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USD: Return of the King

Tha Business

Falling oil prices, China growth fears, submerging markets, Brexit and Italian banks. All of those risks have one thing in common: They have not derailed the US economy. Despite concerns about a recession, it continues to grow at a steady pace. According to the Atlanta Fed, real GDP is expected to grow by 0.7% in Q1’16. That is not a great number; however, the series is extremely volatile.

Atlanta Fed GDPNow
sources: Bloomberg, @Not_Jim_Cramer

It would not be surprising to see growth rebound to 2% or more in the coming quarters.

Global investors are counting on the US because of lackluster growth elsewhere. Europe is doing fine; however, deflation remains a concern and bank credit growth is turning down. Japan continues to fall in and out of recession. In the emerging world, the BRICs are crumbling. Brazil & Russia are suffering due to falling commodity prices while China continues to decelerate. Going forward, rate differentials, relative economic strength and divergent monetary policies should provide support for the USD.

Sentiment & Positioning

With all that said, as of Mar29’16, the net speculative long position in the USD was 7% of open interest, the lowest it has been since Q2’14. This indicates that speculators are the least bullish they have been in nearly two years.

USD Specs

The US Dollar Index is sitting at 94.62, just above a critical support zone at 93-94. Meanwhile, the Trade-Weighted Dollar Index has pulled back ~3.4% from its high on Jan20’16. It is hard to tell that long USD is a consensus trade because investors have lost their conviction.

FX, Rates & Monetary Policy

USDCAD: Has fallen to 1.3011 from a high of 1.4692 on Jan20’16. This is a direct result of the relief rally in oil, which has risen to $36.79 from a low of $26.05 on Feb11’16. These moves have not been driven by improving fundamentals. Rather, they are mostly attributable to short covering.

CAD Specs
WTI Specs
via @Ole_S_Hansen

Rate differentials (see the following chart), relative economic strength and divergent monetary policies should support USDCAD in the near term. Also, it is unlikely that the bear market in commodities is over.

Rates Differentials
sources: Bloomberg, @sobata416

EURUSD & USDJPY: In Europe and Japan, easy monetary policy will be present for an extended period of time. The ECB and BOJ have made it clear that they will do “whatever it takes” to protect their countries from deflation. The ECB recently announced a set of new measures intended to support the Euro Zone. Equities have responded positively but the Euro has not. EURUSD is trading at 1.1389, up from a low of 1.0538 on Dec3’15. Japan is facing the same issue. Even though Japanese equities are up since oil bottomed on February 11th, the Yen is the strongest it has been since Q4’14. It is unlikely EUR and JPY strength will persist for the same reasons mentioned in the previous paragraph.

Growth Forecasts

World Reserve Currency

The USD is the most widely held reserve currency in the world. It represented 64% of official foreign exchange reserves at the end of Q3’15. Countries tend to hold Dollar-denominated assets because they are relatively stable. Foreign central banks also use the USD as collateral for loans and to protect their currencies. For example, if the ECB feels as though the EUR is too strong, it can sell Euros to buy Dollars, thereby reducing the amount of USD in circulation. In theory, this would weaken the Euro.

The foreign exchange market also speaks to the structural importance of the USD. According to the BIS’ Triennial Central Bank Survey, “FX deals with the US Dollar on one side of the transaction represented 87% of all deals initiated in April 2013.”

Lastly, it is important to recognize that many commodities are priced in USD. Therefore, people who want to buy or sell them are required to hold Dollars.

These facts help to explain why demand for the USD will persist. It is still the world reserve currency and that will not change in the near future.

Major Risks

The two major risks to the USD are a dovish Fed and slowing US economic growth.

The Fed is the world’s central bank. Even though both of its mandates are domestic, the Fed has become increasingly concerned about the global economy. This is evident when we look at the rising number of times the Fed has mentioned key terms such as “Global” and “Dollar” in recent meetings.Global Fed
via @SoberLook

A strong USD is good for US consumers and bad for commodities & exporters. The Fed is well aware of this relationship; however, it alone does not guarantee dovish monetary policy. Not long ago, market participants thought that 4 rate hikes in 2016 was a possibility. Now, it is unclear whether or not we will see 1. As of Mar29’16, the probability of a hike in December was just 65%. The market is positioned for easy US monetary policy. As such, positive surprises from the US or negative surprises out of Europe or Japan will force investors to reassess their outlooks. If that happens then the Fed may turn more hawkish, which would be positive for the US Dollar.

2) Slowing US Growth

The US economy continues to muddle along, backed by steady employment and consumption growth. The Eurozone is doing fine but most of its gains are attributable to Germany. Other major players such as France and Italy have not fared as well. Moreover, Japan continues to tread water. Canada has rebounded. That said, its economy is dependent on commodity prices, which may roll over in the short run.

All in all, the US still looks good on a relative basis. Especially versus developed market peers.

Return of the King

Rate differentials, relative economic strength and divergent monetary policies should provide support for the USD. In addition, it will likely benefit from safe haven flows when global risks return to the headlines.

If the Dollar resumes its uptrend then commodities will suffer.

USD Drives Oil
via @NickatFP

Oversupply in many industries such as oil, iron ore and coal remains an issue. On the demand side, China’s deceleration is not helping. The emerging markets are inextricably linked to commodities. If prices fall then the EMs will underperform.

There can only be one king…

 

Disclaimer:
– This material is provided for informational purposes. It is not investment advice.
– The opinions expressed in this report are mine. They do not reflect the opinions of my employer.
– Full disclosure: As of Apr3’16, I was long the USD vs. the CAD & a basket of EM currencies.

 

The Golden Age

Some people say that gold is dead. They point to deflationary pressures and a bear market that started back in September of 2011. The bulls have been wrong for years; however, that may be about to change…

At present, there are multiple reasons to consider gold:

  • Sentiment is very negative and almost everyone is underweight
  • Supply & demand fundamentals are positive
  • Chinese demand continues to rise
  • Gold is a means to portfolio diversification
  • The main risks to prices are overblown

In the next sections, we will examine the bull case for gold and the risks facing it. In conclusion, we will try to answer the following question: Is this the beginning of a new golden age?

Sentiment & Positioning

In the latest Barron’s Big Money Poll, only 3% of respondents thought that gold was the most attractive asset class. Moreover, 71% were bearish on the yellow metal. Volume traded in $GLD (the SPDR Gold Trust ETF) has come down dramatically, which indicates a lack of interest in gold bullion. Volume traded in $GDX (miners) and $GDXJ (junior miners) has been increasing; however, interest in “gold mining stocks” has been falling since mid-2011. This suggests that traders are trying to catch the falling knife, even though investors are not convinced that gold is undervalued.

In terms of positioning, market participants are heavily underweight materials and commodity stocks. Is this a contrarian buying opportunity? It could be. Especially because the current bear market is getting old. The following table shows the 5 most recent bull and bear markets:
Bulls & Bears

Gold prices fell by 44% over the 52 months from September of 2011 to January 7th of 2016. Those numbers match the median length and average cumulative return of the previous 4 bear markets. Gold may continue to fall from here; however, we are probably closer to the end of the bear market than to the beginning…

Supply & Demand

~46% of gold production is FCF negative at current prices. In other words, $1100 is not the equilibrium price. If we stay at these levels then supply will likely decline. Analysts at Credit Suisse ($CS) are projecting a deficit to begin in 2016. They expect that mine supply will fall by 11.5% from 2015 to 2018:
S & D

Even at higher prices, gold miners will be unable to replace all of their depleting reserves. Also, it will be very expensive for them to bring new projects online. Lastly, it is important to note that major gold discoveries have become scarce. These trends are negative for supply and positive for prices.

On the demand side, Asia and Europe should continue to support the market. Total bar and coin demand (in tonnes) increased 33% YoY from Q3’14 to Q3’15. Furthermore, consumer demand was up across the board, with exceptionally big numbers in the US. According to the World Gold Council (WGC), “coin sales by the US mint during the quarter were on par with that of Q4 2008.” Another key source of demand is central banks. They have continued to buy as they look to diversify their reserve assets. This speaks to gold’s utility as a portfolio diversifier. Total demand has been falling; however, the quarterly numbers suggest it could be stabilizing. Going forward, consumer demand is likely to offset ETF outflows.

India & China are the main drivers of demand for gold. In 2014, they accounted for ~1710 tonnes of demand. To put that in perspective, 1700 tonnes = 53% of total consumer demand:
Consumer Gold Demand

Gold is a big part of both India’s and China’s culture. As such, it is likely that demand will remain strong.

 China’s Gold Market

There is an interesting divergence taking place in the physical gold market. China’s demand numbers, as measured by withdrawals from the Shanghai Gold Exchange (SGE) are much higher than those reported by the World Gold Council (WGC). SGE withdrawals exceeded the WGC’s demand estimates by 3,193 tonnes from 2007 to 2014.

The following passage is from Bullion Star’s Koos Jansen helps to explain the discrepancy. “The difference was labeled as net investment (in the CGA Gold Yearbook 2013 at 1,022.44 tonnes), which is calculated by the China Gold Association (CGA) as a residual between what is withdrawn from the SGE vaults and gold sold at retail level (jewelry shops and banks). The WGC doesn’t count net investment on its demand balance, but only measures what is being sold at retail level. Net investment, which roughly equals the difference, can only be caused by direct purchases from individual and institutional customers at the SGE that withdraw their metal.”

In China, gold imports must pass through the SGE before entering the market place. In addition, bullion exports are prohibited. It follows that Imports + Mine Supply + Scrap = Total Supply = SGE Withdrawals. Said another way, SGE withdrawals are equivalent to domestic wholesale demand. The preceding formula is supported by reports from the CGA and the SGE. For example, the SGE reported that 2197 tonnes were withdrawn its vaults in 2013. That is the same number that the CGA reported for total demand in 2013. More evidence comes from the SGE’s chairman, Xu Luode, who said the following in 2014:

The main conclusion is that the SGE’s measure of Chinese gold demand is much higher than the WGC’s. If the SGE’s number are correct then China is absorbing most of the world’s mine supply. Gold withdrawals from the SGE for 2015 amounted to 2596 tonnes, or 91% of world gold production:
SGE vs. WGP

Diversification & Protection

Gold has a negative correlation with US stocks during expansions. More importantly, its correlation with both global and US stocks is more negative during contractions:
Correlations

As a result, gold tends to rise when stocks fall, which is good for portfolio diversification.

Gold is also an FX hedge for foreign investors. In 2015, it performed relatively well in non-dollar currencies such as the Brazilian Real, the Russian Ruble, the Chinese Yuan and the Canadian dollar. This is important because non-US countries are the main consumers of gold.

Loose monetary policy is here to stay. This cycle, every central bank that tried to raise rates has had to reverse course. That is bad for currencies and good for gold, since no one controls its supply.

Gold can also protect us against a rising cost of living because it tends to hold its value over time. If you look at the CPI then inflation seems relatively low. That said, the CPI is a utility index, not a measure of the cost of living. Most people would agree that cost of living is rising. For example, education and medical care costs have been outpacing the CPI for years.

Risks

Gold’s main threats are…

1) A stronger USD

Typically, the US dollar index and gold are negatively correlated. Said differently, when the dollar index does up, gold goes down. Even so, last year, the US dollar (USD) influenced gold prices more than it usually does. In 2015, the correlation between the two was -0.50 in 2015, much higher than -0.36, which is the 30-year average. Going forward, it’s likely that the correlation between gold and the USD will revert back to normal.

An additional concern is rising rates. One may assume that higher interest rates are good for the dollar. Actually, that is not the case. Historically, the dollar has stopped appreciating when the US raised rates. If the USD index has peaked then that would be good for gold prices.

2) Rising rates

Despite the fed’s intentions, the yield curve (2s10s) has flattened to its lowest levels of the expansion. The short end has increased but the long end, which is driven by growth expectations, has not. Basically, the market is not convinced that the era of low rates is over.

Even if rates do increase, gold may perform well. According to Sundial Capital Research, gold actually does quite well in rising rate environments. Gold prices increased by an average of 25.2% in each of the rising rate environments from Dec31’76 to Dec27’13. The median gain was 5.2%, which is much less impressive but still positive. Low rates are probably better for gold than high ones. That said, it may show good returns either way.

3) Leverage

In the US, the paper gold market is much bigger than the physical one is. In other words, many contracts are traded but not much gold changes hands. The level of gold dilution has reached unprecedented levels. In a recent blog post, zerohedge showed that there are 40 million ounces worth of open interest but only 74 thousand ounces of registered gold at the Comex. This works out to a gold cover ratio (open interest/registered gold) of 542! The takeaway point is that the amount of gold that is traded is much greater than the amount that actually exists.

