Monthly Archives: September 2014

Straya T’day 19/9/2014 (updated)

Steel, iron ore hammered

Ugly day in China. The excitement around a supposed move by the PBoC to unleash a monetary response to the slowing economy has faded, the bounce was sadly of the deceased feline variety. Rebar and Dalian iron ore futures have been crushed today, as Reuters details. Little chance of avoiding a new low for spot iron ore now.

ironore199

7-handle next week is likely. Keep an eye out for further capital raising and then bankruptcies in the junior miner space. (Not that you’ll need to remain especially attentive, it’s going to be quite the spectacle.)

Update: spot slumped to $81.70 (corrected from $81) on friday, a new low. 

IO MOnday

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Straya T’day 18/9/2014

Aussie wilts along with the rest

A fortnight ago, I wrote:

As long as it’s relatively lucrative to borrow offshore and hold short-term AUD-denomiated assets, we aren’t likely to see a sustained fall in our currency.

This was quite unfortunate timing for me, given that I have been among the biggest AUD bears going around for the past 3 years. I hadn’t abandoned this conviction at the time of that post, but rather I was anticipating the Fed remaining relatively dovish; enough so that it wouldn’t send the AUD sharply lower until the RBA finally signalled the return of an easing bias. Whatever it was that fixed the market’s attention on the USD (those working papers from the Fed undoubtedly played a part), the timing of the AUD fall was plainly brought dramatically forward as the USD regained it’s mojo over the last fortnight.

I discussed the capitulation of the AUDUSD last week. Here’s how it looks today.

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Chart from IG Markets

The mood in Australia is turning noticeably negative now. The local bourse has copped a hiding  this month, down around 4% despite resilience in US equities.

ASX

The selling has been broad-based across sectors, however financials (XFJ), consumer discretionary (XDJ) and energy (XEJ) have led the charge, with materials (XMJ) continuing to languish due to the rout in iron ore. It’s worth remembering that financials and materials together account for half the local share market.

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Chart courtesy of Yahoo Finance

Weighing on sentiment towards Australia has been a poor run of data from China, beginning on the weekend. There have been short-lived bursts of excitement about government stimulus measures, but anyone hoping for a concentrated campaign to rescues fixed asset investment (and in so doing, rescue Australia), looks destined for disappointment. Rebar futures are again on the nose today.

Data on Chinese property were released today, and the downturn is carrying on with scant regard for the apparent imminency of stimulus.

1_china-300x0

It’s getting quite nasty now, and I expect property will begin testing the government’s reform fortitude in earnest in the coming months. As the Premier recently noted, it’s employment growth that is chief first among the government’s policy objectives. As long as employment is holding up, the government will tolerate deflating property. But what happens if employment starts to seriously suffer as a result of weakening property?

Australian asset allocation

As I said, despite an unfortunately-timed assertion that the AUD would be unlikely to decline materially (that is, break support at .9200), I have been and remain a long-term AUD bear. As such, I continue to favour stocks with a sizeable portion of earnings being generated offshore, or those with solid growth prospects for offshore earnings. This excludes the miners, however, since my bearish medium term view of their main product is central to my expectations for a lower AUD.

Candidates include Seek.com (SEK), CSL (CSL), Cochlear (COH), Westfield (WDC), Computershare (CPU), ResMed (RMD).

I’ve also liked Billabong (BBG) and Elders (ELD) and speculative plays for a while. Both have been crucified and are in the throes of restructuring. ELD is moving back towards a pure-play agribusiness model after various diversification disasters over the years. I believe there is long-term value in the strategy; if it can pull off the turnaround in its corporate model it will be well poised to take advantage of a lower dollar boosting Australia’s agricultural export sectors.

All advice is general in nature and does not take into account an individual’s circumstances. Proceed with caution. 

Dovish talk, hawkish walk

Early this morning, the Fed released its latest monetary policy update. The statement still contained the all-important phrase ‘considerable time‘ in reference to the schedule for interest rate rises following the termination of QE.

