Macro Man

What a difference a day makes. "Sell Aud? Australia? Where's that?  We are back to selling Europe again".

TMM's Bloomberg IB chat bias-o-meter would have us believe that we are about to have a Euro panic similar to that of 10 days ago. If that is any indication of the size and commitment of short term positions then really the price moves so far aren't that impressive. We will not get sucked in (though we may get spat out of existing positions).

But it doesn't matter if we are right or wrong in our method, prices change because people decide levels at which they are willing to trade. So no matter how much we believe in our methodology, no matter how much it can mathemematically be proved correct, no matter how much our theory, or even what we thought was everyone else's theory, tells us we are right; if everyone else is reacting for different reasons then our ultimate reward for rightness (profit on price movements) will remain elusive. Which is a long winded way of saying the market will remain irrational longer than we remain solvent.  This is of course why it is imperative to understand what drives other people to make decisions as much as understanding our own.

We often see the markets as a massive poker table around which sit thousands of players, all with their own different reasons to play and ways of playing. Understand all of them enough to pre-empt their actions and you can profit greatly. But that's nigh on impossible so we tend to group the types. We have in the back of our minds ideas for a piece on all the different types we have encountered over the years but that is for another day.

Instead today we have knocked up a behavioural model of how the markets work, very much from our own perspective. It's remarkable in its familiarity. No prizes for guessing which one we are.

We've been playing Battleships with the RBA - RBA's go. -50bp. Booosh. Hit...... Battleship AND Destroyer. Otherwise known as our short Aus bills and long Aud/Cad positions. Holed, but we still have steerage and the main engine is still running, just. Man the pumps. What a bunch of W&^ers.

 Aud/Usd is 100pts lower, Aud/Cad is back to its lows of a few days ago, eur/aud is breaking higher (but then we do have euro relief going on too). Rates market moved sharply and is pricing more than 25bp of further cuts combined for the next two meetings.

That RBA rate cut has really focused minds over what's going on out there. There has been a massive positional and mood bias, mostly from US leverage that a) China is heading for a hard landing and that b) Australia's two speed economy and constant deficits leave it highly geared and more and more dependant upon the China dream paying for local excesses. Because of that AUS has been a favourite short since the beginning of Feb, when the China fears really started, as Aus was seen as the vulnerable high beta. So today's RBA cut could be seen as the final justification that those shorts have needed. Toldja so! Particularly from that McCrann man. Uuuurgh.

But the China part of the Aus trade may not be paying off as fast as many had hoped. PMI this morning at a smidge under expected is no calamity and, to us, points to flat to up, rather than down the tubes (before anyone starts, we are NOT of the opinion that the official PMIs are rigged).

Is Aus going to tank from here? TMM still think not and rather than abandoning their AUD/CAD ship they prefer to man the pumps and bail like hell. Unfortunately their Aus bills position has already sunk below the waves.

It's meant to be a holiday today, but TMM haven't had much fun either at work or outside. As the media headlines proclaim "This is the wettest drought on record in the UK". With hosepipe bans still in effect, TMM are waiting to hear back from their local water authority as to whether they are also banned from using them to pump the floods out of their houses.

Elsewhere TMM have permanently  switched off the BBC Radio 4 Today program in the mornings and are bearing up to "easy listening" instead.  We suppose that with the Leveson enquiry nailing the Murdoch empire and the BBC's natural bias melded with some of the most embarrassingly twisted economic "analysis", we shouldn't be surprised at the minutiae of political issues being dragged out as headline stories. TMM are waiting for the headline news that Tories are guilty of human genocide because it hasn't been proven that they are not and some email is found saying " I'll kill whoever said that"  in some ministerial hard drive. BBC - GET A LIFE. Or rather get some journalists who have some understanding of the real world.

We do feel that mankind is being poorly served by politicians who have studied nothing other than politics, being reported upon by journalists who have studied nothing other than journalism. Team Macro Man have suggested before that politicians should  only be eligible for election having spent at least 10 years in a "proper job" but we would now like to extend that stipulation to encompass journalists.

