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War & Markets PDF Print E-mail
Written by Mike "Mish" Shedlock: Global Economic Analysis   
Wednesday, 23 July 2014 06:26

Less Growth, Less Certainty, More Geopolitical Risk

Steen Jakobsen, chief economist and CIO at Saxo Bank, has an interesting article today on War & Markets which I present below as a guest post.

Steen says ...

Prepare for less growth, less certainty and more geopolitical risk
Crude oil price is simplest proxy for geopolitical risk
Wars reflect a world where growth is low and energy expensive 

“There are causes worth dying for, but none worth killing for” – Albert Camus

The world is increasingly becoming engaged in civil wars and general turmoil where Camus' words could and should play a central [role] but never will. This article is one of the hardest to write as war is never about right or wrong. They are per definition always wrong and extremely personal and emotional. The fact is, however, that we need to put "the risk of wars" into our macro outlook as they are increasing not only in intensity but also in the numbers of casualties.

I will not condone anyone or any party involved in the present conflicts – I learned my hard lesson advocating the removal of Saddam Hussein, only to learn that his successors are just as bad. Therefore, Camus’ words will remain my mantra.

The simplest way to “measure” geopolitical risk is to look at the price of energy. Energy is everything for a macro economist as it’s a tax on the economy when high, and a discount when low. High energy consumption levels makes it a critical part of any projection but despite this, energy assumptions are often exogenous (given!).

Think about this: Everything you did this morning involved energy consumption: Waking up to your smart phone (charging overnight), putting on the coffee, pouring the cold milk from the fridge, taking a shower, driving the car to work and walking into your air-conditioned office. Likewise, the rest of your day will be one big consumption of energy. The world's energy resources are primarily extracted from “volatile” or underdeveloped regions, creating a real risk of disruption of supply. Herein lies a clear and quantifiable risk.

The way I measure this geopolitical risk is through measuring the spread between the 5th contract of WTI crude oil and the first contract. Of course, there are other factor at work, but in the absence of a better alternative, I use this War Risk Premium Indicator.

War Risk Premium

As can be seen, since July 15 the “war premium” or more neutral “disruption premium” have increased by USD 2 and the world's consumers are now paying two dollars more per barrel of WTI crude. Overall there are many factors influencing the crude market but the price of energy remains the one component we need to know is stable and preferably falling.

The overall impact from war is negative despite the glorified analysis of how World War II stopped the recession – think of the 1970s – probably a better and more relevant analogy to today’s trouble in Gaza, Iraq, Russia/Ukraine, Libya, and Syria. Many will argue it’s different this time, back then we were too dependent on the Middle East!  Sure, but prices were only between 10 and 25 US dollars a barrel back then!

War Risk Premium 2

Now we have lived with an oil rise in excess of  USD 100 more or less since 2007! Crude is now four times higher in price than during the “inflationist” 1970s – the era in which we ended  the Bretton Woods system of monetary management and where central banks started targeting inflation instead.

No, the signal from the energy market about the demand of energy and the risk of getting enough of it is clear: Prepare for less growth, less certainty and more geopolitical risk. The market, however, maintains a steady hand: Israel will be contained inside a couple of weeks, Russia vs. Ukraine will find a solution. The non-acceptance of tail-risk (Black Swans) is clear for everyone to see. The market is “perfect” in its information, zero interest rates will save us and we have all been fooled into believing that the real world no longer matters.

Unemployment, social inequality, wars, innocents being killed, and TV images of people fighting to live another day are not relevant………except for the fact that for world growth to keep increasing we need to continue to see growth in Africa, the Middle East and Eastern Europe.

We need to accept that the world is now truly global – we smiled while globalisation reduced prices and made our companies more profit, now the escalation of wars reflect a world where growth is low, energy is expensive and increasingly hard to get and that we have gone full circle with macro and interventionist policies.

The escalation of turmoil in the world is yet to play a role for the market, but be warned: everything economic has a delayed reaction of nine to twelve month – whenever there is an action there will be a reaction. If the present state of alertness continues through the summer you can bet on higher energy prices having a serious impact on not only world growth but also on markets. But don't ever forget that the real losers are the individual families losing loves ones. No, Camus got it right. There is nothing worth killing for, plenty to fight for.

Mish Comments

The above in entirety courtesy of Steen Jakobsen.

I would not go so far as to say the "risk premium" has risen $2 since July 15. There are too many variables and even random fluctuations that could be at play. If oil would have otherwise been falling because of slowing in China, the risk premium could be way higher. Similarly, oil could be rising for other reasons and the risk premium could be zero or negative although I consider that unlikely.

That said, Steen is generally on the mark with his observations especially his conclusion: "If the present state of alertness continues through the summer you can bet on higher energy prices having a serious impact on not only world growth but also on markets. But don't ever forget that the real losers are the individual families losing loves ones. No, Camus got it right. There is nothing worth killing for, plenty to fight for."

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

 
Setting The Stage for The Next Collapse PDF Print E-mail
Written by Steve Saville - The Speculative Investor   
Tuesday, 22 July 2014 07:08

When the central bank pumps money into the economy and suppresses interest rates it creates incentives to speculate and invest in ways that would not otherwise be viable. At a superficial level the central bank's strategy will often seem valid, because the increased speculating and investing prompted by the monetary stimulus will temporarily boost economic activity and could lead to lower unemployment. The problem is that the diversion of resources into projects and other investments that are only justified by the stream of new money and artificially low interest rates will destroy wealth at the same time as it is boosting activity. In effect, the central bank's efforts cause the economy to feast on its seed corn, temporarily creating full bellies while setting the stage for severe hunger in the future.

We witnessed a classic example of the above-described phenomenon during 2001-2009, when aggressive monetary stimulus introduced by the US Federal Reserve to mitigate the fallout from the bursting of the NASDAQ bubble and "911" led to booms in US real estate and real-estate-related industries/investments. For a few years, the massive diversion of resources into real-estate projects and debt created the outward appearance of a strong economy, but a reduction in the rate of money-pumping eventually exposed the wastage and left millions of people unemployed or under-employed. The point is that the collapse of 2007-2009 would never have happened if the Fed hadn't subjected the economy to a flood of new money and artificially-low interest rates during 2001-2005.

Rather than learning from prior mistakes, that is, rather than learning from the fact that the use of monetary stimulus to mitigate the effects of the 2000-2002 collapse led to a more serious collapse during 2007-2009 and a "lost decade" for the US economy, the 2007-2009 collapse became the justification for the most aggressive monetary stimulus to date. The damage wrought by previous attempts to artificially stimulate has resulted in the pace of economic activity remaining sluggish despite the aggressive monetary accommodation of the past several years, but it is still not difficult to find examples of the mal-investment that has set the stage for the next collapse. Here are some of them:

1) The suppression of interest rates has prompted a scramble for yield, which has pushed yields on higher-risk bonds down relative to yields on lower-risk bonds. The bonds issued by the governments of Spain and Italy now yield only slightly more than US Treasury Notes, the yields on investment-grade corporate bonds are now roughly the same as the yields on equivalent government bonds, and the yields on junk bonds are generally much lower than normal relative to the yields on investment-grade corporate bonds. This tells us that monetary accommodation has greatly increased the general appetite for risky investments, which is always a prelude to substantial losses.

2) Public companies have been buying back equity at a record pace, despite high equity valuations. One reason is that although equity valuations are high, debt is generally priced even higher. Regardless of how expensive a company's stock happens to be, from a financial-engineering perspective it can make sense for the company to borrow money to repurchase its own stock as long as the interest rate on its debt is lower than its earnings yield. Buying back stock boosts per-share earnings and often increases bonus payments to management, but it does nothing to expand or improve the underlying business.

3) The number of unprofitable IPOs during the first half of this year was the highest since the first half of 2000. What a waste.

4) The latest boom has been so obviously reliant on the Fed's easy money that the real economy's response has been far less vigorous than usual. This at least partly explains the reticence of corporate America to devote money to capital expenditure designed to grow the business and, instead, to focus on financial engineering designed to give per-share earnings a boost. IBM provides us with an excellent example. As David Stockman points out in a recent blog post, since 2004 IBM has generated $131B of net income, spent $124B buying-back its own stock and devoted $45B to capital expenditure. IBM has therefore been channeling almost all of its earnings into stock buy-backs and has bought back almost $3 of its own stock for every $1 of capex. Furthermore, 90% of the capex was to cover depreciation and amortisation. No wonder IBM has just reported declining year-over-year revenue for the 9th quarter in succession.

