Tag Archives: onload

Pick Your Poison: No Return On Safety Or More Risk On Your Return

Summary Oil price moves and fluctuations in foreign exchange rates have increased the amount of risk associated with financial assets. The tail risk has increased as a result of the need for central banks to respond to oil prices and the performance of their trading partners. The size of the foreign exchange market and the amount of leverage involved make changes in exchange rates far more risky than changes in any other prices. Markets in Motion Lower oil prices are beneficial for oil consumers whether they be oil-consuming countries or consumers in the US filling up at the gas pump. That does not mean they are beneficial to financial markets. The price of a financial asset is determined by the return one expects to earn from holding the asset and the amount of risk or uncertainty associated with that return. A rapid change in any environmental factor increases the uncertainty associated with the return and therefore reduces the value of the financial asset. There have been numerous articles about the falling fortunes of the oil sector. On January 19, 2015 Barron’s presented a summary of one analyst’s estimates of how much the earnings of the S&P 500 would be reduced by the reduced earnings of the energy sector. The estimates do not seem worth quoting since they were developed without addressing the issue raised by the first sentence of this posting. While the energy sector’s earnings will be reduced, earnings in some other sectors will benefit. The net result is the introduction of considerable uncertainty into any forecasts of the profitability of a large number of companies. That uncertainty will repress stock prices. Thus, the uncertainty introduced by rapidly changing energy prices definitely has stock market implications. However, the December 17, 2014 posting entitled “Oil Prices” pointed out that the greatest macroeconomic risk associated with falling oil prices would be their impact on foreign exchange markets: “The foreign exchange markets are so big that a major dislocation there can have all sorts of unanticipated consequences.” Furthermore, it is quite conceivable that foreign exchange markets and oil markets could reinforce each other in terms of their financial market impact even when their macroeconomic impact diverges. By introducing instability, they both could be contributing to lower stock prices by increasing the risk associated with holding stocks. That can be true regardless of whether they have a positive or negative impact on the return. The December 17, 2014 posting went on to note: “One should keep in mind that financial institutions make markets in both currencies and foreign bonds. If a major financial institution gets caught with excess inventory of the wrong currencies or bonds, dislocation to the financial system could be significant.” One could argue that financial institutions also make markets in commodities such as oil, and therefore, that risk should be noted. However, as big as it seems, commodities markets are small compared to foreign exchange markets. On Jan.16, 2015 the Wall Street Journal was full of stories illustrating just how disruptive unanticipated foreign currency fluctuations can be. However, the foreign currency fluctuations were only very indirectly related to oil prices. The topic du jour was an action by central banks, current action taken by the Swiss central bank and anticipated actions by the European central bank and the Fed. Among the following articles: ” Swiss Move Roils Global Markets ,” ” Bankers, Traders Scramble to Regroup After Swiss Move ,” ” Fallout From Swiss Move Hits Banks, Brokers ,” ” Europe’s Smaller Central Banks Likely to Cut Rates After Swiss Move ,” ” Swiss Shock Tarnishes Central Banks ,” ” Swiss Bank Shares Plummet After SNB Move ,” ” Gold Shines as Traders Seek Safety From SNB’s Shock Move ,” ” Swiss National Bank’s Franc Move Buoys Dollar ,” ” U.S. Government Bond Yields Fall for Fifth Straight Session ,” and ” UBS and Credit Suisse Earnings Get a Swiss Finish ,” one gets an idea of just how important foreign currency fluctuations are. The scope includes non-oil commodity prices (e.g., gold), earnings of banks, pressures on central banks in countries like Denmark, impacts on the economies of many nations, government bond yields, stock market prices in some nations, and the reputation of central bankers. The disruption is not just restricted to turbulence in all those markets, it also involves financial institutions closing their doors (e.g., Global Brokers NZ Ltd.) or having to raise additional capital (e.g., FXCM Inc.). On January 17, 2015 the Wall Street Journal reported estimates of the losses of a number of financial institutions. The article entitled “Surge of Swiss Franc Triggers Hundreds of Millions in Losses” included estimates for Deutsche Bank (NYSE: DB ) and Citi (NYSE: C ). While the hundreds of millions of dollars involved might seem significant, for US banks they pale compared to the regulatory risk pointed out in the March 5, 2014 posting entitled “The Widows’ and Orphans’ Portfolio and US Banks.” Nevertheless, they are just one more reason to avoid US banks in a portfolio designed to have a low volatility and a stable return. Even when addressing issues that seem totally unrelated to foreign currency, it is impossible to ignore a market as large as the foreign currency market. A good illustration occurs in an article published on January 16, 2015 in the Wall Street Journal. It was entitled “What’s the Matter With Canada?” The major thrust of the article concerns Canada’s manufacturing sector, but it was impossible for the article to thoroughly address that issue without discussing the impact of oil prices on the Canadian dollar. It may well be that the decline in US stock prices so far in 2015 is an adjustment to the uncertainty introduced by the volatility in oil prices and currency markets. It certainly is consistent with the increase in uncertainty or risk associated with holding stocks. However, when foreign currency fluctuations are involved, there is a significant increase in what is known as “tail risk.” Countries can default, financial institutions can go broke, and governments can be forced to support their financial system and their economies. Such shocks are often viewed as exogenous and therefore impossible to predict. It is true; they are impossible to predict and this posting in no way constitutes a prediction that they will occur in the US. However, they are not totally exogenous and the ground is fertile for them to occur. Just that fact will impact the return on financial assets. The first half of 2015 will provide significant opportunities to investors as companies adjust to the recent volatility in oil prices and currency values. Because currency fluctuations can have large impacts on all variables from interest rates to revenue growth of individual companies, what is apparent is that regardless of what adjustments are made in a portfolio, the risk associated with any asset has increased.

