Thunderroad Report

Thunder Road report
All I want for Christmas is the S&P 500 (or do I?)

S&P 500: the Las Vegas period
1800
1600
1400
1200
1000
800
600
400
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Strategy
May 2013
All I want for Christmas is the S&P 500 (or do I?)

Soundcheck First set: Second set: Am I missing something? The Stadium Tour Crisis? What crisis? A trend that is not our friend Divergence everywhere Equity market models & correlations breaking down Club 18-13 Money creation, the deposit to loan gap & the S&P 500 Collateral and shadow banking Industrial gas stocks (Praxair and Linde) US Europe
page 3 5 6 11 17
24 27
30 32 37 42 50 57 62
Asia Encore Inflationary Deflation: end-game update Leaving the building Slide away (slides from recent corporate presentations) incl. Cisco, Vallourec, Statoil, Du Pont, Vale, Maersk, Wilmar, Pirelli, Rio Tinto, John Deere, etc.
Research: Paul Mylchreest +44 (0) 207190 7242 pmylchreest@monumentsecurities.com

This is a marketing communication. It has not been prepared under the Independent Investment research regulatory requirements and accordingly there is no prohibition on dealing ahead of the dissemination of this research material.
Front cover: image courtesy of LAs Vegas Convention and Vistors Authroity
Soundcheck
We are approaching a critical point (again) in the battle royal between the forces of inflation and deflation. Deflationary forces are threatening to overwhelm the reflationary push-back of the worlds central banks although this is not reflected in most equity markets (especially the US). Open-ended QE was only announced by the Fed last Autumn, but the impact on (market-based) inflation expectations plateaued within months and has started turning down.
Global manufacturing PMI v. US 5-yr breakeven inflation
60.0 2.80
55.0
2.30
50.0
1.80
Source: Markit.com, Monument Securities
45.0
1.30
40.0
0.80
35.0
0.30
30.0
-0.20
Sep-09
Sep-10
Sep-11
Mar-09
Mar-10
Mar-11
Mar-12
Sep-12
Jul-09
Jul-10
Jul-11
Jul-12
May-09
May-10
May-11
Global manufacturing PMI
US Treasuries: 5-year breakeven inflation
I am no fan of QE, but the Fed is discussing scaling back its preferred reflationary policy tool when the economic cycle is at one of the weaker points since the recovery began in early-2009. This is probably a bluff, or would be a temporary measure at most. With recent support for scaling back from the BIS and IMF, its questionable whether theres a coordinated attempt to talk the dollar up...just as BRICS nations are stepping up their efforts to undermine it (see Encore section)? Or is talk of bubbles impacting their fervour? In equities, previously reliable valuation models based on ISM/PMIs are breaking down - likely due to QE. Correlations between equity markets and various other financial assets and economic indicators are also diverging as the S&P 500 powers ever higher. Currently, few people seem to (even) entertain the notion that western equity markets could see a short-term correction. Maybe thats correct - in light of the mechanics of full-blown QE as explained in the report - but it is worryingly reminiscent of bubble mentality. As we show in the report, the monetary system in the US has changed dramatically since the 2008 collapse of Lehman and the implementation of QE. This goes right to the heart of how NEW MONEY IS CREATED (QE not loans), who creates it (the Fed not the banks) and who gets to use it first (banks not borrowers). As far as its possible to tell, this change appears to have had a very positive impact on equities via the banking system. The chart below shows the surprisingly close correlation between the S&P 500 and the deposit to loan gap in US commercial banks. The deposit to loan gap is a direct result of QE programmes and currently amounts to more than US$2 trillion. These excess deposits create an investment need for the banking system and the collective ability to distort asset prices. This is discussed in more detail below. The question is how much has found its way into equities and what impact will these flows have going forward.
May 2013
May-12
Mar-13
Jan-09
Jan-10
Jan-11
Jan-12
Nov-09
Nov-10
Nov-11
Nov-12
Jan-13
S&P 500 v. Deposits-Loans ("deposit to loan gap" in banking system from QE)
1800 2500
1600
2000
1400 1500 1200 1000
Source: Monument Securities
1000
800
500
600
Apr-09
Apr-10
Apr-11
Feb-10
Sep-10
Feb-11
Sep-11
Feb-12
Sep-12
Mar-10
Mar-11
Mar-12
Feb-13
May-09
May-11
S&P 500
Deposits - Loans: All Commercial Banks (US$bn)
A decision to taper QE would obviously be negative for equities in the absence of a sufficiently strong offsetting improvement in economic fundamentals which is difficult to envisage right now. While QE is benefiting risk assets on the one hand, it is also disrupting the flow of collateral in the vast shadow banking system on the other. QE programmes silo securities which could be used as collateral several times over via hypothecation and re-hypothecation. This reduces collateral velocity and (all important) system liquidity. Recent work by the IMF and the US Treasury has highlighted this, as well as the gross shortage (multi trillions of dollars) of high-quality collateral under stressed market conditions (see below). Lets just hope we dont have stressed market conditions. With regard to portfolio construction meanwhile: Recommendations: Add: some downside protection to portfolios Increase exposure: industrial gas stocks (Praxair and Linde) Buy: Shanghai Composite Index
May 2013
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-09
Aug-10
Aug-12
Nov-09
Nov-10
Nov-11
Nov-12
Apr-13
Jun-09
Jun10
Jun-11
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-10
Jan-12
Jan-13
First set
Crisis? What crisis?
The crisis was never over. Its just being papered over by ueber-activist central bankers whose actions to correct previous policy and regulatory mistakes is making the problem RISING DEBT and BUBBLES in a rotating series of asset classes even worse. Groundhog cycles not groundhog days! We are drowning in central banking Jeff Gundlach
In big picture terms, its all part of central banks war against the final deflationary phase of the current long economic (Kondratieff) cycle, which began with the NASDAQ crash in 2000. The cycle itself began in 1934 and is already over-extended nearly 80 years versus the normal 50-60. The obscene amount of debt and misallocated capital are potent deflationary forces which keep reasserting themselves, e.g. the Lehman/sub-prime collapse in 2008, the PIIGS-driven crisis in 2010 and the nearcollapse in 2012 prompting the Draghi moment. Quoting Decembers Inflationary Deflation report: Each time DEFLATIONARY forces re-assert themselves, offsetting INFLATIONARY forces (monetary stimulus in some form) have to be correspondingly more aggressive to keep systemic failure at bay. Periodically, you can bank on the facade of our Stepford world economy suffering another crack. Cyprus was a small one, although it is likely to be a template for a larger one. Nevertheless, it was also the perfect retort to the assertion of Germanys Finance Minister, Wolfgang Schaeuble, on 27 December 2012 that: We have the worst behind us Now we have the first sign that things could start to go wrong in Japan with the convergence of debt, demographics, declining current account surplus and (now) desperate monetary policy. An unintended consequence is the recent quadrupling of the 5-year JGB yield in just over a month.
0.500 0.450
JGB 5-year yield (%)
0.400
0.350
0.300
0.250
0.200
0.150
0.100
0.050
0.000
Sep-12
Feb-13
May-12
Mar-13
Aug-12
Dec-12
Nov-12
Apr-13
Jun-12
Jul-12
Oct-12
Jan-13
May 2013
May-13
While the deflationary and inflationary forces continue to get larger and more powerful, these opposing forces have been broadly in balance most (but not all) of the time since Lehman. The key has been to keep just enough bias towards inflation to maintain some growth and, whenever possible, rising asset prices especially equities, which provide such a CRITICAL feedback loop in respect of confidence.
US economy: total debt v. Federal Reserve balance sheet ($ trillions)
60.0 -0.50
55.0
-1.00
50.0 -1.50 45.0 -2.00 40.0 -2.50 35.0
30.0
-3.00
25.0
-3.50
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
May-12
Jan-13
Total credit market debt
Federal Reserve Balance Sheet (Inverted/neagtive values)
The point here is that because the inflationary and deflationary forces are in balance much of the time, nearly everybody is lulled into a FALSE SENSE OF SECURITY, believing that risk is relatively low. Its not and, furthermore, SYSTEMIC RISK IS PROGRESSIVELY INCREASING. Just because most people dont see it, doesnt mean its not there. The biggest anaesthetic on the planet right now is the S&P 500!
A trend that is not our friend

At the same time, we have another problem - a trend which has been developing in a diverse range of economic data series and indicates that the deflationary forces have been gathering momentum. There are many variations on this trend and below are a few examples. Lets begin with very big picture the trend in the global manufacturing PMI since the beginning of 2009.
Global Manufacturing PMI (since 2009)
60.0
55.0
May-13
50.0
45.0
40.0
35.0
Sep-09
Sep-10
Sep-11
Mar-09
Mar-10
Mar-11
Mar-12
Sep-12
Jul-09
Jul-10
Jul-11
Jul-12
May-09
May-10
May-11
May 2013
May-12
Mar-13
Jan-09
Jan-10
Jan-11
Jan-12
Nov-09
Nov-10
Nov-11
Nov-12
Jan-13
This is global industrial production growth.

Global Industrial production growth % yoy (since 2009)
15.0%
10.0%
5.0%
0.0%
-5.0%
-10.0%
-15.0%
Sep-09
Sep-10
Sep-11
Mar-09
Mar-10
Mar-11
Mar-12
Sep-12
Jul-09
Jul-10
Jul-11
Jul-12
May-09
May-10
May-11
This is growth in Chinese electricity production and rail cargos.

China: growth in electricity production & rail cargo (since 2009)
50% 25%
40%
May-12
30%
20%
10%
Mar-13
20% 15% 10% 5%
Jan-09
Jan-10
Jan-11
Jan-12
Nov-09
Nov-10
Nov-11
Nov-12
Jan-13
0%
0%
-10%
-5%
-20%
-10%
Sep-09
Sep-10
Sep-11
Mar-09
Mar-10
Mar-11
Mar-12
Sep-12
Jul-09
Jul-10
Jul-11
Jul-12
May-09
May-10
May-11
China Electricity Production (yoy%)
China Rail Cargo (yoy%)
And registrations of new passenger cars in the Eurozone.

Eurozone new car registrations (since 2009)
1,300,000
1,200,000
1,100,000
1,000,000
900,000
May-12
Mar-13
Jan-09
Jan-10
Jan-11
Jan-12
Nov-09
Nov-10
Nov-11
Nov-12
Jan-13
800,000
700,000
600,000
500,000
400,000
Sep-09
Sep-10
Sep-11
Mar-09
Mar-10
Mar-11
Mar-12
Sep-12
Jul-09
Jul-10
Jul-11
Jul-12
May-09
May-10
May-11
May 2013
May-12
Mar-13
Jan-09
Jan-10
Jan-11
Jan-12
Nov-09
Nov-10
Nov-11
Nov-12
Jan-13
Even the average speed of the worlds merchant fleet (excluding anchored vessels).
Total fleet average speed (knots)
9.00
8.50
8.00
7.50
7.00
6.50
6.00
5.50
5.00
4.50
4.00
2009
2010
2011
2012
Shifting to the corporate sector and look at the trend in organic sales growth in this slide from SKFs Q1 2013 results presentation.
2013
SKFs CEO indicated that some of that recent volume decline was down to customer de-stocking which he expected to start to unwind. Even so, the guidance for Q2 2013 is for a further year-on-year volume decline. The end-markets supplied by SKFs bearings and seals basically cover everything that moves in an economy.
Source: SKF
May 2013
The next slide shows the recent trend in Ingersoll Rands order book.
This is from luxury goods supplier, Richemont, which reported results on 16 May 2013 where the slowdown is from a VERY high level, admittedly.
Source: Ingersoll Rand Source: Richemont
Finally...even the VIX.

