The silver lining in Chinese Inflation

China has increased its Reserve Ratio Requirement (RRR, the amount required to be set aside by the banks, not to be used for lending) yet again...by 0.5% to mop up an additional USD 54 bn from the market with an intention to reduce liquidity and control inflation. Let's take a quick look at the different problems confronting China:

The Liquidity Problem:

Consider this, Chinese banks lent around USD 1.6 trillion (almost equal to India's GDP) in 2010, most of it for infrastructure, and lent almost around USD 160 bn in January alone (!), a figure that's almost twice that of December 2010.

The Inflation Problem:

Inflation in China is already quoting around 5%, according to official figures. I've covered Chinese Inflation issue in my earlier posts, consider reading Betting on China Crash and Understanding China and Japan. Also, while food prices are under control for now, the housing market continues to hog limelight. House prices rose in Jan 2011 in 68 out of 70 Chinese cities surveyed. This, despite the introduction of property tax (though a measly 0.6% to 0.8%) and frequent increases in RRR.

The Currency Problem:

China has been under pressure from various international organizations with sovereign members to let its currency appreciate. Currency appreciation will make its exports less competitive though it might play some part in checking inflation. Currency depreciation will boost its economy but increase the inflation problem. So China has constantly let its currency appreciate, and shows this as compliance to currency non-manipulation to better manage international relations. See the USD Yuan chart below which shows how yuan has appreciated against dollar:

Though the appreciation is there, but its too less, too slow...over the last 1 year, yuan has appreciated by about 4% against dollar.

Soft landing measures:

On the face of it, it looks like Chinese measures are failing to keep both inflation and real estate bubble in check. But just think about it, how difficult would it really be for the Chinese government to dictate terms and functioning to Chinese Banks if they really wanted to curb lending to infrastructure? And please bear in mind, Chinese Banking industry is considered by many investors as fairly opaque and government driven...(part of the reason why Chinese banks don't openly participate (except through proxies) during sale / purchases of various sovereign debt instruments). 

China cannot afford to have a real estate bubble crash now...and they know it pretty well. The introduction of property tax also reeks of a gesture to please foreign investors more than anything else. They're completely abstaining from increasing interest rates to avoid a "Yuan Carry trade" situation (read more about this here) which will further worsen the inflation problem. In essence, all efforts are being made to not shake-up the real estate bubble, which has long assumed the position of "too big to fail".

So liquidity control without raising interest rates is probably the best way they've got. And this they're doing not just by increasing the RRR, but even, to a smaller extent, by acquiring Gold mines outside and simultaneously promoting consumption / investment in Gold / Silver in China. So people are just converting their yuan into Gold / Silver, which eventually will go to the owner of these mines from where the metals are being procured...the Chinese government held companies. [This, by the way, is also helping them control inflation through currency appreciation - as yuan supply reduces, it appreciates against its basket of currencies.]

In fact, so strong has the demand been off late, that even China's appetite for Gold and Silver is making frequent headlines. Here's an article from Zero Hedge giving various news items (most of them recent). The result...take a look at the silver prices:

Now, if this is indeed the case, and encouraging gold and silver consumption domestically is indeed a strategy adopted by the Chinese government, it's only a matter of time before both break their all time high and surge further ahead...Now, that's a silver lining in a dark inflationary cloud...

Random Walk - Econo blogging

Apologies for not writing for such a long time...guess I've been hit by the Writer's Block. Nevertheless, this post is about econo-blogging...and about how some digging into it almost took the steam off my writing...

Came across this website econdirectory through Mish's site. The website gives a huge list of all the blogs which write on economy (and does not include those which restrict to just plain and simple stock tips). It covers some 165 websites, most of which have public page views, and some others which don't. Overall, the top 5 guys in the list take up the major portion of readership...here's a sample of what it looks like...

A massive 61% of all page views are with the top 5 blogs, and a good 54% with just top 4. The rest of the 160 blogs consist of the remaining 39% page views. The page view by the latter segment is small enough for each one to not sustain any meaningful ad revenues. 

The NY Times even listed DIY (Do It Yourself) Macroeconomics as one of the top trends of 2010...in which, says NY Times "ordinary citizens pull apart the data and come to their own conclusions". So while more and more econo bloggers are joining the band-wagon, the pie is not undergoing any major expansions, resulting in traffic being held as captive audience by the top few websites.

Its tough getting into the top 20 list, and like even Mish pointed out, that would, under current circumstances, result in having just 5% of the traffic of the top blog...! But just like they say for Euro zone, there's hope...things could've been worse...

Golden movements

Gold has been falling for quite some time now...giving rise to talks about whether it has seen its peak for some time to come...take a quick look at the 30-day Gold Price chart below:

This fall came in the backdrop of US showing signs of recovery, quoting better unemployment  numbers and good consumption increases. This led to people moving out of emerging markets plagued with unsustainable inflation and prospects of lower growth and overall shrinking corporate margins; just as investors moved out of gold as well. People were again backing  dollar denominated assets, US and European markets. Take a look at how US and European markets have performed over the last 1 month.

But still, its not that investors have started looking at dollar any more appreciatively...the US Dollar Index, which shows the strength of dollar against various currencies, continued its downward journey over the last 1 month.

