Morgan Stanley, UBS Raise Gold Price Forecasts, Goldman Again Raises Oil Forecast

It looks like commodities are again coming into the limelight, as the brokers up their forecasts. Gold has already made a bullish technical break to the upside, while crude oil looks poised to do so as well. Last year, Goldman oil analysts predicted $200/bbl crude oil, then earlier this month said oil could fall below $30/bbl by February.

They now see a "swift and violent" rebound to $65 a barrel by the end of 2009 and added there is a scope for a "new bull market" in oil. Technically, oil is not as well positioned as gold for a rally, as the current price is still miles away from the 200-day MA, the make-or-break line for bull markets.


Reuters, Goldman Flip-Flop on Oil Call

Gold Breaks to the Upside

Gold had been struggling to rise above $880/ounce, ostensibly because of some sovereign (central bank) seller. It has now seen a bullish short-term break to the upside. The metal surged $37.10, to $895.30 an ounce in New York futures trading today, its highest closing since early October. It is up $88 just in the last five sessions.

Last November and December, investors were flocking to US treasuries supported by a strong USD index. Now Treasuries are looking toppy because of the prospect of massive US bond issues to fund the Obama Administration's big stimulus plan. The disconnect is now both gold and the USD are strong, which usually doesn't happen.

Surging gold implies several things; a) investors aren't buying the hype about both the US $850 economic stimulus plan or the $586 billion stimulus plan, b) they are increasingly leery of potentially massive supply of US Treasuries, c) inflationary expectations are rising on the assumption that the rush to reflate by essentially all major developed economies will debauch virtually all currencies, even the USD and JPY, which have been appreciating on massive carry trade unwinding.

The most significant of the move in gold is that it is now again above its 200-day MA, which is flattening, and the 50-day MA is rapidly moving toward the 200-day MA, setting up the potential for a medium-term bullish "golden cross" between the 50-day and 200-day MAs.

Bank of Japan Sees Minus Growth in FY08, FY09

After their monetary policy meeting on Jan. 22, the Bank of Japan revised its forecast for Japan's economy to minus growth of 1.8% in FY2008 (to March 2009) and minus 2% for FY2009. The minus 2% for FY09 is similar to the street consensus, while the government's forecast is for zero growth, which no one believes. This is the worst decline in Japan's postwar history, with the previously worst annual GDP contraction being 1.5% in 1998. In addition, the BOJ sees deflation in Japan until 2010.

The BOJ sees only modest growth of around 1% in 2010, but the private sector sees this as doubtful as well. The problem is that Japan's growth had been almost exclusively dependent on net exports, while global demand has virtually dried up and the yen is at 13-year highs as it appreciated some 20% against the dollar in 2008 and more like 40% against Pound Sterling, both record amounts. As a result, exports across all regions (i.e., North America, Europe and Asia) were falling at two-digit rates in November and December of last year, and domestic tertiary sector activity (services and other non-manufaturing) was already in decline before the stuff hit the fan after Lehman Brothers declared bankruptcy last September and instigated a global credit crisis.

The Bank left rates unchanged, but is moving to buy up corporate commercial paper, bonds and J-REIT issued bonds to give as much of a liquidity cushion to corporates as possible The BOJ's GDP forecast virtually ignores the economic stimulus package recently announced by the Aso Administration, which will only act as a band-aid for the domestic economy as plunging global demand and a soaring yen ravages Japan's economy.

Look for more drastic production cutbacks, contract and full-time employee cut-backs beginning with overseas operations of Japanese companies, lots more red ink and continued growth in bankruptcies. No wonder some economists are suggesting that Japan is slipping into depression. The Nikkei 225 benchmark of Japanese stocks reacted by losing over 300 points and now is back under 8,000.

Strong Yen Due to Massive Carry Trade Unwinding

I continue to look for solid evidence of the unwinding of the yen carry trade in any statistics I can find, but to no avail. The MOF's stats on securities purchases and sales by domestic institutions and foreign institutions show investments (equities, bonds, s-t paper) continuing to flow out of Japan on a net basis at a recent pace of a couple trillion yen a month. The balance of overseas loans by Japanese banks (including offshore branches) is down significantly from 1999, but has been rising from lows of a couple of years ago. These outflows of funds engulf the investment income that shows up on the BOP data (some JPY1.3 trillion /month of late).

