Tag: finance

Submitted by Lance Roberts of STA Wealth Management,

Enough with the comparison charts already. The current stock market cycle has been compared to everything from the 1920's, 70's, 90's, you name it.  I will readily agree that, in all the comparisons, the price patterns are similar, however, correlation is not causation.  What is ALWAYS left out of the conversation are the fundamental underpinnings that either supported or impeded those previous market cycles as compared to today.

Today, Business Insider produced the following chart and commentary by Jeff Saut:

In his new weekly Investment Strategy comment, Saut notes that these things work in both directions. Here's Saut:

 

"Accordingly, the alleged pundits that called for a “crash” four weeks ago have, at least so far, also been proven wrong, which I discussed when dissecting their comparison chart to 1929 showing that when comparing apples-to-apples the correlation totally breaks down (see chart 1 and 2). In fact, as proof that you can make ratio charts do just about anything you want, take a look at chart 3 that suggests this secular bull market has another 300% to 400% left on the upside."

There are two major issues with that statement.  First, Business Insider extracted selected verbiage which makes it seem as though Jeff Saut is suggesting that the markets have 300-400% more upside to go.  That is not exactly the case.  Below is actually what Jeff Saut wrote:

"A few weeks ago it was the correlation to the 1929 stock market rally that led to the ’29 crash that made the rounds. I wrote about that, noting that the folks making said comparison were using ratio-adjusted charts, which can make the charts show just about anything you want them to. The same thing happened with Japan’s Nikkei Index in the early 1990s and that also proved to be wrong. Accordingly, the alleged pundits that called for a 'crash' four weeks ago have, at least so far, also been proven wrong, which I discussed when dissecting their comparison chart to 1929 showing that when comparing apples-to-apples the correlation totally breaks down. In fact, as proof that you can make ratio charts do just about anything you want, take a look at that suggests this secular bull market has another 300% to 400% left on the upside."

The point Jeff was trying to make is that you can take any multiple of data series, and with the right manipulation, you can torture the data into saying whatever you want.  As the old saying goes:

"There are three types of lies:  Lies, Damned Lies and Statistics."

Secondly, and much more important, is that while it is true that history does "rhyme", it does not repeat.  As I stated in the opening, there are specific fundamental underpinnings that supported the rampant secular bull markets that followed the major secular bear market lows of 1942 and 1974 which simply do not exist, as of yet, today.

One of the primary drivers that assisted in ending the "Great Depression" was the massive Government spending ramp, roughly 125% of GDP that was used to support WWII.  The surges in industrial production to support the war led to increased employment as women entered the work force while husbands, brothers and fathers were deployed overseas.  However, what drove the secular bull market of the 50's and 60's was "Johnny" returning home from war.  For years, everything had been rationed for the war effort, now the focus turned back to building families, homes and lives which lead to increased consumption as "pent up demand" was met.  However, more importantly, the United States became the industrial manufacturing powerhouse of the world.  With Europe, Japan and Russia in ruins following the war, the U.S. produced and shipped goods and products overseas for the rebuilding of war torn countries.  Government debt fell to historically low levels, household debt remained modest relative to incomes and personal savings rates were high which led to productive investment.  Even as interest rates rose, economic growth continued to rise giving a broad lift to prosperity.

This is something that I discussed at length in "Correcting Some Misconceptions Of A New Secular Bull Market:"

"The United States became the manufacturing center of the industrialized world as we assisted in the rebuilding of Germany, Britain, France and Japan.  That is no longer the case today as much of our industrial manufacturing has been outsourced to other countries for lower costs.  The chart below shows interest rates overlaid against the annual changes in economic growth."

The secular bull market of 80's and 90's is also something that we are unlikely to witness again in our lifetimes.  Unlike the secular boom of the 50's which was driven by "healthy" consumption, the boom of the 80's and 90's was an unhealthy "debt driven" demand cycle which was fostered by an era of falling interest rates, inflation and financial deregulation.   As I stated in "Past Is Prologue:"

"The next chart shows the much beloved and hoped for, secular bull market of the 1980's and 90's."

"There were several contributing factors that drove that particular secular bull market:

 

1) Inflation and interest rates were high and falling which boosted corporate profitability.

2) The extreme negative sentiment of the late 70's was finally undone by the early 90's.  (At the turn of the century, roughly 80% of all individual investors in the market began investing after 1990. 80% of that total started after 1995 due to the investing innovations created by the internet.  The majority of these were "boomers.")

3) Large foreign net inflows to chase the "tech boom" drove prices to extreme levels.

4) The mirage of consumer wealth, driven by declining inflation and interest rates and easy access to credit, inflated consumption, corporate profits and economic growth.

5) Corporate profits were boosted by deregulation of industries, wage suppression, outsourcing and productivity increases. 

6) Pension funding requirements and accounting standards were eased which increased corporate profits. 

