An update on the repeat theme of 2010 in 2012: A bearish view

In the article of 2012 is going to repeat 2010 dated Sep 14 2012, I set out the repeat theme for risks in the rest of the year.

Nearly two months on, the repeat theme has played out nicely with Hang Seng rising from there to the peak by around 10%. For those who made money out of this rise, it should be the time to re-evaluate whether or not it is still justified to hold on with the risks.

The election in the US yesterday was clear a bad sign with Democrats claiming the President and Senate while the Republicans got the lower house. This unchanged setting basically tells us that NO way we will have a full resolution in fiscal cliff on time.  The best case is muddling through with some sorts of half year extension in tax cut.

I am turning bearish here with the fact that uncertainties in the market are growing. Today we have the national congress in China, but my real concern is still in Europe. 

After the US presidential election on the 6^th, the National Congress in China on the 8^{th (}Today), the market will face the Eurozone finance ministers meeting on the 12^th and the Catalonian parliamentary election in Spain on the 25^th.

The Greek Prime Minister Antonis Samaras said that his government would run out of cash on the 16^th of this month if the Eurozone finance ministers couldn’t make the decision to release another tranche of aid during their meeting. The case for Greece has always been a game of brinkmanship and it may actually turn out to be fine. However, the market will need to deal with another European country further down the road. Catalonia, the autonomous community of Spain which has been trying to gain independence, will have the regional parliamentary election. The victory of any anti-Spain party would cast doubt on the fourth largest economy of the Eurozone. 

The updated chart from the repeat theme on Hang Seng hinting a peak in November looks scary too, doesn't it?

Source: Reuters, click to enlarge 

Now, having sold out all Hong Kong stocks , I would go long 2-month ATM call (costs around 2.2%)  and sell 2-month future on Hang Seng Index. The long ATM call is basically a "down side protection" to my bearishness here. And my break-even point would be any 2.2% drop in the index.

The real risks to this short-biased view is that new Chinese leaders after today, namely Xi and Li, somehow feel the the urge to do something to boost the economy. 

But the upside is that if there is no stimulus after the 18th National Congress, what the market has been expecting, building into the price in the past 2 months seems groundless and reversal is due to come.

When will the music stop?

Under QE3, it will take 44 months to create the same liquidity as QE1 did and 15 months as QE2...

What about the impact on asset prices? Pick the number you like....

Source: The Federal Reserve, click to enlarge 

2012 is going to repeat 2010

After the ECB and the Fed both rolled out their own bazooka, all bears, myself included, should have surrendered.

Without digging into details too much, the rest of 2012 is going to be a repeat of 2010 - a policy-induced bull market. Here are quite a few self - explanatory charts:

Source: Reuters, click to enlarge 

Source: Reuters, click to enlarge 

Source: Reuters, click to enlarge 

Let's enjoy the rally while it lasts. If 2012 turns out to repeat 2010, then 2013 is going to be a repeat of 2011, if not 2008...

I will illustrate further here the headwinds facing the market next year both in the US and Europe as we head toward the end of this rally.

The ECB’s bazooka/ Gold rising on misunderstood fundamentals

Basically all assets were buoyed by the ECB’s bazooka, a plan to load up unlimited amount of troubled country’s debt, since last Thursday. I have to admit that my assessment regarding “no open-ended commitment from the ECB” (See rationale here) was wrong and hence I missed the rally in the past few days.

With the one-sided rising asset prices in the past few days, I spot some upward movements in certain assets were unjustified, and gold (silver as well) is one of the assets that rose on a misunderstood fundamental.

The ECB’s bazooka, a.k.a. Outright Monetary Transactions (OMT), is a plan to remove certain “tail risks of  Euro breakup” with the details listed below:

1.          Purchases of sovereign bonds maturing in 1 – 3 years in the secondary market

2.          No quantitative limits are set on OMT

3.          No subordination of private investors

4.          Full Sterilization

5.          Conditionality of OMT is attached to EFSF/ESM program

Indeed, OMT is enough to build a firewall to safeguard the too-big-to-fails (Spain and Italy) as long as those countries comply with austerity measures (Of course, austerity will mean a recession for them). OMT, in my opinion, has several implications to the market:

l   Removing a Lehman-like re-denomination risks in Europe in the intermediate term (until a blowup of the ECB)

l   Increasing recessionary risks for countries under OMT, just like the Greece and Portugal which carried out austerity measures under the current Trioka plans

l   The total liquidity in the euro system will stay unchanged given the full sterilization structure

I think the Operation Twist (OT) by the Fed which was firstly launched in Sep 2011 and then extended in Jun 2012 was a good example in explaining the term “sterilization” and its impact on asset prices.

As I covered here few months ago, sterilization is hardly supportive to commodity prices (incl. precious metals).  This is also the reason why gold peaked at US$ 1,900 last September and trended down to recent low at US$ 1520 in Q2 2012 despite the crisis in Europe kept worsening.

If OMT really means less crisis, no money printing and higher chance of recession in Europe, I don’t see the reason why the “safe-haven”, “money-printing-sensitive” gold could rise as much as, if not more than,  equities, Euro or others assets that benefit from the removal of tail risks in Europe.

While some investors are arguing gold will rise as the Fed will carry out QE 3 on 13^th Sep FOMC meeting to match what the ECB did last Thursday, I am holding my breath to see what will happen otherwise.

I am particularly interested in the movement of gold in Euro (XAUEUR) if QE 3 doesn’t become reality this week. A dramatic fall for this pair is likely to happen: 

Source: Reuters, click to enlarge