Central Bank

Why Europe Is Doing The ‘Ice Bucket Challenge’ With A Glass Of Water

‘Grand’ gestures with minimal effects, Europe is doing the ‘Ice Bucket Challenge’ with a glass of water. Measures won’t measure up to much. Little movement in interest rates, not enough assets to buy and ultimately – you can put out as many cream cakes as you’d like, but if people aren’t hungry, they aren’t going to eat. The pressure is rising and more is needed. Europe has become a ‘binary trade’, and it is important to invest in those set to benefit regardless.

(Click on the image below for a quick video clip summary)

cnbc FMHR Sept 2014

2 Measures That Won’t Measure Up To Much… (more…)

Don’t Be Fooled: Why A New Stock Market High Does Not Guarantee Growth

Published in CityA.M.

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The global recovery does not fully account for the rise in markets, and the growth that would justify these elevated price levels is not guaranteed. (more…)

Why Europe’s Market Correction is a Healthy One…

As European markets suffer the longest losing streak since November, the correction is a healthy one. The index is still up over 8% this year, despite many of the region’s problems remaining unsolved. The latest disappointment, a manufacturing industry contracting more than forecast, is merely the next knock in an overall shrinking group of countries. Just this month the European Central Bank reduced the outlook for growth this year to a 0.1% contraction, keeping the region in recession. As expressed by Tim Geitner in the US, Europe is “only at beginning of a very tough, very long, hard road”.

See this as a quick video clip on CNBC 

Italy struggles to free its labour market, essential to restore confidence and ease debt

Crucial for Italy to restore confidence in their markets and bring down hefty borrowing costs is the structural reform of its labour laws. The country’s growth has lagged the euro average for more than a decade and with unemployment at the highest level since 2001 (9.2%), the fear is they will be left further and further behind. Unfortunately, talks between government and union have failed to ease firing laws, which would stop older workers being protected to the detriment of the youth (suffering from a massive 30% unemployment rate) and encourage hiring. With elections early next year, the time for progress is running out.

Portuguese auction success shows investors convinced short term but long term concerns continue

Portugal, seen as the next card to fall after Greece, succeeded in auctioning 4 month bills at the lowest yield since late 2010. Demand for these bonds reached 7 times the amount on offer, implying investors were sufficiently confident on the short term outlook for the country. Nevertheless, long term bond yields remain elevated, with investors requiring 12.5% to lend to Italy for 10 years. With a 3.3% economic contraction expected this year, unemployment at 14.8% and strikes over pay, welfare cuts and tax hikes, the long-term outlook is yet to be rosy. The deepening slump has dampened deficit reduction, with the figures almost tripling in the first two months of this year. The fear is more rescue funds will eventually be needed.

ECB passing the baton: unwinding support for banks but had better move cautiously

Interestingly, despite the potential pitfalls, the ECB seems to be scaling back certain bond purchases. Prior to the recent Long-Term Refinancing Operations (LTRO), a measure to buy €40bn of bonds was set. Since then, only €9bn has been bought and the policy expected to last until autumn may be wound down sooner. This is understandable with LTRO, injecting a whopping €1tn of liquidity having made this ‘gesture’ obsolete. Furthermore, a member of the ECB has proclaimed that it “has done its part now governments must do theirs”. A move towards letting banks stand on their own two feet is the long-term strategy for stability, but with potential for risk to re-erupt, they had better step cautiously.

Stagflation risk and what this means for stocks

As the outlook for growth continues to deteriorate, whilst the price for goods and services remain stubbornly high, the risk of stagflation returns. This would be a tough scenario, where policy options tackling one of these issues would only worsen the other. This creates substantial downside risk for stock valuations based on bullish growth forecasts, whilst making it more prudent to invest in price makers able to pass on rising input costs.

Lower growth outlook

The outlook for growth is bleak. The IMF has reduced their forecasted expansion of Europe from 2% to 1.6% and Goldman Sachs swiftly followed suit predicting France and Germany will fall into recession next year, with the EU stagnating. The data looks supportive of this view. German retail sales disappointed expectations, with a contraction of -4.3% in July vs. -0.5% expected. With Europe still our largest trading partner, the effect on the UK could be severe.