Vix
60
50
40
30
20
10
2009
2010
2011
2012
May 2013
2013
It makes you wonder whether we are moving towards a point of SINGULARITY where something has to give one way or another? I also find it very interesting that this unfriendly trend is mirrored, for example, in much longer-term trends relating to the US economy almost like a fractal pattern. Notice how the cyclical peaks in US GDP growth have been on a generally declining trend since the late-1940s.
Source: St. Louis Fed
The same with capacity utilisation this is not a sign of a strong economy.
Source: St. Louis Fed
May 2013
10
Divergence everywhere
Currently we have that trend on the one hand and a whole series of divergences on the other Im about to show you some examples which also suggest that things are not quite right. Many high profile commentators have focused on the S&P 500 versus Doctor Copper divergence recently. There is a similar picture with other critical commodities, like oil, and even ones which had been performing very strongly until recently, like lumber.
S&P 500 v. Oil
1700 1600 1500 120 1400 1300 1200 1100 1000 900 70 800 700 600 60 110 140
130
100
90
80
50
Apr-09
Apr-10
Apr-11
Feb-10
Sep-10
Feb-11
Sep-11
Feb-12
Sep-12
Mar-10
Mar-11
Mar-12
Feb-13
May-09
May-11
S&P 500
Brent crude (US$ bbl)
We also have a huge and incongruous divergence between the equity market of the fading and de-industrialising superpower and that of the emerging superpower. The latter, so-called factory of the world, is not exactly experiencing a vibrantly profitable corporate sector. Furthermore, investment is about 50% of GDP and even its government officials acknowledge its manufacturing sector is plagued by overcapacity. Having said all that, I think the Shanghai Composite is poised to turn upwards (see below).
S&P 500 v. Shanghai Composite
1700 1600 1500 1400 1300 3000 1200 2800 1100 3800 3600 3400 3200
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-09
Aug-10
Aug-12
Nov-09
Nov-10
Nov-11
Nov-12
Apr-13
Jun-09
Jun10
Jun-11
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-10
Jan-12
Jan-13
2600 1000 900 800 700 600 2400 2200 2000 1800
Apr-09
Apr-10
Apr-11
Feb-10
Sep-10
Feb-11
Sep-11
Feb-12
Sep-12
Mar-10
Mar-11
Mar-12
Feb-13
May-09
May-11
S&P 500
Shanghai Composite
May 2013
11
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-09
Aug-10
Aug-12
Nov-09
Nov-10
Nov-11
Nov-12
Apr-13
Jun-09
Jun10
Jun-11
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-10
Jan-12
Jan-13
Ironically, when the Shanghai Composite was going parabolic during 2006-07, most commentators werent fearful of an impending crisis.
S&P 500 v. Shanghai Composite (2005-2007)
1600 6000
1500
5000
1400
4000
3000
1300 2000
1200 1000
1100
Apr-05
Apr-06
Feb-05
Sep-05
Feb-06
Sep-06
Feb-07 Mar-07
Apr-07
Mar-05
Mar-06
Dec-05
Dec-06
Sep-07
Jun-05
Jun-06
Jun-07
Jul-05
Jul-06
Jul-07
Aug-05
Aug-06
Nov-05
Nov-06
Aug-07
May-05
May-06
S&P 500
Shanghai Composite
Today, the Shanghai Composite is on its back and most people arent the slightest bit concerned either. Here is a chart of the S&P 500 versus the 10-year yield of the sovereign debt of the weakest of the major European nations - maybe it can just continue and we can all be happy (hmmm).
S&P 500 v. Spanish 10 year Treasury yield
1700 1600 1500 1400 1300 1200 5.00 1100 6.00 7.00 8.00
May-07
Nov-07
Dec-07
Oct-05
Oct-06
Oct-07
Jan-05
Jan-06
Jan-07
1000 900 800 700 600
4.00
3.00
2.00
Apr-09
Apr-10
Apr-11
Feb-10
Sep-10
Feb-11
Sep-11
Feb-12
Sep-12
Mar-10
Mar-11
Mar-12
Feb-13
May-09
May-11
S&P 500
Spain 10 yr Treasury yield
The chart below shows the growth in the central bank balance sheet of the worlds largest debtor versus growth in foreign exchange reserves of the worlds largest creditor. That is the worlds largest creditor which has been dramatically scaling back US Treasury purchases and setting up bilateral trading agreements with all of its major trading partners (to conduct trade in local currencies not the US dollar).
May 2013
12
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-09
Aug-10
Aug-12
Nov-09
Nov-10
Nov-11
Nov-12
Apr-13
Jun-09
Jun10
Jun-11
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-10
Jan-12
Jan-13
Federal Reserve Balance Sheet (US$ trn) v. China forex reserves (yoy%)
3.50 60.0%
3.00
50.0%
2.50
40.0%
2.00
30.0%
1.50
20.0%
1.00
10.0%
0.50
0.0%
0.00
-10.0%
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
May-12
Jan-13
Federal Reserve Balance Sheet
China forex reserves yoy%
Unless you have studied mechanics and history of the gold market very carefully, there is also a confusing divergence between the well-documented rush to acquire physical gold after the recent price fall and the coincident decline in reported holdings of gold in ETFs.
Gold ETF holdings versus American Eagle gold coin sales
90.0 200
88.0
86.0 150
84.0
82.0
May-13
100
80.0
78.0
76.0
50
74.0
72.0 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13
Total known Gold ETF holdings (m oz.)
American Eagle Bullion Sales (000s oz.)
Ive used sales of American Eagle coins as a proxy for physical gold demand, but youve probably seen photographs and read reports about queues, rising premiums and extended delivery times at bullion dealers and falling inventories on the gold exchanges. Indeed, the timing of the biggest falls in the gold price (Friday 12 April and Monday 15 April 2013) was counter-intuitive in the sense that they coincided with indications of supply strains for physical bullion. This was clear from the gold basis in particular, i.e. the difference between the spot price of gold and the prices of near months futures contracts (see Encore below). There is more going on here than meets the eye and the turmoil in the gold market is a sign of renewed crisis, even if it is not being portrayed that way.
May 2013
13
Aside from gold, one would expect renewed problems in the worlds biggest debt crisis to manifest in credit/ money markets. However, indicators which signalled the crisis in 2008 and funding stresses in subsequent years, are looking fairly benign at present. For example, the 5-year Euro/US dollar basis swap did roll over slightly in March after its surge from the 2012 low, but has already retraced most of its very modest correction:
Euro US dollar 5-year basis swap
0
-10
-20
-30
-40
-50
-60
-70
Apr-09
Apr-10
Apr-11
Apr-12
Feb-09
Sep-09
Feb-10
Sep-10
Feb-11
Sep-11
Sep-12
Mar-11
Mar-12
Feb-13
May-09
May-10
May-11
The TED spread has risen from 16.64 bp to 24.32 since late-February, but this can be barely classified as waking up in a 2007-08 context!
TED Spread
160
140
120
100
80
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-10
Aug-11
Aug-12
Dec-12
Nov-09
Nov-11
Nov-12
Apr-13 Apr-13
Jun-09
Jun10
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jan-09
Jan-10
Jan-11
Jan-12
Jul-12
Jan-13
60
40
20
Apr-09
Apr-10
Apr-11
Feb-09
Sep-09
Feb-10
Sep-10
Feb-11
Sep-11
Apr-12
Sep-12
Mar-11
Mar-12
Feb-13
Jun-09
Jun10
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Jul-12
May-09
May-10
May-11
The 2008 crisis emerged in the US sub-prime sector and the Euro/US dollar basis swap and the TED spread are really indicative of stress in dollar funding markets. Given that the major weak spot today is Europe, it probably makes sense to focus on that region.
May 2013
14
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-10
Aug-11
Aug-12
Dec-12
Oct-09
Oct-10
Oct-11
Jan-09
Jan-10
Jan-11
Jan-12
Nov-09
Nov-11
Nov-12
Jan-13
The iTraxx Europe Sub Financials Index, which measures the cost of default insurance on the subordinated debt of 25 European financial institutions, had a recent wobble but quickly shook it off.
iTRAXX Europe Subordinated Financials 5-year
120
115
Source: iTRAXX, Monument Securities.
110
105
100
95
90
Apr-09
Apr-10
Apr-11
Apr-12
Feb-09
Sep-09
Feb-10
Sep-10
Feb-11
Sep-11
Sep-12
Mar-11
Mar-12
Feb-13
May-09
May-10
May-11
At first sight, the money/bond markets in the western world - thanks largely to our central banking friends are telling us there is little (currently) to worry about. Having said that, there are some faint, but worrying, signs which hark back to 2006-08. For example, the recent divergence in the Banks sector from the broader equity market although the banks sector as a whole has participated in the recent rally. This is the last 17 months.
Euro Stoxx 50 v. Euro Stoxx Banks
2900 140.0
2800
May-12
2700 120.0 2600 110.0
2500
2400
Mar-13
Dec-09
Dec-10
Dec-11
Aug-10
Aug-11
Aug-12
Dec-12
Nov-09
Nov-11
Nov-12
130.0
100.0
Apr-13
Jun-09
Jun10
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jan-09
Jan-10
Jan-11
Jan-12
Jul-12
Jan-13
2300 90.0 2200 80.0
2100
2000
70.0
Apr-12
Feb-12
Sep-12
Mar-12
Feb-13
May-12
Mar-13
Aug-12
Dec-12
Nov-12
Apr-13
Jun-12
Jul-12
Oct-12
Jan-12
Jan-13
Euro Stoxx 50
Euro Stoxx Banks
Remember what happened last time and banks had continued to participate in rallies (especially March-May 2008):
May 2013
15
May-13
Euro Stoxx 50 v. Euro Stoxx Banks (2006-08)

5000 4500 4000 400.0 3500 3000 2500 2000 1500 200.0 1000 500 0 150.0 350.0 500.0
450.0
300.0
250.0
100.0
Apr-07
Sep-06
Feb-07
Sep-07
Feb-08
Apr-08
Mar-07
Mar-08
Dec-06
Dec-07
Sep-08
Jun-07
Jun-08
Jul-06
Jul-07
Jul-08
Aug-06
Aug-07
Nov-11
Nov-07
Aug-08
May-07
Euro Stoxx 50
Euro Stoxx Banks
This remains a must watch relationship. Spanish bank shares are not buying the everythings fine collapse in Spanish bond yields. This is Banco Santander:
Spain: Banks (Banco Santander) v. Bonds
7.00 3.50
May-08
Nov-08
Dec-08
Oct-06
Oct-07
Oct-08
Jan-07
Jan-08
4.00 6.50 4.50
6.00
5.00
5.50 5.50
6.00
5.00
6.50
7.00 4.50 7.50
4.00 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-12 Mar-13 Apr-13 May-13
8.00
Banco Santander
Spain 10 yr Yield (Inverted)
The worse the bank, the bigger the divergence...

