It's All About Liquidity

What happens when you have lots of money in the bank? Quite rightfully, the tendency is to either spend it or invest it wisely. In a macro scale and global financial terms, we call this liquidity.

Back in 2006 and 2007, global financial markets were flushed with liquidity, aided by the sub-zero interest Yen-carry trades. After all, funds were cheap and it was not surprising that investors took the risk to invest in assets with higher returns with lower cost of funds. However, many investors were caught badly burned as the global financial markets collapsed in the wake of the collapse of Lehman Brothers, followed by the massive loss of liquidity.

When funds dried up and there was a massive loss of confidence, investors naturally become risk averse. Markets continue to fall until the first quarter of 2009 amidst this phenomena.

Since March 2009, the outlook has changed drastically, due to massive pump priming by countries around the world and the huge injection of funds by the U.S. Government to bailout troubled financial institutions. Quantitative easing (printing of money) by countries such as U.S. and U.K. has certainly contributed massively to the availability of funds as well.

As a result, global financial markets are now flushed with liquidity. Whether this is artificially created or not is subject to your own interpretation though.

With U.S. economy showing signs of recovery, the U.S. Government has to decide whether it's time to gradually withdraw the stimulus plan. Indeed, this is what comes out of yesterday's FOMC meeting, however, with no specific timeline mentioned yet. Federal Reserve is not likely to do so until U.S. unemployment rate starts tapering off. Bear in mind that with all the talk about U.S. recovery, the unemployment rate is still hanging high at almost 10%!

With liquidity being the major driving factor, any move that could potentially dampen liquidity prematurely may spark another round of fear within the financial sector.

On the other hand, i believe the bull party is ain't over until there is a dramatic change in liquidity. As such, I am quite prepared to hold on to my positions until there is a clear sign of otherwise emerged.

Discovering Relationship Between Dollar & Oil

Do you ever wonder if the strength of US Dollar that you are holding affects the price of oil or vice-versa? Here's an interesting article written on its likely relationship and perhaps put you in a better guidance when you should invest in the commodity of crude oil and/or gold.

Since the beginning of the year, the price of crude oil has increased by more than 30% from US$43 a barrel in January to a high of US$60 in mid-May. This could boil down to multiple factors, including improved growth prospects, speculation and the weakness of the US dollar. In addition, the outlook for economic giants the US and China has improved materially over the past month, leading many people to believe that the worst of the global recession is almost over.

US and Chinese economic data, along with comments from central bankers seem to support this rosy outlook. Early this month, US Federal Reserve chairman Ben Bernanke told the US Congress that the recession is easing and that growth should take place by year-end. Most other central bankers expect their countries to return to positive growth in 2010. Given that oil prices
plummeted in the second half of 2008 because of deleveraging and the fear of a deep
recession, the promise of a brighter tomorrow is driving oil prices higher. However, a slower pace of contraction and the prospect of increased demand are not the only reasons oil prices are higher.

Recent US dollar weakness is contributing to the recovery. Of course, many people will argue
that the US dollar is weaker because the US economy is doing better, which is true, but the
relationship between oil prices and the US dollar’s value is too significant to ignore.

Since the beginning of 2008, the correlation between oil prices and the US-dollar index has
been roughly -0.90. In other words, 90% of the time, when the US-dollar index falls, oil prices
rise.

The chart below shows the tight correlation between the two instruments:
Here's the argument for dollar driving the price of oil:
- Oil is priced in US dollars. According to OPEC, the relationship between oil prices and the dollar is almost mechanical. When the dollar falls, oil prices have to go up in dollar terms to stay constant in euro terms. Oil producers receive their oil revenues in US dollars and need to be compensated for the fluctuations of the greenback. This does not always hold true, of course, otherwise the correlation would not have broken in the beginning of the year.

Here's the argument for oil price driving the dollar:
- A study by the IMF in 1996 found that a 10% rise in the real price of oil induces a 2% real depreciation in a typical OPEC's real exchange rate. This should not be completely surprising because higher oil prices do result in higher cost of oil imports for the US, leading to a higher current account and trade deficit, which is US-dollar bearish. It also affects growth. When oil prices were nearing US$150 a barrel, gasoline prices in the US went as high as US$4 a gallon or more. It's like a tax on consumers and significantly affected companies!

The conclusion is that the relationship between oil prices and the US dollar is both schizophrenic and symbiotic. When oil prices were hitting record highs in July 2008, it can be argued that the price of oil was driving the value of the US dollar because of concerns about the strain it would have on the US economy. However, currently it is more likely that the dollar is driving the price of oil because the outlook for global demand is not clear and investors are less focused on the impact that higher oil prices can have on trade than they are on its signal of stronger growth.

The full article can be found at Moneyshow.com.

Money-printing Caused Market Rally?

What has caused the recent stock market rally across the globe? Too fast, too soon, as there are hardly sufficient evidence to fundamentally support a market euphoria? Here's another theory by the well-known commodity investor, Jim Rogers.

