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Asia: Bonds, Capital Flows, And Consequences.
Oil & Commodities: Chinese Government In Potential Copper Debacle. Stocks: Mining Stocks In Focus.

by Dr Joe Duarte

Traders will be watching for earnings, and keeping an eye on the weather as well as gold, metal, and mining stocks.

Asia: Bonds, Capital Flows, And Consequences.

There is a big change coming in Asia. China has lots of money looking for a home. Asian companies are looking to sell debt. And Wall Street is salivating. And while at first blush, this is a rosy scenario, there are signs of a very bad ending as a potential finale to the story, which might present Mr. Bernanke, the apparent heir to the Greenspan throne at the Federal Reserve, with his first opportunity to lower interest rates in response to a global financial crisis.

China is about to become a maelstrom of activity as domestic money is set to make aggressive forays into overseas investments, even as Foreign Direct Investment into China continues to grow. The dynamic is creating a potentially lucrative situation for currency traders, and middlemen, including those on Wall Street whose stocks are starting to show signs of a big momentum run.

Further out is the expected aggressive expansion of Asian corporate bond markets. With Chinese financial service companies looking for places to put their money, and with countries in the region opening their arms to foreign capital, the situation could become an amazing new arena for global capital flows.

According to the Financial Times: “Beijing is accelerating longstanding plans to allow local institutions to invest overseas, a move that could begin to unlock a portion of the billions of dollars of foreign currency now mostly sitting in low-return Chinese bank deposits. The government departments with responsibility for handling the issue have agreed to submit a scheme for overseas portfolio investment to the central government for approval, according to market commentators and reports in the local media. The scheme, known in China as the Qualified Domestic Institutional Investor (QDII) program, would allow Chinese mutual funds and perhaps also companies to invest their foreign currency holdings abroad.”

There is no known timetable, yet, as there are jurisdictional and logistical issues to overcome, along with the usual turf wars associated with big changes. Still, some are saying that a “pilot scheme” could start in early 2006. Indeed, according to the Financial Times:

“The scheme has been held up by the central government's concern about the ability of institutions to properly manage risk in investing overseas, as well as by disagreements between agencies over the issue. Agencies clustered around the central bank have generally supported QDII, which they think will diversify Chinese investment products and ease the impact of large capital inflows into China, whereas stock market regulators fear any outflow could harm local share prices.”

There are hints of some movement already, as

“China has already begun experiments with a form of QDII by allowing its large insurance companies to keep money raised in overseas initial public offerings offshore. Ping An has approval to invest $1.75bn in foreign markets, while China Life and PICC, two other overseas-listed companies, have applied for similar permission. But the lead in investing money directly from China is likely to be taken by Hua'an Fund Management, based in Shanghai.“

The financial times reported that some fund managers in Shanghai have

“said the firm had already begun preparations for a foreign-currency overseas fund. Once the scheme has been established, the authorities may extend it to allow ordinary renminbi savings to be invested overseas through mutual funds.”

A New Bond Market

The global bond markets could be in for a shocker, as $1 trillion, from Asian countries, that has made its way from Asia to the U.S. Treasury bond market, could find a new home in Asia, including money from China, which will be looking for a new investment home, and might find markets closer to home more appealing.

According to Bloomberg, Asia’s “underdeveloped bond markets leave economies hypersensitive to interest rate moves, credit crunches and currency volatility.” And while some progress has been made “in the government bond markets, there is work to do in the field of Asian corporate bonds.”

But, that is about to change, as “Wall Street luminaries funnel into Hong Kong this week,“ with the goal being the serving of notice that “Asia's debt markets are getting ready to take on the world.

According to Bloomberg’s William Pesek Jr., a credible journalist,

“Asia is the new frontier of capitalism, boasting rapid growth, swelling populations, undervalued stocks and droves of companies that have yet to issue debt. It is no wonder that bond firms are clamoring for a piece of the pie. The search for the next big debt investment is drawing a who's who of Wall Street to Hong Kong. Between schmoozing sessions among underwriters, borrowers and investors, participants will attend panel discussions with titles like "Investor Requirements for Debt Markets in Asia" and "Asian Securitization Markets: Identifying Barriers to Growth."

Much of that, in our opinion is hype. As Pesek clearly points out

“Obstacles to deeper markets in Asia are many. They include the small size of public markets that can be used as benchmarks for pricing debt, and a reluctance to follow international accounting standards. Corruption and unreliable regulation do not help. Neither does a legacy of restraints on capital flows, on government bonds, like the one that exists in the United States. Development of corporate markets has been far less substantial."

Is There A Dark Secret?

There are some major issues to note with this proposed expansion in Asian corporate bond markets: According to the Shanghai Daily.com:

“Unlike what the US supposes, the main reasons for the Chinese tendency to save are the limitation of purchasing power caused by an imbalance in income distribution and the lack of effective social security rather than any inconvenience in obtaining financing. Instead of solving the problem, any freeing up of finance may even sharpen the problem of the imbalance in income distribution. The reason is that foreign enterprises in China tend to avoid their social responsibilities while concentrating on doing highly profitable business. When it comes to individual financing services, high-income groups would naturally be the target with the medium and low income groups being neglected. What's more, the US also aims to lower the savings rate of China's corporate sector by facilitating corporate financing. But the fact is that just like other East Asian countries, China's liability ratio in the corporate sector is much higher than that of Europe or the US.”

The Financial Times notes that

“The health of the local stock market, which has languished for years, remains a lingering concern in any extension of QDII. A fund manager with Southern Securities, who asked not to be named, said QDII would have little impact to begin with as it would be restricted to foreign currency. But as fund management companies account for over 40 per cent of the capital floating locally, the launch of QDII will prompt a lot of money to swarm overseas. So, in the long run, the liquidity of domestic markets will get further squeezed because there are more profitable investments to be made overseas."

Conclusion: The Capital Vacuum

Wall Street and Europe are rushing into Asia, with the feeling that China’s banking markets are the highest prize on the face of the earth, as international banking giants are expecting a flood of deposits to move from domestic Chinese banks, and their low deposit rates.

A direct extension of that concept is now the move into Asian corporate markets, with the expectation being of large underwriting fees.

Here is where the whole thing unravels.

While Wall Street is moving into China with both feet, China is getting ready to allow its own money to leave the country. This is mostly government money, disguised as corporate capital, since most major companies in China are still state controlled.

That money is flowing out of China makes little sense, unless of course, you look at it from the Chinese point of view. If you know that your boat is leaking, and somebody is willing to buy it, leaks and all, then why not sell it to them. If there is a bidding war for a leaky boat, then so much the better.

The fact is that in 2006, a whole lot is going to happen in China, when the WTO deal calls for an opening of the Chinese banking sector. The premise pushing international financial companies into China is that Chinese depositors will flock to U.S. and international banks looking for higher interest rates. This is an assumption based on the Western perception that all money behaves similarly.

But, if we are to believe the Shanghai Daily:

“the main reasons for the Chinese tendency to save are the limitation of purchasing power caused by an imbalance in income distribution and the lack of effective social security rather than any inconvenience in obtaining financing. Instead of solving the problem, any freeing up of finance may even sharpen the problem of the imbalance in income distribution.”

In other words, China’s people are saving their money for a rainy day, and are not necessarily likely to want to do anything with it, other than save. There isn’t that much money for banks in savings accounts, even if there is a big move into foreign banks. Their big fees are for mortgages, closing costs, and business loans.

In essence, here is the dynamic. The Chinese government is looking to move its money offshore, just as the Chinese public moves its money out of the Chinese state banking system.

That means that China’s unleashing of their big money onto the global stage is not in response to globalization, but an escape, given the potential for a domestic banking disaster.

In this case, the smart money, China’s government’s money, and the money of its upper echelon of politicians and corporate big shots, nicely converted to foreign currency, and disguised as insurance company and mutual fund money, is getting out while the getting’s good, with the government‘s blessing and in accordance to law. And the Wall Street and European investment banks, might just be left holding the bag.

Already you can see the move into dollars, as higher interest rates in the U.S. are attractive.

Oil And Commodity Summary: Chinese Government In Potential Copper Debacle.

Oil, natural gas, gasoline and heating oil prices might have made a trading bottom, as December crude oil futures closed below their 200 day moving average on 11-10, and slipped further on 11-11.

Despite rising energy supplies, cold weather may be right around the corner, and energy prices could be in for a seasonal rally.

The copper market may be in for a shock, as a familiar story may be starting to unfold. And yes, you guessed it. It involves commodities, and yes, it involves China.

According to Dow Jones Newswires:

“A Chinese government copper trader, who is said to have built a big short position on the London Metal Exchange, has inexplicably ended contact with other dealers in both London and in China, people who have worked with the trader said. Liu Qibing, who worked for China's State Reserve Bureau, took short copper positions that some London dealers said amounted to between 100,000 and 200,000 tons. The traders said the SRB would find it difficult to deliver the amounts of copper traded by what they said was a deadline of Dec. 21."

The news service reported that Mr. Liu has been missing for weeks, and that have may have been removed from his job. The Chinese government is even denying that there is such a person. According to Dow Jones

“The mystery surrounding Mr. Liu's whereabouts is provoking widespread speculation among metals traders in London, the U.S., and China about the size of the short position and its potential cost to the Chinese government. The speculation is that the SRB will have to scramble to meet the LME's requirement that the physical metal be delivered to approved LME warehouses. Some people who watch the copper market say they have seen more Chinese deliveries to Asian warehouses in recent weeks. Compounding the confusion surrounding Mr. Liu, the SRB denies it has an employee with that name. Though London metal traders have Mr. Liu's business card, Wang Huimin, director of the SRB's Materials Management Center, denied knowledge of such a trader or of a London short copper position. ["I've never heard of this person," he said. "Neither have I ever heard anything about the SRB selling short in London. I'm not clear if he is our staff. The SRB has no traders."]

The bottom line is that we could be reliving the China Aviation Oil Singapore situation, where a Chinese entity makes a bet against a market, and the market goes against the big bet, leading to two outcomes. The Chinese government publicly denies that they had anything to do with the disaster. People on the other side of the trade lose money. But, somehow, it all goes away quietly.

And it’s already looking similar. According to Dow Jones:

“Traders in London, Beijing, New York and Shanghai said Mr. Liu went short by 100,000 to 200,000 tons, mostly against the December date, betting the price was ready to fall. But as copper prices continued to rise toward $4,000 a ton, potential losses grew and Mr. Liu was removed from his job, said people familiar with the market. Like all companies, the SRB likely would have used several brokers to handle its orders, a strategy that makes it difficult to independently assess the extent of its short positions or potential losses. If the SRB fails to meet its obligations under LME rules, its counterparties could face a financial loss.”

How big are the potential losses?

“Traders in London and New York say SRB losses could be in the hundreds of millions of dollars. Such a loss would be the largest on the LME since Sumitomo lost an estimated $2.6 billion in 1996. Even if the SRB has the copper, a big short position on the LME could be a problem. The reason is the LME requires delivery to go only to specific warehouses around the world, none of which are in China.”

Much worse is the thought that even if China owns up to the trade, their stores of copper may not be of high enough quality to meet the requirements of delivery.

“The SRB traditionally builds a strategic reserve of copper, although its size is a state secret. Estimates range from 100,000 to 500,000 tons, but many believe the strategic reserve is around 200,000 to 250,000 tons. If Mr. Liu took short positions requiring delivery of as much as 200,000 tons, much of the estimated reserve would be depleted. People in China who follow the market said some of the SRB reserve dates to the early 1990s, raising questions about whether its quality would be acceptable to the LME.”

The Philadelphia Oil Service Index (OSX) was showing signs of life last week, but continues to have trouble making new highs. OSX had a very negative chart reversal on November 4th, and could fall further.

Chart Courtesy of StockCharts.com

The Amex Oil Index (XOI) is still struggling near the 1000 area.

Technical Summary:

Chart Courtesy of StockCharts.com

Nasdaq Showing Some Muscle. Metal Stocks Could Rally.

Watch the mining stocks, both for gold and industrial metals, as they look ready to rally. It is possible that the rally in metals, if it does materialize, could be related to the news of the potential Chinese copper problem, described in our commodity section.

