It's Not Just China And Oil Anymore: Here Are The Two New Concerns Weighing On Risk

While the following summary of key recent headlines suggests a broad array of issues leading to the worst start of the year since 2008...

... in broad terms, the biggest worries challenging that bull case in January were twofold: China and commodities, mostly oil. However, over the past week, two new big concerns appear to have emerged. Here, ironically, is Deutsche Bank explaining what these are (for those confused, "tightening in financial conditions in European financial credit" is a euphemism for plunging DB stock among others):

The year continues to be bruising for risk assets and recent attempts at stabilisation have been unsuccessful. After a mild rebound, equities and US credit spreads are again close to their year’s worst levels.

In addition to the initial concerns about China and energy, two new issues further weigh on risk sentiment: the slowdown in US growth momentum and the tightening of financial conditions especially in European financial credit.

Macro data in the US have been weaker than expected and have raised questions about the sustainability of the recovery. Consumer spending and the services sector, which had been the drivers of growth, have decelerated. Fundamentals there still look sound, but weakness may persist and we have revised our below consensus growth forecasts further down. The Fed turned more dovish in response to the slower momentum and market volatility, and we no longer expect a rate rise in March. Indeed, at this stage it is difficult to see the Fed hiking more than once this year.

The Fed was not alone in this dovish turn. The Bank of Japan surprised markets by cutting rates into negative territory, and we actually expect a further cut later this year. As for the ECB, more easing should be forthcoming in March. A deposit rate cut seemed like the best course of action in response to purely external risks, but if the tightening of financial conditions does not subside an increase in the size of the QE purchase programme may be necessary.

Our macro outlook for 2016 is broadly unchanged so far, uninspiring but not a disaster – but downside risks have risen both in the US and in Europe. Meanwhile, the absence of new news has moved attention away from China, but the underlying problem remains unresolved. As for oil, volatility is becoming less relevant for macro and markets.

Despite this monetary policy support, until US growth, European financial conditions, China and oil concerns are put aside, markets will remain volatile and a sustained change in risk appetite is difficult. Fundamentally, we see 15-20% upside to equities, US credit spreads fairly priced and still believe in the stronger dollar story – but risks remain for all these views.Expectations for a drift higher in rates have not materialised, and dovish central banks and lingering macro concerns will continue to delay this normalisation.

And here is the matrix breaking down all the recent conditions weighing on risk. We wish we could be as optimistic as DB that monetary support from central banks which are now running on fumes in terms of credibility, and that oil, which continues to gyrate with grotesque daily volatility, are "supportive."

In fact, we are confused that DB is optimistic on central bank support: after all it was, drumroll, Deutsche Bank, which over the weekend warned against any more "easing" from central banks whose NIRP is now weighing on the German bank's profitability, something the market has clearly realized judging by the price of its public securities.

Gold tops $1200 for the first time since June 2015...

Since The Fed policy-error'd in December, gold is now up 22% over US equities...

Gold tops $1200 for the first time since June 2015...

Lead soars as pressures ease

 

A sharp and continuous rally in lead prices, for the past three weeks, has wiped out the losses the metal made in the first two weeks of January. The spot price on the London Metal Exchange (LME) has surged 10 per cent from $1,600 to $1,771 per tonne.

On the domestic front, the lead futures contract traded on the Multi Commodity Exchange (MCX), which moves in tandem with the LME spot price, also rose 10 per cent over the same three-week period and closed on a stronger note at ₹120 per kg last week.

Two major factors have triggered the recent rally in lead. First is the recent weakness in the dollar which, in turn, has added sheen to assets like commodities and non-dollar currencies, in the last few weeks.

Two, recent data releases showing an increase in lead imports by China have also supported price rise for the metal. The country’s lead imports have increased about 45 per cent to 297 tonnes in December from the previous month according to data from Bloomberg.

Reports also suggest that an increase in the demand for batteries due to more battery failures this winter season has also helped prop up lead prices. Though the recent rally in lead can also be attributed to short-covering, the charts suggest that the recent uptrend can possibly extend.