And relax. BBVA results not the shocker disasternistas were hoping for, the cult of AAPL continues to fleece its disciples and it is looking more as though that was NOT the big one re Europe. TMM can’t help but think this has got a july 2009 feeling about it. We had the QE sugar rush from mar09 to jun09, then the market sold off because no-one believed it. But then the earnings season was good and the market ripped higher, never looking back. OK it may be a bit premature, but with all the noise subsiding and the market blaming the quiet on “waiting for the FOMC” which to be frank no one really cares about, TMM are more inclined to believe that the markets are “shagged out after a long squawk”. Whatever the reason, we will be invoking the “do not short a quiet market” rule and expecting more up drift.

Whilst it is quiet we will have a look at something we believe is about to change the world much more than any Apple iteration – the changing shape of energy supply. TMM would like to start today’s post with an interesting chart showing energy costs per Gigajoule for major fossil fuel sources in the US. White is Power River Basin coal, orange is henry hub gas, yellow is oil and pink is international coal (Newcastle spot).

As you can see, the big story of energy prices going to the moon over the last decade remains very much intact but gas has been doing something very unusual – after spiking hard it has gone into a massive decline and is almost as cheap as powder river basin coal on a per GJ basis. The cause of this is the fracking revolution in gas production which has massively increased the US’ fossil fuel reserves. It is already being keenly felt in power markets where US coal companies are being killed by the increased competitiveness of gas fired power generation as the portion of the day in which it makes sense to burn gas is longer and more profitable, reducing those peak time margins that coal fired power plants make much of their profits from. For coal equities this is hardly news – Cliffs Natural Resources, Alphadyne and Arch Coal have not been feeling the vim and vigor of a resurgent US economy. Similarly the US’ strategic exposure via oil imports to the Middle East and less than friendly regimes like Venezuela is waning judging by the chart below. Crude import percentage from Saudi in white, Canada in orange and Venezuela in yellow (Note the post Libya ramp in Saudi imports – that won’t be around for long).

TMM can’t help but feel that the money for the “war on terror” could have been better spent, but the US appears to have been a classic case of “better lucky than smart” in that regard since they have secured a reduced exposure to middle eastern madness through oil sands. Now, not that oil is mattering as much as it used to – below are vehicle miles travelled in the US in orange, inferred gasoline demand in green and average MPG of sales in white.

• Energy prices are falling for gas, with knock on effects for other markets in which it is substitutable. Similarly, vehicle fleets are becoming more efficient and gasoline demand in DM is probably in a structural bear market on that alone. This has major implications for US inflation most of which has been from food and energy in recent years despite motor fuel being only ~5% of CPI basket and heating and utilities being another 5%. It may be the case that even if housing recovers and “rent equivalent cost of ownership” (~40% of the basket) stabilizes that the US has a very benign inflationary environment for structural reasons. Buy all the gold you want, but if people’s gas bills cease to exist or go into a nominal decline then that will take the bite out of a lot of quantitative easing in commodities.
• The historic segmentation of the energy markets into transport fuels and utility fuels is starting to blur and is likely to continue to do so. For that reason, the pricing per GJ for each should converge over time. You may not be able to make everyone in the US buy an electric car tomorrow but the ability of WTI to command a big premium over henry hub will weaken over time.
• US energy imports are falling fast and will continue to do so as the vehicle fleet turns over. This is going to have major implications for US defense spending – how much does the US care about the Middle East, ex oil? TMM would note that if the straits of Hormuz are closed, China has more to lose from it than the US. In addition, it has major implications for US tax receipts if people buy LPG cars or electric ones. US utilities pay cash taxes in the US, Saudi Aramco does not. The major problem of the US from a macro standpoint, its twin deficits and high debt may be reduced materially by these trends and the historically cheap USD may be the best buy in FX for the next decade.
• Make it in America? The US and particularly the Democrats have developed some kind of romantic attachment to manufacturing and politically astute CEOs like Andrew Liveris of Dow have picked up on this theme and have called for the US to have an industrial policy, aka, handouts for corporate along the lines of China. TMM see this for what it is – getting something for nothing and think it is largely unnecessary for most businesses. It is highly unlikely the US is going back to making garments or in any way competing with the scale efficiencies of southern China when it comes to cheap labor, especially as China’s factories increasingly replace labor with capital. Where it can compete however is in areas that are skills or technology intensive (when in doubt, buy out Asia’s best and brightest with grants) and anything that is energy cost intensive. Liveris notes that labor is <12% of COGS at Dow and Energy is 25% or more. TMM think that $2 gas makes a much bigger difference than looser labor laws or tax holidays.  

Of course the real crunch comes against renewables. Whilst cost differentials have been narrowing between traditional fossil fuels and solar and wind,.  will the energy addicts be able to resist dirt cheap carbon emitting gas for the benefit of the environment? TMM think not as austerity drives people to short term survivalist individualism rather than long term community spirit though that is arguably in the price these days. The larger shock is that by the time we start running out of gas energy prices might be following solar's quasi Moore's law - which wouldn't hurt any of TMM's power bills.

Well, today is a very important day for markets, as the largest religion company in the World reports earnings. Despite the strength of the earnings season so far, names have found themselves lower just a couple of days later as profit taking has come in. In the short term, that seems reasonable, but does not detract from the trend that the economy looks pretty good with companies making money - that seems pretty "normal" to TMM. Of course, against that, it seems that everyone TMM speak to expect AAPL to sell off post earnings, regardless of the actual top or bottom lines. Make of that what you will. TMM will most definitely NOT be watching the AAPL release, and will instead be getting pissed down the pub.

Anyway, we digress. In amongst the usual bollox arriving in their inboxes this morning about Europe and concern that a certain Shampoo brand (how do we know the girl in JAWS had dandruff?) was going to portent the end of the world , TMM were asked why, despite Oil prices having rebounded from their recessionary depths, Canada was running a Current Account deficit of close to 3%. Given we're fed up to the eyeballs of anything Europe, we thought we'd have a look.

It's kind of interesting actually, that this particular subject has been brought up given that on that long list of supposedly great macro trades that has so far refused to perform is that old chestnut "Short AUD/CAD". Now please forgive TMM for their snarkiness but, in our opinion, this is one of those trades dreamed up by a group of punters we shall now term as the "Off The Cuff Macro Numpties". This particular group are known for their use of a little knowledge, a few good charts and their favourite hobby "Bubble Hunting", which essentially consists of looking for something that has increased in price by 10-20% and yelling "Bubble!". Oh yes, and telling TMM that we are clueless in the comments section below.

But back to Canada. Looking at the Trade Balance (see chart below), indexed such that Q4 2006 equals 1, it is interesting to note that while post-crisis, both import growth and export growth don't actually look that different, the level of exports fell far more sharply and has not really recovered particularly well. Well, to TMM that exports have not recovered tremendously is not that much of a surprise given that the US recovery (Canada's largest trading partner) has so far been rather tepid. That imports have re-accelerated is perhaps more interesting, particularly in the light of the strength of retail sales in Canada since the recovery began.

Now TMM are unconvinced, as discussed before, by the idea that there exists a housing bubble in either Australia or in the UK. This is primarily because of the balance between housing construction, housing supply and household formation. It is not obvious to TMM that valuations are out of line when the above conditions are either in balance or in deficit (not enough housing supply) when many can be explained by structural falls in interest rates (and interest rate volatility) amongst other things. A full discussion of this is well beyond today's post, but TMM do think that these factors are significant in explain why the US and Spain experienced a spectacular crash in house prices, whereas the UK and Australia (at least so far), have not, despite - well, specifically in the case of the UK rather than Oz - very similar macro outcomes and policy responses.

So why do we bring this up? Because TMM do actually reckon that Canada *may* be a candidate for a housing bubble, given the dramatic run up in house prices, interest rates have arguably been kept too loose post-crisis (understandably so, given the external risks), TMM have received plenty of anecdotes and adverts that evoke déjà vu of 2005 in the US. But most importantly, housing construction has been widespread, it is a big country with not too large a population and housing starts (~215k) have been running above household formation (~170k) for a few years now. TMM haven't looked in enough detail to come to any firm conclusions as to whether Canada's housing boom is a bubble or not, they do reckon that it is different enough from Australia's to matter.

So Canada has clearly had something of a consumption and investment boom. What about Australia? The trade dynamics in Australia look almost the mirror image of Canada's, with imports having recovered to around the pre-crisis, while exports (to China in particular) have roofed it So is this perhaps a case of the real trade *not* actually being a case of long commodity currencies etc, but a case of being long the stuff that people actually want. Because the above evidence suggests that there isn't, y'know, that much demand for Canadian oil and other stuffs.

But that's not the end of the differences. A little observed portion of the Current Account balance is the Current Transfers balance, usually confined to those of us bean-counting remittance flows to Mexico or the Philippines. And it is notable for two similar sized economies that over the past few years that Canada has built up a sizable transfers deficit (white line, chart below) while Australia hasn't (orange line). Now that could mean one of many things, but the most likely explanation is US construction workers having found work in Canada's tight labour market sending their earnings back home.

So given all the above, it would appear to TMM that perhaps the confidence with which punters keep trying to sell AUD/CAD may be misplaced. Because it appears to us that Australia is selling stuff people want, while not experiencing a domestic consumption boom, while Canada appears to be precisely the opposite. Canada also appears a more legitimate prospect (though this is far from certain) for a housing bubble than Australia, and increasingly, migrant labourers are sending their earnings home adding an additional headwind to the currency. Combine that with the popularity of the short, the rather tepid response to the soft CPI print over night, a market now looking for a 50bp RBA rate cut next week (after famous idiot well-followed Aussie Journo McCrann has started predicting it) and a soothsayer "Buy" signal on Friday, and TMM reckon it could be time to squeeze some gonads and scoop up some AUD/CAD.

Mood is not good in Camp TMM this morning and it does feel like a camp. Encircled by whatever the politically correct way of referring to Red Indians is these days. For here we sit with a pile of Spanish stocks, our background long equities in general and our view that the world is not about to end and whooping and hollering all around us. There is hardly any point in us going over old points on Europe as Europe (come to that, most views at the moment) has effectively become religious in point of view. We remember all the past cults of markets and it would appear that the last 5 years have programmed a new generation of market participants that the cult of Roubini brings you fame, fortune and credibility. True, TMM themselves could have been classed as the biggest contrarians in 1998 - 2000 mocking the likes of Abby Cohen, and also suffering near depression on the run up to 2008 shouting "can't you see it?" but to TMM this current Cult of the Black Swan is creating a new Mordor where everything is BLACK!



But this disasternista thing is tiring. And we are tired. Roller coasters are fun and the thrill of the big fall is exhilarating to the point of wanting to have another go straight away. But after an hour or so it's uncomfortable and, more boringly, predictable. But with a roller-coaster you do at least get the guaranteed big fall every ride. However perhaps this is more like surfing, with the doomsayers out on their surfboards hanging out at the back waiting to catch the big one. Waiting as the sets roll in, watching the eager young pups jump on rides that just fizzle. If THIS isn't the wave, then just wait .. the big one will be coming along soon.

Is this the big one? It certainly feels like plenty of folks have decided to catch it, as Holland and Hollande (don't they make guns?) on top of a set of weakening PMIs result in what feels like an old fashioned YOURS. One of those YOURS that revolves around speed and momentum (the steepness of the wave) rather than new thought or process. But to TMM this isn't the big one and we will sit it out as we ponder -

1) If this really is the "End of Europe" play, why the heck is eur/usd effectively flat
2) The corporate splurge. Looks like the flood gates are opening on those piles of cash with today's offering being Nestlé's purchase of Pfizer's baby food - for cash.
3) There is virtually no difference between the fiscal policies of Sarkozy and Hollande in terms of budgetary consolidation.
4) Isolation of the German view in Europe is, we would argue, a positive given that the market has been calling bluff on the "Austerity Only" policy prescription that has largely failed in the periphery so far. You can add to this Holland's move to reject Buba orthodoxy and Merkel's likely election loss to the SPD next year.

The compression and isolation of Germany is of course the end-game, when it comes. However it would appear that for them to acknowledge that they need to share the burden, they first need to acknowledge that they are also as guilty as the Greeks. Culturally that is not there. Which reminds us of an incident we experienced when skiing in Italy this year. The Italian waiter gave our order to the guy behind in the queue by mistake. The guy knew it was in error and yet he said nothing. When we told him he was jumping the queue he told us that it was not his fault - the Italian waiter was stupid. We asked if he was German and he replied asking why would that be relevant - in a VERY German accent.

This move does feel forced and it isn't for us, except in commodities and commodities-driven EM. TMM has a sneaky suspicion that those catching this wave are a little too clever for their own good and may be using one of these.

First TMM would like to thank the wonderful folks of Cyprus for their hospitality, fantastic go-karting facilities, interesting beverages (we imagine that a few local producers are retiring to Monaco after our custom) and their UK weather, imported especially to make us feel at home. Special Cyprus weather. We will be back - or at least our teenage children probably will be. So now we are back on planet "caffeine free" let's look at what's been going on.

Before our departure to overcast climes last week, we mentioned the 2 wobbles and a hope in the triumvirate of global economics so it's worth seeing how things have changed. The most obvious thing that greets us is that China is no longer on the front page of "Bear Weekly". Now this, of course, suits TMM who have been long of H-Shares for the past 3 weeks and we have no plans to change that position. The US picture, post the NFPs, had appeared to have also stabilised and despite a shake down in AAPL things are noisy but flattish, having said that, the Philly Fed and Housing Data is not helpful.

But China and the US appear to have been shoulder barged out of the way by Spain. Poor Spain, doing an impression of a Wildebeest at a crocodiles' pool party, with even Argentina tearing off a limb whilst it's underwater. That move by Argentina should make for some interesting politics. Perhaps the UK should hire Repsol to explore for reserves off the Falklands. That could even end up with the Royal Navy and the Spanish Armada on the same side.

But back to Spain, or now Europe. because after the sort of OK-ish Spanish auctions we thought there would be two options - Buy some carry and wait for the next event date for there is nothing that kills a bear more than nothing happening OR decide that whatever happens, this is just can kicking and so refer back to the holy bible of Euro2010/11 for guidance "For was it not writ that should the Spanish yields hit 6% we should trash Italian stocks, start rumours of French downgrades and argue that the German population will not support the rescue of Spain"?

TMM do prefer scenario 1. What do Europe sellers expect to happen? To TMM it would appear that the only scenario that supports selling right now is one where Spain crashes, doesn't receive assistance, defaults and the Euro and then Europe break up. Now call us picky but though that indeed is one potential outcome there are a lot of other scenarios and most of them involve some internal resolve, even if it does involve printing your amount of money. Elections may change the leaders of some countries but as the UK Con/Lib coalition is finding out, they are but the tip of the iceberg of the machine that is government. There is enough mass below the waterline that knows where its true interests lie to stymie any threats to them. Yes Minister indeed.

Having piled back into equities last week the current mood should be considered as red flags to us and we really ought to run with the pack, chop the longs, swing short and whip up the doom. Instead though TMM have decided to do the reverse and have broken the glass on the cabinet containing their Kevlar Gloves and bought some Spanish stocks of international appearance ( braced for comments). Hold on tight !!

