Just sold Euro at 1.3220 in Asia.

After a day going through the numbers and analysing the political statements, I believe we are seeing the end game play out. Bond holders who purchased deep discounted Greek Bonds as a punt will fight through the courts as the ‘New Greek Resistance movement’( The Resistors) gathers pace.

You can treat the patients symptoms for only so long, but to cure the patient the Cancer must be removed.

Stock Pick – The buy/sell ranges for Goldman Sachs in 2012

Goldman Sachs shares lost almost 50% last year, though the post October embrace of risk has seen the global investment banks shares surge from 87 in December to a 117 now. The risk reward on Goldman no longer seems attractive to me, as the market surge is on low volume and tail risks are all too real, from Iran to Greek debt to the risk of contagion in Portuguese debt. In any case, 2011 was an annus horribilis for Goldman. Earnings fell 66% to a $4.5 EPS as the Volcker Rule forced the House of Blankfein to shut down its fabulously profitable proprietary trading business. ROE for the King Croesus of Wall Street was a dismal 4%. Goldman remained in the crosshairs of the Congress, the SEC and even Occupy Wall Street as the most maligned investment bank in global haute-finance, a symbol of the busted Gilded Age of our times. Ever Lucas van Praag has retired at Death Star.

While it is true that Goldman beat 4Q Street consensus, the beat was only due to a tighter cost base (quelle horreur! Layoffs among the Masters of the Universe?) and lower tax rates. It is also significant that the fall in Goldman revenues was not due to trading blowups but due to regulatory imperatives (Dodd Frank, Volcker Rule, derivatives) and political blowbacks. Ironically, Goldman returned more than double the capital ($6 billion in buy backs) than it generated in earnings ($2.5 billion) in 2011. While mark to markets obviously surged in January, volume and client flows are mediocre. Yet firms have exited entire businesses (e.g. French banks in project finance, RBS in cash equities etc.) though UBS and Macquarie demonstrate the Black Death in I-banking still rages.

As Lazard demonstrates, merger advisory is not a goldmine right now. Cash equities revenues are down at least 15-20% across the Street and even FICC market making/client execution revenues were down 5 – 7%. While equity/debt underwriting revenues were higher, I am concerned by the $8 billion in net AUM outflows in GSAM. Goldman is now trading almost at its tangible book value per common share. Sadly, the macro view suggests a discount. This means I go short GS at 117 for a 108 target.

I believe Goldman Sachs risk/reward is no longer investor friendly at 117, though as the animal spirits of Wall Street are still bullish. There is no point being a short sale matador when the bulls go ballistic in a high beta Pamplona. However, at 117 – 125, Goldman is skating on very thin ice.

Naturally, the mood swings of the capital markets will determine the fate of Goldman Sachs shares. A messy Greek default would be another liquidity shock on the credit markets and thus escalate funding risk on Wall Street. Another Abacus or compensation scandal could hit the shares. Naturally, if equity markets continue to surge higher, Facebook reopens the IPO pipeline, credit spreads continue to compress, China has a soft landing, Goldman EPS could be as high as $15. But I doubt it. My thesis is $12-13, the 2010 level. This means Goldman trades between 95 and 125, my ideal buy/sell (short?) zone.
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Researched & compiled by Matein Khalid

Macro Ideas – Is dollar-yen headed to 80-82?

The Japanese yen has been on of the world’s most resilient safe havens, trading near postwar or at least post 1995 highs even though risk metrics in global finance (VIX, debt and FX volatility, credit spreads etc) have plummeted since October 2011. However, the tight trading range of the yen is about to break on the downside, though declines will be limited, in my opinion, to 80-82. Why? One, the January payroll data confirms the emerging consensus that the US economy is recovering (at last) while US Treasury inflation break even yields are negatives. The Fed can simply not justify QE3 when payrolls rise by 250,000 a month, the stock market has doubled (since March 2009) and Brent crude oil is at $116 while commodities are on fire. This means that US Treasury-JGB interest rates spreads can well rise. Nothing dramatic, I concede, but enough to anchor a dollar bid against the yen.

Two, the Ministry of Finance is clearly unhappy with the uber-high yen, the reason it warned the FX market with its code language (“decisive action”) and then decisively intervened in the Tokyo money market. This stealth intervention is no secret to the cognoscenti in the global FX market and the US Treasury. The Japanese do not want to intervene on a post Fukushima scale because Tokyo does not want to embarrass Tim Geithner as Obama faces his rivals in a bitter election battle. However, now that the samurais have descended from heaven, from the mist shrouded peaks of Mount Fuji-yama, yen bulls should be on their guard. Japan Inc will simply not allow dollar yen 74.

