The Nasties Of Hot Money In Asia

Is there "hot money" in the system? Yes, the Fed's and ECB's low interest rates policy has already started the USD carry trade a few months back, and it could add a Euro carry trade to its banner soon. So, where do you think the money is headed or has been residing? Its Asia. The easy way to see where it has been headed over the past few months is to look at Asia's strongest currency this year. At the top of the heap was the Indonesian rupiah, followed by the Korean won and then the Indian rupee. So much so that the central banks at South Korea and Indonesia have expressed strong concerns over the inflow of hot money into their system. Beware of the current gains you have been seeing in stocks, property and currency in these two countries. They could just as easily disappear overnight. It also appears that the new favoured son by these carry trades is Taiwan.

Hence, we may well appreciate the efforts of Bank Negara a bit more over the past 18 months because Zeti refused to join in the bandwagon to "allow" the ringgit to appreciate too much. Rightly or wrongly, much of the hot money bypassed Malaysia and the ringgit because the ringgit is still not "that accessible and free-floated". By maintaining a disciplined approach, Bank Negara has basically staved off any future problems that may have to do with hot money moving too fast into the system and then too fast out of the system.

Many have been wondering why the Malaysian markets did not rise by as much as their regional peers. In fact Malaysian stock market has been in the bottom quartile in performance when compared to other Asian bourses. A huge part of the answer lies in the currency issue just discussed. Safe to say that taking that point further, we may argue that much of the rise in asset prices in other Asian markets may have been mostly "inflated" by the liquidity rush.

Is the region in grave danger of a collapse when these funds exit? What would cause the funds to exit? Well, if the Fed starts to raise rates, not likely over the next 6 months at least. Well, if there is a fresh war or political instability somewhere that causes people to rush to the reserve currency, and/or a massive jump towards risk aversion. The key I guess, is to monitor the rumblings and big trades in USD and the interest rate policy discussions.

On November 10, 2009, Taiwan's Financial Supervisory Commission barred foreign investors from parking their money in time deposits after bringing funds into the country. Plus, foreign investors will not be allowed to extend the deposit maturity beyond three months. Until now, foreign investors were allowed to deposit 30% of the inflows in time deposits for three months with a possible extension for another three months. Portfolio investors can still invest 30% of the net inflows in government bonds, money market instruments, money market funds and derivatives. As of October 2009, foreign investors had parked US$15.5 billion in Taiwan dollar accounts, almost five times the level considered appropriate by the central bank. The central bank has voiced concerns that beside investing in Taiwanese stocks, foreign investors were putting money into Taiwan Dollar deposits to earn interest plus currency arbitrage given the appreciating Taiwan dollar.

The move follows large capital inflows into Taiwan's dollar accounts recently which is putting upward pressure on the Taiwan Dollar and hurting export competitiveness. The central bank has been intervening in the FX market and had recently hinted at capital controls to contain currency strength.

This need not be an explosive issue as it seems that the central bankers in the affected countries are aware of the situation. The danger is when the central bankers do not have the political will to act as they should, or they act too slow to temper the liquidity inflow. One can easily reduce the inflow with various measures, so as to minimise the ill-effects of withdrawal of these kind of hot money.

Funnily, the US Federal Reserve Bank of Philadelphia president Charles Plosser said that the capital flows into Asia are a result of a stronger recovery in the region. He added that the flows are not such that he would consider them to be threatening or inconsistent with fundamentals. OMG, the danger is when enough people in high places in Asia believe that diatribe. These are not long term FDI, its short term, its a play on currency outlook and interest rate differentials, is short term - how in the world can Plosser say its not threatening. It can move asset prices up by 30%-50% in 6 months, and we know its seriously never going to be long term, so when they exit, how can Plosser say that it won't be threatening???!!!


p/s photos: Reon Kadena

Big Picture View - Equities Well Supported (Updated)

