Archive for July, 2012

MARKET NOTEs: Most markets are poised at crucial turning points

MARKET NOTEs:  Most markets are poised at crucial turning points.



Major markets are poised at crucial turning points.  These will unfold over the next 2 to 4 weeks. I have therefore concentrated on explaining the setup in each case and tried to identify the earliest signals that may point to the future direction the markets may take.



Gold [GCQ2]:  As expected in the last post, Gold tested but did not pierce the “triple” top positioned at $1640.  After rallying from $1550, Gold turned down again from just under $1640 to end the week at $1582.29.  As I have mentioned many times earlier, the first leg of gold’s correction ends sometime mid-July, and in fact could end next week.  The critical level to watch in the ensuing week will be $1520.


If over the next two weeks, gold does not break its floor at $1520, an intermediate tradable rally in gold can begin.  The possibility of a break below $1520 should not be ruled out.  Such a breakdown in price would imply a fairly long-term bear market in gold, which could see the metal trade far below current levels.


On the other hand, a bounce back from $1520 or above will signal a tradable rally that will take a shy at the previous top of $1920 over a 6 to 9 month period.  The probability of either outcome is more or less even at 50:50.  Traders should watch price action between $1550 and $1520 to see which course the market takes.  Interesting & nerve wracking time ahead for gold traders.


The first confirmation of a breakout to the topside will come on price piercing $1640.



Dollar Index [DXY]:  This blog had the conviction to be a $ bull for the last 1 year or so when all expert commentary was bearish on the currency.  The buck hasn’t disappointed by its performance either, having rallied from 73.26 in May 2011 to a close of 82.9420 last week, just under its previous high at 83.6700.  Can the $ rally higher?


We are in the very early stages of a $ Bull Run that has a long way to go.  Some strategic pundits may find that strange but the message from the markets is that the $ will make big waves.


After making a high of 81.06 in January this year, the $ should have gone into a correction which it dutifully did.  But the correction since has been very shallow and brief.  Even so, the short time spent below 80 has resulted in an explosive break above 82, not just 80, and a very brief correction from the high of 83.67 and we are back challenging the highs again.  Few currencies exhibit that kind of strength where the market expects a correction instead of new highs.


The comments above don’t mean the $ is on a one-way trip up.  It could break atop 83.67 before a significant correction or could turn down again from that level to make another assault later.  Either way, the $ is a buy at every dip.  Don’t short the mighty buck.



Euro$ [EURUSD]:  As expected in the last post, Euro turned down from 1.2700 to go into a virtual free fall, closing the week at 1.22869, exactly at the previous low made on 1st June.  The price action is distinctly bearish.


The next logical target for the Euro is 1.19 though it may rally a bit from present levels before making its way to that region.  In terms of wave counts, the fall in the Euro has much time & distance to go.  In fact indications are we may be in a full 5-wave impulse move down on the Euro.  We are only into the wave III of that move down.  The first confirmation of this scenario playing out will come on a decisive violation of 1.19.


I remain very bearish on the Euro in the intermediate term.



WTI Crude [CLQ2]:  Oil rallied from low of 77.28 to just under $89 before closing the week at 87.20.  Oil can see two scenarios play out over the next 6 to 8 weeks with more or less equal probability.  As usual, we will let the market tell us where it wants to go.


The first, very straightforward scenario is a rally in crude that takes it beyond $90 level for a while in an attempt to close the gap between 92 and 105 that persists on the charts.  This will imply an intermediate correction in the market that could see crude range between $100 and $76 till the end of December this year.  The probability of this scenario is about 40%.


The second scenario is for oil to compress in price between $90 and $76 till the end of July early August before an explosive breakout, probably to the topside.  In either case, oil price is not likely to stay suppressed for long.


Unless the $76 level is violated decisively in the next few weeks, the probability of a long-term bear market in oil is practically zero.



Silver:  Silver closed the week at $27.05.  The first leg of the correction in Silver ends by the 4th week of July.  If the metal doesn’t break floor at $26 in the ensuing couple of weeks, it could be in for a substantial bear rally.  Bears should cover shorts.