As Fed easing expectations and European sovereign debt risk is priced out of the market, I expect the yen to decline to 80-82 in the next two months. Obviously, if the West’s cold war with Iran turns hot or a messy Greek/Portuguese default triggers contagion, all bets are off and the yen will surely surge beyond 75. However, this is a tail risk, not a base scenario.

Obviously, FX intervention alone will not work unless the Bank of Japan expands its asset purchase program, a prospect Governor Yamaguchi has not exactly embraced with frenzied enthusiasm. Yet corporate Japan needs insurance against deflation risk, the current account surplus is at a 15 year low and US recession risk has plummeted. This may finally convince Yamaguchi-san that the Bank of Japan has now choices.

The Nikkei Dow is now 9000. The Nikkei was 8000 in 16 January. Sure, Greece/ECB provided rocket fuel. Yet is the prospect of a weaker yen also behind the surge in Toyota Motor, Hitachi and Komatsu shares? There is also increasing political pressure for the Bank of Japan to ease policy as exports soften. Note that dollar-yen held 77 even as global equities tanked on Friday. Sterling-yen and Mexico-yen are obvious carry trades to take advantage of a weaker yen. Sterling-yen call can well head to 126 in the next month

Researched & compiled by Matein Khalid

The geopolitical wild card in crude oil is the West’s confrontation with Iran as US/EU sanctions gut its economy, banking system, foreign trade and oil exports. The Irani riyal has lost 50% of its value against the dollar and hyperinflation has devastated the Teheran bazaar merchants, whose money bankrolled the clerical elite of Qom’s revolt against the Pahlavi shahs that culminated in revolution in 1979. Iran’s threat to disrupt the oil tanker shipping sea lanes in the Straits of Hormuz will mean war even if the warplanes of the IDF not launch a preemptive attack on Natanz and Busheir. This could mean panic in the oil market, possibly $150-180 Brent. After all, Brent traded at $127 when Benghazi revolted against the Gaddafi regime last April.

The latest EU embargo is not a problem as European refiners can replace Iranian heavy crude with Saudi blends, albeit with higher sulphur content. Sweet west African crude premiums to Brent will rise in 2011, as will Russian Urals-Brent. As the West Texas-Brent spread demonstrated in 2011, spread trading can prove hugely profitable in the future/options markets of black gold on NYMEX and the ICE.

It amazes me that OPEC is pumping at full capacity, with Saudi Arabia alone at 10.3 MBD, the kingdom’s highest output rate since the onset of Iran-Iraq war in September 1980. Meanwhile, Libyan exports have resumed faster than expected and the return of Exxon and Shell to Iraq means at least additional 0.5 MBD crude production this year, despite the latest spasm of sectarian killings in Baghdad, Basra and Mosul. I am stunned at the sheer scale of output from Russia’s East Siberian oilfield, offshore Brazil, Canadian oil sands, US shale. Net-net, net OPEC production could reach as high as 1.5 MBD in 2012, way more than demand growth. The conclusion is unmistakable. An oil glut is coming and, thanks to Iran’s Supreme Leader, it is simply not priced into the oil futures market. Shukran, merci, Ayatollah Khameini, for setting up the strategic short Brent trade of the year.

Demand trumped supply in oil markets since 2010. This means OECD inventories will not fall but actually begin to build. China’s strategic reserve buying will end even as its industrial production growth slows and European demand actually contracts to 2005-6 levels. The economic risk are to the downside, OPEC and non OPEC supply is flooding the market and EU demand (14 MBD) is about to contract. The outages in the Gulf of Mexico, Brazil, the Caspian Sea and the North Sea are now resolved. Gas liquids (NGL), not subject to OPEC quotas, mean another 0.5 MBD in the world market.

I have been an obsessive student of OPEC my entire adult life, since Sheikh Yamani’s netback crash in the mid 1980’s. The only lesson I learnt in myriad oil cycles is that OPEC quota discipline is non-existent on the way down, that Riyadh alone is the ultimate swing producer. If Iran does not flare up, the world could be on the precipice of a major crash in Brent this summer. It is impossible to include cruise missiles in an oil price regression model. Yet, without war, Brent is headed lower this summer. How low? $80-85 , in my view.
Matein Kahlid

The Mexican peso, whose devaluation in the December 1994 tequila crisis defined the EM traumas of the 1990’s, is one of Latin America’s bellwether currencies. Thanks to NAFTA and the factories on both sides of the Rio Grande, Mexico is leveraged to a strengthening US industrial and business cycle. I believe the Mexican peso is undervalued at current levels as the Hacienda (Mexico’s powerful monetary elite) is now committed to auction USD 400 million in cash whenever the MXN/dollar depreciates 2% from a prior fix in a classic managed float FX regime.