7) Stock based executive compensation was grossly expanded which led to more "accounting gimmickry" to sustain stock price levels.

The dual panel chart below shows the economic fundamentals versus the S&P 500 and the change that occurred beginning in 1983.  (Red dividing line)"

"I have also noted the expanding "megaphone" pattern in the current market as compared to that of the 60's and 70's."

Conclusion

Despite much hope that the current breakout of the markets is the beginning of a new secular "bull" market – the economic and fundamental variables suggest otherwise.  Valuations and sentiment are at very elevated levels while interest rates, inflation, wages and savings rates are all at historically low levels.  This set of fundamental variables are normally seen at the end of secular bull market periods. 

Lastly, the consumer, which comprises roughly 70% of economic growth is unable significantly increase their consumption, as a percent of the economy, as the capacity to releverage to their balance sheet is no longer available.  This "deleveraging" of balance sheets by the aging baby boomers, as they move through retirement, will further exacerbate the consumption side of the economic equation.

As I have said many times in the past I am currently maintaining fully allocated portfolio models.  As a money manager, I must participate with rising markets or suffer career risk.  However, while being a "stark raving bull" going into 2014 is certainly fashionable currently; as investors, we should place our faith, and hard earned savings, into the reality of the underlying fundamentals.  As I said at the beginning of the missive, it is disingenuous to manipulate the data to support a bullish thesis. 

In my opinion, this is the wrong way to view the markets.  Participating with rising markets is the easy part. As investors, we should focus our analysis on what can go wrong.  The "glass is always half full" commentary leads investors into taking on substantially more investment risk than they realize as markets are rising.  It is the unwinding of that "risk" that leads the majority of investors to unrecoverable losses.  Most importantly, one absolutely unrecoverable commodity that is lost during mean reverting events is our most precious form of investment capital – "time."  The reality is that we will not live forever.  By allowing "greed" to drive investment decisions the eventual "mean reversion" destroys our singularly most precious form of investment capital.

On that note, it is entirely conceivable that stock prices can be driven higher through the Federal Reserve's ongoing interventions, current momentum, and excessive optimism.  However, the current economic variables, demographic trends and underlying fundamentals make it currently impossible to "replay the tape" of the 80's and 90's.  These dynamics increase the potential of a rather nasty mean reversion at some point in the future.  The good news is that it is precisely that reversion that will likely create the "set up" necessary to launch the next great secular bull market.  However, as was seen at the bottom of the market in 1974, there were few individual investors left to enjoy the beginning of that ride. 

via Zero Hedge http://ift.tt/1j0vi68 Tyler Durden

In a surprising development out of Canada’s cabinet, moments ago the finance minister, Jim Flaherty, a noted deficit hawk and proponent of paying down government debt, just announced his resignation.

• CANADA FINANCE MINISTER FLAHERTY RESIGNS FROM CABINET
• FLAHERTY SAYS DECISION TO LEAVE POLITICS WAS NOT RELATED IN ANY WAY TO HIS HEALTH

As Bloomberg and Globe and Mail add, Flaherty said he’s stepping down to pursue work in the private sector. “Yesterday, I informed the Prime Minister that I am resigning from Cabinet,” Flaherty said today in a statement e-mailed by his office. “This was a decision I made with my family earlier this year, as I will be returning to the private sector.”

“As I begin another chapter in my life, I leave feeling fulfilled with what we have accomplished as a government and a country during one of the most challenging economic periods in our country’s history,” he said.

Flaherty said there’s “no doubt” Canada will balance its budget as promised in the year starting April 2015, and said the decision isn’t related to his health issues

Still, there is rife speculation that it was indeed his health that was the reason for this unexpected resignation. Either way, Canada’s housing mess will now be someone else’s problem.

via Zero Hedge http://ift.tt/OtSLiy Tyler Durden

With ORCL no longer a bellwether – preferring Twitter or yesterday’s IPO as an indicator of the health of the world economy – we are sure investors will simply shrug at the tech firm’s top- and bottom-line miss (again):

• *ORACLE 3Q ADJ. EPS 68C, EST. 70C
• *ORACLE 3Q ADJ. REV. $9.32B, EST. $9.36B

But the big question is – who knew early!?

 

 

Oracle Corp on Tuesday said new software sales and Internet-based software subscriptions in its fiscal third quarter roes 4 percent from a year earlier.

