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Sandeep Daga's  Instablog

I am a Chartered Accountant, Cost Accountant, Certified Treasury Manager and MS (Finance). I have been tracking financial markets for last 13 years and have worked for a conglomerate in India and in banking sector in London. During my professional career I have developed a good understanding of... More
  • Bull bear fight is emerging - stay watchful
    Skepticism and fear has fueled the latest leg of rally in commodities and equities. “Fear of being left out” has got fence-sitters involved; accentuating the move in several asset classes in last couple of weeks. Typically, pace in this leg of rally attracts trend-followers, panic buying from non-believers as the last bear gives up. At the same time, intra-day volatility rises as fight between bulls and bears picks up. In our previous reports we have been warning about steep rise in volatility in coming weeks; looking at Friday’s movement in Gold and Euro we are quite convinced that coming weeks will not be the time for weak-hearted traders. Currencies are mother markets for the financial complex and rising volatilities in this market should be seen as sign of turning point. Yen and Euro’s reversal last week are case in point.
     
    Stay watchful
    A large part of recent rally is based on two assumptions: Low US Dollar interest rate for “an extended period” and dollar weakness to extend further. These intertwined thoughts are quite pervasive and market has got heavily gravitated towards these over last 9 months. Anything that can question these assumptions could change the whole “price-model” for funds. We see early signs of these changes and warn readers to remain watchful. Following are our summarised thoughts:
     
    1.        Despite “too sweet” US job report released last Friday, Commodities and equities had a bit of shock. As an immediate reaction the prices climbed, then rapidly fell in fears of sooner rate rises. Those fought back again the next hour with signs of economic recovery picking pace and fell again on the back of strengthening dollar thus closing near low of the day. This implies two things: One - Bears are finding reasons to fight back and Two – Contrarian to normal belief, better than expected US recovery could be bad for markets initially.

     

     
    2.        Trend of economic recovery and parameters determining asset market prices have lead-lag relationship. What’s good for economists may not be good for money managers and vice versa. The latest rally has been the best example which has left most economists skeptical. We think that economists will be surprised again to see “financial reasons” driving the markets down at a time when economic prospects are brightening.
     
    3.              Historic interest rate cycles in US and trend in dollar suggest dollar strength and rate cycle have moved together (2008 was an exception). US interest rates were reduced during 1989-93. As a result dollar declined from 103 to 80. Rate rise began from 1994/95 which helped US Dollar rise from 80-120 during 1995-2000; Gold fell from 417 to 250 during this period. 2001-2005 interest rates fell and so did dollar from 120 to 80. We think that asset prices have increasingly higher sensitivity to US rate cycles and any pro-growth data will pull down asset prices in fear of rate reversal sooner than expected.
     
    4.             Technical picture is sounding alerts as well. Euro has failed above 1.5150 in two successive weeks and Yen has swifty revesed its recent gains. While staying in downtrend channel, pace of fall in US Dollar has been slowing in last two months. Friday’s spike has pushed dollar above the channel for the first time in last 9 months. A follow-up rally in Dollar in coming weeks could vindicate “break-out” meaning a healthy sell-off across asset spectrum.
     
    Most of us find it difficult to justify the continuing strength in risky assets. Traders are also from one of us and are skeptical buyers. Dubai “standstill” last week and US job report this week are two contrasting events but yet pose the same risk to asset prices: invalidating assumptions of low rate and continuing growth. Sharp price reaction to these two events have shown market’s vulnerability and traders’ skepticism. We donot expect market to be “one-way street” anymore and see potential risk to new longs. Next two weeks are quite crucial in validating this.
     
    The last week
    A steady rise in commodity prices last week got a shocker on Friday as US Job report surprised on the upside. Gold tumbled, dollar strengthened and profit taking emerged in the whole complex. Intra-day volatility remained quite high in most of the commodities and direction clueless. Base metals (except Nickel) closed the week with modest gain but could slip further in early next week.
     
    Data releases this week showed uneven economic recovery. US non Manufacturing PMI, which covers 90% of US economy, recorded a contraction while factory orders rose much above expectations. An analysis of US Job report suggests helping hand from financial services sector.
     
    After walking out from the first round of negotiations, it seems that Chinese may agree on $50/55 TCRC for Copper smelting.
     
    Exchange stocks continued their build in most metals. SHFE Copper stocks rose 3433mt after falling last week. Low premiums, arbitrage at discount of $150-170 to LME and rising stocks in SHFE and nearby LME warehouses suggest that China is well supplied with Copper.
     