A stronger Mexico peso in 2012 will not surprise me as real GDP growth is accelerating, due to stronger domestic demand, high oil prices and exports. Inflation could rise as the weakness in the peso in 2H 2011 meant a higher cost for wheat (and tortillas!) and petrol. Yet Mexico, unlike India, faces no structural inflation dilemma.

Amazingly, in a nation once fabled for fiscal recklessness and serial sovereign defaults, Mexico’s fiscal deficit is a mere 0.5% of GDP. Mexico’s $14 billion FDI more than offsets its current account deficits, meaning hot money is not needed to finance its modest twin deficits, again unlike the Indian rupee and Turkish lira. In an ideal world, I would prefer to buy the Mexican peso at 14.30 for a eight month 12.40 target against the dollar. This is not the Panglossian best of all possible worlds. The Banco de Mexico is in hawkish anti-inflation pass through mode, an argument for a firmer bid in the peso.

Last week, I postulated that a yen depreciation against the dollar based on US Treasury JGB interest rate spreads was possible but even I was stunned by the speed at which the yen tanked on Wednesday against the buck, down almost to 78 (hedge funds, crowded trades, high octane daisy chains of leverage!). Of course, the yen was the top performing major currency last year against both the dollar and the Euro. But the game’s morphed, if not changed now.

The new embrace of risk in global market (the same week Greece effectively defaults, a sovereign rose by any other name stinks just as bad!). I believe the Japanese yen will revisit 82-85 far sooner than the FX markets thinks (or option skews suggest), I am naturally inclined to pair strong with weak so the Mexican peso against the Japanese yen is naturally a strategic FX trade whose metric are alluring.

This is the Tequila-Shogun FX trade! Of course, 2012 is an election year in Mexico, as was 1994 when Carlos Salinas devalued the peso and 1982 when Lopez Portillo defaulted on Mexican sovereign debt to Wall Street money centre banks. President Calderon’s term ends in July. So watch the Mexican peso like a hawk to generate money making mood swings.

The Mexican peso is the best performing EM currency against the US in 2012 for good reason. The peso benefits from the Bernanke Fed’s latest zero rate FOMC pledge till 2014. After all, offshore (mainly US) investors hold one third of the local peso bond market. I notice the yields on the Mexican Eurobond has tanked and Mexico’s sovereign CDS is now 145, the same as Abu Dhabi. The world’s smart money is eating some profitable burritos and enchiladas, amigos!
Matein Khalid

Sold Cable after US unemployment numbers of +243 US unemployment now under UK levels. Looking for 1.5650 later today

Sold Euro @ 1.3172 looking for 1.2980 test later today

GCC Focus – The macro metrics for Dubai’s DFM
January 9, 2012

The Dubai Financial Market (DFM) is the only listed stock exchange in the Gulf but its shares have been savaged by the secular bear markets in UAE equities, the exodus of offshore institutional investors from regional capital markets and the collapse in trading volumes. The most immediate bearish news was the MSCI’s failure to upgrade the UAE from “frontier” to emerging markets and the seven year plunge in trading volumes, which are down a shocking 70% from even the modest levels of 2010. Naturally, the ice age in IPO’s and a broader emerging markets bear market has reinforced DFM’s share slide. The vibrant equity culture of 2004-6 is now a cruel mirage.

The rise in Dubai’s credit default swaps to 450 basis points reflects the post-Arab spring rise in sovereign risk premia for Arab government borrowers as well as more specific concern about Dubai Inc’s refinancing schedule for 2012. In the past, retail investors from the UAE/GCC offset offshore fund manager buying.

This is simply not the case now as retail trading volumes have plummeted at the same time as the captains and kings of EM fund management have vanished from the local bourses. On some days in December, average daily volumes was a mere 75 million AED on the DFM. In better times, legendary ex broker Manju (says “don’t confuse bull market with legendary”) would alone generate three times this amount in a single session.

It is facile to assume that the DFM shares are cheap at 0.85 dirhams or about half their value in early 2011. This assumption is erroneous as the indicator of a company’s “cheapness” is not its share price (note the fall in shares coincides with the rise in upscale shwarmas, making the share-shwarma equation anachronistic) but its multiple valuation metrics and fundamental catalysts.

The DFM’s shares are not cheap on any criteria I track, EPS for 2010 and 2011 was barely 0.1 a share. Let us assume it doubles to 2 fils in 2012. This means DFM still trades above 40 times earnings. This is far higher than the valuation metrics of all the other financial exchanges I trade, from the CME to Deutsche Borse, NASDAQ to Singapore’s SGX, Hong Kong’s HKEX, Borsa Malaysia and NYSE Euronext. Obviously, since EPS is so miniscule, ROE is not relevant.