TMM are today feeling old. Yesterday was a struggle. Despite a 30 minute power-nap before dinner they felt "urrgh" throughout the meze-athon in a Cypriot restaurant decorated in a melange of authentic style and black marker-pen client graffiti. But then this is day 2 into a tradition that stretches far back in history. As Socrates famously wrote, "Many hours have I sat in solice, drinking beach buckets of luminous green fluids and shot glasses of equally vivid pink liquours, contemplating the origin of this maddness for I am wracked as to the primordance of the concepts of marriage or those of the stag party"

This place goes by the name of Ayia Napa. It sits upon ancient ley-lines that twist the very fabric of space and time, for was it not 9pm a fleeting moment ago, when we wanted to go to bed, and yet now it's 3.30am and sorry I can't hear you? And that ley-line twisting continues into the minds of the club designers (how do you get that full size pirate ship to stay on the front of your shop?) and twists our minds to even cope with being here.

Of course TMM could say that they are here to celebrate Greek Orthodox Easter, but that would be even more of a lie than "yes, your club looks great and wow how many bottles of sambuca for 10 Euro? I'll go and get my 15 friends and be back in 15 mins.. I promise" but not quite as big a lie as the swarthy fellow on the door with "Don't worry, I do you 'special' price".

TMM have discovered if you order anything in Cyprus, say x, you get "special Cypriot x". Special, made in mountain/village/family goat by uncle/grandfather/family goat. And it's very special indeed. But basically Cypriot x is similar to normal x and only differs in being more expensive and... shite.

For example. White wine.. "This is special Cypriot wine, it's like a sauvignon blanc....". but is not and smells of BO. The red? "Yes we have Cypriot red, very special, it is like a cabernet" but it is not and it tastes of musk ox. Very special.

What's this? "This is special liquour, we call it (sounds like "ghalachosinosisisos") it is made using grapes and we take them and turn them into special drink, come come I bring for all. It is made in the mountains using old tradition that no one can remember, to make special taste, that taste like brown sticky fluid in the bottom of food waste recycling bucket after 5 week bin-man strike.. Eees very special. We serve it frozen so you can taste it a little less.. very special"

Last night was "Opening night at Bedrock" which was much like a cross between a BBC Radio One roadshow, Butlins and a McDonalds - if McDonalds were to make McShots, McJaegerbombs and McWhats-this-one-i dunno-just-drink-its.

"And come, I show you, my club full of special pretty friends, yes very pretty, they is made using recessive genes from Northern Europe that would never normally see the light of day, notice how none of them have any dorsal line symmetry? And, ah yes sir, you cannot work out where their dorsal line run? Too many kebabs perhaps.. "

Taxis are special too. They are all stretch limos and come with a special fixed price which switches to a special dynamic price that goes up between departure and arrival. "Because it is special Cyprus price" Ahh, we see! And there we were thinking it was because we are getting special Cyprus driving, where which way you go around roundabouts depends on the shortest route to your exit.. "no ees ok, it not high season, not many cars"

Well at 3.30am after a special bar bill, (made using special Cyprus maths taught to Cypriot waiters from the age of 2) and a special unnecessary hot dog.. (ees special as it no easy to make a food product out of crude oil, you like? Perhaps your friend ..he likes?). We arrived back to the hotel for some special sleep. It's like normal sleep only much much shorter and one wakes to find one's head nailed to the pillow, a dead hedgehog in the mouth and a gallon of battery acid in the digestive system. "Eees special Cyprus sleep, you like?"

So what does today bring? TMM are writing this from the special 2 hour bus trip to the special wine tasting in special mountains wondering if they can squeeze in a special nap, despite Swedish House Mafia's "One" rocking everyone around us, before we all head off for our big special night out in the special clubs of Limasol.

TMM are slightly concerned that Day 3 could be a bit special.