Spain: Banks (Banco Popular) v. Bonds
1.60 3.50 4.00 1.40 4.50 5.00 5.50
1.20
Axis Title
1.00
6.00
6.50 0.80 7.00 7.50 8.00 0.40 8.50
0.60
Sep-12
Feb-12
May-12
Mar-13
Aug-12
Dec-12
Nov-12
Apr-13
Jun-12
Jul-12
Oct-12
Jan-13
Banco Popular
Spain 10 yr Yield (Inverted)
May 2013
16
May-13
Second set
Equity market models & correlations breaking down
On a bi-monthly basis, the governors of the BIS member central banks convene in Basel, Switzerland, for meetings about which there is zero disclosure. Ben Bernanke must have almost hero-status with his comrades at these gatherings right now since the S&P 500 chart is right out of the central bankers current playbook - and (peculiarly) on declining volume.
S&P 500
1800
Source: Tripsite
1600
1400
1200
1000
800
600
400
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Forget Las Vegas (or Basel) for a moment, Im moved to poetry: This is great stuff, Phil Bennett covering, Chased by Alistair Scown, Brilliant...oh thats brilliant, John Williams, Bryan Williams, Pullin, John Dawes...great dummy, David, Tom David, The halfway line, Brilliant by Quinnell, This is Gareth Edwards...(you know the rest).
May 2013
17
2013
Remember Bernanke justifying the Feds decision to implement QE3 in September 2012: The issue here is whether improving asset prices will make people more willing to spendif people feel their financial position is better because their 401(k) looks better for whatever reason, or their house is worth more, theyll be more likely to spend If that wasnt the long-awaited admission that the focus of central bank policy, since the Greenspan era, has been the serial creation of asset bubbles, then I dont know what is? And there lies part of the problem. GDP is nothing more than a measure of current aggregate spending. Its not a measure of future spending potential, or necessarily wealth per se. This was Alan Greenspan speaking on CNBC, 15 February 2013: the stock market is the key player in the game of economic growth. Please, Mr Greenspan, can you explain that, unless you are deliberately targeting a wealth effect? Never has the clich putting the cart before the horse seemed so relevant. But when youve already created the biggest debt bubble in history If you want to retain the illusion that everything is fine, you are left with little choice but to maximise the wealth effect and encourage spending, even if it might be ill-advised. Bernanke cant even articulate his strategy in a consistent fashion as per his post-FOMC press conference on 20 March 2013: Were not targeting asset prices. Were not measuring success in terms of the stock market. In last Decembers Inflationary Deflation report, I argued that: Tactically equities face a volatile period buffeted by alternating cycles of deflationary and reflationary forces until they overcome bonds as the inflationary endgame unfolds. While we know that equities will be a survivor asset class, unlike much of the sovereign debt market of the developed world, I certainly didnt expect equities to move so far, so fast especially when the backdrop of recent months has been gradually more deflationary. There are highly regarded market commentators (both in bulge bracket banks and independent) who base their view on the valuation of equity markets (usually the S&P 500) on the historic correlation between the Institute for Supply Managements (ISM) monthly survey of purchasing managers sentiment and the yearon-year percentage change (yoy %) in the S&P500.
May 2013
18
When the September 2012 ISM report was published on 1 October 2012, the S&P500 closed at 1444.5 and the then relationship between the ISM and the S&P 500 yoy % is shown in the chart below. It implied that equities were just at least 20% overvalued at that time.
S&P 500 v. ISM (May 1999 - Sept 2012)
60.0% 67
40.0%
62
20.0%
57
Source: ISM, Monument Securities.
52 0.0% 47 -20.0% 42
-40.0%
37
-60.0%
32
Sep-99
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
S&P 500 yoy %
ISM
Since 1 October 2012, the ISM manufacturing index has fallen from 51.6 to 50.7 which (all things being equal) would imply an approximately 3% fall in the S&P 500 assuming it was fairly valued then and now (according to the scales of the Y-axes on the chart). In contrast, the S&P 500 has risen by 12.9% and the model suggests that the S&P 500 is about 20% overvalued currently.
S&P 500 v. ISM
60.0% 67
40.0%
May-12
Jan-13
62 57
20.0%
52 0.0% 47 -20.0% 42
-40.0%
37
-60.0%
32
Sep-99
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
May-12
Jan-13
S&P 500 yoy %
ISM
The obvious question remains how could the stock market be 20% overvalued on 1 October 2012, rise a further 15.3% when the model predicted a 3% fall and still be about 20% overvalued? While this framework has provided some great insights and trading calls in the past, and is obviously still worth using, it clearly has flaws - especially it seems in a world of full-blown QE. A flaw in this system is that it uses the YEAR-ON-YEAR PERCENTAGE CHANGE in the S&P 500. When using this methodology in September 2012, it just so happened that the trough in the S&P500 during 2011 had been made almost exactly a year earlier (3 October 2011 at 1099.33). Hence the seemingly high valuation of the S&P 500 a year later on this basis.
May 2013
19
May-13
Bearish commentators have also highlighted how the absolute levels of the S&P500 and the ISM manufacturing survey have become disconnected since the Great Financial Crisis. This certainly remains the case.
S&P 500 v. ISM mfg
1700 1600 65.0 1500 1400 1300 1200 1100 1000 900 800 40.0 700 600 35.0 45.0 55.0 70.0
60.0
50.0
Apr-09
Apr-10
Apr-11
Feb-10
Sep-10
Feb-11
Sep-11
Feb-12
Sep-12
Mar-10
Mar-11
Mar-12
Feb-13
May-09
May-11
S&P 500
ISM mfg
However, stock markets should rise over time with economic/earnings growth while purchasing managers surveys fluctuate either side of an equilibrium, so holding much store by this relationship seems slightly dubious. Instead of the manufacturing ISM, an alternative forward-looking indicator might be the absolute level of durable goods orders excluding transportation. This relationship also suggests that equities were overvalued in late Summer/Autumn of 2012 and are even more overvalued now. Another divergence.
S&P 500 v. Durable Goods (ex-transportation)
1750 180000
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-09
Aug-10
Aug-12
Nov-09
Nov-10
Nov-11
Nov-12
Apr-13
170000 160000 150000 140000
Jun-09
Jun10
Jun-11
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-10
Jan-12
1550
1350
1150
Jan-13
130000 950 120000 750 110000
550
100000
Apr-03
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-11
Apr-12
S&P 500
Durable Goods orders (ex-transportation)
It was these kinds of issues that drove me to search for additional methods which would provide insight on the future direction of equity markets.
May 2013
20
Apr-13
Jul-03
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
One possible problem with using relationships between the equity market and forward-looking indicators, like the ISM manufacturing survey and durable goods orders, could be their old economy nature. The chart below shows the decline in US manufacturing jobs as a percentage of the overall workforce (total non-farm payrolls) they now account for less than 9%. The de-industrialisation of the US is undeniable.
Manufacturing: % of nonfarm payrolls (since 1983)
20.0%
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
Sep-83
Sep-85
Sep-87
Sep-89
Sep-91
Sep-93
Sep-95
Sep-97
Sep-99
Sep-01
Sep-03
Sep-05
Sep-07
Sep-09
Sep-11
Jan-83
Jan-85
Jan-87
Jan-89
Jan-91
Jan-93
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
May-84
May-86
May-88
May-90
May-92
May-94
May-96
May-98
May-00
May-02
May-04
May-06
May-08
May-10
There has been a closer correlation between the absolute level of the S&P 500 and the ISMs survey of purchasing managers in the non-manufacturing sector of the economy than the manufacturing sector. But theres still a big divergence.
S&P 500 v. Non-manufacturing ISM
1750 63.0
1550
1350 53.0
May-12
58.0
Jan-13
1150 48.0 950
750
43.0
550
38.0
Lets check reliable leading and coincident indicators.
May 2013
Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13
S&P 500
ISM non-mfg
21
Firstly, the Summation Index for the McClellan Oscillator which was a good leading indicator in 2011 and a good coincident indicator twice in 2012. Its a measure of market breadth, being a running total of Advance minus Decline values of the McClellan Oscillator. It was flagging the likelihood of a correction in equities from late-January to mid-April and was wrong. It has recently turned up, but the divergence is marked, currently.
S&P 500 v. Summation Index
1700 7000 1600
5000 1500
3000 1400
1300
1000
1200
-1000
1100
-3000
Apr-11
Apr-12
Feb-11
Sep-11
Feb-12
Sep-12
Mar-11
Mar-12
Feb-13
May-11
May-12
Mar-13
Dec-11
Aug-11
Aug-12
Dec-12
Nov-11
Nov-12
Apr-13
Jun-11
Jun-12
Jul-11
Oct-11
Jul-12
Oct-12
Jan-11
Jan-12
Jan-13
S&P 500
Summation Index
The next chart shows the break-even inflation rate on the 5-year US Treasury. This represents the yield spread between the standard 5-year US Treasury and its inflation-linked counterpart and is a market-based measure of inflation expectations.
US 5-yr break even inflation yield (%)
3.00
2.50
2.00
1.50
May-13
1.00
0.50
0.00
With policy makers using extreme measures to reflate both their economies and asset prices, its perhaps not surprising that the rise in the S&P 500 tracked the trend in the break-even yield. That was until recently...but this created another divergence.
May 2013
Feb-09 Mar09 Apr-09 May-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Sep-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Mar-13 Apr-13
22
S&P 500 v. 5-year breakeven inflation