But the ascending dots were what sent a jolt through markets.

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The average view within the Fed is now that the official interest rate will reach 1.375% by the end of 2015, as opposed to 1.125%, which was the expectation in the June meeting. This means a quicker pace of interest rate rises, even if the timing of the first hike is expected to be roughly the same (not for a considerable time, if we’re being precise).

The US dollar has been rallying of late, a kicked off by a couple of papers form the Fed. This one from the San Francisco branch had the following to say;

Evidence based on surveys, market expectations, and model estimates show that the public seems to expect a more accommodative policy than Federal Open Market Committee participants.

While this one from the economists in Washington argued that much of the decline in the labour force participation rate is structural in nature. The implication being that we will not necessarily require higher employment-to-population ratios to see wage-pressures start to appear.

Thees papers helped set the US dollar alight, with the DXY now well-poised for a break-out following the Fed releases.

chartpng

It rose against all the majors last night, but particularly against the yen.

yen

And so the USDJPY continues on it’s merry way.

yenLT

I wouldn’t usually put a great deal of importance on broken trends over very long timelines, there’s too much else that could be going on for technicals to take precedence. But there certainly looks to be a stark divergence emerging between the monetary settings of the US and Japan.

Japan is suffering right now, but a large part of that is due to the sales tax hike in April, which saw a spike in sales immediately before, and a consequent slump afterwards. We’ll have to see how the rest of the year plays out, but if the government presses ahead with another planned hike next year, we can be sure it will heap more pressure on the yen. Many unknowns, but I wouldn’t be surprised to see the USDJPY come within striking distance of 120 by the end of next year, assuming the Fed’s rates schedule pans out as officials are expecting.

It’s worth remembering that the behaviour of the dollar over the next few months could well be an important consideration for the Fed’s interest rate schedule. Disinflation remains a concern in the US (although the latest CPI was negative mainly on account of lower energy prices, and one trusts the Fed will not be worried about that). If the dollar stages a thumping rally over the next 6 months, it will further quash inflation and weigh on US exports. A strong dollar, should it take the steam out of domestic price pressures, could itself delay or flatten the planned rises in short term interest rates.

As always when the USD starts to stir, it’ worth checking in on the barbarous relic, which is staring squarely into oblivion.

gold

Not much further and we can kiss goodbye to critical support at $1180. It’s going to be a wild ride form there.

Straya T’day 16/9/2014 (updated)

Iron rockets

As discussed on the weekend, Chinese data seriously undershot expectations, taking industrial production growth to the slowest pace since the GFC. I mentioned that the market reaction would be interesting since such poor data would push the government further towards more aggressive stimulus measures (at least in the market’s eyes).

The other point I highlighted in the weekend post was the clear signs of stabilisation in the iron ore and steel markets last week.

With iron ore futures in contango, low steel mill inventories, and terrible data, we had the perfect conditions for a rebound in iron ore, and indeed we got it: spot soared 3.9% to $85.20.

ironore16

So, the rebound is upon us, with iron ore and steel futures jumping again this morning in China. Mills have been running lean inventories, and many buyers have been sidelined over the past few weeks in anticipation of lower prices. We’ll likely see a healthy squeeze from here, but I will be most surprised if spot makes it into triple figures, given the chronic oversupply situation emerging in iron ore, the ongoing flush out of property excesses, and the inexorable down trend in fixed asset investment (FAI) growth generally.

To see iron ore stage a sustained recovery above $100 we would need to see a complete abandonment of the Chinese leadership’s commitment to structural reform, and a wholesale re-adoption of FAI stimulus. This remains a remote possibility. Just last week, Chinese Premier Li Keqiang had the following to say at the World Economic Forum:

Growth in emerging market economies has slowed down, and the Chinese economy faces greaterdownward pressure. Facing this challenging environment, we have continued to follow the general principle of making progress while maintaining stability. We have stayed thecourse and pursued a proactive approach. Instead of adopting strong economic stimulusor easing monetary policy, we have vigorously promoted reform and economic readjustment, and made efforts to improve people’s lives.