Medium-term view

Barring the brief fall below $1,600 to hit a six-year low of $1,554 in late November, LME spot lead has been range-bound between $1,600 and $1,800. The metal’s price rose to a high of $1,818 on Thursday last week, but fell back to close below $1,800 — the upper end of the range at $1,771. Price action in the coming weeks will need a close watch as it would decide whether the metal will stay in the $1,600-1,800 range or break above $1,800 to rise further.

A strong break and a decisive weekly close above $1,800 can increase bullish momentum and take it higher to $1,850 immediately. A further move above $1,850 can see the rally extending towards the next target of $1,900.

The lack of follow-through selling below $1,600 is a positive. Also, the metal has been moving inside a channel since October 2012. Since August 2015, this channel support in between $1,650 and $1,600 has been consistently limiting the downside and is providing a strong support. This is why a decisive weekly close above $1,800 will not just boost the bullish momentum, but also signal that the channel is intact. This increases the possibility of the LME spot testing $2,000 in the coming months.

On the domestic front, the recent rally in the MCX-lead futures contract is signalling a break-out of the range-bound movement that has been in place for more than six months since June 2015.

The contract is hovering near the 200 and 100-week moving averages, which are poised between ₹120 and ₹121. A strong rise above ₹121 can take the contract higher to test the next important resistance at ₹130 in the coming weeks. A further break above ₹130 can take the contract higher to ₹140. The contract has formed a strong base in between ₹110 and ₹105. The outlook will turn bearish only on a strong fall below ₹105. Such a fall will increase the danger of the contract falling to ₹100 and ₹98 thereafter.

Short-term view

The short-term trend for lead is higher. The MCX lead futures contract has broken above an important resistance at ₹117. Immediate support is at ₹119 and then a significant support is at ₹117. As long as it stays above these supports, there is no immediate danger of a sharp fall in the contract.

Intermediate dips to these supports may see new buyers coming into the market. At the moment, the downside is expected to be limited to ₹117.

A rise to test the next resistance at ₹127 looks likely in the coming days. The outlook will turn negative for a fall to ₹115 and ₹112 only if the contract declines below ₹117.

If the contract manages to surpass the immediate hurdle at ₹127, it can rise further to ₹130.

Increase in Chinese imports and a weak dollar have helped the metal reverse

"A Key Technical Indicator Just Rang The Bell On The Cyclical Bull Market"

While the primary topic of Albert Edwards' most recent note is the question how long China can sustain its FX intervention before tapping out and letting the hedge funds win with their short Yuan bets once total reserves drop below the critical redline of $2.7 trillion (the answer incidentally is between 5 months and 10 months assuming monthly reserve burn rates of $130BN to $60BN), we will skip that part as we have discussed it extensively in the past, and instead will fast forward to some chart porn by the SocGenarian.

Here is Albert Edwards showing that the S&P had breached key moving averages normally seen at the start of a bear market.

Back in the mid-1990s I spent three memorable years working at Bank America Investment Management, among some of the industry’s finest. Having previously spent three years as an economist at the Bank of England, I was new to markets and I let my economic enthusiasm often get the better of me when making recommendations to fund managers.

I remember the head of fixed income explaining to me it was far better not to try and pick market tops or bottoms but to wait and observe the market turn, making the trade late rather than prematurely trying to pick the bottom or top.

So the chart below is notable, showing that key 200d and 320d moving averages for the S&P have just been breached to the downside. If one is looking for key technical indicators to ring the bell on the cyclical bull market- maybe it has just rung loud and clear.

A renminbi devaluation will only sever an already badly frayed safety rope.

Budget goodies for GIFT, markets likely

Ministry considering tax sops for India's first global financial centre, steps to liberalise futures and options markets.

Finance Minister Arun Jaitley and his team are believed to be considering steps to attract big names in investment banks and global brokerage and trading firms to the Gujarat International Finance Tec-City, known as GIFT City. On the banks of Sabarmati in Gandhinagar, Gujarat, the city has been positioned as a "global financial centre".

Conceived in 2007 by Prime Minister Narendra Modi, then Gujarat's chief minister, the city has had a slow start. The coming Budget could offer substantial tax breaks and possibly a 10-year tax holiday, sources familiar with the developments said, adding exemptions from securities transaction tax (STT) and commodity transaction tax were among the incentives being considered for the GIFT City. However, a decision has not been taken, an official said.

The finance minister is also likely to announce a number of capital market-related reform measures, including removal of STT and stamp duties on trading futures and options, clarification on tax treatment in the exchange-traded currency derivative markets and regulatory positions on participatory notes. Removing regulatory constraints on banks and mutual funds to participate in commodity futures, among others, were also being discussed, a senior government official said.

Classified as a special economic zone (SEZ), GIFT city is being set up on the lines of global financial and information technology services hubs like Shinjuku (Tokyo), Lujiazui (Shanghai), La Defense (Paris) and the London Dockyards. It is aimed at attracting firms to open offshore banking as well as insurance and capital market intermediaries. According to existing provisions in the Act, SEZs are already allowed duty-free imports and are exempt from indirect taxes, besides 100 per cent income-tax exemption on export income for units for the first five years, 50 per cent for the next five years and 50 per cent of the ploughed back export profit for another five years.

The developers and co-developers are given an income-tax holiday for 10 years under section 80IAB.

"The government will definitely have to provide tax incentives to attract units in GIFT. Dubai International Financial Centre, for instance, provides zero tax rates. I am not sure if that will be possible, but that is the global benchmark for international financial centres," said Rakesh Nangia, managing partner, Nangia and Co. The DIFC offers zero per cent tax rate on income and profits (guaranteed for a period of 50 years), free capital convertibility and wide network of double taxation treaties for UAE incorporated entities.

The GIFT City comes at a time when the government has announced phasing out of corporate tax exemptions. It has said that after March 31, 2017, sunset clauses with regards to tax exemptions will not be renewed. After that, no weighed deduction will be applicable for operation, maintenance and development of export units in SEZs. "It is yet to be decided whether they can exclusively incentivise GIFT," said the official quoted above.

Apart from GIFT City, the budget-planners are said to be looking at measures to make India's equity, commodity and currency futures more competitive and liberalising them further. Some other measures could include lifting specific bans on any market segment, participant or product, making trading and clearing rules nationality-neutral and participant-neutral, allowing access to all foreign participants, as long as they meet financial action task force requirements, and over a longer-term period, getting in uniform know-your-customer norms, internationalising the rupee, and moving to a residence-based taxation regime.

The genesis of these suggestions is a report by the standing council on international competitiveness of the Indian financial sector. The council was set up in 2013 and its report was made public only in September. The finance ministry had requested various financial regulators, including the Reserve Bank of India (RBI) and Securities and Exchange Board of India, to examine the report. "The regulators are coming back to the finance ministry with suggestions on which recommendations can or should be implemented. The suggestions on which there is agreement among all stakeholders could be part of the Budget," said another official.

Regarding STT and stamp duty, the report had said that since the two levies add to transaction costs in equity derivatives, "STT should be removed. Stamp duty should not be applicable to cash-settled products such as index derivatives, as there is no delivery of the underling (product) taking place."

STT, announced by then finance minister P Chidambaram in the first Budget of the earlier government, is now levied on all sale transactions on futures and options. It is 0.01 per cent of the traded price of futures and 0.017 per cent on options premiums. A 0.125 per cent STT is payable on the settlement price by the buyer of an option that is exercised. If STT is paid, there is no long-term capital gains tax. But, if it is not paid, the latter is levied at 10 per cent.

The panel's report had divided its recommendations into three categories - short, medium and long-term - based on the nature of the reforms and the time that may be required to implement them. Longer term measures included internationalizing the rupee.

Internationalization refers to a state where exporters from other countries agree to take payment in rupees and where the currency risks in international borrowings are borne by lenders rather than borrowers in India. According to RBI, countries that can borrow in their own currency are less susceptible to international crises. "Consider a time-bound plan for internationalization of the rupee, in line with the plans of the Chinese government for internationalization of the renminbi," the report had stated.

MARKET BOOSTERS

• FM may announce tax breaks, 10-year tax holiday for GIFT City on the lines of the existing special economic zone rules
   
• Other capital market-related announcements aimed at further opening up of derivatives markets
   
• Removal of securities transaction tax and stamp duty on futures & options being considered
   
• Removal of constraints on banks and MFs to participate in commodity futures
   
• Longer-term aim of internationalising the rupee could be announced

Gold price jumps to 3 month high

Hedge funds positioning themselves for further upside

With weakness returning to equities and crude oil on Monday, gold futures trading in New York attracted brisk buying from investors eager for alternatives amid all the market turmoil.

In afternoon trade gold for delivery in April, the most active contract, was exchanging hands for $1,129.30 an ounce, up $12 or more than 1% compared to Friday's close and at its its highs for the day.

Thanks to safe haven buying gold’s trading at a 3-month high and is now up 7.5% since hitting a near six-year low mid-December.

Across 24 commodity futures markets money managers entered a net long position for the first time in five weeks

Large futures speculators or "managed money" investors such as hedge funds dramatically raised bearish bets on gold during the final months of 2015. Net short positioning – bets that gold could be bought back at a lower price in the future – hit a record 2.4 million ounces during the final trading week of 2015.

This year however hedge funds have been non-stop buyers pushing overall positioning firmly back in the black. According to the CFTC's weekly Commitment of Traders data released on Friday speculators added to long positions – bets that prices will rise – and trimmed short positions, leading to a more than 10-fold increase in net longs.

Speculators also added 55% to net silver long positions while copper bulls came roaring back trimming overall short position by a third. Platinum longs were increased and shorts cut, but bullish palladium bets declined from the previous week. Both PGMs remain in small net long positions.

Across 24 commodity futures markets money managers reduced bearish bets, entering a net long position for the first time in five weeks according to data by Saxo Bank.

Better sentiment towards crude oil was the most notable feature of as bullish bets increased by 34% – the biggest percentage jump since 2010. Traders may be regretting the shift with US benchmark crude oil prices plummeting 6.2% to $31.50 a barrel on Monday.

At the start of the year, across all commodity futures net short positions increased to 112,000 lots, the highest since government records began in 2009.

Commodity Market Holiday Schedule 2016, LME COMEX NYMEX SHFE

Jan 01 2016	New Year's Day (Observed)	LME / COMEX / NYMEX / SHFE
Jan 18 2016	Dr. Martin Luther King, Jr. (Observed)	COMEX / NYMEX
Feb 08 2016	Spring Festival	SHFE
Feb 09 2016	Spring Festival	SHFE
Feb 10 2016	Spring Festival	SHFE
Feb 11 2016	Spring Festival	SHFE
Feb 12 2016	Spring Festival	SHFE
Feb 15 2016	Presidents Day	COMEX / NYMEX
Mar 25 2016	Good Friday	LME / COMEX / NYMEX
Mar 28 2016	Easter Monday	LME
Apr 04 2016	Tomb-sweeping Day	SHFE
May 02 2016	Labor Day	SHFE
May 02 2016	Early May Bank Holiday	LME
May 25 2016	Memorial Day	COMEX / NYMEX
May 30 2016	Spring Bank Holiday	LME
Jun 09 2016	Dragon Boat Festival	SHFE
Jun 10 2016	Dragon Boat Festival	SHFE
Jul 04 2016	Independence Day	COMEX / NYMEX
Aug 29 2016	Summer Bank Holiday	LME
Sep 5 2016	Labor Day	COMEX / NYMEX
Sep 15 2016	Mid-autumn Festival	SHFE
Sep 16 2016	Mid-autumn Festival	SHFE
Oct 03 2016	National Day	SHFE
Oct 04 2016	National Day	SHFE
Oct 05 2016	National Day	SHFE
Oct 06 2016	National Day	SHFE
Oct 07 2016	National Day	SHFE
Nov 24 2016	Thanksgiving	COMEX / NYMEX
Dec 26 2016	Christmas Holiday (Observed)	LME/ COMEX / NYMEX
Dec 27 2016	Boxing Day	LME
Jan 02 2017	New Year's Day (Observed)	LME / COMEX / NYMEX / SHFE
* COMEX/NYMEX early closing on any business day preceding a holiday.