The DFM share can drift lower, possibly somewhere near the 0.6 AED levels. The momentum and chart signals at present generate clear sell signals. What is needed to make a 100% profit on the shares, assuming the bottom is somewhere near the 0.6 – 0.65 AED levels? One, Dubai Inc. companies successfully refinances debt with creditors, a scenario I am bullish on. Two, foreign/local buying suddenly spikes daily trading volumes levels to the 400 – 500 million levels of spring 2010. Three, Emaar’s UAE deliveries and a possible Amlak consolidation generates earnings upgrades. Four, DFM generates 300 million or more in net income in 2012. It is darkest before dawn. Sometime in 2012, the DFM will regain its cachet. Stay tuned!

Macro Ideas – The bearish case for Brazil’s Bovespa index

Latin America is no EM safe haven in 2012 since it is exposed to lower commodities prices, a EU recession and a contraction in European bank lending and FDI (60% or more is from the EU). Meanwhile, Brazil’s high interest rates and economic slowdown means lower EPS growth, particularly among commodity exporters and banks who dominate the Bovespa index. It is impossible to be bullish about the Bovespa index at a time when the global macro zeitgeist is so unclear, though the index has fallen from its early 2001 highs and the Brasilia central bank is now is obvious monetary easing mode.

I simply cannot see the Bovespa rise above 70,000 without a strong bid from Vale, Petrobras and Banco Itau Unibanco, who dominate the index. This is even more true if the prices for iron ore, coffee, and above all, crude oil continue to fall, as I expect they will. President Dilma Rousseff does not have Lula’s political cachet and 3% GDP growth could well cause consumer credit shocks in the economy. Banks/financial, energy and mining shares are no less than 60% of the Bovespa, the reason for its fabled high beta mood swings.

The land of Samba, Pele, Gisele, Caipirinha and Ipanema Beach was not profitable for investors exposed to the Sao Paulo borse in 2011 since the Bovespa did squat and the real declined against the dollar. It is entirely possible that the Bovespa remains under pressure, possibly even falls as low as 46-48,000. If tail risks in the Europe or the Gulf escalate, the Bovespa can tank with a vengeance, as tail risks are more ominous when Brazil industrial production, retail sales and GDP growth rate plummets. In any case, the resurgence of the US dollar makes me skeptical about the Brazilian Real, which can well depreciate to 1.94 by April.

The Bovespa is a warrant on global growth and global growth is stalling. So while forward multiples at 9 times earnings are attractive, they are a classic value trap, though I notice some Bovespa shares are cheap relative to the sovereign debt and their equity risk premium is now near post-Lehman highs. Amazingly, Brazil trades at a huge discount to Mexico, Columbia and Chile, which command 15 – 17 times forward price/earnings ratios! Even tiny Peru in the Andes trades at 11 time forward earnings!

Strategy in Brazil? The Bovespa trades in a 46,000 – 65,000 trading range, meaning opportunity to short strangles. I would remain short the Brazil index fund (symbol EWZ) on any risk euphoria upticks. The real safe haven in such macro times is Brazil telecoms not exposed to global cyclical risk. The catalysts for Brazil rally next year? Euro risks abate and local inflation/interest rates fall while EPS growth is at least 10%. This could trigger trading rallies that take the Bovespa to 65,000.

Market View – A soft Yuan policy is inevitable in Beijing!

The Chinese yuan has risen 30 per cent since Beijing revalued its peg to the dollar in July 2005 and adopted a policy of managed appreciation. Chinese growth metrics since Deng Xiaoping initiated his epic, transformational “to get rich is glorious” economic experiment in Guandong’s Pearl River Delta has delivered decades of 10% GDP growth, lifted 600 billion peasants out of poverty, morphed the Middle Kingdom from an impoverished wasteland after Mao’s Cultural Revolution into a twenty first century financial superpower.

However, China’s “miracle decades” coincided with the post-Cold War, credit bubble world when political barriers to exports fell even as FDI and cross-border capital flows expanded on an exponential scale. However, the Western world will now retaliate against China’s mercantilist policies even as its exports, PMI, property prices, retail sales and GDP growth rate all fell at a time when inflation leads to social unrest, as demonstrated by the recent Wukan village revolt in Guandong province and earlier ethnic riots in Sinkiang. As the Hu Jintao and Wen Jiabao era enters its endgame. I am convinced we are at an inflection point for the Chinese yuan (RMB).

China’s trade surplus has fallen to only 2% of GDP while the high CPI (as state secret whose release can only be signed off the Premier Wen as chair of the State Council) means the real yuan is no longer undervalued, as FX reserves fall for the first time in 8 years. This means offshore hot money flows betting on the yuan’s inexorable rise now panic and scramble to close out their bets, the reason the Hong Kong NDF has fallen relative to Shanghai. This is the reason the Shanghai Composite and Hong Kong B shares/red chips have been gutted since September to post-Lehman lows.

