Archive for November, 2011

Market Notes: 29th November 2011: US markets may remain bearish.

November 29, 2011 Leave a comment

Market Notes: 29th November 2011

It is always hazardous to call market bottoms or tops.  Few can get them right.  Nevertheless, it always useful to see how the market reacts to certain areas on the charts that are potential turning points.  Market action in such areas throws up useful clues to where they are headed.  In that spirit, let’s look at what the market are trying to tell us.

Shanghai Composite:

2300 has emerged as a clear area of strong support for the Chinese markets despite all the negative news flow from China on currency, tightening credit, bubble in the property market and rising labor costs.  2300 on the Index represent a top last seen in June 2001, which was crossed in December 2006.  The area has been tested twice, first in June 2010 and then again in October 2011.  This is the third test for the level in progress with the Index poised at 1370.

The Chinese markets have been correcting October 2007 and we are the 2300 area for the 3rd time after a correction of over 4 years.  The probability that the floor at 2300 will be breached is very low.  On the other hand, on finding a floor at 2300 or higher, a tradable rally to the 3000 area is a likely prospect.  I would therefore be accumulating at these levels.

US Dollar Index:

The Dollar Index is currently poised at the top of its recent trading range between 73 and 80.  Wave counts indicate that the Dollar Index is in a downward correction from the top it made at 88.5 in June last year.  We were in a corrective B wave from the recent low 73 made in May 2011.  That B wave up may have exhausted itself at 80 and a downward move over the next few months could now unfold.

On the short-term charts, the $ Index has probably made a double top at 80.  A 5-part impulse wave down to the 72-73 areas should now unfold.  The $ Index is now distinctly bearish and this has implications for the US equity markets that are negatively correlated with the $ Index.  It will also have a profound impact on the INR-$ equation.  Note the move will take months to unfold though the initial fall could be fairly sharp.


As blogged earlier, the Rupee retested the 52 levels on the charts, something it had last touched in March 2009.  It has breached the level significantly but the $-Index is now telling us a different story.  While, there is nothing on the horizon that would provide an impetus for the Rupee against the $ unless the equity markets pick up, the $ itself would be weakening significantly against other currencies over the next few months.

On the charts, the Rupee needs to consolidate before making another decisive move on way or the other.  Considering the moves in the $ Index, one would hazard that the INR should consolidate between 49 and 52 over the next few months before it makes up its mind to move either way.  A move beyond 52 in the near future is more or less ruled out, although there have been rumors that the Govt. would like to see level of 58.  Unless my reading of the $ Index is completely wrong, 58 looks highly unlikely in a depreciating $ environment.


As anticipated by this blog, the Sensex has bounced sharply from the 15,500 levels that were tested between August and November no less than 4 times.  15,500 has thus become an important floor for the market that has withstood the most adverse of news flow on the breakup of the Euro.  That floor is unlikely to be breached in any move down.

However, on the wave counts, the Sensex has invalidated my wave count by making a lower low 15,479 on 24th November.  As always I prefer the market to resolve such contradictions rather than impose my views on it.  Sensex has an important overhead resistance at 17,200.  Once it crosses that, the wave counts will resolve themselves.  Until then, one wouldn’t add to long positions but continue to hold those bought in the panic since the floor of 15,500 limits any downside.

US S&P 500:

A breach of 1220 has invalidated my wave count on the S&P 500 and I noted by being stopped out.  So it is back to the drawing board to see what the markets are trying to tell us.  It is a mixed picture.  An alternate wave count suggests that the US markets may continue to be bearish till the end of June 2012.  By this count we are in complex upward correction to the fall from 1365 in Feb. 2011 to a low of 1115 in early October.  This move up could have some time left to play out and retest the 1300 area but is likely to lack conviction.

The probability that we will see the 1000 level on the S&P by June 2012 is now pretty much on the cards.

The bearish pattern unfolding in the US markets implies that both Shanghai and the Sensex could go flat and dead with declining volumes while not breaching their respective floors.  History for the Sensex favors such a scenario.  Overall, one should wait for a bit more clarity in the markets before committing significant capital.



Spot Gold is now correlated positively with risk assets.  Despite making a deceptive series of higher bottoms since its test of $1600 in September 2011, Gold looks distinctly bearish.  A breach of $1680 will be the first indication that Gold is head to a retest of 1600 levels.  The first logical target for Gold looks like $1550.

Only a move past the double top at 1800 would negate this view.  Position traders can carry their shorts with a stop loss just about the $1800 till January next year unless 1550 is reached earlier.

NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.

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Agricultural Exports: Making INR a strong currency

November 28, 2011 6 comments



India has never had a freely convertible currency since independence.  We therefore have no way of knowing its true value in the international markets.  The currency’s day to day value is loosely determined by demand supply in the local currency markets open only to domestic players and a few authorized foreign banks with in a band set by RBI.  The average level of Indian Rupee [INR] was 44 in 2007 before the world’s financial crisis began.  INR has hovered between 38 and 46 to the Dollar since 2007.  Recently it shot up to 52 raising a hue and cry in the markets.  Indian inflation has raged between 8% and 15% since 2007, depending on which measure one uses, while most of its trading partners have been in a near deflation.  On an average the inflation differential between India and its trading partners can be assumed at roughly 10% pa.  Over a 4-year period, if 44 were a fair value for INR in 2007, then it should be close to 65 today.  Going by inflation differentials, even at 52, INR is overvalued by 25%.  Why is it that India’s middle class prefers a “strong” Rupee even if it is overvalued?



In India’s socialistic era, all foreign exchange earned by Indians, exporters or others, was preemptive purchased by the State at an administered price.  Importers not only needed an import license to import anything from abroad, but also had to buy the foreign exchange from RBI, again at an administered price.  Since the administered price of the dollar was way off INR’s true value, importers, exporters, and domestic producers and consumers are impacted differently by this mechanism.  The State used the administered price mechanism to promote domestic industry as the best way to modernize the economy.  Since the industry required a whole host of imports, in terms of plant and equipment, technical knowhow and raw materials, it was the biggest single buyer of dollars in the market.  Hence the State was obliged to keep the Rupee artificially overvalued in order to provide inputs to industry at the lowest price possible.  This socialistic concept has persisted in our collective mindset ever since Nehru drilled it into the national psyche.  We have still not fully recognized the baneful impact of such over-valuation of the INR.



India’s export basket at the time of independence was largely agricultural commodities like cotton, jute, sugar etc.  Nehru’s love for industrialization meant that these sectors were underpaid for the dollars earned by them and the benefit passed on to industry.  In other words, Nehru’s policy taxed exporters of agricultural commodities to give subsidy to industry.  Nehru’s idea was that industry would create jobs thus shifting labor out poverty in the agricultural sector to better paid jobs in industry.  As with most well meaning State intervention in an economy, this woolly-headed idea worked perversely.  In practice, the policy impoverished the farmers who actually produced something worthwhile and reduced wages to poor agricultural labor.  On the other hand, it added to the unearned profits of industrialists, while the jobs created in industry largely went to the lower middle class and not the poor agricultural labor.   Net net, a policy designed to help the poor actually increased poverty.  Nevertheless the argument for industry is so deeply entrenched in our discourse that to argue otherwise is deemed unpatriotic.



The first order of business in the reform package of the 90s was a haircut devaluation of 20% that slashed away a substantial portion of the hidden subsidy that industry had enjoyed.  It also raised prices for the imported goods consumed by middle class consumers who craved quality goods from abroad.  However, this price increase was a one-time affair.  If for instance the price of cars went up, the number of factories to produce those cars went up too.  So did the middle class wages and in time the affordability of cars & car ownership increased, not decreased.  Hence, the one-time cost realignment is usually a temporary dislocation that should not worry either Government or consumers.  Industry over time learned to live with less subsidy and those that were grossly inefficient, went out of business.  20 years after the first currency reform, there will hardly any people left who will argue for currency controls of the socialistic era.  However, our currency is not yet free and gross over valuation still persists.