1700 1600 2.50 1500 1400 1300 1200 1100 1000 900 800 0.50 700 600 0.10 0.90 1.70 2.90
2.10
1.30
The UK equity market is also tracking the 5-year UK breakeven rate closely with less divergence currently.
FTSE All Share v. UK 5-yr beakeven inflation
3600 3400 3200 2.70 3000 2800 2600 1.70 2400 2200 2000 0.70 1800 1600 0.20
Feb-09 Mar09 Apr-09 May-09 Jun-09 Jul-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13
S&P 500
5-yr breakeven inflation
3.20
2.20
1.20
US inflation expectations as measured by the University of Michigans survey show a similar trend to breakeven inflation yields. The former is also closely correlated with gasoline prices.
UoM inflation expectations v. Average gasoline price
5.0 5.00
4.5
Feb-09 Mar09 Apr-09 May-09 Jun-09 Jul-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13
FTSE All Share Index
UK 5-yr breakeven inflation
4.50
4.0
4.00
3.5
3.50
3.0
3.00
2.5
2.50
2.0
2.00
1.5
1.50
Apr-09
Apr-10
Apr-11
Apr-12
Feb-09
Feb-10
Feb-11
Feb-12
Dec-09
Dec-10
Dec-11
Aug-09
Aug-10
Aug-11
UoM 1-yr ahead inflation expectations (%)
US average gasoline price (US$)
May 2013
23
Aug-12
Dec-12
Feb-13
Apr-13
Jun-09
Jun-10
Jun-11
Oct-09
Oct-10
Oct-11
Jun-12
Oct-12
So we have a whole series of indicators that are signalling the growing strength of deflationary forces. Yet, thus far, equity indices like the S&P 500 and FTSE All Share continue to rise.
Club 18-13
Having examined the shortfalls in widely used predictive models for equity markets, in the coming months I am going to road-test a different methodology for determining fair value and future direction of the stock market. This is based on cycles not cycles in economic indicators, but cycles in TIME. Im embarrassed to say that I first heard of W.D. Gann only several months ago and, although theres a great mystery surrounding him, he might have been one of the truly great traders. He reportedly argued that: Time is the most important factor in determining market movements And: Every movement in the market is the result of a natural law and a Cause which exists long before the Effect takes place and can be determined years in advanceEverything moves in cycles as a result of the natural law of action and reaction. By a study of the past I have discovered what cycles repeat in the future. I havent used Ganns methodology, but have developed a model based on the interaction of numerous cycles of varying duration a bit like the interaction of waves in a ripple tank. The chart below is the predicted direction of the Dow Jones Industrial Average (the data goes back longer than the S&P 500) since 1905. It is actually the absolute level of the DJIA versus its moving average and is based on 13 medium/long-term cycles. These cycles vary from just over 3 years to about 30 years and the chart uses monthly data.
Dow Jones Industrial Average: predicted trend 1905-2013

1.08
1.06
1.04
1.02
1.00
0.98
0.96
0.94
1910
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Predicted
May 2013
24
2010
The actual outcome (the price divided by the moving average) is shown below. While it was early on the 2000 NASDAQ-related peak, you can see how it picked out major highs like 1929, 1946, 1956, 1987 and 2007 and major lows like 1921, 1932, 1949, 1974 and 2009.
Dow Jones Industrial Average: actual v. predicted trend 1905-2013
2.75 2.50 1.06 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.96 0.25 0.00 0.94 0.98 1.02 1.08
1.04
1.00
1910
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Actual
Predicted
As someone who has often questioned the continued rise in the S&P 500 since early 2009, I was quite surprised by the near unbroken rise in the predicted trend from 2009-13. It implies that central bank policy has at least been pro-cyclical thus far with regard to the natural cyclical recovery in equities post-Lehman according to the model anyway. So much for big picture moves in equities, what about shorter-term trends? I added an additional 5 cycles to the original 13 - including much shorter ones with durations as little as 3-6 months - making 18 cycles in all. When I was putting together these charts of 18 and 13 cycles, it reminded me of that (in)famous British holiday company, Club 18-30. Those risqu Saatchi and Saatchi advertisings campaigns were something else. The chart below shows the predicted trend in the Dow Jones market based on these 18 cycles and the actual outcome this time using weekly data and all 18 cycles since 2009.
Dow Jones Industrial Average: actual versus predicted 2009-13
1.40 1.015
1.30
2010
1.010 1.005 1.000 0.995 0.990
1.20
1.10
1.00
0.90
0.80
0.985
0.70
0.980
0.60
0.975
0.50
0.970
May 2013
Jan-09 Feb-09 Mar09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13
Actual
Predicted
25
Its not perfect, but not bad, especially in light of problems in other models. The question is whether it will be of use going forward especially when so many equity market correlations are already breaking down? The next chart shows the outcome so far and the prediction through to the end of September 2013 (for some reason, I had to alter the labelling of the X-axis). While the model predicts much bigger moves in equities later in 2013 and in 2014, it is calling for a short-term correction during the next couple of months:
Dow Jones Industrial Average: actual versus predicted 2009-13
1.40 1.015 1.30 1.010
1.20
1.005
1.10
1.000
1.00
0.995
0.90
0.990
0.80
0.985
0.70
0.980
0.60
0.975
0.50
0.970
2009-01-02
2009-03-02
2009-05-02
2009-07-02
2009-09-02
2009-11-02
2010-01-02
2010-03-02
2010-05-02
2010-07-02
2010-09-02
2010-11-02
2011-01-02
2011-03-02
2011-05-02
2011-07-02
2011-09-02
2011-11-02
2012-01-02
2012-03-02
2012-05-02
2012-07-02
2012-09-02
2012-11-02
2013-01-02
2013-03-02
2013-05-02
2013-07-02
Actual
Predicted
When you read the analysis below, i.e. the apparent correlation between equities and QE, you actually start to wonder whether proper corrections are even possible while the Federal Reserve is still in full-blown (currently US$85bn per month) QE mode? However, given the disconnect between equities and market fundamentals, and the indications from the model, there is still an argument for hedging downside risk. Recommendation: add some downside protection to portfolios, e.g. using Put Spreads. There is a reluctance to purchase downside protection (especially short-term and at-the-money Puts), even with equity indices at all-time highs. But using the S&P 500 (now 1,666) as an example, consider: Buy a September 1600/1425 Put Spread for 25.5 net. Cost is 1.5% spot for protection c.4-15% below spot. The other obvious danger at the moment is that significant leverage is being used by some investors in this move with NYSE margin debt being close to all-time highs:
S&P 500 v. NYSE margin debt
1700 405000
1500 305000 1300 255000
2013-09-02
355000
1100
205000
155000 900 105000 700 55000
500
5000
Apr-97
Apr-02
Apr-07
Sep-97
Feb-98
Sep-02
Feb-03
Sep-07
Feb-08
Apr-12
Sep-12
Mar-00
Mar-05
Mar-10
Dec-98
Dec-03
Dec-08
Aug-00
Aug-05
Aug-10
Nov-96
Nov-01
Nov-06
May-99
May-04
S&P 500
NYSE margin debt (US$m)
May 2013
26
May-09
Nov-11
Feb-13
Jun-96
Jun-01
Jun-06
Oct-99
Oct-04
Oct-09
Jun-11
Jul-98
Jul-03
Jan-96
Jan-01
Jan-06
Jul-08
Jan-11
Money creation, the Deposit to loan gap and the S&P 500
A key point is to understand how the monetary system AND MONEY CREATION IN PARTICULAR - in the US has completely changed since the collapse of Lehman and how this change appears to be impacting risk assets, notably equities, via indirect intervention through the banking system. Most people still think that, under normal economic conditions, bank deposits are used by the banking system to create loans, which is what creates new money in the economy. Its a quaint notion but, in a credit-based system, the reality is actually the reverse. LOANS CREATE DEPOSITS - its just double-entry bookkeeping on the part of the banks. If a bank making a loan has a deficiency of required reserves after making a loan, it borrows them in the Fed Funds market. Shadow banking aside, in the old BL days (before Lehman), there was an almost perfect correlation between the growth in deposits and loans in the US banking system. As you can see from the next chart, it all changed with the introduction of QE after Lehman collapsed. This created the deposit to loan gap - which is currently in excess of US$2 trn.
All Commercial Banks: Deposits v. Loans (US$bn)
10000
9000
8000
7000
6000
5000
4000
3000
2000
Apr-98
Apr-03
Apr-08
Sep-98
Feb-99
Sep-03
Feb-04
Sep-08
Feb-09
Mar-01
Mar-06
Mar-11
Dec-99
Dec-04
Dec-09
Aug-01
Aug-06
Aug-11
Nov-97
Nov-02
Nov-07
May-00
May-05
Deposits: All Commercial Banks
Loans & leases: All Commercial Banks
People like Tyler Durden of Zero Hedge and Bill Frezza of the Competitive Enterprise Institute have tried to educate people on this issue, but with little success. Since Lehman, the weak economy has translated into muted loan growth, but the trend in deposit growth has continued thanks to the impact of QE which creates excess reserves (deposits) in the banking system. The point here is that the CREATION OF NEW MONEY shifted from the commercial banks to the Federal Reserve.
May 2013
27
May-10
Nov-12
Apr-13
Jun-97
Jun-02
Jun-07
Oct-00
Oct-05
Oct-10
Jun-12
Jul-99
Jul-04
Jan-97
Jan-02
Jan-07
Jul-09
Jan-12
The excess deposits in the banking system basically mirror the excess reserves on the Feds balance sheet.
Deposits - Loans v. Excess reserves on Fed balance sheet (US$bn)
2500
2000
1500
1000
500
-500
The question is, what do the banks do with these excess deposits? Here we have to praise the sleuthing work of Tyler Durden at Zero Hedge. Commenting that: Suggesting that banks abuse excess deposits for risky pursuits would be considered absolutely preposterous... He proceeded to show this slide from JPMorgan Chases Q2 2012 results presentation which explained that it was the excess deposits, i.e. the deposit to loan gap which the banks ill-fated Chief Investment Office (CIO) was engaged in hedging. Until it lost billions of dollars.
Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Feb-13 Mar-13 Apr-13
Deposits - Loans: All commercial banks
Excess reserves at Federal Reserve
Source: JPMorgan Chase
May 2013
28
The next slide makes it even clearer note the first bullet point (my emphasis): JPM has $1.1T in deposits and $0.77T in loans Excess deposits of $423B, plus equity of $144B & other assets of $45b create $522B investment need
Because one bank was engaged in making risky bets with its excess deposits during 2011/early 2012, doesnt mean that the rest of the banking sector is doing the same thing. But... The advent of QE3 in late-2012 (US$85bn per month) has created an even greater investment need for these excess liabilities to be put to work? The question is where? I dont know for certain, but look at the next chart which I havent seen reproduced elsewhere. It shows an intriguing correlation between the S&P 500 and the deposit to loan gap (Deposits Loans in US commercial banks) since September 2008.
Source: JPMorgan Chase
S&P 500 v. Deposits-Loans ("deposit to loan gap" in banking system from QE)
1800 2500
1600
2000
1400 1500 1200 1000
1000
800
500
600
Apr-09
Apr-10
Apr-11
Feb-10
Sep-10
Feb-11
Sep-11
Feb-12
Sep-12
Mar-10
Mar-11
Mar-12
Feb-13
May-09
May-11
S&P 500
Deposits - Loans: All Commercial Banks (US$bn)
May 2013
29
May-12
Mar-13
Dec-09
Dec-10
Dec-11
Aug-09
Aug-10
Aug-12
Nov-09
Nov-10
Nov-11
Nov-12
Apr-13
Jun-09
Jun10
Jun-11
Jun-12
Jul-09
Jul-10
Jul-11
Mar09
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-10
Jan-12
Jan-13
This obviously raises all sorts of concerns with regards to Federal Reserve policy and oversight, the relationship between equity markets and economic fundamentals...and of course: What would happen to equities if the Fed actually did begin to taper its asset purchases, even for a short period, since the flow rate of these excess deposits would inevitably decline? Assuming this analysis is correct, another question is whether banks are covering their tracks in equity markets by using shadow banking methods, like repos, to keep risky exposures off their balance sheets. This takes us on to the opaque subject of collateral, which Ive covered once before, and was vital to understand with regard to the 2008 crisis and is vital to understand now. Shortages of good collateral and changes in its flow can have rapid and profound effects on a leveraged system. By way of example, this was underscored in the IMFs Working Paper, The Changing Collateral Space (January 2013): The motivation for investigating the use of collateral is its increasing importance for the functioning of the global financial system. Collateral is the oil in todays financial system: financial lubrication is provided via collateral chains. Moving on to the US Office of Debt Managements 2013 Q2 Report, there is a presentation in the Appendix Availability of High Quality Collateral which is (intriguingly) marked Confidential. One of the slides (below) emphasises the link between QE and its impact on collateral - see the second bullet.
Source: Office of Debt Management
Just to reiterate: QE is a transformation of non-cash HQC (high quality collateral) to cash HQC (high quality collateral) So, the theory is that QE creates cash HQC, which creates an investment need, which impacts risk assets, like equities, via collateralised transactions. May 2013
30
There are two further points which are important to understand regarding collateral. The first one is the following. While QE appears to have a beneficial impact on creating CASH COLLATERAL which can be used for risk assets, there is a corresponding and negative impact on the velocity of collateral and, therefore, on the all-important issue of LIQUIDITY. QE disrupts collateral chains by reducing the FLOW of good collateral, like Treasury securities, where the same Treasury security can be used (hypothecated and re-hypothecated) to finance several positions. This was first acknowledged (as far as I can tell) by the Fed in a January 2011 paper, Responses to the Financial Crisis, Treasury Debt, and the Impact on Short-Term Money Markets: ...we find that OMOs by the Federal Reserve (both temporary and permanent) which also impact the level of Treasury collateral, did not alleviate funding market stresses during our sample period. These results also highlight the need to carefully consider the impact of policies beyond their intended target...LSAP (Large Scale Asset Purchase) purchases of Treasury securities actually removed Treasury collateral. What the Fed is saying is that QE programmes effectively silo securities which could be both used as collateral AND used more than once via hypothecation. The IMF paper (The Changing Collateral Space), referred to earlier, explained this clearly: Collateral is like high-powered money where the haircut is the reserve ratio, and the number of re-pledgings (the length of the collateral chain) is the money multiplier. It warned: In the near future, sustaining collateral velocity (i.e. collateral re-use by markets) will be important since there is an unfortunate constellation from central bank actions and regulatory proposals that will silo good collateral in the markets. And in relation to QE3/4: At this rate (the) Fed could silo over $1 trillion additional good collateral in 2013 (and beyond, if necessary). This is likely to have first order implications for collateral velocity and global supply/ demand of collateral. If continued QE begins to harm systemic liquidity, we have a major problem. This brings us on to the second point regarding collateral. Going forwards, even if market conditions remain normal, a shortage of collateral is likely to develop. Back to the (Confidential) presentation in the US Office of Debt Managements 2013 Q2 Report on collateral. It estimates that during 2013-19, there will be an additional requirement for high quality collateral of US$2.6-5.7 trn assuming NORMAL MARKET CONDITIONS. This results from new regulations such as Basel III and moving OTC derivatives on exchange, etc.
May 2013
31
The slide shows that under stressed market conditions, the requirement would be an almost unimaginable US$4.6-11.2 trn. Remember, this is the estimate of the Treasurys own advisers. The obvious implication of this is the sheer scale and poorly collateralised nature of the current shadow banking and derivatives structure. The implementation of Basel III was delayed and it would have only required the system to find a measly US$1.0-2.5 trn of additional collateral which was impossible. Given the state of the financial system, e.g. excessive leverage and bankrupt sovereigns, what are the chances that we can avoid stressed market conditions in the coming years? It doesnt bear thinking about.
Source: Office of Debt Management
Am I missing something?
Industrial gas stocks Praxair & Linde
The requirement to optimise portfolio construction never goes away. Given that Im not inclined to take on much risk at this point (understatement), I was looking for opportunities in high quality, defensive stocks which have lagged the big moves weve seen in many large cap Consumer Staples and Healthcare names in recent months. The industrial gas company, Praxair, fits into this category, but has been performing relatively poorly - am I missing something? I also like its European rival, Linde, although the latter has only marginally lagged the broader European market since the November low. These stocks look increasingly well-positioned.
May 2013
32
For the majority of my career, I was a sector analyst and, for the majority of that, I covered the chemicals sector. Consequently, the industrial gas stocks are a bit like old friends and Im familiar with the investment case. The industrial gas sector is even more of an oligopoly post the takeovers of BOC and Messer Griesheim, etc.
Industrial gas stocks have the obvious defensive attributes of long-term take-or-pay contracts in the tonnage business and rental revenue in the packaged (cylinder) business. Besides top-line stability, the P&Ls of these companies also have protection from rising input costs mainly electricity - in the form of passthrough clauses in tonnage contracts. Indeed, they fit into the Inflationary Deflation scenario admirably.
Source: Praxair Source: Praxair
May 2013
33
Backlogs of new tonnage contracts possessed by these companies provide stability and growth going forward. Praxair has approximately $2.5bn.
Source: Praxair
Linde has even more.
The most economically sensitive part of the industrial gas business is merchant liquid. I was also struck by the stability of pricing in merchant liquid, even in very weak European markets. Both Praxair and Air Liquide reported that prices are 0.5-1.0% higher than last year, despite utilisation rates languishing in the 60-70% range. There is greater pricing power in other regions. In a sense, the industrial gas business is more of a distribution business than a manufacturing (air separation) business. Consequently, there are economies of scale from having high customer densities around air separation units. Praxair is probably best placed with, for example, its strong position in North America, especially on the Gulf Coast. The density of its air separation units (production plants in the slide below) is probably the best indication of customer density.
Source: Linde AG
May 2013
34
Source: Praxair
The same in South America.
Its a different story in Europe, a small market for Praxair, where Air Liquide and Linde dominate.
Source: Praxair Source: Praxair
May 2013
35
In North America, Praxair is the purer play of the two majors, the other being Air Products. When Praxair reported its quarterly earnings on 24 April 2013, the company tightened the guidance for FY 2013 EPS from $5.85-6.10 to $5.90-6.05. Lindes Q1 2013 results beat estimates at both the revenue and earnings lines.
And reiterated guidance for FY 2013 EBITDA (Operating profit) and beyond (+25% by 2016).
Praxair is trading on a 2014 PE of 17.0x, a premium to the 15.5-16.5x range for Air Products, Linde and Air Liquide. In my opinion, this is more than justified by its superior ratio of return on invested capital versus WACC, i.e. approximately 200% versus 100-150% for its rivals (and better than Nestle for a lower PE). In the 1Q 2013 conference call, Praxairs CEO emphasised that the companys return on capital will rise during 2014-15 as the new projects start up and merchant liquid loadings ramp up.
Source: Linde AG Source: Linde AG
May 2013
36
The Stadium Tour starting in the US