The downside risk is that supply in the futures market overshadows demand in the physical market, thereby weighing on prices. Still, there is an upside risk. If demand for physical gold remains strong and inventories continue to fall then then the Comex may run out of supply. If that happens then gold prices will rise as market participants start to question the divergence between the paper and physical markets.

Conclusion

Gold should be considered as a contra buy…

  • It is hated
  • Its fundamentals are improving
  • Demand from the east is robust
  • It is negatively correlated with stocks
  • The benefits outweigh the risks

Gold is massively under owned. If sentiment improves then it could easily outperform other asset classes in 2016…

 

 

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances.. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

Big Bad China

1989toon

It seems like every day we are inundated with news out of China. Investors are already concerned. The offshore renminbi (CNH) is more international than the onshore one (CNY), which is tightly managed by the government. As such, the rising spread (CNH-CNY) between the two may be indicative of mounting skepticism about China’s economy and its markets. Likewise, capital is fleeing the country as hot money flows have accelerated:

Hot Money Flows - @vikramreuters - Dec18'15source: @vikramreuters

In the following sections we will attempt to analyze China’s markets and determine the biggest risks facing its economy. Lastly, we will try to answer the following question: does it matter to us?

Markets

As the first week of trading in 2016 came to an end, the Chinese markets had already been halted twice. Newly minted circuit breakers, which have since been suspended, were triggered when China’s main equity index, the CSI 300, fell 7% on two separate occasions. The first selloff was triggered by a rumor that the China Securities Regulatory Commission (CSRC) was planning to suspend a short sale ban that has kept a reported ~$185 billion off the market. Subsequently, the CSRC decided to extend the ban in order to calm the markets. The second drop followed a significant devaluation of yuan by the People’s Bank of China (PBOC). China has also backtracked on that move. Basically, the Chinese markets are confusing

That said, the volatility is not surprising considering how unsophisticated China’s market is. One university study found that 2/3 of the new investors at the end of 2014 did not have a high school diploma:

Chinese Traders - BBG Brief
source: Bloomberg Brief

Along the same lines, individuals account for at least 80% of trading on the mainland exchanges. In other words, there are many speculators and few investors. China’s markets are undeveloped and relatively unimportant. Nonetheless, they may offer some clues into consumer sentiment and the government’s ability (or inability) to control the economy.

Economy

It is hard to determine whether China is more capitalist or communism. Either way, it remains an indispensable part of the global economy. In nominal terms, China is the world’s second biggest economy with a GDP of ~$10.3 trillion. However, in terms of Purchasing Power Parity-adjusted GDP (PPP), it has surpassed the US. Moreover, it accounts for ~40% of global PPP-adjusted GDP growth:

World GDP - The Economist - Dec'15
source: The Economist

In regards to trade, China is the world’s biggest player. In 2013, it led the world in exports ($2,209 billion) and was the number two country for imports ($1,950). The combined value of its trading amounted to $4,159 billion, marginally higher than the US’ $3,909 billion.

Debt

China’s aggregate debt level is one of the highest in the world, although it may not seem to be at first glance. China’s government debt-to-GDP ratio is 55%. To put that in perspective, the US and Japan are at 89% & 234%, respectively. Even so, it is always prudent to consider a country’s debt composition. China’s mounting debt comes into focus when we account for non-financial corporate debt (125% of GDP), financial institution debt (65%) and household debt (38%). The grand total is an astounding 282% of GDP, or $28.2 trillion:

China's Debt - MGI - Feb'15
source: McKinsey

The rate of debt growth is also a concern. Non-financial corporate debt, increased from 72% to 125% of GDP from 2007 to 2Q14, a 73.6% increase.

China’s debt load is a global risk because of how tightly managed its economy is. The government has allowed unprofitable companies to stay in business. Though defaults have been very limited, China must allow these companies to fail eventually. Otherwise, it will continue to suffer from high debt servicing costs ( ~30% of GDP).

Overcapacity

Government investment has been a big part of China’s economy. Massive amounts of stimulus went into factories, leading to overcapacity in sectors such as coal and steel. This is making it very difficult for companies that operate within those sectors to make profits – both domestically and abroad. Fiscal stimulus also went into housing and infrastructure, which are both clearly overbuilt. Despite the overcapacity, gross capital formation still represents ~45% of GDP:

Over Investment - GTL - Oct31'15
source: Gordon T. Long

That is more than twice as high as it is in both the US and the European Union.

Monetary Policy & FX

The PBOC has been very active trying to support the economy. It has cut rates 6 times since November of 2014. Likewise, it has been lowering its Reserve Requirement Ratio and selling its foreign reserves in an attempt to prevent excessive devaluation of the yuan (CNY). They are down more than $400 billion (from a peak of ~$4 trillion) since mid-2014:

FX Reserves - BBG - Jan7'16
source: @TomOrlik

FX is also a risk because China has a lot of USD-denominated debt. In mid-2015, non-bank borrowers held ~$1.2 trillion worth of it. This is an issue because Dollar debt becomes more expensive when USDCNY rises, which is exactly what the markets expect to happen.

Corruption Crackdown

China’s anti-corruption campaign is a step in the right direction. That said, it is a big political risk for foreign investors. High profile businessmen and officials have been disappearing while others are being investigated. Moreover, securities regulators have been cracking down on market manipulators, “ensnaring some of the nation’s most high-profile money managers and announcing more than 2 billion yuan of fines and confiscated gains” (source: BBG Brief). Critics of the campaign suggest that it may deter business while failing to address the corruption that exists amongst the ruling party.

Implications

As investors, we should be concerned because China is one of the biggest economies and the world’s leading trader. Therefore, if it slows down then so will global growth:

Slower China, Slower World - $GS - Dec'15source: $GS

China is also important because it is a massive source of demand for many commodities. Thus, its weakness is spreading to undiversified economies such as Russia, Brazil and South Africa. Recessions in those countries might not carry over to the rest of the world. Nevertheless, it is important to consider the amount of debt they have taken on since the financial crisis. In the US, credit is already tightening. If borrowing costs rise for the emerging markets, especially China, then we may see a wave of defaults with untold consequences.

 

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances.. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

Pershing Square x $VRX – Nov23’15

  • Pershing Square acquires 2,144,618 shares from 1-Oct-15 to 23-Nov-15
  • Total cost: $240,933,692

2

  • Pershing Square sells strangles to fund purchases of OTM calls; first on 20-Nov-15 and then again on 23-Nov-15
  • Total exposure through options: 12,500,000 shares; total cost: $65,561,919
  • Total additions: 14,644,618 shares; total cost: $306,495,611

3

  • Total stake: 9.9% (34.12 mln shares)

4

  • Average cost: $113.76
  • Current price: $87.34 (source: Google Finance; 7:59PM – Nov23’15)

5

O Wage Inflation, Where Art Thou?

The labor markets have been improving steadily since th­e financial crisis. Some people would argue that the US is at or near full employment. Even so, there is one piece of the puzzle that is still missing…higher wage inflation.

The Fed’s mandate is to promote maximum employment and stable prices; thus, wage inflation is doubly important.

In the following sections, we will try to determine why it is not speeding up.

Jobs, Jobs, Jobs

At first glance, the US labor market looks unstoppable. The total number of employees is higher now than it was before the crisis:

NFP - Oct20'15

Total nonfarm payrolls rose by 12,654,000 from January 2010 to September 2015.

The Phillips Curve

In economics, “the Phillips curve is a historical inverse relationship between rates of unemployment and corresponding rates of inflation…” In other words, falling unemployment tends to coincide with rising inflation. Intuitively that makes sense. If the demand for labor is higher than the supply then unemployment should fall and wages should rise. That said, the relationship has not held true this cycle. The following chart shows the unemployment rate (inverted) vs. the consumer price index:
Phillips Curve - Oct20'15

Prior to this cycle, falling unemployment was accompanied by rising inflation, and vice versa. This time around, both the UE rate and consumer price growth have been falling.

Not Participating

There are two reasons why the UE rate may fall. The first is that the number of unemployed persons (numerator) falls. That is good. The second is that the labor force (denominator) shrinks. That is bad. Regrettably, the unemployment rate has been falling for the wrong reason:

Not in the Labor Force - Oct20'15

The number of people not in the labor force increased by 10,842,000 from January 2010 to September 2015.

As a result, there is a growing divergence between the unemployment rate (inverted) and the employment rate, which does not consider the size of the labor force:

The Employment Gap - Oct20'15

The UE rate is overstating the health of the US labor markets. That is one explanation for why the Fed has lowered its unemployment target.

Quantity Over Quality

Another reason that wage growth remains muted is the abundance of part time jobs. During the crisis, part time employment rose while full time employment fell. Part time employment has been relatively flat since then:

PT vs. FT - Oct20'15

Full time employment is back to where it was before. That said, the high number of part time jobs may be putting downward pressure on wage inflation.

Along the same lines, many of the jobs that have been added are “cheap labor.” What that means is that they are not high paying jobs. The next graph shows the employment to population ratios by education level:

EMPOP Ratios by Education - Oct20'15

Contrary to what we may expect, the EP ratio for people with less than a high school diploma has been improving while the ratio for people with more than a high school diploma has been worsening. Therefore, it is logical to assume that many of the jobs that have been added are low quality ones.

To Hire or Not To Hire

In the US, there has been a lot of talk about job openings, which are at multi-year highs. Naturally, it makes sense to assume that more openings would imply a larger demand for labor. That, in turn, would lead to higher wages. The problem is that openings do not always get filled. As we will see in the following diagram, hires are lagging behind openings:

Openings vs. Hires - Oct20'15

Said another way, the number of openings is rising faster than the number of hires is. Part of the cause for this trend is the mismatch between what employers want and what candidates have. In addition, employers are being extra choosy “and are intensifying their hunt for the “purple squirrel” – candidates with the perfect combination of skills, education and experience…”

Wage Growth or a Lack Thereof

After the financial crisis, wage growth rebounded quickly and then peaked at 4.37% YoY in October of 2010. Wage inflation has been relatively steady since early 2011:

Wages of Production and Nonsupervisory Employees - Oct20'15

The upper bound is ~3% while the lower bound is ~1%. Currently, wage growth is the middle of that range; the last reading was 1.63%.

Not So Full Employment

Positive wage growth is a good thing. Still, it is not accelerating the way it would if we were at full employment. The US labor markets are not weak but they are not as strong as some of the headline data suggests they are.

If we look beneath the surface then it is clear that there are multiple explanations for the lack of growth in wage inflation. Many people are leaving the labor force, some of the jobs that have been added are low quality ones and openings are outpacing hires.

There is still slack in the labor markets. Maybe that is why the Fed has not moved yet.

If our analysis is right then what are the implications? Rates will stay lower for longer.

Follow us @ConnectedWealth

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

“God Save the CAD”

MAC2589-770x5062
The Canadian Dollar has fallen 23% against the US Dollar since Valentine’s Day of 2013. Is the worst over? Or is there more pain to come?


The Bull Case

There are a few reasons why the CAD might rise:

Regardless, the short thesis is more convincing…


The Bear Case

To Hike Or Not To Hike?

The market is pricing in a rate hike in just over 5 months:Implied Months to First FFR Hike - @MktOutperform - Jul 21, 2015
As a result, near-dated yields are rising…

The Yield Curve

The Treasury yield curve is flatter than it was about a year ago:
TSY Yield Curve - US Treasury - Jul 24, 2015
The short-end is convinced that the Fed will move in 2015…

…The long-end is worried about slowing growth and about deflation…

The USD

The US dollar is appreciating because of rising short term rates:
DXY - @sobata416 - Jul 27, 2015
This is not good for energy, metals, etc., which are priced in USD…

Commodity Prices

Dollar strength is translating into commodity weakness:
DJ Commodity Index vs. DXY - @sobata416 - Jul 27, 2015
Thus, resource exporters such as Canada are under pressure…

Weak Economy, Weak CAD

Falling energy prices are negatively affecting Canada’s economy:
Falling Commodity Prices vs. Economic Output - BOC - Q1, 2015Output Across Industries - BOC - Q1, 2015
Industries that are not based on commodities are doing alright. But will it last???


Technicals

USDCAD – Monthly Chart

USDCAD is trading at 1.30280; the highest it has been since March of 2009:
USDCAD - Monthly - @sobata416 - Jul 27, 2015
That said, it is still far away from 1.61840 (purple X); the all-time high set in January of 2002…

USDCAD – Weekly Chart

If USDCAD breaks up through trend line resistance at 1.30634 (blue X) then could rise to 1.38802 by the end of Q2, 2016:
USDCAD - Weekly - @sobata416 - Jul 27, 2015
On the other hand, if it breaks down through trend line support at 1.28313 (blue Y) then it could fall to 1.26215 by early-mid September…

Conclusion

There is a high probability that the CAD will continue to depreciate. In addition to everything we covered, Canada’s monetary policy is likely to remain loose. Moreover, a technical recession may lead the BOC to cut rates again this year. Finally, ask yourself one question: What will happen to the CAD if and when the Canadian housing market rolls over???

