Thursday, April 28, 2011

English Passions : Weddings and Football

Well TMM are still trying to be on holiday and were hoping to sneak off until next Tuesday after the bank-holidayfest in the UK. Fat chance, as this USD slugfest has picked up a pace after the Beard seismic-shifted opinion from the Plosser-rebel-hawks firmly back to the regime's dovish master plan. We will be mighty brief today, though we know we should be discussing many things. Apart from the market madness there are two major themes in London this morning. Football and a wedding.

Let's start with the scores:

Real Madrid 0 - 2 Barcelona

Federated Beards 1 - 0 Plosser's Hawks

Larry's Finks 1 - 0 Pimco Bill's

Voldemort 3 - 0 Dollar Bulls

Share Bears 0 - 1350 Spooz Longs

Volatile Vixens 15 - 43 Onemonth Silvers

Bond Vigilantes EU 3 - 14 Bankers Centrale

Spam Chuckers 1530 - 0 TMM

A-Team ECB 1 - 0 Merkel Placators

Draghi United 12 - 1 Stark Disappointments

Zombies Ununited 480bio - (-480bio) Germany

UK Doubledippers 0 - 1 ONS Fabricators

FX All Blacks 5 - 5 Walabies

Shanghai A (-3) - (- 10) Shanghai B

USA 0 - 0 Japan (gone into 3 years extra time)

And now for the wedding.

Just for a bit of fun, TMM thought they'd have a quick look at what happened to markets at the time of the last Royal Wedding in 1981. The below chart shows YoY RPI (white line), Cable (Yellow line), YoY GDP (orange line), the Bank of England Base Rate (pink line) and the FT30 Index (green line - this was before the days of the FTSE100...). Coincidentally (or not), the recession ended exactly one month after the engagement of Prince Charles & Diana was announced, with equities rallying, inflation falling (along with the Pound). The equity market peaked a month or so before the wedding, with the BoE hiking rates shortly after and the Betty put in something of a rally. Equities then bottomed just after Diana's pregnancy was announced, rallying until just before Prince William was born, with Sterling resuming its sell-off as rates were lowered in response to falling inflation.

Now TMM would like to offer their most sincere and heartfelt best wishes and hope they have many happy years of marriage. But, to be a bit mischievous (and after all, this is just for fun), TMM also thought they'd have a look at the events around Charles & Diana's separation and eventual divorce.The below chart shows Sterling rallying hard (but equities selling off) after Charles & Camilla's affair was exposed in "Diana: Her True Story" by Andrew Morton in May 1992, but falling sharply (while equities rallied sharply) after the Diana & James Hewitt's "Squidgygate" Tapes were published in Aug 1992. There was little reaction to the release of the "Camillagate" Tapes in Nov 1992, but Sterling bottomed shortly after their separation was announced in Dec 1992. News of the Queen's asking of the couple to divorce in Dec 1995 appears to led the Bank of England to begin an easing cycle, with the eventual divorce leading to another strong rally in Sterling.

Disclaimer:

In no event shall TMM be liable for any loss or damages of any nature resulting from, arising out of or in connection with the Royal Marriage of William and Catherine. Please note:

  1. The stability of marriages can go down as well as up. Any children arising from them may or may not be the product of both parents.
  2. You may not get back all of your original investment
  3. Past relationship performance is not necessarily a guide to married life.
  4. A mother-in-law is for life, not just for Christmas.

Wednesday, April 20, 2011

Is it true?

It's a busy day today leaving Team Macro Man little time to ask themselves some of the more pressing topical questions. these particularly come to mind...

1. Is it true that one of these is any whippier than the other?

(a) Devo.
(b) A UK Zoo.
(c) Lindi St Clair.
(d) An ice cream van.
(e) A day out with Mr Market over the past 2 days.

2. Is it true that Bill Gross has started buying bonds for the biggest bond fund in the world which was crowing about owning no bonds because:

(a) He has miraculously changed his mind and decided to fund the death spiral debt mountain he has so often blamed for the end of the known universe.
(b) Of some really clever bullshit relative value trade excuse "no I wasn't really short because I was actually hedged through a hedge I bought in a garden centre".
(c) Even the greatest bond manager in the world can only take so much red hot iron inserted posteriorly before he screams for his mother.

3. Is it true that the Chinese reserves of 3 trillion dollars would:

(a) Stretch 3 times around the planet.
(b) Take 48 years to withdraw from a ATM in $500 tranches.
(c) Weigh the same in $1 bills as the total number of potatoes processed last year in Belgium?

4. Is it true that the ratings agencies are:

(a) To be religiously followed no matter what your benchmark.
(b) Run by North Korea.
(c) Suffering a death wish.

5. Is it true that leaving your towels on a bathroom floor in a hotel:

(a) Saves you picking them up.
(b) Destroys the planet as it is a sign that you want them washed which, as the hotel points out to you on small cards, will lead to the end of the human race and it will be YOUR fault.
(c) Costs the hotel an extra $1.50 in washing which they'd rather save on the pretext of promoting peace throughout the solar system.

6. Is it true that running a marathon:

(a) Is environmentally friendly as it is natural and emits less pollutants that doing it in a Aston Martin DB9.
(b) Is jolly good as less animals die during it than in the Grand National.
(c) Emits more CO2 from the lungs of the runners than if each one had stayed on the sofa eating chips and watching TV for the duration.

7. Is it true that the latest stretch of hot weather in the UK will prove once and for all that:

(a) Global Warming is a reality.
(b) The media is obsessed with any event which deviates more than a nano-standard deviation from an average of their choice.
(c) Good-looking girls are solar powered.

8. Is it true that whenever June and the end of QE are mentioned:

(a) The equity market calls for more QE morphine.
(b) The bond market calls for more QE morphine.
(c) Fed don't care as there is no July in their calendar.

9. Is it true that the Asian Central banks:

(a) Hire out seats on their FX dealing desks at fairgrounds and hand out stuffed toys to anyone who can hose more than 15 western banks in 1 minute.
(b) Get through a lot of stuffed toys.
(c) Prefer doing it on the way home after a good night out.
(d) Use USDs as biofuel.

10. Is it true that the Vampire Squid:

(a) Really made that much.
(b) Are going to be allowed to keep it.
(c) Are really going to lay people off if revenues don't grow.
(d) Have obviously acquired all of the QE money.

11. Is it true that making the Soothsayer signals on Bloomberg "subscription only" will lead to:

(a) The Soothsayer becoming very rich.
(b) Cloned "similar" systems being developed and used for free.
(c) No one caring as "Hell, they didn't really work anyway and its a good excuse to stop looking at them".
(d) The development of a new and as yet undiscovered fashion in technical analysis.

12. Is it true that the next fashion in technical analysis will:

(a) Not have a sillier set of patterns than the cups, saucers and other table crockery some use.
(b) Be as self fulfilling as the past ones once enough people follow it.
(c) Be wheeled out, as a tea trolley is, when everything else is quiet.

13. Is it true that Basel III is a really good way to make sure that:

(a) A banking crisis never happens again.
(b) It becomes an incontrovertible proof that banks' structuring departments are still smarter than the regulators.
(c) Next time there is a systemic problem in the US, Eurobanks are going to drop their i-banking subs like a bad habit and leave their counterparties with the bill.
(d) there will be at least one buyer for all the Western Nations sovereign debt.