My view is that medium-term prospects for the US economy are considerably weaker than most people believe. In true analytical fashion, the current (Bloomberg) consensus is for a nice steady acceleration in US GDP growth from 2.0% in 2013, 2.7% in 2014 and 3.0% in 2015. Two lessons from long wave (Kondratieff) cycles are, first, the extent to which they are driven by the growth in debt/credit...
US economy: total debt, nominal GDP, real GDP (1960 = 100)
8100
7100
6100
5100
4100
3100
2100
1100
100
Secondly, debt brings forward consumption. As the cycle becomes more and more extended (thanks to central banks after 2000 and again after 2008), the law of big numbers means that the rate at which the private sector can take on even more debt has to slow. Household debt growth has stagnated not good in a credit-driven system.
Household debt growth yoy % (1961-2012)
20%
15%
10%
Q1 1960 Q1 1961 Q1 1962 Q1 1963 Q1 1964 Q1 1965 Q1 1966 Q1 1967 Q1 1968 Q1 1969 Q1 1970 Q1 1971 Q1 1972 Q1 1973 Q1 1974 Q1 1975 Q1 1976 Q1 1977 Q1 1978 Q1 1979 Q1 1980 Q1 1981 Q1 1982 Q1 1983 Q1 1984 Q1 1985 Q1 1986 Q1 1987 Q1 1988 Q1 1989 Q1 1990 Q1 1991 Q1 1992 Q1 1993 Q1 1994 Q1 1995 Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012
Total credit market debt
Nominal GDP
Real GDP
5%
0%
-5%
May 2013
Q1 1961 Q1 1962 Q1 1963 Q1 1964 Q1 1965 Q1 1966 Q1 1967 Q1 1968 Q1 1969 Q1 1970 Q1 1971 Q1 1972 Q1 1973 Q1 1974 Q1 1975 Q1 1976 Q1 1977 Q1 1978 Q1 1979 Q1 1980 Q1 1981 Q1 1982 Q1 1983 Q1 1984 Q1 1985 Q1 1986 Q1 1987 Q1 1988 Q1 1989 Q1 1990 Q1 1991 Q1 1992 Q1 1993 Q1 1994 Q1 1995 Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012
37
There are indicators which suggest that wealth and economic potential, in a broad sense, across the US economy peaked in the mid-2000s. For example, in an affluent economy, one would expect growing numbers of very wealthy people with money to waste on things like pleasure boats and planes.
Real personal consumption expenditure: pleasure boats & aircraft (US$m)
35000
30000
25000
20000
15000
10000
Apr-96
Apr-01
Apr-06
Sep-96
Feb-97
Sep-01
Feb-02
Sep-06
Feb-07
Apr-11
Sep-11
Feb-12
Jun-95
Jun-00
Jun-05
Jun-10
Jul-97
Jul-02
Jul-07
Mar-99
Mar-04
Mar-09
Dec-97
Dec-02
Dec-07
Jul-12
Aug-99
Aug-04
Aug-09
Nov-95
Nov-00
Nov-05
May-98
May-03
Thriving economies are usually associated with an entrepreneurial culture and growth in small business. Charles Hugh Smith recently posted a chart on his blog showing the number of self-employed persons per capita in the US. It peaked in 2004 and has fallen sharply during the last 12 months.
May-08
Nov-10
Dec-12
Oct-98
Oct-03
Oct-08
Jan-95
Jan-00
Jan-05
Jan-10
Source: Charles Hugh Smith, St. Louis Fed
May 2013
38
Sticking with the theme of small business, the next chart compares the ISM Manufacturing Index with the NFIB Small Business Optimism Index which consists of 10 components (including outlook, earnings, sales, inventories, hiring plans, prices, credit conditions, etc.). In the wake of Lehman, small business has never seen the sort of recovery reported in the ISM numbers.
NFIB Small Business Optimism Index v. ISM mfg
110 65
105
60
55 100
Source: NFIB, Monument Securities.
50 95 45 90 40
85
35
80
30
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
NFIB Small Business Optimism Index
ISM mfg
The next chart is particularly thought-provoking the NFIB Small Business Optimism index (lagged twelve months) versus the US unemployment rate.
NFIB Small Business Optimism Index v. US unemployment rate
110 4.0
May-12
Jan-13
5.0 6.0
105
100
Source: NFIB, Monument Securities.
7.0 95 8.0 90 9.0
85
10.0
80
11.0
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Sep-13
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
May-12
NFIB Small Business Optimism Index (lagged 12 months)
US employment rate (Inverted) %
May 2013
39
May-13
Jan-14
The supposed recovery in the US labour market has been exaggerated. Economists are seduced by the headline Non-Farm Payroll data which is now showing a huge divergence versus the percentage of the US population which is employed.
Unemployment rate v. Percentage of population employed (%)
11.0 57.0
58.0
9.0
59.0
60.0
61.0 7.0 62.0
63.0 5.0
64.0
65.0
3.0
66.0
Sep-99
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
Unemployment rate (U3)
Emploiyment / Population
The ABC Personal Finance Index first peaked in the late-1990s before peaking again, but at a lower level, in 2007. On a positive note, however, the current cycle does not appear to have peaked yet.
S&P 500 v. ABC Personal Finance Index
1800 50
1600
May-12
Jan-13
40
1400
30
1200
20
Source: ABC, Monument Securities.
1000
10
800
600
-10
400
-20
200
-30
Jul-93
Jul-94
Jul-95
Jul-96
Jul-97
Jul-98
Jul-99
Jul-00
Jul-01
Jul-02
Jul-03
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jul-12
S&P 500
ABC Personal Finance Index
The ISM data for New Orders Customer Inventories suggests that it will drag down industrial production growth in the next few months.
May 2013
40
Jan-13
The Chicago Fed National Activity Index (3-mth moving average) also suggests that things are flat.
The majority of goods are moved within the US by (diesel-powered) trucks. The chart for Product supplied
Source: Chicago Fed, Monument Securities
May 2013
-40 10 0 -30 -20 -10 20 30 40 2500 3000 3500 4000 4500 5000
-5.00
-4.00
-3.00
-2.00
-1.00
0.00
1.00
2.00
Jan-99 Jul-94 Jan-95 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Sep-99 May-99
Jan-94
Jan-99
May-99
Sep-99
Jan-00
May-00
Sep-00
Jan-01
May-01
Sep-01
Jan-02
May-02
Distillates seems to be rolling over.
Sep-02
Jan-03
May-03
Sep-03
Jan-04
May-04
Sep-04
Jan-05
May-05
Product supplied: distillates
Sep-05
ISM: New order - Customer inventories
Chicago Fed National Activity Index
Product supplied: distillates (000s bpd)
ISM: New orders - Customer inventories v. Industrial production growth
41
52wk moving average
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Industrial production yoy %
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
0.0%
5.0%
-5.0%
10.0%
-20.0%
-15.0%
-10.0%
Jan-13
Housing has been the great recovery story in the US of late. We are now at a critical juncture with both the NAHB survey and lumber prices showing recent weakness, but stories of bubbles developing in some cities like New York.
NAHB survey v. Lumber price
80 500.0
70
450.0
60
400.0
50
350.0
Source: NAHB, Monument Securities
40
300.0
30
250.0
20
200.0
10
150.0
100.0
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-01
May-04
NAHB survey
Lumber futures (US$ per contract)
Europe flatlining
Europe is holding up better than I expected...so far anyway. Consumer credit is basically flatlining although it is currently showing negligible year-on-year growth instead of decline.
Eurozone consumer credit
5400000 6.0%
5300000
May-12
May-02
May-03
May-05
May-06
May-07
May-08
May-09
May-10
May-11
Jan-13
5.0% 4.0% 3.0% 2.0%
5200000
5100000
5000000
4900000 1.0% 4800000
4700000
0.0%
4600000
-1.0%
Sep-08
Sep-09
Sep-10
Sep-11
Mar-09
Mar-10
Mar-11
Mar-12
Sep-12
Jul-09
Jul-10
Jul-11
Jul-12
May-09
May-10
May-11
Consumer credit outstanding (Eur m)
yoy %
May 2013
42
May-12
Mar-13
Jan-09
Jan-10
Jan-11
Jan-12
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Jan-13
The Eurozone Composite PMI has been range bound in contraction territory between 45-50- for just over a year now. Its slightly surprising that Cyprus didnt lead to renewed decline in April.
Eurozone Composite PMI
65
60
55
50
45
40
35
30
Feb-06
Feb-07
Feb-08
Feb-09
Feb-10
Feb-11
Feb-12
Aug-05
Aug-06
Aug-07
Aug-08
Aug-09
Aug-10
Aug-11
Nov-05
Nov-06
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Aug-12
May-05
May-06
May-07
May-08
May-09
May-10
May-11
A key thing to watch now is whether the centre, i.e. Germany, is beginning to crack. The German Composite PMI fell sharply in April from 50.6 to 49.2. German industrial production and retail sales growth are already slightly negative.
Germany: industrial production & retail sales (yoy %)
15.0
10.0
5.0
0.0
-5.0
May-12
Nov-12
Feb-13
-10.0
-15.0
-20.0
-25.0
Sep-99
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
Industrial production
Retail sales
Manufacturing orders, both in aggregate and for export, are lacking momentum.
May 2013
43
May-12
Jan-13
Staying in the core, industrial production in the Netherlands is plunging with the latest print of -5.3%.
On a domestic basis, however, consumer confidence continues to hold up. Maybe they are thinking At least
May 2013
100 110 120 60 70 80 90 -50 -40 -30 -20 -10 10 20 30 40 0
-15
-12
12
-9
-6
-3
Jan-01 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 Sep-99 May-99 Jan-99
May-01
Sep-01
Jan-02
May-02
Sep-02
Jan-03
May-03
Sep-03
Jan-04
Im not Spanish, or Italian, or French.
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
Manufacturing orders
May-06
Sep-06
Germany: Consumer Confidence
Netherlands: Industrial production (yoy %)
Germany: Manufacturing orders v. Export manufacturing orders (yoy %)
44
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Export manufacturing orders
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13
Consumer confidence has fallen to a 20-year low, although there has been a minor recovery recently.
May 2013
-50 10 20 30 10 -5 0 0 5 -40 -30 -20 -10 -15 -10 15
100
105
110
115
120
125
85
90
95
Jan-99 Jul-93 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Jan-93 Jan-01
May-99
Sep-99
Jan-00
May-00
Sep-00
Jan-01
May-01
Sep-01
Jan-02
May-02
Sep-02
Jan-03
Retail sales hit the same rate of decline.
May-03
Sep-03
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Netherlands: Retail sales (yoy %)
Netherlands: Consumer confidence
Italy: Industrial production index (2010 = 100)
Elsewhere in Europe, Italy is heading for the precipice in terms of industrial production.
45
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13
Renewed underperformance of IBEX versus Italys FTSE MIB is telling us to keep a closer eye on Spain.
May 2013
-5% 0% 5% 0.58 10% 15% 20% 25% 0% -30% -20% -10% 10% 20% 30%
0.46
0.48
0.50
0.52
0.54
0.56
Jan-12 Jan-99 May-99 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Jan-04
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Growth in consumer credit has turned negative.
Jul-12
Aug-12
Sep-12
Recent export data is on the brink of a year-on-year decline.
Italy: Exports (yoy %)
IBEX v. FTSE MIB
Italy: Consumer credit outstanding (yoy %)
46
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Acceleration in the decline of retail sales in Spain is worrying, but goes against consumer confidence trend.
May 2013
10.0 15.0 20.0 25.0 30.0 0.0 5.0 -15.0 -10.0 10.0 15.0 -5.0 0.0 5.0
0%
-30%
-20%
-10%
10%
20%
30%
40%
Jan-99 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13
Jan-99
May-99
Sep-99
Jan-00
May-00
Sep-00
Jan-01
May-01
Sep-01
Jan-02
May-02
Sep-02
Jan-03
May-03
Sep-03
Jan-04
May-04
Sep-04
Spain unemployment rate
Jan-05
Retail sales (yoy %)
May-05
Sep-05
The heady days of strong export growth in 2011 are long gone.
Spain: exports (yoy %)
Spain: Retail sales v. Consumer confidence
Unemployment rate: Spain v. Germany
Here is another great divergence...being part of the Euro is strangling Spain.
47
Germany unemployment rate
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
Consumer confidence
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
0 -5
Jan-13
-50
-45
-40
-35
-30
-25
-20
-15
-10
In all this excitement, weve forgotten about France. Credit growth slowing, but still positive year-on-year.
May 2013
0% -10000 -40% -30% -20% -10% 10% 20% 30% 40% -8000 -6000 -4000 -2000 2000 0
10%
12%
14%
0%
2%
4%
6%
8%
Jan-04 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 Sep-99 May-99 Jan-99
Apr-04
Jul-04
For the wrong reason...
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
The Spanish trade balance went positive in March 2013...
Spain: Imports (yoy %)
Spain: Trade balance (Eur m)
France: Consumer credit outstanding (yoy %)
48
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
The popularity rating of the Socialist president, Franois Hollande, has tumbled faster and further than that of any other president since the Fifth Republic began in 1958. Its not surprising.
France: Jobseekers v. Unemployment rate
3400 12.0 11.5 11.0 3000 10.5 10.0 2600 9.5
9.0 8.5 2200 8.0 7.5 1800 7.0
Sep-99
Sep-01
Sep-03
Sep-04
Sep-06
Sep-08
Sep-09
Sep-11
Sep-00
Sep-02
Sep-05
Sep-07
Sep-10
Sep-12
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
Jobseekers (000s)
Unemployment rate (%)
There is a good chance that industrial production is poised to turn down again.
France: Business confidence composite indicator v. Industrial production
120 10
110
May-12
Jan-13
5 0 -5
100
90
80
-10
70
-15
60
-20
Sep-99
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
Business confidence composite indictator (INSEE)
Industrial production (yoy %)
May 2013
49
May-12
Jan-13
Asia
Source: MaPA of Singapore, Monument Securities
Source: Nomura, Monument Securities
May 2013
100 105 -25.0% -20.0% -15.0% -10.0% 10.0% 15.0% 20.0% 25.0% 75 -5.0% 0.0% 5.0% 80 85 90 95
Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Sep-06 May-06 Jan-06 Sep-05 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00
The container throughput at Asias key trading hub is still weak.
Singapore: Container throughput (yoy %)
The Nomura Asia Leading Export Index is showing slightly more signs of life, but its marginal.
Nomura Asia export leading index
50
The share prices of quoted Asian shipping companies are lacklustre. China COSCO:
China COSCO Holdings (China)
5.50
5.00
4.50
4.00
3.50
3.00
Sep-12
Feb-13
May-12
Mar-13
Aug-12
Dec-12
Nov-12
Apr-13
Jun-12
Jul-12
Oct-12
Jan-13
Hanjin:
Hanjin Shipping (South Korea)
18000
16000
14000
12000
May-13
10000
8000
6000
Sep-12
Feb-13
May-12
Mar-13
Aug-12
Dec-12
Nov-12
Apr-13
Jun-12
Jul-12
Oct-12
Jan-13
China Shipping Container Lines:

China Shipping Container Lines (China)
3.30
3.10
2.90
2.70
2.50
May-13
2.30
2.10
1.90
1.70
Sep-12
Feb-13
May-12
Mar-13
Aug-12
Dec-12
Nov-12
Apr-13
Jun-12
Jul-12
Oct-12
Jan-13
May 2013
51
May-13
The HSBC/Markit PMI for China in April 2013 was 50.5 down from 51.6 the previous month. The official PMI also dipped marginally from 50.4 to 50.1.
China: a tale of two PMIs
62
58
Source: Markit.com, CFLP, Monument Securities
54
50
46
42
38
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Sep-12
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Jul-12
May-06
May-07
May-08
May-09
May-10
May-11
PMI (HSBC/Markit)
PMI (official)
Slowing industrial production in China is having a profound impact on prospects in key trading partners like Australia.
China: Industrial production v. Australia PMI new orders
21.0 70.0 65.0 60.0 17.0 55.0
19.0
May-12
Mar-13
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Nov-05
Nov-06
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Jan-13
15.0
50.0 45.0 40.0 35.0
13.0
11.0
9.0 30.0 7.0 25.0 20.0
5.0
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-11
Apr-12
China IP growth (% yoy)
Australia PMI new orders
These charts, together with the one above showing that growth in electricity production and rail cargo are at stall speed. Hmmm. But...are we missing something just coming into view on the horizon?
May 2013
52
Apr-13
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Look at the steady acceleration in the growth of Chinas money supply in the form of the M2 aggregate. It really looks like early-stage reflation.
China: M2 money supply (yoy %)
35
30
25
20
15
10
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
The next chart compares the 3-month moving average of Chinese industrial production growth versus M2 growth. It implies that the longstanding deceleration in Chinese industrial production could be close to an end.
China: Industrial production (3m M.A.) v. M2 money supply