A breach of $26 on the other hand will see substantial decline in prices.  However, the probability of the latter scenario is small.  All told bears should cover shorts.



$-INR:  As expected by this blog, the $ tested but did not breach the floor for the $ at 54.3.  In fact the $ rallied sharply from that level to close the week at 55.40.


As noted elsewhere in the blog, the $ itself is set for a bullish run as measured by its Index DXY.  Since the $ isn’t freely traded in the domestic market, price action alone doesn’t provide enough clues to determine where the $ is headed.


It would be foolish for RBI to let the INR chase the $ up both in terms of policy and the need to intervene strategically.  Hence RBI intervention should not be expected below 57.5.


I expect the $ to breach its previous top at 57.50 before the middle of August to perhaps reach 60.50.  The first overhead resistance to the $ lies 56, followed by its previous top at 57.50.  The $ is a buy at every dip.



S&P 500 [SPX]:  The rally in SPX from the low of 1265.40 1374.81 was almost certainly reactive in nature.  A breach of 1335 will confirm that we are in for a longer and deeper correction in the equity markets.  A clearer picture of the nature and shape of the correction to follow should emerge by the end of this month.


On a breach of 1335, the next logical target for SPX would be 1265.



Sensex:  The Sensex closed at 17,521.12 after breaking atop its 200 DMA at 17,140 making a series of higher tops and bottoms.  The 25 DMA is poised just below the 200 DMA and could break above it early next week.  The break above the 200 DMA, the imminent bullish crossover and the series of higher tops and bottoms on daily charts suggests a bullish breakout that would be confirmed once the Sensex breaks atop 17,900.  In fact, that might well happen and the index could race to 18,500.


However, in terms of wave counts, this is not the place and time for the Sensex to begin a bull run.  On the other hand, it is the time & place for false breakouts and sharp bear rallies as we are in the last stages of a downward correction.  By my reckoning, the index should keep correcting at least till the end of December this year. The wave counts also suggest the complex intermediate rally that began at end of August 2011 may actually be ending and a downturn could ensue soon.


Having said that, my reading would almost certainly be negated if the Sensex were to decisively break above 18,500 in the next week or so.  Until then, I would not chase this rally.


I remain very suspicious of this “breakout”.



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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A brief look at European Equity Markets: 07/07/2012

A brief look at European Equity Markets:  07/07/2012




European equity markets launched into a mega bear market roughly 7 years before the US equity markets.  For instance CAC, the French index most widely followed, last topped out at 6927 back in August 2000 and has since made a series of lower tops.  In contrast, the US equity markets began its current bearish phase in October 2007, a good seven years later.  While the ebb and flow in world equity markets has a very high degree of correlation, they do not move in lockstep.  Could European markets actually recover before the us equity markets?  That appears a rather outlandish notion until you fully consider the crashing Euro against the $.


If the Euro were to crash to parity with the $ as some commentators are suggesting, could the EU markets rally because of cheapening of the currency?


To briefly see how EU markets are currently positioned I will take a brief look at the main indices one by one.



CAC:  The French index peaked at 6927 in August end, 2000.  After the peak, the index made a low of 2402 in November 2003, and then rallied along with the US equity markets to a high of 6182 in July 2007.  Note the high was made before the peak in S&P 500, and the high was significantly lower than the high of 6927 in 2000.


From the high of 6182, the French index crashed along with the world equity markets to a low of 2552 in March 2009.  The low of 2552 matched the low of 2402 in November 2003 but was higher.  CAC rallied with the US markets from the low of March 2009 to a high of 4187 in February 2011 but the high was about 50% retracement of the previous fall.  The rally was far weaker than the one in the US markets that nearly challenged the previous all time highs of 2007.


CAC has since been correcting.  It crashed from 4187 to a low of 2810 in September 2011 and has since tested this low twice and made higher bottoms each time.  Note the low in September 2011 was higher than the one in March 2009, which in turn was higher than the one in Match 2003.  Can the CAC have made a bottom at 3023 in September 2011?


