Sunday, July 21, 2013

The Debasement of Major Currencies Crash & Asset Class Returns As At 30 June 2013

June was a torrential month. We had people running for the escape shutes just on the likelihood of QE being tapered down in the near future. In reality, its just the usual holiday season for most finance industry people ... as usual when there are not much going on, it takes little to move things down. Then the whole world searched high and low for reasons to explain that phenomenon. Many times, its just profit taking. Because seriously, look how easy it was for markets to return to some normalcy? You tell me that what started the rout in inescapable fear and loathing, suddenly reversed course.

Emerging markets stocks and bonds took the brunt of the hit. Remember this trend, when the markets crash due to the finality of the debasement of major currencies, this is what will happen, magnified 5-10 times at least. Just look down the asset classes, every single one except cash is down. Remember this ....


The funny thing was that gold even went down. Of course in a real major correction based on the debasement of major currencies, the developed marlets bonds will TANK in a big way, followed by their stock markets as people pull funds away. They will also pull funds away from emerging markets stocks and bonds. Emerging markets bonds will be the most vulnerable - because they attracted the most inflow over the past 5 years as funds seek out better yields with "better currencies". The debasement of major currencies (USD, Euro and yen) is nothing new, there are a lot of believers, just that we do not know exactly when it will happen.

But why, what is the justification that the debasement crisis will end in tears? There is debasement just by looking at the amount of money printed by most central banks over the last 5 years alone. Technically, in the US alone, they might need only 1/10th of the amount of money running in the system. OK, that might seem scary already. Even if you try to take back half of that, you know there will be dislocation, no matter how well planned. Pumping in is fun, just like alcohol consumption in a party. The way out never is.

Two, the QE funds are largely not flowing through the real economy. Big and small banks, but mainly big banks, are benefiting enormously by taking these funds at zero and getting their 0.2%-0.4% margins leaving that in the interbank. Is it any wonder that even behemoths like Bank of America and Citigroup are making billions again - its not from lending, its not from trading, its not really from investment banking.

Already the real economy is not getting the credit they need to jump start. They can see the low rates but they cannot borrow realistically. Those who do borrow are using it for unproductive ways again, e.g. flipping houses, or carry trades. These inflate certain asset classes (stocks and REITs mainly) but doe not provide the multiplier effect down the entire economy.

When central banks sells bonds again (to soak up liquidity), the big guys holding the cash will demand for much higher interest rates = you go from zero to 3% and then 6% quite fast. Sharply higher rates will pummel all stocks and the chain reaction goes around. Only this time, the severity is pronounced because its not a one off event, investors can see the amount of liquidity to be called back. Even if central banks stopped the soaking up process midway, the confidence is gone. Confidence is one of the greatest asset in valuing assets. 

If QE did what it was supposed to do ... lend to businesses and people who need them, you would have seen a great multiplier effect of more money moving around, improved business velocity ... which would then enable the economy to better weather the turning off of QE or soaking up of liquidity later on. 

The strange thing is that you cannot just sell one currency and thats the end of it, it has to be converted into another currency. But as you can see from the last two paras, everything will collapse in a debasement correction as currencies of all sorts will collapse.

HKD will be under some strange pressure when USD falls by 20% in a week. It might finally prompt a reweighting of the HKD to a basket of currencies. The emerging markets will be very busy defending their currency, not because they are not stronger than the developed currencies but because their bonds have attracted so much foreign money that the moment they all decide to exit the bonds, it literally means that yields may double from 4%-6% to 10%-18% overnight as the ringgit, rupiah, baht will be sold down tremendously as funds repatriate. This will cause an even bigger collapse in emerging markets stocks even though they may be fundamentally superior to developed markets' stocks.

The strange part which i mentioned was that last month sell down did not see gold prices rise as that should be seen as the best alternative if you do not want to hold currencies. 

This piece of advice will be worth millions to the right person. In a debasement of major currencies correction, almost nothing is worth buying. Except hard assets, but not just any hard assets, if USD is tanking then holding a USD property does not help. Pick the right country that can ride out the storm and come out stronger and your net wealth intact.

Buy UK properties, buy Singapore properties, buy large tracts of farmland or idle land in Malaysia, Australia, NZ, buy gold certificates. Looks like many Malaysians already have a great read on the upcoming disaster, many have been ploughing headstrong into UK and SG properties. However, me thing the total exposure to all the hard assets above should be between 30%-60% of your total assets. Get closer to 60% when the storm is near. Currently it is not.

So, when will this happen? I think come next May-September, plenty of time still. There is still the possibility that this event can be further delayed: if QE stops and the markets rumbled but steadies ... however, the central banks DO NOT sell bonds i.e. no soaking up of liquidity .... then its like postponing the inevitable. It will come, if you do not soak up the liquidity the markets will correct the realignment for you. They will just lose confidence in developed markets bonds, then developed markets stocks, then assets of most things, just like you saw from the figures in the month of June 2013 only multiplied.

Once that train starts, you can see a few months of high anxiety. Bernanke should be so glad to get out of his position so that he does not need to go through that.