All this points towards some sort of portfolio reallocation among some major funds of the world. As a part of their strategy, they are taking some profits off the table from Gold, liquidating their positions in emerging markets, and increasing the weight of US and European stocks in their overall portfolio.

However, to me, Gold still looks like a minor correction before the rally resumes...nothing more. Egypt is on the boil due to political unrest, creating tensions in almost whole of middle east...which is spooking the investors worldwide. Once that settles down, Europe will come right back on the radar. And then may be Japan, who knows; with 200% of GDP as debt, 1 in every 4 persons above the age of 65 and no longer contributing to the savings (which was being used by government to raise debt), Japanese government will sure have to look for other avenues to raise debt just to keep paying off its interest on the debt..leave alone retiring the debt. China's real estate bubble can now be seen from outer space (;)), and once that crashes, it'll take a whole lot of other asset classes with it, right from Copper and Soybeans to Equities and Bond prices. Asia, just because of these two big shaky giants...is a risky place to invest.

But fundamentals for Gold still look intact. Central banks are still buying Gold...and these are the biggest players in the market - please bear in mind, they don't get in into the market to make a quick buck and move out as soon as profit targets are achieved...they're in for long.

Take a look at this article here, that talks about how Russia added 135 tons of Gold in 2010...an increase of almost 21% from their 2009 end Gold holdings ! Saudi Arabia has disclosed a purchase of 180 tons which has come in due to "adjustment of gold accounts". Take a look at the latest Official Gold Holdings for countries:

World_Official_Gold_Holdings_January_2011

Getting back to brass tacks, it means that US has almost USD 350 bn of Gold with it. Germany has nearly USD 147 bn, Italy and France has USD 105 bn each, China has USD 45.5 bn worth of Gold, while Russia and Japan have 33 bn dollars worth of Gold each and India has around 24 bn dollars worth of Gold.

The Gold reserves of US, though the largest in the world, are still far away from its Debt levels of USD 9 trillion (not accounting for contingent liabilities - like medicaid and Social security). Germany, France and Italy will need these reserves to boost world confidence in their ability to come out of this crisis...any selling by these central bankers in time of crisis might trigger a sharp fall in Gold prices which will further depress the reserves status of almost all nations with substantial Gold holdings - and so is fairly unlikely to happen. 

China has a long way to go  as far as diversification in gold is concerned since its gold reserves are just 1.8% of its nearly USD 2.5 trillion reserves. This thought has also been propounded recently by Xia Bin - adviser to China's central bank (see here).

The world is still quite close the uncertainty in several aspects...China's hunger for Gold will not go down, central banks will not sell their gold in a mad rush...these, and many such aspects are bullish signs for Gold...so for me, its still a good buy on all dips.

Addendum: See this article from Financial Times that talks about some gold traders estimating that China has probably bought around 200 tonnes of Gold in the last 1 month ! That's nearly 36% of India's Total Gold reserves ! Let's wait for China to release data on Gold reserves again...and we'll know how true these estimates were...

Betting on China Crash

The rumblings of an imminent Chinese crash are getting louder by the day...giving an eerie feeling that something too big is so close that we're not able to see it!

Consider this article in Telegraph a couple of weeks back, which says how many hedge funds are now betting that China would crash sometime soon. It says:

"One academic said: “Economists have contrarian views all the time. But these hedge funds have their shirts on the line and do their analysis carefully. The flurry of 'distress China’ funds is a sign to sit up.” ...A recent study by Fitch concluded that if China’s growth falls to 5pc this year rather than the expected 10pc, global commodity prices would plunge by as much as 20pc."

This is understandably so, given the huge amount of fears from Inflation, asset bubbles (especially real estate) and uncontrolled lending spree by the banks. Its not as if China is not aware of these issues...or not working on them. It has been tightening its bank's reserve ratios to absorb excess liquidity available with the banks. It has been buying European Union's debt to prop up Euro against the dollar and also yuan (Chinese currency). Keeping yuan lower with respect to Euro will help China in boosting their exports to Europe and give them some breathing space in terms of trade deficit (Exports - Imports).

The article further says:

"According to Corriente (Advisors), China has consumed just 65pc of the cement it has produced in five years, after exports. The country is outputting more steel than the world’s next seven largest producers combined. It has 200m tons of excess capacity. In property, Corriente said it had found an excess of 3.3bn square meters of floor space in China – yet 200m square meters of new space is being constructed each year."

Besides, Chinese real estate bubble is fairly well documented...an average apartment in Shanghai costs more than 22 times of disposable income there...making it beyond reach for most people. HK was recently reported as the costliest city in the world for housing. Despite several efforts to curb speculations on housing, China has been able to achieve little by way of increases in reserve ratios. However, recently it has put up a property tax for the first time...(read here). But with the rate at about 0.6%, it looks like a case of too little too late.

Take a look at another recent article in Telegraph that talks about how the real estate bubble could be growing bigger in China. The article mentions:

"The property tax would have "a big psychological effect on potential home buyers," said Ge Haifeng, head of research at China Real Estate Index System in Beijing. "China's housing market may get really quiet in coming months," he said. "

Big Impact !! A 0.6% property tax rate? In India, retail investors pay that much as brokerage (each leg) for all equity transactions ! Does that kind of rate stop them from trading? I don't think so...In India, property tax rates are fairly high and vary from state to state...and to me, a 10% + service tax (of 2%) is a normal rate for property taxes....that's how much people pay in India as their property tax...8-15% of property value...and it still does not stop people from speculating. And many Chinese, who are traditionally gamble-happy people, are expected to stop speculating the housing market because of a 0.6% property tax ! Let's just say, this is being made up to send a message to the markets that a lot is being done to keep bubbles in control...but obviously, the markets are not impressed.