Economics suggest the PBOC should engineer a gradual depreciation in the yuan. Yet this is not possible in an election year in Washington where trade protectionism is on the agenda of both the Democrats and Republicans. Mitt Romney has even threatened to refer China to the WTO for FX manipulation if elected to the White House. Yet as exports to the EU plummet and factories in the coastal provinces close, the State Council simply cannot allow the yuan to appreciate against the dollar.

The PBOC has warned the world that it will increase the yuan’s exchange rate “flexibility”. The smoke signals from the Beijing central bank will shake the financial world. The PBOC intends a policy U-turn and move to a “soft yuan” FX regime as PBOC intervention become sporadic. This means the yuan could easily depreciate to 6.8 as the Chinese trade surplus shrinks and the PBOC floor erodes even as hot money flees Shanghai and the CPI declines. Proxy yuan trade? The Singapore dollar declines to 1.34 – 1.36. The South Korean won is also a proxy short as Iran risk boosts Brent crude and the post Dear Leader Pyongyang risk premium rises.

Stock Pick – Swiss private banking and bank Julius Baer

Swiss private banking has witnessed a succession of game changer deals and shock events in the past month. Brazil’s Safra clan, not Julius Baer or Raffiesen, acquired Rabobank’s strategic stake in Bank Sarasin. UBS was shaken by another scandal in its NRI/India desk in London, as several private bankers colluded with a “mega-client” to evade Indian law via the creation of a Mauritius offshore trust designed to buy local shares. Credit Suisse integrated Clariden Leu into its fold and shed the lion logo that had once been the offshore bank for Mr. Diamond (Dennis Levine), Ernie Saunders and the Habsburg archdukes.

Meanwhile, the industry was shaken by UBS’s epic $780 million settlement with the US Justice Department, the discovery of Arab dictator offshore nest eggs in Helvetica, hostile German and French criminal investigation against systemic tax evasion and the new EU tax amnesties that will gut offshore AUM and juicy 150 basis offshore margins. La dolce vita, the sweet life, is gone in the Paradeplatz and the Rue de Rhone, nodal points of history’s most successful offshore banking hub.

Bank Julius Baer shares have surged more than 25% since its August low even though the macro zeitgeist for Swiss banking and European financials has been anything but benign. I was definitely impressed by the banks 3Q results. Net new money inflows at 6% is stellar at a time of US/German tax tensions with Switzerland, a testament to the bank’s emerging markets growth strategy. Metrics like costs, margins, headcounts, AUM indicate that EPS in 2012 could well be in the 2.7 to 2.9 Swiss franc range.

This means Bank Julius Bear is now trading at 13 times forward earnings. There is unquestionably momentum in the shares, even though they now trade near 2 times book value. At 32 – 34 Swiss francs, lower than current levels, the risk/reward calculus on Julius Baer becomes far more compelling.

Julius Baer, even though it did not acquire Sarasin, is in clear restructuring mode. Yet Switzerland’s largest, publicly traded private bank now incorporates a takeover bid premium since it has ended its dual share structure that gave the founding Baer family control. Swiss private banks hit by hostile international regulators, the erosion of banking secrecy, punitive tax agreements and fickle asset markets, have partnered with bigger parents. This was the logic of the Sarasin-Rabobank, Vontobel-Rafiessen deals in the first place. However, with more than a billion Swiss francs in excess capital, Julius Baer can easily be predator, not prey. I expect the bank’s shares to trade in a 32 – 46 CHF range in 2012. Swiss private banking is in a state of regulatory and strategic flux. There is no way new offices in Singapore, Dubai, Shanghai or Moscow can compensate for the erosion of offshore AUM and operating margins in Europe. Valuation multiple will only contract in such a milieu.
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Researched & compiled by Matein Khalid

What next for gold?

The $340 fall in the price of gold since September even as the Eurozone sovereign debt, banking and political crisis has escalated negates the goldbug’s safe haven argument. Any safe haven whose value falls by 20% in two weeks is obviously no safe haven at all, except for masochists and diehard Goldfingers in the gold souk.

The fact that gold has now fallen 20% from its peak and violated its 200 day moving average (as it did not in September) means it is now officially in a bear market. Moreover, the spike in gold’s correlation with emerging markets currencies only reinforces my skepticism about gold since the initial September sell off. In fact, I actually recommended shorting the shares of Freeport McMoran, a gold/copper producer listed on NYSE. Gold is now ominously correlated to the mood swings of the risk on/risk off herds in the daisy chains of global finance. The world’s ultimate safe haven, the Mommy of the capital markets, in Uncle Sam’s debt, even if it is no longer AAA to the rating agency Johnnys.