According to Rogers, the recent market rally is flooded with "artificial" liquidity as a result of the various printing money (technically known as Quantitative Easing) initiatives taken by central banks of certain developed countries, particularly U.S. As such, Rogers believe that the next financial meltdown will be in the currency markets.

Rogers claimed that he has bought the Yen because he expects the Japanese currency to withstand future problems, but he does not have short positions in any currency and is currently not buying the yen any more. However, Rogers has not shorted the U.S. dollar at the moment, although it may be at the peak.

Nevertheless, Rogers also believe that for the moment, currencies may look safer than anything else in the markets, as stocks may face a new bottom since they were artificially lifted by the amount of money created by central banks, but there are pitfalls ahead.

Rogers's view seem to coincide with the views of other legendary investors such as Warren Buffett....

Beware of the potential next currency crisis, particularly if you have exposure to multiple foreign currencies!

Should You Invest In Foreign Currency Account?

What is a Foreign Currency Account? Foreign currency account is essentially an account maintained in a financial institution in another currency other than the local currency. As most banks in Malaysia are offering this facility, you can easily open up one account, with normally the condition that you have an existing deposit account with the bank.

There are several purposes why one would require a Foreign Currency account, namely:

1. An account to hedge against foreign currency transactions whether in the form of business or personal use;
2. Higher yielding interest rates (e.g., Australian and New Zealand Dollar) compared to local interest rates;
3. Children education funding;
4. Individuals with sources of income from overseas;
5. Investment return
   

One should bear in mind the most important factor to consider is the direction of the foreign currency versus local currency, no matter what the purpose are. In other words, one should invest into foreign currency account only if there is a perception or expectation that the foreign currency will appreciate against local currency. Otherwise, the benefits of having a foreign currency account may well have been offset by a depreciating foreign currency even though one may gain from the supposedly higher yielding interest rates for instance.

In general, many have this perception that local currency will tend to depreciate over time but certainly this could be a false perception at times. Economic fundamentals and market sentiment definitely have a large role to play in the direction of currency strength. For instance, the value of Australian Dollar had in fact depreciated by more than 20% against Ringgit Malaysia early part of this year!

Therefore, it's important to study these factors before plunging into any foreign currency or open a foreign currency account.

There are generally two types of account, being call deposit and term deposit account. Call deposit is equivalent to a savings account and in most currency offered, there will be nominal interest rates computed daily credited month-end. Currently, US Dollar does not offer any interests. Term Deposit on the other hand is a fixed term deposit account whereby higher interest rates are given upon maturity.The term can range from 1 week to 12 months.

Locally in Malaysia, there is generally no fees charged for opening a foreign currency account. However, the catch is this.....the bank would have earned from you already the moment you open one due to the exchange rate spread between buy and sell rates. As such, don't be overly excited when the bank officer tells you that they do not charge any fees!

How To Predict Stock Market Movement Using Currency

Most traders use technical analysis to make a prediction the likely movement of stock market. For most layman, learning up technical analysis takes time and a fair amount of patience and technical interest. For most, they simply give up.

There is one other way of making advance predictions of stock market movement, and based on my observation, the correlation between the two is a pretty good one.

Take currency versus US Dollar comparison. When US Dollar gains strength against other currency, stock market will likely go down. On the contrary, the exact opposite movement (market rises) happens when US Dollar depreciates against other currency.

Take the following two examples (USD vs Ringgit and USD vs Singapore Dollar) to study the correlation:



Do you see the opposite trend being formed? It may not be the most perfect correlation but generally, it holds true.

To explain this, generally speaking it is a case of US Dollar demand is stronger during rising risk aversion (i.e., funds are risk averse to investing overseas and therefore more funds are repatriated to U.S.). On the other hand, US Dollar demand will be weakened when funds are more eager to invest overseas, thus outflow of funds from U.S.)

So if you would like to predict the day's market movement, study the currency strength versus US Dollar.

Is US Dollar A Bubble In The Making?

Many perceive the US Dollar to be a safe heaven, never mind that the US economy is in shambles and the largest banks and automotive companies are almost to the brink of bankruptcies, never mind that US has been selling Treasury bills by the tons to avert a financial collapse and never mind that the US stock markets have shed its value by about half in less than one year! The US Dollar has in fact appreciated against most major currencies by a large scale except for the Yuan and the Yen.

So what caused the Dollar to appreciate?

- Risk aversion to global markets, due to the crash in most global asset classes and the credit crunch in the US. There is therefore a strong demand for US Dollar to be averted back to the US. Also, severe deterioration in world wide economy following the US footsteps has further caused risk aversion and repatriation of funds from both developed and emerging markets.

With the US resorting to printing money (or technically termed as "quantitative easing" to make it sound diplomatically correct!) in order to bailout the banks and save the faltering economy, questions are asked whether the Dollar's strength can sustain in the future.

In essence, any currency will lose its value when the supply is more than demand over time. The problem with quantitative easing is that by the time the money reaches the level of the common consumer and caught up with the excess money in the market, inflation cripples in and the dollar worth of currency will therefore be reduced. This is not the case when the money is first injected as it takes time for inflation to recognise the new money and catch up.

