Bond Bulls May Yet Have Reason for Cheer

The bond-market limbo act goes on. At the start of 2011, bond-fund giant Pimco bet against U.S. Treasurys when the 10-year note was yielding about 3.3%. But Treasury yields ended the year under 2%, along with yields on German and U.K. government bonds, extending further a 30-year bull market for bonds. There might be further to go yet.

Central-bank bond purchases, known as quantitative easing, will play a part. While earlier rounds of QE pushed up yields on hopes that this would support recovery, repeat operations may have diminishing effects. In the U.K., yields have continued to fall despite a new £75 billion purchase operation. The Bank of England is widely expected to increase that program early this year, and many speculate that the U.S. Federal Reserve may engage in a third round of QE. Former European Central Bank board member Lorenzo Bini Smaghi has suggested that even the ECB could make use of the policy if monetary conditions demand it.

Such central-bank purchases may coincide with a reduction in the stock of securities still regarded as "safe" due to potential ratings downgrades in the euro zone. That could have a dual effect. Yields could be kept down as investors question the effectiveness of QE in generating economic growth. But buyers who have little choice about investing in bonds due to regulation may be forced to compete with central banks for paper.

Banks are being required to hold greater liquidity buffers. Central-bank reserve managers, particularly from Asia, are likely to remain core buyers of government debt. And despite deep concerns about the euro, many investors within the currency bloc have no choice but to invest in euro-denominated bonds. Even those struggling with the effects of low yields, such as pension funds, need to match assets with liabilities. Rather than shunning low-yielding bonds in countries like the U.K and Germany, funds that expected yields to rise may be forced to accelerate purchases to reduce the mismatch in their portfolios.

Many advanced economies are entering a multiyear period of paying down debt. That will likely weigh on growth and on domestic inflation, as it has in Japan, boosting the allure of government bonds over risk assets. This process may cause periodic outbreaks of panic about banking systems, as in 2011, driving yields lower. As the panic fades, yields may rise—but so far, they have risen to a lower peak each time.

This environment also creates a challenge for governments. Germany in November saw investors balk at buying new 10-year bonds at yields below 2%. But with two-year bond yields anchored at 0.3% or below by zero interest-rate policies, investors will have to buy longer-dated bonds to generate any return.

That means long-dated yields could go lower and for longer than many thought possible. Just look at Japan, where 10-year yields ended 2011 at 1%.

Source: http://online.wsj.com/article/SB10001424052970203550304577138101578099224.html?mod=WSJ_Heard_LEFTTopNews

Gold: Haven turns riskier but retains its appeal

Bewitched, bothered and bewildered – that is how many gold bulls have felt in recent months. As the eurozone crisis has ratcheted up to fever pitch, their beloved precious metal – supposedly a haven against precisely this sort of financial market turmoil – has barely budged in price.

Since mid-October, gold has traded in an uninspiring range of roughly $1,650-$1,750 a troy ounce.

More worryingly for its supporters, the metal appears to be moving more closely in line with risky assets such as equities and emerging-market currencies than other havens such as US Treasuries.

“There has been a lot of disappointment with gold in the fourth quarter, especially from those who were banking on the metal’s safe haven properties, given the escalating situation in Europe,” says Edel Tully, precious metals strategist at UBS, the Swiss bank, in London.

The problems began in September. After hitting a record of $1,920 early in the month, gold collapsed 20 per cent in a matter of days. It was the metal’s sharpest weekly fall since 1983.

The plunge came amid a broader market sell-off, surprising some investors who had assumed that holding gold could act as a form of insurance against bullish positions in other commodities or equities.

The reason for the sharp fall was simple: as investors were rapidly losing money on other positions, they sold their gold to raise cash.

However, it caused investors to question gold’s claim to be a “safe-haven” asset. The metal’s case has not been helped in the months since, when gold has tended to rise as risk appetite rises, and fall when risk appetite wanes.

The dominant theme has been a “dash for cash”.

Most prominent among the investors forced to sell was John Paulson, the hedge fund manager who shot to prominence with an enormously profitable bet against the subprime mortgage market during the financial crisis.

Over the third quarter, Mr Paulson’s fund sold more than a third of its holdings of the SPDR Gold Shares exchange traded fund, equivalent to about 34 tonnes.

Elsewhere, European banks have been using their gold holdings to raise cash amid a widespread shortage of dollars in the region.

Dealers say that banks – primarily in continental Europe – have been actively lending gold in the market in exchange for dollars. The move has pushed gold lease rates – the implied interest rate for lending gold in the market in exchange for dollars – to record lows.

The one-month gold lease rate in December hit -0.57 per cent, suggesting that a bank lending gold for one month would have to pay to do so, at an annualised rate of 0.57 per cent.

“Gold is a function of liquidity,” says Walter de Wet, head of commodities research at Standard Bank. “Certainly there has been a lack of liquidity, particularly in the interbank market in Europe. That is putting a drag on gold.”

But while investors are feeling bruised, few are ready to call time on bullion’s decade-long rally.

“Commodity hedge funds are still involved in trading gold. It is still a popular trade,” says Fabio Cortes, manager of a commodities fund of funds for Oakley Capital, the private equity firm in London. Of the metal’s safe haven appeal, he adds: “It hasn’t lost it – it has been reduced to some extent.”

Indeed, the fundamental drivers of the surge remain in place. Central banks are buying record quantities of the metal. The so-called “official sector” bought 364 tonnes of gold in the first three quarters of this year, according to data from Thomson Reuters GFMS, the precious metals consultancy, compared with sales of more than 400 tonnes a year in the decade to 2009.