Chart Of The Week: Bonds Versus Oil

Summary Important bottoms in crude oil have often matched important bottoms in Treasury yields. The bond market seems intrinsically stretched in context of its multi-decade progression. Long-term bonds are especially risky during the late stages of oil-market crashes. While many factors influence the bond market, it’s worth noting that cyclical bottoms in oil prices (NYSEARCA: USO ) have often matched cyclical bottoms in long-term Treasury (NYSEARCA: TLT ) yields. The oil crashes ending in March 1986, December 1998 and December 2008 are especially noteworthy. In all three cases, bond holders were severely clobbered after the free fall in oil prices ended. With the long bond currently near six-year-old resistance, it’s worth contemplating the damage that might be inflicted upon a reversal in the price of crude. Chart of the week: Oil prices versus long-term Treasury yields (click to enlarge) The bonus chart below presents a long history of 30-year U.S. Treasury prices expressed on log scale for comparability across time. In addition to the precarious set-up versus oil, the bond market seems intrinsically stretched in context of its multi-decade progression. The rally since December 2013 is “too steep, too fast.” The long bond seems to at least need a breather, and again, please note the tendency for sharp sell-offs following rocket-ship ascents. Bonus chart: 30-year Treasury prices (click to enlarge) Recap Important bottoms in crude oil have often matched important bottoms in Treasury yields. The bond market is currently stretched in context of its multi-decade progression. Long-term bonds are especially risky during the late stages of oil-market crashes. At this juncture, the two markets should not be contemplated independently. Now that you’ve read this, are you Bullish or Bearish on ? Bullish Bearish Sentiment on ( ) Thanks for sharing your thoughts. Why are you ? Submit & View Results Skip to results » Share this article with a colleague

Switzerland’s Monetary Policy Change – GLD Rallies

The Swiss National Bank’s decision to end its policy to peg the Swiss franc to the euro stirred up the financial markets. The decision seems to have also pulled up the price of GLD. How SNB’s decisions relates to the recent rally of GLD. The big news from the Swiss National Bank to stop pegging its currency to the euro has shocked the foreign exchange markets. Some analysts have also linked this move to the recent recovery of gold, including the SPDR Gold Trust ETF (NYSEARCA: GLD ). This relation, however, isn’t straightforward – let’s examine the recent rally of GLD . After over three years, the SNB announced an end to its policy to peg the currency at a minimum exchange rate of 1.20 euro to the Swiss franc. The ongoing devaluation of the euro has, according to the bank, triggered it to make this move. As Thomas Jordan, chairman of the SNB, stated : “Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated substantially against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB has concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.” This decision has stirred up the financial markets – mainly devaluing the euro against leading currencies, including the U.S. dollar. Normally, an appreciation of the U.S. dollar would tend to coincide with a decline in the price of GLD. But the price of GLD kept going up. The SNB’s recent move actually raises the uncertainty in the financial markets, which plays in favor of gold investments such as GLD. Paul Krugman suggested that the implication of the recent regime change in Switzerland is that the markets will become more skeptical about other central banks, speculating whether these banks will follow through on their dovish policies. I think this is a bit of stretch, but some traders will make this connection – albeit one central bank’s policy change won’t necessarily impact the reliability of other banks. The latest news from SNB suggests the ECB’s next policy change could surprise the markets with a bigger than currently expected QE program. When it comes to GLD, however, the main issues relate to the changes in the U.S. dollar, the uncertainty in the markets and long-term treasuries yields. In the past week, the U.S. dollar devalued against the Swiss franc, which is now likely to keep recovering. U.S. long-term treasuries’ yields kept falling down, which tend to have a negative relation with the price of GLD. An economic slowdown does play in favor of GLD, because it tends to cut down U.S. treasuries’ yields. Moreover, the World Bank recently released its updated economic outlook for the next few years. The bank projects the global economy will grow by 3%, and not 3.4% as it previously estimated. It also revised down its outlook for China, EU and Japan. Albeit the U.S. GDP is expected to actually grow faster than previously estimated, the fear factor of global economic slowdown is keeping GLD up at least in the short term. This is another indication why the demand for gold on paper leads the way for physical demand for gold; if it were the other way around, an expected lower growth rate in China’s economy – the leading importer of gold – would have resulted in a drop in the price of gold. In any case, it seems that the physical demand for gold in the short term hasn’t picked up: The Gold Forward Offered Rate, or GOFO, has risen in recent weeks, after they were negative during part of December of 2014 (and several other times during last year). A rise in GOFO rates is another indication for a fall in the short-term physical demand for gold. The next big news item will be the upcoming ECB monetary policy meeting next week. This time, all eyes will be towards ECB president Draghi to see if he states the amount of the ECB’s QE program. Current market expectations are around 500-700 billion euros, albeit some have also suggested this figure could, in theory, even reach 2 trillion euros. So any number higher than this could drive further down the euro, which could push more investors towards precious metals, including GLD. Again, the appreciation of the U.S. dollar isn’t helping GLD, but a fear of ECB pumping cash into EU’s banks to buy sovereign debt could drive higher the demand for the yellow metal. The Swiss National Bank’s move shook up the foreign exchange market and apparently also, in the process, pulled up GLD. The next ECB monetary policy meeting could also be the next big event to stir up the foreign exchange markets and GLD – in times of uncertainty, GLD strives. (For more please see: ” On Demand for Gold and GOFO rates “)