According to JP Morgan Tokyo, (From Tohru Sasaki, global forex strategist at JP Morgan in Tokyo via FT Alphaville) "Indeed, in 2008, the yen’s nominal effective exchange rate appreciated by 32.4 per cent - the largest increase in the floating currency regime that began in 1971. USD/JPY declined 18.9% in 2008, which is the largest decline since 1987, and GBP/JPY declined 40.2%, which is the largest fall since 1958. However, the net outflow (portfolio + FDI - trade balance) from Japan reached ¥14.2 trillion in 2008, which is the largest outflow since data is available from 1989. Obviously, there was strong downward pressure coming from yen sales by domestic players last year. The fact that the yen appreciated significantly even under such circumstances suggests that foreign investors’ unwind of carry trades dominated yen sales by the Japanese. Considering the historic appreciation of the yen over the period, it may be no exaggeration to say that the magnitude of unwinding of carry trades by foreigners exceeded ¥20 trillion last year."

The renewed spurt of late in the yen is also seasonal, as Japanese institutions par back overseas investments ahead of March-end book closings.

FT Alphaville » Blog Archive » Why the yen is defying economic gravity:

Should Japan Ignore Tim Geithner and Intervene to Prop Up the Yen?

"I believe its very important for the US and for the global economy that our major trading partners operate with a flexible exchange rate system, in which market forces determine the value of exchange rates." (Tim Geithner, Treasury Secretary designate).

Japan has not intervened in currency markets since 2004. But two weeks ago, BOJ governor Shirakawa hinted Japan is considering intervening, and foreign traders are wondering why they have not already. An article in BusinessWeek openly wondered when Japan will intervene. Why? The Yen recently hit a a 13-year high against the dollar and is soaring against the UK Pound as well as the Euro, slam-dunking profitability of Japan's most globally competitive firms. The yen rallied nearly 20% against USD last year and has hammered exports and pushed the world's second largest economy deeper into recession. Exports plunged a record 35 percent in December.

In the summer of 2007, a weak yen was sparking outrage in France and hurting importers in Japan. Pundits were calling it "anomalous" and a risk to the world financial system. In June 2007, the trade-weighted yen hit a 22-year low. In 2004, Japan's Ministry of Finance has lost more than 70 billion dollars in the past financial year trying to bet against currency speculators in throwing some $360bn in the markets to keep the yen from appreciating beyond JPY100/USD. Then, Cabinet Office insiders admitted that the currency losses had spiraled out of control, after a renewed attempt by the Finance Ministry to prop up the dollar and talk down the value of the yen. The experiment was not pleasant for Japan, and dispelled any notion that the MOF was more powerful than the market, despite the fact that Japan could ostensibly create unlimited amounts of yen to satiate demand for the fiat currency.

Japan already has some $1 trillion in forex reserves, mostly in USD. Without the politically pressing need (the head of Japan's biggest business lobby, the Nippon Keidanren, is urging the government to intervene in the currency market if the yen keeps rising and asked other countries to join in too) to get the yen down to more profitable export levels to ameleorate the current pain in Japan's economy, the Japanese government as an "investor" would normally be wanting to reduce their exposure to USD. Selling the dollar would be easy, i.e., just start dumping USD forex reserves. To intervene to push down the yen, however, the MOF would have to issue financing bills (debt) to fund the intervention, siphoning money off from funds needed in the already announced domestic stimulus plan.

Geithner tells Japan: lay off forex intervention - Yahoo! News

The Great Experiment: Can Keynesian Policies Really Save the Day?

John Maynard Keyne’s treatise, the General Theory of Employment, Interest and Money that was supposedly a solution for depression and deflation was not published until 1936, i.e., after the Great Depression. Between 1941~1979, the Keynesian economic philosophy was in its ascendancy, but the US economy had already pulled out of depression by then. From 1979~1979, criticism from Milton Friedman and what became known as the monetarist economic philosophy replaced Keynesian thought, but the US Federal Reserve officially abandoned monetarism as a monetary policy in 1984.