14. Is it true that Gordon Brown:

(a) Sold the UK's Gold at $255.
(b) Oversaw the run up to the biggest financial crash in the UK.
(c) Blew the UK debt to 58% of GDP.
(d) Is seriously being considered for the post of chairman of the IMF? (you can express your own opinion on that HERE).
(e) Has been sponsored by Al Qaeda to stand for the post.

15. Is it true that ex-Australian Treasurer Peter Costello:

(a) Sold gold at about $330.
(b) Turned down the job of heading the World Gold Council.
(c) Is Gordon Brown's brother.

16. Is it true that the USD is:

(a) The monetary unit of the USA.
(b) Toast.
(c) Worth less than a Greek promise?

17. Is it true that if you are a large hedge fund you can:

(a) Push the market around at a whim in the style of an asian central bank.
(b) Pick your global domicile to fit your personal tax requirements.
(c) Expect to be a pretty small one if the markets don’t get any easier.

18. Is it true that the date 19th April 2011 (yesterday) was:

(a) 13/4/7DB in hexadecimal.
(b) The day that the Machines in Terminator became "aware" as Skynet went active, in preparation for its attack against humanity tomorrow.
(c) Together with (b), why the algos trashed USDs and sent Tech Equities higher this morning.

19. Is it true that when more and more Chinese property developers come to market that:

(a) Liquidity is getting really tight onshore.
(b) This demonstrates the idiot demand for anything in Chinese Yuan.
(c) Once again when things get really bad the onshore guys will get bailed out and a bunch of high yield managers will lose 40%+ and give you a WHOCUDAKNOWN?
(d) Anyone who think the PBOC has any real control over liquidity needs their head checked.

20. Is it true that Team Macro Man:

(a) Prefer McDonald's Egg and Sausage McMuffins over the Egg and Bacon McMuffins as early morning alcohol sponges (but not from here),
(b) Really wish they hadn't come in to work today.
(c) Really wish they never had the need to work.
(d) Will be taking the rest of Easter off and look forward to being back next week.

Team Macro Man wish you a Happy Easter.

Tuesday, April 19, 2011

Dude! Where's my coupon?

Just when we thought it was safe to Nancy around in the open rather than heading for the shelter it started raining fire. Shrapnal damage, but we are alive. Ratings agencies really are the scourge of the financial markets. You have to wonder how long it will be before they step just a little too hard on the wrong toes and befall some unfortunate "accident" in a public place that everyone denies witnessing. TMM think that Obama's playlist has a lot more "Hit 'em Up" by Tupac on it these days and that the IRS and latex glove wearing contingent of the TSA will be instructed to give extra special treatment to S&P employees.

The other great debate du jour has been "Greek Restructuring"...

TMM have been hearing a lot of noise about default and restructuring recently and have noted that when “default” comes up it seems to affect the market more than the word “restructuring”. Well, TMM are going to let you in on a little secret: there is absolutely no difference between the two. As soon as a corporate or nation is not paying the full principal, full coupon or paying them on time that is a default under the original indenture of any debt instrument that at a bare minimum specifies when you get paid, how much and in what currency. All restructurings are a default – they are just waived by the bondholders (or not, in some cases). So with that in mind, what matters in a restructuring? Restructuring is all an NPV game – you are basically reducing the NPV of the cash flows of a bond or loan by either extending out the maturity, reducing the coupon or reducing the principal.

TMM have played with the Greek 10 year here and its pretty easy to see that even in a serious haircut or coupon reduction the risk adjusted yield looks pretty interesting but note you can get the same all-in return on reduced coupons or principal or both.

In corporate restructurings debtors will often accept these terms but there is something else they can get their hands on – equity. The problem is that getting the equity of a country is pretty difficult though the French tried in the Ruhr which did not work out so well for them in the longer run. One suggestion that is very popular in the faculty club particularly amongst the likes of Robert Shiller is having some kind of GDP linked warrants – much like equity, if the restructuring works and the country recovers you get some upside. This has its merits but suffice to say when the warrants are linked to the GDP of the country and that GDP is recorded by the country its about as easy as collecting tax on swimming pools in Greece. So for now let's just assume this is not on the table.

So, when should a country restructure? There is plenty of literature on this and the likes of Nouriel Roubini (before he went tabloid) and Ken Rogoff is a good place to start. However, TMM think that two conditions have to be met to make a restructure worthwhile:

  1. You have an ungodly amount of debt. Depending on the pattern of savings in your country this could be <80% of GDP (Latin America in the 70s and 80s) or >200% of GDP as is the case of Japan. It all comes down to how long and how low people will lend to you – if you are a deflationary country where the savings all go back into bonds at ever lower yields then the game isn’t up until your private sector is a net borrower and the yields start widening (helllllloooo Mr Kan). If your borrowings are mostly offshore, in a different currency, come from foreigners and your economy is volatile the game is up whenever borrowers freak out, your economy weakens significantly and or your currency does (ask any friendly Latin American about the 70s and 80s where credit risk resembled being short a put on the CRB Index).
  2. You have exhausted all other options to increase GDP. The usual tricks here are weakening your currency (not an easy option if you have foreign currency debt issues), wages (never an easy sell – just ask the Greeks, Portuguese or Spanish now) or cutting rates (tough call when you don’t print your own currency and no one but your central bank wants to buy your debt). The usual way to get out of such a crisis is to let your currency go to hell – Asia did this during the financial crisis which led to a lot of immediate term pain but an incredible rebound in GDP as Southeast Asian countries became competitive again, particularly with China. Similarly, Iceland is doing OK now. These cases are ideal for GDP warrants since the bounce back is generally quick though transition costs are high – it’s a bit like Chapter 11 in the US but with rioting. Getting people to take a haircut on wages is never that easy and cutting rates is seldom doable in a crisis.

As you can probably work out by now the FX devaluation get out of jail free card is not available in Europe so what does one do when you want to default but don’t want to wipe out your local banking system? How, in effect, do you default without taking just about everything including the government with you?

First, if you don’t want a riot you ensure your local banking system can either a) take the hit, or b) sells its deposits to someone who can. Argentina’s devaluation and default wiped out people’s savings and wrecked havoc on the economy for years because of it. If you sell the deposits then people are materially less likely to burn down the central bank.

Second, you try to ensure that foreigners hold as much of your bonds as humanly possible because they do not vote and ultimately have little pull in the restructuring. Ultimately a country will have to come back to the market and if it runs a primary deficit then it has to do so almost immediately post restructuring – otherwise you end up printing money and going into a hyper-inflationary spiral. So, with that in mind you can either complete a restructuring with the consent of your borrowers who know that the next best option is watching the people burn your capital or, if you run a primary surplus you can do more or less as you wish – just remember that lenders have long memories, especially Elliott Associates.

Third, you don't default on supranational bodies like the EU and IMF or on bilateral loans. The reason being that these guys are the lenders of last resort and can block your access to capital markets, trade and even in the extreme cases, send a gunboat to make you pay. Iceland is currently perched upon this precipice with respect to its Icesave obligations, but given the unrealistically high debt level that is involved in this particular instance, TMM reckon that the UK & Netherlands will settle for 20c on the EUR or so.