I think this is more likely a warning signal to speculators to move out of the market and not get caught with their open positions when the rates are increased. The idea in such a case would probably be to remove the panic from the market when property rates are raised further, and thus ensure that a crash in real estate prices would not happen. But how it actually unfolds, only time will tell.

Chinese Automakers are also facing tough times with restrictions on selling cars being put up in most populous Chinese cities to reduce traffic jams. It'll again have a cascading effect as the automobile ancillary units are also an industry in themselves and will suffer major losses due to loss of revenue.

Also, with China talking of "no need for yuan to appreciate" since exports will slow down in 2011, it looks like even the pretense of letting yuan come up over a period of time is over now. This is not going to help the geo-political equations, look forward to comments from the US.

Even the credit default swaps (CDS) rates - the instruments through which people bet for a sovereign nation defaulting on payment of its debt, have been increasing for China...it means that more and more people are buying these instruments at ever higher prices, in the belief that when Chinese economy really looks weak, or even tumbles, they'll make a handsome gain on these investments. I have a rather dated article mentioning this, take a look at that here.

Will China really go bust? Its difficult to predict, given the fact that we don't even know that the numbers that we're talking about are true or not (these are, and can be massaged by government agencies). China's public debt is reportedly just about 20% of its GDP compared with 40% for India, 60% of US and nearly 200% for Japan. It can no doubt continue to build bridges to nowhere for some more time, and hoard gold to protect itself from a dollar bust scenario, but eventually, all this lending spree and housing bubbles have gotta give...and they will. But when? Now, that's a trillion dollar question!

Guest Post - "The Business of Resolution" by Arun Varma

I'm kicking off a brand new section on this blog - Guest Post. The intent here is to find emerging experts in various domains, not necessarily from Finance & Economy, and provide them a platform to express what they feel most passionately about...as long as it follows the basic tenets of being Simple and Applicable.

This Guest Post is from Arun, a good friend who has taken some time out of his busy schedule to give me an interesting piece to share with all of you. You'll find his details at the end of the article. So here goes our first Guest Post...Thanks Arun !

The Business Of Resolution

It was the 28th of December, an exceptionally cold evening in Boston going along the expected lines. David, Mark and I were frittering away time at Karen’s, following the latter’s invite to what she called an ‘exotic’ dinner. I was more hopeful than curious, as I badly wanted some fiery Paneer tikka masala and Tandoori Roti, but I was getting ready to delude the host with my ‘That was exquisite’ praise (It wasn’t my first time after all!). My hope was butchered when I found Quesadillas and Tacos. Mexican and exotic? I'm telling you, people have to use words more carefully, just so that you don’t raise hopes. So the acclaim went on, animatedly!

Post dinner the caboodles were kicking back by the fire place and the conversation was again along expected lines. (Something about this evening was so predictable!) Year-gone-by-problems, Anticipations…you know what I mean right? And then abruptly something unexpected happens.

David: Mark, so any New Year resolutions this time around?

Mark: Well not really.

David: What do you mean? How can you not have New Year’s resolution? (Flabbergasted!)

Mark: Well…You know, I really haven’t thought about it.. I guess…You know…Maybe…. (Almost apologetically with the look of a kid caught stealing candies)

The comments that followed almost crucified Mark instantly for the baleful sin of not having thought of a New Year’s resolution. As much as I was empathetic for Mark’s misery, I was glad that I got away without any damn resolutions.

Cut to the 31st of December. It was time for possibly the most hyped and over rated New Year eve party – the crystal ball drop at Times Square New York. Because my idea of a great new years eve is not blasting my urinary bladder (Folks who have been there will tell you why!) in acute East Coast winter (-8 C for the record) in the middle of a million inebriated demented lunatics, I was chilling at home and watching the ‘party’ live on TV. 

The ad aficionado that I am, my focus was more on the ad intervals than the ‘party’. To my surprise, Chantix (A Nicotine patch brand from Pfizer) was running their ad slots back to back. Pharma ads apart from being incredibly expensive (due to their lengths related to legal compliance) are usually not placed midnight. For a while, I thought it was a misadventure of some godforsaken media planner. But then I was surprised even more, when ads related to legal agencies offering to help one get out of debt appeared, again back to back. And then it hit me, and almost immediately astounded me! Quitting smoking and getting out of debt are 2 top resolutions Americans make and marketers were trying to milk the opportunity right there! So this resolution thing is that behemoth of a business!

Picture this. GSK which spends a whopping $15 Million only on the promotion of their smoking cessation product, Nicoderm, generated a sales of more than 1 million boxes just in the month of January last year in the US. If online search traffic on Google is anything to go by, look at the worm below:

(click for a sharper image)

From a low of 20 index points on the 26th of December, the query volumes for the keyword ‘Chantix’ (Pfizer) touched a peak of 90 points on the 3rd of January. This despite all the news of Chantix incited violence doing rounds!

