Did the Citi rescue force a rally in stocks, or a panic out of US Treasury bonds...?
SO THERE YOU HAVE IT, writes Dan Denning, head of The Daily Reckoning Australia – the number of the bust.
"US financial firms have taken write downs and losses of $666.1 billion since the beginning of 2007," according to Bloomberg.
The end of times in finance rolls on, the latest twist of the knife being the decision of US regulators to come to the aid Citigroup, the world's largest financial services firm. The Feds stepped in and guaranteed around $306 billion of Citi's troubled assets. In exchange, Uncle Sam gets preferred shares with an 8% dividend.
That news was enough to send the S&P 500 up 6.5% on the day. London jumped almost 10%. But what to make of this latest triage of the broken financial system?
It keeps things ticking over. But how do you fix a world that has too much debt by adding more debt? The US government, through its various agency paramedics, is injecting money and buying equity all over the economic shop. But it's not cheap.
Bloomberg tallied up the various commitments, loans, and guarantees made on behalf of the US taxpayer by various Federal agencies and non-elected officials. It was not a small number. It came to US$7.76 trillion, a vaguely patriotic sum, echoing the year the Declaration of Independence was proclaimed in 1776. But the Bloomberg article points to a state of dependence, instead. Or better yet, a pledge of eternal subservience to the power of debt.
The $7 trillion plus figure is nearly half of annual US GDP. Just under half of it, some $3.18 trillion, is money tapped by financial firms through various auction facilities. It goes to rebuild balance sheets, rather than building factories, bridges, or new sources of power.
The Federal Reserve is the biggest instrument in this ramping of commitments. The Fed has pledged $4.74 trillion on behalf of Americans. That's 61% of the total amount, and $24,000 for every man, woman, and child in America (born free, but now everywhere in debt). Here in Australia, in contrast, local shares have caught a bid from rising commodity prices, despite the Margin Calls on Insiders and Short Sellers.
Oil was up $4.50 to $54.43 for a 9% gain on Monday. Gold Bullion shot up nearly $30 to $821.90 for almost a four percent gain. Copper was up 6%, nickel 7%, zinc 6.4%, and tin 11.3%. And what, pray tell, may have led to that move?
Chinese monthly refined copper imports were up 15% in October, an eight-month high. But what China gives it may also take a way. Cochilco, China's state-run copper outfit, cut is forecast for copper prices in 2009. Where does that leave us with the base metals and with base metal shares? We asked Diggers and Drillers editor Al Robinson:
"China's resurgent demand for raw materials is already surprising the market," he wrote to us via e-mail from meters away. "It reverted to 'net importer' status in all base metals for October, according to the London Metal Exchange (LME). China already needs more resources than it can get its hands on.
"It's buying more rock than it's selling, in other words. That's great news for the Australian resource sector in 2009. But this story goes further," he adds...
"China isn't experiencing some sort of meek comeback, following the Olympic slowdown. It actually imported enough copper in October to offset the rest of the LME's inventory rise. The 'rest of the world' may not be setting commodity demand ablaze. But China is already starting to fill in the gaps created by Western recession – on its own."
While China fills the gaps, you may also start to see some short covering from traders who went short the base metals. That short covering could lead to big one day moves in the shares (which are appallingly over-sold). But it may not quite mark the bottom in metals prices. That's going to be a function of supply and demand (with supply tightening as projects are shelved and demand idling).
The other thing to look for is bargain hunting. Investors and fund managers who liquidated long positions in the resource sector earlier this year to raise cash may begin nibbling if they find the right share at the right price. Such as China, for example. Today's Australian reports that "Rio [Tinto] may sell stakes to China to reduce debt." Rio's Chairman Paul Skinner was in Melbourne to discuss, among other things, the possibility of Rio selling assets or an equity stake to China Inc. in order to help pay off some of Rio's US$9 billion in debt that matures in 2009.
Maybe Rio should first ask the Fed before giving up equity to China. Bernanke can be pretty accommodating, we hear. And now it is time to bring that $7.76 trillion back into the picture and put it in the context of Australian resource equities.
The Citigroup bailout deal prompted a rally in stocks and a rise in US bond yields on Monday. The yield on two-year US notes rose as the price of two-year notes fell, thanks to the government auctioning another $36 billion of them into the market. But it's hard to believe the Citigroup deal unleashed a lot of pent up bullishness on US financial stocks. It's easier to believe that the ever-increasing supply of US government bonds is prompting investors who've rushed into them to look around for other, more desirable assets.
Chinese investors, for instance, might decide than an equity stake in Rio Tinto – with its portfolio of iron ore, coal, and other assets – is a better investment than more promises to pay by the US government.
Perhaps we've been hasty, though, in calling the pricking of the bond bubble in the past. It could be that the US Dollar becomes the clear winner in the global currency wipe out currently taking place. The Dollar could end up being the preferred liquid currency in which to ride out the global crisis, despite the inflationary nature of US monetary and fiscal policy.
If that's the case, then the US Treasury market will continue to suck up the world's supply of available savings and capital the way a bush fire sucks up oxygen. A fire sucking up all the oxygen in a system leads to a massive destruction of life. Hence the Greek word "holokaustos". According to the Merriam-Webster dictionary, a holocaust is a "sacrifice consumed by fire" or "a thorough destruction involving extensive loss of life especially through fire."
The bonfire of the Treasuries, then, is what we're getting at. First you crowd all the world's capital into the US bond market. Then you set fire to it.
Smart money generally goes where it's treated best (for yield and capital appreciation). In times of fear, what's safe is smart. And so now the world's investors and savers have an interesting choice: is the US bond market safer than cash? Is it smart to play it safe? Or are equities safer than bonds? Or are equity stakes in projects with tangible assets better bets still, even a world with a shrinking economy? And what about gold – the liquid money of last resort?
Our guess is that the printing of the Treasuries (increasing the supply of US bonds to fund the mega bailout, fuelling the eventual inflationary fire) will gradually spook investors now and into 2009. The leading edge of bargain hunters may already be finding their way into over-sold resource stocks for refuge. And will they find it? Or will their courage end in more losses?
It wouldn't be surprising to see big one-day gains in over-sold resource and Gold Mining stocks in the coming months. But we reckon the real story is that investors are rethinking their long-term asset allocation and will execute a new strategy after reviewing their 2009 performance. More cash, fewer shares. And of the money that remains in shares, it will probably be parked in long-term positions that are selling at cheap valuations, perhaps with a nice yield.
Expectations will be lowered and time horizons (for equities, anyway) will be lengthened. You'll have to expect less and be willing to wait longer. Not that being in the equity market during the most serious financial crisis since 1929 is a sure thing. We live in dangerous times. Not much is certain. But for investors, the actions taken by US monetary officials are starting to lead to movements in global capital. This could signal the beginning of the bottom in commodity, mining and Gold Investment prices, and the beginning of bargain hunting in resource shares.