The sheer violence of gold’s fall is a testament to the fact that the yellow metal was the mother of all crowded trades on COMEX and margin calls amplified the dash for cash when the “animal spirits” of bullish hedge funds were gutted by the fear of credit Armageddon in Club Med. John Paulson, the hedge fund Midas who made $15 billion for his investors (and $2.7 billion for himself in history’s biggest paydirt since King Croesus!), has sold 34 tonnes of the gold index fund, a 2400 gorilla that holds more bullion in its vault than all but four of the world’s leading central banks.

The inexorable rise of three month dollar LIBOR amid funding stresses in the interbank market has forced Old World banks to lend their gold reserves to raise greenbacks. This is the reason gold lease rate have plunged. Europe’s banking colossi are in distress, as a rise in CDS and the Black Death in bank share values prove. John Pierpont Morgan (J.P. Morgan) was so right. Liquidity is like a cab on a rainy night in New York (or more aptly, Paris). It disappears when you need it the most.

I agree with my goldbug friends (from Davos to Doha to Deira, as it were!) that the secular case for gold is anchored in negative real interest rates, reserves demand from emerging markets central banks, the risk of a Club Med default and Super-Mario’s eventual resort to QE at the ECB. The World Gold Council estimates central banks will accumulate 430 tonnes to add to their gold reserves next year and the wealth bonanza in rural China makes the bullion rice bowl irresistible for the Han farmer, the planet’s largest human tribe. Yet I doubt if investors can ignore the obvious fact that dollars and US Treasury debt, not gold, are the new hedges against stock market crashes and Eurozone banking crises. Gold did squat when the monstrous North Korean dictator Kim Jong Il suddenly died in a geopolitical black swan event, with Seoul only 35 miles from the DMZ.

Global reserves are now $11 trillion and barely $1 trillion is in gold at a time when the Euro has lost its store of wealth allure. Yet history cautions me. The breakup of Bretton Woods, the ERM, the defaults of Brazil and Argentina, the failure of the Florentine Renaissance. Medici Bank and Lehman Brothers in 2008 meant the Black Death in interbank lending and epic liquidity squeezes. The endgame for the Eurozone, ipso facto, means a $500 fall in gold. Mao shot gold hoarders. Lenin wanted gold to pave capitalist latrines. De Gaulle branded gold a barbaric relic. But I only want to short the gold ETF every time its spikes to its 200 day moving averages!
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Researched & compiled by Matein Khalid

Market View – The bearish case for silver & Treasury notes
January 2012

While my call to short silver in this column in April near its parabolic climax at $48 proved profitable, I am still skeptical about its prospects now that it has fallen to $30. Naturally, fear and loathing in gold and margin calls on COMEX has provided the ballast for the latest silver shock. As an industrial metal, the white metal is not exactly the metal flavour de jour on the eve of a global economic slowdown. Silver fell 7% in a single session in mid December so it cannot remotely be relied upon as a “safe haven” asset. Moreover, the plunge since the $50 April high has triggered massive speculative losses and changed the trading behavior of the silver market, a vivid example of George Soros’s theory of reflexivity.

Silver has violated long term bullish trend line in the charts and the proverbial silver bulls, the heirs to the Texan Hunt brothers, have been painfully divested from their “animal spirits”. After all, silver plunged to $8 in the global credit seizure after Lehman Brother’s failure and the onset of recession in the twilight months of 2008. Why should another European sovereign debt/banking shock and a dollar spike not trigger a silver bottom to $18-22 in 2012? Thinking the unthinkable is not mere cerebral frolic in the world of precious metal trading but a lifeline for investors in silver. So while I do not claim $18 silver is inevitable, it is definitely not unthinkable.

The 10 year US Treasury note yield has plunged from 3.78% in early 2011 to as low as a recent 1.8% despite the US sovereign credit downgrade and the dysfunctional budget politics of Washington DC. Uncle Sam’s long duration IOU’s are now the world’s ultimate safe haven asset class as gold, German Bunds and the Swiss franc, have proved sad sacks. Yet there is a scenario that could lead to a bloodbath in the Treasury bond market whose probability, I contend, is non-trivial.

What if US economic data improves as payrolls, retail sales, capex and house prices rise? What if Berlin decides it cannot allow the 50 year dream of Monnet and Schuman to die in the debt firestorm of Athens, Lisbon, Rome and Paris? What if China manages a soft landing with 9% GDP growth and no banking crisis in the Middle Kingdom? The world is so surreal now, nowhere more so than the Treasury bond market.

