Investing in Macro Tipping Points

THESE ARE NOT RECOMMENDATIONS - THEY ARE MACRO COMMENTARY ONLY - Investments of any kind involve risk.  Please read our complete risk disclaimer and terms of use below by clicking HERE

DRIVER$ - USD & Energy

USD

The $9 TRILLION Crash Gains & Pains

The financial world focuses far too much on stocks. The stock market, despite being at record highs (meaning record market capitalizations) remains one of the smallest, and least sophisticated markets on the planet. Consider that stocks, even at current lofty levels, have a global market capitalization of slightly over $60 trillion.

In contrast, the global bond market is well over $100 trillion. And the global currency market trades OVER $5.3 trillion per day.

It is currencies, not stocks, where the most significant moves occur. The currency markets are the largest, most liquid markets in the world. They are always first to move when things change. Stocks are the DUMB money compared to currencies.

So who cares?

Everyone should care, because, globally, the world is awash in borrowed money… most of it in US Dollars.

When you BORROW in US Dollars you are effectively SHORTING the US Dollar. So when the US Dollar rallies… you have to cover your SHORT or you blow up.

I’ve written before about this problem. Last month I projected that the US Dollar carry trade (borrowing in US Dollars to finance other investments) was the largest carry trade in the world. At that time I believed the US Dollar carry trade is believed to be north of $3 trillion.

I was WRONG… WAY, WAY WRONG. It’s MANY MULTIPLES LARGER THAN THAT.

Off-shore lending in US dollars has soared to $9 trillion and poses a growing risk to both emerging markets and the world's financial stability, the Bank for International Settlements has warned.

SOURCE: the TELEGRAPH.

The US Dollar carry trade is north of $9 trillion… literally than the economies of Germany and Japan COMBINED.

And the US Dollar is rallying… HARD.

The fact that Oil is imploding at the same time this happens is not coincidence. Oil producers and explorers were financing their projects using what? BORROWED DOLLARS.

This is going to begin seeping into emerging markets and other assets soon. Imagine what the world would look like if $9 trillion worth of shorted Dollars had to be covered? Imagine the SELL PRESSURE this would induce in all other assets.

Just like 2008.

OIL - WTI

QE allows more borrowing from the future than would be possible if market interest rates really had to be paid. This allows financiers to temporarily disguise a growing problem of un-affordability of oil and other commodities.

The problem we have is that, because we live in a finite world, we reach a point where it becomes more expensive to produce commodities of many kinds: oil (deeper wells, fracking), coal (farther from markets, so more transport costs), metals (poorer ore quality), fresh water (desalination needed), and food (more irrigation needed). Wages don’t rise correspondingly, because more and more labor is needed to provide less and less actual benefit, in terms of the commodities produced and goods made from those commodities. Thus, workers find themselves becoming poorer and poorer, in terms of what they can afford to purchase.

QE allows financiers to disguise growing mismatch between what it costs to produce commodities, and what customers can really afford. Thus, QE allows commodity prices to rise to levels that are unaffordable by customers, unless customers’ lack of income is disguised by a continued growth in debt.

Once commodity prices (including oil prices) fall to levels that are affordable based on the incomes of customers, they fall to levels that cut out a large share of production of these commodities. As commodity production drops to levels that can be produced at affordable prices, so does the world’s ability to make goods and services. Unfortunately, the goods whose production is likely to be cut back if commodity production is cut back are those of every kind, including houses, cars, food, and electrical transmission equipment.

Conclusion

There are really two different problems that a person can be concerned about:

1. Peak oil: the possibility that oil prices will rise, and because of this production will fall in a rounded curve. Substitutes that are possible because of high prices will perhaps take over.
2. Debt related collapse: oil limits will play out in a very different way than most have imagined, through lower oil prices as limits to growth in debt are reached, and thus a collapse in oil “demand” (reallyaffordability). The collapse in production, when it comes, will be sharper and will affect the entire economy, not just oil.