The software maker had forecast that new software sales and subscriptions would be up between 2 percent and 12 percent in its third quarter, which ended in February. Investors scrutinize new software sales because they generate high-margin, long-term maintenance contracts and are an important indicator of future profit.

via Zero Hedge http://ift.tt/1ePvQUY Tyler Durden

US equity markets are up around 2% from Friday's close – extending yesterday's hope-filled gains on the back of Vladimir Putin not nuke-ing the world this morning and lower-than-expected inflation prompting hope for moar free money tomorrow. This jump is a ridiculous deja vu all over again of Putin's first press conference. Bear in mind that the USD is unchanged on the week and Treasury yields are up a mere 1-2bps – so hardly a resounding risk-on conviction. Following yesterday's epic low volume, today was little better. Copper was flat as Oil prices rose back towards $100. Gold and silver were pummeled – just for good measure (gold's biggest 2-day drop in 3 months) – as was VIX (which took over the role of S&P 500 driver from AUDJPY after Europe closed). The afternoon saw VIX diverging (higher ahead of tomorrow's FOMC) from rising stocks. For the week, USD unch, Bonds unch, Stocks +2%, Gold -2%.

 

Deja Vu all over again…

 

As AUDJPY ruled until Europe closed

 

with VIX strongly in control from there – until 2pmET for that late-day divergence, which is worrisome…

 

While stocks are exuberant, Treasuries are not…

 

Credit markets have rallied but merely back to pre-Putin PR 1.0 levels…

 

And nor is the US Dollar… plenty of vol here but the USD s almost dead flat…

 

As gold and silver mirror equity strength…

 

Gold's biggest 2-day drop in 3 months… as it looks like gold will have "golden cross" tomorrow as the 50DMA crosses above the 200DMA

 

Charts: Bloomberg

Bonus Chart: Something happened today… USDJPY and Bonds stayed in sync as stocks disconnected

 

Bonus BonusChart: A little reminder of the concept of mean-reversion – and how it is gone from the mainstream media's vocabulary… (h/t @Not_Jim_Cramer)

 

Bonus Bonus Bonus Chart: The Japanese stock market is not enjoying the exuberance of global stocks…

via Zero Hedge http://ift.tt/1l1dBDI Tyler Durden

"Fat Finger" or just more "High Freaks"? At 1110ET, the FTSE100 futures contract (representing the most liquid vehicle for trading the broadest UK stock market) suddenly rocketed up 1.3% on huge volume… and then, just as remarkably, Nanex shows, most of that price exuberance returned to normal within 10 seconds… Doesn't look like a fat finger order to us? with 5 waves of buying on the way up? Of course, one thing is sure, Virtu made money!

Via Nanex,

1. March 2014 FTSE (Z) Futures

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2. March 2014 FTSE (Z) Futures – Zoom of 27 seconds of trading.

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3. March 2014 FTSE (Z) Futures – Zoom showing 5 seconds of trading.
Note the 5 separate buying waves.

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4. EWU – a related ETF traded in New York.

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5. EWU Zoom

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Perhaps AG Schneiderman's probe is well timed?

via Zero Hedge http://ift.tt/1qR2gXP Tyler Durden

On Sunday, Senate lawmakers unveiled the 442-page plan that will eliminate the mortgage-finance giants; replacing them with a new system in which the government would continue to play a potentially significant role insuring U.S. home loans. The Johnson-Crapo bill would, as WSJ reports, construct an elaborate new platform by which a number of private-sector entities, together with a privately held but federally regulated utility, would replace key roles long played by Fannie and Freddie.

 

 

Via WSJ,

Fannie and Freddie don't make loans, but instead buy them from lenders, package them into securities, and sell those bonds to investors. They guarantee to make investors whole if loans default, attracting a diverse range of investors to the U.S. mortgage market.

 

…

 

The Senate bill would repurpose the firms' existing regulator as a new "Federal Mortgage Insurance Corp." and charge the agency with approving new firms to pool loans into securities. Those firms could then purchase federal insurance to guarantee payments to investors in those bonds. The FMIC would insure mortgage bonds much the way the Federal Deposit Insurance Corp. provides bank-deposit insurance.

 

Mortgage guarantors would be required to maintain a 10% capital buffer against losses and to have that capital extinguished before the federal insurance would be triggered. Those private firms, which could include banks or insurance companies, would issue a single security through the government-regulated platform. Different components of Fannie and Freddie could be sold to seed both new guarantors and the mortgage-securitization platform.

Market impact:

Shares of the firms' common stock dropped sharply last Tuesday, when lawmakers announced that they had reached agreement on broad outlines of the bill. Still, several large investors have said that they're invested for the long haul, either because they believe Congress isn't likely to reach agreement or because they believe courts will invalidate the government's ability to seize all of the firms' profits as dividend payments.

 

If courts rule that the government overstepped its authority in revamping the bailout terms, Fannie and Freddie would be allowed to retain any profits after paying a 10% dividend to the government—currently around $12 billion annually for Fannie and $7 billion for Freddie. A court win would increase prospects for shareholders to enjoy returns in any liquidation of Fannie and Freddie because the companies would again be able to retain profits.