The case for such an interpretation is rather involved and I don’t wish to discuss my wave counts.  Briefly then, CAC has traced out a major A-B-C corrective wave from 2000 to 2009 over nearly 8 years.  Thereafter, it rallied from a low of 2595 in March 2009 to a high of 4187 in what could be construed as the first leg of a bullish Wave I.  We are thus in Wave II of which the most destructive a part involved a retest of the bear market low of 2595.  CAC made a low of 2693 on 23rd September followed by a higher low 2890 on 11th November, followed by a higher low of 3006 on 30th May.  These series of higher low together with the wave count lead one to believe that CAC may have put in low of 2890 on 11th November 2011.


That doesn’t mean CAC is going to launch into a new bull markets any time soon.  That depends on how the Wave II correction plays out and these are usually very subdued giving little hint of the explosive rallies to follow.  The first tangible clue to the structure of the Wave II will come from a rally in CAC above 3500 in the next few weeks.


That said I am pretty confident that the low 2890 will not be taken out by any subsequent crashes.



DAX:  In terms of wave structure, the DAX story in broad outline is much the same as that of CAC.  The only major difference being the German economy is inherently more resilient than the French counterpart.  Hence, the depth of corrections are relatively lower and recoveries correspondingly that much more robust.


DAX peaked out in March 2000 at 8095 and without much fuss crashed in a simple straightforward manner to a low of 2180 in March 2003.  From there, DAX recovered along with the US equity markets peaking at 8095 in July 2007 once again without making a new high.  Crashing from there in line with world markets, the index made a low of 3695 in March 2009.  With that, the index completed a full A-B-C correction with the low of C being considerably higher than that of A.


From March 2009 level of 3695, DAX rallied to a high of 7552 in May 2011.  It did not reach the previous two tops at 8095 but that is classic deception for Wave I of a bull move. The subsequent correction saw the index fall to 5032 from where it has rallied with two higher tops and bottoms.  The first leg of Wave II correction may well be over at point 5912 on 6th June.


That doesn’t mean we are going to see a bull run in the DAX any time soon.  Much will depend on how wave II unfolds.  But the low of 5032 in September 2011 is likely a bottom that won’t be taken out again.


Let me be clear.  DAX has still a long way to go as far as WAVE II correction is concerned.  The C wave of Wave II can be quite destructive.  But we are likely to have an upward bias in EU equity markets for the next 6 to 9 months that may look like a bull market albeit with very sharp corrections.



FTSE 100:  The FTSE 100 story is much more like the DAX than the CAC.  The wave structure following the high in December 1999 is much the same as that of DAX.  Notice though that FTSE is not as strongly upward biased as DAX with low in March 2009 at 3512 not being all that much higher than the low of 3281 in March 2003.  Likewise, FTSE did not equal the previous top of 2000 in 2007 although it came close.  In all other respects, the wave count for FTSE is a replica of DAX.


From the low of 3512 in March 2009, FTSE rallied to a high of 6102 in February 2011.  That to my mind completed the Wave I of a new bull move.  The index corrected from there making a low of 4942 10th October 2011 and has since rallied and corrected again.  For all practical purpose, the first leg of the Wave II was complete at 5382 on 8th June.


We could see an upward bias in FTSE with sharp corrections as the B leg of wave II unfolds.  Again this is still a complex correction not a classic bull run.  Much of the gains and more in the upward drifting in values in B leg and more are just wiped out in C that follows.



Spain Madrid General:  Note the structure and correlations of the Spanish market are completely different from its continental cousins are more like those of the US market.  If that appears strange, it is also true!


The Spanish market peaked at 1740 in November 2007 along with the US markets.  It has been correcting since with no end in sight.  Having made a low of 739 in March 2009, the index rallied to 1273 in June 2010 and then meandered down from there to low of 629 in May 2012.  The correction is by no means complete and has room to run both in terms of price and time.  That said, we might be into a Wave IV pullback currently though it is hard to see that reach above 780.