As a result of the worst financial crisis and economic recession in 80 years, everyone has suddenly become a Keynesian again. President-elect Barak Obama’s economic team is perceived to have a strong Keynesian bent, including Lawrence Summers, Timothy Geithner and Cristina Romer.

Americans (of which I include myself) would still like to believe that they can avoid a major debt deflation/depression like the 10-year malaise that Japan experienced in the 1990s, but the jury is still very much out on this conclusion, even with the inauguration of Mr. Obama.

As observed by Milton Friedman, money stock during the Great Depression (1929~1933) decreased a massive 31%, while the velocity of money (defined as GDP divided by the money supply) fell 21%. The result was a 50% decline in GDP. Famous economists like Irving Fisher, Charles Kindleberger, Hyman Minsky, Joseph Schumpeter and Nikolai Kondrachieff have observed that “all or nearly all” other economic variables (such as during 1929~1933, 1837 and 1873) are effectively controlled by excessive debt and price declines during debt deflations. Once debt deflation begins, fiscal and monetary policy become impotent to stimulate the economy because the velocity of money is declining.

The US Fed has essentially pulled out all the stops in dramatically inflating its balance sheet and making every effort (including quantitative easing) to expand the money supply and ensure liquidity. The Obama administration is promising record ($800 billion-plus) fiscal stimulus. But government investment and spending was but 17.8% ($2.1 trillion) of the US economy in Q3 2008. Between Q4 2006 and Q3 2008, household assets (real estate and stock assets) depreciated by some $5.6 billion, and the losses are expected to have exceeded $10 trillion by Q4 2008.

New York University’s Noriel Roubini now says that losses in the financial system could exceed $3 trillion, and has been steadily upping his forecasts of the potential losses since boldly predicting that losses would reach $1 trillion at a time when the government and other economists thought the losses would be 1/4th that. Goldman Sachs is now estimating that total losses and write-offs in the financial sector will reach $2.1 trillion, while major banks, insurers and GSE (government sponsored enterprises like Freddie Mac and Fannie Mae) had realized just over $1 trillion at the end of December 2008. However, as we have seen over the past week, the losses continue on a global basis, necessitating further bail-outs in the US, the UK, Ireland, France and other OECD nations.

This after the Fed and US treasury had committed over $8 trillion to backstop the US financial system. As an indication of the balance sheet deleveraging that still needs to be done, Merrill Lynch has estimated that the major European banks would need to shrink their balance sheets by 5.5 trillion Euros to bring them back in line with pre- credit bubble (2002~2003) levels, whereas only some 800 billion Euros of deleveraging has occurred so far. In addition, the $3 trillion number of losses quoted by Mr. Roubini compares to US bank capital of only $1.4 trillion when the crisis began—i.e., the bulk of the US banking system is effectively bankrupt.

All of this Keynesian fiscal largesse comes at a time when total debt (government, financial sector, non-financial sector and individual) in the US has already reached some 360% of GDP. This is already a mind-boggling number, and is poised to become even more mind-boggling.

Yet the historical pattern of debt deflations indicates that the ultimate low in US treasury yields lies years away. That said, the path to the ultimate low will not be a straight line. As the experience from Japan indicates, there could be many “false dawns” that draw investors back into the stock market. If history is any guide, however, these “bear traps” will only result in more losses and further wealth destruction as the persistent forces of a debt deflation. In Japan from 1988 to present, in the US from 1872 to 1892 and between 1928 and 1948, the total return on bonds exceeded the total return on stocks. Thus the currently popular notion that Treasuries should be shorted could prove to be a painful exercise. Another approach to the same question is to look at the reverse yield gap in equities versus bonds. Japan has had a reverse yield gap on equities versus bonds on and off for the past four years, while the US and the UK are also now experiencing reverse yield gaps.

