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

2015 DRIVERS - 5 Macro Themes to Watch

2- Big Things Happen - When Liquidity Flows Change Significantly.

PRIOR TO THE OIL SHOCK - Situation Getting Serious

Richard Duncan recently wrote based on his latest Macro Watch research:

Global Liquidity is getting tight. Consequently, our global economic raft is once again beginning to sink.

• Commodity prices are falling,
• The consumer price inflation numbers are weakening in all the major economies and
• Asset prices (particularly overvalued equities prices) look increasingly vulnerable to a sharp correction.

Without a fourth round of Quantitative Easing the global economy could well be sucked down into a deflationary whirlpool next year.

To measure global liquidity, he took the total assets of the five largest central banks (the People’s Bank of China, the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England) plus the total foreign exchange reserves of the world’s other central banks and projected this data out to the end of 2016 based on current central bank guidance. Here’s what that looks like:

Looking out to 2015 and 2016:

• the Fed’s balance sheet flattens out since Quantitative Easing has (supposedly) ended.
• The BOJ’s assets increase at the rate of Yen 85 trillion a year.
• The ECB’s assets expand back to the level reached in 2012.
• The numbers for the PBOC are my estimates and assume that China’s central bank will continue accumulating large amounts of foreign exchange reserves in order to prevent the country’s huge trade surplus from pushing up the value of the Yuan.

Now, by adding all of those assets together, he calculated the annual percent increase in global liquidity, as shown below:

Duncan observes:

1. Notice that at present (the end of 2014), global liquidity has only increased by 5% relative to one year ago.
2. At the peak of the crisis, in 2008 and 2009, global liquidity expanded by 25% to 40% a year.
3. During 2011, it grew by 15% to 20%.
4. Even before the crisis began, global liquidity grew by 15% during much of 2004 and 2005.

Therefore, the current growth rate of only 5% is very much less than what the global economy and the financial markets have grown accustomed to.

Looking ahead, thanks to printing by the BOJ and the ECB, the growth rate will pick up to 8% or 9% at the end of 2015, but then move back down again to 7% by the end of 2016. As the base grows larger, it becomes necessary to print more and more money every year to prevent the growth rate in global liquidity from slowing. And, of course, if the growth rate does not remain high, the additional liquidity ceases to provide sufficient monetary stimulus to keep the global economy inflated.

After 2016, if we assume that the BOJ and the ECB eventually end their quantitative easing programs, the growth rate of global liquidity will slow rapidly and soon come to a relative standstill. Global asset prices and the global economy were reflated after 2008 by an unprecedented amount of fiat money creation by the world’s central banks. If that monetary stimulus ends, asset prices are very likely to deflate again and the global economy is likely to begin spiraling back toward depression.

Ultimately, it may prove impossible to keep the global economic bubble inflated, but the Fed almost certainly won’t allow it to deflate without at least attempting QE 4 and possibly QE 5, 6 and 7.

I believe it’s only a matter of time before the Fed turns back on its printing presses. Until then, beware of falling asset prices.

All of this work by Richard Duncan was before the Oil Shock fully materialized.

THEN THE OIL SHOCK HIT - Situation Goes Critical

With a 50.6% drop in Energy prices since the spring, clearly the impact to the global energy producers is something we haven't seen for decades. In a highly leveraged industry resting on high yield junk bonds things could get tenuous.

$316B IN OPEC AND $500 WITH NON-OPEC

What is for sure is that at$70/bl there is an immediately annual liquidity removal of $316B from OPEC producers and close to $50B when you include non-OPEC.

Realizing that most OPEC & Non OPEC producers require oil revenues to maintain their budgets it will require additional selling of assets to maintain sovereign subsidies.

Can anybody say "LIQUIDITY SQUEEZE"?

Not to worry, QE4 will happen and now likely even sooner than we had originally expected.

2015 DRIVERS - 5 Macro Themes to Watch

"Macro is back, and 2015 is shaping up to be an epic year for the guys who trade these fundamental shifts. To a man, after several years of little action in the macro world, they are positively licking their lips at the potential opportunities that are headed their way next year." - Grant Williams

1- Big Things Happen - When Currency Markets Re-Allign

“When currencies begin to trend, they can do so for decades.”