Which brings us to the most important point. Generally, it is in no-one's interests for restructuring to be "involuntary", whereby creditors and debtors cannot agree on a restructuring, or the domestic political and social situation prevents such orderly restructuring. It screws your economy and it screws your access to financing. And it is just this sort of outcome that markets have particularly worried about because memories are scarred by Argentina's acrimonious involuntary default and before that, Russia's. The trouble with assuming that the headline "default" or "restructuring" implies and Argentina or Russia style outcome is that these are the utter worst case scenarios. Neither of those countries had a particularly good history of rule of law nor a particularly good history of economic management. That said, it is easy to label Club Med as not having particularly good economic management, but TMM would argue that the presence of the ECB has at least removed inflationary monetary policy from that sphere, even at the expense of not being able to devalue (this point, of course, is contentious).

Furthermore, neither of these countries was a member of the EU, a construct that already sees large fiscal transfers between its member states and a shared monetary policy, for better or worse. TMM reckon that this point is particularly important in ruling out the possibility of "involuntary restructuring". Private investors know that with IMF and EU oversight that reform programs will be enforced as best as they can, and the idea that the Zombies need to restructure is hardly a new one. For that reason, TMM argue that the only restructuring that will go on is the negotiated "voluntary" type in which Argentinean or Russian-like recovery rates are not in the picture. This ensures that financing continues without the "sudden stop" effects upon the economy that were seen in Argentina and Russia.

The far more likely shock is Ireland deciding that if Mangler wants to bail out Hypo and Deutsche, she can do it directly. Forcing Ireland to back its insolvent banks is ridiculous and it would be a lot easier to just sell the deposits to RBS, Deutsche, Santander or similar and de-lever the economy. While bondholders would squeal at this, it might be for the best – it is hard to see Irish land values rebounding when the country is saddled with debt and has to go through a fiscal consolidation materially worse than it would be otherwise. To that end, watch the Eurobanks – TMM considers the possibility of rude shocks to be far more likely in the bank senior debt market than the sovereign space.

Monday, April 18, 2011

Bunker mentality

TMM have probably done their views on European debt to death over the past 2 days so even though it looks like the market is on a Euro-Zombie hunt, all it has come up with is that Greece may restructure. About as impressive as going tiger hunting and coming back with a pack of bacon from Tesco. With the Easter holidays kicking off this week, it doesn’t feel as though anyone really wants to do anything they don’t have to but the sales forces have gone into overdrive trying to tip clients into panic mode again. Which is all getting a bit wearing.

If the brokers had their way today you would see everyone heading for the bunkers again. Which made TMM wonder where you get them from. We haven't seen them in the local home and garden DIY stores alongside the sheds and pergolas but imagine there is some huge international trade in these things that we just aren't aware of. If there is should we expect Bloomberg coverage to pick up to keep bunker speculators informed? We would look forward to stories along the following lines.

* BBG : Q1 2011 BUNKER SALES RALLY 57%

Bunker sales have rallied strongly, say the International Bunker Sales Consortium. Like for like sales for Q1 2011 rose 57% on new orders from Libya, Cote D'Ivoire, Greece and Portugal.

Herman von Duckencover from SchnellfurdasBunker Gmbh said that German bunkers were a natural choice for most buyers given their proven track record and expertise with poured concrete technology. German Premier Mangler Merkel, speaking at the German Bunker Manufacturers Conference somewhere underneath Berlin said "Bunker technology is the future. Germany plans for bunker development and manufacture to be responsible for 23% of GDP by 2013" Bunker analyst, Runin Hide, said "The secondary benefits are already being seen. Hamburg has taken orders for 4 specialist Bunker Transport Ships totaling 1 Megatonne capacity and Piraeus has already seen the start of a major port redevelopment to allow for the delivery of new mega-bunkers for Athens.

Spain says its future needs are adequately supplied through an exclusivity agreement with China, though China refused to comment. Libya's plans to join the secondary market have been delayed by blocking by the out going presidency of the reforms needed to allow the export of second hand bunkers.

Next weeks G20 summit is expected to discuss North Korean bunker market manipulation. The US is particularly concerned that bunker hoarding by the people's democratic republic has led to price disparities that have disadvantaged western bunker manufacturers. A communique is expected calling upon North Korea to free up its Bunker market. Official figures are unavailable as to the bunker reserves held by the country but officials estimate that they control up to 30% of the market.

The US are particularly keen to open the global bunker markets in readiness for the release of their Californian made electric bunker. With an expected range of at least 30 days on a supply of batteries originally designed to power electric toothbrushes, the Terre-slurp B is seen to compete with Krupps Gross-ferkoffen-Bunker which runs on traditional materials. Meanwhile Fiat has introduced a new convertible bunker that looses its roof in just 15 seconds.

For today at least TMM are ignoring the sirens and are going to relax in the run up to the holidays.

Friday, April 15, 2011

Pricing Zombie Nations

Equation of the day:
PIIGS = IS + Zombies

We suggested yesterday that as the European periphery succumb to bailouts and aid packages they effectively become the financial equivalent of Zombies. The living dead, slowly decomposing but threatening the living with their bite. The Zombie Nations.

Each nation is drawing up plans to battle its Zombie status and TMM are now in a position to share what their insiders have gleaned as to how things are progressing.

Greece's working paper can be found here, Portugal's here, and Ireland's here.

Now TMM have been short of barge-poles for a while and so were intrigued to notice that barge-pole sales have collapsed as investors have declared that they wouldn't touch Zombie Nation debt even with a bargepole. Intrigued, TMM thought they would have a closer look at this Zombie Nation debt to see if it really is as toxic as a bottle of "Fukushima Spring" or whether there may be something worth salvaging.

Now, much of this stuff has been covered elsewhere, but TMM still get the impression, given the rumours flying around the past day with respect to Greek or Irish restructuring, that - outside of the credit market - many market participants have not actually done their homework when it comes to working out roughly what is priced into Zombie Nation bonds. So in the interests of shining some light on the them, TMM have dusted off their bond pricing spreadsheets.

So the first task is to work out what a cured Zombie would trade at as a spread to Bunds. TMM reckon that any IMF/EU-negotiated voluntary restructuring would aim to put the Zombies on a fiscally solvent and sustainable path, but not necessarily one that is Maastricht compliant and, as such, TMM reckon that broadly, these spreads to Bunds are likely to be roughly in the region of where Italy trades (currently 130bps). Additionally, idiosyncratic factors such as prior fiscal responsibility (in the case of Ireland), and making up the numbers (in the case of Greece) will likely lead to specific tiering. In 1999, Greece traded at an average of about 190bps at a time when it was generally uncertain that they would meet the Maastricht criteria to enter the Euroarea, and applying TMM's MDI (Moist Digit Indicator) to add an additional 30bps of risk premia, reckon that a "clean" Greece would trade at about 220bps above Bunds. TMM only have data on Portugal going back to 1997, a time at which Portugal traded about 125bps over Bunds. Given the structural weaknesses in Portugal's economy ( similar to Southern Italy), TMM's MDI reckons 150bps is probably the right number for a "clean" Portugal. Lastly, Ireland's past fiscal prudence and flexible labour market in the context of a 1990s average spread to Bunds off 105bps make TMM's MDI think that a "clean" Ireland should trade roughly flat to Italy, at about 130bps.