 


Disclaimer: This analysis should not be interpreted as investment advice.

Strategists & Writers Who I follow

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Shane Obata

Danger Down Under – A Brief Look At Australia’s Trade Flows

Global growth forecasts are falling and the risk of deflation is rising. As a result, countries that are dependent on commodity exports are especially vulnerable. Australia relies on exports to China. If prices fall and China slows down then Australia will be in big trouble.

 

Unbalanced trade flows…

Australia exports “primary products” and imports “elaborated transformed manufactures” :

Exports & imports by level of processing    If commodity prices continue to fall then so will the value of Australia’s exports.

 

A China derivative…

China is Australia’s biggest two-way trading partner:

A China derivative

If its economy weakens then Australian trade will suffer.

 

Reliant on commodities…

The majority of Australia’s exports are “Minerals & Fuels.” :

Exports by sector

Australia’s most important mineral is Iron ore; it made up 22.6% of its exports 2013-14:

Top 5 exports

Moreover, 8 of its top 10 exports are commodities:

Top 25 exports

If the world continues to move towards deflation then Australia’s economy and currency will come under pressure.

 

Expensive imports…

Australia imports a lot of petroleum:

Top 5 imports

It also imports a lot of elaborate manufactures such as passenger motor vehicles and computers:

Top 25 imports

On one hand, if oil prices continue to fall then Australia should benefit. On the other hand, if its currency continues to depreciate then import prices will increase.

 

That’s all folks!

Australia’s economy is inextricably linked to commodities and to China. If global debt continues to rise and Chinese demand falls then the “land down under” may enter the #DangerZone.

US recap for Feb, 2015: The markets vs. the economy, earnings, and oil

The markets vs. the economy

Feb, 2015 was one of the best months for the S&P 500 in the past 25 years.

That said, it was a terrible month for economic data.

Will the S&P 500 catch down to US macro? Or will US macro catch up to the S&P 500?

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Market participants are concerned because of the divergence between stock prices and economic fundamentals. As a result, the US indices and the USD index have lost momentum.

Next Friday’s nonfarm payroll report will be important for financial assets.

If it’s weak then it’s likely that 1) the markets will sell-off, 2) the USD will pullback, and 3) US Treasuries will resume their uptrend. If it’s strong then the opposite may happen.

 

Earnings

Earnings revisions are at a level that’s typically associated with NBER recessions.

Moreover, long term EPS growth rates are falling while forward P/E ratios are rising.

If the fundamentals don’t improve then valuation bulls will have a hard time justifying their optimism.

At least monthly buyback announcements are the highest they’ve been since Jan, 2000…

 

Oil

Rig counts are falling but production and inventories continue to rise.

Nevertheless, oil prices are stabilizing as traders and investors try to front run a bounce:

2

Crude oil volatility remains elevated; expect more price swings to come.

 

A few things to consider

  • Will US economic data turn around?
  • If the SPX pulls back then will the global markets hold up?
  • What happens if and when US crude stocks reach capacity?

 

$hane Obata

The Canadian Housing Market – In Charts

1) Canada’s housing market is 63% overvalued relative to its historical average…

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2) Home prices in Vancouver are more expensive than they are in Sydney, London, and New York…

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3) “Canada is in serious trouble” because its households never deleveraged…

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4) Since 2000, growth in assets held by Canadian banks is as follows…

Personal lines of credit: + ~650%
Credit card loans: + ~400%
Mortgages: + ~250%
Disposable income: + ~100%

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5) In Canada, multifamily construction is at record highs…

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6) Housing construction is more important to Canadian workers than it is to their US counterparts…

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In conclusion…

– The Canadian housing market is very expensive.
– Median house price to median household income is higher in Vancouver than it is in Sydney, London, and New York.
– Canadian households – unlike their US counterparts – never deleveraged after the financial crisis.
– Credit is growing a lot faster than income is.
– There’s a lot of supply coming onto the market.
– The share of Canadian workers in housing construction is twice what it is in the US.

 

If rates rise or if commodity prices continue to fall then it’s likely that Canada’s housing market will come under pressure.

 

– $hane Obata

 

*H/t @fxmacro