Currencies trade approximately $5.3T per day. with nearly $200T in SWAPs alone. The total size of the Bond market is approximately $100T. The Global Equity markets is a small $50T. Currencies shifts and King Dollar often dictate major Global Macro movements.

"King Dollar, and the world’s reserve currency is making some serious waves right now, which threaten to cause chaos in world markets. Debt dynamics, deflation, positioning and technicals all suggest that a dollar bull market of some considerable velocity and length is underway.

• When dollar bull markets occur, emerging markets get hit.
• When dollar bull markets occur, carry trades get unwound.
• When dollar bull markets occur, they tend to usher in disinflationary forces as commodities and goods get re-priced.

The preceding three factors lead to a self-reinforcing of the dollar bull market, creating more of the same in a cycle of liquidation and bad debts, creating more demand for US dollars."

The Global Macro Investor, Raoul Pal

A look at the long-term charts of the DXY Index shows just how massive the potential reversal of this trend is. The sheer size of the reversal gives us a strong hint of the degree of carnage that will be wrought upon a world in which the dollar carry trade has reached somewhere between $5 trillion and $9 trillion.

MASSIVE SHORT SQUEEZE

To borrow in a currency is equivalent to shorting a currency. The US$ loans borrowed are sold in exchange for local currency. Local currencies consequentially rose.

Asian Sovereign's after the 1997 Asian Crisis learned to hold higher reserves in case this "hot money" reversed to stop the local currency from subsequently plummeting.

The "Cardinal Sin" of Carry Trade is to trade in a currency that might rise. The "Carry" needs to be in a currency that is expected to depreciate. The US dollar has been expected to fall by analysts since the 2008 financial crisis.

Presently, as the US$ rises the $9T 'Carry' is on the wrong side of the trade which must be covered or hedged - FAST.

According to the BIS' latest report, US dollar loans to China’s banks and companies have jumped to $1.1 trillion — that’s TRILLION — from virtually zero just five short years ago. The annual rate of increase of those loans is a mind-boggling 47%.

Grant Williams points out the following:

"Consider Brazil, for example, where cross-border dollar credit now stands at $461 billion, or roughly 20% of GDP. For Mexico those numbers are even more eye-watering. A country with a GDP of just $1.1 trillion has outstanding cross-border dollar credit of $381 billion — or roughly 30% of GDP. Frightening.

Meanwhile, in Russia the same metric has reached $751 billion. Why does this matter? Well, the charts below, which show the appreciation of the US dollar against those three currencies in the last five years, highlight the danger to countries that have been able to borrow seemingly endless amounts of (relatively) stable dollars to finance business operations and expansion.

Lastly — and perhaps most importantly — witness the change in direction of the Chinese renminbi which, after trending higher against the dollar for many years (and, in the process, moving virtually everybody to the same side of the boat in the belief that a stronger Chinese currency was a given), has suddenly started to look as if it may also succumb to the renewed strength of the dollar. The only difference here being that the Chinese may actively be looking now to devalue their currency in light of the ongoing attempt by the Japanese to devalue their way back to competitiveness. Few thought this a likely scenario until very recently; consequently, few are positioned accordingly; and when things like that happen in the macro world, you can get some REALLY funky moves."

When currency wars break out, they can get very nasty very quickly.

Under no circumstances should you take your eyes off the US dollar, folks. The sheer number of places where you will witness the knock-on effects of a soaring dollar — chief amongst them emerging markets and the commodity space — will be breathtaking.

TO BE CONTINUED WITH #2 TOMORROW

2015 DRIVERS - 5 Macro Themes to Watch

1. Big Things Happen - When Currency Markets Re-Align,
2. Big Things Happen - When Liquidity Flows Change Significantly,
3. Big Things Happen - When Geo-Political Conflicts Dominate the Nightly News SoundBites,
4. Big Things Happen - When Investment Greed and Euphoria SHIFTS to Fear and Panic,
5. Big Things Happen - When Collateral Contagion, Counter Party Risk and Margin Calls Increase.

A WITCH'S BREW

The result of the 5 themes above is a concoction that is 'unwittingly' being formulated by world leaders and central banks