For now, it seems, the market believes the bill (or some form of it) will be enacted…

 

Still confused? Here is Acting-Man's Ramsey Su to explain it all (and destroy some hope)…

No Opportunity Necessary,  No Experience Needed

Freddie and Fannie are back in the limelight.  This time, the plan is coming from Senate Banking Committee leaders Tim Johnson (D., S.D) and Mike Crapo (R., Idaho).

Here are the bios of Johnson and Crapo, two lawyers with not a trace of experience in real estate finance and housing matters.  They represent Idaho (pop 1.6 million) and South Dakota (pop 0.8 million) with a combined population of about half a Phoenix (pop 4.3 million).  Neither State played any role in the subprime bubble.  Johnson/Crapo simply do not possess even the most basic qualifications for the job.

It is not my intention to belittle Johnson and Crapo but here are the circumstances.  At issue is the failure of the two mortgage giants that resulted in placing them under conservatorship for over five years so far.  On one side are all the lobbyists, trying their utmost to mold political decisions to their clients' best interest.  Hedge funds are salivating and suing the government to give them more money for reasons that I cannot understand.  On the other side of the table are these two Senators who are supposed to look out for the public good and somehow come up with a system that can replace the agencies.  Judging by their resumes, would you hire these two men to fix the agencies? Do you think they possess the knowledge and skills to comprehend the complexity of the mortgage industry and the secondary market for securitized products?

 

Inner Contradictions

Giving the Senators the benefit of the doubt, I read the proposed plan.  It is full of political jargon with objectives that are mutually exclusive.  On the one hand, they want to protect taxpayers but they also want to provide financing with downpayments as low as 3.5% while making sound loans at low cost only to qualified buyers using the CFPB qualified mortgage guidelines, blah blah blah ……..  For a second there, I thought Franklin Raines (long the mouth piece/CEO who took down Fannie) had returned.  

 

• Protect taxpayers from bearing the cost of a housing downturn. 
• Promote stable, liquid, and efficient mortgage markets for single-family and multifamily housing. 
• Ensure that affordable, 30-year, fixed-rate, prepayable mortgages continue to be available, and that affordability remains an important consideration. 
• Provide equal access for lenders of all sizes to the secondary market. 
• Facilitate broad availability of mortgage credit for all eligible borrowers in all areas and for single family and multifamily housing types. 

What exactly are Freddie and Fannie today?

They are two duplicating agencies that package real estate mortgages under a set of underwriting guidelines.  These packages are resold on Wall Street as agency MBS (mortgage backed securities).  For a fee, the agencies guarantee these securities.  Since the agencies are under the conservatorship of the US Treasury, this guarantee is practically as good as any other Treasury debt.  

 

Are Freddie and Fannie profitable?

If you read the headlines, they are supposedly making money hand over fist.  They are returning hundreds of billions of "profits" to the Treasury.  But how can anyone determine what is "profit"?  The agencies are essentially insurance companies, collecting a premium to guarantee about $4.5 trillion of debt.  However, there are no insurance commissioners nor guidelines as to what they need to reserve against potential claims.  

 

Then what should be the amount of reserves?

Well, that is a question with no answer.  If you treat the agencies as insurance companies, which they are, then it is possible to calculate the needed reserves, bigger ones for the subprime and high LTV loans, smaller ones for low LTV and prime borrowers, etc.  However, how can an insurance company reserve for government intervention, especially the retroactive type?  For example, the administration is touting that about 2 million mortgages have been modified through various fixes under the Making Home Affordable Program.  Who paid for this?  Furthermore, the agencies are now holding these modified loans that actually do not meet present underwriting guidelines.  This is a high risk portfolio with high LTV and most likely subprime borrowers.  One hiccup in the economy and they will all return to the delinquency pool.  What if FHFA, under Mel Watt, decides to launch principal reduction programs, who will pay for those?

 

A Great Business Model

Back to the "profits", as long as real estate prices appreciate, default risk will remain low and the agencies are home free.  If real estate prices stall, or decline, then the agencies simply ask the Treasury to fund their losses.  What a great business model!  No wonder hedge funds who bought the agency stocks at bankrupt prices are clamoring for the return of these "profits".

The agencies have monopolized the mortgage market, commanding a 90% market share during the last few years.  The remaining 10% are going to jumbo loans and non-mainstream programs that have little effect on the overall market. 

 

Not Charging Enough

What should be the cost for the agencies to insure the mortgage industry?

Whatever the agencies are charging, they are not charging enough.  This is evidenced by the fact that no one in the private sector is willing to step up and compete.  There is not a single mortgage program that offers financing to the masses that is not agency conforming, not from the too-big-to-fail banks, not from the small regional banks.  Why bother when you can originate loans and collect fees, while letting let the agencies rubber stamp them with an iron clad guarantee backed by the US taxpayers. 