Moreover, Chinese demand is increasing rapidly as Beijing deregulates the country’s gold market.

Chinese imports of gold from Hong Kong have hit record levels in recent months, and the country is on track to more than double imports from last year.

Matthew Turner, precious metals strategist at Mitsubishi, the Japanese trading house, argues that the crucial determinant of whether gold lives up to its safe-haven billing is whether investors fear inflation.

“At different times investors seek different safe havens. During equity market crashes, investors tend to seek safety in the dollar, or bonds, and only sometimes gold,” he says. “Other financial panics might involve investors selling government bonds or fleeing the dollar due to rising fears of inflation. In these scenarios, gold can outperform.”

This suggests the trigger for gold’s next move is likely to be the actions of central banks – particularly the European Central Bank, which many investors believe will be forced to provide a backstop to the eurozone by more aggressively intervening in the sovereign bond markets.

In the second quarter of 2010 and the third quarter of this year – the two moments when the ECB moved to expand its bond-buying activities – gold demand jumped.

For next year, the ECB is likely to be the key to gold’s performance.

As Ms Tully predicts, if the ECB were to embark on a policy of quantitative easing, it would have “explosive implications for gold”.

Source: http://www.ft.com/intl/cms/s/0/6e68b5e2-24d9-11e1-8bf9-00144feabdc0.html#axzz1i2iwpKa6

Forex traders hunt for fresh havens

Investors looking for havens from the eurozone crisis have had a frustrating year.

Central banks in countries that have attracted people trying to seek shelter in their currency have sent a firm message: only a limited number of investors are welcome here.

That has left investors hunting for havens outside the US dollar, which has attracted huge inflows this year from those looking for somewhere liquid to park their cash.

But analysts say that there are fresh haven opportunities in 2012. They point to the Norwegian krone and the Canadian dollar as among those currencies that could do well in times of market stress.

New currency havens next year would be welcomed by investors who have this year found themselves thwarted by unexpected foreign exchange interventions.

For the first half of the year, the yen and the Swiss franc were seen as ideal. Haven currencies – also referred to as “hard” currencies – are usually those that are backed by stable governments and economies. Strong exports and current account surpluses, which Japan and Switzerland possess, are key factors as they are likely to shore up demand for a currency.

But following the market turmoil over the summer, the demand for the yen and the franc grew so high that the Swiss National Bank and the Bank of Japan took steps to weaken their respective currencies.

Alarmed by the rate at which foreign money was flooding in from investors concerned about the escalating eurozone crisis, the Bank of Japan embarked on its biggest monthly foreign exchange intervention in eight years in August. That sent the yen, which had risen more than 5 per cent against the dollar since January, tumbling nearly 5 per cent in one day.

The move was welcomed by the country’s exporters, who had been complaining that a strong yen was harming trade. But foreign investors were undeterred. The central bank sold more yen on October 31 after the currency hit its strongest ever level against the US dollar.

Then, on September 6, the Swiss National Bank said it was prepared to buy euros in unlimited quantities to weaken the Swiss franc, effectively pegging its currency to the euro. Markets opted not to test its resolve.

Investors instead began looking for the next best haven. Some have pointed to Norway, a big oil exporter with a current account surplus.

Indeed, HSBC’s currency analysts argue that the krone is “in a league of its own” against other G10 currencies due to Norway’s strong economic fundamentals.

But others have raised concerns over liquidity. Investors this year have prioritised liquidity above most other factors, fearing that any “lock down” in markets will leave them unable to get their cash out quickly and return it to shareholders or other investors. That explains why the US dollar has been the ultimate haven this year.

Trade in the Japanese yen accounts for 19 per cent of the $4tn a day foreign exchange market. Trade in the Swiss franc is more than 6 per cent. In the krone it is just 1.3 per cent, according to the latest data available from the Bank for International Settlements.

“The main problem is finding something that has all the constituents of a safe haven,” says Simon Derrick, currency analyst at BNY Mellon. “The thing that everyone forgets is liquidity.”

The pound is another contentious haven. Sterling has tended to strengthen this year when the euro weakens, as the UK economy has looked in better shape than that of the eurozone. But if the outlook for Europe deteriorates significantly, the UK is very exposed through its trade links. That has led some to label the pound a “bogus” haven.

Others believe the Canadian dollar could come to the fore. The so-called “loonie” is backed by a politically stable country, with large reserves racked up by the central bank. On the downside, it is traditionally referred to as a commodity currency because of its oil exports, making its performance closely tied to that of the global economy. Its strong trade links with the US also make it susceptible to any weakening in the US economy.

However, Simon Derrick, currency analyst at BNY Mellon, argues that those who believe the US dollar will be a decent haven next year should consider diversifying into the Canadian dollar, as that should rise against other major currencies if the US dollar does well.

Investors hopeful of less government intervention to weaken currencies next year could be disappointed. The SNB believes the franc is still significantly overvalued. Many analysts believe the central bank will still adjust the ceiling at which it will buy euros to weaken the franc again next year.

The Bank of Japan is also widely expected to take further action, though in the past intervention has not managed to weaken the yen for more than a few days due to the vast size of the market. As a result, many analysts still believe the yen will be a key haven next year.

But most agree the US dollar will remain the least contentious haven for 2012. “The anticipated relative outperformance of the US economy, especially if continued to be supported by fiscal and monetary policy, is expected to provide continued support for the dollar in the coming year. We maintain our view that the dollar and the yen will be the top performers among the G10 in 2012,” says Morgan Stanley.

Source: http://www.ft.com/intl/cms/s/0/3fc72532-2d78-11e1-b985-00144feabdc0.html?ftcamp=rss#axzz1i2eOMioF