Risk-Off Correlations - When Opposites attract

"Commodities tend to zig when the equity markets zag."
Jim Rogers

Looking at the recent sell-off in broad asset classes with the spill-off from the ongoing European crisis, we thought it would be interesting to look into asset correlation movements during "Risk-Off" periods such as today. We already touched in 2011 on asset correlation during the sell-off experienced in our conversation "Misery loves company".

More recently in our conversation "St Elmo's fire", we pointed out we had been tracking with much interest the ongoing relationship between Oil Prices, the Standard and Poor's index and the US 10 year Treasury yield since QE2 has been announced - source Bloomberg:

We argued at the time:
"We do expect the SPX index to fall further in conjunction with Oil prices. We saw that "Misery loves company" back in 2011. In similar fashion, many various asset classes are experiencing significant correlation on the downside, following a similar pattern."
Indeed, both SPX and Oil prices are lower, with Oil dropping another 1.67% toady to 86.35 dollars.

We also indicated that Oil prices were poised to fall further because drilling-rig use and stockpiles are at their highest levels in decades, according to Michael Shaoul, Oscar Gruss and Son Inc.’s chief executive officer as reported by Bloomberg:

"The CHART OF THE DAY compares weekly data on the number of oil rigs, as compiled by Baker Hughes Inc., with the Department of Energy’s weekly figures on crude inventories. Last week’s rig count of 1,382 was the highest in 30 years, Shaoul wrote yesterday in an e-mailed note. The number increased 45 percent from a year ago. Oil stockpiles totaled 382.5 million barrels, the most since mid-1990.
“Even though demand has remained steady, it has been overwhelmed by supply,” the New York-based analyst wrote. “The clear risk is that this will be resolved by sharply lower prices in the coming months.” Oil has tumbled 14 percent on the New York Mercantile Exchange this month. The loss exceeds an 11 percent decline in Brent crude, another benchmark, and would amount to the biggest monthly loss in two years." - source Bloomberg.

Commodities, like in 2011, have experienced some significant retracement in conjunction with equities with Cash silver losing as much as 1.3 percent to $27.9275 an ounce and to around $28.30 last week. The metal was 1.5 percent lower last week for a fifth weekly drop, the longest losing streak since July 2011. Raw materials slid to a five-month low as well and more than $4.3 trillion was erased from the value of global equities this month on concern that Greece will exit the euro as the region’s debt crisis deepens according to Bloomberg. Even Gold Bullion wasn't spared and declined 1.9 percent last week as the dollar advanced 1.1 percent against a six-currency basket including the euro, which is poised for its biggest weekly drop in five months versus the U.S. currency according to Bloomberg.

Moving back to Oil and SPX, it seems other pundits as well are following the same disconnect between Oil and SPX as indicated by the below graph from Daiwa produced on Bloomberg, wondering:

** 3yr OIL V SPX: SPX to reset? ** Or Oil to bounce?

Truth is, in similar fashion to 2011, positive correlation between growth assets is most notable when investors are most concerned about risk according to AMP Capital's Oliver - source Bloomberg:

By Sungwoo Park and Saeromi Shin -May 31 (Bloomberg):
"The relationship between commodities and equities is the strongest in more than a year and near a 16-year record, as risks posed by Europe’s debt crisis and a global slowdown make the asset categories “more closely intertwined.”
The CHART OF THE DAY shows the 200-day correlation coefficient between the Standard and Poor’s GSCI Spot Index of 24 raw materials and the MSCI All-Country World Index of shares rose to 0.73 on May 25, the highest since January 2011 and near the strongest since at least 1994, data compiled by Bloomberg show. A correlation of 1 indicates the gauges move in lockstep, a value of zero shows there is no relationship.
When investors are most concerned about risk, “positive correlation between growth assets is most notable,” said Shane Oliver, head of investment strategy at AMP Capital Investors Ltd., which has almost $124 billion under management. “Everyone is looking at the same threats to growth, and so they are all selling together.”
The S and P GSCI index declined 4.2 percent this year through May 29 while the MSCI equities gauge gained 1.5 percent in the period. By contrast, the Dollar Index, a measure of the greenback against six currencies, touched a 20-month high on May 25. Investors are seeking safer assets, such as the dollar, as Europe wrestles with Greece’s debt and the possibility of that nation exiting the euro. Also of concern is the slowest economic expansion in about three years in China, the world’s biggest consumer of metals and cotton. Copper slipped to a four-month low last week, while cotton tumbled to a two-year low. Commodities and stocks have become “far more closely intertwined” as resources have taken on a greater role amid China’s economic expansion and increasing consumption in emerging-market nations, Oliver said. In 2000, after a 25-year commodity bear market, resource companies had low weightings in share gauges. “This has now reversed,” he said. When global risks are perceived as limited, “individual assets are largely driven by their own fundamentals and so the correlation between growth assets such as equities and commodities was low,” Oliver said. “In the current environment of heightened macro instability due to debt problems in Europe and the U.S., this is no longer the case. It’s either ‘risk on’ or ‘risk off’ with growth assets moving together.”