One of the biggest success stories of our liberalization has been the growth of our software services industry.  It is the employment created by the software industry, and not just its profitability, that has brought prosperity to millions and help drive consumer demand in diverse industries such as cars or housing.  Software services have been the true driver of incremental growth that has propelled the GDP growth rate from 4-5% to 8-9%.  What lies at the heart of our success in software services?  Simply put, it is labor arbitrage.  An average programmer in the US or EU costs 10 to 20 times her equivalent in India.  Technology makes it possible to replace highly paid US labor at a small fraction of the cost in India.  And that labor saving is shared in reduced costs for businesses outsourcing work to India and profits for the firms providing such services from India.  It is that simple.  In fact software services grew out of what we now call body shopping!  The sector is one way to convert our natural advantage in low labor costs into a profitable export business.  That is the key take away from the software services story after first generation currency reforms in the 90s.



If low cost labor arbitrage is our key strength, can we not use the same model to build profitable business in other sectors?  People are trying that in areas such as legal services, design and engineering, accountancy, etc.  However, our biggest pool of labor, the unskilled and semi-skilled labor in rural areas and small towns is still not the focus of development.  Agricultural production for exports represents our single biggest opportunity to use this pool of poor people not only to earn profits but also lift them out of poverty without wasteful subsidies.  So why don’t we produce agricultural products like, corn, vegetables, sugar, wheat, rice etc. in greater amounts for the export markets that sucks in this pool of labor much as software exports sucked in our unemployed graduates?  What prevents us from arbitraging our unskilled and semi-skilled labor profitably?



The US and EU have long had import quotas that shut out agricultural exports from countries like India even though Indian products would have been much cheaper.  That constraint has now vanished with China emerging as the largest importer of agricultural products sending commodity prices to all time highs.  So market access is no longer the constraint it was.  What we need is reforms that help organize production for export by the private sector.  That means allowing the private sector to lease land from farmers, breaking up the cartels in Agricultural Produce Marketing Committees, allowing the corporate sector in multi-brand retailing, warehousing etc.  It also means creating infrastructure at our ports for export.  All these are can be done with some concerted effort at reforms.  The intriguing question is if the steep currency devaluation now underway and the reforms in retailing lined up are part of a package designed promote agricultural exports?  Our ability to propel ourselves into a new orbit of growth critically depends on further currency and agricultural reforms.



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26/11: Three years on, do we have a strategy?

November 25, 2011 5 comments

Three years ago, this day, 26/11 was in New York.


The day was a happy one for me, my happiness those days being tightly tethered to the equity in my trading account. The world was bearish; the markets near bottom, as now. We were busy hunting for bargains to cover our shorts. My supervisor couldn’t have been more pleased.


I barely noticed the small news item flash on my news screen that spoke of a gunman firing shots at VT.  Gang wars I thought, even as I dismissed it as inconsequential to what I was doing then, pausing only to note I should call home and ask when free later in the day.


Over the next few days the true horror of the story began to unfold.  Having travelled often, it was easy to identify with the victims at the hotel and share their panic and terror.  The sheer randomness of the act somehow troubled me immensely.  How do you grapple, and come to terms with, something like that?  What do you make of a person who can carry out such a premeditated act of murder in cold blood?  How would I react in such a situation?


But the conversations that really moved me were with my Dad on the phone.  Being in the forces himself, he knew what was going on.  He was stationed in Mumbai then, and worked a few hundred yards away from Taj.


Needless to say, we were utterly unprepared for what hit us.  We struggled for 10 or 11 days before we could end the siege.  There was horrendous loss of civilian life.  Worse, the terrorists had brought a sprawling densely packed metro to a halt.  It is beyond me to capture the frustration my Dad felt.  He was livid as a ponderous, top heavy, uncoordinated bureaucracy got its act together. Days were lost before we gathered enough men and material to tackle the terrorists. Nobody involved came away unscathed – despite individual acts of incredible bravery – policemen, soldiers, and civilians.


The act had been planned and rehearsed for months if not years at the highest levels of Pakistan’s spy agency.  It was designed to strike terror in our hearts.  Brigadier S K Malik meticulously out lined the strategy in a book on Quranic Warfare. It was an operation executed with military precision by men so highly indoctrinated that only one surrendered when panicked by an injury.  This was no terror strike even if the victims were randomly chosen civilians.  It was a military strike on carefully selected targets designed to create maximal psychological impact.  If there was any lingering doubt, those have all been dispelled by Headley.  Worse, we would not have known what we know but for the generous technical and other intelligence inputs we received from the Americans. If you have any doubts on that score take look at the Pune, Mumbai and Delhi blasts where we haven’t found any of the people involved so far.


26/11 happened after 10 years of ISI supported insurgency in Punjab that killed thousands of people.  The Punjab insurgency was followed by another 2 decades of insurgency in Kashmir that killed tens of thousands of people.  Contrast the casualties in Punjab and Kashmir with those in all of the wars with Pakistan in 1948, 1965, 1971 and 1990.  In all, they were a few thousand, or a tiny fraction of the numbers we have lost in the two insurgencies. Which of them is then the real war?  The 4 formal engagements or the 3 decades of unending insurgency that has claimed 100,000 lives?  Forget the casualties.  Lets look at the troops engaged in CT duties.  By any parameter, the real war with Pakistan is the insurgency.  If wars are fought to bend the enemy’s will, we are right in the middle of a 3 decade old war.


The bigger question though is why don’t we recognize the war for what it is?  How can we fight it, and more importantly end it, without recognizing it as war by other means than conventional, and finding methods by which to fight it.  These are not terror strikes.  You cannot defend against them.  Even the US had to take the war to those who sponsored terror and put the terrorists on the defensive before it could render its homeland safe.  Merely building walls isn’t enough.  And since the terrorist retains the choice of time, place and manner of attack, you simply cannot defend all possible targets cost effectively.  We may not have been bled white but we have been bled.  And if Pakistan cannot sustain this war for reasons of economy we mustn’t forget we are 7 times the size of Pakistan.  And last but not the least, Pakistan doesn’t come alone.  The real elephant in the room that provided Pakistan with nuclear umbrella under which to wage this war with us is China.


Indian foreign policy in the 80s was shackled by the holy cow of feigned non-alignment. It saw us virtually tied down as a Soviet satellite.  The US was aligned with Pakistan and saw us not hostile but still firmly in the Soviet camp.  And then Afghanistan happened.  Pakistan used the opportunity to sideline us, acquire nukes, rebuild its arsenal and wrangle a lot of money out of the US.  Thus buttressed, it pursued its low level conflict with us in Punjab and Kashmir with impunity.  There was precious little we could do about it other than defend with whatever we means we had.  Note we nearly went bankrupt trying to do so in the late 80s.  Lets us never forget that, as is our wont.


Following the 90s reforms things changed which is why we now play up our economic success.  It well to bear in mind just how tenuous that success really is.  Be that as it may, we have now mended our fences with the US, built up adequate reserves to afford the weaponry we need, and can buy the best we wish from the sources we prefer.  The old constraints are gone.  It is a new world.  But has our strategy of fighting the ongoing war changed?


From all that I can see, we continue to plod along the earlier path of indolence and indifference.  Let us be brutally frank.  What has been our biggest strength in this 3-decade-old war?  It is our indifference to human lives lost.  We have lost close to a 100,000 of our civilians and soldiers without batting an eyelid.  There is no hue and cry over our losses; no Govt. has lost an election over our reverses; we haven’t sacked any general, military or police, for incompetence; no civil servant has been ever lost sleep over governance.  People continue to die every single day.  Is there any other country in the world that takes such losses with our equanimity?  How many more need to die before we can wake ourselves up from our stupor to set things right?


