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4. Hold the rest till top of market. For uranium miners, this is at least a price per pound of $140 in the uranium market; for gold, it depends: need to see a new international monetary agreement and some type of resolution to the global sovereign debt crisis.
5. Exit uranium if China and India back off nuclear.
6. Possibly exit on change of management.
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» Outside the Box: “Finest Worksong” (John Mauldin)
Sep 18, 2014 - by InformedTrades
Originally Published by Mauldin Economics

“In theory there is no difference between theory and practice. In practice there is” – Yogi Berra, as cited by Ben Hunt in today’s Outside the Box. Or, to put it in macroeconomic terms, “Why is global growth so disappointing?” In the aftermath of the Great Recession, fearing a deflationary equilibrium (which, as Ben notes, is macroeconomic-speak for falling into a well, breaking your leg, at night, alone), the Fed bought trillions of dollars in assets … and saved the world. Sort of. If you don’t count the reckoning yet to come. The theory was that with all that monetary-policy injections, global growth would spring back to “normal.”

But what did practice show? The global economic engine never fired back up. The central banks’ answer? Do more. So the Fed gave us QE 2 and QE 3, and then we got Abenomics, and now it’s Draghinomics.

Still no real growth. What’s missing? asks Ben. He has a surprising answer. Read on.

Ben works for Salient Partners and writes the fascinating letter called Epsilon Theory. You can subscribe to it for free here, or by emailing

I had dinner last night with my good friend Richard Howard, who, besides being a charming young Australian lad, is also the wickedly brilliant chief economist of Hayman Advisors, the hedge fund outfit run by my friend Kyle Bass. We try to get together every few months at one of the local eateries and hash out the world. And yes, for those interested, the recent action in Japan has both of us smiling a “we told you so” sort of smile. But also thinking that the magic will last for Abe-sama a little while longer. Actually, we talked about why this trade could take a lot longer than most yen bears expect.

(Side note: As longtime readers know, I had just hedged a good portion of my newly acquired mortgage this year by shorting the yen using 10-year put options. Just for grins, I called my broker [a.k.a. The Plumber – Eric Keubler of JPMorgan] and asked how much my position was up. I know, I bought 10-year options and shouldn’t check more than once a year at most, but I was just curious – so sue me. Anyway, with a 5-yen move in my favor I expected to see a rather nice profit. It turned out the profit was about 3% of what I was expecting [not a typo]. That seems odd, I said. No, he told me, all the volatility in the option price has collapsed. The complacency in the currency market and especially in the yen-dollar market is simply massive. This made me glad that I bought 10-year options, as I fully expect that the volatility will have to reappear in the future – unless human nature has somehow changed without sending me a memo. But it goes to show you, gentle reader, that you can be right on the trade and lose money, perhaps a lot of it, if your timing sucks. Ironically, I can get roughly the same trade today for only a few dollars more than I paid five or six months ago, with the 5-yen advantage to the home team. Go figure. I plan to add to this trade, so if you are watching and know when I’m going to do it, you will know that volatility is exceedingly high when my personal situation allows me to execute.)

Richard and I then went on to talk about the interesting decision by CalPERS to completely exit hedge funds. I think the consensus as we left the table was that it is both an odd decision and a perfectly reasonable one, depending on your perspective. Please note that in their press release CalPERS used 5 years and 20 years as their retrospective time horizons. The intervals between 1994 and 2009 and the present just happen to be very convenient time periods to compare overall portfolio returns for CalPERS and for equity markets in general versus hedge funds. If you used 2000 or 2006, your internal rate of return would suck, and your portfolio performance would be less than flattering. Still, hedge funds in general have not performed as well for the last five years as they did in the past, and in general they didn’t offer the downside protection in 2008 that they did in the prior correction of 2000-2001.

In my opinion, CalPERS was not very good at choosing hedge funds, and their timing in entering and exiting a number of their funds wasn’t any better. You can go to any number of pension funds and find far better results than CalPERS achieved. To be fair, I would suggest that the majority of hedge funds are not worth the fees they charge, as they simply provide leveraged beta. Choosing hedge funds is as much an art form as it is a science. Kind of like choosing stocks.

I mean, every asset class has its own particular rhythm. As we all know, over the very long run stocks generally do well. But there are some periods of time when the performance numbers don’t live up to the promise. Those are called secular bear markets, and we had one beginning in 2000. I don’t think we have come to the end of it, and so we still live in a world where we have to look for absolute returns. That’s just the way I see the data.

All that said, I can totally understand CalPERS’ decision to exit the hedge fund world. First, their entire hedge fund investment portfolio was less than 2% of their total portfolio. Even if their hedge fund portfolio was crushing it, that wouldn’t move their overall needle. They were paying $135 million in fees for the privilege of being continually second-guessed by their critics. Frankly, if they had asked me, I would have said, either go large or go home.

And there’s the problem. They really can’t go large. Let’s say they put 10% of their fund into hedge funds. That means at least $30 billion. I don’t think you can allocate $30 billion appropriately from the standpoint of public pension fund responsibility. I wouldn’t even begin to know how to do it. Two or three billion? Absolutely. It would be difficult, but it could be done.

The problem is, you don’t want to become too big a portion of any one fund. Seriously, there are not that many good large funds. Most hedge funds are way too small to be considered as potential investments by CalPERS. So if you are CalPERS you are size-constrained and limited to a small universe of very large hedge funds. Which is not typically where you find hedge fund alpha. And you don’t want to have 100 different funds, as the complexity of tracking all that is enormous.