The yield gap can be expressed as the expected risk on equities minus expected growth on dividends, with inflation and growth being crucial factors. A steep fall in bond yields indicates growing fears of deflation as well as a flight to safety. Conversely, a steep rise in equity yields indicates growing fear of a collapse in dividends. In Japan’s experience, the yield gap has tracked GDP growth relatively well over the past decade. When nominal GDP is negative, the yield gap is also usually negative, as GDP growth is a proxy for dividend (profit) growth. Following the Great Depression, investor perceptions of equity risk dramatically changed, resulting in a reverse yield gap that persisted until around 1959. In other words, investors came to demand a yield premium over bond yields to purchase equities because of the perceived risk.

Japan's "Rapidly" Deteriorating. Will the BOJ Intervene to Stem the Yen's Surge?

In its January monthly economic report, the Japanese government used the word "rapidly" deteriorating to describe the current state of the Japanese economy--for the first time since data became available in 1975. The economy was described as "worsening" in the December report.

According to Economic Minister Kaoru Yosano, "essentially all economic indicators are deteriorating"..."there is no way the global and Japanese economies can recover in several months". This is the fourth consecutive month that the government has revised downward its view of the economy, whereas the longest streak of consecutive monthly downgrades was between February 2001 and June 2001 when the IT bubble burst. Capital expenditures are "decling", employment conditions are "rapidly deteriorating" and corporate profits are "substantially declining", while production is effectively imploding.

The Bank of Japan is scheduled to hold its next monetary policy meeting from Jan. 21 for two days, and the BOJ is expected to reveal their stance regarding the purchase of risk assets to ensure liquidity and market stability leading up to the fiscal year end book closings in March 2009. They have already indicated they will purchase up to JPY3 trillion of commercial paper, but are expected to leave overnight call rates at the current 0.1%. They are also expected to revise down their forecast for economic growth from the current 0.1% to a minus 1% or so.

Overseas, investors and Japan observers are surprised that the MOF (who instructs the BOJ to intervene) has not intervened to stem the appreciation of the yen, which is now back above JPY90/USD, given the severe damage this is causing to the profits of Japan's internationally active companies. While economists will tell you that intervention is never a long-term solution and that intervention to support one’s home currency rarely works, economists do insist that intervention to weaken one's home currency does work, because of the ability of the financial authorities to supply limitless amounts of fiat currency until buying demand is satiated.

We however would argue that the strong yen is a self-inflicted malaise, i.e., due more to the repatriation of excess savings (government and private sector) from overseas investments, as much as it is "safe haven" buying by foreign investors.

Excess Capacity at Japanese Manufacturers

Japan's Nikkei newspaper is reporting that domestic production capacity at Japan's steel, oil product, petrochemical basic material and automobile manufacturers is currently 30%~20%. During the post-bubble Heisei Malaise in the 1990s, Japanese manufacturers were burdened with three excesses; a) production capacity, b) employees and c) debt. We are now seeing a resurgence of the first two of these three excesses, i.e., excess capacity and excess employees.

Continued production cutbacks in January~March 2009 will mean more revenue/profit declines as well as employment cutbacks, which will extend from mainly contract workers heretofore to full-time employees, which in turn will depress personal consumption and be a heavy drag on Japan's GDP.

The Collapse in Global Trade and Japanese Shippers

(From Edmund Conway of the UK's Telegraph)“Freight rates for containers shipped from Asia to Europe have fallen to zero for the first time since records began, underscoring the dramatic collapse in trade since the world economy buckled in October." The BDI (Baltic Dry Index) has plunged 96%, and while it is a very volatile indicator of shipping trends, the latest phase of the shipping crisis is different. The malaise has spread to core trade of finished industrial goods, the lifeblood of the world economy. Shipping journal Lloyd’s List is reporting that in Singapore are now waiving fees for containers traveling from South China, charging only for the minimal ‘bunker’ costs. Container fees from North Asia have dropped $200, taking them below operating cost.