TMM recognise that this is all very subjective, but at least will be the right sort of order of magnitude.

So what is priced in?

First, Greece... The below chart shows the implied loss-adjusted spread to Bunds (y-axis) given an assumed haircut (y-axis) and time to default (z-axis). Eyeballing the chart, were Greece to immediately restructure, in order for the loss-adjusted yields on its bonds to be high enough to meet TMM's 230bps spread to Bunds, the haircut would need to be about 40% or less. Obviously this number creeps up the longer the default is delayed. TMM's base case is that Greece restructures with a haircut of 45% when the EFSF expires in 2013 and should that scenario play out, TMM's model reckons that 10yr Greece is adequately priced, offering a loss-adjusted yield of around 5.6% and around the 220bps to Bunds they reckon is appropriate. Not bad, and certainly worth a punt.

Ireland's underlying fiscal position is nothing like Greece's, and TMM reckon that in any case, should push come to shove, that the Irish Government will spin out the depository assets of its remaining banks to Santander or RBS or whoever, and allow bank senior creditors to wear their share of the burden (and this is something TMM feel very strongly that the Irish should do). In any case, TMM reckon an Irish restructuring in a year's time of about 30% is the most likely of restructuring scenarios, and one that would provide a loss-adjusted spread to Bunds of about 135bps which, again, is about where TMM reckon a "clean" Ireland should trade. Also worth a punt (or rather, a Pund).

Finally, Portugal... again, the problem here is less out of control fiscal policy and made up numbers (in the case of Greece) or banking-related problems (as with Ireland), but low trend growth and structural rigidities. TMM assume that the IMF and EU will continue to pressure Portugal to reform, but they don't have a central view as to if/when/how Portugal will restructure. But for the sake of comparison, a restructuring of 30% occurring upon EFSF expiry would leave 10yr Portugal trading at just 104bps above Bunds, which is too low given TMM's view of a "clean" Portugal trading at about 150bps over...

So there it is... eyeballing the charts, TMM reckon that Ireland and Greece price in some pretty severe restructuring scenarios, while Portugal is well on its way to doing so too. It's also worth pointing out that owning this stuff here gives you the wildcard option that restructuring is less aggressive than those scenarios or even that they manage to pull things off without restructuring...

Either way, there may just be a Dawn for the Dead:

Thursday, April 14, 2011

Plants vs Zombies

A Portuguese, a German, a Greek and an Irishman walk into a bar. The German pays.

TMM have been struggling for inspiration in generally uninteresting markets over the past week or so - something that is, perhaps, understandable given that punters have been keeping things pretty close to home ahead of earnings season, at least in equities. The FX Carry love fest that has sucked many in over the past couple of weeks appears to be flagging (see chart below of HFR Macro Hedge Funds - orange vs. KRW/JPY - white) and this, perhaps, is forcing many to trade their P&L given that month-to-date numbers for many in Macro-land are now likely negative...

...Especially given that speculative shorts (see chart below) had begun to build in Treasuries which have subsequently squeezed higher.

What with the recent Squid-driven reversal in commodities, it's starting to look a little Pink Flamingo-esque. Except it doesn't quite all add up: this morning has seen the return of Eurobear Missionaries making readings from the Book of Eurorevelations at Speakers' Corner. According to the Good Book, it is written that the Irish Government will seek audience with the Fellowship of Bondholders in order to voluntarily restructure its debt. Financially speaking, Greece, Portugal and Ireland have already died and are effectively financial Zombies. The walking dead. So should we really care if another leg falls off them? The problem is that every time the Zombies scream, the market worries that Spain has been bitten and might just turn into one of them too. Or that Ireland will bite and infect the British banking system. Market judgment, if you were to look at prices this morning , is that Spain may well be infected as it's trading along with the peripheries rather than, as it has until recently, as a core.

TMM are yet to be convinced, and are of the opinion that the past few days' moves have been nothing more than position squeezes ahead of the stream of earnings releases that begin in earnest next week. Indeed, TMM's bond valuation models suggest that Irish restructuring is largely priced in and their credit trading mates report very little volume going through on the widening move...

With a market severely affected by ADHD, together with the Zero-G parabola we mentioned yesterday, we end up with everyone desperately looking for something new to hang on to. "The next big risk". Many of the comments that TMM have received on IBs and emails over the past few days have been along the lines of "equities have failed to push on... sell rallies", which fits in nicely wiith their current resurrection of the EuroZombies. But TMM get the sense that punters have been trying to get short of equities on the idea that margins are being badly affected by the run up in commodity prices. That is certainly a view that TMM take seriously given their generally constructive view on Equities this year, so it seems like a perfect time to have a closer look...

In terms of earnings expectations in general, this is looking to be the quarter that EPS surpasses the 2007 peak (see chart below), a fact that many operating in other asset classes find surprising. TMM must admit they've been very surprised in general with just how well earnings have recovered after the recession.

But coming back to profit margins in particular, punters have rightly observed that the rapid run up in commodity prices presents a serious headwind for profit margins, given that so far, the consumption data has been weak, meaning that it is hard for rising input costs to be passed on. Of course, at face value that seems obvious, but there is also a flip side to this story, in that wages are unable to rise when the unemployment gap is rather large, a situation that the US currently faces (see below chart of US Average Hourly Earnings). The reason that TMM bring this up is that while raw materials make up a significant part of corporate costs, so do wages... and this is particularly important for a service economy like the US.

In addition to raw materials and wages, the other big drivers of margins are financing costs, which are close to multi-year lows and over the past year or so, TMM have noted many of the "smart" corporates extending their debt maturities and fixing their interest payments. That provides structural support going forward. So, tying all of this together, TMM built a very simple and naive model of SPX margins (see chart below, red line, actual margins YoY detrended [in order to strip out structural productivity effects from IT and globalisation] - blue), which while not perfect, due to base effects in CPI (we were too lazy to strip these out) seems to generally do a reasonable job in explaining the broad trends. And the message from the model is that margins are likely to improve further, so TMM reckon that this earnings season could be a lot better than many punters (which seem to be somewhat bearish, in contrast to analysts) expect. In that light, TMM reckon that dips in Spooz prior to the earnings season truly getting under way are a buy.

So, if we see the Earnings as the green shoots of recovery, then today is going to be Plants vs. Zombies.

Wednesday, April 13, 2011

Its All Going Bunker Hunt

Quote of the day .. *TEPCO PRESIDENT: MUST RETHINK PLANS TO EXPAND GLOBALLY.

No kidding - just as Australia looks to be passing a carbon tax that will bury one of their larger Australian assets, a brown coal power station that kicks out more carbon per MW than any other power source. Sometimes you just can't get a break.

Anyone got any conviction out there? Feels to us as if the market is floating around weightless and unable to grab hold of anything? Just like inside one of those parabolic-flying-Zero-G-simulating planes? The sort of feeling you get as you go over the crest of a roller-coaster? If so we know what happens next. The inflation expectation trade that we mentioned yesterday is picking up more interest today as we are beginning to detect price falls in unexpected places like China. Headline data from here is starting to trend downwards but how much of this is seasonal and due to some fairly heavy handed persuasion to cap prices from the government is anyone's guess. All we know is that if veggie prices are down ~15% in Heilongjiang those cabbage speculators got stopped out.

The one place that isn't seeing price falls is Silver, but we really are no good at it and would appreciate any guidance. While ETF oz are up the ETF action (see below) can't account for half of what one is seeing in open interest or volume trading on Comex.



Its recent moves appears to be driven by the new Far East mania for "things" as "things" are harder to make and more durable than bits of paper. But just because they are harder to make does not make them any more valuable at the end of the day. TMM find it hard to make a hand crafted jug out of used Nicorette gum, though they did manage it once, but that doesn’t mean that Nicorette crafted crockery will be the next big inflation hedge. Just as Tulips weren't, though TMM are planning on opening a florists in Shanghai. TMM find silver particularly hard to understand because so much of it is produced as as by product of other metals not least of all gold - in general, there is more of this stuff around than people generally know what to do with but we are hearing anecdotal purchases in China of 250 koz. Spillover from a now heavily regulated property sector? TMM thinks so - and thus we are not stepping in front of this freight train just yet.

There does seem to be a collective move ex-China though to "Bunker Hunt" Silver and TMM had a quick look at what happened then. The first thing they noticed was the general topicality of the man having discovered that he also played a very significant role in opening up the Libyan oil fields, which Colonel G would later nationalise. The second thing we noticed was that his ultimate down fall in cornering the market was marked by the the implementation of "Silver rule 7" blowing him up through margin calls. Another casualty of leverage. So why Silver? We only need to look at the Gold/silver ratio to realise that this is beyond the precious metals general move.



Once again, like the Nasdaq in early 1999 this is one of many things that look entirely out of kilter and yet it is not something TMM would endorse fading just yet - for that we'd need to see some breakdown in autocorrelation, which we will discuss tomorrow.

Tuesday, April 12, 2011

Inflation Pendulums, Nukes and Shoe Shops

It was only 8 months ago that the world was screaming that deflation was a foregone conclusion and the only way that the world could adjust. At that point we felt that we weren't seeing deflation, we were seeing wealth degradation. Since then of course the whole idea of deflation is as fashionable as building nuclear reactors in earthquake zones. On that subject, Japan's announcement that the calamity is now as bad as Chernobyl has TMM asking if the total amount of radiation is actually a problem. Isn't the area affected more important? There is a letter in this week's New Scientist suggesting that all nuclear power stations be built underground where the benefits of containment, natural shielding and gravity fed water cooling systems is obvious. Is there any good reason why not? What's that Lassie? There are strange men in white coats down the old mine?

But back to that inflation thing. The inflation story has rightly become the pressing theme in the last 6 months but TMM do wonder if we are now near the zenith of the counter swing in this pendulum of inflation expectations, for today saw something remarkable...

...The UK we have just printed inflation figures BELOW expectation...

Well when we say "expectation", it would depend who you talk to as there is a feeling that someones expectations might have been a little too informed to the point where even the ONS is examining the security on the 6.45 football supporters special it uses to ferry its hedge fund locum courier from Cardiff to London.

RTRS-UK ONS SAYS AWARE OF MARKET RUMOURS OF EXACT MARCH CPI RATE BEFORE DATA RELEASE, IS INVESTIGATING.
TMM are eagerly awaiting a follow up along the lines of:

RTRS-UK ONS SAYS IT IS HAPPY WITH THE EXPLANATION OFFERED BY THEIR COURIER THAT HE ONLY PUT IT DOWN WHILE BEING GIVEN A CAN OF TENNANTS EXTRA BY A RATHER ATTRACTIVE LADY.
It was still an eye watering 4% and as most UK residents know the cost of living here has absolutely sky rocketed over the past few years. When married to the slow down in the public sector it has crucified confidence and the consumer has responded accordingly, deciding to rein back on Plasma TV's and bling leading today's BRC retail sales figures to print -3.5%. We fully understand how the high street reflects the mood of the UK public but as we have protested before we don't see it as being a disaster due to "jobs being lost in retailing". That's just evolution and vital to keep the UK from evolving into Frogstar B - The planet in Douglas Adams Hitch Hikers Guide To The Universe.

"Frogstar B was thrown into poverty through an event termed the Shoe Event Horizon. The foundation of the Shoe Event Horizon theory is that when depressed, people tend to look down, and when they look down, they see their shoes. To cheer themselves up, they might buy themselves a new pair. Thus, in a generally depressed society, demand for shoes will rise. In the critical condition, demand for shoes rises faster than the capacity to make good quality footwear. As shoe quality decreases, the demand increases further because shoes wear out faster and need to be replaced more often; as the demand for shoes increases, cheap mass production causes shoe quality to drop even more. What results is a spiral of increasing shoe demand and decreasing shoe quality. Eventually, this destabilizes the economy to the point where it is "no longer economically viable to build anything other than shoe shops", and planetary society collapses".

That sounds familiar enough without even having to substitute "shoe" with "Apple".

We were going to now mention the UK housing market, but having Aussie-housing-ourselves-out it will have to wait. Instead, we will note that the Battle of Spain, which is where the markets expect the European Wars of the Periphery play out its decider, has seen the Chinese doing an impression of the Prussians with Wen as Blucher coming to the rescue with his host of bond purchases. Europe has gone too quiet again. If you think that everything is too pessimistic at the moment then perhaps its worth re-establishing the Optimism clubs of the 1930's, where organised positivism was seen by many as a way out, and by others as a sure sign of economic hard times.

Oh, look. They are back.

Monday, April 11, 2011

Caldera of Ozzie Ire

TMM probably should have realised that by broaching the topic of Australian rates, the composition of household wealth and thus housing we were walking around the caldera of a very active volcano of debate in both markets and policy. You see, some people like Jeremy Grantham have made the point that Australia is a housing bubble because its growth is so far away from trend, others, admittedly with some skin in the residential property game like Chris Joye at Rismark in Australia have staunchly defended Australian residential real estate prices as more business as usual in affordability terms and the rise in values as being due to secular declines in inflation and therefore rates. Steven Keen and Chris Joye have even debated here. So, what does TMM think?TMM think that rather than throwing peanut shells from the sidelines that its worth taking a step back and ask what a housing bubble is anyway. As with everything, there is demand and supply:

  1. Demand: Real wages, population growth, employment growth, CREDIT, tastes and preferences, cost of capital.
  2. Supply: Costs of construction, real geographical constraints, supply side constraints like zoning, short term elasticity of supply.
  3. Market Microstructure (how 1 and 2 sort it out).

You would be inclined to think the whole world has decided that any real estate market comes down to one variable and one variable only, the one in BOLD above - which is a gross oversimplification that allows journalists to lazily fill column space without doing any real work.

TMM thinks we covered the demand side in Australia pretty well (real wages, employment, rates in the previous piece) and Joye makes a good case that given these ratios have been stable since the late 90s as people's tastes and preferences adjusted to new, lower long term inflation expectations that there isn't anything untoward in house prices' rise in the 2000s.

On the supply side there has not been much work done on the costs of zoning in Australia aside from stuff like this but it appears that the costs are mind-blowingly high. More work needs to be done on this by the RBA and their ilk on how the geography of Sydney and its ring of national parks affects housing but its an article of faith that this is a big deal for affordability. Ed Glaeser covers this well in the US and it is worth noting that those markets that are most constrained like New York have bounced hardest coming out of the crisis, Phoenix and Las Vegas, less so.