So you either end up with a portfolio that is ridiculously spread out and is going to regress to the mean, that is, to general market performance; or you going to be over-allocated to some fund that will prove to be a time bomb just when your public relations team is being overwhelmed with something else. I’m not sure who in the universe is in charge of the rules on timing, but it does seem that things are structured so as to cause the greatest possible embarrassment.

So I can certainly understand extremely large public funds leaving hedge funds. I do think that they should consider what other forms of alternative investing might make sense. Pension funds have one commodity that very few other investors have: they have time and lots of it. Most of them sell their time for ridiculously cheap premiums in the fixed-income market. Perhaps figuring out how to increase the return on your patient cash would be the way to go. And that’s not a bad strategy for individual investors as well. Just saying…

That’s the news from beautiful, sunny Dallas. It is time to go ahead and hit the send button as The Beast is lurking in the gym, waiting for me. Have a great week, and enjoy Ben Hunt’s essay.

Your ready to get on a plane again analyst,

John Mauldin, Editor
Outside the Box

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Scottish Independence Would Shake Up the Global System

“Finest Worksong”

Take your instinct by the reins
You'd better best to rearrange
What we want and what we need
Has been confused, been confused

– REM, “Finest Worksong” (1987)

The politics of dancing
?The politics of oooh feeling good

– Re-flex, “The Politics of Dancing” (1983)

The fault, dear Brutus, is not in our stars, but in ourselves.
– William Shakespeare, “Julius Caesar” (1599)

In theory there is no difference between theory and practice. In practice there is.
– Yogi Berra, (b. 1925)

Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back. ...

Indeed, the IMF's expectation for long-run global growth is now a full percentage point below what it was immediately before the Global Financial Crisis. ...

But it is also possible that the underperformance reflects a more structural, longer-term, shift in the global economy, with less growth in underlying supply factors.
– Fed Vice Chairman Stanley Fischer, The Great Recession: Moving Ahead,” August 11, 2014

There is one great mystery in the high falutin’ circles of the Fed, ECB, and IMF today. Why is global growth so disappointing? There are different variations on this theme – why aren’t businesses investing more? why aren’t banks lending more? – but it’s all one basic question. First the Fed, then the BOJ, and now the ECB have taken superheroic efforts to inflate financial asset prices in order to bridge the gap between the output shock of 2008 and a resumption of normal economic growth. They’ve done their part. Why hasn’t the rest of the world joined the party?

The thinking was that leaving capital markets to their own devices in the aftermath of the Great Recession could result in a deflationary equilibrium, which is macroeconomic-speak for falling into a well, breaking your leg, at night, alone. It’s the worst possible outcome. So the decision was made to buy trillions of dollars in assets, forcing all of us to take on more risk with our money than we would otherwise prefer, and to jawbone the markets (excuse me ... “employ communication policy”) to leverage those trillions still further. All this in order to buy time for the global economic engine to rev back up and allow private investment activity to take over for temporary government investment activity.

It was a brilliant plan, and as emergency intervention it worked like a charm. QE1 (and even more importantly TLGP) saved the world. The intended behavioral effect on markets and market participants succeeded beyond Bernanke et al’s wildest dreams, such that now the Fed finds itself in the odd position of trying to talk down the dominant Narrative of Central Bank Omnipotence. But for some reason the global economic engine never kicked back in. The answer? We must do more. We must try harder. And so we got QE2. And QE3. And Abenomics. And now Draghinomics. We got what we always get in the aftermath of a global economic crisis – a temporary government policy intervention transformed into a permanent government social insurance program.

But the engine still hasn’t kicked in.

So now villains must be found. Now we must root out the counter-revolutionaries and Trotskyites and Lin Biao-ists and assorted enemies of progress. Because if the plan is brilliant but it’s not working, then obviously someone is blocking the plan. The structural villains per Stanley Fischer (who is rapidly becoming a more powerful Narrative voice and Missionary than Janet Yellen): housing, fiscal policy, and the European economic slow-down. Or if you’ll allow me to translate the Fed-speak: consumers, Republicans, and Germany. These are the counter-revolutionaries per the central bank apparatchiks. If only everyone would just spend more, why then our theories would succeed grandly.

Hmm. Maybe. Or maybe what we want and what we need has been confused. Maybe the thin veneer of ebullient hollow markets has been confused for the real activity of real companies. Maybe the theatre of a Wise Man with an Answer has been confused for intellectually honest leadership. Maybe theoretical certainty has been confused for practical humility. Maybe the fault, dear Brutus, is not in external forces like Republicans or Germans (or Democrats or Central Bankers), but in ourselves.

Let me suggest a different answer to the mystery of missing global growth, a political answer, an answer that puts hyper-accommodative monetary policy in its proper place: a nice-to-have for vibrant global growth rather than a must-have. The problem with sparking renewed economic growth in the West is that domestic politics in the West do not depend on economic growth. What we have in the US today, and even more so in Europe (ex-Germany), are not the politics of growth but rather the politics of identity. At the turn of the 20th century the meaning of being a Democrat or a Republican was all about specific economic policies ... monetary policies, believe it or not. You could vote for Republican McKinley and ride on a golden coin to Prosperity for all, or you could vote for Democrat Bryan and support silver coinage to avoid being “crucified on a cross of gold.”

