"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Friday, January 24, 2014

Market Response to Emerging Market issues Taking a Deflationary Tone

These credit/currency related crises that we have experienced since 2008 all have produced the same thing after the market begins to sift through the details - a DEFLATIONARY reaction.

By that I mean a rush into the relative safety of US Treasuries out of equities. The result is a drop in interest rates as investors seek return OF capital and not necessarily return ON capital.

In the process, the Japanese Yen has tended to be the recipient of inflows. I am still unclear as to why anyone would regard the Yen as a safe haven currency but I suspect it might have more to do with Yen carry trades being unwound which puts upward pressure on the funding currency as those trades are reversed.

The other thing which typically has happened is we get a spike higher in the Volatility Index or VIX. Here is a chart of what I prefer to call the Complacency Index. For those of you who might be newer to the markets, this index measures investor sentiment in general (derived from option premiums). When it is rising, it indicates investor unease/discomfort/concern with current events. When it is soaring it indicates downright fear/panic. When it is falling or flatlining it reflects complacency/ease/lack of concern/confidence.

To provide you with a better longer term perspective - I am also adding this weekly chart. Note that the current spike upward does not seem to be much when viewed in this light does it?

I am also noticing that commodities in general ( there are some exceptions ) are weak today especially as the US Dollar has actually worked up off its session lows and moved into positive territory. Yesterday the Euro was seen as a safer place to park money than the US Dollar - that has completely reversed today. ECB President Draghi's comments are certainly not helping the Euro especially when he stated that while the economy is recovering, risks on the downside remain and unemployment remains very high. Not exactly a full-throated endorsement of confidence is it?

Copper, another key benchmark, is also lower today. This late session recovery in the US Dollar and further downward movement in equities is actually bringing deflation fears back to traders' minds and as those fears strengthen ( at least for this immediate moment) gold is fading lower along with silver and copper and the other metals.

Emerging Markets Stress Continuing

Yesterday I mentioned that stress in emerging markets was providing strong safe haven flows into bonds and into gold. The Commodity currencies were generally under pressure as a result with Europe benefitting as well as the Japanese Yen. The Dollar is not getting much of a safe haven flow, which coming on the heels of this sort of thing is rather remarkable. US Treasury yields are sinking once again.

The Turkish Lira was a big event yesterday; today it is the Argentinian Peso. Ukranian credit markets, etc,. The list could go on. This is where the bid in gold is coming from especially as equity markets weaken.

This is one of those events where things can spiral out of control very quickly, especially in this age in which huge leveraged bets have been placed.

We will keep a close eye on this but one thing is certain - at least for now - gold is responding like one would expect it to do during times of economic uncertainty.

I am also noticing the VIX is rising once again. It is by no means in "fear/panic" territory but some of the complacency that has marked the US equity markets for so long is having some second thoughts.