I do not have the answers.  I have a lot of questions though. What really bothers me is that it is well nigh impossible to ask hard questions in our polity let alone get answers.  Why is discussing these thing so taboo?  We say we are a democracy, we swear by it, but we as citizens have absolutely no clue why politicians are playing with our lives?  Is it too much to ask what is being done to end a 30-year-old war with Pakistan?  Look at the way the US debates its war on terror in Afghanistan and the attention it pays to its own causalities of war.  Are we children of such an inferior God that we dare not even ask why we need to die in such numbers?


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Has capitalism failed the John Rawls rest?

November 21, 2011 Leave a comment


We are not born equal at birth. We are not made equal in our schools and colleges. Nor can we have equality thrust on us by an artificially created social order. Nevertheless, a yearning for equality is basic to our sense of justice and fair play. To argue otherwise is akin to setting the clock back. Does the Left have any new answers beyond the shibboleths of the past? Occupy Wall Street (OWS) continues as an inchoate cry in the wilderness, attempting to draw attention to a problem that it is unable to articulate. It is time to move beyond the accepted parameters in which the problem is framed in the US into a larger framework that takes in the rest of the world. The issues in this larger framework look a lot different from the way they look now.

The first impression created by OWS is that the inequalities that have shown up in the US represent a failure of capitalism. Much ink has been spilled trying to justify inequality as something inherent in nature forgetting that most human attributes are tightly clustered around a normal distribution curve with few outliers beyond three standard deviations. Does the ratio of the wealth of top 1 percent to mean in wealth distribution match that in a standard normal curve? Obviously, going by this norm, not only do we start unequal but also our system further exacerbates inequality! Given our deeply ingrained sense of justice that demands equality, these attempts to defend the indefensible are misplaced.

The second of the arguments advanced in justification of inequality is John Rawls’ proposition that the least advantaged under capitalism must do better than the mean under an alternate system. That is a difficult test to apply in practice, as there are not comparable alternate systems. Rawls’ formulation implies that even if we start out as unequal, acquired attributes such as education combined with equality of opportunity, should produce less inequality than we start with. OWS activists have argued that capitalism has failed to produce less inequality over time and is hence unsustainable.

Both these formulations miss the big point about capitalism, which is that capitalism is an economic system of production and wealth creation that is not confined to any specific geography. True, Adam Smith talked of the Wealth of Nations when most production and consumption was local. In today’s context, to talk of the US economy without talking about its trading partner China is utterly meaningless. In a modern economy, that is as tightly integrated as ours, goods are produced in various geographies and consumed in geographies just as diverse. To examine if capitalism has failed, as a first approximation, look at the US and China combined as a unit. Has capitalism really failed?

From 1990 to 2007, as US Inc discovered the virtues of cheap Chinese labour, and equally cheap manufacturing infrastructure, factory after factory shifted production from the US to China. What did that mean for labour? Obviously, high cost labour in the US, usually senior in years, was laid off, and younger workers, more in number but at a small fraction of the cost, were hired in China. The combined workforce increased, not decreased, and the combined costs were lower than before. Were the Chinese workers cheated? Far from it, they were happy, they prospered and the marginal utility of every dollar paid to them was greater to them than to the US worker they replaced. As a result of lower costs, profitability of capital increased and those who put up the capital thrived. In short, capitalism worked fabulously, seeking out efficiency and sharing out prosperity to those who grabbed the opportunity. It would be far better if worker mobility was as fluid as capital across national barriers. But the lack of it is not capitalism’s fault.

Was this great relocation of factory production from the US to China of no benefit to the US and its people? The US was the single biggest beneficiary of the shift in manufacturing to China. Firstly, it is US capital that reaped the profits and continues to do so. The recession in the US has hardly dented corporate profitability. Secondly, US consumers benefitted from lower costs and wider choice. The dislocation in the US labour markets was claimed to be temporary. Free markets, it was argued, would create higher paid, high value jobs more suited to the US workforce in things like design, engineering, law, finance, etc. While this remains true, the number of such jobs has not proved to be sufficient. Nor has the US education system proved equal to the job of creating such skills. Retraining labour and reorienting education are much more difficult to bring about than thought earlier. Hopefully, these should correct if recognised as urgent problems.

If capitalism is not to blame, what accounts for the present US woes? In my view, it is nothing more than the normal excesses of capitalism in two related industries — housing and finance. However, one needs to better understand the genesis of the problems in these two industries before the remedies become obvious.

The housing boom was driven to bubble levels by an underlying factor that should not be missed. Senior labour was the first to be displaced by low cost Chinese workers. Such seniors received lump sum payments in compensation that they prudently sought to invest in housing; an asset of immediate use and capable of preserving capital. Housing has a huge multiplier in the national GDP of the US, and the kicker given to housing by senior labour camouflaged falling manufacturing GDP in the last 15-20 years. But for the need to preserve capital by seniors, the housing bubble would have burst much earlier. Housing was joined in its excesses by the finance industry.

Two factors drove overcapacity and overreach in the financial services industry. Firstly, the real boom in housing meant a growing mortgage portfolio that had to be financed in the secondary markets. Secondly, there was the need to recycle growing Chinese surpluses from manufacturing to finance consumption and housing in the US. The problem with recycling was that China gathered all the dollar surpluses in government hands and refused to invest them in anything but US government debt. In a bid to make these surpluses available to US households, the US government used its housing finance institutions to feed the housing market with cheap money. Banks thus borrowed cheaply from Uncle Sam to put on housing assets and the liquidity bubble insured prices kept going up lending a false illusion of well being to all involved in the bubble till it burst in 2007.

The great manufacturing shift from the US to China was a historic opportunity driven by new transportation, communication and computing technologies. Far from being a failure of capitalism, it was a roaring success. As always with free markets and capitalism, the least advantaged benefitted the most; they just happened to be in China and not the US. And while the US is taking longer than desirable to adjust to the new challenges and opportunities, there is nothing to suggest that its unique dynamism will not prevail again. OWS needs to distinguish between gaming of the system by bankers from the working of the capitalist system. The former was a barely legal fraud made possible by lax regulation. The bankers themselves would love nothing more than to conflate the two. Bending free market rules is not part of capitalism.


The writer is a trader. She can be reached at or @SonaliRanade on Twitter

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Market Notes: After the Greek & Italian bond market chaos

November 14, 2011 Leave a comment

Market Notes:  After the Greek & Italian bond market chaos


Gold makes a lower top:  After making a lower intermediate top of $1802 on November 8th, Gold fell to 1763 before attempting a rally back to $1800.  If Gold fails to rally past the 1800 level over the next three or four trading sessions, it will have confirmed a lower intermediate top at that level after the high made at 1920 on 6th September.  If that happens, a fairly long intermediate down trend in Gold prices could ensue stretching into November next year.  Long term bulls in Gold who got stuck at the highs should reconsider their stop losses.  A move below 1750 over the next few trading session will confirm this prognosis.


HG Copper:  Copper is in the process of completing a highly orderly correction in price that started in February 2011 from a price level of 4.67.  The correction should end mid-December this year.  Copper tested its bottom at 3.0 twice in the recent past, turned down again from a significant overhead resistance at 3.75 and is headed to the bottom again.  It is very unlikely that the double bottom at 3.0 will be breached but until then Copper price trend is bearish.


NYMEX Crude:  Crude has recently tested its bottom at $75 twice before staging a significant rally to its first major resistance at $100.  It is significant that crude did not go bearish in the recent turmoil in the equity markets following the near collapse in Greek & Italian bond markets.  A breach of the $100 mark, apart from a nick, looks unlikely as crude is in something of complex bearish correction.  Traders who bought the panic should consider taking profits or setting up protective stops.  A nick or two above the $100 mark would not change this prognosis.


$Index:  The $-Index has made a significant base at 76.73 in the last few trading sessions.  A break below that level would take it a retest of it recent multi-year lows of 73.5.  The intermediate trend for the Index from its recent top in the 80 region remains down.  On the time charts, the correction in process could continue for a while.  A break below 76.75 levels would see the Index test 75 region.  The probability of such a test appears high.


INR:  The Indian Rupee continues to aim for it all time lows of 52 against the $.  It is presently consolidating between 49 and 50 and this could continue to mid-December before a more decisive move on the INR unfolds.  One should note that the 49 level was the lowest point touched by the Rupee in May, 2002.  And that all time low against the $ is the new base that is shaping up in the market.  Barring a pause here for time, or a breach of 48.5, the Rupee looks pretty bearish for now.


S&P 500:  From its recent lows in the 1100 region, S&P 500 has rallied to its first major overhead resistance at 1270.  Despite the Greek and Italian chaos, the market observed the top of its previous trading range as a support that was remarkable showing resilience where none was expected.  1270 remains a formidable hurdle to cross in the next few sessions.  On the time charts, the US has some more time to run in the bullish territory.  Upon further consolidation between 1220 and 1270, a break past 1270 looks probable.  In that case a retest of 1360 region is not unlikely.  Remain modestly bullish on US equity markets, especially the Energy, Banking and Tech sectors.


Sensex:  The Sensex appears to be mirroring the moves in the US equity markets.  After its recent lows in the 15,500 region, the Sensex rallied to its first major overhead resistance at 18,000.  Not unexpectedly, it turned down from that region in order to consolidate gains.  The top of the previous trading range at 17,000 is likely to be the new support.  The Index may consolidate here briefly.  On the time charts, the correction from its recent highs at 20,660 is complete.  A break past 18,000 looks highly probable in the near future and the would bring the recent highs once again in play.  Remain bullish on the Indian markets especially Tech & Telecoms.


Shanghai Composite:  The correction in the Chinese index from its top at 6060 in Mid October of 2007 is complete.  As expected, the index held its new bottom 2330 despite all the turmoil and negative news flow on China.  The Chinese market continues to be significantly out of sync with news flow and has followed its own path despite significant correlation with world markets.  Upon holding 2460 in the current correction a significant change in trend would be confirmed in the near term.  Accumulation in Chinese stocks for the long term to buy & hold investors is probably the best strategy for China.


NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.

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Deterring a Covert War

November 14, 2011 16 comments

Deterring a Covert War


Recent developments like the granting of MFN status by Pakistan to India, and the cordial talks at Maldives, on the surface indicate a thaw in relations between the two estranged neighbors. On the other hand, the Indian Army maintains that the training camps for terrorists in POK are intact, and in business, while infiltration attempts into Kashmir have not ceased.   Pakistan’s softening of anti-India rhetoric has followed a sharp deterioration in Pak-US relations over Afghanistan.  Is Pakistan’s softening stance on trade with India a change of heart that it is prepared to accommodate Indian interests in Afghanistan?  Or is it a mere tactic to calm things on the eastern front as Pakmil grapples with its many problems on the Western front and in Afghanistan proper?



Perhaps that is the wrong question to ask.  Pakistan has consistently sought to use armed aggression to seize Kashmir.  This began right after independence when Pakistan used irregular militias to invade Kashmir.   Indian intervention prevented a complete capture of Kashmir.  After India’s disastrous showing in the 1962 war, Pakistan tried the same gambit in Kashmir again in 1965 using similar irregular militias.  Unexpectedly, India counter-attacked Pakistan across the international border; forcing the Pakistanis to agree to a truce that saw both sides restore the status quo ante.  Indians must note that we did not accept Pakistan’s pleas in 1965 that the irregulars were not under Pakistan’s control despite its denials.  Nor did we hesitate to counter attack, not in a tit-for-tat fashion, – but in a manner, time and place of our choosing, – so as to compel Pakistan to vacate aggression. Contrast the aggressive retaliation in 1965 with our entirely defensive response in the 1990s.  Instead of taking the fight to enemy, we sought to counter ingress of militants by using the army as a mere adjunct to the State police forces.



What made India so defensive in the 1990s as compared to our robust response to Pakistani aggression when it used irregular militias in 1948 and 1965?  The answer of course is acquisition of nukes by Pakistan in the 1980s.  How do nukes alter the balance?



Consider the 1971 war in the then Eastern Pakistan.  Would India have interfered openly in Dhaka to compel the Pakistani army to surrender?  The answer is almost certainly no. On the other hand, would that have prevented the creation of Bangladesh?  Almost certainly not, given the kind of political blunders committed by Pakistan, followed by the repressive military measures unleashed by its army.  But any Indian support to the rebels in Bangladesh would have remained covert from start to finish.



The moral of the story is two fold.  Firstly, nukes don’t deter covert wars even if they are undeniable over time.  Secondly nukes do deter conventional counter strikes to deter covert wars.  It is said nukes are great equalizers.  They are not.  Nukes are highly asymmetric with respect to their deterrence value against covert versus conventional wars.  Our nukes have proved to have almost zero deterrence value in so far as aggressive use of covert war by Pakistan is concerned.   Both in 1948 and in 1965, Pakmil did not expect a conventional counterstrike from India largely because its leadership held Indian politicians in contempt and didn’t think they would have the gumption to come up with a robust response.  In both cases, the regimes that lost the war were subsequently toppled in Pakistan. With the coming of nukes a conventional counterstrike lost its deterrence value.  This was brought home to us vividly during Operation Parakram.  In what has since been euphemistically billed as “Coercive Diplomacy”, we massed troops along the Pakistan border for the better part of a year. Painfully the realization dawned that we could do very little with them because Pakistan could have gone nuclear in response.



India has struggled to find a means to deter Pakistan’s use of covert war against it.  Cold Start, a sort of limited conventional war, fought by rapidly deploying forces to seize Pakistani territory, was in fashion for a while. The idea was that seized territory could be used as a lever to deter Pakistani covert thrusts.  The concept is not without merit since any major loss vis-à-vis India almost guarantees a regime change in Pakistan.  This was true in the aftermath of Kargil as it was true in 1948 and 1965.  That, if not the seized territory per se, would have a deterrence value against a Pakistani army. Despite its professionalism, Pakmil is as much a political party, acutely susceptible to domestic public opinion, as it is a fighting force.  However Cold Start has remained a concept that hasn’t been operationalized.  Meanwhile, Pakistan has added more wrinkles into the game with its development of tactical battlefield nukes.  These tactical nukes could be used against rapidly deployed self-contained Indian brigades used as a part of Cold Start.  In effect as of now, India has nothing operational with which to deter determined use of covert warfare in Kashmir or elsewhere.  The lacuna is so obvious that Pakistan continues to use such methods against us regularly, openly, and with obvious impunity.  Pakistani chutzpah is nothing but a reflection of India’s inability to do anything beyond purely defensive measures on its own soil such as gridding the whole of Kashmir with Army & Para-military forces.



Indian inability to deter Pakistani covert aggression confers a huge advantage to the latter.  This is inherent in the nature of asymmetric warfare using terror against civilians as a tactic.  The aggressor can chose the point of attack, the time of attack and the manner of attack.  It has the element of surprise on its side.  The manner of attack is limited only by human ingenuity.   The targets are dispersed widely and can be chosen at random.  Worse, as technology progresses, the difference between the technical means available to the aggressor terrorist and conventional forces converge, whittling away the latter’s advantage in combat.  Worth recalling here that police action to maintain law and order has always depended on the police force’s ability to concentrate its forces at a point in time and place quicker than the opposition.  The vital advantage has slipped away following developments in personal technology and the trend is unlikely to be reversed.  In many instances we have seen Pakistani militants have better armor, weaponry and communications gear than our army soldiers.