Today’s elections almost never hinge on any specific policy, much less anything to do with something as arcane as monetary policy. No, today’s elections are all about social identification with like- minded citizens around amorphous concepts like “justice” or “freedom” ... words that communicate aspirational values and speak in code about a wide range of social issues. Don’t get me wrong. There’s nothing inherently bad or underhanded about all this. I think Shepard Fairey’s “HOPE” poster is absolute genius, rivaled only by the Obama campaign’s genius in recognizing its power. Nor am I saying that economic issues are unimportant in elections. On the contrary, James Carville is mostly right when he says, “It’s the economy, stupid.” What I am saying is that modern political communications use neither the language nor the substance of economic policy in any meaningful way. Words like “taxes” and “jobs” are bandied about, but only as totems, as signifiers useful in assuming or accusing an identity. Candidates seek to be identified as a “job creator” or a “tax cutter” (or accuse their opponent of being a “job destroyer” or a “tax raiser”) because these are powerful linguistic themes that connect on an emotional level with well-defined subsets of voters on a range of dimensions, not because they want to actually campaign on issues of economic growth. Candidates have learned that while voters certainly care about the economy and their economic situation, the only time they make a voting decision based primarily on specific economic policy rather than shared identity is when the decision is explicitly framed as a binary policy outcome – a referendum. Even there, if you look at the ballot referendums over the past several decades (Howard Jarvis and Proposition 13 happened almost 40 years ago! how’s that for making you feel old?), the shift from economic to social issues is obvious.

Both the Republican and the Democratic Party have entirely embraced identity politics, because it works. It works to maintain two status quo political parties that have gerrymandered their respective identity bases into a wonderfully stable equilibrium. The last thing either party wants is a defining economic policy question that would cut across identity lines. But until the terms of debate change such that an electoral mandate emerges around macroeconomic policy ... until voters care enough about Growth Policy A vs. Growth Policy B to vote the pertinent rascals in or out, despite the inertia of value affinity ... we’re going to be stuck in a low-growth economy despite all the Fed’s yeoman work. I know, I know ... what blasphemy to suggest that monetary policy is not the end-all and be-all for creating economic growth! But there you go. At the very moment that elections hinge on the question of economic growth, we will get it. But until that moment, we won’t, no matter what the Fed does or doesn’t do.

What reshapes the electoral landscape such that an over-riding policy issue takes over? Historically speaking, it’s a huge external shock, like a war or a natural disaster, accompanied by a huge political shock, like the emergence of a new political party or charismatic leader that triggers an electoral realignment. In the US I think that the emerging appeal of national Libertarian candidates (all of whom, so far anyway, have the last name Paul) is pretty interesting. The 2016 election has the potential to be a watershed event and set up a realignment, if not in 2016 then in 2020, which hasn’t happened in the US since Ronald Reagan transformed the US electoral map in 1980. And yes, I know that the conventional wisdom is that a viable Libertarian candidate is wonderful news for the Democratic party, and maybe that will be the case, but both status quo parties today are so dynastic, so ossified, that I think everyone could be in for a rude awakening. It’s a long shot, to be sure, mainly because the US economy isn’t doing so poorly as to plant the seeds for a reshuffling of the electoral deck, but definitely interesting to watch.

What’s not a long shot – and why I think Draghi’s recently announced ABS purchase is a bridge too far – is a realigning election in Italy.

I like to look at aggregate GDP when I’m thinking about the strategic interactions of international politics, but for questions of domestic politics I think per capita GDP gives more insight into what’s going on. Per capita GDP gives a sense of what the economy “feels like” to the average citizen. It addresses Reagan’s famous question in the 1980 campaign with Jimmy Carter: are you better off today than you were four years ago? It’s a very blunt indicator to be sure, as it completely ignores the distribution of economic goodies (something I’m going to write a lot about in future notes), but it’s a good first cut at the data all the same. Here’s a chart of per capita GDP levels for the three big Western economies: the US, Europe, and Japan.

Source: World Bank. For illustrative purposes only.

The Great Recession hit everyone like a ton of bricks, creating an output shock roughly equal to the impact of losing a medium-sized war, but the US and Japan have rebounded to set new highs. Europe ... not so much.

Let’s look at Europe more closely. Here’s a chart of the big three continental European economies: Germany, France, and Italy.

Source: World Bank. For illustrative purposes only.

Germany off to the races, France moribund, and Italy looking like it just lost World War III. I mean ... wow. More than any other chart, this one shows why I think the Euro is structurally challenged.

First, why in the world would Germany change anything about the current Euro system? The system works for Germany, and how. Alone among major Western powers, the politics of growth are alive and well in Germany. “But Germany, unless you lighten up and embrace your common European identity, maybe this sweet deal for you evaporates.” Ummm ... yeah, right. The history books are just chock-full of self-interested creditors with sweet deals that unilaterally made large concessions before the very last second (and often not even then).

Second, why in the world would Italy accept anything about the current Euro system? The system fails Italy, and how. The system fails other countries, too, like Spain, Portugal, and Greece, but these countries are in the Euro by necessity. Their economies are far too small to go it alone. Italy, on the other hand, is in the Euro by choice. Its economy is plenty big enough to stand on its own, and with a vibrant export potential, an independent and devalued lira is just what the doctor ordered to get the economic growth engine revved up. Short term pain, long term gain.

Why doesn’t Italy bolt? Lots of reasons, most of them identity related. Also, let’s not underestimate the power of cheap money to keep the puppet-masters of the Italian State in a Germany-centric system. The system may fail Italy as a whole, but if you’re pulling the strings of the State and can borrow 10-year money at 2.5% to keep your vita nice and dolce ... well, let’s keep dancing.