Bloomberg is quoting Frontline Ltd, the world’s biggest owner of supertankers, as saying that about 80 million barrels of crude oil are being stored in tankers, the most in 20 years, as traders seek to take advantage of higher prices later in the year. (hat tip to Investment Postcards from Cape Town)

Lloyd's List quotes the Drewry Container Forecaster, who now estimates that global container traffic totalled 153m teu last year, representing growth of 7.2% from 2007. A few months earlier, Drewry had been forecasting trade expansion of 8.6% for 2008.This year, growth is expected to slow to just 2.8%, with a few isolated trades such as the Asia-Middle East and Asia-Africa corridors likely to post some positive figures. The big east-west routes are in terrible shape, with Drewry forecasting that the Asia-Europe trade will shrink by 4.1% in 2009, following growth of just 1.9% in 2008. Pacific traffic is also very weak , with Drewry calculating that eastbound volumes from Asia to North America dropped 5.7% last year, with a further contraction of 3.2% forecast for 2009.

Trade data from Asia's export tigers has been disastrous over recent weeks, reflecting the collapse in US, UK and European markets. South Korea's exports fell 30% in January compared to a year earlier. Exports have slumped 42pc in Taiwan and 27% in Japan, according to the most recent monthly data. Even China has now started to see an outright contraction in shipments, led by steel, electronics and textiles.
A report ING yesterday said shipping activity at US ports has suddenly plunged. Outbound traffic from Long Beach and Los Angeles, America's two top ports, has fallen by 18% year-on-year, a far more serious decline than anything seen in recent recessions. Denmark's A.P. Moller-Maersk, the world's largest container line, said the shipping industry was unlikely to recover before the end of next year (2010) and it had no plans to try and buy smaller rivals.

In addition to plunging demand, shippers in Asia are being hounded by pirates. Shipping piracy worldwide went up 11% in 2008 due to an unprecedented number of attacks in the Gulf of Aden, an international piracy watchdog said in its annual report released Friday. The International Maritime Bureau said its Kuala Lumpur-based Piracy Reporting Center received a total of 293 cases last year, up from 263 in 2007. It was the highest number since 2005.Out of the 293 attacks that occurred last year, 111 were reported in Somalia and the Gulf of Aden. It was an increase of nearly 200 percent compared to 2007. Somali pirates are responsible for the attacks in the Gulf of Aden, the IMB said.

US News and World Report is reporting that pirates worldwide are increasingly heavily armed with rocket launchers, heavy machine guns, and agile speedboats that let them challenge ships farther away from their sanctuaries. And the cost is going up for legitimate ocean-going commerce. In 2007, according to the British insurer Lloyd's of London, the average pirate ransom demand was about $500,000. The figure has jumped to between $1 million and $8 million. Lloyd's estimates that pirates will very likely pull in $50 million this year.

All of the above points to continued deterioration in the earnings environment for global shippers, despite the benefit of plunging fuel costs as crude oil has plummeted by over $100/barrel from last year's peak. Japanese shippers were painting a sanguine earnings picture of continued demand growth, but all of that changed dramatically from October of last year.

Nippon Yusen KK (9101.T), which projected a 6% year-on-year increase in group pretax profit, is expected to log a 10% drop to about 180 billion yen. Mitsui O.S.K. Lines Ltd. (9104) is seen reporting a 270 billion yen group pretax profit, falling below its earlier forecast, while Kawasaki Kisen Kaisha Ltd. (9107) is likely to see its profit slide 32% to about 85 billion yen, a bigger drop than forecast. It will be the first pretax decline since fiscal 2002 for Mitsui O.S.K. Lines and the first since fiscal 2006 for Nippon Yusen and Kawasaki Kisen Kaisha. Net profit at Mitsui O.S.K. Lines is expected to fall short of its projection by about 20 billion yen. Kawasaki Kisen Kaisha is seen booking more than 16 billion yen in valuation losses due to a decline in the prices of its foreign stockholdings, contributing to an expected 14% tumble in net profit to 71 billion yen. Depending on the continued strength of the yen, even these numbers may have to be revised downward again.

However, the stock prices of these companies have already taken a beating, with P/E multiples (uncertainty about the "E" nothwithstanding) trading between 3X and 5X+ forward earnings, and PBRs below 1.0X, while ROE is between 18% and 31%.