23.0 35.0
21.0
May-12
19.0 25.0 17.0
Jan-13
30.0 20.0 15.0 10.0 5.0 0.0
15.0
13.0
11.0
9.0
7.0
5.0
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
Industrial production 3m M.A. (yoy %)
M2 (yoy %)
May 2013
53
May-12
Jan-13
We know that the Chinese leadership is doing its best to cool speculation in the property market, so where is this liquidity going to go. Apart from gold, my guess is partly into real goods and services (good for the equity market) and partly into other forms of speculation...maybe the equity market?
Shanghai Composite
3600 3400 3200 3000 2800 2600
2400 2200 2000 1800 1600 1400
2008
2009
2010
2011
2012
My hunch is that the Shanghai Composite is a good buy here - volumes have picked up too. In Japan, we have the LDP, with intimate connections to the US establishment dating back to the 1950s, experimenting with a steroidal version of the Bernanke playbook. So far, so good with the Q1 GDP of 0.9% qoq beating expectations of 0.7%. The latest PMI for April suggests further recovery is in prospect.
Japan: PMI manufacturing v. Industrial production (index)
60 115 110 55 105 100
50
2013
95 45 90 85 80 35 75 70 30 65 25 60
40
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-11
Apr-12
PMI manufacturing
Industrial production (index)
May 2013
54
Apr-13
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Toyota is forecasting that 83% of its forecast net increase in operating income in its March 2014 fiscal year will come from a weaker Yen.
There is a good chance that Japan will be the first of the major economies to experience a currency crisis as the G-20 and G-7 approved Yen devaluation eventually gets out of control. There is even the possibility of a classic Ludwig Von Mises crack-up boom: This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices Ironically, the most recent CPI data (March 2013) showed deflation getting worse.
Japan: CPI (yoy %)
3.0
Source: Toyota
2.0
1.0
0.0
-1.0
-2.0
-3.0
Sep-00
Sep-01
Sep-02
Sep-03
Sep-04
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
May 2013
55
May-12
Jan-13
Earlier, we looked at how (despite all of the QE), US breakeven inflation rates have lost momentum and recently turned down. This is not the case in Japan where we have the shock and awe QE of Abennomics.
Japan: 5-yr breakeven inflation (%) since May 2012
2.0 1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
21/05/2012
04/06/2012
18/06/2012
02/07/2012
16/07/2012
30/07/2012
13/08/2012
27/08/2012
10/09/2012
24/09/2012
08/10/2012
22/10/2012
05/11/2012
19/11/2012
03/12/2012
17/12/2012
31/12/2012
14/01/2013
28/01/2013
11/02/2013
25/02/2013
11/03/2013
25/03/2013
08/04/2013
22/04/2013
But Japanese consumers are beginning to respond.

Tokyo department store sales (yoy %)
20
15
10
06/05/2013
-5
-10
-15
-20
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-11
Apr-12
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
Jul-12
Oct-12
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Is this foreshadowing the end-game outlined by von Mises? But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against real goods, no matter whether he needs them or not, no matter how much money he has to pay for them. We are witnessing the greatest monetary experiment in a major economy in modern times.
May 2013
56
Jan-13
Encore - Inflationary Deflation: end-game update

Brief summary: Excessive monetary stimulus and low interest rates create financial bubbles. This is the biggest debt bubble in history. It is a potent deflationary force and central banks are forced into deploying increasingly aggressive (offsetting) inflationary forces. The avoidance of a typical deflationary resolution to this economic long (Kondratieff) wave is pushing the existing monetary system beyond the point of no return. The purchasing power of the developed worlds currencies will have to bear the brunt of the adjustment. Preparations for this by the BRICS nations, led by China, are advancing rapidly. The end-game is an inflationary/currency crisis, dislocation across credit and derivative markets, and the transition to a new monetary system. A new basket currency is likely to replace the dollar as the worlds reserve currency. The Inflationary Deflation paradox refers to the coming rise in the price of almost everything in conventional money and simultaneous fall in terms of gold. The critique of the loose monetary policies of the US, Europe and Japan, etc, by BRICS nations, notably China, has been stepped up since March. The opening salvo was fired by the Deputy Governor of the Chinese central bank, Yi Gang: China is fully prepared in terms of both monetary policies and other mechanisms, to deal with a possible currency war. China will take into full account the quantitative easing policies implemented by central banks of foreign countries. This was followed by Gao Xiqing, head of the China Investment Corp sovereign wealth fund, who criticised Japans devaluation of the Yen: Treating your neighbours as a garbage bin and starting a currency war would not only be dangerous for others but eventually be bad for yourself. Followed by Chen Yulu, an adviser to the Peoples Bank of China: The currency war situation is quite severe. China is definitely a victim. Then Li Yining, a professor at Peking University and probably the nations most famous economist (he also taught Chinas incoming Premier, Li Keeqiang): We have already taken a position on this before and China doesnt approve of some countries overly accommodative monetary policy...This is an act of transferring the crisis to others. Its generally believed that the G-20 and G-7 have rubber-stamped Japanese monetary policy because there was no criticism in the official communiqus. Private views are in stark contrast. Speaking the day after G20 in late April 2013, the governor of Chinas central bank, Zhou Xiaochuan, commented: Although unconventional monetary policies in major advanced economies have helped stabilize financial markets and foster economic recovery, it is necessary to re-evaluate the marginal benefits and costs of such policies after multiple rounds of monetary easing. And:
May 2013
57
Policymakers in advanced economies should also be mindful of the spillover effects of these policies, such as more volatile capital flows, exchange rates, and commodity prices. Prolonged easing could exacerbate the financial vulnerabilities and affect the stability of the international monetary system. New BoJ Governor, Haruhiko Kuroda, at the recent G20 meeting:
At a supranational level, China and other BRICS have recently begun to express their annoyance at the lack of progress in giving them a greater say in the worlds monetary affairs. A prime example is their demand for an increase in their quota at the IMF. Speaking at the 27th meeting of the International Monetary and Financial Committee on 20 April 2013, Zhou Xiaochuan, commented: To ensure the legitimacy, credibility, and effectiveness of the IMF, it is imperative not to further delay the IMF quota and governance reform. We urge members that have yet to ratify the 2010 quota and governance reform to do so as soon as possible. This was Brazils Finance Minister, Guido Mantega, speaking at the same meeting: Target dates have been missed, delays and procrastination have become routine. The Fund missed the October 2012 deadline for the entry into force of the 2010 quota and governance reform. It then missed the January 2013 target for the completion of the review of the quota formula. Now we learn that the discussions of the next general quota review, which we have agreed to complete by January 2014, have also been postponed. No clear date has been set to initiate these discussions and we risk missing a third deadline. There is no doubt in his mind where responsibility lies: The obstacle to the entry into force of the 2010 reform has been the delayed ratification by the United States Congress. In the case of the quota formula review, the main obstacle is resistance to change on the part of over-represented European countries. In other words, America is unable and Europe unwilling to follow through with agreed reforms. The institutions major shareholders are gambling, perhaps unwittingly, with the IMFs legitimacy and credibility. And: Emerging market countries have done their part. Major advanced countries have yet to do theirs.
Source: Russia G20
May 2013
58
Ive been documenting the steps being taken by the BRICS, and China in particular, to undermine the dollars monopoly on world trade. The BRICS meeting in March 2012 made it a policy to increase trade in local currency and China has set up bilateral agreements and/or currency swaps with most of its major trading partners. Two more were added in the space of two weeks beginning at the end of March 2013: China and Australia agreed to plan for the direct convertibility of Yuan into Australian dollars; and China and France agreed to set up a currency swap line to make Paris an offshore trading hub (this follows a similar agreement with the UK/London).
There is an eerie similarity between what happened in the run-up to the last change in the world monetary system, i.e. the collapse of Bretton Woods in 1971, and what is happening now. The former was led by one country, France, which was an outspoken critic of the existing system, just like China is today. It sought to undermine Bretton Woods, in part by refusing to purchase US Treasuries and by buying gold. Today, we have China pursuing a similar strategy. The result is meagre Chinese purchases of US Treasury debt. During the last 12 months of reported data on foreign holdings of US Treasury debt, i.e. from February 2012 to February 2013, net Chinese purchases were US$67.7bn. Its aggregate holdings of US Treasuries are still more than US$90bn below their peak in July 2011 a matter of days before S&P downgraded the US AAA-rating on its sovereign debt. Which brings us on to the subject of gold. China did not provide an update on its gold reserves during the six years from 2003-09. It then surprised markets (not some in the gold community) when it reported a 76% increase to 1,054 tonnes. Reports from people close to the LBMA have been suggesting aggressive buying by China since late 2011. Circumstantial evidence is also provided by trade data on Chinese gold imports through Hong Kong:
China: Gold imports through Hong Kong (tonnes)
250
200
Source: Hong Kong Census & Statistics Dept.
150
100
50
0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2012
2013
May 2013
59
The recent collapse in the gold price occurred over a two-day period Friday the 12th and Monday the 15th of April 2013. The chart below from the London-based bullion broker, Sharps Pixley, appears to confirm the story that 400 tonnes of paper gold - 100 tonnes followed a few hours later by a further 300 tonnes in 48 minutes - was suddenly dumped into the COMEX futures market on 12 April 2013.
Below is a chart from my friend Sandeep Jaitlys Gold Basis Service on 1 May 2013. Sandeep is the world expert on the gold basis, i.e. the difference between the spot price of gold and the prices of near months gold futures.
Source: Sharps Pixley
The basis (blue line) crossed into negative territory on 5 April 2013 meaning that the gold price had moved into BACKWARDATION - and that backwardation was increasing until the price was smashed (light green arrow). May 2013
Source: Gold Basis Service / Sandeep Jaitly
60
In Sandeep Jaitlys view: The action in gold and silver was done for a reason: to bring them out of backwardation. The action worked momentarily but there is only so much physical bullion to do this with and that is fast running out. Gold almost moved out of backwardation as the price fell sharply, but the backwardation quickly reasserted itself and moved to new highs. Why is backwardation in the gold market significant? The gold price should not move into backwardation in normal market conditions. Given golds extreme (high) stock/flow characteristics versus other commodities, backwardation implies a risk-free profit from selling spot, buying the future and taking delivery of the latter. Backwardation implies that traders/investors are placing a premium on holding physical and/or are nervous about prospect of physical delivery on the expiration of a futures contract. Basically, it tells you that there is little physical gold being offered in the market. The point here is that, just before the gold price collapsed, the market for physical gold was extremely tight. The collapse in the price was, therefore, counter-intuitive. Prior to the collapse we had also been witnessing a large drawdown of gold inventory on the New York COMEX and in the JPMorgan vault in particular. Furthermore, the backwardation in gold and drawdown in COMEX inventories was preceded by what has become (in the gold market) a high-profile announcement by ABN AMRO in late-March 2013. ABN wrote to its customers for whom it acts as custodian for gold and other precious metals to notify them that after 1 April 2013, they could no longer take delivery of physical metal but would be cash settled (i.e. default/confiscation in any other name). One of the biggest misunderstandings in the history of finance is the mechanism of price discovery in todays gold and silver markets. ABNs move was just more evidence that gold and silver markets are gigantic fractional reserve systems and that the screen price of these metals is a hybrid price of predominantly paper gold and a FAR smaller volume of bullion. Besides the COMEX futures (primarily paper) market, more than 95% of the trading on the supposed physical market of the LBMA is actually in the form of UNALLOCATED gold which are paper/unsecured claims to an indeterminate volume of gold held in bank vaults. The ABN news just confirmed a trend that seasoned analysts of these markets had suggested for years. The fraction is getting smaller. I think that we have crossed an important threshold in the Gold War. Rather than scaring investors out of gold and silver, the price collapse and the circumstances surrounding it has led to a well-publicised rush to purchase gold by investors across the globe. Two things came together causing the perfect storm for bullion demand in both the East and West the fall in prices in conjunction with excessive monetary stimulus AND the Cyprus bail-in of depositors money (and the realisation that other countries were formulating similar plans in the event of bank failures).
May 2013
61
Weve seen rising premiums against spot for bullion products and extended delivery times. There have been occasional examples of this before, notably late 2008, but never on a sustained basis, which would have dramatic ramifications. The recognition in the gold market of the profound difference between physical gold versus and mere paper claims has been on the horizon for years. My sense is that theres been a dramatic step forward in the understanding of the fractional reserve nature of these markets. Ive been told that a high-profile hedge fund manager and gold advocate had a similar realisation a while back. While arranging to move his gold out of the banking system, he (apparently) asked what would happen when more people realised the true situation. The reply: Price discovery. Its a great irony that the monetary metals in the form of physical gold and silver are the only financial assets which have no counterparty risk in the midst of the worlds biggest debt crisis...and so few people see the investment case.
Leaving the building