Still, nothing focuses the electoral mind like the economic equivalent of losing a major war. At some point in the not so distant future there will be an anti-Euro realigning election in Italy. And that will wake the Red King.

In the meantime, Draghi will go forward with his ABS purchase scheme, a brilliant theory that will deliver frustratingly slim results quarter after quarter after quarter. Until the politics of growth are embraced outside of Germany, European banks will remain reticent to lend growth capital to small and medium enterprises. Until the politics of growth are embraced outside of Germany, large enterprises with plenty of cash and access to cheap loans will remain reticent to invest growth capital. Maybe a little M&A, sure, but no new factories, no organic expansion, no grand hiring plans. The thing is, Draghi knows that he’s pushing on a string with the ABS program and that growth won’t return until the fundamental political dynamic changes in France in Italy, which is why he is calling both countries out by name to institute “structural reforms”. But in typical European fashion this entire debate is Mandarin vs. Mandarin, with almost all of the proposals focused on regulatory reform rather than something that must be hashed out through popular legislation. So long as economic policy reform is imposed from above ... so long as we are engaged in modern-day analogs of Soviet Five-Year Plans ... I believe we will remain stuck in what I call the Entropic Ending – a long gray slog of disappointing but not catastrophic aggregate economic growth. That’s not a terrible environment for stocks, certainly not for bonds, and the alternative – economic reform based on the hurly-burly of popular politics, is almost certain to be a wild ride that markets hate. But to get back to what we need (real growth) rather than what we want (higher stock prices) this is what it’s going to take. Elections always matter, but in the Golden Age of the Central Banker they matter even more.

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» South Africa maintains rate on improved inflation outlook
Sep 18, 2014 - by InformedTrades
South Africa's central bank maintained its benchmark repurchase rate at 5.75 percent due to a slightly improved outlook for inflation and the downside risks to the economic outlook.
But the South African Reserve Bank (SARB), which has raised its rate by 75 basis points so far this year, said its monetary policy stance remains accommodative and it still expects that interest rates will have to normalize over time.

SARB issued the following statement:

"STATEMENT OF THE MONETARY POLICY COMMITTEE Issued by Gill Marcus, Governor of the South African Reserve Bank
Since the previous meeting of the Monetary Policy Committee the domestic inflation forecast has improved slightly, but the inflation trajectory remains uncomfortably close to the upper end of the target range. At the same time the domestic economic growth outlook has deteriorated further, with declining growth in both consumption expenditure and gross fixed capital formation, as confidence remains low. The combination of stubborn inflation and a sluggish growth outlook continues to pose a difficult dilemma for monetary policy.

The global environment has been characterised by increased financial market volatility, following heightened speculation relating to the timing and extent of US monetary policy normalisation. This impacted on emerging market currencies in general, and on the rand in particular. This was further illustrated after yesterday’s FOMC meeting, which reaffirmed the gradual pace of US monetary policy normalisation, and its data dependent nature. However, despite increased political instability and significant risks in a number of regions, the international oil price has declined along with continued weakness in global food prices, contributing to a more benign global backdrop for the domestic inflation outlook.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban areas surprised on the upside at 6,4 per cent in August, having measured 6,6 per cent and 6,3 per cent in June and July 2014 respectively. The higher turnout was mainly due to higher-than-expected food prices, which had been anticipated to continue their recent downward trend. Downward pressure was exerted by petrol prices which increased by 5,8 per cent, down from 8,3 per cent in July. The categories of food, housing utilities and transport together accounted for 3,8 percentage points of the inflation outcome in August, unchanged from the previous month. Core inflation, which excludes food, petrol and electricity, increased to 5,8 per cent, from 5,7 per cent in July, driven mainly by the impact of the weaker exchange rate on some goods categories.
Administered price inflation excluding petrol measured 6,5 per cent, up from the 6,4 per cent in July. The headline producer price inflation for final manufactured goods, which reached a recent high of 8,8 per cent in April, measured 8,1 per cent and 8,0 per cent in June and July respectively, driven in part by lower agricultural product inflation.
The Bank’s forecast of headline inflation is slightly more favourable than that presented at the previous meeting, mainly a result of lower expected food and petrol price pressures. Whereas for some time inflation had been forecast to peak at an average of 6,6 per cent in the fourth quarter of this year, the peak now appears to have occurred in the second quarter, at an average of 6,5 per cent. Inflation is now expected to average 6,2 per cent in 2014, compared with 6,3 per cent previously, and 5,7 per cent in 2015, (5,8 per cent previously), and to return to within the target range in the first quarter of 2015 instead of the second quarter as previously forecast. The inflation forecast for 2016 increased to 5,8 per cent from 5,6 per cent, mainly as a result of the revised electricity price assumption following the review of Eskom tariffs by Nersa. The revised assumption makes provision for electricity price increases of 11,6 per cent from July 2015 and again from July 2016.
The forecast for core inflation is unchanged at an average 5,6 per cent and 5,7 per cent in 2014 and 2015 respectively, reaching a peak of 5,8 per cent in the first quarter of 2015, and moderating to 5,5 per cent in 2016. As before, the MPC sees the risks to the headline inflation forecast to be skewed to the upside, with possible renewed pressure coming from the exchange rate.
Inflation expectations, as reflected in the survey conducted by the Bureau for Economic Research at Stellenbosch University in the third quarter of 2014, have again remained more or less unchanged, and anchored at around the upper end of the target range. Inflation is expected to average 6,2 per cent in 2014 and 6,1 per cent and 6,0 per cent in 2015 and 2016 respectively. As usual, there is a
fairly wide dispersion of expectations between the different categories of respondents. While business people expect inflation to average 6,4 per cent in 2015 and 2016, analysts’ expectations average 5,7 per cent and 5,4 per cent. Expectations of trade unionists are for 6,2 per cent in both years, and all categories of respondents expect inflation in the current year to average 6,2 per cent. Household inflation expectations for 2014 remained unchanged at 6,3 per cent.
The global growth recovery remains asynchronous amid sustained improvements in the US and UK, and deteriorating prospects in the Eurozone and Japan. Although growth in the US is not expected to exceed the 2,2 per cent achieved in 2013, this is mainly a result of the contraction during the first quarter of this year. Real output growth of 4,2 per cent was recorded in the second quarter of 2014, and consensus forecasts are for growth rates of around 3 per cent in the next two quarters. Similar growth rates are expected in 2015. At the same time the unemployment rate has been declining at a faster pace than previously anticipated. While the growth outlook for the UK remains positive, possible downside risks could emerge should Scotland vote for independence from the United Kingdom.
Growth in the Eurozone has remained weak, with the German economy also under pressure following a contraction in the second quarter. Sanctions on Russia are expected to be an additional constraint affecting the Eurozone’s growth outlook. Although the Japanese economy appears to be recovering from the VAT-induced slump in the second quarter, the recovery looks fragile.
While emerging Asia appears to be benefiting most from the US recovery, emerging markets generally are facing increasing headwinds. Signals coming out of China continue to be mixed, amid a sharp slowdown in industrial production in August. Latin American economies also face a challenging outlook, particularly in Argentina, Venezuela and Brazil, which is currently experiencing a technical recession. Growth in sub-Saharan Africa is expected to remain relatively strong, although commodity producers may be adversely affected by lower commodity prices and possible spillover effects from the Ebola outbreak.
There is a continued absence of significant upside global inflation risks, despite pressures experienced in some emerging markets. The various indicators of US inflation remain well contained below the 2 per cent level, while the fear of deflation in the Eurozone persists. Declining international oil and food prices, along with a number of other commodity prices, are expected to reinforce the current benign global inflation environment.
The divergent growth outlooks in the advanced economies are likely to be the main drivers of monetary policy developments. The UK is expected to tighten monetary policy early next year. The stronger performance of the US labour market has led to heightened speculation that normalisation may begin earlier than previously anticipated. These expectations resulted in an appreciation of the US dollar against most currencies, as well as rising long-term US Treasury yields ahead of yesterday’s FOMC meeting. At yesterday’s press conference the FOMC Chair reaffirmed the view that policy normalisation will occur gradually, but is contingent on no surprises to employment growth or inflation in either direction.
The data dependent nature of the forward guidance means that changes in the outlook for inflation, unemployment and growth are likely to lead to bouts of global financial market uncertainty in advance of FOMC meetings in the coming months.
At the same time, however, the ECB has loosened monetary policy and has indicated its willingness to embark on some form of quantitative easing should this be necessary. Monetary policy is also expected to remain accommodative for some time in Japan. Since the previous meeting of the MPC, policy rates have been reduced in the Eurozone, Israel, South Korea, Chile and Hungary, and increased in Russia and New Zealand.
Following a few weeks of relative stability, the rand exchange rate weakened in the past few days in response to US dollar strength, as well as the widening deficit on the current account of the balance of payments to 6,2 per cent of GDP. Since the previous meeting of the MPC, the rand initially traded in a range of R10,50 and R10,75 against the US dollar, but has weakened since early September reaching a low of R11,07. On a trade-weighted basis, however, the rand depreciated by 0,4 per cent, having appreciated against the euro and the British pound. The rand is expected to remain sensitive to changes in sentiment regarding possible changes in US policy which will affect the appetite for emerging market assets generally, as well as to possible impacts from geopolitical risks and domestic factors.
Since the previous MPC, non-residents have been net sellers of bonds to the value of R29,3 billion, but this has been offset in part by net purchases of equities to the value of R16,2 billion over the same period. Year to date there have been net outflows of bonds and equities to the value of R6,3 billion. These trends indicate that financing of the current account through portfolio inflows is likely to become increasingly challenging.
The current account deficit in the second quarter of 2014 was wider than generally expected by the markets, following the 4,5 per cent of GDP recorded in the first quarter. This widening was a result of increased dividend outflows, lower dividend inflows following a large once-off inflow during the first quarter, and weak export growth, impacted to some extent by the platinum strike. Export growth in the third quarter is expected to remain constrained by the slow return to full capacity production by the platinum mines and the strike in the steel and engineering sector in July, which had significant spillover effects on the manufacturing sector in general. The current account is anticipated to narrow gradually over time.
The domestic economic growth outlook remains weak following growth rates of -0,6 per cent and 0,6 per cent in the first and second quarters of the year respectively. These growth rates are well below potential output growth and indicative of a widening output gap. Partly as result of this outcome, as well as the expected impact of the metal workers strike in July, the Bank’s forecast for GDP growth for 2014 has been revised down further to 1,5 per cent, from 1,7 per cent previously, with the risks still assessed to be on the downside. The forecasts for both 2015 and 2016 have been revised down by 0,1 percentage points, to 2,8 per cent and 3,1 per cent respectively. The Bank’s leading indicator of economic activity continues to trend sideways, consistent with a subdued growth outlook. Business confidence, as reflected in the RMB/BER business confidence index, remains negative despite a five index point increase to 46 in the third quarter. Adding to prevailing concerns are indications from Eskom that electricity supply constraints may be more severe and endure for longer than previously expected.
The near-term outlook for mining remains subdued, with platinum production not expected to return to full capacity before the end of the year. In July, mining production recorded a broad-based year-on-year decline of 7,7 per cent, but a 0,9 per cent increase on a month-to-month basis. Manufacturing output declined significantly in July, recording year-on-year and month-to-month contractions of 7,9 per cent and 5,4 per cent respectively, largely due to the impact of the four- week strike in the steel and engineering sub-sector. Capacity utilisation in the sector declined from 82,1 per cent in the first quarter of 2014 to 80,6 per cent in the second quarter. More positively, the Kagiso PMI reflected some improvement in sentiment in August, with the index rising 3,1 index points to 49, marginally below the neutral level, while the construction sector has recorded growth rates of 5 per cent in the first two quarters of the year.
Growth prospects have been constrained by the weakening trend in gross fixed capital formation which grew at an annualised rate of 0,5 per cent in the second quarter. Real fixed capital expenditure by both the public corporations and the private sector contracted during the quarter. Of particular concern is the continued downward trend over the past three quarters in private sector investment, despite higher capital outlays in the manufacturing sector. This has been reflected in the continued slow pace of employment creation in the private sector and the rise in the unemployment rate to 25,5 per cent in the second quarter of 2014.
Consumption expenditure by households also continued its moderating trend which began in the first quarter of 2012, amid declining real disposable income growth. Annualised growth of 1,5 per cent was recorded in the second quarter of 2014. The slowdown was particularly marked in the durable and semi-durable goods categories, probably impacted by the prolonged strikes in the mining and manufacturing sectors. Retail trade sales contracted by 0,9 per cent in June on a month-to-month basis, but increased by 1,2 per cent in July, higher than generally expected. Wholesale trade sales contracted by 5,2 per cent month-to- month in July, and by 4,6 per cent year-on-year. Domestic vehicle sales have also slowed. Given the above, somewhat surprisingly the FNB/BER consumer confidence index increased from -6 to +4 in the second quarter.
Trends in credit extension to households are consistent with the weak growth in household consumption expenditure, showing a further divergence between credit extension to households and to the corporate sector. Growth in total loans and advances over the year measured 9,7 per cent in July, with lending to the corporate sector increasing by 17 per cent, and to households by 4,1 per cent. The latter reflects continued sluggish growth in mortgage credit extension and tighter credit criteria for unsecured lending in particular. Twelve-month growth in general loans to households, which is mainly unsecured lending, reached a low of 0,2 per cent in July, while growth over three months exhibited an annualised contraction of 2,5 per cent. This decline is across all income groups, but more pronounced at the lower levels. A positive development is that household debt to disposable income moderated from 74,4 per cent in the first quarter to 73,5 per cent in the second quarter.
Growth in corporate sector borrowing during the first half of the year was dominated by the agricultural sector, electricity supply (renewable energy projects) as well as wholesale and retail trade sectors. The cost of bank funding appears to have increased recently as a result of changed regulatory requirements relating to the implementation of Basel III, the impact of the bail-in of certain African Bank Limited creditors and the consequent rating action by Moody’s Investor Service, all of which could result in tighter funding conditions.
No new wage and unit labour cost data have been released since the previous meeting of the MPC, although settlements in the steel and engineering sector and the clothing sector have been well above current and expected inflation rates. The MPC remains concerned about the apparent delinking of wage demands and some wage settlements from underlying inflation and productivity growth trends, as well as the possible impact of forthcoming wage negotiations, including in the public sector. These concerns relate to settlements at all levels, including executive pay. Excessive wage settlements could have adverse impacts on employment, inflation, the general competitiveness of the economy and the profitability and viability of small businesses in particular.
Notwithstanding the 9,5 per cent increase in July, food price inflation is expected to slow over the coming months. Pipeline pressures from agricultural prices continue to moderate following sharply lower maize prices since March, while manufactured food price inflation declined to 8,5 per cent in July compared with 9,5 per cent in April. International food prices, as reflected in the FAO international food price index, declined for the fifth consecutive month in August in response to positive maize and wheat supply conditions. These developments are expected to impact favourably on domestic consumer prices, although base effects are likely to interrupt the declining year-on-year trend in the final months of the year.
International oil prices declined in recent weeks, having traded in a range of between US$105-US$114 per barrel for the year to the end of July. Since August, the price has fallen below this range and is currently trading at around US$98 per barrel. This is despite rising tensions and instability in the Middle East and conflict in the Ukraine, events that in the past would likely have resulted in an oil price spike. As a result of this lower price, the domestic petrol price was reduced by 67 cents per litre in September, having been unchanged in August. At this stage there is an average over-recovery on the petrol price due to the lower international price, but the favourable impact is being partially offset by continued rand weakness.
Despite the slight near-term improvement in the inflation outlook and the relatively stable inflation expectations, the MPC is concerned that the forecast remains uncomfortably close the upper end of the target band. Given the upside risks to the forecast, the proximity to the upper end of the band makes the inflation outcomes highly vulnerable to changes in inflationary pressures.
A key upside risk is the exchange rate, which is vulnerable to the slow pace of adjustment to the current account deficit, as well as to the uncertainty surrounding the future path of monetary policy in the advanced economies. At this stage it is difficult to assess the extent to which normalisation of US monetary policy is already priced in to the rate.
The MPC remains concerned about the risks of a wage-price spiral, should settlements well in excess of inflation and productivity growth become the economy-wide norm. Such developments could also undermine South Africa’s international competitiveness and delay the current account adjustment.
The deterioration in the longer term inflation trajectory relative to the previous forecast is a result of the revised tariff increases granted to Eskom by Nersa. The view of the Committee is that such relative price adjustments should not be reacted to automatically. However, while the focus of monetary policy should be on the second round effects of these increases, this is complicated given the multi-year nature of the adjustment.
While inflation is the primary focus of the Committee, the MPC is also mindful of the anaemic state of the domestic economy, rising unemployment and the downside risk to its growth forecast. Domestic expenditure has deteriorated further, particularly private sector fixed capital formation, and, together with continued moderation in household consumption expenditure, is indicative of the lack of demand pressures in the economy.
The MPC is still of the view that interest rates will have to normalise over time. However, given the slightly improved inflation outlook notwithstanding the upside risks, the stable inflation expectations and the downside risks to the weak growth outlook, the MPC has decided that the repurchase rate will remain unchanged at 5,75 per cent per annum.
Despite the 75 basis point increase so far this year, monetary policy remains accommodative, and will continue to be supportive of the domestic economy subject to achieving its primary inflation targeting objective. Future decisions will, as always, be highly data dependent."