Outside the EU, countries aren’t immune. China’s Purchasing Managers Index has fallen below the 50 mark, the line separating expansion from contraction and GDP growth came in at 9.1%, falling from 9.5% and below expectations.

QE increases stagflation fears

In an effort to boost the economy, the Bank of England surprised many commentators by increasing their purchases of UK government bonds, from £200bn to £275bn.  However, this is not without its risks. It is not a guaranteed strategy to boost growth and crucially create jobs. Instead, it is more likely to increase inflation.

Taking bonds out of the market and pumping cash in their place only reduces the value and purchasing power of the currency, making goods and services more expensive. Inflation is already above the 2% target set for price stability, hitting a rate of 5.2% at the latest measure this week. In the EU the value jumped to 3% in September, the fastest increase in 3 years and potentially a reason behind their Central Bank’s decision not to cut rates.

Unemployment in stagnating economies is an issue and highlights the threat. Spain is struggling with 1 in every 5 of their people without a job, increasing to 45% of the youth population, and Portugal’s jobless level has reached highs not seen for over two decades. The US’s September figures are stuck at 9.1%, although CPI came in below expectations. Here in the UK the level might ‘only’ be 7.9% but this is still high and stubbornly so, with inflation surprising on the upside.

The stagflation quandary (where stagnation and inflation meet) is that to tackle unemployment and boost growth, interest rates would be cut, however not only are they already low, but that would boost inflation even further. Likewise, to tackle inflation, interest rates might be increased but this would only hurt growth and employment.

A lose-lose situation.

Risk of Stock Downgrades

So what has this meant for stocks? Firstly, there is downside risk to stock valuations. With many valuations based on forecasted growth, downgrades could negatively impact and seem more expensive. Analysts are 10 times more bullish on the growth outlook than economists. Although, always more optimistic, that is twice the historical average.

Secondly, it may be more prudent to invest with those that are price makers not price takers, as well as with a protected demand base, in order to be able to pass on rising costs.

IMF Revelations: The End of European Dominance & The Rise of Emerging Markets?

As “super-injunctions” are labelled “pointless” by the rise of ‘new’ social media sites, the world seems a smaller place for those wanting to hide potential transgressions.  Indeed, such accusations can have broad ramifications as the head of the International Monetary Fund this week steps down from his leadership position. Could this trigger the end of European dominance at the IMF and even pave the way for Emerging Market leaders to acquire a more appropriate size of the power pie?

Jurisdiction Arbitrage: The Super-Injunction Flaw

Last week, an anonymous twitter user exploited a ‘jurisdiction arbitrage’ to name celebrities whose identities are being protected by a series of ‘gagging-orders’. The Twitter site is based in the US and therefore “outside the jurisdiction of the British courts”. Furthermore, not only would the user himself be “difficult to trace” but the number of other users who forwarded on the names and could be charged represented a “mass defiance” and “unlikely” any of them would be pursued. Therefore potential wrong-doers can, for the moment at least, be named and shamed in some form of media. Just how dangerous can these revelations be?

Revelations at The IMF

This week legalities are once again in the headlines as Dominique Strauss-Kahn, (now the former) head of the International Monetary Fund, stands accused of politically damaging indiscretions. Regardless of the outcome of the case, the political impact has been made and focus is on identifying his potential successor.

The European Bias

Historically the IMF Managing Director has been European and the World Bank President American but nowhere in the “Articles of Agreement’ is this mentioned. So where did this bias come from? It dates back to the Bretton Woods conference, where the fund was formed and this informal agreement struck. In the aftermath of World War II, European economic stability played a large part in the health of the world’s economy and voting power reflected the balance of power. The US has a 16.7% share, Germany 5.9% and the UK & France 4.9% each; leaving the ‘door open’ for ‘behind the scenes’ negotiations. Unsurprisingly, since this time, there have been 10 Managing Directors, all of them European.

