in order to not be seen paying for it they intend to pay with gold."
My comment - Well, even if true, which I doubt, India and China would not talk about it. Also, a transfer of gold, which would not make sense for either country, would be far more visible than a currency transaction. Oil is the most fungible commodity so the supply would show up somewhere, for anyone who wished to purchase it.
"Many thanks as always for such a fantastic and interesting service. I was wondering whether you could expand on your extremely interesting comments re money flows - do you have access to any data that shows flow from cash to bonds to equities, by participant type? I would be extremely interested in seeing any data you may have on this.
"Many thanks for such a valuable analysis,"
My comment - Thanks for the enthusiastic feedback.
I do not have precise data on money flows from one category of investment to another, other than what may be highlighted in some of the external reports which we sometimes post. However, one does not need to be a stats wonk to see what is going on, and once hard data becomes available, it is almost certainly out of date and therefore of questionable value. I will repeat with what I said on Wednesday:
"The key to successful navigation in this environment is to identify and follow the money flows. This requires common sense, analytical curiosity, an understanding of crowd behaviour, and a willingness to observe price charts in the manner of a naturalist."
The most important clues, which anyone can profit from, are in the price charts. A persistent uptrend can only be demand driven, and a persistent downtrend can only be supply driven. When they eventually lose momentum, which they inevitably will, the game has changed for at least the short term. Learn how to read price charts factually - I think you would enjoy TCS which Eoin has taught since 2007, and you will be in a better position to monitor money flows than most other people in the markets.
"Intelligence is quickness in seeing things as they are."
Elephant book – Thanks to a subscriber for this heavyweight 152-page report from Deutsche Bank expressing a cautious attitude to the South African market. Here is a section:
While the above represents our neutral position, we do make allowances for a discretionary adjustment to the equity risk premium implied. At present, we feel there remains a strong case to assume an exit multiple well below the historical average:
While we think recent adjustments to commodity price forecasts have better encapsulated the current macro environment, we continue to see risks biased to the downside for as long as GDP projections are being lowered. While acknowledging the tenuous relationship between SA GDP and the earnings growth reported by SA listed companies (large foreign-sourced earnings component and different composition), current expectations do not appear out of line but look vulnerable to any further cuts to GDP.
Our own commodity forecast profile anticipates that prices peak in 2013 and then begin to decline. For as long as investors believe Resource earnings are close to peak levels, the Resources sector will likely trade at a discount trailing multiple relative to history.
In what will likely prove a slower, more volatile growth environment for large OECD economies, with elevated forecast risk due to the reliance on policymakers, we believe equity investors will demand a higher equity risk premium than usual.
With a greater level of comfort around our earnings forecasts following recent downgrades and limited directional bias from commodities and exchange rates, we have reduced the amount by which we expand the equity risk premium from 50% in 4Q11 to 25%.This implies an exit PE multiple in two years' time of 11.1x. This aims to cater to downside risk to earnings forecasts in the interim, as well as the potential for a lower-than-average multiple for the reasons given above. Relative to our assumed neutral rating over time, our discount caters for earnings falling short of expectation by c.13% over the next two years.
My view – The South African market is generally associated with the commodities sector because of the significant weighting of industrial and precious metal miners. However, a point often overlooked is that a number of Autonomies are also listed in the country from sectors such as brewing, telecommunications and luxury goods. In addition, South Africa's large young population is migrating into the middle classes. This is reflected by the relative outperformance of the consumer retail and food sectors.
The FTSE/JSE All Share is one of only four indices to have successfully held a move to new highs since August. The banking sector has outperformed the wider market since October and continues to extend the breakout to new all-time highs in nominal terms. A sustained move below 40,000 would be required to question medium-term scope for continued upside.
The Rand has surged versus both the US Dollar and Euro over the last month. Sustained moves above ZAR8 and 10.75 respectively would be required to check medium-term scope for continued outperformance.
For an investment community obsessed with the Eurozone's banking sector it is noteworthy that South Africa is not the only country where banks are leading. While a number of Europe's stock market indices are in cyclical bull markets the weakness of their respective financials remains a headwind which is currently being countered by profligate central bank support. For higher growth, less debt challenged economies, where secular bull markets are evident, one would expect banking sectors to perform at least as well as the wider market. As liquidity providers, banks should prosper in a bull market. They are often leaders and when they move to positions of persistent underperformance it is generally a sign of trouble to come. Banks are therefore worth monitoring.
Many industrial metals had a torrid time in 20011 and experienced deep corrections. However they have all bounced and copper in particular is testing its high. Additionally, the global liquidity situation cannot be ignored. Against a background of slowing global growth, central banks are busy expanding their balance sheets and injecting liquidity into their respective markets. Those with the capacity to do so are cutting interest rates. India and Indonesia have also announced large infrastructure development projects which may create demand for industrial resources.
BHP Billiton (yield 2.98%) has held a progression of higher reaction lows since October and a sustained move below ZAR25,000 would be required to question medium-term scope for continued upside. Anglo American (0.64%) exhibits similar recovery potential. Kumba Iron-Ore consolidated above the 2008 peak for much of 2011 and broke upwards to new high ground in January. Anglogold shares a similar pattern with the FTSE/JSE Africa Gold Mining Index and has been consolidating mostly above the three year range since late October.
In the energy sector, coal miner Exxaro (yield 2.95%) has rallied impressively over the last month to hit new all-time highs. While somewhat overbought in the short-term, a sustained move below ZAR17,000 would be required to question the consistency of the advance. Chemical/energy company Sasol rebounded impressively to challenge its April peak where it has paused. A break of the progression of higher reaction lows, currently near ZAR39,000, would be needed to question the consistency of the almost six-month uptrend.
Brewer, SABMiller (yield 2.2%) remains in a consistent medium-term uptrend. It unwound the overbought condition relative to the 200-day MA from October and broke upwards again last week. A sustained move below ZAR27,000 would be required to begin to question medium-term scope for additional upside.
Luxury goods manufacturer, Compagnie Financiere Richemont (yield 0.83%) has been consolidating in the region of the 200-day MA since early 2011 and is now retesting the peak above ZAR4,500.
Vodafone's South African unit, Vodacom (yield 5.28%), has been trending consistently higher since mid-2010. It accelerated somewhat this week but a sustained move below the 200-day MA, currently near ZAR8,600, would be required to question medium-term upside potential.
British American Tobacco (yield 1.36%) hit an accelerated medium-term peak near ZAR40,000 in December and is now reverting towards the 200-day MA. A sustained move below ZAR35,000 would be needed to question medium-term uptrend consistency.
Among more domestically focused companies, the pace of cement manufacturer, Afrimat's, uptrend has increased. A break of the rising lows would be needed to check medium-term upside potential.
In the foods sector both AVI Ltd and Tiger Brands are becoming increasingly overextended relative to their respective to their 200-day MAs. Clear breaks in their short-term progressions of higher lows are likely to suggest mean reversion is underway. Retailer Shoprite Holdings has a similar pattern but is less overextended. Higher end furnishings manufacturer, Steinhoff, broke upwards to new highs this week.
Investors continue to voice concerns about the quality of South Africa's governance. However, despite some unsavoury characters, the current administration has retained the comparatively sound economic policies of its predecessors in a sign of stability most were not expecting. There is significant room for improvement on the governance front but the performance of the currency, equity and government bond markets suggest investors are willing to give South Africa the benefit of the doubt.
The significant underperformance of the Greek stock market during 2011 (-52%) reflected substantial uncertainty regarding the country's economic recovery path, the effectiveness of fiscal adjustments made during the year as well as mounting concerns about debt issues in various sovereigns across Europe.
A multifaceted economic crisis has unfolded in three main areas (a) sovereign debt issues -- debt sustainability and capacity as a country to produce positive economic returns through structural and fiscal reforms, (b) banking sector issues– sovereign debt exposure and deteriorating loan quality have seriously affected balance sheets, funding conditions and capital requirements and (c) under-investment issues– the necessary element that will put the economy back on the growth track and instil market confidence towards a sustainable recovery.
During these turbulent times, we maintain exposure in selected non banking names for the largest part of 2012 and expect to reevaluate our stock picks towards the end of the first half of the year or until balance sheet repair in the banking sector is reasonably secured. Post recap, opportunities may arise in financials as well. Earnings momentum in the banking sector remains particularly weak with considerable negative tail risk. Elsewhere in the economy, there are limited signs of growth re-acceleration, mainly supported by cost cutting. Still there are certain sectors/business models capable of withstanding recessionary pressures going forward.
My view – As long as negotiations with Greece's creditors remain unresolved there will continue to be speculation about the prospect of an unruly default. However, if we accept that default is a fait accompli then the only question is what the fallout is likely to be. The ECB is doing everything it can to erect a dampener for any negative repercussions by making huge amounts of liquidity available. In the event that this is not enough, the central bank can be expected to release even more. Everything will be done to mitigate the risk of contagion to other sovereigns and the wider financial sector.
The Greek ASE Index rallied from above 600 to more than 800 in January. It pulled back somewhat over the last week and will need to hold above the January low if base formation development is to be given the benefit of the doubt.
“Could you please furnish directions as to how one might, as a subscriber, listen to the daily audio commentary via the iTunes podcast? I have had difficulty subscribing via the RSS feed and was wondering if there is a simpler way of adding the daily commentary to my podcasts. Many thanks.”
My comment – Thank you for this question which may be of interest to other subscribers. Here is a link to my reply to a similar question on September 22nd 2011 which I have repeated below:
1. Connect the iPhone to your computer and open iTunes .
In future, all you will need to do is Sync you iPhone with your computer and it should automatically transfer the latest version of the podcast.
“I would like the following stocks in the chart library please: (Disclosure: I or my family holds these stocks)
“Berkeley Mineral Resources (BMR) London
My comment – Thank you for these suggestions, a number of which were already in the Chart Library. The remainder have now also been added.
“Would you add the following Singapore listed stock to the library: Broadway, symbol: BWAY”
My comment – Thank you for this suggestion which has been added to the Chart Library.
I have also accepted an invitation to speak to the San Diego chapter of the MTA in the first week of April. A date and time has yet to be fixed but it will take place in the Del Mar area.
I still have some space available on my itinerary. If you would like me to speak to your local chapter or organisation in California or New York please contact your respective chairperson and ask them to contact me.