The yield on the ten year note is down 120 basis points since the S&P500 downgrade of Uncle Sam’s AAA debt. The world’s hot, smart and dumb money is up the wazoo long bonds. Yet the Bernanke Fed’s pledge to continue 0 – 0.25% rates is conditional on soft growth and minimal inflation risk. Take out these conditions and the ultimate pain trade in debt becomes all too possible. If T-bond yields rise to 3.5% or, horror of horrors, 4.5%, the inverse long duration Treasury debt ultrashort fund (symbol TLT) could soar triple from its current 17-18 level. Yes, triple to 50-54. Will it? Quien sabe? Time will tell, as always!

Macro Idea – Short Zynga and Brent, long Citigroup!

I had advised my readers not to buy the Zynga IPO as its business model (churn rate, revenue monetization, new games cannibalization, dependence on Facebook, serial acquisitions, Mark Pincus’s CEO for Life voting shares) and its valuation made no sense to me. This call was vindicated by Zynga’s (symbol ZNGA) failed IPO. The shares fell to $9.50, below the $10 IPO offer price. I believe Zynga is still obscenely overvalued and can well fall to $7 or even lower. This is a classic twenty first century dot.com/social gaming bubble and has no business trading at $7 billion or 7 times revenue. Zynga dominates social gaming and Kleiner/Avalon/Foundry do not plan to sell their stakes so $7 could well be a floor for now. Yet it is crazy to value Zynga more than four times the value of Electronic Arts, no matter who makes the apples-oranges argument. As I remember from the offplan flipping times, we wuz born at night but we wuz sure not born last night. Mark my words. This puppy (Zynga IPO) is bad news and headed south on NASDAQ.

In life, as in markets, it is easy to trade consensus and meekly accept conventional wisdom. Yet this sort of intellectual flabbiness violates my contrarian DNA. This is not to argue that contrarian positions alone create value. After all, as Dr. Kissinger observed, even paranoiacs have real enemies. Take Citicorp (OK, Citigroup). The shares were savaged by Chuck Prince’s failed mother of all subprime/CDO bets, a Sophoclean tragedy that has taken the shares down from, a pre- split price of 520 in 2007 to 27 now. George Soros is so right when he says the big money is made when things go from Godawful to just plain awful. Gulf sovereign wealth funds lost tens of billions bottom fishing on the Citi that never sleeps (neither do its shareholders!).

Citi’s fall from grace has been tragic and there is no shortage of bearish news – the Fed stress tests, exposure to Club Med sovereign debt, Dodd Frank, Volcker Rule, the rise in bank funding costs, a flattish yield curve, sluggish capital markets new issue trading/underwriting, China’s hard landing risk. But Citi trades at a 50% discount to its tangible book value at $50 while Basle Tier One Capital is almost 12%. Voila, as the poet Saadi lamented, it is always darkest before dawn, as it was usually was during the Mongol invasion of pre-Safavid Persia. Vikram Pandit has repositioned Citi as an emerging markets bank, 2012 consensus EPS could be $4.30 and the Citi Holdings run rate can well accelerate. A double bagger in Citi in 2012? Why not? Yet Citi’s gross exposure to Europe, the epicenter of credit Armageddon, is $20 billion. The $4.20 EPS could be slashed down to $2 and the shares fall 50% Caveat Emptor.

I seriously believe a major fall in Brent is possible in 2012. If Libya and Iraq production surges while OPEC pumps 31 MBD, Riyadh pumps 10 MBD and global fuel oil demand falls even as the dollar spikes, Brent can plummet to $65. No typo here, amigos. A 40% hit in black gold. Iran? Sure, but oil prices fell to $7 while Iraq and Iran traded Scud ballistic missiles, battled in the streets of Khorramshahr and Fao , bombed tankers in the Gulf in the 1980’s. Yemen and Syria export miniscule high sulpher oil or LNG. The post-Khomeini era could see a US-Tehran rapprochement. Short Brent. Watch Pakistan and Hungary’s CDS creep above 800 basis points. A EM massacre is imminent in Budapest.

GCC Focus – The bullish case for Omantel

Oman’s MSM index has lagged the GCC, a compelling reason for me to once again cross the Hajar Mountains with securities traders and Excel cowboys in tow. I believe Omantel has money making potential in 2012, thanks to its lovely dividend yield, free cash flow and the broadband ballast in its revenue model, particularly as it gains mobile market share while new networks/product offering. There are few other places in the world where I have an iron clad guarantee of 8.5% dividend yield but this is entirely possible in the Sultanate’s incumbent telco Omantel. I expect EPS estimates are way too modest, fund manager positioning is entirely underweight and allocation of more 3G spectrum/licensing of mobile LTE is entirely possible.