 

The Fed

Let us not forget the Federal Reserve.  Under QE3, the Feds purchased $788 billion of agency MBS last year and $105 billion so far this year ending March 8.  As of March 12, the Fed holds $1.57 trillion of agency MBS on its balance sheet.  

If the agencies are privatized, are the Feds still authorized to hold these loans on their balance sheet?  Can the Feds continue to purchase originations?  Would the Senators' plan neutralize the Fed and render one of its favorite manipulation tools useless?  How much higher would mortgage rates be if the Fed were out of the picture?

Chris Whalen provided an excellent analysis on Zero Hedge that may be a little too technical but it highlights some of the screw-ups that have led to the agencies' demise.  It is about to get worse.

 

Details

In closing, I am attaching the "Details of the Agreement on Housing Finance Reform" below.  What I see is at least 2,000 pages of regulations, expecting a miracle fix that even Moses may have trouble performing.

Details of the Agreement on Housing Finance Reform 

Outlined below are some of the details of the agreement that Chairman Johnson and Ranking Member Crapo have reached that will form the basis of a bipartisan housing finance reform text: 

• Start with S.1217 as the base text and generally maintain its overall architecture. 
• Wind down and eliminate Fannie Mae and Freddie Mac. 
• Promote a smooth and stable transition from the old system to the new system by providing specific benchmarks and timelines to guide Federal Mortgage Insurance Corporation (FMIC) and market participants. 
• Transfer appropriate functions to the modernized, streamlined and accountable FMIC, modeled in part after the FDIC including its regulatory authority. 
• Mandate 10 percent private capital, up front, and create a mortgage insurance fund for the system to protect taxpayers against future bailouts. 
• Create a member-owned securitization platform that will issue a single, standardized FMIC-wrapped security, and permit private label securities to be issued in a manner that encourages standardization and improved market liquidity. 
• Establish a mutual cooperative jointly owned by small lenders to ensure institutions of all sizes have direct access to the secondary market so community banks and credit unions are not at the mercy of their larger competitors when Fannie Mae and Freddie Mac are dissolved. The small lender mutual cooperative would provide a cash window for individual eligible loans, and small lenders could retain servicing rights. 
• Provide clear rules of the road for servicers that choose to participate in the FMIC system. 
• Maintain a vibrant multifamily market by building upon successful risk-sharing mechanisms and products and providing access to a broad range of markets. 
• Require strong underwriting standards that mirror the definition of “qualified mortgage”, and set down payment requirement at 5 percent (with a short phase-in) except for first-time homebuyers at 3.5 percent. 
• Facilitate the broad availability of credit for eligible single-family and multifamily borrowers, monitor consumer and market access to credit, and provide market based incentives and transparency to serve underserved areas. 
• Eliminate affordable housing goals and establish transparent and accountable housing-related funds that would focus on ensuring there is sufficient decent housing available. The funds are NOT paid for with tax dollars, but through a small FMIC user fee (10 basis points) that only those who choose to use the system pay. 
• Allow current conforming loan limits to be maintained so that mortgage credit continues to be available in high cost areas. 
• Maintain broad liquidity in the To-Be-Announced (TBA) market and direct FMIC to take into account the impact of new products on the TBA market.

Addendum: The Bill Has Been Published

via Zero Hedge http://ift.tt/1gLr0II Tyler Durden

If you said a short list of commodities manipulated by the Too Big To Prosecute banks, you are probably right, but the answer we were looking for is that these are all the various, and increasingly more ridiculous, commodities that serve to make up the bulk of China’s hot money flow (those flows into China which are not reflected in the current account flows or FDI) facilitating synthetic structures, also known as Chinese Commodity Funding Deals.

Of these the copper “monetary metal” funding pathway is best known, and in fact we covered the inevitable end of the Chinese Copper Financing Deals in gruesome detail last May in “The Bronze Swan Arrives: Is The End Of Copper Financing China’s “Lehman Event.” What happened next was that despite repeated warnings by the PBOC and SAFE that it would end the hot money inflows masked by funding deals, China not only encouraged more CCFDs but aggressively expanded into other commodities, such as iron ore, and as we now learn, weird and wacky commodities such the abovementioned soybeans, palm oil, rubber, zinc, aluminum, gold and nickel. To be sure this was largely precipitated by the near collapse in the overnight lending market in June of 2013 when China’s first and so far only real tapering attempt nearly destroyed the domestic financial system.

So what has changed since last May, in addition to the realization that virtually every hard asset is now being used by China to mask hot money inflows into the Chinese economy taking advantage of rate differentials between the Renminbi and the Dollar? Well, this time around China may finally be serious about normalizing its epic credit bubble, which as we pointed out before, added a ridiculous $1 trillion in bank assets in just the fourth quarter of 2013 alone. Specifically, as Goldman notes in a just released analysts on the future of CCDS, “the recent managed CNY depreciation is a signal that the government wants to increase FX volatility and reduce the hot money inflow pressure gradually.“

In other words, the day when the Commodity Funding Deals finally end is fast approaching.