Flaws of a European Successor

Proponents of a continuation of European dominance point to the IMF’s crucial role in stemming the European Sovereign Debt crisis. A German government spokesman, Christoph Steegmans, maintains that the leader needs to understand “Europe’s particularities”. Interesting then that there has been no talk of electing an official from the Middle East as Egypt requests a $4bn loan to ‘fill its budget gap’. With all the turmoil, doesn’t a leader need to understand the ‘particularities’ of this region too? Instead, focus is on German candidates (including Axel Weber, the former head of the Central Bank who recently withdrew from the race to succeed Trichet as head of the ECB). A favourite amongst pundits is French finance Minister Christine Lagarde. Bank of Canada Governor, Mark Carney has even been given odds of 10-to-1 by a British bookmaker. Gordon Brown’s name has even been thrown into the ring but was quickly opposed by our PM Cameron due to the record budget deficit which continued to build during his tenure. Here lies the crux of the issue, since the EU and ECB have yet to solve the debt crisis, is it time for someone else to have a go?

Opportunity for Developing Markets

The economic balance of power is changing. China has overtaken Japan as the second largest economy and it has been argued that it will surpass the US’s share of global GDP in a decade. Back in 1973, the developing nations asserted more of their power as a group led by Indonesia and Iran vetoed the nomination of a Dutch candidate (seen as too closely aligned to the interests of wealthy nations). With this in mind, candidates from South Africa, Turkey, Singapore, Indonesia, Mexico and a Chinese official who advises the IMF already have been mentioned in the press. Brazil too has contributed to the discussion, as their Finance Minister argues for a “new criteria”. Indeed changes to IMF governance were decided in 2008 and last year, shifting 5.3% of the voting share to emerging markets. Although nothing has yet taken effect. However, with the increased contribution of funding coming from these regions and the negativity within these countries expressed against too much focus on the developed world, change is warranted.

Investment Conclusion

As ever, economic issues can often lie opposed to equity market movement. But changes (or continuation) of dominance could affect short-term sentiment for various country’s financial markets. Exploit any over-reaction in the short-term whilst remaining focused on quality in the longer-term. The shift of economic power is well underway, let’s see if the political powers play catch up….

Gold may Glitter but can it Deliver?

The classic “safe-haven” investment has seen a strong uptrend in its value since the autumn of 2008. Risk aversioninflation fearsfalls in the dollar and demand from the east have all been credited as drivers of this move. But just how supportive are these factors going forward — what is the risk gold could lose its lustre?

A Hedge against Inflation

The fear of inflation is heating up as on Wednesday the Bank of England suggested that “there is a good chance” inflation will hit 5% later in the year, far above the target rate of 2%. Elsewhere, on the same day, Chinese inflation figures surprised on the upside. However, is gold an adequate hedge? It can be shown graphically that it is not. Charting the inflation rate (CPI change year on year) against the gold price, we can see that over the past decade the relationship breaks down. Indeed, if the gold price kept up with increases in general price levels, it would be valued at $2,600 an ounce instead of around the $1,500 level. How about if instead of actual inflation, we look at the market’s expectation of inflation? Even in this case, the relationship does not hold. Instead, there are other factors at play. As previously discussed, investors may be more focused on the sustainability of the economic growth rate and allow for some inflation. Inflation alone may not provide sufficient support.

The Gold Price (white) vs. CPI change year-on-year (orange). Source: Bloomberg

A Beneficiary of Risk Aversion

So — could upcoming economic, fiscal or political disappointments sufficiently boost the gold price? Here the case looks stronger. From sovereign debt crises in Europe, to the tragic tsunami in Japan and the turmoil in the Middle East, there has been enough newsflow to stoke fears and flows into gold (a “whopping” $679m of capital was invested in precious metals in one week alone at the beginning of April). Furthermore, a lack of confidence in the dollar further boosted investment for those looking for a more reliable base.

Demand from the East and Central Banks

In addition to jewellery demand, central bank purchases may provide much support for gold as we move forward. Russia needs to acquire more than 1,000 tons and China 3,000 tons to have a gold reserve ratio to outstanding currency on parity with the U.S. This is even likely to be an understatement with China stating publicly they would like to acquire at least 6,000 tons and there are unofficial rumors that this may go as high as 10,000 tons.