Lacking any inherent superiority over militants, the army has had to fall back on sheer numbers to suppress militants.  Furthermore, it is compelled to deploy itself as a widely dispersed force, over a large geographical area, in order to defend the maximum number of points that could come under attack, both in terms of people and places.  No wonder then that the army needs vast number of troops to suppress a handful of militants.  Pakistan has thus been able to tie down about a 100,000 of army troops with a few thousand militants in Kashmir alone.  Given the lopsided asymmetries, it is no wonder that Pakistan persists with its use of terror as a weapon of choice.  The fact is that it is wonderfully cost effective means no sane Pakistani general is ever going to give it up regardless of the state of play in Kashmir.  It is high time we take this salient fact into account in our strategic calculus.  Hoping that the problem will go away once Kashmir is resolved is childish.



So how do you deter use of covert war in a situation where both the protagonists are nuclear armed?  The answer, obvious from recent world history, is that a covert war can only be deterred by another covert war.  In simple terms, if Pakistan uses irregular militias and militants against us, then we must use such covert and deniable means as we have, to make equal if not more trouble for Pakistan in areas where it is most vulnerable.  A balance of terror is necessary to deter terror.



India had built up considerable covert capability in Eastern Pakistan in the events leading up to 1971 war.  It was used with great effect although, as noted earlier, it may not have sufficed to liberate East Pakistan as quickly, in the absence of the coup de grace delivered by the regular army.  Such capability in Western Pakistan persisted till the 80s when it was foolishly disbanded under the orders of IK Gujaral.  Such has been the folly of politicians who land up in the Prime Minister’s chair.  Covert capabilities may be relatively inexpensive but are as difficult to create as regular forces and requires years of hard slog.  The fact there is no visible effort from India to deter Pakistan on Pakistani soil, coupled with Pakistan’s use of the same with impunity, shows India has done nothing to revive covert capabilities.  It is high time that we did so, whether or not we intend to use them. Just as with conventional war fighting forces, capability to fight a covert war should exist independently of the decision to use it. Creation of such capabilities should be separate and distinct from active deployment of such capability.



Covert war is the only effective deterrent India will have against Pakistani adventurism in a long time to come.  We need to shed our hypocrisy and empty moralizing in this regard.  Nothing can possibly justify the death of our civilians in Kashmir or elsewhere at the hands of militants sponsored by Pakistan.  That is not a choice we should leave to politicians anymore.  They should be firmly told there is no moral superiority in getting your own citizens killed.  As in conventional war, when attacked covertly, we must take the covert war back to the enemy.  We must never again fall into the trap of dealing with a covert war as if it were isolated incidents of terrorism to be dealt with by police methods.



Pakistan’s use of militants in its covert war has not been as costless as it had hoped.  Militias over time acquire a vested interest in persisting with a conflict far beyond its strategic utility to the sponsor.  In Pakistan a whole ecosystem to sustain jihad has evolved overtime that is simply impossible to dismantle even if the Pakmil wished to.  Parts of the jihadi complex are already in rebellion against the Pakistani army over spoils of war.  Others have evolved their own ideological and political agenda with considerable sway over electoral politics in parts of Punjab.  As history shows, bands of militants develop internecine rivalries that overshadow their original purpose. In fact should conflict in Kashmir and Afghanistan end, it will be the beginning of the battle for Pakistan where religion and politics will combine with selective use of armed jihadis to capture political power.  Islamists in many Muslim countries have used this strategy. Pakistan is susceptible to the same combination of guns, religion, politics and poverty.  That leaves Pakistan vulnerable to covert warfare to a far greater degree than India even without taking the active insurgency in Baluchistan into account.



Pakistan has an expansive agenda in Afghanistan.  It’s objective remains far more than just strategic depth or a wish to contain Indian influence.  Pakistan controls the only meaningful trade routes that a landlocked Afghanistan has.  Pakistan could easily contain and counter any Indian influence in Afghanistan by merely using trade and it historical ties of common culture and religion with its western neighbor.  On the other hand, Pakistan’s weakness in Afghanistan stems from its ambitious expansionist agenda where it wishes to straddle and effectively control all trade routes from India to central Asia, not just Afghanistan.  This ambitious agenda conflicts with Afghan nationalism.



Pakistan’s negativity in Afghanistan through its proxy militants has cost it the goodwill of the Afghans who see US intervention in their country as a wasted opportunity for development.  As the US experience of the last 8 years in Afghanistan shows, no combination of conventional carrots and sticks can deter Pakistan from its Afghan adventure.  Pakistan has been willing to forego all aid and risk a conventional, albeit a limited war, with the US in order to preserve its proxies in Afghanistan.  Pakistan’s capacity to sustain its belligerence economically & politically beyond a point is suspect.  Pakistan’s external and internal financing is precarious. Its current account deficit is bridged by inward remittances and foreign aid whose strings are controlled by the US. In times of distress, not only do remittances dry up but also capital flight aggravates the negative impact. Nevertheless Pakistan has signaled confrontation rather than conciliation to the US in recent exchanges.  The US, much like India, has found itself with no good options when confronted with irregular militias using terror against civilians to cause mayhem.  Taking the war to militia safe havens that are sheltered by an overt nuclear power bent on aggressive intervention in a neighbor’s territory is not that easy even for the world’s only super-power.



The US, like India, will have to conclude that covert war is what can possibly moderate and contain, if not deter, Pakistan’s expansionist agenda in Afghanistan.



Pakistan is uniquely vulnerable in Baluchistan. It is it saddled with an active insurgency there.  The Bloch have a long history of alienation and suppression to remember. To add to the incendiary politics, Pakistan is disproportionately dependent on Sui gas that fuels its power plants and domestic kitchens.  Needless to add, Pakistan’s power situation is precarious.  Baluchistan would also provide Afghanistan with port access to the Arabian Sea were it to be revert to its pre1948 independent status.  In a great many ways, Baluchistan is Pakistan Achilles’ heel where long term US and Afghan interests could converge.



The time may therefore have come to bring home to Pakistan the true cost of its belligerent use of proxies to further its expansionist foreign policy agenda. India, having paid an enormous price in blood and treasure to Pakistani covert wars, needs to shed its squeamishness and revert back to covert strategies to moderate and contain Pakistan’s covert wars against it’s interests at home and abroad.


In fact readiness to pay back Pakistan in the same coin must go hand in hand with normalizations of relations between the two countries.  It is lack of retaliation from India that has enabled Pakistan to persist with it covert strategy in Kashmir.  Had there been a robust response from India taking the covert war to Pakistani soil, Kashmir would be far easier to resolve bilaterally.  To obtain peace one must be ready to war. This has always been true of conventional wars.  After 30 years of one-sided covert war it is time for India to realize that the aphorism holds just as true for covert wars.  No amount of make believe dossier exchanges nor diplomatic homilies from us or the rest of the world is going to change Pakmil strategy.  We do not cease to build up our defenses when peace prevails.  In the new world, covert wars will replace conventional wars and we must be ready to wage them if we are to face them.  Mere defense against a covert war can never ever be cost-effective.




What holds true for India holds true for the US in Afghanistan.  Pushed beyond a point, the US may have to rethink it hands off approach to Baluchistan.

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A rare opportunity to reform Indian agriculture

November 14, 2011 2 comments



Indian politicians, always a lazy and indolent lot, are back at their usual game of throwing others’ money at intractable problems to buy votes rather than work hard to create a more efficient and caring society. Twenty years of patchy economic reforms, aimed at dismantling the Nehruvian licence-permit raj, have yielded modest dividends through a step up in economic growth from 3-4 percent to 7-8 percent. Growth has brought higher level of aspirations that the politicians are able to cope with through imaginative policies and programmes. So they hark back to the practices of yesteryears. The practice of throwing crumbs at the poor in a bid to woo their allegiance is being reinstated with a vengeance.

In the name of inclusive growth, India has fashioned two poverty alleviation programmes. The first already in operation is called the National Rural Employment Guarantee Act (NREGA), which offers a daily wage of Rs 100 to any adult who is without a job in the rural areas. India spent close to Rs 60,000 crores on the said programme. The second is the Right to Food Security (RTFS) Bill, which will guarantee food at highly subsidised rates to below poverty line (BPL) families. India has vast pools of unskilled labour in the rural areas that escape the state’s efforts at education. Given the nature of the economy today, such labour is unemployable fully in a modern economy, and doles may be the only way of mitigating their misery. Hence some poverty alleviation programmes must figure in India’s developmental strategy if only to compensate for past neglect. But India’s fiscal deficit, a manageable 4 percent of the GDP in 2008, has ballooned to 8 percent while growth rates and tax revenues continue to falter. A continuation of the present system of doles threatens to undo what has been achieved through modest economic reforms so far. An urgent re-examination of India’s strategy is therefore called for.

Programmes such as NREGA and RTFS represent a failure of the socialistic policies followed by India towards agriculture in the Nehru era. The abolition of the British zamindari (landlord) system, coupled with modest land reforms that returned land to the tillers and put a ceiling on land holdings, helped dismantle the feudal system of the pre-independence era. It also helped India’s growth rate leapfrog from less than 1 percent before independence to 4-5 percent, largely due to wealth creation in the agricultural sector. Nehru’s planners however then set about diverting agricultural wealth in a variety of ways to help nascent industries grow in the belief that industrialisation was the key to India’s modernisation. This was done by insulating Indian agriculture from world markets through import/export controls on its products. Prices of food and many cash crops like cotton, jute, sugarcane, tobacco, tea, etc, were artificially depressed in domestic markets through administrative measures to provide cheap raw materials to industry. By the 90s, almost no commodity was left unregulated by the government in a bid to balance the need for cheap inputs to industry against the farmers’ demands for higher prices. Politicians made fortunes playing the referee in the system.


While economic reforms saw some rollback in the number of agricultural commodities subject to price controls, the basic system continued as it was. Economic reforms did not attempt to neutralise or reverse the flow of wealth from agriculture to industry. Access to world markets and international prices for agricultural produce remains a distant dream.
An effort to right the internal terms of trade between agriculture and industry must begin by deconstructing and demystifying the nature of subsidies we offer to agriculture in return for artificially setting the price of their produce in domestic markets. It is a myth that agriculture pays no taxes. Everybody pays the going indirect taxes. In the direct taxation area, barring a few plantation farmers, most farmers do not earn enough to qualify to pay income tax anyway.


We offer farmers modest subsidies on water, power and fertilisers. But as I have argued earlier in my blog,, these subsidies pale into insignificance with what we take away from the farmers in terms of lower prices for their products.

A simple way to think of the enormity of this burden is to examine why a farmer should pay the international price for steel but receive only one-third the international price of the vegetables he produces. The administered price mechanisms that the government uses to set prices for rice, wheat, corn, cane, etc, in effect calculates the wages owed to the farmers in terms of Rupee wages in India while a farmer abroad would earn 20-40 times more for his labour in a similar activity. That calculation is at the heart of how we cheat farmers out of their wealth by making them pay international prices for manufactured goods but making them accept far below international prices for their produce. As a first step towards reforms, the government must produce a white paper on agricultural pricing and taxation so that we know the true dimensions of this heist of farmers’ wealth. It is absolutely essential to understand how our socialists perpetrate this fraud on our poor farmers in the name of the poor.

China has arrived on the world commodity markets as one of the largest importers of food. As its labour vaults into the middle class, it puts more meat on the family table. It is very easy to underestimate the quantum increase in demand for agricultural products caused by this move up the food chain. Likewise, many African countries, not to mention India, are growing and eating better. Food prices have doubled in the last decade internationally and the UN estimates they will go up by another 50 percent in the next five years. For decades India has fought agriculture subsidies and quotas in the US and the European Union (EU) to obtain a market for its farm produce. The Chinese market, larger than the US and EU combined, is entirely quota-free and offers a ready market for India’s farmers. But both the government and the private sector have paid scant attention to the business opportunity that could at one stroke solve the problem of rural poverty for us. Our agriculture is so ring-fenced with archaic regulation in the form of land ownership and tenancy laws, cluttered price controls and subsidies, price cartels in the form of Agriculture Produce Marketing Committees (APMCs) and political landmines, that it is impossible for anyone to know where to begin with reforms.

The Indian private sector has shown that where regulators stay away, it can still work miracles against all odds. The soya industry in India is an excellent recent example of what can be accomplished in agricultural exports. India has no option but to reform agriculture. We can begin by doing two things. Firstly, recognise that land ownership is now fragmented and that tillers and owners are not the same. Land lease by the corporate sector is an overdue reform whose time has come. Secondly, it is time to dismantle the small trader-dominated cartels at district level APMCs by letting the corporate sector enter agricultural procurement, processing, distribution and marketing chains. The two steps can unleash the kind of explosive growth we saw after independence by bringing capital and technology into the agricultural sector. Else, given the problem of rural poverty, we risk slipping back into our old socialistic ways of resurrecting a licence-permit raj to feed the beast of subsidies that irresponsible politicians are piling on.



The writer is a trader. She can be reached at or @SonaliRanade on Twitter

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Regulation lags behind change in our global village

November 7, 2011 2 comments


The Occupy Wall Street (OWS) movement has been an inchoate cry in the wilderness that the economic system, especially in the US but also in much of the west, has not performed as promised in creating prosperity for all. Capitalism’s raison d’être was that it worked more efficiently than communism, while producing more prosperity for the poorest among society. One simply had to accept its inequality as something ordained by nature. By pursuing economic efficiency, rather than distributive justice, the system did create more wealth. John Rawls, an eminent philosopher, proposed a significant test for justifying inequality. Rawls proposed inequality could be justified when the last person in an unequal system is better off than the average in an equal system. It is not clear if modern capitalism has failed the Rawls test. But what can no longer be denied is that capitalism must fix the problems it has created over the last two decades to retain its primacy as the preferred economic doctrine.
OWS is perhaps right to focus on the immediate problem of inequality. Modern capitalism cannot work without a functioning democracy as a necessary check on its excesses. However, over the last three or four decades, the discourse on economic systems was so captured by capital via sponsored think tanks that it left no space for criticism. This is unfortunate because capitalism’s case for self-renewal depends critically on its tolerance for innovation and creativity. To shut out the emerging problems is to deny reality. And the ugly reality is that the very regulatory mechanisms that guarantee a free market within its domain of validity were captured by ideologues. Alan Greenspan is a prime example of a committed high priest set atop a prime regulatory body. He let the banking system go haywire to the point of fraud and beyond in the name of free, self-regulating markets as dogmatically as any commissar. The price of his dogma is what we are faced with. The fact is, as the financial markets have evolved with globalisation of production, the regulatory mechanism to hold them to rules that ensure free competition and fair ethical practices has woefully lagged. Lack of effective regulation is at the heart of our crisis, which the OWS movement needs to focus on.
Nothing brings home the stark reality of globalisation better than the Greek announcement of a referendum to decide if the European Union (EU) imposed austerity measures were acceptable for a bailout package. The Greek resort to a referendum is unexceptionable. On the other hand, Germany and France cried foul. This ludicrous situation comes about because the burden of Greece’s default would eventually fall on the German and French taxpayers who have no vote in the Greek referendum! The fact is that markets for goods, services, jobs and indeed politics are still largely contained within nation-states, and regulated nationally. But capital is now more or less fully international and increasingly footloose. Athens itself has more houses with swimming pools than registered taxpayers, a fact that the authorities in Greece could verify using Google Earth. A clutch of top 10 Greek billionaires can repay the entire Greek national debt by writing a cheque! And yet you have most of the civilised world in a tizzy over the Greek referendum while the most obvious question remains unasked. Why do the billionaires not pay taxes?
Greece can be dismissed as too small a peg to hang capitalism on. So let us turn to the US. Bank after major bank has paid fines totalling a few billion after being sued by the regulators for wrongful practices in the mortgage and other security markets. What were they doing? One of the biggest scams run by most major investment banks was to originate pools of toxic mortgages, package them, and sell them to one set of investors as near A-grade securities while going ‘short on them’ on their proprietary accounts in conjunction with a few favoured hedge funds. Hedge fund investors are usually the super-rich. In the subsequent crash, hundreds of billions dollars were lost by banks investing in such toxic mortgages while the hedge funds laughed all the way to their bank. Ethical and legal questions apart, one is not questioning the right of knowledgeable hedge funds going short. That is as it should be in free markets. The question is: where did the profits go? Were any taxes paid on such profits?
Capital gains made on investing savings by taxpayers are spared a second round of taxes on such gains. This is only fair, as savings should not be taxed, a fact Central Bankers forget promptly when they need to make real interest rates negative. However, are hedge funds a mere pool of savings put together by the taxpayers or just joint stock companies that actively trade markets? Legal quibbles apart, if the only business you are in is trading stocks or securities, and a significant portion of your profits derive from such trading, then such profits should be taxed as normal business income. Is that so in the US? If not, why not? The Bush era Republican capture of Congress in fact widened this loophole to exempt dividend income as well. Most hedge funds in the US through legerdemain of playing around with tax jurisdictions, capital gains, profit sharing contracts and the like end up paying no taxes. Famously, Warren Buffet himself quotes his own example where, despite being a billionaire, he pays no taxes while his humble secretary does so. The fact is, if you went by the hedge fund flows after 2007, most of the money made from the froth in the markets in the US went to Chinese commodity markets without paying any taxes! So who pays for all that the governments do for society? Does capitalism meet the fairness test?
We cannot run a globalised economy by ignoring capital flows any longer. These are valuable pools of capital. Their availability is what made the Chinese miracle possible. And it is their pursuit of profits that will help lift the rest of the developing world out of poverty. Nevertheless, it takes huge amounts of investment in a variety of ways to enable this pool of international capital to obtain its profits for which service it pays nothing in taxes. The challenge before a globalised economy is to identify such capital pools, and find a way to tax these fairly with respect to where the profits originate as also where they are ultimately destined [actual investors]. The IMF has examined taxing international bank transactions that on the face of it appears unfair as it targets everybody and not just those who escape taxes.
In a way, the present legal system that regulates international capital flows was designed to let the super-rich get away without paying taxes. This worked as long as the capital escaping taxes was deployed largely within the developed world. It has become a problem precisely because the pool is now deployed in the less developed world that leads to hollowing out of the economies in the developed world. If you combine the labour force of China and the US as one, labour has done exceedingly well under capitalism! That is the ultimate irony!

The writer is a trader. She can be reached at or @SonaliRanade on Twitter

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Market Notes 6th Nov. 2011 – After the Greek referendum panic.

November 7, 2011 Leave a comment

Market Notes 6th Nov. 2011 – After the Greek referendum panic.


Shanghai Composite:  The Chinese markets held its predicted floor at 2325 [2300-2350 regions] after a general synchronized crash in the world equity markets.  The 2325 region therefore marks a floor that is unlikely to be breached in a hurry and sets up a good long term stop loss for buy & hold investors.  That said, it doesn’t mean it can’t be retested again before the end of this month though the probability of a retest below 2450 looks remote.  Hard to forget we are talking of the Chinese market where tests of extreme points tend to be exaggerated. Wave counts and time charts don’t show any clouds on the horizon beyond a retest of the recent floor at a higher level.  The first confirmation of a new intermediate bull trend in the index will come after it crosses over the overhead resistance at 2700.  Continue to remain bullish on Chinese equity markets no matter how adverse the news flow.


S&P 500:  As pointed out in the last blog post, the crucial point for reference on the S&P 500 index continues to be 1220.  This level was sorely retested on the day Greece announced a referendum resulting in a mini-crash in the world equity markets on 11/01 and still held up fine.  The index continues to be in a failed 5th wave that indicates an oversold market.  In absence of excessive short sellers, the index should have been retesting the lows at 1100 region at this point in time.  The 5th wave exhausts itself around the middle of November, when the index could retest 1220 again and even go lower before moving up.  For position traders that would be an opportunity to buy. Barring the said retest, of 1220, there isn’t much to worry about the US equity markets.  A new intermediate bull trend would be confirmed above 1270.  Look out for the shale oil & gas story in the US.  Those reserves are enough for 100 years with the potential to be a game changer in geo-politics, oil markets and the US economy.  The world’s pundits continue to ignore its impact treating it as mere hype or seeing it mired in pollution related controversy. The gas is real, already supplying about 30% of US gas demand at this point.  No matter what the technical difficulties the US will not pass up their extraction.  At some point, the markets will sit up and take notice.  Shale related resource stocks represent a great opportunity to buy.


BSE Sensex: The Sensex marked the week by filling up the gap between 17,200 to 17,700 regions that was noted in the last blog post.  The top of the previous trading range at 17,200 held up as the new support despite a general crash in world equity markets after Greece announced a referendum.  The first confirmation of a new intermediate uptrend in the Sensex will come when it breaks above overhead resistance at 17,700.  As far as time charts are concerned, the correction that started at 20,600 on 1st March of this year is now complete.  Continue to be bullish on the Indian market.


$ Index:  The $ Index broke through at the obvious support at 76.7 indicating that the recent floor at 73.5 may come up for a retest at some point in future.  Meanwhile it continues to consolidate above 76.7.  The index is in an intermediate down trend, the first wave of which may complete around the 22nd of November.  A further break below 76.7 to retest the 75 region cannot be ruled out.  A neutral to bearish stance on the $ Index is indicated till the end of this month.


$-INR:  INR continues to consolidate in the 49 region against $ despite the huge volatility in the $ Index which is instructive.  Benign neglect on part of the RBI or does it know something we don’t?  On the time charts, INR could continue to consolidate in the 49 region for some more time, probably end of December with a slightly bullish bias. In the long term however the Rupee looks set to retest it’s all time low of  52 against the $ in the new year.  As Gold imports moderate, and oil prices are adjusted more frequently to international markets, the Rupee might find a floor.  Gold and oil consume India’s foreign exchange in about equal measure that is indicative of our mismanagement of the economy.  That is why the recent petrol hike by Oil Companies on their own was such a significant step towards reforms.  Keep fingers crossed.


NYMEX Crude:  Crude is testing the top of its trading range at 95.  Near term wave counts indicate crude is in a complex correction with an upward bias.  Unless crude breaks above 95 decisively, the further round of correction below 95 may continue for some more time.  I will start blogging Brent.  The US shale oil & gas impact on NYMEX crude prices is reflected in the increasing & persistent gap between US prices and Brent.  It may be time to track the two separately to get more precise clues on what the markets have to say.


Cash Gold:  Gold has completed the first half of its upward correction after the fall from 1920 region.  The corrective pattern may continue over the next 4 weeks.  Gold failed to breach the overhead resistance of $1770 in this upward correction which is significant bench mark now.  Expect Gold to mark time between 1680 and 1770 for the next few weeks with a bearish bias.  A break below 1680 isn’t ruled out though.


NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions


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Land, Rice fields, Golf Courses: Understanding China’s property bubble.

November 2, 2011 2 comments

Land, Rice fields, Golf Courses: Understanding China’s property bubble.