Here is Goldman’s take on what will certainly be a watershed event – one which will certainly dwarf the recent Chaori Solar default in its significance and scale.

Financing deal concerns mounting as CNY volatility rises

 

Concerns on an unwind of commodity financing deals trigger selloff

 

The recent sell-off in copper and iron ore prices reflects the market’s ongoing concerns regarding the impact of a potential unwind of Chinese commodity financing deals, though the weak underlying market fundamentals should not be discounted. The concerns intensified following the recent CNY depreciation which has raised uncertainty regarding the profitability of the deals and the impact on different asset classes were they to unwind. Up to 1mt of copper and 30mt of iron ore could be released were the deals to unwind, which would be bearish given the relatively limited physical liquidity to absorb the shock.

 

CCFDs are facilitating China’s total credit growth

 

We believe CCFDs are ongoing and facilitating ‘hot money’ inflows into China by providing a mechanism to import low-cost foreign financing. In general, the profitability of most hedged commodity financing deals remains substantial (iron ore is the exception), due to a still positive CNY and USD interest rate differential, limited depreciation in the CNY forward curve and available commodity supply. In 2013, ‘hot money’ accounted for c. 42% of the growth in China’s monetary base of which we estimate that CCFDs contributed US$81-160 bn or c.31% of China’s total FX short-term loans. Given this, it is crucial for the government to manage the immediate impact of ‘hot money’ flow changes on the economy and markets.

 

More commodities are used; a medium-term unwind is bearish

 

An increasing range of commodities are being used to raise foreign financing, which now includes iron ore, soybeans, palm oil, rubber, zinc, and aluminum, as well as gold, copper, and nickel. CCFDs create excess physical demand and tighten the physical markets artificially; in contrast, an unwind creates excess supply and thus is bearish to prices. We think CCFDs will be unwound over the medium term, mainly triggered by an increase in Chinese FX volatility, as indicated by recent CNY depreciation and PBOC’s latest move to widen the daily trading band. FX volatility could result in a higher cost of currency hedging, effectively closing the interest rate arbitrage. Higher US rates are another likely catalyst for an unwind in the long run. A continuous CNY depreciation in the short term, however, would trigger some deals to be unwound sooner than expected, and hence place downside risks to our short-term commodity price forecasts.

It should now become apparent why the ongoing sharp devaluation of the CNY, far more than merely impacting a few massively levered speculators, and recall that the European Knock In point of maximum vega is about USDCNY 6.20 as discussed previously, will have a far more broad hit to asset levels not just in China but across the world if and when the inevitable moment of CCFD unwind finally begins, and in a reflexive fashion, initial selling begets more selling, more CNY devaluation, greater margin calls, further CCFD unwinds, and so on, until finally the PBOC has no choice but to come in and bail out the financial system one more time.

For those unfamiliar with the concept of CCFD, and too lazy to read our previous article on the topic, here is Goldman’s Roger Yuan with a succinct summary of just why these key component of China’s shadow funding mechanism are so important on the way up… and down.

Days numbered for Chinese commodity financing deals

As part of a broader shift in China’s funding base from domestic to various foreign funding vehicles, Chinese commodity financing deals have become increasingly prevalent, owing to the combination of the relatively high level of Chinese interest rates and the existence of Chinese capital controls. Financing deals use commodities and other goods as a tool to unlock the interest rate differential, with potential implications for Chinese growth, China’s linkage with ex-China interest rates, CNY volatility and commodity market pricing.

In contrast to some media reports, we find that the bulk of Chinese commodity financing deals are ongoing, facilitating ‘hot money’ inflows into China and providing a mechanism to import low cost foreign financing. In general, the profitability of most currency and commodity hedged Chinese commodity financing deals remains substantial, owing to a still positive CNY and USD based interest rate differential (>4%), limited depreciation in the CNY over the past month (<2%) and the CNY forward curve (limited cost of hedging the currency exposure), and a lack of tightness in the underlying commodity (i.e. limited cost of hedging the commodity). Returns in copper are still >10% (Exhibit 1), and up to 1mt of physical copper could still be tied up in deals (Exhibit 2).

While triggered by concerns about Chinese credit following the Chaori default, an unwind in iron ore financing deals, and concerns about an unwind in copper financing deals, the recent copper price weakness has reflected the combination of sluggish Chinese demand growth and strong global copper supply growth, rather than a financing deal unwind. Supporting this assertion is the fact that nickel (to an even greater extent than copper), and zinc both have a sizeable amount of exposure to financing deals, and their prices have substantially outperformed copper. Further, were this a true copper financing deal unwind, Chinese bonded copper prices would have led the price declines (instead they lagged the domestic Shanghai copper price declines), Chinese bonded stocks would have declined (instead they have risen) and the LME futures curve would likely have moved into contango (it remains in backwardation).