The next most popular resolution – getting fit, is another money spinner. Gyms see the greatest membership growth in the first three months of the year, with approximately 12.4% of new members signed in January, 9.5% in February and 8.7% in March. Overall, Gyms, Health & Fitness Clubs posted 3.2% growth in 2010, reaching revenue of $25.09 billion. 

Additionally, Weight Loss Services are expected to grow 1.9% to reach $3.87 billion. ‘Planet Fitness’ the chain of basement gyms that I patronize, ran a $10 per month campaign until the 12th of January, that’s cheaper than a jug of beer at a decent bar. Oops we are talking fitness here! I almost suffocated in my gym the first 2 weeks, when the place was packed like sardines in a can!

It’s not the gym alone, people do anything to lose the flabs gained over the year. Even ‘demanding’ (strenuous?) tasks like popping pills, using ‘fat burning’ belts, lie down mats with poking pines (Search Acushakti on Google) and  wacky ways like applying creams, tans and hypnosis! Look at the ‘how to lose weight’ graph for the last 30 days:

(click for a sharper image)

The traffic spiked up from a low of 40 points around Christmas to an incredible high of 90 around the 3rd January. Additionally, unlike quitting smoking, losing weight does not seem to lose steam that soon!

Managing one’s personal finance seems to be another problem people battle against. Household revolving credit debt declined for the first time in 20 years in 2009, and is expected to decline even further in 2010. Furthermore, the personal savings rate will hit a 16-year high in 2010, as consumers continue to focus their efforts on managing their balance sheets.

As a result of this, the Financial Planning & Advice industry is expected to expand 4.1 percent, increasing to $39 billion. Portfolio Management companies are also expected to experience strong growth, expanding 33.4% and a huge part of this growth is inclined towards the first quarter of the year.

New Year Resolution industry is wider and broader than we imagine. Think about a certain average Joe deciding to spend quality time with family starting January 2011. This can mean more holidays (Impacting the travel industry), more movies, more eat-outs and more anything as quality time just means better life.

Another angle is what I would call ‘Cumulative effects’. Joe who decides to join a gym opts for better diet which means demand for healthy food goes up. Joe needs sweat shirt for his gym leading to more cumulative effects. Joe needs an MP3 player / Ipod for a groovy work out. The domino effect is mind boggling!

No wonder then marketers agree to part with heaps of moolah to cash in on the resolution craze. Like people who wait until the next year to meet their goals, start a project or reform a habit, marketers keep their budget apart to influence these vulnerable minds precisely when and where its most delicate.

As for Mark, maybe he should resolve to think faster from next year!

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Arun Varma is a Boston-based digital media professional who previously worked with Google. He is a contributor columnist to Socialnomics.com, one of the top 10 social media blogs in the US as ranked by the PC Magazine. He enjoys conceptualizing and hosting business quizzes and is all set to complete his MBA from HULT International Business School. 

Follow him on Twitter @varmaarun

Feedback: arunvarma100@gmail.com
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Follow-up - Nifty Trading Strategy - Short Strangle

Thought I'd do a quick follow-up on the Nifty Trading Strategy given a few days back in my post. But before that, I got quite a few queries asking me to explain the strategy a little better, mostly by those who only part understood it and were fairly keen on executing it.

So here's a quick primer on a "Short Strangle Strategy":

Its made by shorting a put option and a call option. The put option must be of a lower strike than the call option. The idea here is, if the underlying (here, Nifty) is likely to stay within a particular range before the next option expiry, you can make money by betting on it. If it does so, good...you get to keep all the premium received by selling a call and a put. If it does not, well, the losses, theoretically, are unlimited. Let's understand this a little better; here's the profit profile of a short call and a short put option.

(click for a sharper image)

So, like it was suggested in the strategy, shorting 1 Nifty (6100 strike) call option on that day would have paid you 

Rs. 15.4 *50 (each lot of nifty has 50 units) = Rs. 770.

Thus, you'll retain this entire amount if Nifty stays below 6100, and you'd break-even at 6115.4 and for every point above 6115.4, you'd stand to lose 1*50 = Rs. 50

And shorting 1 Nifty (5700 strike) put option would have yielded 

Rs. 87 *50 = Rs. 4350.

Thus, you'll retain this entire amount if Nifty stays above 5700, and you'd break-even at 5613 and for every point below 5613, you'd stand to lose 1*50 = Rs. 50

So the total money received by you at the start of strategy would have been 

770+4350 = Rs. 5120.

You'll retain this entire amount if Nifty stays between 5700 and 6100, and you'd break-even at 5613 and 6115.4 for every point below 5613 or above 6115.4, you'd stand to lose 1*50 = Rs. 50

So this is how the profit profile of the suggested short strangle would look like:

(click for a sharper image)

And here's how the strategy has performed from the time it was given:

(click for a sharper image)

As of now, the strategy is making money to the tune of over Rs. 2800 / lot. There are 3 more trading days left - since 26th is a trading holiday. The options will start losing their time value fairly quickly now which will make this strategy more profitable. Any sharp downside movement (we're quite far away from hitting the upper limit of 6100) although, will result in losses. 

Happy Trading !

Strong China Growth - Bullish / Bearish ?

Like I said in the last post - these are interesting times indeed...Please consider the two news articles given below.

