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Last week, risk assets generally rebounded from their losses during the week prior, with the help of a few upbeat announcements from global authorities, particularly at the International Monetary Fund (IMF). Some analysts might call last week’s market performance a technical rebound, referring to the tendency of asset prices to mean revert, or rise after periods of falling and fall after periods of rising. Emerging market stocks climbed, with gains led by Chinese shares, as represented by the mainland benchmark Shanghai Stock Exchange (SSE) Composite Index and the Hong Kong benchmark Hang Seng Index (HSI). U.S. stocks rose slightly, but underperformed their emerging market counterparts. Japanese shares fell, with the benchmark Nikkei 225 (Nikkei) falling about 0.8%. The performances of European stock markets varied, with the German benchmark Deutscher Aktien Index (DAX) outperforming both the SSE Composite Index and the HSI, after survey data showed German investor confidence unexpectedly rose to a two-year high this month. However, the French benchmark CAC 40 fell slightly, while the Spanish benchmark IBEX 35 fell 5.6%. Since reporting a greater than expected budget deficit for the 2012 fiscal year in March, Spain has been the focal point of the European debt crisis, and Spanish sovereign borrowing costs have been rising steadily, hurting domestic equity prices.
In the commodities markets, both crude oil and copper rebounded following their losses from the prior week. Gold fell despite U.S. dollar (USD) weakness, and natural gas slumped to fresh ten-year lows on the New York Mercantile Exchange (NYMEX) following a bearish inventory report Thursday morning. I will devote two paragraphs to NATURAL gas before I continue to discuss risk assets in general, because sizable opportunities appear present in the energy markets today.
On Thursday, the Energy Information Administration (EIA) reported the amount of natural gas in storage in the U.S. was more than 57% above its five-year average for this time of year. However, the rate at which natural gas inventories have been building recently has been close to its five-year average. Compared to years past, the rate of change of natural gas supplies has decreased substantially over the past few weeks. While I firmly believe natural gas is a long-term buy, I am leaning toward buying natural gas as a trade from the end of this month through at least mid-May, and perhaps until summer. Natural gas has a seasonal tendency to rally in the last week of April. In fact, according to Equity Clock, April 29th through May 11th has been one of the most consistently profitable times of the year to own natural gas during the past decade.
As I have discussed in recent issues, natural gas market fundamentals may lead to a sustained rebound in prices this year and/or next. This month, rig counts declined to levels historically associated with turnarounds in prices, and significant numbers of power plants have been switching from coal to natural gas fuel. Power plant switching alone may add as much as 700 billion cubic feet (bcf) of demand to the natural gas market this summer, especially if seasonal record high temperatures in the eastern part of the country continue. Given analysts are concerned that natural gas supplies may exceed available storage capacity of about 4.3 trillion cubic feet later this year, demand from power plant switching may be enough to spark a natural gas price rally in the coming weeks. Note that based on the data presented in the featured chart, July and August are not favorable months to own natural gas. Selling natural gas in early July may be wise, but we will have to see how this year’s once-in-a-decade setup in the natural gas market develops throughout the spring. Presently, I am long 2014 natural gas calls, and I may open positions in options expiring in 2012 as soon as this week.
In my view, last week, risk assets rebounded less because fundamentals improved, and more because fundamentals did not worsen as quickly as many had feared at the end of the prior week. Demand at Spanish and French debt auctions on Thursday was stronger than expected, despite ongoing concerns about the implementation of budget cuts in Spain and the risks presidential elections may pose in France. I will return to the topic of political risk in the European Union (E.U.) later in this report. Borrowing costs, or bond yields, at the auctions in Spain and France were lower than and equal to expectations respectively, and relatively high bid-to-cover ratios implied substantial buying by banks. Although government bond buying by banks can alleviate market stress in the short run, sovereign debt purchases by the private sector may worsen the European debt crisis in the long run, as I discussed last week in “Euro Debt Crisis Heating up Again.”
As I mentioned earlier, a couple of announcements from the IMF also boosted RISK assets. On Tuesday, stocks and commodities jumped after the IMF upgraded its global economic growth outlook. And on Friday, markets opened higher after IMF Chief Christine Lagarde announced she was confident her organization would raise more than its $400 billion* target for its firewall against the European debt crisis. As of Sunday, the latest estimate for funds raised was slightly over $430 billion, an amount that will almost double the lending capacity of the IMF. But investors should note that nearly half of the contributions were from the euro area, and none of them were from the U.S. and Canada, whose leaders maintain that the E.U. needs to do more to deserve international help. On the other hand, each of the emerging BRIC economies: Brazil, Russia, India, and China, has or is expected to contribute.
Looking ahead this week, given the extent to which central bank policies have impacted asset markets since the financial crisis, I recommend traders pay close attention to the Federal Open Market Committee (FOMC) policy statement Wednesday in the U.S., and the Bank of Japan (BOJ) policy announcement Friday in Tokyo. The FOMC consists of twelve members of the Federal Reserve (Fed), the U.S. central bank, who vote on monetary policy decisions. I have recommended buying safe-haven assets, such as U.S. government bonds, or Treasuries, the U.S. dollar (USD), and the Japanese yen (JPY) in recent issues to protect against possible turmoil in the second-half of the year. In my opinion, the European debt crisis, scheduled U.S. fiscal tightening, and/or the Chinese economic slowdown may increase market volatility later this year.
U.S. government debt has rallied since I wrote the piece “Treasuries Still in Style,” and I would wait for a pullback before buying. Such a pullback may occur as soon as this week, especially if the FOMC does not hint at a third round of quantitative easing (QE III), or bond purchases intended to stimulate the U.S. economy.
In my view, the market’s reaction to this week’s FOMC statement may be similar to the previous one in March. Specifically, market participants were hoping the FOMC would hint at QE III to boost asset prices. But the Fed disappointed by not indicating another round of asset purchases was imminent, and risk assets, precious metals, and Treasuries, all fell sharply. Losses were steepest for precious metals, which investors use as stores of value to protect against the money supply expansion and USD weakness associated with Fed stimulus. One of the few assets that rose was the USD, which benefited from the reduced expectations for money supply growth. Money is like any good, in that an increase in its supply usually lowers its value, and vice versa.
Over the past few days, financial commentators have revived chatter about the possibility of a hint at QE III at the upcoming FOMC meeting, even though Fed officials tried to downplay expectations of further easing in mid-March. The USD Index (DXY), which measures the strength of the greenback against a basket of six major currencies, has declined by about 2% over the past ten calendar days, while Treasuries have risen slightly and gold has declined slightly. Given that most asset prices and inflation are significantly higher and volatility significantly lower than at past moments when the Fed hinted at QE programs, I would not be surprised to see the Fed hold off on QE III again. In response, I suspect Treasuries may decline and the USD may rally, especially if they each hold onto their recent gains and losses respectively. I favor buying the USD outright, especially if the greenback falls early in the week, because present macro dangers make shorting Treasuries a risky trade in my view.
On a similar note, many analysts have been speculating that the BoJ will announce further easing measures late this week. Amid pressure from corporate lobbyists and the Japanese government, the BoJ announced an aggressive easing program earlier this year, in an attempt to combat chronic deflation and JPY strength. Japan’s economy has a large export sector, which is adversely affected in the short run by strength in the domestic currency. But over the past couple of months, corporate lobbyists in Japan have grown quieter, as the JPY has weakened beyond the BoJ’s target of 80 per USD to its current level of about 81.5. Consensus is that BoJ officials will continue to announce aggressive easing measures at their coming meetings to push the domestic annual inflation rate toward their 1% target. According to Reuters, market participants expect the BoJ to announce another 5 trillion JPY worth of asset purchases this week.
However, the words of Japanese central bankers suggest the consensus view may be overly dovish. In particular, BoJ Governor (Gov.) Masaaki Shirakawa has told Japanese government officials that more easing is necessary in the short run, but that tighter monetary policy is inevitable. On the other hand, during a trip to the U.S. last week, BoJ Gov. Shirakawa stressed that monetary policy alone cannot defeat deflation, and may have adverse consequences for the Japanese economy.
In my eyes, a couple of factors, mainly domestic and international political pressure, have been influencing Gov. Shirakawa’s word choice. Gov. Shirakawa faces domestic pressure from lawmakers to keep the JPY weaker, as exemplified by last month’s backlash from Japanese lawmakers against a speech delivered by the BoJ governor in the U.S. In the speech, Gov. Shirakawa questioned the effectiveness of easing. During his trip to the U.S. this month, the BoJ governor was careful to express his opinions in a manner that would receive less scrutiny from lawmakers.
Simultaneously, Gov. Shirakawa may feel international pressure not to announce easing on Friday, because the IMF, the World Bank, and the Group of Twenty (G20) finance ministers all had meetings in the past week. Currency intervention has been a hot button issue in the international political arena since the financial crisis, because difficult economic conditions have incentivized central bankers to go to unprecedented lengths to try to stimulate their economies. Countries around the world, especially emerging market nations, have criticized easing policies in the developed world for spurring hot money flows, fostering global monetary instability, and raising inflation.
My personal view is that the JPY is a buy ahead of this week’s BoJ monetary policy announcement, because markets expect such a large amount of easing that the BoJ may have difficulty surpassing expectations. Given Gov. Shirakawa’s rhetoric in the past, I suspect he at heart does not support further easing. He often has spoken about the risks of more easing, and has stated that sound economic policies enacted by lawmakers are more suitable to solve Japan’s economic problems, including deflation and the world’s highest debt-to-gross domestic product (GDP) ratio, than monetary policy in the long run. I may buy the JPY in the next 72 hours, especially if it depreciates early in the week.
Did you like what you read? Read the full newsletter here.
- NATURAL Gas May Rally Near-Term • 1
- The IMF Rescues RISK Assets • 3
- Are the USD & JPY Buys Ahead of the FOMC & BOJ? • 3
- Watch ELECTIONS in Greece & France • 6
- A Long-Range Missile with Far-REACHING Implications • 7
- STOCKS: Earnings Season & Clash of the Tech Titans • 8
Editor of The Opportune Time email@example.com www.theopportunetime.com
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