Updated:
Stocks gained on a fresh wave of M&A announcements, including a deal by Xerox to acquire Affiliated Computer Services for $6.4 billion.Abbott Laboratories gained after the company said it will buy the pharmaceutical business of Belgium's Solvay for as much as $7 billion in a deal that will expand its presence in emerging markets. Covidien will acquire brain-monitoring technology firm Aspect Medical Systems for $12 a share in cash, or a total of about $210 million, net of cash and short-term investments acquired. Johnson & Johnson says it's bought 18% of Crucell for 301.8 million euros ($440 million) -- a 30% premium to Friday's close -- and will pay development milestones and royalty payments if flu vaccines that the two firms will develop make it to the market. Among major economic news this week, the Case-Shiller housing price index and consumer confidence data are due out Tuesday morning, while GDP, ADP employment and crude inventories are slated for release on Wednesday. The above news indicate that corporations are more willing to tap the markets for the low rates. Expect more such M&A activity in the coming days. This links up nicely to the article posting below. Of course we have to bear in mind that the US$ weakness is also supporting US equity purchases.
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Every now and then, its important to reassess the big picture view. Getting the big picture correct will make for a more confident trading mindset, or reasons not to trade the market. It is clear that the developing economies are recovering more rapidly than developed nations. If you look at central banks at developed countries, they are still keen to keep rates low. This emphasised the fact that while there is some sort of recovery, it will be a long drag to becoming substantive.

By mid-2009, most central banks in advanced economies reached the trough in their rate cycles. Fed and Swiss National bank reduced the lower end of their target bands to 0%. Bank of Japan has been taking a "zero rate interest policy" 0.1% interest rate for sometime now. Sweden's reserve deposit rate is negative, and that's a useful indicator. A few central banks - Fed, BoJ, Sweden and Bank of Canada - have made explicit commitments to keep policy rates low for a long period. Australia should be the first to tighten among the G-10 central banks, as early as Q4 2009. Bank of England could be next, possibly by December/January.

Whether a central bank starts to tighten is a clear indication of how confident the central bankers are of the recovery in their country. The danger is that some could stay loose for too long, thus fomenting a bubble. That is exactly what is happening in HK, owing to its dollar peg, which resulted in very low rates, but that does not correspond with its real economy which is recovering quicker thanks to its ties to China - thus fueling its property boom.

• ECB held at 1% in June 2009 and may stay there depending on economic data.
• Federal Reserve held at 0-0.25% since December 2008 and will likely remain there all 2009 and 2010.
• Bank of Japan held at 0.1% since December 2008 and will likely remain there all 2009 and 2010.
  
• Bank of England held at 0.5% since March 2009, lowest rate since 1694.
• NZ held at 2.5% since April 2009 but may resume cutting to 1.5% later in 2009.
• RBA of Australia held at 3% in June 2009, lowest since 1960, and may hike in Q4 2009.
• Canada held at 0.25%, its lower bound, since June 2009 and may resort to quantitative easing.
• Swiss National Bank cut target range for 3mo Libor to 0-0.75% in March 2009 and may stay there until 2010.
• Norway cut 25bp to 1.25% in June 2009, its rate trough. Norway may hike in Q4 2009.
  
• Denmark cut 10bp to 1.55% in June 2009, maintaining a 55bp spread versus the ECB.
• Sweden cut repo rate 25bp to 0.25% in July 2009, committed to staying there until end-2010. In a break with the tradition of zero setting the lower bound, the deposit rate was set at -0.25%.

Economic indicators can be sluggish and yet stock prices can rally, there is nothing wrong with that. The equity markets collapsed a few months before the subprime implosion took over. The recent G20 meeting reinforced the view that they will plan to leave the emergency stimulus in place even though there are signs of some recovery. The G20 basically did not want to pull the brakes too soon. That can only mean one thing, higher equity prices. Yes, there will be bouts of minor correction, but these are just bumps. You have very low interest rates, some signs of recovery, an easy monetary policy, a much lower risk aversion attitude, where can you place your bets ... bonds??? ... of course its equities.