The first one is dated 14th of December 2010, and talks about the day when Asian stocks rose due to China reporting strong growth numbers. It says:

"Asian stocks advanced on Tuesday, supported by optimism that China would avoid aggressive moves to curb inflation that could inhibit its strong economic growth and blunt its voracious demand for raw materials."

Compare this to the second one which is dated today, 20th of Jan 2010, and talks about how Asian markets tumbled when China said it grew by a robust 10.3% in 2010. It further says:

"China said its economy grew 10.3pc in 2010, marking the fastest annual pace since the onset of the global crisis but concerns about persistent inflation sent Asian markets tumbling."

What a difference 28 - 29 trading days can make ! Inflation was high then, is high now. Interest rates haven't been raised during this period, although liquidity has been sucked in through increases in RRR - the reserve ratio requirement which mandates banks to keep a certain percentage with themselves as cash and not give it off as loans.

It doesn't end here though. The first article goes on to say:

"A Reuters poll released on Monday showed economists still see a rate rise in China in coming months, but expect policymakers to rely more on lending controls in 2011 as its weapon of choice in the fight against inflation."

...while the second goes:

"Analysts said the pick-up in growth in the fourth quarter - partly driven by stronger exports - and the still-high inflation in December supported the case for further interest rate hikes and bank lending curbs."

Apparently now the markets are really sceptical about interest rate hikes coming up...quite a bit of change of view from the previous one !

Like I said before...interesting !

Goldman Sachs on BRICs v/s US Markets

An interesting article in the Telegraph on Goldman shunning BRIC (Brazil, Russia, India and China) nations for US markets for better returns this year. Just thought I'll evaluate this news literally...and here's what I've managed to come up with, please take a look at the following charts of global indices and how they've moved over the last 6 months:

(Click for a sharper image)

Notice among all the markets in the world, namely, US, France, Korea, Canada, UK, Australia, Brazil, India and China, only the latter 2 are actually in a downtrend right now, the rest are actually at or well above their support levels.

The reasons are fairly well publicized, Inflation and an economic hard landing for China and Inflation and fiscal deficit for India. Inflation is the common major worry in both the economies though. China is rumored (conservatively speaking) to suppress its actual inflation figures which some believe to be in early double digits...and for countering a growing distress among local lower-middle class population, it has raised salaries for government employees twice in the last 1 year...and that too by over 20% each time! This is in turn putting an upward pressure on the salaries of their peers in private organizations in China, thereby hurting their wafer thin margins.

India is a worse story in Inflation, recent ads in newspapers and TVs are from poultry chains showing the marginal price difference between vegetable and poultry products...and asking people to make a better choice ! Some people are reportedly even switching to fruit diet as they are almost as costly as vegetables here. Although unlike China, the liquidity is quite tight here, asset bubbles not as great and the banking industry much more robust, but with the government racing down to find the depth of moral bankruptcy through various scams over the last 1 year, its an overall fairly uncertain scenario, which is something no investor will like.

It'll be interesting to see how things unravel from here...will China really crash? Will India see a major correction from here? Will the US economy rebound? Will EU stabilize thus sending gold southwards?

But then again, always keep in mind the (potential) vested interests of such investors, and that there have been times when they have given an outlook for $200 / barrel of crude oil (when oil was $122). Crude eventually went to $147 and then turned back to touch $35 in less than a year. These are interesting times indeed.

Global Inflation, local solutions

Inflation is making headlines globally again, and going by Google trends, is almost as worrying for most people globally as it was in 2008 !

Consider the following news pieces over the past few days:

• South Korea raises rates to tackle Inflation (here): S. Korea increased rates to 2.75%, about 75 basis points more than its low during Feb 2009 period, when it had slashed rates to tackle recessionary effects. This is its 3rd attempt since, to bring inflation back to under 3% from about 3.5% currently and for Korean PM to bring the growth back on track to at least 5%.

• Australia faces food-inflation risk with Tomato prices shooting up by 20% (here): Situation might get further aggravated due to floods in Australia, which reportedly could have caused as much loss as 1% of its GDP. Besides, with petrol prices inching up further in the coming weeks, the inflation is unlikely to come down anytime soon. Moreover, flood situation is likely to result in a delay in increase in rate hikes as well, to be able to offset the lack of growth in the flood affected region.

• China increases its RRR again in a bid to control Inflation (here): China (as also Taiwan) has increased is reserve ratio requirement (RRR) by 0.5 % which mandates banks to hold more money with themselves instead of lending it, in a bid to reduce the money in circulation and tighten liquidity. China is clearly refraining from increasing the borrowing interest rates as it might not only hit the growth hard, but even fuel the Yuan carry trade (wherein, people from foreign countries with lower interest rates can take loans in their countries and invest in China at higher interest rates - something similar, but in reverse order has happened in Japan for a long time due to its long bout of near zero interest rates). If a Yuan carry trade does happen, it'll negate all measures being taken to contain inflation as a whole lot of foreign money will come in into China's financial system.

• India's WPI inflation touched 8.43% in December (here): Indian markets are caving in due to better growth prospects from US and due to upward pressures on interest rates due to high inflation. Although onion prices in India have come down from its highs of over 2$ / kg to around 1$ /kg, its still high enough to be unaffordable to over 75% of India's population. Expect some interests rate hikes soon from India. Since moving money in and out of India is not easy due to various capital flow controls, unlike some other countries, India would not trigger a massive Rupee carry trade by increasing interest rates.

