Oil, steel, copper and the recession

One of our independent research houses had this graph in their daily newsletter today in which they contrasted plunging oil to surging steel manufacturing stock prices, making the case that looking at oil prices you'd expect the global economy to just grind to a halt while steel manufacturing prices (up 50% in December) tell a different story. I wrote back with the following answer and graph:

"Nicolas,

re: the graph that contrasts oil and steel in today's checking the boxes: I think it's likely more appropriate to use commodity prices for steel rather than steel manufacturing companies. We still witness the same divergence -- steel is up while oil is down. On the other hand, it's not as if this signal is unanimous. Copper, for example, which is also used in pretty much everything is down in lockstep with oil. What do you think?"

I'll let you know if I hear back.

at 4:30

Nicolas wrote back and said that he'd forward it to the other members of the team. I think he's just their sales guy. Anyways, I responded:

"Thanks Nicolas. I'm talking about this with a colleague [JTR] and we're thinking that
steel is likely surging b/c of the infrastructure buildout in the US and China
whereas copper may be used more in electronics than roads and bridges. Do let
me know what the rest of the team thinks, I'll be very interested."

More Ukraine

Apparently the hryvnia reversed it's sharp decline at least temporarily. Here's Bloomberg News from this morning:

"Dec. 19 (Bloomberg) -- Ukraine’s hryvnia jumped 10 percent
against the dollar, the most in seven weeks, after the central
bank increased its key interest rate for the second time in two
days.
The currency climbed to 8.2500 per dollar by 12:55 p.m. in
Kiev, from 9.1000 yesterday. The central bank raised the
refinancing rate to 22 percent from 18 percent, after increasing
it one percentage point yesterday."

Wow, 22% overnight rate. That compares to, umm..... zero percent in the US. I mean, I'm not saying that I think ZIRP is the greatest things since sliced break and I'm not saying that Urkaine has many other options to stem the decline in the currency and thus remain solvent but... a 22% overnight rate... cuz that's not going to stifle the econnomy at all....

More Ecuador

Goldman apparently thinks that after the default Ecuador will abandon dollarization:

"Dec. 17 (Bloomberg) -- Ecuador’s default on $3.9 billion of
international bonds means it’s only a matter of time before the
country drops the U.S. dollar as its currency, Goldman Sachs
Group Inc. says.
Ecuador’s use of the dollar gives President Rafael Correa no
outlet for providing credit to the economy as access to foreign
financing dries up and revenue from sales of oil, the nation’s
biggest export, tumbles. Correa, a critic of so-called
dollarization, also may use the default as an excuse to abandon
the policy, said Alberto Ramos, a Latin America economist with
Goldman Sachs in New York."

I would bet that in that case you end up with a huge surge in inflation. Ecuador's economy will need to be financed somehow and, as the article says, with int'l capital mkts drying up (and who can blame them if Ecuador has defaulted on every sovereign bond they have ever issued) and with oil at $45... where's the money come from? To quote Ben Bernanke: "The [Ecuadorian] government has a technology called a printing press..." Welcome back to Latin America in the 90s. Overvalued currencies, currency boards or outright dollarization, currency mismatches, and debt defaults.

Then again, I would bet my left hand on this assessmet. Over the summer Goldman forecast an oil price of up to $250 by year-end. Granted, that was the upper limit of their forecast but... $50 is a far way from $250.

More Ukraine

Wow, if you're Ukraine, you're really getting effed right now:

"Dec. 18 (Bloomberg) -- OAO Gazprom, Russia’s natural-gas
exporter, threatened to halt supplies to Ukraine on Jan. 1 should
the country fail to pay debts for November and December sales.

The company has received $800 million from Ukraine, along
with notification that no more will be paid before the end of the
year for supplies in November and December, Gazprom spokesman
Sergei Kupriyanov told reporters in Moscow today."

Ukraine

I'm reading this in the news this morning:
"Dec. 18 (Bloomberg) -- Ukraine’s hryvnia plunged 16 percent in two days to a record low against the dollar after a government official said the weakening currency may trigger defaults on more than half of loans."

