Archive for October, 2009

Indicator turned bearish despite high in index

Sunday, October 11th, 2009

As you look at the trend analysis of the S&P 500, Dow Jones Index and Nasdaq, you will notice that all of them are still in strong up-trend. The US dollar index, on the other hand is in a strong down-trend. As Marc Faber wrote about his observations on investors in his latest market commentary,

… the longer a trend has been in place, the more confident investors become that the trend will last forever.

Indeed, there are many (including the so-called ‘cash on the sidelines’ crowd) who are more and more convinced that good times has returned. The fear of several months ago has given way to greed today.

But now, we will show you another graph:

NYSE Bullish Percent Index

NYSE Bullish Percent Index

In the midst of strong up-trends in stock indices all over the world, this Point-and-Figure (P&F) chart is giving a negative cue. To put it simply, this chart is telling us that the percentage of stocks in the NYSE that are still giving P&F buy signals has turned into a down-trend.

We shall see what transpire ahead.

America’s balance sheet

Friday, October 9th, 2009

Take a look at the September 2009 report from the hedge fund and investment company Sprott Asset Management:

US Government Financial Summary


US Revenue for 12 months ended August 31, 2009 $2,157,940,000,000

Obligations [1]

Total Outstanding US Debt (August 31, 2009)
Unfunded Social Security Trust Fund
Unfunded Medicare Trust Funds

Total Obligations



To make it easier for you to understand these colossal numbers, imagine owing $200,000 and earning $3640 per year on your job (that is, optimistically assuming that the economy can grow at 2% per year)! In other words, the earnings per year are only 1.82% of the total outstanding debt, which is far below the rate of price inflation. Based on market rate of interests (i.e. the long-term bond yield), the earnings will not be enough to even cover the interest payments.

No wonder the GFC is not the final crisis (see Is the GFC the final crisis?)!

[1]Richard Fisher, President and CEO of the Federal Reserve Bank of Dallas, is on record stating that unfunded liabilities from Medicare and Social Security totalled $99.2 trillion as of May 2008. The NCPA data above is the most recent estimate available. Fisher?s speech can be retrieved at:

New urgency for action against Iran

Wednesday, October 7th, 2009

Two years ago, we mulled over the possibility of an Israeli strike on Iran. Back then, even though it was already strongly suspected that Iran had the intention to build nuclear weapons, a working bomb was still years away.

Just a few days ago, there were a couple of developments (that we learned from that will bring in a new urgency for action. Over the weekend, there were two leaks:

  1. The New York Times reported that an unreleased report from the International Atomic Energy Agency (IAEA) discovered that Iran is closer to building nuclear weapons than previously thought.
  2. The Sunday Times reported that the purpose of Israeli Prime Minister Benjamin Natanyahu’s secret visit to Moscow in early September was to provide the Russians with a list of Russian scientists and engineers working on Iran’s nuclear program.

These two leaks were significant developments:

  1. Many initially believed that Iran is still far away from a working nuclear weapon. This leak busted that wrong belief.
  2. It’s thanks to the Russians that development (1) happened.

Now, there’s a renewed urgency to the threat of Iran’s nuclear ambition, especially from the perspective of Israel, who is facing an existential threat from Iran.

Assuming that these leaks were true, coordinated and planned, it can be interpreted to send a message to the Russians and the Iranians. To understand why, consider why would the Israelis gave the Russians a list of their scientists and engineer currently in the Iranian nuclear program? Surely, the Russians do not need that list because they should know where their personnel are and what they were doing (given their highly competent intelligence service). By giving the Russians a list of names that they already knew, the Israelis essentially blew the cover of their intelligence operation. The only explanation of the Israelis’ action is that they already knew what they needed to know and the point of that list was intended to surprise the Russians of the extent of the Israeli intelligence. The message to the Iranians is that their deception of the extent of their nuclear program was penetrated and that they faced military actions soon.

With the Iranians getting the signal that they are facing war and the Russians put on notice that their relations with Europe and the US can potentially descend into a crisis, there are two possible outcome:

  1. Russians pull their scientists and engineers out of Iran and join in sanctions against Iran, which will force the Iranians to abandon their nuclear program.
  2. Russians will play dumb and continue goading the West, which will invite war.

Assuming that the leaks were intended by the US/Israel, then it means they are throwing the ball into the court of the Russians.

Should war break out, it is likely that oil and gold prices will surge while stock prices will tumble. Perhaps even US Treasury bond prices will rise too.

Return (and potential crash) of the great Aussie carry trade

Monday, October 5th, 2009

Since April 2006 to the July 2008, the main narrative for the Aussie dollar is that it was going to reach parity with the US dollar. As you can see from our Market Club chart, during that period of time, the trend of the AUD was up:

USD/AUD trend from October 2004 to October 2009

USD/AUD trend from October 2004 to October 2009

Back then, short-term interest rates in the US was down while in Australia, it was still going up. Then as the Global Financial Crisis (GFC) struck, Australia’s rising interest rates trend was reversed into a hasty cuts by the RBA. That was the period when the AUD fell precipitously in the context of global deflation. Then in the context of “green shoots,” zero short-term American interest rates and the RBA’s hints of more interest rates hikes to come, the AUD returned to an upward trend again.

