FX CONCEPTS FX CONCEPTS

GLOBAL MACRO RESEARCH GLOBAL MACRO RESEARCH

CURRENCIES INTEREST RATES EQUITIES COMMODITIES
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com


MARKET INSIGHT REPORT
High Poker Stakes
By John R Taylor, Jr.
Chief Investment Officer

Mario Draghi seems to be on the verge of some unorthodox moves later today, even if it
is only to set the deposit rate below zero for the first time. In todays world, this will bring
all five of the largest central banks into this poker game. No matter how much this
seems routine to us as we still work at the same financial institutions for the same hours,
commute the same way, and have vacations too, this is not routine. It is anything but
routine. In the hundreds of collective years that these banks have operated none of
them have done what each one of them is doing today and is expected to do into the
near future. Even looking at the situation in a very positive light, the stimulus that these
banks have put into the market has done very little to add to local industrial production,
capital expenditure, or, most important, economic well-being. The average employee in
each of these countries has not seen his pay climb in a real sense for many years and in
some cases that average individual no longer has a job. Productivity improvement
through capital investment and education as well as hours worked by a growing
population are the inputs that lead to healthy growth, but in Europe and Japan both of
these factors are missing, and in the US and Britain only the capital investment and
improvement in productivity factor is lacking. Although central banks and politicians are
certain these positives are just around the corner, the same forecasts have now been
made for the past five years. Now we welcome the Eurozone, through their only Chief
Executive, Mario Draghi, tacitly admitting there will be no growth, no just below 2%
inflation target without some further legerdemain.

By moving the deposit rate below zero, it will cost the banks to keep their euros sitting
safely within the ECB. Although the number that will be subject to this is less than !150
billion there is a possibility the Swiss National Bank will have to follow suit forcing
another !250 billion plus into a cost and revenue-less center from the bankers point of
view. As the Swiss amount is something around 50% of the Swiss GDP, this is serious
money that must be put to work even if that work yields no return as anything is better
than taking that loss. The central bankers idea is to get the bankers to use those euros
and Swissies productively, financing home construction, new investments in plant or
equipment, and things like that. But these loans or investments are not being made
today because of real risks within the banking system and in the borrowers themselves.
After five years, we should see there are few investments any bank will make. At its
best, the top tier of international companies can borrow from the global capital market
and buy each other not start new projects, but buy a competitor or expand the
business-line by buying it in. This process of consolidation does yield productivity
increases, but only by firing labor and doing with fewer people as the consolidation
allows it. If the new homeless money further stimulates the merger and acquisition
business that is of no benefit, but quite possibly this footloose money will go into cross
currency transactions, hedged back safely with derivatives not maturing and turning
into cash for years that will finance the emerging world, the places with a growing
population, lower costs and export markets in the very countries that will be lending them
the money. This process follows the historical precedents first in the early 1990s and
then in the middle 2000s that led to commodity inflation, overbuilding and over-
investment in export facilities, resulting in deflation in the developed world. Once again
the workers of Europe and North America will see their wages driven lower and the
decline in living standards continue. Seems like a losing hand to us.
FX CONCEPTS FX CONCEPTS
GLOBAL MACRO RESEARCH GLOBAL MACRO RESEARCH
CURRENCIES INTEREST RATES EQUITIES COMMODITIES
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com


CURRENCY Commodity Currencies Long-Term View

Battered Beauties
By John R. Taylor, Jr.
_____________________________________________________________________________
Way back in the months between January
and April 2011, many commodities made
cyclical highs, in some cases these peaks
were above the highs seen in 2008 and in
almost all cases approached those highs.
Prominent among these commodities were
the industrial metals. For the countries
producing and exporting these metals, the
sharp price drop seen in 2008 was little
more than a passing nightmare that was
forgotten with the rising economic tide in the
second half of 2009 and 2010. In some
cases exporting countries like Russia, South
Africa, Chile, and Mexico saw their
currencies move back toward the highs in
early 2008, and others like Indonesia, Brazil, Peru and Australia actually surpassed the
highs of early 2008. This very major peak was followed by a decline in prices and in
volatility that did not end until early this year. Some of the major industrial metals,
whether traded on exchanges or not, had declined by very significant amounts, and by
the first quarter of this year the currencies of the countries that produced and exported
these metals were significantly lower as well. As the year 2013 progressed, the
expectation grew that China would suffer a slowdown and these metals as well as gold
would all decline further through the present year. What we can see now is that some
if not all of these fears were overblown and the exports and prices in these markets
would hold up well and even move up through the current quarter. Some of these
commodities are reaching highs for the year.

The chart on the right shows the Chilean peso and the Australian dollar, together with
the UBS Industrial Metals Index that shows a composite of the prices paid for many
different industrial metals on a daily basis. As an index, it eliminates almost all of the
individual market anomalies that often appear in the commodity space. This index shows
three highs to the left and there would be a fourth one at the end of April 2011, and all
three of the highs, plus the fourth, tend to generate a significant low at the end of the first
quarter of this year. Even if the global economy fails to show much grow in the months
ahead, the convergence of these cycles almost assures that prices will rally somewhat
over the next few months. The first high we would expect is in the month of August, with
a second very likely in the first half of October. If the global economy grows,
therefore tightening supply lines and prices for these metals, the next peak should
be at the end of the year or early in Q1 2015. This would coincide with an inflation
peak and a scramble to buy currencies like Chile and Australia once again.

Recently we have covered both the Australian dollar, Aussie Has Few Friends, but That
Will Change (June 2) and the Chilean peso, Chile a Microcosm of the Emerging
Situation (June 3), as well as the industrial metals, Industrial-sized Gains Ahead (June
4). In every case we were on the bull side as we have been with copper and the equity
markets as well in every case, we are talking about the next few months.