Bad Feedback Loops

–Where to from here? For the technical view on the markets, the Slipstream Trader recorded a new market update this afternoon. You can view it on his YouTube channel. We’ll keep providing this free updates as long as you keep watching them. If you have any constructive feedback, leave it in the comment field below today’s update.

–The most important conclusion from yesterday’s Markets and Money is that global interest rates are headed up. This is true even if central banks try to artificially suppress short-term interest rates, like the Reserve Bank of Australia did yesterday. Case in point is the fact that 10-year Spanish government bonds are now yielding 6.45% and 10-year Italian government bonds are yielding 6.25%.

–This means Spain and Italy are close to joining Portugal, Ireland, and Greece in paying a large premium above what Europe’s most stable economy, Germany, pays to borrow. And even French 10-year bonds trade at an all-time premium to German bonds. Europe’s banking problems are getting worse.

–The trouble is that Europe’s banks are full of government debt that must be written down. For example, French bank BNP Paribas wrote down $768.3 million in Greek government debt overnight. It’s dawning on some banks and investors that sovereign defaults are inevitable in Europe.

–If you had your money in an Italian or Spanish bank right now, what would you do? You’d probably do what Irish savers did at the height of that country’s banking crisis. You’d withdraw your money. This spells trouble for banks in Italy and Spain.

–A mini-run by savers on deposits can remove billions from the balance sheet of a bank in short order. A feedback loop is created. The bank is forced to liquidate assets in order to raise cash. Selling assets begets falling asset prices begets more selling begets more depositor withdrawals.

–The real issue at the heart of the whole affair is that the European Central Bank (ECB) does not have the resources to bail out Spain and Italy in the same way that it bailed out Ireland and Greece (both of which now have banking systems almost entirely depending on the ECB for new cash). Savers in Europe are beginning to understand this. And the smart ones are either getting cash in their hot little hands, or exchanging their Euros for gold. You can see that on the chart below.

–That chart is evidence that gold is being remonetised in the world’s financial system. South Korea’s central bank announced yesterday that it purchased gold as reserve asset for the first time in 13 years. It bought 25 tonnes of gold in June and July. Central banks in Russia, Mexico, and Thailand have also bought gold this year.

–Meanwhile, everyone seems to be selling equities. This is joyous news for the aforementioned Slipstream Trader Murray Dawes. Today’s two per cent down opening on the ASX/200 allowed Murray to take profits on some of the trades he entered just yesterday. He’s loving it.

–Muzza isn’t the only one rubbing his hands with glee this morning. The enigmatic Kris Sayce is set to publish his latest issue of the Australian Small-Cap Investigator, in which he’ll recommend a speculative oil play. We asked him if he wanted to wait a day or two before making the recommendation public. He declined and said, “I reckon it’s the perfect time for it. Everyone is terrified. Prices are falling. This is exactly when we want to get in.”

Greg Canavan also wrote to us this morning about the debate between his contrarian and rational side. The contrarian side says, “Buy when others are fearful”. The rational side says, “The architecture of the global financial system is stuffed. Stay in cash and gold.”

–He’s publishing his next report today and we reckon he’ll reach a compromise of sorts. The advantage of having a valuation model is that you focus on what a business’s intrinsic worth is, and then you try and buy it a good price. The challenge in this market is not to get slaughtered by forces that are beyond your control (think Dangerous Liaisons).

–Speaking of Greg and things beyond our control, he sent the chart below late last night. It’s courtesy of the Reserve Bank of Australia. It can be summed up in two words: bloody scary. Or three words: what goes up…

–This commodity price chart squares with what RBA Governor Glenn Stevens has said about Australia at this point in history. Namely, the increase in the terms of trade and in commodity prices is historic and “structural”. If that’s the case, then this period where the Aussie market is influenced by debt woes in Europe and America ought to be transitional. There ought to be a point at which Australian stocks are more correlated to Asian and Chinese growth.

–But we don’t seem to be at that point yet. We seem to be at a point where credit writedowns and the contraction of global credit are leading investors to be pretty bearish about growth. You don’t pay a lot for stocks when you aren’t convinced they’ll grow earnings.

–Maybe we’ll ask ‘Adventure Capitalist’ Jim Rogers. He’ll be in Melbourne tomorrow and Friday as a guest of RBS Morgans. Our understanding is Jim will be talking about his new commodity indices. He always has something interesting to say.

–Jim has put his money where his mouth is, moving to Singapore with his family. He’s also created investment vehicles that allow retail investors to take a punt on rising agricultural prices. What does it tell you about America when its most enterprising individuals decide to leave the country? We’ll let you know what he has to say if we catch up with him. Until then.


Dan Denning
Markets and Money Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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2 Comments on "Bad Feedback Loops"

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Rick W
A large portion of the commodity price index is nothing more than a reflection of currency inflation. I expect the picture would be quite different if the prices were in CHF or gold. Prices of motor cars and durables are no more now in Australia than in 2003. The conversion costs of our commodities into durable goods is coming down courtesy of the efficiency of the Chinese economy setting new benchmarks. This is an historic shift of greater significance than the emergence of Japan in the 1960/70s. On the matter of inflation, bad news for savers that the RBA did… Read more »
According to the WSJ, quote the “Dow Theory” is now telling us the market is heading down. The century-old Dow Theory, a way to analyze market trends and turning points, says both the Dow Jones Industrial Average and Dow Jones Transportation Average need to move in tandem to confirm the trend. On Tuesday, the Dow Theory officially gave a sell signal unquote From my May 7 2008 pre-crisis ASX starting point until yesterday the whole of period percentage movement of the main ASX indexes now looks like this : XEJ energy -19.9 XXJ fin x prop -18.5 XHJ healthcare -17.1… Read more »
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