USD vs Treasuries Bailout Plan

The credit crisis triggered by the sub-prime meltdown has finally taken its toll on Bear Stearns, Lehman Brothers and Merrill Lynch, which were all top 5 investment banks in the USA. AIG, the insurance giant, has also been bailed out on the brink of its collapse by the Fed's US$80 billion. The collapses were triggered as banks and financial institutions are not willing to lend money to each other worrying their own survival and thus, corporate debt cannot be paid.

So, how does the US$700 billion bailout plan would work? Here's a rough rundown of Fed and Treasuries plan on how it is suppose to work out.

• The US$700 billion will come from issuing of debt to other countries in the form of treasuries debt/bonds. Issuing debt reduces the appeal of one currency and thus will depress the value of US Dollar in the short term. "Only short term?", you may ask, I will address that in the next few points.
  
• The money is intended to buy all the illiquid mortgage assets from banks or financial institutions. Buying all the illiquid assets at fire-sale/market prices gives market some confidence that will soon drive up the values of these assets. Note that the money is used for expenditure (unlike the usual Treasuries debt), but for investments on these mortgage assets with potential returns.
  
• As the illiquid assets are bought by fed/treasuries, banks will receive cash with which they can start lending again and therefore relieving the credit market conditions over time.
  
• When market has recovered, the securities are then sold again at a profit giving good return to Fed/Treasuries/taxpayers.
• The profit can then be used to reduce US Fed/Treasuries debt which mean strength for the USD.
  

Over the short-term (next 6 months - 1 year), it'll have negative impact on USD but good long-term outlook for the USD on these basis when the market recovers.

Note: of course there are a lot of other variables needs to be taken into account for the USD to strengthen. The view is based on current sentiment and market condition and should it stay unchanged over the interval mentioned.

End of Oil Play (at least for me)

Early last week, oil has dropped to US$90 and by this week it has bounced back to US$110 on the back of the US Treasuries US$700 billion bailout plan.

For me, this signaled the end of oil play. Why?

• The bailout plan may signify that there's major weakness in US economy to warrant such tremendous plan. This weakness is felt throughout the world including all emerging economies. As demand destruction is already in play since July 2008, it is my belief that the demand cannot be reduced further as it has already reached bottom. However, as the world economies are slowing with some already in recession, it is my prediction that demand cannot increase in the next year or two and thus capping oil prices.
• The cost price of extracting oil is around US$50-$70 per barrel* and this is coined by several broadcasters and based on some reports. If this is correct, this is a good place to exit oil play as oil producers will definitely sell their oil at profit price and will do all they can to push up oil above their cost price. Regardless of whether this is true or not, I'm going to take profit from short trade.
  

Thus, exiting the oil play at this point provides a profit of roughly 20% from the point of entry where shorting oil of around US$132 (July 2008) and when oil is now at US$106 at the point of writing. Or, if you follow my advice and exit at anything below US$100, say exactly US$100, this would represent ~24% return.

Related blog link: Crude Oil Trade... The starting of the end??

* the cost price of oil is assumed to include the compensation for producer's own consumption and possibly the residents of its owning countries.

Indonesian Rupiah

Being Indonesian, it'll be incomplete not to do some analysis on my home country's currency with regards to the changing central bank policies around the world.

Here's a starter:

• Indonesian Rupiah will tend to benefit from the strength of the USD. Sounds weird? Read on.
  
• With its high interest rate (9.25% currently), it yields higher than other major currencies, not even the NZD and the AUD can beat that.
  

Why would the Indonesian Rupiah benefit from the strength of the USD ?

• From the currency movement for the past year, rupiah has been trading steadily against the USD. The USD/IDR pair has been trading around 9100-9300 much of the year. It's been trading within the range of 2% and one would say that the Rupiah has been pretty much 'pegged' to the USD much of the year due to relatively stable political situation in the country. This is also the directive for the Indonesian Central Bank to keep USD/IDR rate stable as the USA is its 2nd biggest trading partner; with first being the Japanese.
  
• Current Indonesian government has been doing all the right things, in my opinion, to avert further decline in the currency against other currencies. While those may not be what the Indonesian people would like to see done, but those are the correct policies towards better economies in Indonesia.
• One action that directly impacts the currency is the partial removal of subsidies on fuel. Fuel subsidies have been taxing on the government budgets and such removal has helped to cut the budget deficit and defend the currency. Budget deficit causes one country to 'borrow' more money overseas while depressing its own. Such move (cutting subsidy) has not been popular with the Indonesian people, but a move in the right direction towards a better economy, in my opinion.
  
• Indonesia is a commodity-rich country, while it does not benefit directly from the rising commodity prices, it has helped to moderate inflation (which otherwise would run even higher) and curb budget deficits which would otherwise runs really high. Compare it with the Philippines (which imports all of its oil and rice consumptions), Indonesia is in better shape in a rising-commodity-prices environment.

Conclusion:
Indonesian Rupiah is a good alternative to USD at this moment with high interest rate of 9.25% currently.

Note: I would suggest to buy this currency only if you're residing in Indonesia or very much in touch with the political situation in Indonesia as political situation within the country is one major factor that affects the currency.

USD against Other Currencies

USD has staged a come-back over the past 2 months. The USD bullishness is due to external more than internal reason and such rally may not last unless USA's internal fundamentals strengthens or external fundamentals worsen.

The statistics showed it:

• AUD per USD has dropped from 0.9400 at the beginning of August 2008 to close at 0.8560 at the end of the month. As of yesterday's closing, AUD stands at 0.8150 substantially lower than previous month's close. It has accumulated 17% losses since its high of 0.9840 on July 15th.
  
• Less damaging move seen in the EUR which has dropped from 1.5620 to 1.4570 in August alone. The Euro is quoted at 1.4260 as of yesterday's closing price. Since its high of 1.6030 on July 15th, it has staged 11% loss against the USD.
• The SGD has seen similar moves where the USD has gained to SG$1.4340 per USD from its low of SG$1.3440. The USD has profitted 6.69% since July 15th against this Asian currency.
  
• NZD is the worst of the lot discussed here staging a 18.6% loss against the USD since March 14th 2008 as it first enters a period of recession among the countries in the world. It closed at 0.6680 yesterday from its high of 0.8210 in March 14th.
  
• GBP/USD pair has dropped from its high of 2.1160 in November 9th 2007 to 1.7650 as of yesterday. It has seen 16.6% loss against the USD since then.

Those who watched CNBC and Bloomberg would certainly understand the reason behind those big moves against the USD currencies. To summarise, here's why:

• For the AUD, it's the dropping commodity prices. Its commodity-dominated exports will soon cause damage to the earnings for the Australians. This is affirmed with the RBA (Reserve Bank of Australia) to reduce rates from 7.25% to 7% on concern of declining economic growth (YES, not recessionary yet). Reducing rates will have negative impact on the currencies as it lowers yield for a particular currency.
• Recessionary risk in Europe is high on European Central Bank's mind. Recessions brings lower export earnings which lowers demand for a particular currency. With the USA seen already 'ahead' of Europe in recession and the first to come out of it, the European region and its corresponding EUR currency faces this pressure and thus the decline.
• The Singapore currency remains resilient to the USD strength due to the persistent growth in the Asian region while only managing 6.69% decline. However, it is showing signs of weakness that may follow once it hits this Asian region.
• The New Zealand is the first country in the world to go into recession and this is reason enough to see the most decline amongst other currencies.
  
• The United Kingdom saw a stagnation of 0% growth in GDP in the last quarter. With inflation running high, it is technically already in recession. Its housing market decline follows those of its US counterpart. Overall, the UK economy is not in good shape and showing potential signs of slipping into recession in the next quarter or two, and thus its currency is reflecting that.

So what's the potential moves for the currencies:

• The AUD has a strong support at region around 0.8000. This level has been the resistance hit at least 5 times in Feb 2004, Nov 2004, Feb 2005, Mar 2005 and Dec 2006 before finally broken in Mar 2007. Once broken, it has the potential to go down to 0.7400 and onto 0.7000, the bottom level where it started catapulting itself to a high of 0.9840. With such a decline seen over the past 2 months, it's just a matter of time before the upward correction comes and if it does, it will potentially trade between 0.8000-0.8750. Having said that, the fundamentals remain bearish for the AUD/USD pair and with more bad news, i.e. RBA cutting more rates/recessionary pressure, it may potentially break this 0.8000 barrier without any difficulty.
  
• On chart, the EUR has formed a double top in April and July. This usually signals the change of direction in the currency movement. As of now, the EUR has dropped to the shoulder zone of a head-and-shoulder formation. This signify a short-term consolidation zone where it may trade between 1.4300 - 1.5000 in the next 2 months. Breaking this, it will head towards the strong on the level around 1.3700 (which represents the peak in Nov 2005 and broken in 2 years later in Nov 2007). It may potentially hit 1.3700 by end of this year.
  
• Just like the Euro, USD/SGD pair has also entered a period of short consolidation of 2-3 months at range of 1.4370-1.4630. At the end of the year, we could see the pair head towards 1.5000.
• NZD has just hit the support level of 0.6630 level against the USD and may trade in the range of 0.6630 - 0.7120 in the next 2 months. Should the fundamentals in New Zealand remains bleak, it will break this and heads towards 0.5920 by end of the year. Looking at the chart, it has the potential to hit 0.5920 much sooner (in one/two month's time).
• The GBP/USD pair has NO clear support level between current level (1.7650) and 1.7000. The UK fundamentals allow 1.7000 level seems realistic towards end of this month (or next 2).

Conclusion:
Long USD against a basket of currencies (but this doesn't mean shorting other currencies).

Related blog links: Bullish USD Outlook

Note: Invest at your own risk.

Hurricanes effect on UltraShort Oil&Gas ETF

Gustav hits the ground as a category 2 storm and does minimal damage to the oil rigs on Gulf of Mexico. Perhaps, this is the only time where, regardless of the outcome of the hurricane, the UltraShort Oil&Gas ETF will still benefit.

The impact on Gustav being a category 5 hurricane has been discussed in previous post. Here's the analysis on Gustav being a tame hurricane:

• Crude oil drops 10% within 2 days on expectations that oil productions can continue without much delay due to limited damage on tame Gustav.
  
• The continued drop in oil prices do not benefit the refiners and will cost them profit and depress their stock prices.
• Their depressed stock prices of the refiners will have bullish effect on the price of UltraShort Oil&Gas ETF

With 3 hurricanes in the pipeline, they will cause massive shut downs to the refineries. However, as similar story as Gustav, regardless of outcome, it'll be bullish for Ultrashort Oil&Gas ETF.

Related blog link: Gustav and its impact on Ultra & UltraShort Oil&Gas ETFs