566 remains a possible target for wave V for the Spanish market.



It would appear from the foregoing that those economies in Europe that have export markets, will be able to take advantage of the falling Euro to export their way out of trouble.  The others may continue to sink.


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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The Hype over Gujarat’s Economic Performance

The Hype over Gujarat’s Economic Performance



Bibek Debroy’s blog post of 3rd July has been around on twitter as something of a rebuttal to the ET story on Gujarat’s growth.  Bibek Debroy makes some excellent points on [a] the purpose of such an analysis, [b] assembling the necessary data set for it, and [c] laying out the argument for or against the proposition.  Given the structure of government statistics, this is often a difficult task, as the following note will show.


The argument over Gujarat is not over Gujarat per se.  The argument is really over Modi’s stewardship of Gujarat and his style of administering the State relative to his peers elsewhere.  In particular, Modi fans have posited that [a] under Modi’s stewardship, growth in Gujarat has accelerated over the what prevailed before him, and [b] that post-reforms, Gujarat’s performance under Modi is head and shoulders above that of its peer States.  Based on these two premises, a case is made for Modi to be some thing of a miracle economic manager, who should now be promoted as Prime Minister in order to enable him to repeat that performance, if at all it is so repeatable, at the center.  That then is the crux of the political issue.


Modi took over as CM Gujarat in October 2001.  The 10th Plan period runs from April 2002 to March 2007, both years inclusive.  Likewise, the 11th Plan period spans five years from April 2008 to March 2012.  The two together neatly capture the 10 years of Gujarat’s development under Modi.  Therefore, this 10-year period is the key to testing the two key propositions posited by Modi fans.  The question therefore is to see [a] if Gujarat’s performance during this 10 year period has been truly spectacular and [b] if its has been far above the that clocked by its peers.


Bibek Debroy has chosen the peer states to be Andhra, Maharashtra, Gujarat, Tamil Nadu and Karnataka.  We stick to that group though a case can be made to include Bihar and perhaps the city states as well which have far higher growth rates.


Over the two Plan periods spanning 10 years, that coincide with Modi’s tenure in Gujarat from 2002 to 2012, what is the growth rate of these 5 States?


Bibek Debroy has used figures from the Planning Commission [PC] for the 10th plan period, and the “Expected” mid-term appraisal figures for the 11th plan period while citing Gujarat’s superior performance relative to its peers.  The fact is, data for all the 5 years of the 11th Plan period is now available for Andhra, Tamil Nadu and Karnataka, while the data for 2012 is awaited for Gujarat and Maharashtra.  So why not take the growth registered by the 5 states over the first 9 years spanning 2002 to 2011 as the basis for comparison?  That would give a clearer picture of relative performance crystallized in one easily understood number for all states.  That number should be the Compounded Annual Growth Rate [CAGR] calculated over 9 years using actual data.


Why use CAGR?  Suppose a state starts the 9-year period with GDSP at some value X.  Nine years later it’s GDSP grows to some value Y.  What is the ONE growth rate R such that, when applied to X, exactly returns Y after 9 years?  Solving the common annually compounded interest rate formula arrives at that rate and the rate is called CAGR.  We mention it here because PC appears to be using a different metric when it talks of average growth rate over a plan period.  Perhaps it is using an arithmetical mean, which is shabby practice.  One doesn’t really know.  Hence we have calculated CAGR for all 5 States using 9 years of actual data.


Here are the CAGRs over the 9-year period.  Gujarat 10.35%, Maharashtra 9.95%, Tamil Nadu 8.87%, Andhra 8.39% and Karnataka 8.61%.  Since data for 3 states for 2012 is available and the last 4-year CAGR of Maharashtra and Gujarat are known, we have used actual data and 4 year CAGR for Maharashtra and Gujarat to arrive at the 10 year CAGR.  These are Gujarat 10.28%, Maharashtra 9.90%, Tamil Nadu 8.92%, Andhra 8.23% and Karnataka 8.39%.  The difference between Gujarat and Maharashtra for both 9 and 10 year periods is miniscule and probably within the margin for error.