Errrr.... that strikes me as supremely dumb. So last month the IMF provided a $16.5 billion package to the Ukraine to help avert a default. If a lot of your debt is denominated in US Dollars (, which it is for many smaller developing economies even though the larger ones have made big strides in issuing local currency denominated debt) then you can get really effed if your currency depreciated against the dollar but you're still on the hook for repaying the debt in dollars. It's not necessarily just poor fiscal management that can get a country into this position. Sure, that was probably the case in e.g. Argentina in the 90s/2001/2002 but take Russia now for instance. They are sitting on 400-something billion in reserves, which are the result of some prudent fiscal management. And their currency fell 10% (against the Euro -- a bit more the appropriate benchmark for them) since the beginning of the month and 14% since November. Investors have pulled out more than $200 billion since August. And why? Well, in part b/c the banking sector is shoddy and b/c Russia has a past of currency crises so that amplifies jitteriness, which is obviously really bad if you're in a tight spot with your currency. But a good deal of it was a huge degreee of risk aversion because of the August campaign and b/c of the repatriation of rik capital to the US, Europe, etc (b/c people, and by people I mean banks, needed to reduce leverage). So not really b/c of poor fiscal management.

So let's say Ukraine wasn't a huge spendthrift and so the popular word "bailout" that's being used for the IMF package is not really appropriate and it's a legitimate effort, etc. If the IMF lends you 16.5 billion so you can stabilize the currency so you don't have to default on your dollar-denominated debt... it seems really stupid to then say: "We may have to default on our dollar-denomianted debt." B/c that immediately undermines the confidence the IMF package was supposed to give, makes investors pull out money, depreciates the currency and.... as a result you'll have to default on your dolalr-denominated debt. It just seems so silly.

Ukraine credit default swaps trade at 30%. In contrast, Russian CDSs trade at 7.5%. (that means that to insure $1 million in Ukraine debt you'll have to pay someone 300 grand.) Here's a graph of the hryvnia (up means worth less b/c it means you'll have to pay more hryvnias for one US dollar):

There's more to write about this but...

... for now let me just highlight that the Fed cut 75 basis points today (that's 0.75%). So the Fed Funds target rate is now at 0.25%. The effective rate, however, has been close to zero for a while now. Let's see if soon we'll have to pay to lend money out.

Ecuador

As you probably know, Ecuador formally defaulted on part of its debt. I guess there's a reason why it's (was) the highest-yielding debt in Latam. The way they went about it is a little wonky b/c they first announced that they would just not pay the coupon on time or maybe not at all. (If you're not a finance person: When countries or corporations put out bonds they say: "Okay, you give me a thousand bucks. I give you this bond and every six months [or year or whatever] you get a 'coupon', a fixed payment of e.g. 10 bucks [hence, fixed income.] Then at the end of out agreement, let's say ten years, I pay you back the 1000 bucks and you will have gotten your money back plus 2*10 years * $10 = $200." And that obviously implies a certain interest rate. If you miss one of those "interest payments", the coupons, you are technically defaulting on your debt.) But the coupon payment that was due was just $30 million, hardly a ton of money, even for Ecuador. Then a day later they said that they just wouldn't pay back the debt at all.

But... why did they default on the coupon first? i mean, technically, that's a default and triggers all the consequences so I'm not sure why if they are already in default they didn't just say "Eff it, we're just not gonna pay any of it back" right away.

The other wonky thing is that Ecuador claims that these particular bonds are "illegal" and so they shouldn't be on the hook for them. I don't know the actual argument but would be interested. But then one of my coworkers said that apparently Ecuador has never issued a sovereign (i.e. national, issued by the state) bond that it has not defaulted on. Really? Whaaaaat? I find that hard to believe. But I don't really know how to verify it. But isn't that crazy? Again, no wonder it is/was the highest-yielding debt in Latin America. I mean, the annualized yield on an Ecuadorian bond is north of 20%. If you could be sure to get your money back, what a crazy return would that be? But that's (obviously) just it. My friend Luther keeps saying that there are some inflation-protected Brazilian bonds that yield 20%. hmmm......

Argentina

Argentina, once again, pulled off a pretty spectacular stunt. First, the country is running into financing problems. But, in part b/c they defaulted on their debt in 2002 without any serious plans for restructuring -- which I, in my master's thesis, said was not necessarily as bad as typical orthodox economics suggests--they couldn't access capital markets very easily to finance their fiscal deficit (another victim of the commodity downturn, btw.) So... what does Cristina Kirchner (who is rumored to be bipolar) do? She nationalizes the pension plans to plug the hole. So imagine someone says: "Errr... your 401K... that's now mine." And then... b/c the economy is so bad, what do you do? Right! Fiscal stimulus. Except you don't have any money b/c you have all this deficit in the first place. So then... you turn around and take the money from the confiscated pension plans that you were going to use to pay down the deficit and you announce a fiscal stimulus funded with that. It's really pretty brilliant, if you think about it.

Guzzle guzzle

My friend Priya sent me this a while ago:

"What is happening to the price of oil - has demand dropped do steeply!!! Isn't there a lag before the gas guzzling Americans change their driving habits..."

Since then oil has dropped to $42 intraday sometime last week and even Saudi Arabia's statement that it was indeed restricting output according to OPEC regulations barely put a dent in the decline for more then a few hours. I wrote this back:

"a) nobody knew for sure why it shot up so insanely. a good deal of this was a correction like in much of the commodity complex -- look at e.g. rice.
b) as the price of oil increased many companies and governments purchased more to have higher inventories when the price is even higher. That put additional upward pressure on the price.
c) the dollar is strengthening. that typically depresses the oil price (I'm never entirely sure why)
d) there is some lag in alternative energies gaining traction but 1.) we're seeing the first effects -- I mean, production of the hummer was halted, right -- and 2.) the mkt obviously anticipates the associated drop in demand and prices it in.
e) Some emerging markets with parastatal oil companies (e.g. Venezuela, Russia) rely on revenues to balance their budget. As the price of oil drops the incentive becomes larger to dissent from restricting output in coordination with other players (i.e. OPEC). Increasing output then decreases price. (but still increases revenue as long as elasticity is >1... which I'm sure it is.)
f) probably most important: we're pricing in a global recession. China's growth will slow form 10% to maybe 7%. The US is contracting, Europe will contract severely... Oil is in everything and as we contract demand for oil is destroyed.

that'll be $10, please."

So then this weekend I had brunch with some people who were very dismayed that gas prices were coming down b/c it delays development of alternative energies. I'm not sure if that's true but regardless those people are relatively privileged, white, middle-class, urban types (not sure what being white has to do with anything but it just kinda fits in) who don't spend a good amount of their minimum wage on gas commuting to work from the outskirts where they can afford housing (regardless that one of them claimed that she was "poor.") Anyways, I'd be interested to see what some of them think is the reason why oil shot up so much -- seeing that I, with some economics training have no clue and no argument really convinces me -- and why it's coming down again. Maybe I'll send out an email. Okay, bedime!

mortgage applications

Wednesday last week a pretty astonishing piece of data came out. After the Fed extended its new credit facilities (and maybe the rate cut in Australia and the Bank of Japan's acceptance of BBB corporate debt as collateral for loans) mortgage rates in the US shot down on that. Mortagage applications (obviously) shot up on that. By 112%! My sales guy at Goldman, had sent out this little thing then:

"HUGE leap in mortgage applications
See attached chart - as the Fed has finally engineered a rally in mortgage
rates (origination now coming in 4.5s), mortgage applications jumped by 112%
(week over week change). Refinancing jumped by 203%. while this is only one
week of data, its a step in the right direction and should make the Fed happy
to see..."

The chart he had attached to that was truly impressive:

The white line is mortgage rates, the orange line is % increase in mortgage applications. But an increase like that for one week could easily be a dataglitch. And indeedy, today the release came out as:

MBA Mortgage Applications (United States)
OBSERVATION PERIOD: DEC 5 (Weekly)
ACTUAL : -7.1%
PRIOR : 112.1%
REVISED : - -
SURVEY : - -

And it made me think that it was nothing more than a dataglitch. But then I realized: Wait, that's 7% off the level applications had risen to last week. Below is a similar graph as the previous one except with absolute mortgage application levels instead of changes:


For someone like me who thinks that a stabilization in housing prices is the first necessary condition for economic recovery, this is encouraging... even though still just the first step in that direction. The very very first.

This is what the recession looks like

I'm a bit on hiatus b/c I'm at home studying for that stupid CFA exam but I just looked after getting up -- yes, when I'm on my own I go to bed at 3 and get up at 10, and yes I looked b/c both my friend Lauren and Jack the Ripper commented on it -- and the non-farm payroll numbers this morning were awful. The economy lost over 533,000 jobs in November. In October we lost 240,000. So yes, this is what the recession looks like. Unemployment is up to 6.7% (from 6.5%). Economist surveys suggest this could reach 8%. The WSJ writes this:
Indeed, Friday's numbers cap a series of bleak economic reports this week suggesting that after escaping a serious downturn so far, the U.S. faces the type of severe recession that occurred in the early 1980s rather than the relatively mild ones of the early 1990s and 2001.

So yes, this is what we're dealing with and it could get a lot worse over the next few months. On the other hand the economy is receiving massive stimulus from a number of sources: a big impending fiscal stimulus under the Obama administration (funded by taxing upper income strata, which have a relatively inelastic labor supply and a pretty low marginal propensity to consume, meaning they'll still work even if taxed higher and they still consume similar amounts even if they are relatively poorer), immense monetary easing -- interest rates will likely fall close to zero and the Fed is a) expaninng it balance sheet fast and furiously and b) printing money, something they haven't done in the 2000 or 90s recessions -- as well as a big stimulus from low commodity prices -- mostly metals and obviously oil. The stronger dollar is a bit worrying b/c it won't spur exports as much. So all in all the economy is likely to recover while therese numbers still start to look worse. Employment, for example, lags economic activity somewhat. What worries me more than the recesison itself (which does worry me) is that I suspect the brunt will be asymmetrically borne. That's what happened in 2001-2002. We came out of the recession okay but real income for middle and working class had fallen and much of the recovery was fuelled by increased productivity -- which is only a euphemism of squeezing more work out of fewer workers at lower wages (b/c it's not like we invented such great new ways of producing things right then and there.)

Anyways, what's the market say to this number?

JTR says: "IF STOCKS RALLY ON THIS NEWS, THE LOWS ARE IN"
Well, not exactly rallying but perhaps we hold that most recently established range. I wouldn't bet the non-farm on it though. The last hour could still break through any resistance on the downside, regardless of what happened during the rest of the day. Could be interesting.

More Thailand

So last night, as I was finishing up some data work where I could have the news on without being too distracted I head about that apparently the Prime Minister was ousted peacefully. The NY Times has this:

"The protesters decided to end the airport blockades and halt six months of daily street demonstrations on Tuesday, after a court banned Prime Minister Somchai Wongsawat from politics and ordered his political party and two partner parties dissolved. The protests, aimed at bringing down the government, began in May and led to the takeover of the prime minister’s office in August and the airport seizures last week."

The Bloomberg correspondent (I only get Bloomberg news on my Bloomberg Terminal, funny how that works, right?) was really quite snarky about the whole thing. This whole: "Oh, and now we'll get the next guy, wonder how long he'll last, if they could just get their act together." And then he flirted with the Thai lady they had on the ground in Bangkok. It felt a bit like a weirdo parallel newscast. Really? This is hwo they do news after business hours? Anyways, he sorta does have a point b/c I think the next prime minister is just going to be the next in line guy. And that, I think, is again an idiological replica of Thaksin. The party, likewise, is just going to reconstitute under a different name, I imagine, so I'm not sure how much has changed. Well, I guess I just wanted to follow up since somehow Thailand got itself onto here.

Technical Analysis

Bloomberg to Jack the Ripper:

so is this going to be a head and shoulders, a double-bottom or
just a continuation of the blue trendline?



Reply:
TOUGH ONE...COULD BE A CUP AND HANDLE PATTER TOO
Reply:
yeah, or a crack pipe pattern

More on Language

A sales contact forwards me this:

"MEXICO OCTOBER REMITTANCES: SHARP INCREASE (!!!)
1.Yes, you read that right: October remittances jumped sharply,
posting the first double-digit gain (+13.0% YoY) in two years.
2.Base effect? Seasonality? Neither: even adjusted, remittances
rose strongly reversing a near uninterrupted year-long downtren
3.So what is behind this jump? My bet is that the weaker peso i
encouraging Mexicans to send more money home--they are literall
getting far more bang for the buck; in fact, the number of
remittances was off 3% YoY, while the avg US$ size soared 16.4%
4.Given US slump, risks to remittances are on the downside, but
the 13% gain shows a potential stabilizing effect of remittance
BottomLine: one month is not a trend, but this is one piece of
good news in an otherwise downbeat Mexican story."

I'm not really concerned with the content. Rather, I think there are two things pervasive in finance that don't really help the whole clear thinking effort.
a) People randomly add numerals to give the impression that they are making a number of sequential points and
b) Everything has to end with a bottom line, even if it's a completely unnecessary and platitudinal summary of what was just said.

Imprecise Language and Resulting Clouded Thinking

So the Renminbi (slash Yuan) fell by 1% to 6.9 Yuan per US$. That's a big move. a) Treasury has been trying to bully China into faster appreciation of the Yuan for years and b) nothing happens to the Yuan without the People's Bank of China wanting it to happen ot the Yuan. 1-year futures price in a depreciation to 7.20. I'm not sure what happened to warrant this big move. PBoC cut rates aggresively last week but that should've been absorbed instantaneously.

Anyways, regardless, I'm just intrigued by one of JPMorgan's Chief Economist's reaction to this:

"1) The problem China is facing [for exports] is a demand or income issue, not a pricing issue. China's exports are weakening not because that China's products are no longer competitive enough, but the end-demand is disappearing on the worsening global financial crisis and recession; In fact, China's export growth has so far out-performed all its competitors."

I really don't see the point. In econ 101 language: "the demand curve is shifting in, causing a reduction in price and quantity sold." If you want to maintain your quantity sold (or your profit... althought that ultimately depends on the elasticity that you're at) you want to lower prices, i.e. shift the supply curve down/outwards. that's exactly what's happening with the Yuan depreciation.

You can make an argument that demand is so inelastic that a shift in supply will have no impact on the quantity sold. But that's not what this gentleman is saying. He's saying that the problem is a demand issue, not a pricing issue. I dunno, but if I were still teaching econ 101, I'd mark that paragraph and say: "don't confuse shifts in demand with movements along the demand curve" or something along those lines. Really, I do think that he means that it's an issue of the elasticity of demand but it's just imprecise. The kind of imprecise language that's so pervasive in this fast-fast-fast world of finance. I think we could use some more precision.

Another strike against Paulson

So not only is the man condemned to
a) defending a ludicrously huge wager
b) wearing a suit that's too big
c) have a ridiculous picture on Bloomberg Television whenever they say there's a talk by him coming up

he also is completely out-awesomed by his Great British counterpart. Let's seeeeeeee:
Paulson is the Secretary of the Treasury.
Alistair Darling is the Chancellor of the Exchequer. Come on now, which one's sexier?

Paulson is called Paulson.
Darling is called Darling. To make matters worse (for Paulson), his first name is Hank while Darling's first name is Alistair. Again, which one is more awesome?

Finally, Paulson is just a plain old Secretary.
The Office of the Chancellor of the Exchequer is one of the four Great Offices of the State. Has a certain oomph to it, doesn't it.

I'd say Paulson 0, Darling 3. At least....

more on Thailand

from my sales coverage in Thailand:

"Unconfirmed reports of Army movement, talk of a tank division moving towards BKK. This is normally a precursor to a military coup.

PM Somchai is in Chiang Mai, holding a cabinet meeting and is expected to annouce Sate of Emergency. It's too early to say if we will have a smooth transition. PPP supporters threaten to come on street to fend off coup."

I feel like this is the kind of thing that in the olden days would be delivered by telegram with a "stop" at the end of each sentence and I'd be reading it while knocking back scotch in a humid office in Kuala Lumpur, contemplating this news' impact on our rubber investments in Indochina.

"Talk of a tank division moving towards BKK. This is normally a precursor to a military coup." Isn't that a little hasty? I mean, when a tank division of the Bundeswehr moves towards Berlin I don't assume a military coup, I think it's perfectly normal.