Oh What a Tangled Web…

This is interesting…

This morning, ANZ Bank [ASX:ANZ] warned that loan defaults would be ‘at least’ $100 million more for the first half of the year than it flagged just a few weeks ago. The charge will now be over $900 million.

The increase in bad debts relates to ongoing weakness in its resources loan book. That’s not really surprising when you consider the prolonged commodity bear market.

What is surprising is that you haven’t seen the banks take more of a hit from their exposures.

Given the preference of banks to lend against Aussie residential property, their overall exposure to the resources industry is low. According to the Financial Review, ANZ has 1% exposure to resources (as a percentage of its total loan book), second only to the Commonwealth Bank [ASX:CBA] with 2% exposure.

Still, such a small exposure doesn’t help when things turn south, as they certainly have in the commodity space over the past few years.

And while commodity prices have had some respite over the past few weeks, I would argue that it’s simply another bear market rally. The long term downward trend remains intact.

The overnight price action confirms this view. Oil fell around 3.5%. Gold fell around US$20 an ounce. The Aussie dollar sold off versus the greenback, losing around 1.3%.

Incidentally, the performance of Aussie gold stocks yesterday afternoon hinted at gold’s overnight fall. Stocks in the sector were among the market’s biggest decliners.

At the time, the gold price wasn’t under much pressure. Hmmm…

Gold looks really interesting here. It’s had a great run this year, and is now correcting slightly. You can see this in the chart below:

Source: StockCharts

[click to open in new window]

Decent support sits around the US$1,190 to US$1,200 an ounce region. If gold holds around here and starts heading higher, it will be bullish.

Also take note of the sentiment towards gold at this point. Some will say that the bear market isn’t over, and that gold will make new lows. Some will say this is a great buying opportunity.

I favour the latter scenario, but don’t listen to anyone right now. Just watch the price action and let the market tell you what to do. If prices fall below, say, US$1,180, then the new bull market scenario is on ice.

But if prices hold around US$1,200 or so, and then move higher, then the new gold bull market thesis is alive and well. You should know the outcome within a few weeks.

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The source of the overnight market weakness was, surprisingly, the US Federal Reserve. Voting member James Bullard gave an interview that suggested the Fed could move to raise rates as early as April.

This comes just a week after the Fed met to decide on interest rate settings. At this meeting, the Fed took great pains to let the market know that interest rates rises would be few and far between.

Here’s the problem for the Fed. They know the business cycle is long in the tooth. At the end of most business cycles, you see strong employment gains and rising inflationary pressures.

They are reluctant to raise rates too much because they know that the economy cannot handle higher rates. But as soon as they signal this stance, the market goes nuts, thinks the Fed will bail investors out no matter what, and excessive risk taking ensues.

The Fed, in turn, sees this, panics, and then tries to reset expectations…again.

It brings to mind the well know saying,

Oh, what a tangled web we weave

When first we practise to deceive!

For years, the Fed and other central banks have worked tirelessly to deceive markets. They want everyone to think things are better than they are.

But this only works while the Fed promises to support markets no matter what. When they try to take away this implicit support, the deception reveals itself.

This is the bind the Fed is in. It’s the same bind it’s been in for years. The market and economy either need to take their medicine now and recover with a stronger foundation, or the Fed can continue to ‘support’ the recovery while weakening the foundation.

It’s as simple, and disastrous, as that.

Making things worse, China is now a part of the same calculus. From Bloomberg:

China’s monetary and fiscal stimulus have yet to spur a rebound in the world’s second-largest economy, according to the earliest private economic indicators for March.

A purchasing manager’s index focused on small businesses, a gauge of corporate confidence and a new reading of the economy derived from satellite imagery all remained at levels signaling deterioration, though the pace of declines moderated. Sales manager sentiment was unchanged.

The reports follow mixed official data showing investment and property sales recovered in the first two months of the year as trade plummeted and manufacturing remained weak. Meanwhile, the newest data show government reforms to slash industrial capacity and shift to a greater reliance on consumption and services haven’t been able to offset the slump.

The irony is that China has had numerous bubbles to study and avoid over the past few decades, but it hasn’t learned any lessons. Instead, it’s just doing things on a grander scale, in the forlorn hope that its central planning firepower makes China an exception to the rule.

The funny thing is that it was central planning in the West that got everyone into bubble trouble in the first place!

Human nature is a funny thing. Despite ample opportunity to learn from our mistakes, we never do. We just keep making the same old ones, over and over again.

The key to evolving as an individual, or human race even, is to learn and benefit from your mistakes. It’s too much of a stretch to think that the people we put in charge of things will ever show enough humility and wisdom to admit and learn from errors. But that doesn’t mean you can’t.

On that note, I’ll sign off for the week. The office will shut down over Easter. I hope you have a relaxing break. I’ll be back next Tuesday.

Greg Canavan,

For Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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