    Japanese Yen fell sharply reversing its quick gains of last couple of weeks.
     
    Rising stocks, new investment flows and steep US dollar yield curve has resulted in rising forward curve for several commodities, especially Aluminium, WTI and Zinc. 1 year contango for Aluminium is about 5%, Crude about 12.7% and Zinc about 3.8% as against USD Libor of 1.6%. The abberation in case of Crude and Aluminium are not sustainable. Either forward selling or inventory financing will help bringing rationality.
     
    Physical market
    Aluminium and Nickel are two well supplied metals but yet have contrasting physical markets. Aluminium premiums held high as Nickel’s premium dropped this week. Possible shutdown of Alcoa's Portovesme and Fusina in mid-December has pushed European premium for Aluminium higher to $85-90 from $65-70 . Full financed contango in nearby months and low premiums have been attracting some physical interest in Copper from China; however, broadly end demand is quite subdued. Premiums for other base metals remained range-bound.
     
    Market mood

     

    1.4750 for Euro and 76.50 for Dollar index hold key for reversal to start taking shape. A continuation of dollar strength next week could pose surprises for many.
     
    Bullish technical patterns in most of the base metals hold despite Friday’s reversal. The pace of recent rises have been checked by this week’s correction; however, dollar’s strength have been broadly rejected by base metals. Lead, after breaking below the triangle consolidation pattern is back into the range; it is getting closer to a break-out. Aluminium has overperformed other base metals and momentum looks good amid high volumes. Nickel’s downtrend is well guided by patterns and continuation is expected. Gold, which has breached the trend-line, could see high volatility in coming weeks and failing to make new high could see it reversing quickly towards $1100. We expect Crude’s flag consolidation to continue with $75 possible in coming week.


    Disclosure: None
    Tags: Copper, Macro, Commodities
    Dec 06 11:13 pm | Link | Comment!
  • Dubai "Standstill": A harsh reminder of ground realities to partying bulls
    Dubai’s inability to repay debts reflects upon leveraged commercial property market across the world. In China, Mid-east or US, newly constructed commercial properties are suffering from low occupancies and thus unbearable pain for leveraged builders. Dubai problem is neither new nor sticky. Abu Dhabi’s “case by case” help could ease the short-term crisis. However, the case brings forward several those questions which remained unanswered and were ignored in last 8 months of steep rally. It was a wake-up call for those finding money making easy once again and economic recovery a smooth process. Let’s look at likely implications and scenarios that may fold-out in coming days/weeks.
     
    A harsh reminder
    Similar to Ireland, Greece, Spain and some other smaller east european countries, Dubai too was a case of ambitious growth (especially in real estate) based on borrowed money. On several fronts this is similar to the state of Asian “tiger economies” of 1997 who built world-class infrastructure using “hot monies”. No surprises that all met the same fate – quasi sovereign defaults. Dubai event may not be a “black swan” but another chapter in Credit crisis; it is material enough for the world to stand-up and keep a close watch on. While it is easy to make an optimistic case of this situation, dumping it as a bump in the road to recovery, the event could have some medium-term impact. Here are a few that we think are significant:
     
    1.        Dubai brings world’s attention back to struggling commercial property market globally. Commercial property prices in Dubai have collapsed about 50% in last one year. The correction in China was much milder (20-30%) while those in US fell by 42.9% since 2007. Given, low demand, high leverage and history of loan defaults, US and Dubai cases are comparable (arguably). For quite some time, Wilber Ross has been seeing US commercial property as next bubble to burst. We feel that Dubai event could have a psychological spill-over to beleagured US market as well.

     

     
    2.        Dubai has been one of the largest asian international trading hub and an open trade centre. Accodingly, trade finance and document collateral (Letter of Credit, Bank Guarantee) has involved several of the local, UAE and foreign banks who have (or are doubted having) large indulgence in domestic real estate market. Trust on these banks may not be easy to re-establish – especially after downgrade by rating agencies in the last week. This could affect trades and money flows. Significance will be closely watched.
     
    3.        We think that in some ways Dubai was seen as “gateway” to emerging economies. With dense population, ambitious growth plans, brand new infrastructure, and low barriers to trade, it allured investors interested in emerging economies. The event may affect perceived default risk for the Mid-east region and also that of other asian emerging economies. Undoubtably, the Risk of “unknown” in emerging economies could be priced higher.
     
    4.       Lastly, analysts are relaxed looking at small size ($80-90b) of exposure. UBS notes that the Dubai World could have “sizeable”off-balancesheet liabilities. Besides, a “standstill” for lenders could also mean the same for several foreign firms involved in related services like architecture, interior-designing, electrification, automation, tourism, physical commodity trading etc. Several UAE banks have fund and non-fund based exposure to                 Dubai real estate market; they risk loss of credibility. Like others, we too are closely watching the spill-over effect.
     
    The event has made investors more watchful of bumps and turns. This is evident in Credit spread market, which has remained watchful despite late evening “U-turn” in most equities and commodity prices. Caution (rather than danger) could push Longs to get-off the bus, slowly and gradually, especially towards the year-end. We would imagine a profit-taking wave to pick momentum gradually.
     
    The last week
    We have beeen warning of rising volatility in Commodities towards the year-end; last week was a good testimony of this symbolising typical bull-bear fight, triggered by Dubai event. Copper saw a new 2009 high ($7055), Gold made a new record ($1195 ) before risk-reversal caught-up. Clarification from the kingdom and statement from US banks helped calming the nerves on Friday evening. Although market recovered most of its losses, bullish technical patterns for most of the base metals are not convinving now and are sounding bearish in some cases, especially Lead.
     
    Antaike expects rising Aluminium demand in China in 2010 and yet more surplus.  The Chinese reseearch agency suggest infrastructure demand to lift Chinese aluminium consumption to rise 8.7%; but yet Chinese exports of Aluminium to grow. Meanwhile, Chinalco admitted restarting most of its idled capaciities.
     
    Spence strike got over, bullish markets ignored it.  Metal exchange stocks rose again, market shrugged it off as well. As suggested by us in our previous report, high Zinc prices has been attracting stocks to warehouses (LME and SHFE). 
     
    After warning by some of the Asian banks of internvention if currency appreciates beyond their bearing capacity, BoJ sounded a note of caution after JPY appreciated to 14 year high against Dollar. Dollar index is being supported around 75, but is yet in downtrend channel.
     
    Physical market
    Large inflows of Nickel in LME (3300 mt in the week) helped ease physical premium for the metal which were earlier supported by Sudbury strike. China is rumoured exporting most of the base metals and steel – either to warehouses or to other user countries. Indian physical market for Copper is mired by high prices, slowing re-stocking and large availability of scrap. It is getting difficult for physical traders to rotate material. Premiums for most of the base metal remained steady, close to previous week’s level.
     
    Market mood

     

    Last week we said: “….While all these suggest a possible strength in dollar, we would watch for break-outs (JPY >94, USD Index > 76.50, Euro < 1.46) before betting against the trend.” We continue to hold our view that currencies are torch-bearer for all asset markets and place for close watch.
     
    In our last report we saw bullish technical patters in most of the base metals. Last week prices broke above the pattern and pushed higher. However, Dubai event acted as a dampener and causes big “yo-yo” on friday. This “diluted” bullish short-term patterns for Lead and Aluminium; other base metals appear in neutral zone. We would watch for any “rejection” of late Friday rally; if that happens, Lead and Aluminium will top our list for going short.

    Disclosure: none
    Tags: Copper, Metals, Commodities, Macro, Dubai
    Nov 29 10:22 pm | Link | Comment!
  • Running short of parking slots?
    A run-away rise in Gold and negative yields in US short-term treasuries offer one of the two conclusions: a rush for safety amongst investors or too much money chasing too few assets. For the first hypothesis to be true, the risky assets need to show a meaningful fall. Given steady to rising equities and commodity prices, love for risk hasn’t lost despite sliding trend of economic data from US and Europe. Clearly, money’s steeplechase for asset classes continued this week defying long-held fundamental relationships. The dichotomy has created a large divide between money managers and fundamental economists. We feel that “reflation” tactics of US will fetch flak from around the world and the recovery could potemtially come under its own weight.
     
    Running short of parking slots?
    Earlier this year, Warren Buffet, George Soros and many others expressed fears about un-explainable rise in asset prices and 1970s type inflation. First part of their expectations is proving to be true, gradually but steadily. Several indicators prove this point; let’s have a closer look.
     
    US banks continue favouring US treasuries over lending as best bet (Geither admits tight credit for smaller companies yet); the rush is accelerating towards the year-end. US 3m treasury yields turned negative last week as demand for paper rose. We came across a similar phenomenon this time last year when yields turned negative briefly. Given improved cashflows and financial conditions of banks this year, we would not be surprised to see more money at disposal of banks thus spreading negative yields further up the tenor. This could be an year-end phenomenon, but it speaks loud and clear about risk appetite of US banks and surplus money at their disposal. It also states that despite steep rally in asset prices globally in hope of economic recovery, US banks do not see meaningful business opportunities.  Negative yields, an extra-ordinary case, reminds views of Jim Rogers, who sees bubble in US Treasuries. He could be right, but other asset classes are not different as well.
     
    Gold rose about 10% this month and 41% in last 12 months. Although Gold has been on the uptrend for last few years (2002: +23%, 2003: +19%, 2004:+5.5%, 2005: +18%, 2006: +22%, 2007: +31%, 2008: +5.6%, 2009 (todate): +31%), bets on Gold’s continuous rise has been cummulating to new records. Net speculative Long position in Comex Gold is above 32 million Oz equalling notional value of about $50bn. Besides, about 1600mt have been held by investors in several ETF funds equalling about $80bln. Dollar’s weakness and lack of investible avenues is one of the biggest driver for prices higher. Gartman find a bubble in gold but is friendly with the trend.
     
    Industrial commodities are no exception to the trend. Despite close to record inventories (and rising) in Crude, Natural Gas, Nickel, Aluminium, Tin and multi year high stocks of other base metals viz: Zinc and Lead, their prices have bounced sharply from year’s lows. Total LME stocks of all traded products rose to a record above 6 million tons recently and are rising yet. Base Metal stocks in Shanghai are at 540kt, a record level while Copper stocks in Comex have been rising too. Most of the research agencies expect metals to be well supplied in 2009 and 2010; they forecast a deficit developing only from 2011. However, prices continue to defy the statistic, a clear indication of money chasing this asset class as well. Some see bubble developing in Chinese asset markets, especially real estate; the largest consumer of metals.

    Money needs place to hide, to park itself. Too much money starts running short of available parking slots and create bubbles. Formation of bubbles could extend over several months and years together. Latest move in asset prices show a divorce from fundamentals and hence talks of bubbles.  Having seen a bubble burst recently, some are fearful of a relapse with smaller pre-crisis bubbles growing bigger. World leaders and thinkers viz: German finance minister, Chinese officials, Bill Gross (PIMCO) have started raising issue and pointing fingers on each other . We think that debate could intensify further pressing US Fed to to take some money tightening (not rate raising) measures creating ripples in the market who are thriving on dollar carry trade. Given extremely lopsided market, we feel that first quarter of next year could be quite challenging for money managers.

    The last week
    Base metals and Gold pulled sharply higher without support from dollar and equities. It clearly looked like new money rather than short covering. Commitmentof Traders report suggest continuous accretion of longs across commodities.

    Antaike revised Chinese Aluminium consumption forecast upwards meaning about 500kt of additional consumption than previously thought. Given strong regional premiums for Aluminium, this isn’t surprising. However, Aluminium led the complex higher on the back of this news-story. Besides, news of hike in non-residential power tariff by 5.7% in China also helped the sentiment for Aluminium.

    Antaike’s report suggested that Chinese secondary output of Lead in Jan-Sep rose 53% y-o-y, the principal driver behind rising lead production. Given short supply of lead concentrate in China, this news doesn’t surprise.

    There were talks in the market about CTA activities in few base metals; traders expect accentuating move by CTAs.

    Physical market
    Physical premiums for aluminium and zinc remained firm this week. Rotterndam premiums for Aluminium ticked slightly higher while some trades in US indicated small re-stocking demand.  Copper premiums remained depressed in most of the regions.

    Year-end stock clearing by traders could push down premiums in weeks to come. However, we expect Aluminium and Zinc demand to hold up.

    Market mood
    With 3m Oz of open interest at $1200 Dec-09 Call of Comex Gold, all eyes are on expiry on Monday. An unsuccessful attempt of surpising the option seller could mean quick price correction in rest of the week.

    Most of the base metals are looking good technically and could push higher especially after a firm close last Friday. A revisit of $7000 for Copper and $2350 for Zinc and $2100 for Aluminium could be on cards this week.

    However, those watching the bigger wave should be focussing on currencies which are (arguably) close to inflexion points. Euro has failed above 1.5050 several times and is pushing close to the bottom line of the up-trend channel. Mirroring this, Dollar index seem to be supported below 75 and is suggesting a double-bottom, but needs validation in coming weeks. Similarly, Japanese Yen seems to have made a double bottom at 87-88.50 range. While all these suggest a possible strength in dollar, we would watch for break-outs (JPY >94, USD Index > 76.50, Euro < 1.46) before betting against the trend.

    Disclosure: None
    Tags: Copper, Metals, Commodities, Macro, Economy
    Nov 22 10:44 pm | Link | Comment!
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