More broadly, the main reason why the government has not shut down ‘hot money’ inflows in an abrupt fashion to date, in our opinion, is that a complete shutdown could have major consequences for China’s short-term liquidity. Indeed, China’s economic growth is increasingly supported by different types of FX inflows, including those from commodity financing deals, as they can bring in low cost foreign funding and increase China’s monetary base, the foundation of both China’s rapid credit growth and solid economy growth. In 2013, we estimate that c.42% of the increase of China’s monetary base can be attributed to the low cost foreign funding or the ‘hot money’ inflows (Exhibit 3).

These FX / hot money inflows are of substantial size and high volatility (Exhibit 4) and the government attempts to smoothly manage the short-term liquidity cycle in response to these flows. When these flows are very strong China tends to respond (Exhibit 5), as in June and December 2013, as well as February/March 2014, with bearish implications for equities and commodities (Exhibit 6).

There are three main drivers of ‘hot money’ inflows: commodity financing deals, overinvoicing exports, and the black market. In this article, we focus on the Chinese commodity financing deal channel, which has by our estimates facilitated roughly US$81-160 bn of FX inflows since 2010, which is c.31% of China’s total FX short-term borrowings (duration < 1 year) (Exhibit 7). Of these deals, gold, copper and iron ore are three leading commodities, followed by soybean, palm oil, natural rubber, nickel, zinc and aluminum.

One reason why the range of commodities and the amount of each of those commodities being used for financing purposes has increased since mid-2013 is that the Chinese government moved to reduce the amount of money that can be borrowed per commodity unit. This reduction in apparent financing deal ‘leverage’6 (to c.3-10 times the value of the commodity from much higher levels a year ago), has meant that larger amounts of commodities are needed to raise the same amount of low cost foreign funding. In copper’s case for example, the amount of copper used in financing deals could have risen from 500kt to 1mt over the past nine months, as shown in Exhibit 2.

Looking ahead, our view is that Chinese commodity financing deals will gradually unwind over the medium term (the next 12-24 months), driven by an increase in FX hedging costs, which would slowly erode financing deal profitability and eventually close the interest rate arbitrage. Indeed, we expect that the government will continue to increase FX volatility in order to manage the hot money inflow cycle, thus increasing FX hedging among broader market participants, and raising the cost of hedging the currency for commodity financing deals. This FX policy outlook would be in line with the government’s policy targets of gradually increasing the CNY trading band before eventually loosening the nation’s capital controls, and is likely to occur before the CNY/USD interest rate differentials close, based on our Economists’ forecasts. Finally, an abrupt government crackdown on Chinese commodity financing deals, even with an offsetting monetary stimulus package, is unlikely in our view, given the potential negative impact this could have on credit and thus economic growth.

With respect to the impact of an unwind in Chinese commodity financing deals on China’s economic growth, we expect that the government will actively manage the impact on domestic credit creation, however we note that this process, if not managed perfectly, will not be without downside risks to Chinese growth.

From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market (ZH: unless of course momentum algos take offsetting commodity futures hedge selling in, say, gold and boost, or “ignite” the downward momentum to a far greater degree than the offsetting physical buying, making a recursive pattern whereby buying physical ends up resulting in a lower physical price as has been the case with gold over the past year). This reflects the fact that physical inventory is much smaller than the open interest in the futures market (Exhibit 9). As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price (Exhibit 10).

In this context, an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry) (Exhibit 11).

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Submitted by Omid Malekan via OmidMalekan.com,

Present Obama’s viral interview on Zack Galifianakis “Between Two Ferns” was both funny and informative, thus deserving the buzz it generated. To his credit the President has consistently shown an ability to engage his electorate at their own level via their preferred media, a nice change from his predecessors who would complain about the lack of engagement in politics but not do anything about it. Both the content of the interview, and the fact that the President felt it was needed in the first place, can teach us about the current state of Obamacare and the problems it continues to have.

Critics of the interview have focused on the President’s line that young people  ”can get coverage all for what it costs you to pay your cell phone bill.” This line, which the President often uses, is hard to substantiate. It contradicts the Obama administration’s own figures that “a 27-year-old with income of $25,000 will be able to get such coverage for $145 a month.” Verizon is generally believed to be the costliest wireless provider, and a single line plan with unlimited voice and texting and 2GB of data costs $75 a month (a figure that generally lines up with national cell phone billing data). If you want to do your own research, the Kaiser Family Foundation has a handy calculator that lets you enter your age, state and income level, and get an estimate for the monthly cost of enrollment. Play around with it and you’ll see the President’s math is hard to justify.