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» How You Can Tell When a Company’s P/E is All Flash (Andrey Dashkov)
Sep 18, 2014 - by InformedTrades
Originally Published by Casey Research
College reunions are toxic. Except for the few precious moments of genuine human connection, these parties are nothing but status pageants. Suits and watches are inconspicuously glanced at, vacation photos (carefully selected the night before) are passed around; compensations guesstimated; Platinum Master Cards flashed (“Oh no, let me take care of this round!”); spouses evaluated based on trophy-worthy qualities… and inconspicuously glanced at.

It’s hard to tell true, praiseworthy success from carefully crafted smoke and mirrors. Your college friend may have rented that car, watch, suit—and even his “spouse.” In fact, there are escort agencies out there that provide “dates” for single men to social occasions. Don’t ask me how I learned about it.

The point is, both people and companies like to project high status and success to the public. Not only do your friends from Beta Phi Delta want to look alpha (pun intended), but companies, too, often want you to think they earn more than they actually do.

There are many incentives to do that: management’s compensation may be tied to earnings-per-share (EPS) goals; the company may be trying to maintain an image of rapid growth; or it could be attempting to raise funds by issuing debt or shares. Higher EPS would benefit the company and the team at the helm in all of these cases.

The Illusory P/E Ratio

Another reason why companies try to massage their earnings is that millions of investors pay attention to the price-to-earnings ratio (P/E). It is one of the most intuitive financial metrics. Potential investors see it all across the Internet, on free finance sites and many trading platforms. However, despite its popularity, I’d argue that it’s one of the most illusory financial metrics that exists, and the blame is on the denominator, earnings. Let’s see how we can make better use of it.

“E” in the P/E ratio stands for earnings per share, which is a ratio itself. EPS is the company’s net income for the reported 12-month period (or forecasted net income for the next 12 months) divided by its shares outstanding. Without going into too much detail, here are some of the potential issues with the usefulness of reported historical, or trailing, earnings per share for investors:
  • Seasonality. Earnings of a lot of companies fluctuate due to seasonal buying activity, weather, and other factors. In these cases, quarter-to-quarter comparisons are meaningless, and it’s necessary to understand the company’s operating cycles (annual, based on contract renewals, etc.) to make use of the reported earnings.
  • Dilution. There are two broad measures of shares outstanding: basic (or common) and diluted. Diluted shares outstanding include common shares, options, warrants, convertible preferred shares, and convertible debt. All of these can potentially be converted to common stock and result in lower earnings per share because of the higher denominator in the EPS ratio. However, when you look at a P/E ratio on the Internet, it’s not always clear whether it was based on basic or diluted shares. The latter is more conservative, and we pay more attention to it than to the basic EPS.
  • Accruals-based accounting, in which revenues are recognized at the moment they’re earned, and expenses are recognized when they’re incurred. In contrast, under cash-based accounting, revenues are recognized when cash is collected, and expenses are recognized when cash is paid.

    Accruals-based accounting has its advantages:
    • It allows the company to match revenues to expenses in time more closely (for example, the cost of a piece of equipment is depreciated over its useful life to match the revenues this equipment generates); and
    • It provides the market with information about the company’s operations as soon as it has enough objective evidence that the transaction will be fulfilled. For example, when a company sends an invoice to a customer, it records a receivable, which sends a signal to the market that a sale took place. We don’t need to wait until the actual funds are deposited in the company’s bank account, which may take a month or more, to become aware of this sale.
    However, accrual accounting has two major drawbacks for analysts and investors:
    • Reported income and expenses do not mirror actual cash inflows and outflows; and
    • Management can accelerate or postpone recognition of revenue and expenses, which makes reported net income figures less reliable.
    Consider a real-world example. A friend of mine—let’s call him Steven—spent several years as a credit manager. One of his responsibilities was to expense a “reserve” for anticipated credit losses. The first time he was about to charge the expenses, he estimated them realistically and quickly realized that it wouldn’t work. The reserve wasn’t there to cover the related losses calculated fairly and correctly.

    After a discussion with the corporate accounting department (his superior), if they needed to find more profit to make their numbers, Steven would lower his reserve estimates. If they were having a good year, he was told to increase the reserve write-off to provide a cushion for the next quarter.

