Trying to Build on Broken Foundations

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Publisher’s note: Brand new Slipstream Trader market update video – just uploaded and free to watch on YouTube

In this week’s overview Murray Dawes looks at a few different scenarios that could arise out of a momentary impasse in the US S&P500. He points out where there’s resistance in the chart… and highlights where there could be “some great sell signals” coming up. He also gives his view on what the coming European rescue package could mean for buyers and opportunists… To get Murray’s insight ahead of the crowd – for free – just go here

From Greg Canavan in Sydney:

— Despite signs of a deteriorating global economy, markets continue with a ‘cautiously optimistic’ theme. Stocks sold off slightly in the US overnight but there was no sign of reality-based trading going on. The volatility and fear is seeping out of the market as traders bet on some sort of miracle play coming out of Europe.

— Australia’s response looks a little more realistic with stocks down around 1 per cent at midday. The China slowdown is having an effect. More on that below.

— In a sign that the elites have absolutely no idea what to really do about the Euro debacle, the latest concoction to save the Eurozone as we know it is to have the big ’emerging’ economies of China and Brazil buy IMF bonds.

— The idea behind this is to boost the IMF’s firepower in helping to bailout bankrupt European nations and banks. The Europeans don’t have the resources to bail themselves out so they’re recruiting the emerging economies to contribute.

— If this sounds insane, it is.

— The German constitutional court has made it clear… attempts to leverage the European Financial Stability Facility (EFSF) will be thwarted. That leaves the EFSF insufficient moolah to plug all the holes in European sovereign finances.

— To get around this, the IMF is now talking about setting up its own SPV (special purpose vehicle) or just getting poor countries to buy IMF-issued bonds. Then the IMF could use the funds to contribute to the Eurozone bailout.

— It’s all a charade of course. It’s just a way of making it look like the poor emerging economies are not subsidising ‘wealthy’ Europe’s failed welfare system. They’re buying ‘solid’ IMF bonds, not Spanish or Italian obligations!

— You may be interested to know the head of the IMF, Frenchwoman Christine Lagarde, met with French President Nicolas Sarkozy in Paris on the weekend. No doubt Sarkozy told her the French government was in no position to bailout its insolvent banks because in doing so, it would lose its prized AAA credit rating.

— We’re sure he also made it clear the Germans weren’t keen on contributing to a French bank rescue. So he’s told her to get on the case and sort something out pronto. Enter the ‘poor bailing out the rich’ plan.

— This whole euroshow grows more farcical by the day. Yet the markets hold up in the hope that something will be worked out. They’ve got about three weeks to come up with a watertight plan. Apparently the G20 meeting in Cannes on the weekend of 4-5 November will be the big reveal.

— Perhaps the market thinks the end of current European Central Bank chief Jean-Claude Trichet’s reign, in a few weeks’ time, might be decisive. Mario Draghi, former Goldman Sachs banker and current head of Italy’s central bank, will take over as new ECB head.

— It doesn’t take much imagination to believe that an Italian and former investment banker will have much more inflationary tendencies than the conservative Trichet. But there is still a limit over what he can do.

— Chances are, in addition to scrounging up as much cash as they can, the elites are busy re-writing the rules to avoid economic and financial reality. They’ll try to engineer a Greek default without calling it a default, so as not to trigger all the insurance claims that come with it.

— The market might like such alchemy in the short term. But everything that has occurred since the credit crisis got underway in 2008 has shown that avoiding reality now only leads to bigger problems later.

— In a sign that everything in the world is connected, new data out shows growth in China’s trade slumped in September to its lowest level in seven months. Europe is China’s largest trading partner. Exports to the eurozone grew just 9.8 per cent year on year in September, down from 22 per cent growth in August.

— Determined China bulls will say that still represents pretty decent growth. But it’s the speed of the growth that matters. And it’s slowing down.

— Year-on-year import growth – important for Australia’s commodity producers – slowed from 30.2 per cent in August to 21 per cent in September. That’s a pretty dramatic slowdown.

— Not that you’ll see any of this concern flowing through to Australia’s miners just yet. Yesterday, Rio Tinto released a pretty bullish quarterly production report. Head honcho Tom Albanese said, ‘While we are mindful of current market volatility, the fundamentals are holding up well, particularly for bulk-traded commodities’.

— Thank goodness for the bulks – iron ore and coal. According to the Financial Review, Rio’s iron ore division is expected to account for around 80 per cent of total earnings this year. That’s partly due to the poor performance of the copper division, which will produce around 35 per cent less than it did last year. Still, that’s a massive dependence on iron ore.

— But what has and is happening in the world of commodities gives no clues as to what will happen. Mr Albanese should be all too aware of that. He brought RIO to its knees in 2008 by failing to see any of the credit crisis coming.

— Nor did many others in the commodity space. That’s because focusing on price only can be very misleading. The chart below shows the CRB Commodity Index (red line) and the All Ordinaries Index (black line) from November 2007 (the stock market peak) to the end of 2008.

— As you can see, while the market was heading into a downtrend, commodities were powering higher. In fact, commodity markets peaked in July 2008, eight months after the equity market topped out.

$CRB chart
Click here to enlarge

— Financial crises are strange beasts. They lure people into thinking that it’s a crisis limited to the banking and financial sectors. But over time they spill over into the real economy, which then flows into commodity markets.

— So don’t take heart from the comments of mining executives. They won’t see the truck until it’s bearing down on them at 100 km per hour.

— See this impending slowdown for what it is. It’s the result of trying to build a global economic recovery on a broken foundation. Those brought in to fix the problem are both corrupt and blind to the foundations’ defects. They’ll keep attempting to build another structure on top, until it collapses completely.

Greg Canavan
for The Daily Reckoning Australia

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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2 Comments on "Trying to Build on Broken Foundations"

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Patrick Donnelly
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The collapses before the final one, will set stock exchanges back.

The final one may see the ASX drop massively as foreign investors have to pay off all their loans. They have invested in the ASX because it is better there than everywhere else, bar commodities directly.

Massive amounts of so called capital have to be sucked back into the banking ‘system’! Just heads up!

Ross
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