We continue to like this market, but remain concerned about external events derailing the current rally. At the top of our potential problem list is the weather. Stocks have picked up steam as oil prices have dropped. But, as we discuss in our oil summary, below, if there is a major arctic blast, natural gas and heating oil prices are likely to move higher. If and when that happens, we will have to see if the stock market rally can last.

For now, things look fairly stout. The Nasdaq 100 made a new high on Friday, and is leading the market higher. Breadth and volume are improving significantly, and the number of stocks making new highs on the Nasdaq Composite is outperforming the same measure on the NYSE, a sign that money is moving back into technology.

The advance in the overall market, though, looks to be gathering, a seasonal tendency in the stock market for the months of November, December, and January.

There are still other signs that this rally has legs, as all the major indexes are now above key bull market support levels. The Nasdaq 100 is near a major break out and the Nasdaq Composite remained nicely above its 200 day line, along with the small stocks.

For now, we trade with the trend, but we remain cautious.

Alternative Markets On The Rise And Fall

The dollar made a new high on 11-10, and gave back some gains on 11-11.

Gold remains volatile and range bound.

Oil prices fell below key long term support on 11-10, and fell further on 11-11. Natural gas is trying to form a base, though.

What To Do Now

The trend is up. There is particular strength in biotech and health related stocks, as in the financial and transportation sectors.

Keep your options open, and continue cautiously build positions into stocks on your lists.

Chart Courtesy of StockCharts.com

A Little Froth Appeared Friday.

Market Sentiment got a bit ahead of itself on Friday. We would expect the market to be a bit more tentative this week, and to be more vulnerable to external events.

The CBOE Put/Call ratio checked in at 0.68 on 11-11. That is way off the 1.31 on 10-13. A consistent string of low readings can be a sign of excessive optimism and often signals a top in the markets. Readings below 0.5 are of concern, but not as serious as readings below 0.40. Readings above 1.0 are bullish. The numbers cited here are meant to be evaluated on a closing basis.

The CBOE P/C ratio for indexes fell to 1.03. The current rally was preceded by readings of 2.26 on 10-13, but still below the 3.28, on 9-26. This was close to the 3.89 on 9-22. The index number rose to 3.01, on 9-2, a rare figure that preceded a rally in stocks. Readings below 0.9 suggest too much bullish sentiment, just as readings above 2 are usually required to mark major bottoms.

The VIX and VXN had readings of 11.63 and 14.21 on 11-11, both holding steady. When these indexes begin to rise, it is a sign of concern as rising volatility indexes suggest that an acceleration of the prevalent trend is on its way. A fall near or below 20 on VIX and 30-40 on VXN is considered negative, a fact that is usually confirmed when the volatility indexes begin to rise. Readings above 40 and 50, respectively, are often signs that a bottom may be close to developing.

The futures traders polled by Market Vane registered a 63% Bullish consensus. This number is now neutral.

Our Big Trend Model rose to 45% after its bullish reading of 10%, on 10-21, an extremely oversold level and very bullish level. The index had a very accurate oversold reading of 12.5, delivered on 4-29-05, a correct call on that trading bottom. Readings near or below 40% often precede market bounces, but may initially be signs of caution when markets have had a rally. Readings above 80% are usually bearish. The Big Trend Model is composed of technical and monetary indicators and updates automatically on a weekly basis.

The NYSE insiders sold stocks aggressively on 10-28, for the second straight week after a six week buying binge. We‘ll be watching this carefully. Short selling by NYSE specialists remains near all time lows by historical standards, since we‘ve been keeping this indicator. This indicator is very positive when short selling by the specialists is low as the same time that they are net buyers of stock. The heavy amount of selling over the last few months has turned this indicator neutral. This is a set of very smart investors, and when they turn positive or negative, it is just a matter of time before the market follows. Spec data is released to the public with a two week lag, so is not useful as a market timing tool, but is excellent background and confirmatory information.

Market Moves

The Amex Biotech Index (BTK) closed above 660, a key chart point, continuing to act well.

The Amex Pharmaceuticals Index (DRG) is still struggling. The index made a new low last week. At some point, these companies will start to look cheap.

The Philadelphia Semiconductor Index (SOX) moved higher on 11-10, closing above 460 with major resistance at 485.

Small stocks continued to move higher. This is the start of a very positive season for the small stocks.

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The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx