How would you like your Markets - Shaken or Stirred?

Ok, this post isn't about connecting Markets and Bond, though Casino Royale did attempt that...Its about re-looking at major factors that can move the markets from here in either of the 3 directions (sideways is also a direction ;)).

Post QE II (where US released some USD 600 bn to induce growth into the system), everyone and their pets were bullish on the emerging markets and inflation in some pockets thereof. However, Chinese counter measures for preventing money flowing in freely into their system, combined with the Europe crisis, has clearly shown the world the other side of the coin. Where do we go from here, is a question people have started asking again now.

So I thought I'll compile a list of global and domestic (India centric) factors that can affect the markets significantly in either direction:

• European Crisis: 

Although Ireland has agreed to the bailout by IMF, Portugal and Spain have already started to look bad if we take cues from the bond markets. Ireland story is not done yet though; it looks like they got the raw end of the deal - IMF has gotten them to agree on spending their Pension Funds first (for repaying their debt which is coming due soon) and only after that they should touch the 1st dollar (or Euro) given by IMF. What this implies is by the time Ireland gets to spend IMF money, they are already bankrupt...and hence completely dependent for quite some time on IMF. Irish are not very happy with this...protests will happen, heads will topple, and may be, just may be, terms and conditions will be re-looked into.

Portugal is not as big an issue as Spain - given the massive difference between the size of their economies. Its like saying I have a tooth-ache...may be a tooth has gone bad and needs to be pulled out...and o yes...I have brain tumor too...but thats not aching so much...!

Spain is a bigger problem than Portugal, and this time around, the markets are not waiting for crisis to come up before it tanks again. Money is flowing out of Europe. And to top it all, there are some bank runs being planned as well (No, I'm not kidding!). December 7 is being planned as the day when civilians across Europe are getting together to take out all their deposits from various bank accounts...(read this article from Zero Hedge). That means banks had better spruce up their cash levels to meet sudden surge in requirements, and if they don't...well, we'll know which banks were naked behind the curtains ! Can't say how much support is there for this cause, but it's been on for quite some time now. [As an aside, Wikileaks has said that early next year, they're going to do a big leak on a major US Based bank...read here. So if we miss solid action on banks in Europe on Dec 7th, we can still look forward to action from US banking circles early next year.]

• Inflation:

India and China are reeling under severe inflation...(while US is praying it'll have some of it !) and are unable despite all their efforts to bring it down. They are also growing at a scorching pace...India has grown @ 8.9% last quarter as compared to 8.2% in the same quarter last year. Indirectly, the growth and inflation impact is even causing intermittent cash crunch in call-money markets in India (these are short term borrowing markets, in which companies borrow for 1-3 days to tide over their working capital gaps). In fact, RBI has recently made some temporary changes to CRR to infuse more liquidity in the market to cool down the lending rates in call-money market. Too much of inflation and uncontrolled growth always poses a risk of a hard landing...bringing in crash scenarios for markets to consider. If these scenarios persist, RBI is quite likely to raise interest rates / suck out liquidity from medium term perspective (especially by clamping down on lending to Real estate sector), which will further push the markets down (though not lead to a crash).

• Currencies

Dollar is clearly appreciating against all major currencies...very unlike what was envisaged just some time back. Euro is retreating...and no big support will come in till clarity comes in on the extent of crisis in the rest of Euro zone. China, Russia, Brazil, some other SE Asian markets have started trading in their local / preferred currencies apart from Dollar, as "Dollar is better than Euro" is not being seen as a convincing argument by markets. India is not a major market in the world, in fact, it is not even a significant part of the portfolio for many major funds, who, anticipating more scams, hard landing, might take money out of the markets, pushing rupee further down. Export lobbyists wont complain though. But its not that all's well for dollar from here, as soon as Europe crisis is played out / contained, dollar too will take a hit, 'coz fundamentals of US economy are not exactly confidence boosters.

• Interest Rates, Growth cooling

Interest rates are very likely to continue hardening in China and India, both to cool down inflation, contain growth, and avoid adverse effects of QE II money flowing in. Meanwhile, other SE Asian economies - Singapore, Thailand, Indonesia, Malaysia, are too cooling off. And "Japanese economic growth" has long been accepted as an Oxymoronic term, like Military Intelligence - the words exist separately, but sewn together, mean nothing. Every time high-growth economies like China increase their interest rates (there is already talk about another increase, after the recent one), commodity prices are going to take a huge hit, and so are equity markets (partially due to contagion effect, and partially due to prospects of reduced growth). A lot really depends on how central banks act at this stage...the question is no longer whether, rather how much, and when.

There are some other such factors, but I believe these are the ones with most far-reaching consequences. So while most of the factors are pointing towards a gloomy scenario, its still too early to write off the bullish scenario for the markets that we had envisaged earlier. It all really depends on how each of the above factors plays out...and how well or badly the central banks tread the thin line between inflation and growth. US too is not out of the woods yet...it just keeps postponing its problems, right from contingent liabilities of social security to medical expenses, from unemployment to huge fiscal deficit...

The time is running out for Europe, US,...at some point of time, something's gotta give...just then we'll know really how decoupled we are from the developed world...till then...stay tuned to the markets, and never forget to take cues from the Bond markets - for its him who'll tell whether the markets will be served shaken or stirred.

Wrap Up - Scams, Markets, Bonds, Currencies

I was on a 4-day vacation, so could not post anything, but managed to keep in touch with the latest happenings. So much has happened that I think I'll have to skip a few topics - mostly related to Scams...but a quick word on those nevertheless:

Medianama has given some really interesting links (HT: Deepak Shenoy - Capital Mind) to audio files and transcripts of conversations between Niira Radia and several prominent personalities like Ratan Tata, Ambanis, A Raja, Barkha Dutt, Vir Sanghvi, etc. Fairly interesting read / listen, depending on how much you like to hear the now famous "All India Radia" ;)

And now, back to the markets - Ireland has finally accepted the $ 113 bn EU bailout package with severe austerity measures, which is obviously not going down well with the civilian rights groups...markets are not impressed, the Dow is down over 1% at the time of writing, and the focus has now shifted to Spain and Portugal (yes, already !) The Spanish 10-year bond yields rose 0.14% to 5.35% and that of Portugal rose 0.09% to 7.23%. Bond yields increasing means bond prices are going down - markets, expecting higher risk of default, are willing to pay lesser for a "secure" government bond. This will typically hit the Mark to Market (M2M) of treasuries of banks and central banks who are large holders of these bonds - for them, the value of a prime part of their portfolio just went down...who may then be needed to set aside some more capital to make up for the losses...for which they sell some other country's bonds...and so goes the contagion.

As an aside, the yields on 10-year US Treasuries is approx. 2.83% and that of India's is around 8.03%...so technically, India is far more likely to default than Spain / Portugal...but unlike these countries, India still has the power to print its own currency (INR) and pay back the debt in the worst case scenario (although that would trigger hyperinflation here, but thats a separate story altogether).

Meanwhile, after a brief respite during the Ireland bailout talks, Euro continues to slide against the dollar. Here is a quick recap of the last 1 month's euro-usd movement:

(Chart: Courtesy Yahoo! Finance - Click for a larger image)

It reinforces the fact that market players are not yet completely done with Europe with Ireland bailout news...they would like to get a sense of where it all is going before coming back into the markets - in the meanwhile, they'll keep selling stocks and taking money out of European markets...leading to slide in both - European markets and euros.

Similarly, INR has also weakened against the dollar considerably over the last few days...a glance here as well:

A similar logic here as well, though default is not the top-of-the-mind topics for India, one scam after the other is rocking the markets, resulting in a few exits as well. Both euro and rupee have hit a 2-month low...can't really say how much lower they can go from here.

But to me, overall markets look good to go up from here...am still going with what I've said in my earlier posts...but beware of Bank Nifty, banking stocks, and of course, realty...

Nifty, Markets, Trading Strategy

LIC Housing Finance Scam really knocked the steam out of the markets which were showing all signs of reversing a trend yesterday. However, I think it should be better today, Banks though still have some more downside left. But overall, Nifty should move up from here, as it has a strong support coming up at 5850 levels, with another decent support coming up at 5750.

A quick look at the same chart that I've posted in my earlier posts here and here:

Overall markets will continue to remain cautious, with Ireland bankruptcy possibility still lurking around the corner and new issues like the N/S Korea war creating further jitters. But overall, I don't think in the times of geopolitical distortions, currency wars, protectionism, etc, a military war-game is required...there are better and more advanced tools available now to kill an economy ! So expect markets to gradually tide over these news, and focus on the regulations, policies, dictats...for these will be driving the world for some time to come.

Just a quick word on the trading strategy for Nifty, i think selling a Dec 5700 put (currently at 95) should work out in this scenario as Nifty looks unlikely to breach 5700, in which case time decay will take the value out of this instrument. Aggressive traders can even look at selling 5800 puts.

(Disclaimer: Please do your own research before taking any positions. I am not a trader / investment advisor and may have vested interests in recommendations).

Indian Companies raising International debt

This is another trend that’s catching up…more and more Indian companies are going abroad to raise debt. 

[Note: Here, I’m attempting to just introduce this topic for arousing general interest, without getting much into the details, as I understand my readers may not be as well versed with the debt market dynamics as with the equity market. Over a period of time, I intend to introduce more in-depth and well-researched articles on debt markets –  nevertheless, it's important to understand this to really understand the overall economy dynamics and even the equity markets !]

What is the International Debt Scenario ?

Just in this year alone, Indian companies have raised USD 10 bn of funds through sale of bonds…this figure is higher than the last 8 year put together !

Recently, after a gap of almost 13 years, Reliance (RIL) raised a debt of USD 1.5 bn internationally. Till date, ICICI Bank was the most active Indian corporate entity on this circuit, but off-late others have also decided to jump on the band-wagon. Axis Bank, SBI, IOC, Essar Energy, JSW Steel, GMR, Reliance Communications, IDBI Bank, Rural Electrification Corporation (REC), etc. are just some of the names who have either recently raised, or have concrete plans to raise international debt shortly.

Why raise debt?

If you are in need for funds (for expansion / acquisition / any other purpose), there are two ways of raising capital – either issue equity (sell stake to a Private Equity player / Strategic Investor OR issue an IPO / FPO and raise money through normal capital market route from retail investors) OR raise debt. Now, the big differentiator between equity and debt is, equity is tomorrow’s money, debt is today. Someone who is parting with equity to raise funds is parting with returns from future growth, while someone who is raising debt, believes the returns on debt will be good enough to pay the interest and still enhance overall shareholder value / enterprise valuation.

Why International debt?

This is an easy one…the interest rates outside India are much lower than that in India, so its cheaper to raise money outside, and pay, say, 7% interest per annum, rather than raise the debt in India and pay, say, 12% interest per annum. For example, a whole lost of money that Reliance is recently raised, will be used to retire the more costly debt, resulting in direct savings in quarterly interest payments and therefore, higher PBT (Profit Before Tax) – a figure that’s closely watched by all investors in the market during every quarterly result release.

Global Perspective

While its heartening to know that Indian corporates are reaching out internationally, but we’re still nowhere close as compared to our smaller peers…for example, this year India has seen some 12 international bond issues, while Korea has already done 69 ! For India to reach even that level, several things have to go right starting with improvement in India’s rating (and image) in the Global markets, enabling Indian corporates can raise debt at even lower rates. The bond offerings have to be more frequent so that its worth the while for bond portfolio managers to track India and some top Indian companies. Besides, the offerings have to be bigger in size – nobody’s going to track a whole economy or an industry and a company within that industry for a total bond offering sizing up to 100 mn dollars…besides, as the debt offering increases in size, the cost of raising that debt comes down proportionately (to some extent – I know I might be wrong here simply due to over-simplification).

You might want to go through this dated 2007 article briefing how bankers told companies not to go for international debt sales then ! 

And Finally, so what?

There are a lot of takeaways for the lay investor in this information itself…

·         Dollars coming in into the system (not such miniscule (!) amounts as USD 10 bn) is likely to push rupee up, thereby making our exports less profitable (think Infosys)

·         It also, to some extent, gives us a hint about the view of rupee in large corporate treasuries (responsible for raising such funds). If we can generalize these instances, (again, a risk of gross oversimplification) we can say that the rupee is seen as appreciating in the medium to longer term (If a Dollar is worth say, 45 INR today, and I have to pay 1 $ as interest, I pay only 45 bucks. But if tomorrow, Dollar becomes worth 55 INR, then also I have to pay 1$ interest, but in this case, I pay 55 rupees. And I’m earning in Rupees…Ouch !)

·         I take this as a fairly bullish sign for these companies – that instead of diluting more equity, they are going for debt.

·         Also, such debt results in a whole lot of new money coming in into the system, providing system with even more liquidity. This liquidity is later on going to be responsible for keeping further lending rate hikes in check…and probably even bring them down (however, for the effects to take place at such a scale, the debt borrowing has to be huge). So small and medium enterprises will be able to raise money domestically at relatively cheaper rates – resulting in their enhanced bottom-line.

Musings - II

Finally, as expected, China has raised bank's reserve ratio by 0.5%, which means that the Chinese banks will have to deposit an additional 0.5% of their total deposits with the Chinese central bank. This is expected to suck out nearly USD 50 bn from the Chinese financial system, which will help in keeping inflation in control / even reducing inflation. 

Now, this move is mostly to account for excess cash flowing in from the US, courtesy US Fed (QEII - in which US is printing over USD 600 bn of paper currency). But US is going to release this money in phases till April next year...so expect China to keep an upward pressure on interest rates and RRR (Reserve Requirement Ratio) to keep absorbing this money.

As yet, RBI has kept quiet regarding reaction to QE II funds flowing in into the Indian economy. However, if RBI feels "compelled" to do something about it, they will also likely hike the reserve ratio to suck out liquidity from the system, just like China, and not  tinker with the interest rates as it will directly hit the growth rate.


[Also, regarding such opinions given in Economic Times "...Realty Stocks are showing signs of life"...if I were you, I would not believe it much, 'coz if RBI takes any liquidity tightening measures, realty stocks will be the first to go down.]

Besides, Europe's problems are far from over...once the Ireland insolvency issue is sorted out, Poland / Spain will crop up...probably in that order ! And once again the world will be looking at Euro as an unsustainable currency and the ensuing chaos.

These factors, in my view, are going to be some of the biggest factors in keeping upward moves in markets in check...As I've pointed out in my previous posts here and here, the markets are expected to move down some more before pointing up. RBI still shows no signs of doing anything about curbing the inflow of QE II money, which will probably be the stance till the IPO  / FPO calendar is mostly done (MOIL, SCI, SAIL, ONGC, EIL, OIL, and some more) coming up between now and March 2011. So expect some see-sawing in the markets for the next months...with markets going up with QE II money pouring in and coming down as China increases its interest rates  giving markets jitters about the demand. I don't know (or think) if the markets are going to go majorly in any direction in the near term (now - 6 months), but I think the volatility is going to increase from here.

Indian Markets, Nifty - What Next?

Questions are again popping up from various pockets as to how much more downside is left in the market...I think the market will correct a little more from here, maybe about another 100 - 150 points on Nifty (till 5850, currently at ~ 6000). There is even a (small) possibility of a fall towards 5700.

Here's a quick look at the Nifty Chart: (notice how the DMI is not supporting the fall much).

Bank Nifty too looks like it might fall some more...and SBI (one of the highest weights in Bank Nifty) also looks set to correct some more...However, these falls (including Nifty's) should last less than a week after which markets should again look up.

Markets, Currencies, Gold and Geopolitical Equations

Trust markets to save the surprise element for a well-drafted climax. The stage was all set for a thriller action-packed movie whose story was supposed to be something like this:

US Government reduced interest rates, encouraged borrowing, created asset bubbles, and made people believe that bubbles are here to stay...everyone and their grandmothers minted money where ever they put their investments...everyone's happy...then came crisis, 'something's gotta give' proponents were proved correct - and then...Lehman happened...all hell broke loose...Intermission !

US released approx. $ 1.7 tn of funds into the markets, bailed out "too big to fail" institutions, and things started improving...some jolts came from Europe's crisis pockets, but they too were managed by showing strength of confidence and trust in Euro and Euro-zone. But as time elapsed, people realized things were not improving...jobs were still getting lost...growth was still anemic, foreclosures were still setting newer records...and the US Government (better known as G'mint by now), was under pressure again. US G'mint has to seem to be doing "something" in the face of obvious debacle in mid-term elections.

US Federal reserve releases money into US's banking and financial system, thinking they'll be able to spur growth and depreciate their currency against others - giving them a double benefit (dollar depreciation helps US in improving exports, eases interest payments on debt)

Meanwhile, the economists and analysts, both independent and attached to large investment houses worldwide denounce the policy...(with yours humbly included in this crowd) and prophesy that dollar will depreciate against all currencies, all right, but US financial system will die a slow death, (ok there was a divide here with some calling for a deflation), and all other assets in all other markets will shoot up...(of course, no Top for Gold in sight)

And out comes the market, with the final verdict - the worst of both worlds - Euro crisis breaks-out first, US dollar appreciates (like Zero Hedge wrote in one of his posts - People see it as a Bullish sign for dollar that US will default Later than Europe !). Markets worldwide tank...China raises its interest rates in anticipation of free dollars flowing in...Euro loses value, all commodities go down, markets tumble, even Gold tanks...The End !

I know that its still too early in the day to talk about the "outcome". We're still quite far away from playing out the entire game. On these lines IceCap Asset Management has come up with an excellent (and funnily sarcastic) view of the overall game-plan (HT: Zero Hedge)...(you can see the Nov 2010 report from Icecap here). A small preview of what's in this report:

With the QE2 announcement now out of the way, Mr. Bernanke’s game plan is as follows:

1. Lower interest rates for "everybody" and "everything"
2. Stocks & Bonds will then increase in value making "everybody" and "everything" feel wealthier
3. "Everybody" will then start to buy "everything"
4. Pray that the price of "everything" doesn’t increase too much and therefore cause "everybody" not to buy "everything"
5. If steps 1 to 4 are successful, businesses will begin to create jobs for "everybody" because they will once again be buying "everything"
6. Ignore the housing market problem
7. Ignore the debt problem
8. Ignore the effect of numbers 6 & 7 on the banks
9. Pray that foreigners continue to buy newly issued American debt

The report is a good read...please do take time out to go through it.

The point here is, the crisis in Europe has not gone away...and again predictions of who's next (after Ireland) have started pouring in...neither has US taken the right step by taking on more debt to get out of their debt trap, and they will pay for it sometime or the other...there is an increased coordinated activity globally on debasing dollar as the world's reserve currency, on acquiring Gold by central bankers - either through market or stealthily through un-announced mines acquisitions...the banks are on the edge again, with over 900 banks closing down in US alone in the last year or two, (and expectations from European banks are no better)

The way it is, (HT: John Mauldin - for giving this perspective) its not really about the markets / asset bubbles per se, there is a larger game at play here - that of Confidence and Trust. Confidence on Governments, on Growth, on policies and policy changes...Trust between banks and FIs, between countries, between two counterparties exchanging commodities for Dollars. At a really broad level, its a Geopolitical failure...with Governments not taking enough / correct steps, thinking of their economy as mutually exclusive from that of trading partners and global economy... In the past as well, many recessions were due to lack of confidence and a complete break-down of trust...even the crisis that started in 2008, was triggered when banks stopped trusting each other with their money...that's when the financial juggernaut stopped rolling, and government pushed in money thinking it'll lubricate the system and things will be smooth again...

Like Soros said recently, the "new world order" is emerging...lets hope once the game is played out completely, we'll make a fresh start with Confidence and Trust.

BSE launches Realised Volatility Index

BSE has launched India's first Realised Volatility Index today in a bid to increase its (abysmal) equity derivatives volumes. You can download the PDF to view more about this here. BSE will lauch 1, 2 and 3 month futures and options contracts to trade in this RealVol Index.

First, let's understand what this is and how it can be used, followed by goof-ups:

What is Realized Volatility? How does it compare with VIX, which is already launched?

Realized Volatility is calculated from actual volatility of BSE Sensex. In contrast, Voltility Index (VIX), which is a measure of implied volatility in the market (as the market views it - it may incorporate the "fear factor" in the market, or swerve drastically with spikes / drops in call-money rates, which are referenced as borrowing rates for short term (1-2 days)). So unlike VIX, if market is very volatile, but closes near its previous close, the RealVol will either not be affected much or it'll go down to a certain extent.

How do Realized Volatility Futures / options help?