In Liny, a small town in Shandong Province, a blind lawyer by name Chen Guangcheng is being held under extra-judicial house arrest in a local village. The detention comes after serving a 51-month formal prison sentence for leading a class action suit against local party bosses [Commissars].  This is an example of the extraordinary powers that vest in party officials of the CCP that actually run China; away from the gaze of its spanking new metros and Beijing. Understanding how this power structure works is critical to an appreciation of what made Chinese reforms in the 70s work so efficiently.  Forty years later, it also the key to understanding why the Chinese economic miracle can grind to a halt without further course correction.



Consider an agrarian peasant village at the outskirts of Liny circa 1970s with its rice fields.  All land belonged to the State controlled by the local CCP bosses who decided what was grown, how it was grown, where and at what price it was sold, etc.  CCP bosses also decided your fair share of what the produce fetched and the kind of things you could spend your money on.  Any opportunity to break free of this monotonous drudgery, indeed semi-slavery, was manna from heaven.  That arrived in the 70s in the form of demand for cheap factory labor in sweatshops around the coastal province of Guangdong.  These factories were then churning out garments, shoes, toys and such like for the US markets. Their demand for cheap labor sparked off a virtuous cycle that pulled in Liny into the matrix of China’s economic development. Yet, many analysts overlook the role of the CCP bosses in Liny in sustaining this process, for without their iron grip over the peasants still in Liny, the virtuous cycle would long since have ground to a halt.



Consider the same village in Liny 40 years after the first band of peasants selected by the local party bosses left for the factory in Guangdong. Since labor was excess in relation to the available land, and still is, there was no fall in rice production even as Liny continued to export labor.  Instead monthly remittances from workers brought in extra income, which their families could keep to themselves rather than share with the commune.  The need to have families spend that extra income forced the bosses to relax dress codes, because they wouldn’t buy another pair of Mao pant & shirt. One or two were enough. Thus came consumer reforms.  Housing, always in short supply, was another thing to liberalize for which peasants were willing to pay with their life.  So CCP bosses stumbled onto housing as another area for reforms.  And it was basically in land, housing & related infrastructure development, that the CCP struck gold, spawning a model that was uniquely Chinese and not seen in South Korea or any of the other Asian Tigers.



All land virtually belongs to the CCP bosses. More importantly it is free, carrying zero cost.  And CCP can put the land to any use it deem fits, not per party directives from Beijing, but at the local managing committee level.  Furthermore, CCP is virtually the only capitalist in town because none other is permitted.  Talk of an entrepreneur’s dream with no competition, virgin markets, unique product and no price controls.  Any surprise then that the local CCP bosses took to capitalism like a duck takes to water?  It is this process by which local CCP bosses turned into entrepreneurs, with beneficial results for all, that to large measure explains the Chinese miracle and the little resistance to reforms.  Free ownership of land provided every CCP local committee with huge amount of equity capital that only had to be monetized by housing schemes to make money for everybody in the chain.  With such incentives, and a willingness on part of the party bosses to share “profits” among themselves, horizontally and vertically, success was assured.  We in India would have shouted corruption and brought the whole thing to a halt before the first house got built.



Liny’s Commissars did well.  From building houses with workers’ remittances, they have scaled up to building whole townships that will house workers as they retire from their factories in Guangdong and return to the villages.  In the 40 years since the first reforms, many such townships have been built, even occupied, but many many more are being built in many little Linys all over China.  The problem is that not many workers are returning to Liny anymore.  There are other alternatives available in bigger cities.  Migration controls are no longer that effective.  People can chose where to live. The Commissars no longer have captive customers. That has resulted in many Linys building ghost towns that are simply sitting vacant on what were once rice fields.  Some have added golf courses to attract the retiring workers to no avail. There are far too many of them to shrug off.  But that’s not the only problem.


Commissars in Liny not only controlled all land, but just about everything in Liny including the local banks, steel shops, the odd oil refinery and much of the older smoke stack industry that exists. The local banks in particular are still the preserve of the Commissars.  On the way up, when the first houses were being built, this common ownership of all assets, and mutual profit sharing among the Commissars, ensured everybody was on the same page and totally committed to the local enterprise.  No housing scheme lacked for capital, labor or captive customers. Commissar control over peasants was total & tailor made for housing led development. Since no peasant owned houses, selling a house was a matter of allotment out of a queue, profits assured.



But the same nexus turned vicious over time as liberalization led to loss of control over customers who sought better things than the commissars had to offer.  Unsold housing, even with land free, had to be financed by banks, and held on to.  Gradually the stock of unsold houses accumulated while frenetic development unchecked by market forces continued unabated.  The Government in Beijing was most supportive.  They had this wonderful device to mark all land and property valued to indices they fully controlled.  The Commissars in Beijing ensured the land & housing there on went up in value in all districts year after year by 5 to 10%, sometimes more.  Liny’s commissars were therefore able to mark to market, their stock of unsold houses that yielded decent profits on books, even as unpaid bank loans and interest thereon piled up.  Since the same commissars controlled the banks & the housing development companies, nobody complained.  Profits to Commissars still came in though the cash was harder to scrounge.



These ponzi like schemes work when the general economic tide is rising lifting all boats but up to a point as long as incremental cash to pay running expenses is available.  It collapses when the local banks can no longer fund the unsold houses without help from banks in Beijing.  For many that point has now been reached.  If there has been no collapse so far it is because the Beijing commissars now realize they cannot unwind the housing ponzi schemes in Liny without sacking the commissars who elect them to their positions in Beijing. Indeed the problem is so deeply intertwined with they way CCP has evolved over the last 40 years that to reform would invite a revolution of sorts.  The virtuous cycle that powered China’s development has come full circle and turned vicious with a malevolence that is hard to exaggerate.  The CCP will try anything and everything before it gives up its hold on and support for Liny’s commissars. Chen Guangcheng’s fate is but a small though vivid example of what happens to whistleblowers that threaten to expose the Commissars, near and far.  Dissent and tightening cash could blow the lid off this can of worms any time.


China’s GDP numbers are much admired and there is little doubt that on the whole they are very impressive.  How much of that GDP growth is “real” and comparable in value creation to say that in the US?


Consider land held at zero cost in Liny.  When you build houses on the land, the entire monetary value of the land gets “monetized” and added to the Chinese GDP as soon as the houses are declared ready.  Liny’s commissars don’t wait for houses to be sold to book profits.  The old commie system of accounting for “production” and marking to market persists.  But the land was always there and had value even before houses were built on it.  In other words, just because the commissars usurped land from peasants in the past, and carried it a no cost, doesn’t mean all of the value of a house was incremental GDP.  Land accounts for 15 to 30% of the value of a typical housing project or townships that are being built in the countryside.  Housing by itself is close on 20 to 30% of China’s incremental GDP.  So about 1 to 2 percentage points of the 8-10% GDP growth are merely due to monetization of land!  This fact is usually overlooked or glossed over in the China story.



The fact is the property bubble in China is intrinsically intertwined with CCP’s control of political and economic structures in the provincial towns of China.  The bubble is huge as is evident from the reports of ghost towns but it is hard to put a number on it.  China cannot deal with the problem through normal market mechanisms, as that would endanger the CCP’s hold on power.  Chinese authorities are trying to contain & compartmentalize the problem by curbing local bank lending to property, shoring up bank capital, and improving supervisory mechanisms.  There is much talk of banning shadow banking which is nothing but a variation of Liny’s ponzi whereby several banks get together to form a informal syndicate to lend to township development.  The bubble in Chinese property will unwind, as al bubbles must.  The question really is if it can be done without deep reforms in the way CCP is currently managed.  Meanwhile China trudges on its managed book profits in Liny, approaching a 50 year cycle that marks deep cyclical turns in economic and social systems.  The unwound property bubble combined with an ageing population ensures the next Kondratieff cycle in China dues end of this decade will be momentous.


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