If interest rates were at more realistic levels there would be less incentive to buy back stock and more incentive to invest in ways to increase productivity.

5) Thanks to the combination of government support, low interest rates and a flood of new money, some large, poorly-run companies are staggering around like zombies, consuming resources that could have been used more productively. General Motors is a prime example.

6) On an economy-wide basis there has been no deleveraging in the US. This is evidenced by the following chart. Instead, the Fed's promotion of leveraged speculation and the government's deficit-spending maintained the steep upward trend in economy-wide credit. Consequently, in terms of total debt the US economy is in a more precarious position today than it was in 2007. It will therefore not be possible for interest rates to normalise without precipitating an economic collapse.

34592

7) The abundance of cheap credit prompted hedge funds and private equity firms to buy more than 200,000 US houses, which in many cases are now being rented to people who lost their homes when the previous Fed-promoted boom turned to bust. This has boosted house prices and created the false impression that the residential real-estate market is immersed in a sustainable recovery, prompting new (mal-) investments in this market.

8) The strength in auto sales is linked to the ready availability of subprime credit, which, in turn, is an effect of central-banking largesse, making it likely that auto sales will tank within the next two years. This will not only affect the assemblers of cars and the manufacturers of the components that go into cars, but will also affect all the industries that are involved in the shipping, storage, selling and financing of new cars.

9) While there is no doubt that the shale oil-and-gas industry would have been a great success story without the flood of cheap credit engineered by the Fed, the flood of cheap credit has led to a massive increase in the industry's debt-to-revenue ratio that has probably made the economics of shale-oil production look better than is actually the case and made the industry acutely vulnerable to tighter monetary conditions. Consequently, despite its solid economic foundation there will probably be many bankruptcies within this industry over the next few years.

A final point is that just as you never really know who has been swimming naked until after the tide goes out, you will never be able to identify all the mal-investments until after the monetary stimulus comes to an end.

 

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War Drums Beating Ever Louder, Consequences PDF Print E-mail
Written by Larry Edelson: Swing Trading   
Monday, 21 July 2014 06:46

Do you believe me yet? After all, I have been warning you over and over again that the new dynamic you need to be aware of is the rising tide of WAR.

About the great battle — between the public sector (government) and the private sector … and how it would lead to uprisings all over the world, to civil wars, and even to international wars.

Few of you believed me. Many thought I was crazy, or simply a fear-mongerer. And yet, here we are, only two years into my warnings of a rising cycle of social unrest that will not peak until 2020 …

And nearly everywhere you turn, geopolitical unrest is exploding off the charts, threatening to destroy the portfolios of almost all investors, catching the majority of them on the wrong side of the markets.

Just consider …

Israel and Gaza, in a war that could easily spread throughout the entire Middle East.

Malaysian Airlines Flight 17, likely brought down by a surface-to-air missile shot by pro-Russian separatists in Ukraine’s bloody civil war.

Vladimir Putin, bullying his way through Eastern Europe and now even attempting to reopen a Russian base in Cuba.

Boko Haram, murdering and kidnapping hundreds of innocent people, crusading to create an Islamic state.

ISIS, the Islamic State of Iraq and Syria, known for its harsh Wahhabist interpretation of Islam, and brutal violence directed at Shia Muslims and Christians in particular. Terrorizing the Middle East, killing thousands.

Ukraine’s civil war, thousands dead.

Syria’s civil war, 170,000 now dead.

All of Africa, where there are now fully 24 countries engaged in wars, involving 146 different militias-guerrillas, separatist and anarchic groups.

Asia, where 15 countries involving 129 different radical and separatist groups are waging wars and uprisings.

Europe, where nine countries are under siege via 70 different militias-guerrillas, separatist groups and anarchic groups.

The Middle East, where eight countries involving 169 different rebel and separatist groups are now engaged in conflict.