In fact, the only commodity that appears to be running scarce in "Risk-Off" periods appears to be the dollar - source Bloomberg:

According to John Detrixhe from Bloomberg on the 29th of May:

"The dollar is proving scarce, even after the Federal Reserve flooded the financial system with an extra $2.3 trillion, as the amount of the highest-quality assets available worldwide shrinks.

From last year’s low on July 27, the greenback has risen against all 16 of its major peers. Intercontinental Exchange Inc.’s Dollar Index surged 12 percent, higher now than when the Fed began creating dollars to buy bonds under its extraordinary stimulus measures at the end of 2008.

International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The U.S. is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category, data compiled by Bloomberg show."

From the same article:
"The greenback’s share of global foreign-exchange reserves climbed in the last three-months of 2011 to 62.1 percent, the highest since June 2010, while holdings of euros fell to the lowest since September 2006 at 25 percent, according to the latest quarterly data from the International Monetary Fund.
Foreign official holdings of U.S. government debt increased in each of the first three months of 2012, climbing by 3.24 percent to $3.73 trillion in the best start to a year since2009, according to data from the Treasury Department." - source Bloomberg.

Whereas opposite attracts during "Risk-Off" periods, it looks like the greenback is still working so far as a powerful magnet.

"Which would you rather have, capital lined up on your borders, trying to get into your country or trying to get out of your country? We are the capital magnet of this planet and we are the savior for not only people, for not only freedom, but also for capital."
Arthur Laffer

Stay tuned!

The US downgrade was not a downgrade of America's economy but a dowgrade of its leadership.

This week post, will not deal with data and financial action of the last couple of days, as it is available to all to see, enabling one to draw its own conclusions on the state of the US economy in particular and Developed countries economies in general.
This week post is an intentional attack on the clear lack of leadership and political failures responsible for the current society and economic woes in the United States.

From the anonymity of a personal blog, to the wilderness of internet liberty (which reach and powers have extended, beyond our wildest dreams, allowing communities to discuss and gather, lies to be refuted, and, even government to be toppled),it appears more and more that common sense has left most of mainstream media as well as Washington. “The Truth is Out There” was the motto of the X-Files, and indeed it is, within a growing population of internet bloggers, less contrived by political intervention, and thanks to a healthy competition in both quality and content.

Make no mistake; the downgrade of the United States was not a downgrade of its economic might, but more and simply a downgrade of its leadership.
While the Tea Party has risen to prominence in US politics, it has only been able to do so, because it has been in a position to fill a political vacuum and feeding itself on economic woes. It closely follows the steps of the Greenback Party which was born because of the Great Depression of 1873.
I have touched on the subject at length in my post "I promise to pay the bearer on demand..." - Panics and Populism.

The great irony today is, that, whereas the Greenback party opposed the shift from paper money back to a bullion coin-based monetary system, the Tea Party members are supporting the reverse.

But this leadership vacuum did not start with this current administration. The gradual erosion of the American leadership started a long time ago. Did it started under the failed leadership of President Richard Nixon? The point here is not to argue about the exact date of the start of the decay and play the blame game, but its consequences on the US economy and what must be done to address it.

Many years ago the American people had been warned by one of its greatest leaders, in the tradition of the founding fathers of the United States of America such as Thomas Paine or Thomas Jefferson, namely President Dwight D Eisenhower in one of his greatest speech, his farewell address, on the 17th of January 1961. It is a must read: http://www.americanrhetoric.com/speeches/dwightdeisenhowerfarewell.html
“Another factor in maintaining balance involves the element of time. As we peer into society's future, we -- you and I, and our government -- must avoid the impulse to live only for today, plundering for our own ease and convenience the precious resources of tomorrow. We cannot mortgage the material assets of our grandchildren without risking the loss also of their political and spiritual heritage. We want democracy to survive for all generations to come, not to become the insolvent phantom of tomorrow.”

50 years on, American people did not listen and they had to face the embarrassment of US downgrade, much more representative of its lack of political guidance and wisdom than of its economic woes. As a currency issuer, it is a fallacy to believe the US can default, as it is a fallacy to believe that the FED is responsible solely for the dire economic situation of the American people.

American people have been failed not by the quality and ingenuity of its great business companies and business leaders (Apple, Google, IBM, the list is too long!) and people, but by its failed politicians and failed politics. The latest comments by Dallas Fed President could not be more evident to where the culprits are, for the current economic situation, namely Washington:
“I believe what is restraining our economy is not monetary policy but fiscal misfeasance in Washington. Pointing fingers at the Fed only diminishes credibility. The ugly truth is that the problem lies not with monetary policy but in the need to construct a modern, appropriate set of fiscal and regulatory levers and pulleys to better incentivize the private sector to channel money into productive use in expanding our economy and enriching our people.”

A great country needs great leadership, and the debt ceiling summer comedy debate between Republicans and Democrats made more damage to the image of American leadership in the world and its economy than to the safety of its Treasury Bonds. And I expect, like David Rosenberg, to the see the US 10 year bond yielding well below 2% in the near future but that is another story.

But there is hope. It is payback time, with the recent rebellion launched by great business leaders demanding accountability and leadership. From Warren Buffet to the CEO of Starbucks Howard Schultz, one can only hope that the tide is turning. Here is what Howard Schultz had to say: "Our national elected officials from both parties have failed to lead," he wrote. "They have chosen to put partisan and ideological purity over the wellbeing of the people. They have undermined the full faith and credit of the United States. They have stirred up fears about our economic prospects without doing anything to truly address those fears."

An Open Letter to Starbucks CEO Howard Schultz From American Small Business League President Lloyd Chapman

American small business have always been at the heart of any strong economic recovery America has had.
Here is what they have to say in relation to American leadership throught the voice of their speaker president:

"Congress needs to go back to work, focus on job creation and solve the crisis of uncertainty. That said, the most effective economic stimulus President Barack Obama and Congress could implement would be to direct more existing federal infrastructure spending to small businesses, our nation’s chief job creators. This is an issue my organization, the American Small Business League, advocates for on a daily basis.

The latest U.S. Census Bureau data indicates that small businesses create 90 percent of all net new jobs, employ more than half the private sector workforce, are responsible for more than half of GDP and more than 90 percent of U.S. exports. It is clear that economic recovery needs to be based on small businesses.

I think members of Congress realized this in 1953 when they passed the Small Business Act. Today that law requires that 23 percent of all federal contract dollars be awarded to small businesses. Yet since 2003, a series of federal investigations have found most of that money has gone to Fortune 500 companies and other large firms.

In Report 5-15, the Small Business Administration Office of Inspector General referred to the issue as, “One of the most important challenges facing the Small Business Administration and the entire Federal government today.

During President Obama’s campaign he stated, “It is time to end the diversion of federal small business contracts to corporate giants.”

The Small Business Act defines a small business as generally less than 500 employees and independently owned, which, by definition, excludes publicly traded companies. Therefore, President Obama could stimulate the economy with an executive order stating, “The federal government will no longer report federal contracts awarded to publicly traded companies as small business contracts.” Our research indicates this would redirect up to $200 billion annually in federal infrastructure spending to small businesses."

It is not too late to restore the greatness of America and cure its economic woes, and, if it has to go through a campaign donation boycott so be it.

"I promise to pay the bearer on demand..." - Panics and Populism.

From the Bank of England's website:

http://www.bankofengland.co.uk/banknotes/about/faqs.htm#2

"The words "I promise to pay the bearer on demand the sum of five [ten/twenty/fifty] pounds" date from long ago when our notes represented deposits of gold. At that time, a member of the public could exchange one of our banknotes for gold to the same value. For example, a £5 note could be exchanged for five gold coins, called sovereigns. But the value of the pound has not been linked to gold for many years, so the meaning of the promise to pay has changed. Exchange into gold is no longer possible and Bank of England notes can only be exchanged for other Bank of England notes of the same face value. Public trust in the pound is now maintained by the operation of monetary policy, the objective of which is price stability."

Indeed in a deleveraging and restructuring world, the promise to pay the bearer has changed.

Public trust has been seriously impaired in the latest financial crisis, in both the financial sector as well as in trust in elected governments in general and politicians in particular.

The difficulties of imposing drastic austerity measures in numerous European countries are indeed endangering democracies. General strikes are on the rise in many European countries, France, Greece, Spain, etc.

The rise of populism is a stark reminder of the impact of economic crisis on fragile democracies as seen in the 30's in numerous European countries which led to the Second World War.

Populism in Latin America has had important impacts.

Populism has been fiscally supported in Latin America during periods of growth such as the 1950s and 1960s as well as during commodity price booms such as in oil and precious metals, which also explains today how Chavez in Venezuela is able to maintain his grip of the country. The fate of Chavez is intimately linked to the price of Oil.

Highly unequal societies leads to a rise in populism.

It is a global trend.

From Latin America, to Europe and the US, populism is dangerously rising.

Populism movements are deeply correlated to Panics and Depression throughout human history.

The emergence of the Tea Party movement in the US in 2009 is reminescent of the rise of the Greenback Party, which was active between 1874 and 1884, following the US civil war.

The Greenback Party was born because of the Great Depression of 1873:

http://en.wikipedia.org/wiki/Panic_of_1873

"The Panic of 1873 or Depression of 1873 marked a severe international economic depression in Europe and United States that lasted until 1879, and even longer in some countries. It began with financial failures in Vienna (capital of Austria–Hungary then) that spread to most of Europe and overextended American banking in late 1873. It was one of a series of economic crises in the 19th and early 20th centuries. In Britain, the result was two decades of stagnation known as the "Long Depression", during which Britain lost its world economic leadership. In U.S. literature this global event is usually known as "Panic of 1873", while in Europe it is known as Long Depression or Great Depression."

Effects in the U.S.
The failure of the Jay Cooke bank, followed quickly by that of Henry Clews, set off a chain reaction of bank failures and temporarily closed the New York stock market. Factories began to lay off workers as the United States slipped into depression. The effects of the panic were quickly felt in New York, more slowly in Chicago, Virginia City, Nevada and San Francisco.

The New York Stock Exchange closed for ten days starting September 20. Of the country's 364 railroads, 89 went bankrupt. A total of 18,000 businesses failed between 1873 and 1875. Unemployment reached 14% by 1876. Construction work halted, wages were cut, real estate values fell and corporate profits vanished."

Sounds eerily familiar doesn't it?

From the same Wikipedia document we learn about the impact this crisis had in both Germany and Austria.

Germany and Austria:
A similar process of overexpansion was going on in Germany and Austria, where the period from German unification in 1870-71 to the crash in 1873 came to be called the Gründerjahre or "founders' years". A liberalized incorporation law in Germany led to the founding of new enterprises, such as the Deutsche Bank, as well as the incorporation of established ones. Euphoria over the military victory against France in 1871, combined with the influx of capital from the payment by France of war reparations, encouraged stock market speculation in railways, factories, docks, steamships - in short, the same areas of overexpansion as in the United States. It was in the immediate aftermath of Bismarck's victory against France that he began the process of silver demonetization. The process began on 23 November 1871 and cumulated in the introduction of the gold mark on 9 July 1873 as the currency for the new united reich to replace the silver coins of all the constituent parts. Germany was now on the gold standard. Demonetization of silver was therefore a common element in the crises on both sides of the Atlantic Ocean.

On May 9, 1873, the Vienna Stock Exchange crashed, no longer able to sustain false expansion, insolvency, and dishonest manipulations. A series of Viennese bank failures resulted, causing a contraction of the money available for business lending. In Berlin, the railway empire of Bethel Henry Strousberg crashed, bursting the speculation bubble there. The contraction of the German economy was exacerbated by the conclusion of war reparations payments to Germany by France in September 1873. Coming two years after the founding of the German Empire, the panic became known as the Gründerkrach or "founders' crash".

Britain
In Britain the long depression resulted in bankruptcies, escalating unemployment, a halt in public works, and a major trade slump that lasted until 1897.

The Austrian Business Cycle Theory I reviewed in a previous post is a very good explaination of the recent crisis as well as the previous ones:

http://macronomy.blogspot.com/2010_05_01_archive.html

The over expansion of credit and loosening of credit standards seem to always led us to economic crisis.

The panic of 1873 was followed by a similar panic in 1893 in the US.

Similar to 1873, the crisis was caused by railroad overbuilding and unsound railroad financing which led to a series of bank failures. Compounding market overbuilding and a railroad bubble was a run on the gold supply and a policy of using both gold and silver metals as a peg for the US Dollar value. Until the Great Depression, the Panic of '93 was the worst depression the United States had ever experienced.

http://en.wikipedia.org/wiki/Panic_of_1893

"The 1880s had been a period of remarkable economic expansion in the United States. In time, the expansion became driven by speculation, much like the tech bubble of the late 1990s and the housing bubble of the early 21st century, except that the associated industry was railroads."

And the panic of 1893 was followed this time by another panic in 1907.

http://en.wikipedia.org/wiki/Panic_of_1907

"The Panic of 1907, also known as the 1907 Bankers' Panic, was a financial crisis that occurred in the United States when the New York Stock Exchange fell close to 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on banks and trust companies. The 1907 panic eventually spread throughout the nation when many state and local banks and businesses entered into bankruptcy. Primary causes of the run include a retraction of market liquidity by a number of New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets at bucket shops."

The panic of 1907 led to the creation of the FED in 1913, the financial system was shored up in 1907 by the intervention of J.P. Morgan and other bankers.

The market overbuilding and the the real estate bubble led to the financial crisis of 2007 which started with subprime.

The Greenback Party:

http://en.wikipedia.org/wiki/United_States_Greenback_Party

"The Greenback Party (also known as the Independent Party, the National Party, and the Greenback-Labor Party) was an American political party with an antimonopoly ideology that was active between 1874 and 1884. Its name referred to paper money, or "greenbacks," that had been issued during the American Civil War and afterward. The party opposed the shift from paper money back to a bullion coin-based monetary system because it believed that privately owned banks and corporations would then reacquire the power to define the value of products and labor. It also condemned the use of militias and private police against union strikes. Conversely, they believed that government control of the monetary system would allow it to keep more currency in circulation, as it had in the war. This would better foster business and assist farmers by raising prices and making debts easier to pay. It was established as a political party whose members were primarily farmers financially hurt by the Panic of 1873.

The Gilded Age was an era of political ferment and conflict over the proper uses of governmental activity. The Greenback movement began as a protest against the national system of money and banking that had emerged by the mid-1870s. In particular, Greenbackers condemned the National Banking System, created by the National Banking Act of 1863, the harmonization of the silver dollar (Coinage Act of 1873 was in fact the "Crime of '73" to Greenback), and the Resumption Act of 1875, which mandated that the U.S. Treasury issue specie (coinage or "hard" currency) in exchange for greenback currency upon its presentation for redemption beginning on 1 January 1879, thus returning the nation to the gold standard. Together, these measures created an inflexible currency controlled by banks rather than the federal government. Greenbacks contended that such a system favored creditors and industry to the detriment of farmers and laborers.

In 1880 the Greenback Party broadened its platform to include support for an income tax, an eight hour day, and allowing women the right to vote. Ideological similarities also existed between the Grange (The National Grange of the Order of Patrons of Husbandry) and the Greenback movement. For example, both the Grange and the GAP favored a national graduated income tax and proposed that public lands be given to settlers rather than sold to land speculators. The town of Greenback, Tennessee was named after the Greenback Party about 1884."

In the US the Tea Party movement has been building up following the massive economic recession:
On June 8, 2010, in the Super Tuesday primary election, several tea party backed candidates have won.

http://en.wikipedia.org/wiki/Tea_Party_movement

"According to president of the American Enterprise Institute, Arthur C. Brooks, America is locked in a culture war in which either America will continue to be an exceptional nation organized around the principles of free enterprise, limited government, a reliance on entrepreneurship and rewards determined by market forces, or America will move toward European-style statism grounded in expanding bureaucracies, a managed economy and large-scale income redistribution. Brooks states that while some have tried to dismiss the "tea party" demonstrations and the town hall protests as the work of extremists, ignorant backwoodsmen or agents of the health-care industry, this movement reveals much about the culture war that is underway, and it is not at all clear which side will prevail."



Untermyer: Is not commercial credit based primarily upon money or property?

Morgan: No, sir. The first thing is character.

Untermyer: Before money or property?

Morgan: Before money or anything else. Money cannot buy it ... a man I do not trust could not get money from me on all the bonds in Christendom

J.P. Morgan testifying before the Pujo Committee