However, I am unequivocally interested in Omantel if its shares fall below OR 1.20. As I believe Brent crude oil is due for at least a $20 fall in 2012, it is entirely possible that I might be able buy Omantel at 1.14-1.20 Omani riyal, particularly as government spending boosts liquidity in the economy and higher bank loan growth seep into the MSM. Oman’s stock market was the GCC Cinderella in 2011. However, sometime in 2012, I expect Oman to be the GCC’s premier market as Cinderella eventually goes to the fairy tale ball.

Saudi Telecom’s multiple catalysts include acquisitions in MENA at bargain basement prices and the listing of Viva on the Kuwaiti stock exchange. STC has a 28% stake in Viva and a successful floatation could set a precedent for some of its Southeast Asian telecom assets. STC is primarily a dividend play at 7.5% and its shares offer value anywhere in the 25-28 SR range for a 35 target. True, STC 3Q was a horror, with an annual decline of 53% in earnings due to a $230 million forex loss and a $30 million government mandated provision. Yet STC shares have plummeted since the earnings report and now offer deep value metrics. Obviously, the FX loss was due to Oger Telecom’s exposure to the South African rand and the Turkish lira, both victims of a higher dollar, having lost 20-28% of their value.

Etisalat 3Q proves quite clearly that the UAE telecom market is hyper-competitive/saturated while its franchises in Nigeria, India, Pakistan, Egypt and Sudan are in some of the most risky and unstable emerging markets in the world. Political unrest, recessions, devaluations and wars in MENA, Africa and South Asia are clearly negative for Etisalat’s bottom line, EPS growth and margins. The legal issues against Etisalat’s Indian subsidiary is also a negative overhang against the share. There simply is no compelling strategic or valuation catalyst to buy Etisalat shares at current levels.

Saudi Arabia’s Mobily is a play on the broadband revolution in the kingdom (smartphone/tablets definitely helped by youthful Saudi demographics) and its potential rising market share metric. Besides, unlike STC, Mobily does not have emerging markets FX risk! Zain is restructuring and it is impossible to calculate its franchise value for now.

Stock Pick- The biggest losers in Emerging Markets in 2012

Emerging markets had an annus horribilis in 2011, grossly underperforming the S&P500 or even MSCI World. While Arab states afflicted with political convulsions like Egypt lost half their value, even Brazil, India, Turkey, Russia, South Africa and China lost 20 – 30%. To add insult to injury, once favourite high yield EM currencies like the Indian rupee, Turkish lira, South African rand and Brazilian real were all the losers in global FX. What were the common themes behind the emerging markets Black Death?

One, capital outflows amid global risk aversion due to the protracted Eurozone sovereign debt crisis. Two, excessive monetary tightening to combat inflation by key central banks (RBI, PBOC, Banco do Brazil, RBSA, etc). Three, higher dollar and fall in commodities prices. Four, a steep fall in export growth and industrial production. Five, unsettled political unrest that ranged from the Wukan village revolt in China, the Arab (and now Russian spring), the telecom scandals in India. Six, exodus of international bank funding from Eastern Europe and the Arab world.

It is easier for me to predict the losers than the winners in the EM sweepstakes for 2012. Hungary exports almost half its GDP to a Eurozone on the brink of recession, the political elite in Budapest have lost investor credibility and forint devaluation is inevitable. Poland and the Czech Republic’s currencies and stock markets will also be collateral damage victims of a Hungarian devaluation, even though Prague and Warsaw are also major exporters to the EU. This will happen even as Austrian, Italian, French and German banks slash credit line to Eastern Europe, making them loser numero unos in EM. Classic shorts, in my view.

My second bearish bet is India, though the easy money has been made on both short Sensex, short ICICI New York ADR and short rupee positions since October 2010. As India’s economic growth rate plunges, earnings estimates on Sensex and the index valuation will both move lower. I expect EPS for Sensex at 1200 rupee and 11 times earnings or 13000 Sensex as a target.

China and Brazil demonstrate that EM “decoupling” arguments are fantasies, that Shanghai and Sao Paulo are both leveraged to the global growth cycle via exports and commodities prices even while “open economies” like Singapore, Taiwan and South Korea suffer from the contraction in world trade.

Ironically, the winners in 2011 were smaller EM’s that dance to the beat of their own liquidity and macro drummers- Venezuela, Mongolia, Pakistan, Malaysia, Philippines, Thailand.

I am not sanguine about EM in early 2012 as growth will simply not stabilize, let alone accelerate, in BRIC as the Eurozone slowdown begins. Note that Shanghai fell below 2170 the same day Chicago VIX was 21 and Russia trades at six times earnings with $108 Brent and Iran war games on the Straits of Hormuz. I would short Budapest, Prague and Warsaw against the broad EEM index fund and remain short India, long Thailand and the Philippines. South Korea’s Kospi is yummy anywhere below 1750.
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Researched & compiled by Matein Khalid

Re-instated short Euro position at 1.2940