Despite growing downward pressure on the economy, more jobs were created, thanks to new steps of reform taken.

The message is unmistakable: As long as employment growth is holding up, China is not going to undertake large-scale stimulus of the sort that sends demand for steel and iron ore soaring. As China shifts to a more services-oriented economic model, with a higher share going to consumption, it is quite possible for it to sustain adequate urban jobs growth, without pumping up FAI, aided as always by gushing credit. (I’ve discussed this process in more detail in a previous post).

We saw a limited set of supportive macroeconomic policy measures from the second quarter, lasting until about a month ago. This in turn supported demand for raw material imports, but as soon as the policy support faded, iron ore and steel tanked, exacerbated by seasonal factors.

Without massive monetary support for property, iron ore is not going to go much above it’s last high of $98 on this bounce. And if it does, it will not last long. In that scenario, which is my base case, the iron ore miners will begin toppling in earnest from late Q1 2015 onwards.

Arrium’s recent equity raising was but a taste of the pain to come.

Update

The bounce in steel is looking decidedly lacklustre, with rebar pretty much falling across the curve today. This has taken the steam out of iron ore futures, with the January contract managing a mere .3% gain.

I have been loath to commit to the point too aggressively, lest a strong Q4 restock befool me, but there are very good reasons to suspect that this year the iron ore rebound will be much more muted than it has been in recent years. We should still see a rally from current low prices by the end of the year, but the risks are heavily skewed to the downside.

China data disappoints

This was supposed to be a fairly upbeat post courtesy of iron ore’s more positive price action this past week; spot fell 1.9%, after dropping close to 5% the week prior. Although it was the fifth consecutive week of declines, there was clear indications that the market was bottoming for the time being.

iron ore spot

Steel futures managed to eke out a small gain on friday, as did spot iron ore. Dalian iron ore futures dropped like a stone on wednesday before staging a heroic recovery, and although spot dropped that day it was stable into the week’s end, suggesting the worst may have been behind it, at least in the short-term.

Chinese data dump muddies the pond

Alas, the good news ended there with a fairly miserable set of figures from China’s stats bureau yesterday.

Growth in industrial production plummeted to 6.9% in August, down from 9% in July, on expectations of 8.8%.

CHina industrial production

Fixed asset investment (the long-time driver of Chinese growth), came in at 16.5%, form 17% last month, well below expectations for 16.9%.

fixed asset investment

Retail slipped as well, to 11.9%, down from 12.2% on expectations of 12.1%. They’re holding up better than FAI, which is a plus for Chinese rebalancing.

retail sales

In the most basic sense, for China to successfully rebalance, retail sales need to grow faster than FAI for an extended period, such that the investment share of GDP declines from its extraordinarily high levels it reached in the aftermath of the financial crisis.

China, as with all countries in the early phases of development, has long been characterised by elevated levels of investment. However, in response to the Asian financial crisis in 1997-1998, China pushed its investment share up to defend its growth rates. This effectively meant China was growing more and more dependent on external final consumption demand. This was fine as long as China could run very large current account surpluses with the rest of the world. However, when the global financial crisis hit, this foreign demand dried up, and China doubled down on internal investment demand (in infrastructure and property, primarily) to support growth.

In so doing it saw its current account surplus shrink as it sucked in imports of raw materials and suffered the loss of demand for its manufactures. Investment’s share climbed to levels virtually unseen in large economies. The issue was, without large current account surpluses, China had to flood its own economy with credit to support extremely high levels of investment.

Rebalancing therefore means investment growing more slowly than consumption, as well as  credit growing more slowly than nominal GDP. Credit growth has slowed, but it will need to remain at roughly the pace it is at present if China is to meaningfully rebalance its economy. The trouble is the economy is blatantly running out of puff each time credit and/or investment slows.

The central conundrum of the rebalancing process is that consumption falls when investment falls (since income is reduced) and nominal GDP growth slows when credit growth slows. How far each of these must slow before the the economy reaches a sustainable state is not known. But it is ever-more apparent that it’s not going to be as smooth a transition as the China bulls expect (‘believers’ is a preferable term to bulls, I think, in keeping with Michael Pettis’ terminology).

Market reaction

How the markets react to this in the coming week is going to be very interesting. The calls for stimulus will be deafening now, and the government is likely to respond with supportive measures of some kind. I still find it highly unlikely that an about-face is coming regarding ‘big bang’ investment stimulus, and the markets are going to be very disappointed if that turns out to be the case.

An exciting week ahead!

Straya T’day – 12/9/2014

History rhymes for valiant AUD

Despite its well-earned moniker, something finally stuck to the ‘teflon’ Aussie dollar and it’s been absolutely creamed this week, with interesting parallels to the early stages of last year’s rout.

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The staggering jobs figure yesterday didn’t provide an iota of support for the AUDUSD beyond the hour or so after the data hit the wires. In fact, the impact was just the opposite, with the pair ruthlessly sold later in the day. Something very similar happened in May 2013.

As in the past few months, the AUDUSD traded in a well-defined range up to May last year. The 1.0200 level was a widely recognised line in the sand; this year .9200 was the key support. The primary source of demand for AUD-denominated assets in each case was the attractive interest rate differential between Australia and other major economies (known as the ‘carry trade’). Carry trades can be lucrative for as long as a currency is stable or appreciating, however an aggressive reversal can erase profits in a very short space of time. This fact actually makes reversals more likely to be aggressive, since long positions profiting from carry are always on high alert for a change in the trend and thus prone to stampeding for the exits.

The RBA began hacking away at the interest rate differential in late 2011, however there was little reaction in the exchange rate, in part owing to the still-wide gap between local and foreign interest rates, but also because of the announced return of QE by the Fed in September 2012. The Aussie battled on.

As has been the case this year, there was no shortage of bearish sentiment in the lead-up to May 2013, the rationale for which was outlined in this perfectly timed piece from the Macro Man blog. The terms of trade had clearly peaked, the sharp drop in LNG mining investment over the following few years was being recognised, and the unemployment rate was trending higher.

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Signs that the RBA was likely to continue chopping at the cash rate began weighing on the Aussie early in 2013, pushing it to the lower bound of the range, but 1.0200 held nonetheless.

Then whispers of a scaling back of the Fed’s bond buying program began to seep out. One of the first manifestations of this concern was in gold, which was simply massacred, falling close to 20% in a month.

gold

The Aussie dollar wasn’t far behind. Following a soft CPI reading in late August, the RBA cut the cash rate on May 7, dragging the AUDUSD beneath critical support at 1.0200. This year it was renewed vitality in the USD, especially against the yen, that drove the initial move in the AUDUSD below support, but coincidentally, in both instances a stomping seasonally-adjusted jobs figure briefly resuscitated the pair just after the initial break (the 2013 figure was later revised down, no doubt a similar revision will transpire for the 2014 one).

2013
AUDhistory1

2014
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In both cases, the failure to re-establish support after the bullish data release was about as bearish a signal as you’ll see, and acted as the catalyst for the subsequent collapse. Longs still committed prior to the jobs report were forced to accept reality when a wave of selling arrived above the previous support levels, and folded shortly thereafter.

It’s hard to say exactly what the magnitude of the drop will be for the AUDUSD now, since so much is riding on the words and actions of the Fed. The taper of QE was announced by Bernanke in late May, and the associated plunge in US bonds was a major reason for the severity of the decline in the AUDUSD (that is to say, USD strength played a significant role).