In a world of plentiful highly portable hot money, interest rates differential is one of the major drivers of such high volatility between currencies. Twelve months ago, as we described in Another complication in RBA?s interest rate cut,

Now, let?s put yourself in the situation of say, a rich Arab investor with plenty of cash (US dollars). Previously, when Australia?s short-term interest rates were high and rising and the Australian dollar was appreciating, it was pretty good to convert your US dollars into Australian dollars and park your money in an Australian term deposits. The biggest risk for you is that the Australian dollar may depreciate, resulting in a loss as measured in terms of US dollars.

Today, we have a rapidly falling Australian dollar and a RBA signalling its intention to cut interest rates. What will you do? Obviously, you will want to pull out your money from Australia as soon as possible. If the other foreigners are thinking the same, you can expert further downward pressure on the Australian dollar, which will increase the pressure for more foreign money to pull out of Australia. This is going to be a problem for Australia.

Today, the situation is reversed. The very same hypothetical Arab investor is going to pump more of his excess zero yielding US dollars into higher yielding Australian dollars. Not only that, zero yielding US dollars will tempt many money shufflers to borrow money for free in the US to be ‘invested’ in Australia. The RBA’s threats to raise interest rates are sure to tempt even more hot money to flow in. As the AUD rose further, it made this carry yet even more profitable, which further lured in more hot money, which in turned caused the AUD to appreciate even more. Some of these hot money is sure to find its way into the Australian stock markets (instead of the safer high yield cash deposits). The formula looks pretty simple:

  1. Borrow money for free in the US, courtesy of Ben Bernanke.
  2. Buy AUD to be ‘invested’ in Australia (i.e. short the US dollar).
  3. If you are more risk adverse, put the AUD into government guaranteed term deposits, courtesy of the Australian tax-payers.
  4. If you enjoy risk taking, punt on the Australian stock exchange and/or capital raisings.
  5. Watch you wealth grows as the AUD appreciate and Australian stock prices trend up. With the RBA expected to raise interest rates, watch in glee as your potential returns increases.
  6. At the first sign of trouble, (1) liquidate your Australian stocks and pull out all your government guaranteed term deposits immediately, (2) sell the AUD to buy back the USD, (3) repay the free money borrowed from Ben Bernanke, (4) pocket your easy profits and (5) retire in Bahamas, thanks to the American and Australian tax-payers.

If you are a small investor, take note of step 6. At first sign of trouble, you can expect the AUD to fall sharply. In fact, judging from the recent tiny rebound in the USD (and fall in the AUD), some of these hot money are already executing point 6.

If this trend reversal becomes entrenched, we can expect tighter credit conditions in Australia (because Australia are net borrowers of foreign money) and the stock market to fall. Then the mainstream media will start to chatter of how ‘confidence’ has fallen in the market. If this chatter continues for an extended period of time (‘justified’ by falling stock prices and AUD), then consumer sentiments will start to follow as credit conditions tightens at the same time. As consumer confidence declines, aggregate spending will decline, which will in turn pull down more economic ‘indicators.’

The Indians will be carrying more firewood soon (see Do sentiments make the economy or the economy makes the sentiments?).

Of course, the Black Swan that can derail this scenario is further government interventions (which in turn will carry more Black Swans of unintended consequences).

The new defensives- drugs & health care

Thursday, October 1st, 2009

Conventionally, if investors want to be at the most ‘defensive’ (i.e. not take any risk) for their investments, there are no better places than US Treasury bonds. The US is the keeper of the world reserve currency and their Treasury bonds are backed by the full faith and creditworthiness of the US government. By definition, the US government can never default on its debt because it has the full powers of taxation on its people and as a last resort, crank up the monetary printing press of the world’s only reserve currency. In other words, the US Treasury bonds are the safest ‘cash’ an investor can ever get.

But the problem is, under the colossal weight of debt that the US government is going to face (see How is the US going to repay its national debt?) and the commitment of Ben Bernanke towards the idea of debasing the currency (see Bernankeism and hyper-inflation), the safest of ‘cash’ is no longer safe in real terms. The US government cannot technically default on its debt because it can always print money and repay them in continually depreciated dollars. The Chinese government are acutely aware of this (see Nations will rise against nations) and are earnestly diversifying their safest ‘cash’ into other forms of store of wealth. With interest rates effectively at zero (which is below the rate of price inflation) and likely to stay there for a considerable period of time (see Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber?s view), even risk-adverse savers are forced to speculate if they want to preserve the purchasing power of their savings.

So, we have this ironic situation that the most risk-free investments (US Treasury bonds) are actually very risky (currency depreciation through debasement). For US-based investors, Marc Faber reckoned that they are better off risking their wealth in defensive stocks than risking it in ‘cash.’

The question is which sector is defensive?

One sector that Marc Faber has in mind: