Saturday, June 21, 2008

The Race of Negative Catalyst

Learning sharing session. This cycle taught me a lot about investing under fire. You have two races going on at the same time - inflationary and deflationary. That's why we are seeing both headlines at the same time, who will be the winner ?

When subprime broke out "officially" in fall last year, investors continue to park their money in emerging markets and bond and commodity. The housing bubble continue to deflate, more banking write downs and credit crunch begin to take its toll. Housing prices continued to fall and no sight of ending yet.

Deflationary forces continue to force people to make choices, where to park their money? Tight demand and supply in soft commodities and hard commodities create an investment opportunity, unfortunately those trillion dollars are chasing after the smallest market on the planet. This for sure will drive price through the roof. Oil is a big portion of consumer spending but it's unfortunately take a long time for supply to response. For short term, curbing demand by cutting subsidies may help, for long term, if no supply coming on stream, demand shock will create a pricing shock again.

The unintended consequence of money flowing into commodities had created huge inflation risk for emerging economies. With record surplus, most government decided to subsidize or implementing price control. Suppressing inflation will only work for so long, the longer you do that the stronger the demand will be, the higher the price you will get, it's a self-reinforcing cycle.

Everybody is betting on a recession in the US and UK will bring down commodities -- i.e. inflation will take care by itself. But no, the growing emerging economies will continue to create much stronger demand. So, this is a wrong bet. Finally, riots, street protests, change of government shake up things. Something has to be done, you can't just sit and wait for miracle. When they lift the inflation cover -- cutting subsidies, inflation race is on again. Raising interest rate is unavoidable and effective tools to combat inflation.

This will threaten the debt markets because it will destroy the value of bonds. There is also potential small bank failures in the US. Money will need to run again. Where will you run ? Hard asset like gold? Emerging economies with strong reserves?

Equities? Talking about equities, S & P 500 profit as a percentage to GDP is still above average, room to fall further. Inflationary expectations lead to decline in companies profit will make matter worse.

When inflation pressure is receding, will money begin to flow back to debt market? Equities? Emerging market again? Some positive development normally show up at the darkest eleventh hour, this makes market timing very very difficult. This also makes sector rotation play tough.

The silver lining is of course regulation change preventing institutional money to flow into crude oil future will save the day. Will this lead to underinvestment in crude oil production and alternative energy -- lead to a big future problem?

I am keeping this entry as a marker for future reference. When will the price gets to the bottom?

Reference :
DJIA : 1182
S & P : 1,317
KLCI : 1206
HSI : 22745
Nikkei225: 13942
Gold : US $ 903
Crude Oil : US $ 135
10 yield : 4.17
FedFund Rate : 2%

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