As such, the current strength in US Dollar will likely be hampered in the long term as inflation or hyperinflation takes effect in the US, as and when the economy recovers.

It is also likely that prices of commodities will again be on the rise by then!

On the other hand, better lock down your mortgage rates before interest rates move up in tandem with inflation or a hyperinflation!

Can Rate Cut Work Its Magic In U.S.?

As expected, U.S. cut its interest rates by 50 basis point to 1%. Multiple central bankers followed suit thereafter, including China and Norway, who slashed rates respectively. The Bank of Japan is also considering cutting rates on Friday but will watch market conditions before deciding. More countries are expected to follow suit.

The interest rate cuts, sent the U.S. dollar plunging to its biggest one-day drop in 23 years yesterday!

It is widely expected that U.S may further reduce rates in December. If this happens, U.S. will be reminiscent of Japan, which has been maintaining a zero or sub-zero interest rate over the past decade. However, bear in mind that Japan failed to revive its economy despite slashing rates to zero in 1999! Also recalled that Japan became mired in a decade of lost growth in the 1990s after the real-estate prices collapsed, which is now happening in U.S! That caused a severe bout of deflation in Japan, which is a destabilizing drop in prices.

Will history again repeating itself, albeit this time in the U.S?

Currency: Does US Dollar Deserve To Be Strong?

This article is written by Abd Ghani Hamat. He shares his view on why US Dollar remains strong despite a faltering economy and what the reality may potentially unfold.

"The poignant reminder simply won’t go away. Last week, investors bracing for a global recession traded the US dollar to two-year highs against major currencies except the yen. In fact, the British pound suffered its biggest one-day percentage drop on Friday since September 1992, Reuters reported.

It’s unsettling to note that the greenback had firmed up against the likes of euro and sterling even after the US financial system has hit the rocks, dragging down the world with it.

Why has the world continued to accept an artificially strong dollar and not let it slide? It’s untenable. Sooner or later, the dollar will find its true value.

The world will wake up one day and realise that the game is up; it cannot continue to prop up a currency whose country has run up a federal deficit of almost US$1 trillion (RM3.53 trillion) or 7.5% of GDP in a single year and national debts of US$10 trillion.

It’s not right for the world’s biggest debtor to have a strong currency. A time will come when the greenback will be subject to the same argument that resulted in Argentina, for example, devaluing its peso by 30% in 2002.

The only reason the dollar has remained strong — as the whole world is aware by now — is that too many countries have too much money to lose on a cheap dollar.

A sudden withdrawal of the foreign money, which had been a big contributor to the steady appreciation in US asset prices, would lead to massive writedowns and losses. But what is the point of holding on to assets and securities that have shrunk to a fraction of their values with no guarantee whatsoever of their restoration in the foreseeable future?

The situation in the US is truly dire.

Federal Reserve chairman Ben Bernanke, in explaining the US$700 billion bailout package last week, said: “If we don’t do this (bailout), we may not have an economy on Monday.”

The general consensus in the country is that the financial meltdown has not played out fully, and main street is bracing for the impact at any time.

“Wealth has eroded enough that you will see some changes in the US style of living,” reads a comment on a US investing website. Of course, there are also less savoury comments, like the one calling for a lynching of Wall Street barons.

But why is the world ignoring US economic fundamentals and continuing to have confidence in the dollar? After all, the writing has been on the wall for the longest time.

In March 2006, the UNDP’s International Poverty Centre issued a report saying “the growth of the US economy since the 1990s had relied on sucking in foreign savings at an alarming rate”.

Terry McKinley, the author of the report titled The monopoly of global capital flows: Who needs structural adjustment now?, said the inflows of capital into the US were almost twice as large as the amount needed simply to finance its current account deficit.

He said this implied that the corresponding capital outflows from the US were almost the size of the current account deficit itself.

“This suggests, in turn, that capital inflows are not only financing excess consumption by US citizens but also reciprocal investment by US private investors abroad.

“In other words, central banks in other countries are helping subsidise US foreign investment and profits.”

Sobering thought. The rest of the world had helped the US become a monster!

Now, the question is, are central banks the world over helping to keep the dollar artificially high to give themselves time to unwind their positions in the US? For, surely the world has realised that it is doing itself a lot of disservice by backing a declining world economic power. If that is the case, the dollar is due for a very rough ride.

But where do you put the money, or what’s left of it, that you pulled out of the US? Where ever it is, I suppose, it should be a major consideration in all this talk about a new global financial architecture.

It is important to note that the decline in US financial strength has coincided with the emergence of new global economic powers in the likes of China, India, Brazil and Russia. Not only have the new economic powers eroded the dominance of the US and Europe in world economy, they are also transforming the flow of trade and capital.

As we look to contain the impact of the looming global recession at home, we simply cannot ignore the changing economic landscape.

While we keep a close watch on commodity prices, we must note that the world post-recession will not be so West-centric as it is. Therefore, efforts to contain the immediate impact of a global financial turmoil should not be at the expense of finding our rightful place in world economy later on.

No doubt, with so many new economic powers about, it would be harder to carve a market niche. That’s why we should start ridding ourselves of the inefficencies and set proper goals now.