Therefore, as is so often the case in our modern markets, we await the Fed for a sense of how big this AUDUSD selloff will be. It’s fair to say that the spike in US yields won’t be as pronounced as the first ‘taper tantrum’, so that may well limit the speed of the move. But few would look at the AUDUSD chart tonight without seeing the infirmity written all over.

Straya T’day 11/9/2014

Drowning in Jobs

Yesterday I said the market would be looking for a strong result from today’s employment report, along with reassurances that last month’s leap in the unemployment rate was a ‘statistical aberration’. Evidently the ABS has a sense of humour, because calling today’s report a statistical aberration significantly undersells it.

Supposedly 121k new jobs were created in August, in seasonally-adjsuted terms, with the labour force participation rate jumping and the unemployment rate diving back to 6.1%, from 6.4% last month.

Unsurprisingly, the result met with swift derision.

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As far as interpreting this data goes, it’s best to ignore the seasonally adjusted figure, which has long been renowned for it’s volatility, and instead focus on the trend. On this, the news was still reasonably good, with 18k jobs created, however the unemployment rate ticked up to 6.2%. The headwinds for jobs do still remain owing to Australia’s poor competitiveness profile, however fast-moving developments in the currency markets suggest some relief may be in the offing.

The price action on the Aussie battler was particularly informative. The algos leapt at the enormous beat, and pushed the AUDUSD back above the key .9200 support level which had been taken out in the previous session. This didn’t last long though, with heavy selling pressure arriving each time it retested .9200 in the afternoon. Once it was clear this level would not be re-established, the once-indomitable Aussie battler quickly gave up the fight.

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This suggests a fairly aggressive unwind of the popular leveraged carry trade, with longs looking to get out before the all-important Fed meeting next week. Now that this range has been decisively broken, it will take a very dovish Fed to prevent a move down to the .9000 and below.

The bias is clearly lower; a break of critical support, followed by a retest and rejection after an extremely bullish (if noisy) data release, very bearish price action.

AUD2chart

I’ve had a bearish long-term view on this old boy for about 3 years. The voracious global yield hunt has supported it this year, helping it to gleefully brush aside the unfolding terms of trade bust (the booming domestic housing sector did the rest). There’s no assurances that the Fed won’t once again massage down expectations of tighter monetary settings, but the stage is definitely set for a substantially lower AUDUSD.

It took the market’s wild taper tantrum last year to really send the AUDUSD into a tailspin.

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We probably aren’t going to see such a violent sell off in bonds this year, so the pace of the sell off isn’t likely to be a ferocious. But a stampeding exit from the carry trade combined with sizeable re-positioning of shorts provides plenty of scope of a decent down move in the near future.

Stay tuned for the Fed.

Iron ore

The market is now quite clearly searching for a bottom. Futures contracts have stabilised in China in the past two sessions, which has typically signalled a turn. It looks as though we’ll only see spot prices in the 70s only briefly on this move, if at all. Alas, steel remains weak. Consequently, Chinese steel mills are running on razor thin inventories, reluctant to tie up more capital than they absolutely need to. This provides the conditions for a healthy rebound in spot iron ore prices if and when the steel price recovers and mills replenish their inventories of iron ore.

This is what the miners, and the bullish sections of the sell-side, are pinning their hopes on. There’s wide scope for disappointment here. Steel capacity in China is enormous, any turnaround in prices will be met with a rapid expansion in supply, and so prices are likely to remain in structural decline unless demand stages a heroic recovery. This I do not believe is likely, as I’ve outlined previously. Therefore I expect the inevitable rebound in spot iron ore prices to be quite muted, certainly by the standards of late 2012. If property doesn’t improve soon, then there is the risk of little seasonal rebound in iron ore prices at all.

I’ll stick my neck out and say I’m looking for a recovery just above $90 on the reversal of this down move, peaking in December, before the next leg down form January onwards, which will drive out all Australian juniors who produce at a break-even above FMG. Whether FMG can wrench its costs down fast enough to survive the reckoning is going to be one of the most enthralling corporate melodramas of our day.