Even when stocks rake in just 5% or 6% return, that is still powerful compared to the prevailing interest rates of 2%, and the differentials are substantive enough for people to put their money to work. Asset managers will have to reduce their cash holdings and put them to work in order not to under perform. The very low rates are not designed to prop up the stock markets per se... its really to boost corporate borrowing and corporate lending, which is a much bigger concern, all of the G20 are grappling with unemployment and needs the corporate side to borrow and spend more. The stock markets are just a bystander beneficiary to that objective. Good till year end.


p/s photo: Zhang Xin Yu

Central Banks & Their Gold Strategy

We all know that the biggest demand for gold comes from central banks. Just how has their buying or selling strategy been over the last 12 months? Is their strategy influenced by the amount of USD being printed into circulation? Are they afraid of the dollar not being able to uphold its long term value? Will they ever regard holding US Treasuries as an option only? Is any of them seriously hinting of reverting back to the gold standard? By holding more gold and less USD does that mean more flexibility to their monetary policy?

• Reduced central bank gold selling and increased investor buying may have been helping to underpin high prices in 2008 at a time of turmoil in financial markets. The renewal of the central bank gold selling agreement with a lower threshold suggests that gold sales by central banks will be lower in the next five years, a move the could support gold prices.
• Gold's share in global foreign exchange reserves is about 10%, the third largest asset by value despite being unevenly distributed across countries. The U.S. and European central banks account for the highest amounts both in absolute terms and as a share of reserve holdings (about 50%). Emerging market central banks have a much smaller share. Gold's share in global reserves declined sharply since the 1950s -1960s.
  

Regulation of Central Bank gold sales


• In August 2009, the central banks party to the central bank gold agreement (CBGA), who collectively have a gold share of just under 60% in their reserves, agreed to renew the treaty but with a lower maximum sales threshold. Analysts suggest that the marginally lower threshold could provide a "mild support" for gold.
• The annual sales by the central banks party to the treaty will be less than 400 tons. The previous agreement had a cap of 500 tons per years. The IMF's planned sales of 403 tons are included in the overall cap of 2000 tons from 2009-2014. With the Swiss National bank suggesting it will not sell, only the European central bank and the Banque de France are likely to take advantage to sell. The Italian and German central banks have been reluctant to sell their gold holdings.
• In H1 2009, estimated net sales by official holders of gold were 39 tonnes, 73% lower than in H1 2008. Net gold official gold sales are expected to be only 140 tons in 2009, the lowest since 1994.
  
• In 2008, European central banks sold the lowest levels of gold in about decade, reversing the practice of recent years whereby official sales helped depress gold prices. Banks bound by the central bank gold agreement (most of the European central banks) sold about 343 tons of gold , the lowest since the first agreement was signed in 1999, and well under the 500 ton annual limit.
• In the fall of 2008, central banks stopped lending out gold to banks as they were afraid they would not get it back. This reluctance contributed to an increase in bullion borrowing costs to 2.649% for one month, the highest since May 2001 and high above recent levels (5yr average 0.12%).
  
• An asset allocation assessment would suggest European central banks still have too much gold. EM central banks have low gold holdings in part because of the rising cost of gold and worries about an inability to sell when forex liquidity is required.
  

Gold holdings of Emerging Market Central banks

• GCC private investors have much higher stocks of gold than its central banks do. However, Qatar increased its gold reserves in 2007.
• China announced early in 2009, that it had increased its total gold holdings by 75%, likely from shifting non-monetary gold to the central bank. Although that increase now makes China one of the top 5 official gold holders, gold makes up less than 2% of China's $2.1 trillion in foreign exchange reserve by value. On the margins, China is likely to keep adding slowly to its holding but it is unlikely to make purchases on the open market given the potential for disrupting prices and reducing the value of USD holdings
• Aside from China with 1054 tons, the emerging market central banks with the largest gold holdings are Russia (540 tons), Taiwan (424 tons), India (358 tons) and Venezuela (356 tons) as of May 2009. Aside from Venezuela and Lebanon, the gold shares of which make up 37.5% and 27.5% respectively of total reserves, most of the other large holders have a gold share of only about 4% of reserves.
  

Gold Sales by the IMF

• The IMF, the third-largest official holder of gold, intends to sell 403 tons (12%) of its 3217 tons of gold, pending approval from 85% of its members which will likely be given in the fall. Any sales are likely be gradual though and may be sold to central banks.
• IMF gold sales are unlikely to be disruptive for the gold market and could be positive if the gold is purchased by other official investors (like central banks).
  
• The IMF is likely to start selling in 2010, selling about 200 tons a year.

p/s photos: Aya Nakata