Perhaps the "tell" of the housing bubble in the US was that markets with vastly different fundamentals started to perform similarly, in that subprime defaults were mere symptoms of the underlying credit bubble that had manifested itself in increasing leverage across all income, demographic and geographical groups in the US. That does not seem to be the case in Australia right now. As far as the distribution of leverage goes, many bears point to the First Time Buyer Credit leading to a ramp in prices in the aftermath of the GFC. TMM are sceptical on this point given that, unless they misunderstand the ABS's numbers, that only around 220k first time buyers took advantage of this perk. In terms of the effect of such a group moving en masse into delinquency, the numbers are just not large enough to produce a meaningful spill over into the rest of the economy (220k * 300k average first time buyer price ~AUD 66bn). As TMM noted on Friday, the Household Net Worth position in Australia does not show any particular sign of overleveraging, sitting at around 600% of disposable income, relative to liabilities of around 140%. A point often made is that using average wealth and income levels masks the underlying skewed distribution, and is one that TMM are always very aware of. However, in Australia, they do not necessarily believe that there is much wrong with this level of abstraction given that Australia's Gini coefficient sits at just 30.5 (25th lowest in the World), vs. 45 for the US (95th in the World, and below that of the Ivory Coast!).

In terms of geographical distribution, Perth and Brisbane are ripping while Sydney has been flat lining for a long time. To TMM that says a lot about what they pay wheel loader drivers vs what they pay lawyers today and indicates that forces aside from credit are at work here. Note that in these regions there was pretty much no one living in many of these areas.

On market microstructure, the picture is reasonably positive. Most houses are sold via auction in Australia which can induce bidders to bid up but also ensures people know where the next best print is - its hard for a market to go completely illiquid when they know where the next bid is which was a serious problem in some areas of the US where housing seemed more like selling CDO tranches in early 08 than anything else.

Then there is the issue of how that market micro-structure can or will handle "weak hands" i.e. - over-levered players who get stopped out and put a lot of supply on the market as was the case with US subprime... or any agricultural futures expiry this year. As far as TMM can tell, those people have largely been blown out already: looking at the hands-down crappiest securitisation in Australia in 2007 (Mobius NCM-04) losses have already been taken and those loans that are still performing are at much lower LTVs. No one prints this stuff anymore and if deals like this haven't taken down the market they are not likely to anytime soon at LTVs <60%.

Finally, is there any evidence of return-chasing, that other key ingredient of a Bubble? As regular readers will recall, TMM have a particular fondness for considering whether a certain market's returns are auto-correlated as this provides a statistical measure as to whether current returns are explained by past returns (i.e. - did punters see that prices had gone up and decide to buy more?). To that end, TMM have compared the 8-quarter rolling 6m auto-correlation of year-on-year house price growth in both the US (see chart below, red line) and Australia (blue line). In the US, it appears that the bubble began to form in the mid/late-1990s, crescendo-ing into 2005 before crashing spectacularly - the strong auto-correlation from 2007-2010 being a function of house price declines leading to even more declines (leverage working in the other direction). But in Australia, aside from a brief period of positive auto-correlation between 2001-04 at low levels relative to the US, something arguably related to the Zoning issues TMM discussed above, it is not particularly obvious that there was any particular degree of return chasing in the Aussie housing market. TMM would also note that Australian house prices fell/went sideways from 2003-05 and similarly from 2007-9: house price falls are not unusual and therefore embedded into household expectations, unlike in the US where house prices had not fallen on a nationwide basis since the Great Depression.

So, are TMM Aussie housing bulls? Hardly. TMM are less concerned about some inherent instability and fragility in the housing market than they are about broad instability and fragility in the Australian economy. While LTVs may be low going back to those Perth wage changes it is quite clear that Australia has an awful lot riding on the mining boom and implicitly Chinese fixed asset investment. Seeing how much of Australia's total investment is in mining and how average wages in suburbs in Perth have consistently outstripped GDP for some time running, we are also concerned about how a real shock (namely, China slowing substantially) would impact real incomes and in turn housing. Australians have a lot of wealth locked up in housing (around 440% of disposable income) and the tax system encourages people to be long property. It is possible that a real shock could lead to a mother of an unwind but once again, that is a shock from an external source, not some inherent criticality in Aussie housing itself.

TMM can't help but feel that Australian housing is riding the Dragon and little else. Then again, just about everything else Australia is, including the AUD. Looking for the next subprime debacle and opportunity to short billions of mortgages for <100bps per year and watch them go to 20c is not something that is going to work in Australia before a couple of other interesting things happen - like copper going to $4000/ton and the AUD/USD revisiting .70 or worse. Put simply, there are easier trades.

Friday, April 08, 2011

Spendor Australis

Captains Macro Log, star date 08/8&^7/9&18

We have spent the last 3 days searching sector Alpha for the Ultimate Trade. Having taken damage from a surprise attack from the Aussieyen, USS-TMM has been repaired using its long Dilithium battery stocks and long equity core. We have now entered a spectacular binary star system in the Spendor Australis sector on a most critical mission of Australasian research. Our eminent professor, Dr Cpmppi, will attempt to study the decay of the consumer expelled at relativistic speeds from the massive stellar explosion in the commodities sector which will occur in a matter of weeks. Meanwhile our sensors are continuing to indicate a strong presence of the Borg who have locked on to the strong trend signals emanating from this system.

There are a few things about this system that have been causing USS-TMM's research crew to scratch their heads in recent months, the first of which is the slightly strange prudence of the Aussie consumer. The crew of the USS-TMM must admit that they have been surprised that despite a record surge in income growth on the back of the Klingon, sorry China driven Terms of Trade shock and very sharp rebound in the Aussie economy that Skippy and the rest of the Romulans haven't been loading up on plasmas and Priuses. Indeed, the savings ratio (see chart below), having spiked to levels not seen since the early-1980s has just gone sideways over the past couple of years.

Now, Starfleet Command reckon this is the result of the two speed economy of this Binary System, as the East deleverages from the housing boom, while the West increasingly falls under the gravitational influence of the Klingon Empire which has been scouring the galaxy for raw materials. And, as an explanation, that makes sense to some extent, but doesn't really stand up well to what the data is showing: State Unemployment rates (see chart below), while higher than the peak of 2007/8, are all still below what one might assume to be NAIRU.

So is it the debt load? The crew of the USS-TMM must admit they shake their heads in despair when the Bondvigilantians start jabbering on about debt-to-GDP ratios and the like, because that neglects to consider the other side of the balance sheet. And, as the below chart clearly demonstrates, while household debt stands at around 150% of household disposable income, household Net Worth sits at just below 600% of that number. It is therefore something of a stretch of the imagination to argue that the Romulans have over-leveraged themselves.

To dig a little deeper, TMM constructed a rudimentary model of Australian Retail Sales, which involved much tweaking to the warp drive engines given that the ABS appears stuck in the 20th Century in terms of both data frequency, quality and the existence of appropriate deflators, and make the ONS look positively competent. But anyway, TMM eventually managed to get the engines back online, inputting Consumer Confidence, Consumer Expectations, Wages, personal credit, terms of trade & house prices, with the system spitting out something vaguely resembling the actual data (see chart below). What is interesting to TMM is that post the 2001-3 slowdown, retail sales were also slow to move higher post the initial rebound, underperforming what one might imagine given what TMM reckon affects consumption. After a year or so, sales began to rise quite strongly to more in line with the model. So, under that prism, perhaps we should not be surprised at how tepid consumption has been so far? And although TMM's model has retreated from its highs, it is still pointing to ~2.5% real growth in retail sales in the coming months. Given that the official measure appears to have bottomed out, TMM are optimistic that the Romulans will return to their old habits in the coming months.

So what does that mean for the RBA? Well, in recent months, headline CPI has been falling, helped by the seemingly bulletproof Aussie Dollar, but in the coming months, favourable base effects drop out and the TD Inflation Gauge (see chart below, white line; headline CPI - orange line, RBA Trimmed Mean -yellow line) is pointing to inflation moving higher. TMM reckon the RBA is too optimistic in its inflation forecasts given both this and their expectation that the consumer is about to reawaken...

...so while on TMM's adjusted Taylor rule, the RBA are marginally ahead of the curve after November's hike, in TMM's view, in the coming months Fleet Admiral Stevens is likely to get itchy trigger fingers.

And given this, the curve does not appear to be pricing in enough tightening (see chart below, courtesy of TMM's allies on Planet Nomura).

Captains log Star date 08/8&^7/9&19

Target has been acquired and firing solution calculated. Photon Torpedoes armed and locked. USS-TMM is engaging Aussie Bills.

Thursday, April 07, 2011

Twenty Five Questions

TMM are immersed in research, so they thought given it is once again ECB day that a round of Twenty Five Questions was in order:

  1. Does the Dollar Index trade 70 or 80 first?
  2. When will they finally board up DFS (Dreadful F'in Sofas)?
  3. If you were able to rescue only one Central Banker from a plane crash of central bankers, which one would it be?
  4. Do you care that Portugal has asked for aid?
  5. If Spain is the Fukishima of European Debt, how high are its sea walls?
  6. Will Trichet do "a Gaddafi" with respect to the periphery rebels?
  7. Which day will see the first coaches of periphery protesters arrive in Brussels or Frankfurt?
  8. What will be the date of the first Fed rate rise?
  9. If TMM can't afford to fill their cars up with fuel, how come the roads are still so busy?
  10. When will it be cheaper to fill your tank by distilling your own ethanol from 12 yr old malt rather than fill it with petrol?
  11. What will be the next investment fad in China after Penny Blacks? Presumably, if they mix Lafite with coke, then TMM guess they will use the stamps for mailing things to friends they want to impress.
  12. Is the BBC capable of phrasing any news item without blaming Government cuts (today they tried it again re: record levels of diagnosed depression in the UK)?
  13. Complete the following penned by Mr Obama "Dear Mr Gadaffi, thank you for your kind letter of the 6th inst..."
  14. If you are a US federal employee, what will you be doing tomorrow?
  15. Isn't "No More Nails" great?
  16. Isn't Australia Great!
  17. Find x where DDDF+GGUF+TDI+DPI = $/x-Yen [candidates may refer to the TMM glossary].
  18. Was the number of references to Vigilance in today's ECB statement a surprise to you?
  19. Does the FX market need greater regulation?
  20. Does the Equity market need less regulation?
  21. Which will be worth more next year, a Beijing Apartment , or the copper plumbing in a Beijing Apartment?
  22. Why don't they fit solar panels in the dashboards of cars to keep the battery topped up?
  23. With all the CB issuance and word of Chinese banks either coming to market or issuing more equity, how much more can HK and China equities run?
  24. If China's done with fuel prices rises why does Sinopec still trade like someone who couldn't make a spread on cracking carbon chains?
  25. Is today "the turn day"?

Wednesday, April 06, 2011

High conviction losing trades

So the first thing TMM have done is tattoo their own 2011 Non-Prediction "USDJPY will not be easy" to the back of their hands...! So much for trying to do the reverse of catching a falling knife. AUDJPY started well but has since Edward the Seconded us.

To be honest, TMM are suffering from Bloggers block and are finding it hard to coherently tie all the strands of what is going on together today. Made all the harder as these strands in other markets would be considered bloody great steel hawsers. Though surviving March due to their generally constructive view of US equities, TMM cant decide whether there is a new direction in flow developing or whether we are just seeing independent eddies on a slack tide. Today's data releases form the UK and Switzerland are added twisted swirls in the patterns.

Is the DGDF uprising going to succeed? The DGDF freedom fighters are now being supported by GGUF air cover today and have pushed forward into new territory. We just don’t know if next week will see the pull back but one thing has been noted in the market's rules book: the Dollar is no longer a knee-jerk buy on global stress.

TMM are also seeing that more and more of the metals complex is being assimilated by the China negative real rates Borg - anecdotal stories of gold demand and 10 ton orders in silver are making us think we don't want to step in front of this one. It appears everyone is selling apartments to buy metals. Platinum is also remarkably robust given the weakness in auto demand in China and the interruption to 20% of global demand in Japan. But it isn't just metals, how about this for bubble mania, Stanley Gibbons, the stamp collecting company, has almost run out of Penny Blacks after a Chinese company placed an order for 10,000 of the world's first sticky stamps."We normally sell no more than a hundred penny blacks in any given year so this trade order creates a demand 100 times the normal market size," said Mike Hall, philatelist and Gibbons' chief executive.

TMM are well aware China can stay insane longer than we can stay solvent and we aren't inclined to step in front of the bus...

...and rather than ramble on, will leave today's post at that.

Tuesday, April 05, 2011

Mean Reversion and Creative Destruction

With the risk on trade in so many things partying on, TMM are always wondering what could make the music stop not just for the markets at a whole but in particular what can really change the dynamics in individual markets and especially commodities. Tim Wu's excellent The Master Switch is mostly about information empires - AT&T, Microsoft, Google and others - but applies equally well to really disruptive change in other non-information based industries - like autos. Wu notes something oddly true about what drives changes in industries beyond the ebb and flow of GDP:

History also shows that whatever has been closed too long is ripe for ingenuity’s assault: in time a closed industry can be opened anew, giving way to all sorts of technical possibilities and expressive uses for the medium before the effort to close the system likewise begins again. This oscillation of information industries between open and closed is so typical a phenomenon that I have given it a name: “the Cycle.”

TMM think that this idea of information being a natural monopoly can equally well apply to other industries where network externalities are big - it is hard to be an auto company and require use of highly specialized parts without losing cost competitiveness. Ultimately if you are a small part of a big supply chain it is hard to stray too far from the template. As a result, Wu notes that the big shocks in IT come from people who kind of know what the existing platform is but have no vested interest in it:

Another advantage of the outside inventor is less a matter of the imagination than of his being a disinterested party. Distance creates a freedom to develop inventions that might challenge or even destroy the business model of the dominant industry. The outsider is often the only one who can afford to scuttle a perfectly sound ship, to propose an industry that might challenge the business establishment or suggest a whole new business model. Those closer to - often at the trough of - existing industries face a remarkably constant pressure not to invent things that will ruin their employer. The outsider has nothing to lose.

Disruptive industries tend to be a conundrum for the macro investor because macro primarily deals in cycles and existing paradigms - rewriting the rules is something venture capitalists think about all the time and which entrepreneurs claim they are always doing but it happens much less often than one might think. So, as a disinterested macro investor how does one determine when something might be changing in a big way? How do you tell the Steve Jobs from the whack jobs?

When it comes to equities chasing momentum can be messy - corporate profits are cyclical for most industries and great success breeds great competition over the medium term. Jeremy Grantham's unshakeable belief in mean reversion is no article of faith given GMO's track record. However, occasionally strong trending behavior is telling you something, especially in tech. To that end, look at Apple, Baidu, or others - value guys who get altitude sickness at >30x trailing PE ratios missed the boat on these names, bigtime. Things that trend this far and trade this rich do so because people slowly but surely realize that there is a paradigm shift going on - if there isn't, it is time to think about shorting. To that end, TMM have been noting some very strong trending behavior in the lithium space for some time: FMC,  Rockwood, and others its time to ask - is this it? Are electric cars ready for prime time and how is this likely to play out?

The documentary "Who Killed the Electric Car" asserted that GM basically killed the electric car to defend its existing business. While the jury is out on this they certainly dropped a promising program way too early to focus on bigger SUVs with fatter margins. There were barriers to adoption before which were as below:

1) People need to be able to adequate range on a charge.
2) They need to be able to recharge quickly.
3) The EV has to be competitive on cost on a "total cost of ownership" basis - ie, NPV 10 years of driving costs and use sensible discount rate to work out what the breakeven EV premium is.

On all these counts the old EV1 with NiMH batteries didn't really stack up - charging time was hours not minutes, range was short, and the costs were high.

However, look at the Tesla Model S and some recent changes in battery technology.

- Lithium charging in minutes not hours.
- 300 mile range.
- Cost of ownership breakeven slightly under $100 crude depending on whose numbers you are using.

One major difference between what Tesla is doing and what others like Nissan's leaf, GM's Volt and others are doing is rebuilding the car from scratch. Induction motors which don't use rare earth metals and are easier to cool are used in preference of direct drive, there is no backup power generation which obviates the need for any engine or fuel tank and most other parts are largely off the rack - the design IP is in battery management and aesthetics more than anything else which makes for a very simple and easy to service design. Compare that to the various halfway house options being offered by other manufacturers - they are too invested in their existing infrastructure and designs to break cleanly. Similarly, look at the mind blowing stupidity of Chinese auto companies which are now getting cheap loans to make lead acid battery powered cars with a range even worse than the EV1. Until TMM had seen websites like this one from Baoya Auto we couldn't reconcile the fundamental outlook on lead with current spot - now we just know its another way in which China is creating GDP out of utterly pointless investment. Absolutely every single established player in the industry cannot bring itself to make the jump and it looks like the disinterested outsider is going to have to shake things up.

Tesla seems to be doing a lot of clever things right now and may remake the auto industry - if only because all the majors cannot bring themselves to start off with a clean sheet of paper. For slightly more low beta way to play this theme it is probably better to just catch the trend in lithium miners and chemical producers as there is probably going to be a lot of competition between battery chemistries and the intermediate parts of the industry. One thing is for sure though - if this is the way it goes the whole internal combustion supply chain is going to get gutted faster than Blockbuster was by Netflix and Apple TV. TMM have one thing to say about the future of Lear and Magna if they continue as a "business as usual" proposition:
And on lead, TMM think that the bigger they are the harder they fall - every $ rise in LME lead pushes more E-bike users in China to lithium ion which is lower cost on total cost of ownership even at a 25% discount rate. We are sticking with this one - given high silver prices are inducing so much lead production in China and the pending technological shift that will kill demand, this is more likely than not going to play out like whale oil prices.

Monday, April 04, 2011

AUDJPY, burn up on re-entry

You would think that the balmy summer weather that hit London this weekend has permeated the general mood of the financial markets. Risk on in general, equities buoyant, and our only care in the world is who speaks next at the Fed. But as we mentioned last week we think the market is getting a bit too over excited about US rate rises. Mr Dudley started to swing things back to the dove camp on Friday but today we have the leader of the hawks, Big Bad Beardy Ben billed for later. (As an aside, every time anyone mentions Dudley, TMM can't get Mr Dudley from the the Little Britain sketches out of their minds. In that analogy, who is Ting Tong? The US economy?).

One of the biggest and most obvious winners of the USD rates up trade has been USDJPY which has seen the market getting even more excitable as it perceives an option driven black hope in the 85.00 to 90.00 area which will suck in all those venturing near. Basically, we think the market is now fairly well positioned for an up move so the pain trade would be back below 83.50.

Elsewhere, TMM are starting to think that they have seen a top in more than just copper. Colour from physical traders in China is indicating that rate rises in onshore markets are forcing a lot of inventory financing deals to be unwound and physical copper is hitting the market, we are now hearing similar stories about Zinc too. TMM are of the opinion that as long as China rates are rising and fixed asset investment is being slowed that it will be very hard for industrial metals to continue their march upwards even if the markets appear tight. Which then leads us on to think about the AUD. There is an awful lot going for the Aussie, but if we are looking for metals to top then shouldn’t we be expecting AUD to roll too? That AUD vs Base metal commodity index chart is starting to show some interesting divergence.

And putting the above 2 thoughts together shouldn't AUDJPY see a pull back? It's managed a 17% rally from its post Earthquake lows now certainly looks like the tightest wound of the Aussie elastic crosses if there is to be a snap back.

As we are a bit bored we think AUDJPY may well be an interesting sell on the sidelines to liven up our otherwise dull day.

Friday, April 01, 2011

TMM Quiz Time

TMM are particularly weary this morning. Not only have they survived a month, quarter and in some cases, year end, they were out last night having their brains sapped at a quiz night. So coming in today they thought they would test their readership with exactly the sort of questions they were exposed to last night. Are you ready ? Fingers on buzzers. Starter for 10 and no conferring...

  1. Who won the 1938 Nottingham cup?
  2. Why did James Francis not shoot for the moon in January this year?
  3. If A is 8, B is 19 and C is D, what is M?
  4. Who shot Angel?
  5. "Happy Jay", "Mickel Mouse" and "Red Burr" are all types of what?
  6. On which continent is Hojhab?
  7. Where would you find your "dinegestators"?
  8. In which language is "Urdatch" a greeting?
  9. If a man has 3 pennies, a coat hanger and a ping pong ball, where would he find his wallet?
  10. Kj is the chemical symbol for which common element?
  11. Which calibre is now standard on all Toyota pickups 33mm, 45mm or 50mm?
  12. If a 5.3 earthquake was to hit Blackpool in the UK, what would be the estimated value of improvements to the area?
  13. What percentage of the air in the London Underground is human skin?
  14. "You've got Mice" was a hit for which 1960s band?
  15. How many "flims" are there in a "meld"?
  16. Whose last words were "Pass the spam"?
  17. Who invented the "teetlespouse"?
  18. When did hay stop being legal tender (the year, but extra points for the exact date)?
  19. How many days in a quinquorum?
  20. 1365 is famous for what?
  21. When will Voldermort stop taking the piss?
Not surprisingly TMM didn’t win, but were left checking their hearing aids. We are taking it gently today as we are packing our various travel bags for a variety of week-end jollies. We wish you a very happy and prosperous Q2.