In my view, a rapid drop in oil prices is likely a symptom that we are approaching a debt-related collapse - in other words, the second of these two problems. Underlying this debt-related collapse is the fact that we seem to be reaching the limits of a finite world. There is a growing mismatch between what workers in oil importing countries can afford, and the rising real costs of extraction, including associated governmental costs. This has been covered up to date by rising debt, but at some point, it will not be possible to keep increasing the debt sufficiently.

The timing of collapse may not be immediate. Low oil prices take a while to work their way through the system. It is also possible that the world’s financiers will put off a major collapse for a while longer, through more QE, or more programs related to QE. For example, actually getting money into the hands of customers would seem to be temporarily helpful.

At some point the debt situation will eventually reach a breaking point. One way this could happen is through an increase in interest rates. If this happens, world economic growth is likely to slow greatly. Oil and commodity prices will fall further. Debt defaults will skyrocket. Not only will oil production drop, but production of many other commodities will drop, including natural gas and coal. In such a scenario, the downslope of all energy use is likely to be quite steep, perhaps similar to what is shown in the following chart.

Figure 5. Estimate of future energy production by author. Historical data based on BP adjusted to IEA groupings.

Related Articles:

Low Oil Prices: Sign of a Debt Bubble Collapse, Leading to the End of Oil Supply?

WSJ Gets it Wrong on “Why Peak Oil Predictions Haven’t Come True”

Eight Pieces of Our Oil Price Predicament

DRIVER$ - Sudden market swings, dollar rise expose emerging market vulnerability: BIS

(Reuters) - Sudden swings in financial markets recently suggest they are becoming more fragile and sensitive to unexpected events, the global organization of central banks said on Sunday, warning that a rising U.S. dollar could have a "profound impact" on emerging markets in particular.

MSCI's all-country world stock index is hovering around multi-year highs after rebounding from sell-offs in August and October.

    The downturns were triggered by uncertainty over the global economic outlook and monetary policy, as well as geopolitical tensions, and the Bank for International Settlements (BIS) said the sharp and sudden dips pointed to frailty in the markets.

    "These abrupt market movements (in October) were even more pronounced than similar developments in August, when a sudden correction in global financial markets was quickly succeeded by renewed buoyant market conditions," the BIS said.

    "This suggests that more than a quantum of fragility underlies the current elevated mood in financial markets," it said in its quarterly review. "Global equity markets plummeted in early August and mid-October. Mid-October's extreme intra-day price movements underscore how sensitive markets have become to even small surprises."

    The comments followed the organization's warning in September that financial asset prices were at "elevated" levels and market volatility remained "exceptionally subdued" thanks to ultra-loose monetary policies being implemented by central banks around the world.

Since then, the U.S. Federal Reserve has brought its monthly bond-purchase program to an expected end. However, Japan's central bank has expanded its massive stimulus spending while China unexpectedly cut interest rates, adding to stimulus measures from the European Central Bank.

These divergent monetary policies [US' TAPER ending and Japan's Massive new stimulus], coupled with the dollar's recent appreciation, could have a profound impact on the global economy, particularly in emerging markets where many companies have large dollar-denominated liabilities, the BIS said.

"It's the warning that the rising dollar could bring more (emerging markets) trouble in its wake - as it did in the 1990s - that is going to challenge FX markets tomorrow morning while we're all thinking about what the U.S. non-farm payroll data mean for Fed rate hike timing," Societe Generale's currency strategist Kit Juckes told clients in a note on Sunday.

Juckes was referring to the larger-than-expected 321,000 rise in U.S. jobs in November reported on Friday, data which sent the dollar to multi-year highs against the yen and euro.

Separately, the BIS report said that international banking activity expanded for the second quarter running between end-March and end-June.

Cross-border claims of BIS reporting banks rose by $401 billion. The annual growth rate of cross-border claims rose to 1.2 percent in the year to end-June, the first move into positive territory since late 2011.

