Thursday, September 25, 2008

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.

Saturday, September 6, 2008

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.

Wednesday, September 3, 2008

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

Sunday, August 31, 2008

Gustav and Its Impacts

So much focus on Gustav, the tropical storm-turn-hurricane category 5 when it hits the Gulf of Mexico. What does this mean to Ultra Oil&Gas ETF (DIG) ,Ultrashort Oil&Gas ETF (DUG) and the US Dollar currency?

Let's zoom into the ETF story first.

While this news may be bullish for the Crude Oil commodity itself, unfortunately, not for its refineries.

  • So far in my articles, I have always assumed direct correlation between crude oil prices and its benefits to oil & gas companies. Higher energy prices translates to higher profits, and vice versa. So far, this direct correlation has been true due to the fundamentals of economics. The situation is direly different now.
  • If you examine closely the components of DIG & DUG, both are either long/short the oil & gas companies, NOT the actual oil&gas commodities. As such, damages to oil&gas facilities which belongs to the refiners will adversely impact its production capacity and incur losses on the part of the companies.
  • While the crude oil prices will surely rises in the case of reduced production capacity, the oil & gas companies are unable to profit from the rising oil prices due to the damages to their oil rigs which harvest the expensive oil (damage assessment during Katrina - similar category hurricane in 2005 - is huge and is available at this link)
  • This is part of the reason why you've seen the DUG rises while crude oil price rises. Market is finally getting the sense of this sentiment.
  • In short, Ultrashort Oil&Gas ETF has more potential upside and the reverse for its long counterpart.


What does this have to do with the US Dollar ?

  • Precisely the point, NOTHING.
  • The market has been so attached with the fact that rising crude oil is attributed to the weak dollar and the stronger USD will therefore cause prices of oil to go down. This correlation will be broken soon.
  • USD fundamentals remain strong (more due to external factors than internal) and will continue to do so unless there are signs of reversal in ex-USA economies, especially the Euro-zone.
  • Perhaps, this is a new environment where the strengthening of USD will go alongside the strengthening of crude oil price.

Saturday, August 23, 2008

Crude Oil Trade... The Starting of the End?

I have been monitoring the Oil & Gas ETFs (especially Ultra & Ultrashort Oil & Gas ETFs)* to gain more understanding of the interest in Oil & Gas sector.

The following graph reflects the market cap of each ETFs which I have been tracking since 5th August.

Notice the increasing market cap of Ultra Oil & Gas ETF as Crude Oil price drops and reverse for UltraShort Oil & Gas ETF.

The above chart shows the decreasing interest of short-oil trades. However, does this mean that money is pouring into the long-oil counterpart? We'll answer this question in the next section below.

Keep a watch out on your short-oil trade and possible exit once the market cap is near balance. Should the rate of change stays, it should roughly be in the next month or two.

To answer the question above: "Does this mean that money is pouring into the long-oil counterpart?", let's examine the following stacked chart which shows the combined/total market cap for both the ETFs.

Notice the declining trend? People are definitely pulling their money out of any oil & gas trade and putting it elsewhere...

Is this a sign for equity rebound as money is being pulled out of these trades and poured onto equities? Or money waiting at the sideline?




* I chose these two ETFs as they are the ones directly related to what I invested in. There are so many other ETFs that does similar trades and thus readers discretion is advised. This analysis is meant as a "representative" of the trade and not the collective whole.

Friday, August 22, 2008

Crude Oil Bear Ended???

Crude Oil rises from $112 to $122 overnight. Is this a sign that the commodities bear is over?

In my opinion, NO. There are a couple of reasons which I think is in play:
1. Profit taking. Recent oil bear has been on a sharp drop over period of just a month (record high of $147 was on July 11th). So, a correction to the upside is normal and this is probably the period where the shorties (people who short oil) take profit as crude has been unable to break the $111-$112 support.
2. Reaction to the Russia-Georgia conflict is well overdue. When the news of Russia-Georgia conflict emerged, oil didn't spike up and this previous reason aggravate the correction.
3. Fundamentals for oil bear are still intact for the moment. UK re-affirms one such fundamental in its stagnant GDP reports growth for the past quarter. It is most likely to enter recession in the next quarter. With that news, USD will strengthen relatively against European currencies which causes USD-denominated commodities prices to drop. The story on worldwide demand destruction is also unchanged.
4. Warren Buffet's view on USD. He just appeared in CNBC (just at the point of writing) and said he has no bets AGAINST USD. His neutrality is a change of course over his previous bearish view on the USD and re-affirms the USD's upside potential.

Conclusion:
Shorties, stay on course.

Friday, August 15, 2008

Bullish USD Outlook

This sentiment is helped by the following factors:
1. Dropping commodities and gold as they are mostly priced in USD
2. The most important factor is: the shift of concerns from high inflation to slowing economic growth across the various central banks, i.e. ECB (European Central Bank), RBA (Reserve Bank of Australia), BOE (Bank of England)
3. The shift of concern causes those central banks to start holding interest rates for their currency with the strong possibility to cut rates soon (this is reflected in interest rate futures for AUD which is pointing to a 25 basis point cut in Oct 08 and another in Jan 09).