Realized Volatility provides traders with a tool to hedge their option values against volatility movements. As some of you might be knowing already, an Option price varies primarily with 3 parameters - Price of underlying, Volatility, and Time to expiry. So let's say if you've bought a Call option on Nifty (can't imagine anyone buying an option on Sensex due to poor liquidity), you should make profits if Nifty moves up. BUT, if the volatility of Nifty drops, or its taking too long to move up, (which it does finally), your option will still end up losing its value. So, higher volatilities / time add to option values and vice-versa.

Thus, for options traders, even if their view goes right, but volatility drops, they still end-up making losses. To avoid this, they can sell volatility futures / call option / buy put option and thus hedge their long call option position against volatility.

Goof-ups:

This idea is probably borrowed from CBOE, which is ok...but there are major issues in implementation. To understand this, first lets have a quick look at the comparison of similar products from BSE and CBOE.

(click on the image for a larger view)

• BSE is taking the average standard deviation formula into account, without doing (n-1) in the denominator ! Statistically speaking, you should average with 'n' if and only if, you are taking the entire data set (or population) into consideration for calculation. But if you are taking only a sample data from the bigger data set, you should take 'n-1' to account for degrees of freedom. This is an unacceptable error ! [Besides, taking average standard deviation is not a very good measure, its always better to use conditional volatility (EWMA, GARCH, etc.) for better accuracy...but more on this sometime later].
• A little digging reveals the reason why they are doing so...this is because they are resetting the value of n after every interval. It means that for calculating 1-month RealVol, lets say today is the first day of RealVol futures / options contract, they will take only 1 day volatility into account. On the 2nd day, they take the average of the last 2 days (including today's EOD Sensex value), on the 3rd day, average of last 3 days, and so on...till the 22nd day (last trading day, unlike calendar days which will be 30 at this stage), when they'll take average of last 22 days. And then bang ! Again the next 1 month starts with 1 day average !!! See example below to understand this better. 
  
  

  

  
  In this example, I've calculated 1 month RealVol (annualized) based on CBOE method and BSE method...and see the difference on the first couple of days...What this means is, if  day1 (second last row) is, say extremely volatile, (lets say Sensex tanked by 5%), then the first day RealVol value will be high, then if sensex closes at the same level next day, the RealVol will be nearly half of yesterday's value...! Such a drastic drop (30%) in value of RealVol in just 1 day, whereas if you actually see using the correct methodology (CBOE's), its not so drastic. People long on volatility futures / options on day 2 will most likely get stopped out...despite the fact that volatility did not really fall by that much...! CBOE, on the other hand, calculates RealVol on 22-day rolling window basis (for 1 month series), and so does not see large fluctuations at the beginning of the series.
  BSE's method of NOT taking rolling window is also the reason (perhaps) behind ignoring degrees of freedom (not taking 'n-1') in the denominator, as otherwise, on the first day the real vol figure will be undefined !

I hope you've got the picture...the intention is good, but as usual, the execution is poor. Even in nifty options, the volume are extremely poor for the 2nd and 3rd month series, so for BSE (with really poor liquidity in derivatives overall) RealVol series of 2nd and 3rd months most definitely will not be traded in near future. It just the 1st month which will see some action...but as soon as market realizes that the RealVol is not actually helping them in hedging their options, they'll forsake this instrument...and then BSE guys will wonder why the heck is their derivatives section not taking off...[By the way, futures and options are not fungible across exchanges, so if you buy Nifty options, and hedge using RealVol option on Sensex, though there is good correlation, its not a very good hedge anyways]

I hope someone in BSE is taking a note of this...and also in NSE...so that they'll not make the same mistake. Expect something similar from NSE soon.

Margin Requirements hiked - Effect on Global Markets

There was one other point that I did not cover in my last post (Rumblings of Markets...), due primarily to 2 reasons - one, the post was getting too long for audience's perceived comfort (in my view) and two, this is a lesser known, less talked about, but an extremely important point nevertheless, which needed a separate coverage.

And the point is about exchanges increasing margin requirements on various contracts.  Margin requirement is the minimum amount that a trader needs to deposit with her broker / exchange in order to take a futures contract. This is apparently being done to remove some of the speculative money from the markets. We'll jump in into the dense world of commodities, but first, some news for those of you who have skipped this important piece.

As per Bloomberg, "Ice Raises Margins on Sugar Futures by 9.9% as of Close Nov. 12" which lead to a sell-off in raw sugar prices that was so sharp, that it beat all records set in the last 22 years ! Simultaneously, ICE also increased margins on cotton, leading to a 2.7% sell-off. CME raised margins on soybeans, while Chicago exchange did so for Silver (which tanked 7.1% later). If you would like to, read this good piece from WSJ Online here.

Back in 2006-08, when authorities in India accused commodity futures for pushing and keeping prices of physical commodities higher, the ones who did not support this view said that futures prices are in fact determined by the physical prices. So if sugar demand goes up / supply goes down, the mandis / local markets will push the physical prices of sugar up, and thereby the futures prices will also go up since physical prices are an input to calculating futures prices. If this does not happen, there is an arbitrage opportunity which allows prices to come back in sync. This is another way of saying that the tail (futures market prices) cannot wag the dog (physical market prices).

But going by the events listed above, it seems like the futures prices were actually being held up to some extent by speculators and it wasn't entirely tied to physical prices. Such a sharp sell-off in various commodities underlines the fact the speculative money can in fact, keep the prices artificially high. The margin money is the life-line of traders, its what they calculate ROI on, its what is churned n times a day to make money. E.g. if we assume that the margin required for  1 futures contract is around Rs. 25000, a trader with Rs. 50000 will be able to take only 2 contracts in either 1 or 2 different assets. On the other hand, a trader with Rs. 10,00,000 (ten lakhs) will be able to take 40 such contracts. Assuming both are normal, disciplined traders, its an easy guess who will make more money. Thus, margin money determines your churn, which affects your profitability directly. Any increase in margin money requirements slows the churn cycle so if 0.5% daily returns were good earlier with X margin money, nothing less than 0.75% daily return is good with 1.5X margin money.

Besides, the margin money requirement also has a contagion effect: You need more margin money, you decide to pull out some money from some other trade, ----> that asset prices goes down, ----> traders holding that asset get margin calls ----> they sell something else -----> that asset prices goes down...and so on. Besides, stop losses start getting triggered, which leads to further sell-off, leading to further downslide...and so on...not just in the same market / asset class, but in others as well.

This is probably one of the major reasons (apart from the ones given in my last post), which has lead to a sharp sell-off in various asset classes across the globe. It looks likely that this sell-off will continue for some part of next week as well, till traders re-align their portfolios again.

But notice how all these margin requirement hikes are happening across exchanges across geographies simultaneously...giving an eerie feeling of an implicit dictum from the big daddy of commodities...(but its just my guess, I could be entirely wrong here). Also, notice how these requirements have been upped in commodities which China imports heavily...(sugar, cotton, soybeans). [Co-incidence anyone?] 

They have good reasons to do so - one, they are faced with inflation issues just like in India (any they're hoping that this move will cool down prices which will be reflected in lower inflation figures), and two, with their currency appreciating against dollar, their exports will take a hit and so they might have wanted to make some downward adjustments to their import bill as well (to keep trade deficit in check). If these are indeed the reasons, expect margin tightening in more commodities, in more markets.

There is just one thing which can derail the above tactic - the producers / sellers of these commodities, who will not be very happy with the falling prices (some of these players are really really big in the market). Besides, typically, their sale contracts are not based on end-of-day prices, but more on monthly average / quarterly average prices, which will come down drastically with the effect of such falls. Also, with falling prices, the chances of defaults by the buyers increases drastically (not very uncommon) further putting in question the actual sales figure done by these producers / sellers for this month / quarter.

Expect these players to come back big time to push the prices back up again. If they need to borrow money to put in the markets, they will. Expect banks to increase their lending to these guys and to usual trading companies to make good their increased Working Capital Requirements (due to payment of higher margin money). Whether and how soon the prices come back up will really depend largely on such players in the market. 

But till then, it'll be the case of the tail wagging the dog.

Rumblings of Markets bumbling, tumbling & crumbling

I don't know whats' scarier, that so much has happened to the markets in just a couple of days OR that this happens so frequently. This post looks like its gonna be a long one...so I'll start with listing down the dots, and then spend some time connecting them...followed by some philosophical discussion ;). Stay with me on this one, for its gonna have some links to very good documents and other blog-posts as well.

Some of my select picks among many data points:

• China Market tumble 5% on Interest Rate Increase:

The People's Bank of China increased its lending interest rates by 25 basis points (0.25%) to 5.56% - its first increase since 2007. The central bank is expected to follow suit this week-end or early next week. This is apparently being done to rein in inflation which is a major cause of concern in China. China has obviously timed it to offset dollars flowing in from the QE II release, and there are talks of another rate increase before the end of this year. Markets see this as a dampener to growth, and future investments in the markets so the markets tanked over 5%, its single biggest loss since Aug 2009. A snippet of what went on in the Chinese markets on 12th Nov (courtesy: Bloomberg)

• Commodity Markets tumble: 

Crude Oil, Sugar, Soybeans, Corn fell sharply on news of interest rate hike from China. The markets are expecting a slow-down in demand of various commodities due to increase in interest rates (interest rates are usually increased to rein in inflation, as people save more (to earn more interest) and spend less - thus this kind of move takes away free-money from the system, clamping demand and thus reducing inflation). If you would like to read more about this, read it on Mish's blog - here. As per LA Times, sugar fell 11%, gold 2.7%, copper 3.2%, and soybeans 5%.

• Ireland's debt crisis spooks investors:

The PIGS (Portugal, Ireland, Greece and Spain) are back in news. Apparently, investors are getting worried about Ireland's ability to repay its debt, and mirroring this sentiment are the bond markets worldwide, which sent the Irish bonds prices tumbling resulting in difference in yields between the Ireland and German 5-year bonds to a record 6.6% (yields on bonds increase when bond prices go down - which they do in such times when sovereign rating suffers (country doesn't seem to have money to repay its debt) or if prospects of interest rates reduction in future are higher - more on this in some other post). But EU was quick to come out with some reassurances (here - a post by Calculated Risk) which calmed the markets down to some extent. Read a good article on this from WSJ here. 

However, this news did cause quite some worry to global investors who pulled out their money from equity and commodity markets - not really because Ireland is a large economy but due primarily to the fear of contagion effect, i.e. If Ireland defaults, Portugal and Greece might get in a worse condition than they are now (since they hold substantial amounts of bonds from Ireland) and if they too default, so will Spain, and then so will France and Germany - the two biggest countries in the EU...and then down goes Euro - triggering a global currency crisis. (I know it seems like a doom's day scenario, but if markets are taking these thoughts into consideration, its scary to sense how close we might be to this turning into a reality). [Another good post for further reading by Mish here]

• Euro falls against Dollar, then pulls back some:

Spooked by the Ireland debt crisis, the Euro fell sharply against dollar but recovered a bit after the regulators made some reassuring statements. If the focus again moves towards evaluating the sustainability of the Euro-zone as a region, and Euro as a sustainable currency, dollar may not fall against other currencies as was widely believed post QE II (that's a release of USD 600 billion by US Federal Reserve into the banking and financial system to spur markets and growth).

Now, the essence of the above picks is that there is no single path post QE II - this path was thought to be something like this:

Fed Releases Money (QE II - USD 600 bn) ----> US doesn't have fundamental to absorb this cash ----> Money finds its way into other markets (China, India, Brazil, Russia, Korea, Singapore, etc.) and other asset classes (real estate, commodities) (as a result of all this dollar selling and buying of local currencies, the latter goes up against the former) ----> Markets worldwide move up, so does Gold ----> Inflation (as imported by US) increases in world markets ---->US starts exporting more to feed that growth (as with depreciated dollar, US goods become cheaper; also, US interest payments (huge now, even bigger in future with a strong dollar) feel lighter for the government)----> US economy recovers due to jobs returning, fueling demand ----> World markets increase interest rates to rein inflation ----> Markets tank ----> Dollar moves out ----> Local Currency appreciates ---> Exports pick up ----> Economy picks up....

Now, that's more or less the holy grail of the markets, and economics.

What has instead happened (from the little data unraveled so far), is that the cycle has skipped some middle steps ...

Fed Releases Money (QE II - USD 600 bn) ----> Fearing inflation and asset bubbles, China increases interest rates to rein potential / future inflation (a precautionary measure)----> Markets tank ----> ....???

Just like life, markets too are in a hurry to catch up with the end...but all said, this puts a big question mark over how things are going to unravel post QE II. An excellent post by Mish (again) on this here.

And with this, the age-old questions are here to haunt us again - Is this the end of the beginning or the beginning of the end? Have we topped out on markets? On Gold? Should we completely get out? But stay in cash ? Which Currency?

My take is, (atleast for Indian markets) hang-on...we have good supports coming up a little further down from here...domestic demand is still intact...asset bubbles (real estate, indices) aren't of enormous proportions as in other countries...Inflation is a concern but regulator is taking measures occasionally to rein it in, Gold - well, a good hedge for its strong fundamental factors is a possible depreciation of dollar against INR. We'll have to be cautious, alert, nimble...as things pan out better in the open.

Till now, the normal approach was seen as US Fed release money ---> US markets improve ----> US Economy recovers....(as expected by the US Fed)...

And the contrarian approach was that this will not happen....instead the dollar will depreciate, US will not benefit from releasing money, other countries will...and so on.

But with the developments in the markets during the last couple of days, the contrarian approach really seems that Gold will go down, emerging markets will go down, dollar will appreciate against most other currencies, etc. 

At the end of it, the funny thing with taking a contrarian approach is, if you're taking a contrarian approach without knowing how many contrarians are there in the market, and if there are too many contrarians in the market, which one is the contrarian approach, really? 

Think about it...I will...!

Leaving you with some food for your thoughts...

Follow-up - Currency regulations, markets

A quick follow-up to some of my earlier blog posts:

Earlier I wrote about impending regulations due to currency crisis, it might be worth noting the slew of opposite opinions coming in from PM's Economic Advisory Council (here), which categorically denies the need to have any new / additional regulations to be put in place to stop the flow of free money coming from US into India. Another one supporting that argument, Stephen King (from HSBC) says, India may not need to have such regulatory measures to be put in place...and the same can be done by tightening lending to real estate and other such measures.

Going by the recent minor depreciation in INR vs USD, looks like the markets support this view...but I'd still keep an eye open for this, for this'll affect the markets in a far bigger way that any other single fundamental factor. Besides, with RBI giving optimistic estimates of inflation coming down by December, markets might just be in a wait-and-watch mode...'coz if the inflation doesn't come down as expected / projected...RBI might put in some regulatory measures to prevent the flow of cash from US. But overall, for now, this news is a kick on my back - side !

In another post, I wrote about the markets not looking too good for another rally immediately. From that time, Nifty has moved down from 6300 levels to a little under 6100 at the time of writing this review. 200 points on nifty - not bad ! (pat on my back).

Currency Crisis - Impending Regulatory Restrictions

Ok, Fed's fed-up with no real progress on the growth since the last QE (Quantitative Easing) of nearly a trillion dollars - so its' decided to pump in another 0.6 trn more into the system - primarily for buying debt of nearly insolvent organizations...not good - say many central bankers.


I was reading this excellent article through Mish, (you can read full text here). It points out that some countries, including South-Korea, China (incl. HK), and Brazil have already indicated in no unclear terms that they're deeply concerned about a lot of QEII money flowing into their currency and upsetting the finely balanced currency system (read appreciating local currency, lower exports, expanding trade deficit, coupled with lobbyists getting upset, and governments not seeming in control of the economy). So they've indicated a slew of measure to be put in place to ensure that the money doesn't flow-in too easily.


That said, the Golden Indian regulatory bird is yet to flutter its wings...and I don't think its sleeping...so I do expect some tightening in FDI policies sometime soon...timing is of essence here - considering a battery of PSU FPOs and IPOs lined up. If the markets get a whiff of such measures, its gonna tank - taking disinvestment targets out of reach for this financial year at least.


So Stay tuned...and stay nimble.

Musings - I

So, Gold is finally trading over $ 1408 (/ ounce)...guess QE-II is starting to take its effect already !!! (atleast on market psychology). Just in case you want some other views on this...you can find some more reading stuff of here...and several such blogs.

But, its once in a while that such news reports emerge...highlighted by one of the most read and respected blogs on global economy...Mish (on my reading list). Its reports like these that are hard to ignore.

Also, for traders in Indian stock markets, Nifty looks set for a minor correction (i could go wrong here) but just a minor one as there are good number of supports within 10-15% range. Post that, it looks set for another rally...I'm inclined to take a contrarian approach here - almost whoever i still speak to (on markets) is of the opinion that markets have run-up quite a bit and should see a major correction from here on...desist from fresh investments, etc. Its exactly this thinking that's going to keep people nimble and cautious...not a very good recipe for a crash !

A quick chart for those interested:

World Markets - Step on the Gas

Recently Mark Mobius said on Bloomberg: The U.S. Federal Reserve’s bond purchase plan will further drive the rally for global stocks and push commodity prices “higher and higher,”...

Couldn't agree more...with Gold to its highest price ever recorded (pushing USD 1400 / ounce) [Note: Its not an inflation adjusted price - any idea where to get that figure for the latest prices?] and Oil also looking to break-out, it looks increasingly likely that it is going to be interest rates, inflation, and growth running around in spirals trying to catch each other...with Currency dynamics popping surprise hurdles in the game.

If crude goes up, inflation mostly will...and so will related commodities like Sugar (used in ethanol - which is used in Bio-diesel - a substitute for crude oil for energy requirements), Palm Oil (with bio-diesel demand going up, Palm oil - an input in Bio-diesel also goes up), and so does Soy Oil (an alternative to palm oil in cooking), and Groundnut oil (an alternative to palm and soy oil) and others. The cost of transporting and cooking food goes up...stoking inflation further. And then people rush to Gold, traditionally considered a hedge against inflation. A depreciating dollar would help but only to a certain extent...beyond that, its upto the central banks to manage inflation.

However, consider this - while the selling price of most commodities goes through the roof, the cost of producing these commodities does not...resulting in increased margins for most commodity producing companies...(plantation, mining, drilling, etc.). So if I were to stick out my neck, I'd say go long on global commodity producers' stocks. And unlike Mobius, still avoid Airlines stocks - as for them Crude Oil is an input cost, and market share is as big a worry as margins. So increased volumes (due to increased economic activity) might just get offset against depleting margins....net result - stunted growth. Unless, of course, the airlines are hedging their input costs (intelligently)...so lets look-out for some smart financial managers in airline companies.

We're going through a rough patch, but its nothing to be worried about,...please return to your seats and put your seat belts on and enjoy the journey...!

Buy Gold? or Sell? Which ETF?

Off-late I've been getting quite a few queries from people on investing in Gold - makes me wonder if the Greater Fool Theory (http://en.wikipedia.org/wiki/Greater_fool_theory) is at work here and if we've reached a peak already !

However, to me Gold's still quite far away from its top...atleast it's difficult to say purely on technicals what the "Top" could be. With USD 0.6 Tn worth of QEII coming in fresh into the system, and central banks worldwide re-iterating their "buy" position on Gold, it seems fairly unlikely that Gold has reached a top.

Moreover, for people who're buying Gold in any of the emerging market currencies (Yen, CNY, INR, SGD, etc.) , the bearish outlook on dollar (more on that in another post) underlines that fact that even if Gold were to go nowhere in the next one year, but if dollar were to depreciate wrt these currencies, the owners of gold in such currencies would still end-up gaining.

This said, I usually tell people to get in into gold with a longer term perspective (3+ years), for bigger gains - and not worry to much about the impending 10-15% correction (there'll an 80%+ probability of this at any time, anyways!) in the short term.

In India, I recommend people to go with Benchmark GoldBees - listed on NSE. Its one of the most liquid Gold ETFs available. It can bought in units of 1gm each just like shares.

I'm trying to keep these posts simple, so as not to scare / overwhelm my audience by showing graphs depicting M3 with Gold Price, or Gold as % of overall investments over the last 40 years or so...etc. I'm in the process of updating my reading list. For those interested in a more in-depth analysis of such topics, can always go through them.

And yes .... a quick disclaimer: I may have positions in Gold / vested interest in influencing opinions of larger public in a way that benefits me most ! So do your own research and take your own decision. Thus far, I've never heard of good returns with "no-risk". There is no such thing as free-lunch. So stop expecting one ! Happy investing. And Happy Diwali.

Please do send in your comments / suggestions / complaints etc. I'll try and address as many as I can.