A bubble with no clear end

George Soros described gold as the “ultimate asset bubble” and with sentiment driving the price as much as fundamentals, it’s unclear when the trend will reverse. An increasing monetary base is looking for a home. As Marcus Grubb, MD of Investment at the World Gold Council was quoted as saying at a ‘WealthBriefing’ Breakfast on Thursday: “In the next 10 minutes the world’s gold producers will mine $3m of gold, while the US prints $15m.” However, an often-overlooked drawback in investing in gold is its lack of yield. With some stock offering attractive dividend yields and investors wanting their investments to provide attractive returns during the life of their investment, capital flows may wander.

The Investment Insight

Remain wary of relying on one driver of returns; it can often be overshadowed by another. Instead build a complete picture and continuously question your base case scenario. Gold is a more complex asset than many give it credit for and as always, it pays to be well diversified.


Libya – Oil, Water, Gold – The Real Issues

The oil price has sky rocketed over the past few months. The finger has been pointed at the troubles in Libya and claims of supply disruptions have dominated the press. However, are these claims grounded in fact or are we watching yet another sentiment driven bubble? What are the issues we should be aware of and how should we best invest in the face of such turmoil?

Expectations are often more damaging than reality

Libya’s contribution to global oil production is in stark contrast to the column inches it has been awarded in the press. As quoted by the National Journal, the country produces around 2% of the world’s oil. OPEC (Organization of the Petroleum Exporting Countries) has claimed that they have managed to “accommodate most of the shortfall” and instead attribute the rise in the oil price to fears of a shortage rather than any genuine supply issues. Oil reached a 2.5 year high last Friday. This is against a flattish demand side dynamic. Paris-based International Energy Agency and the U.S. government’s Energy Information Administration left fuel demand growth for this year unchanged and OPEC only raised their forecast by a relatively small amount (to 87.9m b/d from 87.8m b/d).

Note - this chart also highlights the Crude vs. Brent trade with the discount at record levels. Source: http://www.tradingnrg.com/crude-oil-price-forecast-recap-for-march-and-outlook-for-april-2011/

EU Sanction: A further boost for the oil bulls

On Tuesday, the EU extended sanctions against Libya to include energy companies, freezing assets in an attempt to force leader Muammar Gaddafi to relinquish power. Phrased another way, by the German Foreign Minister, this is a “de facto embargo on oil and gas”. Approximately 85% of exports are for delivery to Europe and importers will now have the task of finding potentially more distant and/or expensive alternative sources.

The pent-up downside risk

Nevertheless, many are not paying attention to the downside risk to the oil price as we move forward. Libya has Africa’s largest proven oil reserves but 75% of the country’s petrol needs are met with imports because of limited refinery capacity. Any improvement on this front, if a regime change is eventually secured, could significantly reduce imports and boost global supplies.

 Is water the next oil?

In addition to oil reserves, one asset belonging to the Libyan government which is rarely mentioned is an ability to bring water to the desert. With the largest and most expensive irrigation project in history, the $33bn GMMR (Great Man-Made River) project, Libya is able to provide 70% of the population with water for drinking and irrigation. The United Nations estimates that by 2050 more than two billion people in 48 countries will lack sufficient water, making this an enviable asset indeed.

How can the US pay for the Libya intervention?

It is interesting to note, with all the claims being made that the intervention is oil motivated that, Libya has another form of ‘liquidity’.  According to the International Monetary Fund (IMF), the country’s central bank has nearly 144 tonnes of gold in its vaults…

How to best invest: Retain context

The tide is starting to turn, Goldman Sachs has called the top for commodities in the near-term and oil fell by 4.5% on Monday and Tuesday alone (Source Bloomberg) . With this amount of volatility, short term noise can sometimes overwhelm. For a long term investor, looking for steady and stable returns, an ability to cut through the sentiment (whilst acknowledging it’s importance in driving returns in the shorter term) is valuable. Often many factors are at play and it will ‘pay dividends’ to be well-informed as they become wider known and priced in by the markets. Knowledge may be king but preparation will come up trumps.