I have been monitoring the following 2 ETFs to understand the USD-buying interest:
1. PowerShares DB US Dollar Index Bullish Fund (AMEX:UUP) has market cap of ~USD 575 million (as of 12 August 2008), which represents 6x the interest in the bearish counterpart. As of the point of writing, the market cap has grown to ~USD697 million (a 20% increase in just 3 days*). Examining the chart of this ETF, this instrument had been consolidating for 4 months from mid-March till mid-July while testing low of ~USD22.30 at least 5 times. The resistance at USD23 and USD 23.30 has been broken to the upside. Future break out at ~USD 24 can test the next resistance at ~USD 25.
2. PowerShares DB US Dollar Index Bearish Fund (AMEX:UDN) has market cap of ~USD 95 million (as of 12 August 2008) and has dropped to ~USD 72 million (-24%) in just 3 days. Looking at the chart of this ETF, it has broken the support of ~USD 28.50 which is heading towards support of ~USD 27 and breaking this could test further support at the range of USD25.80 - 26.40.

One can argue that the increase/decrease in the market cap explained above is due to the changes in ETF prices. However, if we examine the absolute prices of the ETF in the same period as above, they're in the range of USD23.66 - USD24 (~1.4%) for the AMEX:UUP and USD27.00-28.09 (~4%). Clearly, the larger market cap movement represents new/lost substantial interest in respective ETFs.

However, there's still possibility that this sentiment can reverse, in my opinion:
1. Commodities stops dropping and starts rising again
2. Other central banks starts focusing on high inflation (due to point #1)

Conclusion:
Strong possibility of continued upside move of the USD against all major currencies.

PS: Invest at your own risk.

* I know that I need to monitor this over longer period of time. As I just started monitoring on 12th August 2008, only this information is available for me at the point of writing. This is intended to show the tremendous increase of the USD buying interest at this period.

Tuesday, August 12, 2008

Indonesia's JCI to trade from 1625 to 1800 towards end of 2008

Crude oil gains ~50% YTD, partial removal of subsidies in Indonesia, high inflation rate, dropping commodities prices. So, what are the real factors that makes Indonesia's JCI to trade between 1625-1800 which is a 18%-26% drop to current level of ~2200 ?

Want to know the answer? "ALL" is the answer as it chains from one even to another before we finally see the effect on the Jakarta Composite Index (JCI) index.

Let me break it down one by one why this is so:
1. Crude oil gains ~50% YTD has put tremendous budget constraints on the budget of Indonesia government to run its economy. The government has finally decided to pass some of the higher price to its consumers. This has created high inflation environment in Indonesia.
2. Partial removal of subsidies was caused by the high oil price described in previous point. The key point is the "partial" where only a percentage of the subsidies is removed, not everything.
3. High inflation rate, in general, erodes corporate profits as prices are higher and thus costs of production. The end result of this is lower profits which translates to lower stock prices.
4. Dropping of commodities prices has not helped lower inflation. It reduces earnings of the commodity-producer-heavy index and therefore eroding profits and thus share prices. Dropping prices also does not help lower inflation either: gasoline costs only Rp. 6,000 per litre in Indonesia (which is equivalent to US 65 cents or SG 92 cents) even after the partial subsidy removal. Just for comparison, gasoline in Singapore is SGD 2.20 when oil was at record price. Even with oil at USD80, gasoline that costs US 65 cents is still very cheap and therefore still put pressure on government budget, thus high prices is here to stay and thus high inflation.

The figure 1625-1800 is derived from the 5 year chart of the JCI and represents the support level of the bull market trend that has formed since mid-2003.

Tuesday, August 5, 2008

Short Oil - The Trade for H2 2008 ?

Crude oil hit record high price of US$147 twice and can't seem to break beyond that and starts getting bearish.

There are a few fundamental reasons that markets have in mind that makes oil to drop... at least for now and probably till end of 2008:
1. Significant demand destruction worldwide. There are no exact number to justify this, however, developing countries like India and Indonesia (which together accounts for 20% of total world population - according to this site as of 2007 estimate and net importer of oil as of today) whose governments lifted oil subsidies due to budget constraints, helped to kill some demand from these developing worlds. As for the USA, you know the sub-prime that leads to housing problem and credit crisis, all these helps to reduce demand in the country.
2. Recession risk in Europe & Japan. With Spain and UK are entering recession (but not in recession yet) with strong possibilities of other European countries following suit, this will help curb potential demand in Europe. Japan helps to contribute to this risk and thus demand destruction.

Analysing the following 2 ETFs will help understand the actual interest in shorting oil:
1. Proshares Ultra Oil & Gas ETF (AMEX:DIG) has market cap of USD 120 million and this represents just 5% of the market cap of its short counterpart. Technically, it has formed double top during the time oil was at record price of USD 147 and this is a good indicator for a change in price direction of this ETF.
2. Proshares UltraShort Oil & Gas ETF (AMEX:DUG) has market cap of USD 1.99 BILLION and this represents 16.6x the interest in the long counterpart. This indirectly means that for everyone that bets oil will go up, there are at least 16 others who bets it'll go down. Technically, the reverse of the former ETF has happened here: double bottom which is a good indicator for a change in price direction of this ETF.

I personally feel that this trade is good only till roughly end of the year or when oil drops below the USD 100 mark.

Conclusion:
Short oil and hold till end of the year or when oil drops below the USD 100 mark.

PS: Invest at your own risk.