    The beauty of it was that such draws and deposits are almost impossible to catch unless the amounts are outrageous, so any auditor would overlook them. Steven and his team were safe legally, but the practice misrepresented his company’s financial performance nevertheless.

    When I asked another friend—let’s call him Jack—to share any stories about his company’s creative accounting, he said he too would get calls from the corporate accounting department at the end of each quarter. Another easy target to massage is insurance costs. To get the lowest prices, many of its insurance policies were paid annually, and the premium period did not correspond with the accounting year. If the company was having a good quarter or year, he was encouraged to write off the entire annual premium in that accounting period. Conversely, if it was struggling to make its numbers, the team would show the premiums for future months as “prepaid insurance,” effectively delaying the expense until the next accounting period.

    The effect, as with our first example, was to smooth out period-to-period fluctuations to keep stockholders happy by “making their numbers” or beating them by a little bit. The justification was that they weren’t really manipulating profits—“in the long run, it all comes out in the wash.”

    Part of Jack’s annual performance review was “being a good team player.” Helping the corporate team was part of that evaluation.

    Other common revenue and expense “management” techniques include adjustments to how depreciation expense is calculated, which is doable within limits under generally accepted accounting principles (GAAP), and can affect net income as desired; and adjustments to revenue recognition policies that technically comply with GAAP but distort the underlying economic reality to artificially boost the top line and thereby juice earnings.
Normalization Helps Solve the Numbers Game

The first two issues with earnings—seasonality and dilution—can be addressed simply: instead of looking at price to reported earnings per share, pay attention to P/E calculated from normalized earnings based on diluted shares outstanding. Normalization takes care of seasonality and some of the nonrecurring revenue and cost items. Using diluted share count instead of basic will return a more conservative number, because it assumes that all options, warrants, and convertible debt are converted into common shares. The more common shares there are, the lower the EPS.

As shareholders, we need those conservative estimates. Our returns (share price appreciation and dividend income) aren’t based on management achieving arbitrary earnings targets that can be fiddled with, but on how the company functions as a business. To get a clearer picture, using normalized diluted EPS should help.

Note that I wrote “clearer” but not “clear,” “true,” or “objective.” The reason we stay away from such absolutes is that it’s prohibitively difficult to say what’s going on with any company’s earnings with 100% accuracy.

One simple tip can help you make better use of P/E: use normalized earnings and diluted shares. These numbers are often available on free websites or in SEC filings.

Now I’ll go ahead and clear my browser history. Although reading about escort services for college reunions is a great study of the human condition, I’ll have a hard time explaining to my lovely wife why I need to do it for work. And speaking of the work I do… you can receive more unique insights on better investing strategies by signing up for our free, retirement-focused e-letter, Miller’s Money Weekly.

The article How You Can Tell When a Company’s P/E is All Flash was originally published at
View the Casey Research Guide to Crisis Investing on InformedTrades
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» [text] JPY Plunges To 6-Year Lows, Nikkei Tops 16,000 As Japanese Deficit Runs 41st Month In A Row | Zero Hedge
Sep 18, 2014 - by InformedTrades

"For the 41st month in a row, the Japanese Trade Balance is in deficit (around JPY1 trillion). Of course, the fact that exports fell 1.3% (but but devalued currency means competitive?) means nothing as all that really matters is the collapsing JPY (now at 108.60) at its weakest against the USD in 6 years. That can mean only one thing - a surging Japanese stock market - as the Nikkei breaks 16,000. What is odd - just as in the US - is the rising equity index (no doubt helped by Japanese pension funds buying JPY393billion in Q2) against a backdrop of plunging indivdidual stocks. Sony is limit down (as we explained earlier) with offers outnumbering bids 8-to-1. And that's Japan...41st month in a row of trade deficits... no J-Curve in sight"
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» Malaysia maintains rate, but warns it may raise again
Sep 18, 2014 - by InformedTrades
Malaysia's central bank maintained its Overnight Policy Rate (OPR) at 3.25 percent but signaled that it is ready to raise rates again to ensure sustainable growth by saying a "further adjustment to the degree of monetary accommodation may be taken depending on how new information will affect the assessment of the balance of risks."
Bank Negara Malaysia (BNM), which raised its rate by 25 basis points in July for the first time since May 2011, said its current policy stance remains supportive of growth and it would continue to assess the balance of risks surrounding the outlook for growth and inflation along with the risks of destabilizing financial imbalances.
Although Malaysia's inflation rate has stabilized with the diminishing impact of higher utility and energy costs, the central bank expects inflation to edge higher in 2015 - after remaining stable for the rest of 2014 - and to be above its long-term average of 3.2 percent due to domestic costs.
Mitigating these upward pressures are an absence of external price pressure and moderate demand.
Malaysia's inflation rate rose to 3.3 percent in August from 3.2 percent in July and 3.3 percent in June.

Malaysia's economy has been supported by continued growth in domestic demand and exports and its Gross Domestic Product expanded by 1.8 percent in the second quarter from the first quarter for annual growth of 6.4 percent, up from a rate of 6.2 percent.
"Going forward, domestic demand is expected to moderate but remain the key driver of growth," the bank said, adding that private consumption is expected to moderate while investment will remain robes and exports will benefit from the recovery in advanced economies and regional demand.
"The prospects are for the Malaysian economy to remain on a steady growth path," BNM said, adding its expects the global economy to expand at a moderate pace with growth in Asia supported by expansion of domestic demand and an improved external environment.

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