So where is the case for superlative performance from Gujarat under Modi’s stewardship?  At best its performance is line with or slightly superior to that of its peer states.  Note that Gujarat and Maharashtra have vied for the top slot before economic reforms, after economic reforms but before Modi, and after reforms, after Modi.  Should Gujarat’s slightly superior performance be attributed to Modi?  If so who gets the credit in Maharashtra or Tamil Nadu?  Not to mention Bihar.


The question is politically important. Gujarat’s so called superior performance, relative to its own history, and its present peer group, is being used to assiduously promote a personality cult around Modi together with a fascist ideology.  The idea is that an adoption of the two at the Center will lead to faster growth.  There is no basis for such a case, but even if it did exist, would we be willing to succumb to such a proposition?  That is why, hype or not, Gujarat’s and Modi’s economic performance need to put through a more detailed scanner than is possible here.


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Will the depreciated Rupee help the economy?

July 7, 2012 1 comment

Will the depreciated Rupee help the economy?



From the beginning of March this year and end May, over a period of three months, the Dollar rose by approximately 20%, going from R48.50 to R56.50.  The steep depreciation of the Rupee came after the Dollar was allowed to depreciate in value against the Rupee from R52 in March 2009 to R44 in March 2011; a depreciation of 18% in the value of the Dollar in Indian markets.  Why did RBI allow the Rupee to appreciate by 18% during the 2009-2011 period?  Is the current depreciation in the value of the Rupee against the Dollar justified?


While these are valid questions, the debate on the external value of the Rupee misses its salience to the broader economy.  Japan, the Asian Tigers, and most recently China, have all industrialized and shown phenomenal growth rates using a cheap home currency to reorient their economies for rapid growth in exports.  Indians used to be dismissive of such strategies on the plea that Japan and the Asian Tigers were “small” countries, which made an export lead growth strategy feasible.  India, with a huge population, and a large domestic market, needn’t follow a similar strategy.  Then came China with a population larger than ours and showed how a cheap domestic currency could be used to implement an export led growth strategy with resounding success.  Yet we cling to tired old arguments, both unwilling and unable to export our way out of poverty.  What accounts for our negative attitude to exports?


The two largest items on India’s import bill are crude oil [$100 billion] followed by gold [$50 billion].  These two items account for a little over 50% our import bill.  We produce little of crude domestically and virtually no gold.  Yet in the world markets we are 3rd largest importer of crude and the largest importer of gold.


An argument for keeping the Rupee over-valued is that since India imports more than it exports, and as most of our imports like crude are price inelastic, India is better off keeping the Rupee over-valued.


The argument is deeply flawed at many levels.  Firstly, remember that our current account deficit [CAD], which now is in the region of $90 billion a year, has to be financed.  In other words, the excess of imports over exports every year have to be paid for by [a] borrowing on the international markets and/or [b] selling other assets such as equity in our profitable companies to investors abroad.  Since the 90s we have been financing the CAD by borrowing from NRIs, borrowing from other international investors and selling shares in Indian businesses through FII or FDI routes.  Note, we started with borrowing from institutional investors in the 70s.  When that source ran dry we turned to NRIs.  In the 90s even that wasn’t enough so we started selling the family silver – shares in domestic companies and new businesses.  This is not to say FII or FDI is undesirable.  But we are not doing it to foster competition in domestic markets.  We are allowing such investments primarily to fund the CAD.  We have no other choice.


The simple fact is, no matter how attractive a strong Rupee appears from a tactical standpoint, it leaves a huge CAD in its wake that has to be funded.  We have been running a persistent deficit for the last 65 years and are running out of funding options.  What little advantage we may gain in “cheaper imports” via a stronger Rupee is lost by having to pay higher than normal for funds with which to cover the deficit.  Hence, over time, a stronger Rupee debilitates the economy and the shrinking funding options is what precipitates depreciation of the Rupee!  Therefore, a “strong Rupee” is actually causes a profoundly deeper weakness.  Furthermore, a strong Rupee sends out wrong price signals to the economy and sets up perverse incentives that perpetuate the deficit instead of correcting it over time.  The fact is, nations cannot persistently spend more than they earn.  There is a day of reckoning when nations too can and do go belly up.