Slide away (slides from recent corporate presentations)
Cisco: orders picking up in the Americas:
Source: Cisco Systems
May 2013
62
Vallourec on E&P spending:
Statoil Im a (structural) bull on energy stocks, but do oil majors ever achieve volume growth targets?
Source: Vallourec Source: Statoil
May 2013
63
DuPont on world agriculture markets:
Source: Du Pont
Vale on the Chinese auto market:
Source: Vale
May 2013
64
Vedanta - note the improvement in free cash flow (top right)
Source: Vedanta
The Maersk Group on Q1 2013 trends:
Source: Maersk Group
May 2013
65
Wilmar International - strong market positions:
Source: Wilmar Intl
Expanding geographically:
Source: Wilmar Intl
May 2013
66
Toyota - currently predicting lower Japanese sales in this fiscal year
Source: Toyota
Pirelli on tire markets - outlook better in South America & Asia Pacific, worse in Europe:
Source: Pirelli
May 2013
67
John Deere on expected 2013 farm incomes in US:
Source: John Deere
And stocks to use ratios for the major crops:
Source: John Deere
May 2013
68
Glencore Xstrata makes a point:
Source: GlencoreXstrata
Miners really getting religion now:
Source: Rio Tinto
May 2013
69
Over the hump:
Source: Rio Tinto
Asahi Glass on 2013 prospects:
Source: Asahi Glass
May 2013
70
Important Information Monument Securities Limited FSA No 149028 Disclaimer This information has been has been issued by Monument Securities Limited (MSL) in accordance with MSLs Investment Research Policy. This information is only intended to be distributed to existing Eligible Counterparties and Professional Clients of MSL. Further, MSLs investment research is intended for use solely by Eligible Counterparties and Professional Clients, who possess a certain degree of knowledge and experience in the subject of this information. Therefore the contents may refer to terms and subjects that may be unsuitable for a retail client and this information should not under any circumstances be forwarded to a retail client. This content is for information purposes only and should not be construed as an offer, solicitation or recommendation to buy or sell any investments or investment advice. MSL do not recommend or endorse any particular investment, or course of action. This information has no regard for any investment objectives or financial situation of any eligible counterparty or professional client. Any investment that is mentioned may warrant further investigation or research, which will be solely at the discretion of the eligible counterparty or professional client. The value of investments as well as the income from them, can go down as well as up and investors may get back less than the amount invested. Past performance is not necessarily a guide to any future performance. Tax rates may vary according to specific circumstance and can affect the value of any possible returns. Fluctuations in exchange rates may also affect the value of an investment. Information and opinions expressed herein are based on sources believed to be reliable, however we do not represent that they are accurate or complete. Further any views or estimates are based on judgements made as at the date of this information. All opinions and estimates are subject to change without notice. MSL and/or connected persons may from time to time have positions in or effect transactions in any investment or related investment mentioned herein and may provide financial services to the issuers or such investments. MSL has put in place systems and controls mechanisms supported by appropriate procedures to identify and manage any conflicts of interest that may arise. A copy of our conflict of interest policy is available on request. In relation to this content, we do not believe that any relationships, circumstances, interests or potential conflicts of interest that would require disclosure under the FSA Conduct of Business rules are likely to arise. In particular no major shareholdings or financial interests exist between MSL and any relevant company. In the event that this situation changes then appropriate disclosures will be made. All investments involve a degree of risk and may not be suitable for certain investors. All investors should make their own investment decisions based on their circumstances, financial objectives and resources and after seeking any appropriate professional advice. This is a marketing communication. It has not been prepared under the Independent Investment research regulatory requirements and accordingly there is no prohibition on dealing ahead of the dissemination of this research material. Monument Securities Limited is authorised and regulated by the Financial Services Authority FSA Number 149028 in the UK.
May 2013
71

Thunderroad Report

Diunggah oleh

Informasi Dokumen

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

Thunderroad Report

Diunggah oleh

Hak Cipta:

Format Tersedia

Thunder Road report

All I want for Christmas is the S&P 500 (or do I?)

All I want for Christmas is the S&P 500 (or do I?)

Research: Paul Mylchreest +44 (0) 207190 7242 pmylchreest@monumentsecurities.com

Source: Markit.com, Monument Securities

Global manufacturing PMI

US Treasuries: 5-year breakeven inflation

1400 1500 1200 1000

Source: Monument Securities

Deposits - Loans: All Commercial Banks (US$bn)

JGB 5-year yield (%)

Source: Monument Securities

50.0 -1.50 45.0 -2.00 40.0 -2.50 35.0

Source: Monument Securities

Total credit market debt

Federal Reserve Balance Sheet (Inverted/neagtive values)

A trend that is not our friend

Source: Markit.com, Monument Securities

This is global industrial production growth.

Source: Monument Securities

This is growth in Chinese electricity production and rail cargos.

Source: Monument Securities

China Electricity Production (yoy%)

China Rail Cargo (yoy%)

And registrations of new passenger cars in the Eurozone.

Source: Monument Securities

Source: Monument Securities

Source: Ingersoll Rand Source: Richemont

Finally...even the VIX.

Source: Monument Securities

Source: St. Louis Fed

Source: St. Louis Fed

Source: Monument Securities

Brent crude (US$ bbl)

Source: Monument Securities

Source: Monument Securities

Source: Monument Securities

1000 900 800 700 600

Spain 10 yr Treasury yield

Source: Monument Securities

Federal Reserve Balance Sheet

China forex reserves yoy%

Source: Monument Securities

Total known Gold ETF holdings (m oz.)

American Eagle Bullion Sales (000s oz.)

Source: Monument Securities

Source: Monument Securities

Source: iTRAXX, Monument Securities.

2700 120.0 2600 110.0

Source: Monument Securities

2300 90.0 2200 80.0

Euro Stoxx Banks

Euro Stoxx 50 v. Euro Stoxx Banks (2006-08)

Source: Monument Securities

Euro Stoxx Banks

4.00 6.50 4.50

Source: Monument Securities

7.00 4.50 7.50

Spain 10 yr Yield (Inverted)

The worse the bank, the bigger the divergence...

Source: Monument Securities

6.50 0.80 7.00 7.50 8.00 0.40 8.50

Spain 10 yr Yield (Inverted)

Source: Monument Securities