(Editing by Pravin Char and Rosalind Russell)

FT HEADLINE 12-09-14

DRIVER$ -Dollar surge endangers global debt edifice, warns BIS

WE WARNED OF THE US$ CARRY BOOMERANG IN 2013

PATTERNS - Markets Steadily Breaking Down

Not only materials & mining sectors but also now dividend-paying, REIT & financial sectors are turning lower on the financial markets.

Energy investors have found themselves in a nightmare the past few months (black arrow below). It is the same nightmare that materials and mining investors (green, blue and brown arrows) have been living through since 2011 as:

• Global demand turned down,
• Excess supply piled up and
• Earnings evaporated.

Now the same nightmare is stalking the last late cycle sectors left hovering at hideous valuations:

• Dividend paying (purple),
• REITs (orange) and
• Financials (red lines shown below).

As these sectors also finally give up on the dream that QE could prop up a sagging economy, the 2009 lows beckon prices, and the broad market TSX (grey line,) back to reality.

FINANCIAL REPRESSION - Wall Street Moves to Put Taxpayers on the Hook for Derivatives Trades

They would allow financial institutions to trade certain financial derivatives from subsidiaries that are insured by the Federal Deposit Insurance Corp. — potentially putting taxpayers on the hook for losses caused by the risky contracts. Big Wall Street banks had typically traded derivatives from these FDIC-backed units, but the 2010 Dodd-Frank financial reform law required them to move many of the transactions to other subsidiaries that are not insured by taxpayers.

Wall Street Moves to Put Taxpayers on the Hook for Derivatives Trades 12-05-14 Michael Krieger, Liberty Blitzkrieg

Wall Street has for some time attempted to put taxpayers on the hook for its derivatives trades.

READ:  Citigroup Written Legislation Moves Through the House of Representatives. Here’s an excerpt:

Five years after the Wall Street coup of 2008, it appears the U.S. House of Representatives is as bought and paid for as ever. We heard about the Citigroup crafted legislation currently being pushed through Congress back in May when Mother Jones reported on it. Fortunately, they included the following image in their article:

Click to Enlarge

Unsurprisingly, the main backer of the bill is notorious Wall Street lackey Jim Himes (D-Conn.), a former Goldman Sachs employee who has discovered lobbyist payoffs can be just as lucrative as a career in financial services. The last time Mr. Himes made an appearance on these pages was in March 2013 in my piece: Congress Moves to DEREGULATE Wall Street.

Fortunately, that bill never made it to a vote on the Senate floor, but now Wall Street is trying to sneak this into a bill needed to keep the government running. You can’t make this stuff up. From the Huffington Post:

WASHINGTON — Wall Street lobbyists are trying to secure taxpayer backing for many derivatives trades as part of budget talks to avert a government shutdown.

According to multiple Democratic sources, banks are pushing hard to include the controversial provision in funding legislation that would keep the government operating after Dec. 11. Top negotiators in the House are taking the derivatives provision seriously, and may include it in the final bill, the sources said.

The bank perks are not a traditional budget item. They would allow financial institutions to trade certain financial derivatives from subsidiaries that are insured by the Federal Deposit Insurance Corp. — potentially putting taxpayers on the hook for losses caused by the risky contracts. Big Wall Street banks had typically traded derivatives from these FDIC-backed units, but the 2010 Dodd-Frank financial reform law required them to move many of the transactions to other subsidiaries that are not insured by taxpayers.

Last year, Rep. Jim Himes (D-Conn.) introduced the same provision under debate in the current budget talks. The legislative text was written by a Citigroup lobbyist, according to The New York Times. The bill passed the House by a vote of 292 to 122 in October 2013, 122 Democrats opposed, and 70 in favor. All but three House Republicans supported the bill.

It wasn’t clear whether the derivatives perk will survive negotiations in the House, or if the Senate will include it in its version of the bill. With Democrats voting nearly 2-to-1 against the bill in the House, Senate Majority Leader Harry Reid (D-Nev.) never brought the bill up for a vote in the Senate.

Remember what Wall Street wants, Wall Street gets.