Its not just the emerging market economies / Asian economies which are facing teething troubles due to inflation, even UK and US are reporting increases in inflation. Besides, Compare the response to inflation in China now (@ 5.1%) as compared to in 2008, when it was over 8.3% and its RRR was about 16% as compared to 19.5% today ! Back then, it was a real problem with excess liquidity, now its not. Thus, at this stage one question that needs to be asked is not How to control inflation, but rather, What is causing inflation despite poor growth and high unemployment in most of the developed world?

Reasons for Global Inflation:

Inflation can be caused primarily due to 2 reasons - if liquidity / amount of money in the system is high (like in China), or if Supply and Demand dynamics of inflation causing elements change. For example, food - which contributes a decent chunk to inflation figure, and is fairly inelastic in nature (just because food prices have gone high, you'll not stop consuming food...may be make a temporary dietary shift, but still eat something). Or real estate, if everyone starts buying houses tomorrow, then considering the decent amount of weight it has in inflation figure, inflation will rise along with prices of other related commodities like steel, cement, etc.

Yet another way of looking at inflation is, like Mish says, to look at the supply and demand of money itself. But this time around, I think its primarily the supply and demand of commodities, which is causing inflation globally, and not the excess supply of money / poor demand for money (which might happen if interest rates are reduced to such low levels, that people do not have any incentive to save). 

If we look at the real estate bubbles forming across different countries like India, China, Singapore, Australia, Thailand, etc., its not very difficult to see why costs of some of the basic commodities is going up, which is further stoking inflation. Food prices globally are also on the rise, from basic food items to raw materials like soybeans and palm fruits, which are used to produce soy and palm oil (to be used in cooking). High energy prices (crude oil nearing 100$ - though now it has come back to 91$ / barrel) aren't contributing to reducing inflation in any way either. Just like Australia, India too is looking at higher petrol prices due to high crude prices globally...India will rise today to an approx. 5% hike in petrol prices...and how this will affect inflation is anybody's guess.

Its a combination of liquidity control and food / commodity production investments which are a key to controlling inflation right now, rather than just using text-bookish ways of taming it through fiscal / monetary measures. The former is the playground of central bankers, while the latter, that of the governments. China has already started investing big time in food production to tackle this issue, Singapore has started implementing roof-top harvesting concepts to reduce dependency on imports of essential commodities in future as also to reduce the fluctuations in food prices, heck, even Greenland is using greenhouse effect to increase its produce of agriculture.

Though these are baby steps towards future sustainability, and is surely unlikely to yield either results or fruits (literally !) in near future, but it looks increasingly likely that another Green Revolution is required in sync with liquidity control measures to tackle inflation from here on...

How Fed pumps in money into the system

An interesting article in the NY Times explains it all - how US Federal Reserve pumps money into the system...basically, the grail of how Quantitative Easing works.

Take a look at how QE works here, explained in a simple way:

(click for a sharper image)

Basically, Fed prints money and deposits it in its own account (I know what you're thinking of right now...I wished the same ;)). This money is then used to buy back bonds sold by US Treasury to banks. The bank use this money for lending, both commercial and retail, through lower interest rates, which motivates people to take loans and spend it on either revenue / capital expenditure. This creates demand for people, products, services and takes the economy on a higher growth path.

The article gives a glimpse of how it all is actually executed by a few traders sitting in the Fed's office...and buying bonds from the 18 PDs (Primary Dealers - who have the sole authority to buy bonds from treasury in the first place).

So, by issuing QE I, Fed bought back bonds worth over $ 1 tn from these large banks / PDs, and with QE II, Fed is again buying back another $ 600 bn from them. All this money is supposed to go into the system as loans to companies and people like you and me...to build better products, to buy houses, etc. but is it actually happening?

Consider this really interesting article from The Telegraph, which talks about trap that America's have-nots are in. It talks about how high-end luxury stores like Cartier and Louis Vuitton US are witnessing strong growth over 50%, but bargain shops like best buy and Walmart are seeing a drop in sales !

It summarized the context of this post beautifully:

"Such is the blighted fruit of Federal Reserve policy. The Fed no longer even denies that the purpose of its latest blast of bond purchases, or QE2, is to drive up Wall Street, perhaps because it has so signally failed to achieve its other purpose of driving down borrowing costs."

It further goes on to say:

"Corporate America is in a V-shaped recovery,” said Robert Reich, a former labour secretary. “That’s great news for investors whose savings are mainly in stocks and bonds, and for executives and Wall Street traders. But most American workers are trapped in an L-shaped recovery."

I like that phrase - "L-shaped recovery"...personifies the current pain of American Middle-class...with its growing mortgages as interest rates grow, inability to get out of their investments in housing, unemployment hitting every 5th employable person, and even pensions at risk because of states inability to keep up with the payments.

And all that Fed does is to pump in more money into the system - very much like digging deeper in order to get out of the trench...all the best making it work Sammy.

Indian Markets - down but not out, Trading Strategy

Its amazing to see a strong unidirectional trend in the markets...this time its down ! Consider this, from the start of this year, Nifty has gone down by nearly 7% while some others like Bank Nifty and CNX Realty have shed over 10% and 12% respectively !

Here's the chart for Nifty:

(click for a sharper image)

And for Bank Nifty:

(click for a sharper image)

The reasons for such drastic fall are apparently the flight of hot-money from India in the backdrop of strong consumption / demand and reduced unemployment numbers being reported from US and rising default risks in EU region again reminding investors further about the relative sustainability of the US.

The flight of money from India is also reflected in the USD INR Chart of the last 5 days (see chart below). Notice how INR has moved from 44.4 to nearly 45.4 in just 5 days...in currency markets, that's a HUGE movement.

(click for a sharper image)

China's inflation worries and its continuing stress on further rate hikes is keeping the entire Asia Pacific region on tenterhooks for an impending crash. Besides, China has been coming under increasingly higher pressure to let its currency appreciate in order to help US and Europe cope with their crisis better, which if it happens, would be disastrous for most markets as it will lead to China crashing.

However, I think given the strong 200DMA supports coming up for both Nifty and Bank Nifty, the fall should take a breather here. Moreover, with China reporting a trade surplus (net of Exports - Imports) of nearly USD 13 bn for Dec 2010, (which happens to be much lower than what it was last year in the same quarter), it is in a better position to bargain for slower / no increases in yuan (CNY) during meeting with Barack Obama on Jan 19 this year. [Keeping its currency weak will help China in boosting its export value, and thereby increasing its trade surplus. Ditto for US, which is going to be one of the points of discussion during the meet] Such a bargain (though US is unlikely to give it) will help China immensely in keeping itself from a crash, which will be a good boost to Asian markets.

Besides, with US pumping in more money into the system through its currently on QE II, China is going to find it tough to increase interest rates. This is because if it does, it'll boost what is known as the "Yuan carry trade". The term Carry trade was earlier associated with Yen, wherein, given the near zero interest rates in Japan, investors used to borrow in Yen and invest in foreign markets where interest rates were higher, thereby making a neat sum in this simple arbitrage. For China however, increasing interest rates will bring in even more from the US where the rates are currently near zero. This will further pump up the money supply in China boosting inflation further - which is the last thing China wants at this stage. This will, among other factors, keep China from increasing the rates too much, too often...and it is more likely to contain inflation by sucking liquidity out of the financial system (by increasing reserve ratio for banks, making loans to real estate more difficult, etc.).

Given this scenario, I'd suggest another trading strategy for this month...to sell a Strangle. Sell Nifty Jan 5700 put for 87 and sell Nifty Jan 6100 call for 15.4. This will result in a net inflow of (87+15.4) = 102.4 * 50 units = 5120. If Nifty ends up between 6100 and 5700, before 27th of Jan (another 12 trading days) the entire money is yours.  The break-even points would be 5598 and 6202. Beyond these points, you'll end up losing 50 bucks for every point. Keep your stop-losses in place and trade.

See my earlier trading strategy and its follow-up here.

Disclaimer: No positions as of now. But be aware of the risks...I'm not a trader by profession and don't claim to have any expertise in either trading or recommending trading strategies.

Global Oulook for 2011

Here are a few questions that I posed in my post earlier. These are a part of the Global Outlook for 2011, some of the most important questions staring us in the face right now....from Euro to Gold, Currency wars to US recovery. Enjoy the ride...

• Is Euro zone going to fall apart? Will Euro cease to exist as a currency?

Tough one to start with....the troubles in EU seem never-ending...its like the "Hydra of Lerna" (from Greek mythology)...a deadly serpent which had nine heads, and each time one head was cut-off, two more came up. Only this time, it all first started with Iceland instead of Greece. [Remember the good 'ol joke about Iceland's capital? It was arguably around 4 Euros !]

The troubles have since passed through Greece and Ireland, and looks set to suck-in Portugal, Italy and Spain sometime soon. And don't forget, its not that Iceland, Greece and Ireland are out of troubled waters just because they got handed over some nice bail-outs.

Unlike the US, since EU is woven with the same currency with different political leaderships, the more Euros that are printed and given out, the more the purchasing power of the other EU nations reduces (as it devalues their currency as well). People in countries that are better off, like Germany and France, don't like this Robin-hood story being played on them...(I think rightly so). But what choice do they have? If they don't bail-out these guys, their banks are going to take a big hit on the Iceland / Greek / Ireland bonds they hold...which is going to put them into trouble...creating a contagion effect.

Moreover, as per recent reports, German leadership, under pressure from the vote-bank, is getting tougher on such bail-outs. Reduced bail-outs with severe austerity-imposing conditions will not make things any better for the troubled countries.
So from the looks of it, EU has tough choices, and it'll have to do a tight-rope walk between keeping its vote-bank happy and letting the Euro go down. My guess is, it'll continue making and imposing tough choices on near-default nations, who'll have to abide by the rules, and manage their civil unrest internally. May be, just may be, to teach others a lesson, one of the countries just might be let out of the EU, possibly the worst & smallest one, which will also help shoring up Euro value and giving a moral boost to the general EU public.

Accordingly, Euro should continue to do badly, but abandoning Euro altogether is probably not an option. Euro should sustain for some more time.

• Which countries in Euro-zone are getting into trouble next? Will anyone default?

Taking over from the previous question, Portugal, Italy and Spain should be next in line, possibly in that order. But to default either the country has to choose it or or they have to be made to default. My guess is, and its really just a guess, that probably Portugal should default, although i cant say due to which of the 2 reasons above...and probably Germany and France may even force Portugal out of the EU.

Again, like I said above, not doing it with Portugal will further emphasize the fact that individual country's leaderships are willing to sacrifice their people's financial health for the overall health of the EU...which not many people will like. Also, while Portugal is big, its not as big a problem as Italy / Spain...so letting it default will probably just cause tropical storms in the financial sectors and not a Default Tsunami. Such an action will also prove to people that their leadership cares first about them and then the general good of people who've spent & speculated mindlessly in the boom times.

• How will the currency war be played out between US and China?

Include Euro here and what we get is a thriller of a race... to the bottom ! Let's try and understand what's happening here...as global demand for almost everything goes down, countries increasingly prefer a weaker domestic currency (e.g. 54 INR / USD is weaker than 45 INR / USD; 8 CNY / USD is weaker than 6.6 CNY / USD...and so on). This helps the countries compensate the lack of demand / growth with increased export value. Therefore, with say, 15% weaker currency, even a drop of 10% in exports will result in net realizations of +5% for the country.

So, to prop up their fledgling economies, all countries are trying hard to push their currencies down. China, under pressure from various groups and markets, has let their currency appreciate from nearly 8.3 CNY / USD to current levels of 6.62 CNY / USD...a strengthening of almost 25% ! And the US is still crying hoarse about Chinese currency's undervaluation...! Now, this is not to say whether Chinese currency is fairly valued or not, the point is, the amount of strength Chinese currency shows from here, that much growth is required in Chinese exports just to keep the value of exports same...and where is that growth going to come from? US, UK, EU, India, SE Asia, Australia? All have the same problem and are trying hard to keep their currencies weaker and fulfill all their domestic demand internally by putting more import restrictions in place.

My take on this is, its going to end up in favor of China ! Despite all its problems of unemployment, housing starts, foreclosures, states approaching bankruptcies and what have you, US is still the safest bet amongst the likes of Euro, Renminbi and Yen, can keep pumping in money to keep a semblance of sanity longer than most believe, and still amounts for a massive pie in the global consumption.Many states are nearing bankruptcies, but can pull along from an year's perspective.

China, on the other hand, is already struggling with inflation and poor domestic consumption growth at the same time...(consider reading my earlier post on Inflation in China and India). It has massive infrastructure just lying around waiting to be used, strengthening currency is further eroding wafer-thin margins from export oriented manufacturing units - further limiting the worker's pay rises. Although China is making amends to avoid a crash, in terms of diversifying into Gold, asking its trading partners to use CNY as base currency for trading, buying out debt from EU zone to help stabilize Euro, and investing big-time in agriculture to address the supply side issues in agriculture, my feeling is, its too small an effort too late in the day.

Also, given the expectations that demand from Japan is not going to be very encouraging, (consider my earlier post on Understanding China and Japan), commodities and manufacturing dependent China is far less likely to be able to avoid a crash...which might help it in at  least one way - it'll weaken its currency quite a bit. Such currency crisis at global levels have occurred before but this time around the difference is restrained geo-political efforts in containing it. Almost everyone is so deep in crap, that fending for themselves is top priority now.  There is no consensus on who to trust and which side to stand on. In times of global crisis, like these,  USD will appear a fairly decent haven, especially when compared to CNY, Eur and Yen.

• Will the US Economy recover?

Fairly unlikely but considering the uncertain scenarios elsewhere in Japan, China, EU, Australia and SE Asia, I think it should do just OK this year...or rather "muddle through". US states will continue to have problems clearing their pension bills, the unemployment is really difficult to come down, the foreclosures are likely to maintain pace, and Fed is likely to give-in to a QE III if need be, to keep the rotting machinery lubricated for some more time. So its not that the problems in US are going to get solved any time soon, but I look at this as a Titanic sinking, due to its massive size, it'll take time sinking.

• Are Gold and Silver the new proxies for currencies? Will countries start dealing in Gold and shun dollar completely?

While gold is widely accepted as a good alternative to any currency, world is not likely to move freely (stealthily, maybe) to a gold standard. This is primarily because large economies like Japan, China, EU countries, hold humongous amounts of US bonds...so if they show clear interest towards dealing in Gold, US Bond prices are going to crash...and so will the M2M value of all central banks' holdings. So right now, countries are stealthily diversifying their holdings into gold and other currencies (e.g. China, instead of buying gold from markets, which will be widely known and reported, is quietly buying gold mines worldwide, and marking down their potential reserves). 

 

However, this is a shift that will continue to take place, albeit slowly - like IMF has started accepting payments in Gold. So instead of seeing a massive move towards Gold as a reserve currency, we're fairly likely to see subtle shifts, which will also help in keeping the Gold prices up and rising for the year to come.

Happy New Year !

Wishing all my readers a very Happy and "investful" New Year 2011...!

I was surprised to see, for the first time since this blog was launched, this blog registered Zero hits on a day (i.e. the 1st of Jan 2011)...but I'm happy about this! I think all you guys must have had good fun celebrating the new year bashes ! I too had a good time...with barbeques, and vodka, fun and dance...and with family over here with me, it was extra fun !

Its always good to keep one eye on investments, markets and outlook, and another one on celebrations and family...there are always reasons to celebrate, no matter what !

Hope you guys have a great year ahead !