The point here isn’t to nitpick the numbers or get into a semantic argument, but to show one of the key shortcomings of this appearance and the President’s other attempts at getting young people to sign up: if you are promoting something that has shaky credibility, and you use dubious arguments that your target audience will realize might not be true, you end up hurting your cause.

Even more revealing than the content of the interview is the fact that the Administration felt a need for it in the first place. As you have probably heard, Obamacare has not enrolled enough young people. That is why the President has dispatched his wife to promote it on Jimmy Fallon, enrolled celebrities that appeal to young people (including a former member of N’Sync) and made appearances such as ‘Between Two Ferns’. The question nobody asks is why young people haven’t signed up.

Nobody needs to tell young people to buy a cell phone, or to go to college, despite the hefty cost. So why do we need to keep trying to convince them to sign up for Obamacare? The answer, which virtually all of the supporters of the ACA have admitted at one point or another, is because Obamacare is a bad deal for young people. We know that because the system was designed to force young and healthy people, who seldom seek medical treatment, to sign up or face penalties.  If something is a good deal, like having an iPhone or getting a college degree, young people spend their money on it voluntarily. You only need a  a penalty for not buying something when its a bad deal.

But don’t take my word for it, just look at the arguments made by the law’s proponents. The whole idea of insurance is that a group of people put money into a pool, and those that need it take it out. If a specific group is expected to put in more than they’ll take out, that insurance is a bad deal for them.

Google “Obamacare needs young people” and you’ll see 90 million results, including all sorts of smart people effectively admitting that Obamacare is a bad deal for the young and healthy. You’ll find reports like this one on CNN explaining how Obamacare needs all these young people to put money in then not take any out. You’ll even find Bill Clinton (with Barack Obama at his side) saying “this only works..if young people show up..we gotta have them in the pools.” Even the President himself,  during the interview with Galifianakis, says this about young people: ”if they get that health insurance they can really make a big difference.” You buying insurance “making a difference” for someone else means its a bad deal for you, as you are both taking money out of the same pool.

Some argue that young people should sign up anyway, because if something catastrophic happens to them then the insurance will save them lots of money. Again here Obamacare defeats itself. Since the President keeps telling young people that they can still sign up for Obamacare even if they have a pre-existing condition, then they might as well not sign up today while they are still healthy and wait until after something goes wrong.

To summarize the problem in the same lingo that the President and Galifianakis bantered in, lets say you are the kind of person that always takes beers to a party. Lets also say that a bunch of people really want you to go to a specific party, but you find out that the only reason they invited you in the first place is because you bring more beer than you drink, and if you don’t show up the guys that drink lots of beer but don’t bring any won’t have as much fun. Might you then decide not to go to this party, and just stay home and watch Funny or Die videos by your favorite comedian?

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Politicians, these days, appear to magically conjure ever-more-surprising poll-results to support their perspectives. In fact, surveys are used to justify everything in our increasingly divided nation – so why is it so easy to create a poll in your favor? The answer, notes Washington Post’s Reid Wilson, is not in over-sampling partisan perspectives – the problem is that Americans are changing the way they communicate. Simply put, if you want to produce a survey that tilts distinctly Republican, call landlines only. If you want to produce a Democratic-skewed poll, stick to cell phones.

 

Via The Washington Post,

Most political polling these days is seriously skewed. But the problems with polling aren’t oversamples of partisans bending results to one side’s preferred perspective — the problem is that Americans are increasingly changing the way they communicate.

 

Traditionally, pollsters have gauged voter or consumer opinions by calling their targets at home.

 

…

 

But voters aren’t waiting around by their clunky old landlines anymore… more than half of us either don’t own a landline phone or don’t use their phone as their primary means of communication. Today, we live on our cellphones.

Those who use cellphones look remarkably different, demographically speaking, than those who use landlines. More than 60 percent of adults under age 45 use only their cellphones, Stryker reported, using data collected by the CDC, versus just 13 percent of those 65 and older. Hispanics are much more likely to rely solely on their cells than any other race.

 

…those who own only cellphones are much more likely to lean towards Democrats than those attached to landlines. Cell-only respondents leaned toward Democrats by 11 percentage points; those who answered surveys on landlines leaned toward Democrats by just 2 percentage points.

 

The implications are clear: If you want to produce a survey that tilts distinctly Republican, call landlines only. If you want to produce a Democratic-skewed poll, stick to cell phones. If you want a survey that accurately represents the views of the modern electorate, controlling for the percentage of cellphone-only users is just as important as making sure your sample accurately reflects gender, race and education breakdowns of the broader population.

So, in summary, as Wilson notes:

when evaluating a poll, after checking the partisan breakdown, be sure to check just how much of a given survey was conducted among cellphone users. It’s another grain of salt one should use when gauging the electorate — and the accuracy of any given survey.

Unless, of course, the results fit with your exiting bias – in which case celebrate them!?

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