The Americas, where five countries are either at war or experiencing massive domestic unrest, involving 25 different rebel and separatist groups and drug cartels.

lrxAnd these are just the “official” wars. They do not include other hot spots around the world that are almost certain to lead to either civil or international war. Chief among those:

China versus Japan, Indonesia, Vietnam, the Philippines, Malaysia and Brunei … over the Spratly and Senkaku Islands, the East and South China Seas.

Europe, nearly all of it, where recent elections have seen substantial gains for parties ranging from the populist to the neo-Nazi groups:

Where France’s right-wing Marine Le Pen’s Front National group topped a nationwide poll for the first time in its history …

And where a backlash in many struggling euro-zone nations decimated by unemployment and austerity measures catapulted parties like Greece’s neo-Nazi Golden Dawn to the forefront, winning enough votes to send a representative to Brussels for the first time.

As I’ve also stated before, you may think all these conflicts are unrelated … or the result of religious extremists … or that they have no impact on you.

But mark my words: Look closely, as I have done, at all of the above conflicts — whether they are religiously inspired or not — and you will see two common threads:

1. Private sector groups rising up against authoritarian, unjust and corrupt governments.

2. Private-sector groups rising up against governments that want to increase taxes or even confiscate wealth while, at the same time, levying austerity measures on its people to slash previously promised benefits.

In lesser developed countries, it’s the result of government corruption, imperialistic actions taken by developed countries, pillaging of natural resources, and more. Yes, they are shrouded in religious, especially Islamic extremism …

But when distilled down to the truth, the forces driving them are no different than the forces that are driving the civil and international unrest you are now seeing in developed countries.

It’s merely a matter of degree. Yet an impartial and objective study of the forces that are driving the war cycles higher — wherever in the world they are playing themselves out …

Can all be distilled down to a great battle between the public and the private sectors …

And a battle that will soon come to main street USA.

How so? Naturally, it will take a different form, and allege different reasons when it strikes Main Street USA.

But its essence will be the same: A backlash of the private sector against the public sector … against loss of privacy … against rising taxation … against Washington’s fiscal irresponsibility … against a bankrupt Social Security system …

Against an ineptly run Veterans Affairs Department … against student loans that Washington underwrote and that are now bankrupting scores of college and post graduate students …

Against an insane Internal Revenue Gestapo Service that wants to, and will, monitor everything you do, every penny you save, every penny you spend, every item you buy — all in the name of making sure you are paying every penny of tax you should.

Not to mention the Internal Revenue Service’s massive bullying of other countries, which has now forced some 77,000 foreign financial institutions to cow-tow to Washington and report the financial activities of every American with an overseas financial account.

An uprising coming to America? You bet it is. And I suspect it will be one that will make the Vietnam era protests and our own version of Tiananmen Square, the Kent State shootings of May 4, 1970, look like a walk in the park.

And the consequences for investors and the financial markets will be simply astounding:

 They will cause gold to soar to more than $5,000 an ounce over the next few years. Silver to more than $125.

 Oil to soar to $200 a barrel and then even higher.

 Mining shares, perhaps the most undervalued sector of all, to at least QUINTUPLE.

 Food prices, now in the final throes of their bear markets, to suddenly reverse and explode higher.

 And the U.S. stock market? Other than a healthy pullback now and then, it will ironically explode higher …

[Editor's note: Larry has a time-sensitive report for you, Outrageous Opportunity: How to Position Yourself to Profit in the Bull Market of a Lifetime. This $79 value is yours free. Click here to learn how to get your copy now.]

As not a soul will want to touch U.S. or European sovereign debt and as capital from every corner of the globe crowds into U.S. equities as it becomes the last beacon of hope for capitalism …

The last, confiscatory-free place to invest your capital and get a decent return to boot.

As I have said for over two years now, you have to think differently to financially survive today.

The war cycles — the rhythms of historical, cyclical mass human behavior that are almost as predictable as the seasons of the year — are here now …

And they are ramping up with an intensity that even I underestimated.

Stay safe, and stay tuned to protect and grow your money.

Best wishes,

Larry

The post War Drums Beating Ever Louder, Consequences … appeared first on Money and Markets – Financial Advice | Financial Investment Newsletter.

 

 
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23 July 2014 ~ Michael Campbell's Commentary Service

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