If we are running a persistent CAD that keeps growing every year, obviously deep structural changes are needed to correct the imbalance.  On the import side, it obviously means curbing the use of crude and gold to take the two largest items on our import bill.


Instead of curbing demand we subsidize POL products, which promotes their consumption.  Similarly for gold, by keeping real interest rates negative on bank deposits we force households to save via gold rather than via financial products.  Were the real returns on bank fixed deposits positive after accounting for inflation, the investment demand for gold would disappear.  But government uses sly taxation of wealth saved in bank deposits to manage its fiscal deficit. In the process it sets up perverse incentives for gold imports.  Elimination of subsidies on POL products would force the economy to be more fuel-efficient and cut the demand for POL by incentivizing the development of other options such as solar or wind power. We often forget that subsidies hurt the larger economy by killing off innovation that would mitigate the current problem.  Similarly, an explicitly stated policy of keeping yield on 3 year fixed deposits at least 1% pa higher than WPI or CPI would not only force RBI to be more market driven in setting interest policy but also eliminate the investment demand for gold.  In fact, consistently followed, the policy could also free existing stocks for consumption demand and/or exports.


The argument that gold imports don’t hurt is absolutely fallacious.  Not only are gold imports awfully deflationary, they are also far more expensive to the economy than to investors who buy if the Rupee is over-valued.  The notion that gold imports don’t really add to the “real deficit” is equally off the mark.  The privately held gold hoard is simply not available to society when needed.  In 1962, when India was in grave difficulty over the war with China, frantic efforts to mobilize gold to buy arms mustered a paltry 30 MTs of gold.  In contrast, we import about a 1000 MTs annually now and our accumulated holdings must be 20 to 30 times that amount.  So lets not pretend that gold held by private households is easily available for a public purpose.  That is an empty slogan.


Why can’t we step up our exports?  Since independence, if you look at what we have accomplished by way of finding new markets for our exports, the picture is very revealing.


In the 70s, we went to the IMF for a bailout.  Increasing exports was a must.  Casting about for a way out, government discovered that unknown to it, several smart traders in Surat were importing small diamonds, using their own capital and connections, for polishing and cutting, and re-exporting them with handsome margins.  The gems & jewelry industry, much like the software services industry, was born in the private sector and recognized only after it was well established.  The rest is history.


Similarly, in the 90s a crisis forced us to devalue the Rupee and the software services industry took off responding to the increased profitability that the 20% Rupee depreciation gave them.  In both, the basic arbitrage was labor cost.  The gems & jewelry industry monetized cheap skilled Indian labor. The software industry followed.  Are there no more opportunities to monetize our abundant labor?  The fact is such opportunities abound.  All the opportunities available to China were also open to us.  The need is for government to set up the right incentives to make those opportunities profitable for the private sector.  The rest will follow.  Are our policy makers too pusillanimous?



Vast markets for agricultural products are opening up as people with higher income move up the food chain.  China is now the world’s largest importer of food and its markets are not closed by quota regimes.  With our cheap rural labor, that is a huge opportunity given the right enabling policies for investment in agriculture.  If such exports haven’t taken off it is because we have archaic laws, poor infrastructure at ports, and lack of focus from policy makers.  Yet as Soya exports show, nothing is impossible.  It would be in the fitness of things if the current BoP crisis, and the consequent depreciation of the Rupee, is used as an opportunity by government to open up the farm sector for investment in export oriented agriculture since we now have a huge surplus in most agriculture crops except pulses.


A depreciating Rupee is an opportunity not a weakness.  Instead of being defensive government needs to launch a program to educate people and business on how to benefit from it.  For that to happen government needs to put its own policy making shop in order.


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