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Bill Gross’ bet on "the New Normal"

Bill Gross is buying long-term government treasuries and he expects slower growth and low interest rate in coming years (source: Bloomberg).

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said he’s been buying longer maturity Treasuries in recent weeks as protection against deflation.

“There has been significant flattening on the long end of the curve,” Gross said in an interview from Newport Beach, California, with Bloomberg Radio. “This reflects the re- emergence of deflationary fears. The U.S. is at the center of de-levering as opposed to accelerating growth.”

Gross had said during the midst of the credit crunch that Treasuries offered little value as investors seeking a refuge from turmoil in global financial markets drove yields to record lows in December. He boosted the $177.5 billion Total Return Fund’s investment in government-related bonds to 44 percent of assets, the most since August 2004, from 25 percent in July, according data released earlier this month on Pimco’s Web site. The fund cut mortgage debt to 38 percent from 47 percent.

“We’ve exchanged our mortgages for the government’s check” as the Federal Reserve winds down purchases of agency debt, Gross said today. “Mortgages are expensive compared to Treasuries and other vehicles.”

Fed policy makers last week committed to complete their $1.45 trillion in purchases of mortgage securities and extended the end of the program to March from December.

Policy Reversal

Pimco’s Total Return Fund handed investors a 17.85 percent gain in the past year, beating 94 percent of its peers, according to data compiled by Bloomberg. The one-month return is 1.94 percent, outpacing 57 percent of its competitors. Pimco is a unit of Munich-based insurer Allianz SE.

Pimco in July reversed a policy to steer clear of U.S. debt when it said it would buy five- to 10-year Treasury securities.

“With Treasury yields near the top of our expected range, Pimco plans to overweight duration and take exposure to the five- to 10-year portion of the yield curve,” the firm said July 20 in a report on its Web site.

On that day, the yield on the 10-year note touched an intra-day high of 3.72 percent and a low of 3.57 percent. The note yielded 3.29 percent at 10:36 a.m. today in New York.

Gross said intermediate- to long-term bonds will perform well as long as policy rates and inflation remain low, after minutes of the Federal Open Market Committee’s Aug. 11-12 meeting was released on Sept. 2.

‘New Normal’

Officials at Pimco have forecast a “new normal” in the global economy that will include heightened government regulation, lower consumption and slower growth. The economy will likely expand at a 2 percent to 3 percent rate going forward, Gross said.

The world’s largest economy shrank at a 1.2 percent annual rate from April to June, more than the originally reported 1 percent contraction, according to a Bloomberg News survey before the Commerce Department’s Sept. 30 report. The jobless rate climbed to 9.8 percent this month, from 9.7 percent in August, according to a separate Bloomberg survey before the Labor Department reports figures on Oct. 2.

Michael Mussa: US economy will have a sharp rebound

Michael Mussa is a no-nonsense economist. It’s always good to hear him.

Mussa offers some insights of why he thinks US economy will have a rapid recovery. He expects annual growth rate to be 4.5% and accumulative growth rate from now to the end of 2010 to be 6.8%, both substantially higher than the blue-chip forecast.

Mussa’s forecast largely based on the observation that the sharper the economy falls, the steeper the economy will come back. This statistical behavior of business cycle is shown in the following graph and also documented in my previous post.

Mussa’s forecast still left many questions unanswered: Should we simply rely on a historical statistical pattern to make our economic forecast? We know every recession is different; What if this Great Recession is so different that it will break this historical pattern.

Now I give you Michael Mussa (Source: PIIE, about 30 mins)

Rank 2009 market rally

Following my last post that looks at the current market rally in historical perspective, here is another update from FT.

Just admit it: most institutional managers simply missed the rally since March. Now in order to keep their jobs or get higher compensation, they have every incentive to get into the market even when the market is already overpriced.

This is one of the main reasons why we had bubbles in the first place: investment managers compete for portfolio performance with their peers — as long as the party is on, they will have to keep dancing.

I am afraid we are likely to head into another asset bubble.

(click to watch; source: FT)

The future of China’s exchange rate policy

Nicholas Lardy and Morris Goldstein, of Peterson Institute of International Economics, talk about the evolution of China’s exchange rate policy and the future.

Starts to watch from 3’30”.

Bet on precious metals

Source: WSJ

While gold is grabbing the headlines, its sister precious metals are actually reaping the most gains. For the year to date, platinum and palladium, two lesser-known metals, have surged 38% and 56%, respectively, far eclipsing gold's 12% gain. Silver is up 42% over the same period.

[platinum prices]

With their dual roles as precious and industrial metals, platinum and palladium are managing to profit from both sides of the debate over whether an economic recovery is on the horizon.

Platinum and palladium have a multitude of uses, with the auto industry taking about 60% of each metal's annual production for catalysts to reduce tailpipe emissions. Some bulls view the metals as a bet on economic recovery, and on the struggling automobile sector in particular.

Meanwhile, for those concerned about the fragility of economic conditions and the Federal Reserve's printing of money, some see the metals as a store of value like gold.

However, despite "cash for clunkers" programs around the world boosting vehicle sales, analysts still think auto makers' demand for both metals will decrease this year. Even with output likely to decline because vital South African mines are plagued with power shortages and labor disputes, both the platinum and palladium markets still confront the threat of a surplus.

[platinum market] 

One factor supporting prices is the growing appetite from exchange-traded funds that are backed by platinum and palladium. As investors speculate on commodities, the total amount of the metals held by six such funds — traded in the U.K., Switzerland and Australia — hit records last week, with about $1 billion in assets, according to Barclays Capital.

Of late, China may also have helped prop up the metals, with imports of platinum and palladium up 92% and 63%, respectively, in August from a year earlier, fueled by stronger demand from jewelers and auto makers.

Last year, Chinese jewelers and auto makers accounted for 16% of platinum's global consumption, according to metal refiner Johnson Matthey. China's jewelry demand for platinum is this year projected to exceed peak purchases seen in 2002, meaning a jump of 43% from last year, according to John Reade, a UBS metals strategist. However, real demand growth isn't strong enough to support such explosive imports, suggesting stockpiling.

With car makers in Detroit and elsewhere still facing weak sales, the rally in platinum and palladium seems to have gotten ahead of itself. Without the support of a sustainable rebound in industrial demand, prices could wane once stockpiling slows down. Any loss of faith in the strength of the expected global recovery would likely hurt the two metals a lot more than gold.

Why China must do more to rebalance its economy

Martin Wolf writes on FT that rebalancing its investment-skewed economy is in China's own interest.


China has had a good crisis. That became obvious at the “summer Davos” of the World Economic Forum, in Dalian, less than two weeks ago. Chinese confidence was palpable. But so was anxiety. The giant has survived the shock. But its recovery is driven by a surge in credit and fixed investment. In the longer term, China needs to rebalance its economy, by increasing consumption. It is time for the Chinese to enjoy themselves more. How unpleasant can that be?

The man who best captured both the confidence and the uncertainty was premier Wen Jiabao. He told the meeting that “the unprecedented global financial crisis has taken a heavy toll on the Chinese economy. Yet we have risen up to challenges and dealt with the difficulties with full confidence”. But he also admitted that the “stabilisation and recovery of the Chinese economy are not yet steady, solid and balanced”.

The data coming out of China suggest a powerful recovery is indeed under way. In the first half of the year, noted the premier, gross domestic product expanded 7.1 per cent. The September consensus forecasts suggest that the Chinese economy will expand 8.3 per cent in 2009 and 9.4 per cent in 2010. The Asian giant is expected to become the world’s second largest economy in 2010, even at market prices.

According to the Economist Intelligence Unit, domestic demand may expand by as much as 11.5 per cent in real terms this year. Such a surge in Chinese internal demand is exactly what was needed. Chinese household consumption is also forecast to grow 9.3 per cent (see chart). Yet, as usual, real fixed investment is the locomotive. It is forecast to grow 14.8 per cent this year. If so, it would have grown faster than GDP in all but one of the past 10 years. This rising ratio of investment to GDP, from an already high level, is not a strength but a weakness. It suggests declining returns on capital. It risks creating ever-rising excess capacity. Moreover, when growth rates finally fall, the collapse in investment is going to knock a huge hole in demand.

The heavy reliance on investment is not the only risk ahead. So, too, is the surge in credit and money (see chart). Many believe this is bound to lead to another upswing in bad debt and destabilising asset bubbles. The jump in the ratio of broad money to GDP is also worrying, coming after a long period of stability.

China, it appears, has saved itself. Has it also been saving the world?

The most encouraging development is the shrinkage of China’s current account and trade surpluses (see chart). Both exports and imports have fallen sharply, but exports have fallen further. Yet China’s trade has been so volatile (along with everybody else’s) that it is hard to be sure this will prove a turning point. Much will depend on the nature and pace of the global recovery. Moreover, the country will continue to run a substantial current account surplus and accumulate still more foreign currency reserves, even though they are already far larger than China needs for insurance purposes. After all, they reached $2,132bn (over 40 per cent of GDP) in June of this year.

That would be equivalent to official holdings by the US government of $6,000bn (€4,000bn, £3,670bn) all denominated in the currencies of other countries. It is little wonder such a huge exposure makes the Chinese government nervous. But nobody asked the Chinese to do this. On the contrary, US policymakers have consistently (and wisely) advised them to do the opposite. Having made what I believe was a huge mistake, the Chinese government cannot expect anybody to save them from its consequences.

A substantial appreciation of the Chinese currency is inevitable and desirable in the years ahead. The longer the Chinese authorities fight it, the bigger their losses (and the pain of adjustment) are going to be. What they have to do is cut those losses, by ceasing to accumulate yet more reserves. As Morris Goldstein and Nicholas Lardy of the Peterson Institute for International Economics argue, in an excellent recent study, the policies required to do this are also needed to help rebalance the economy in the long term.

It is important to understand how distorted China’s economy now is: in 2007, personal consumption was just 35 per cent of GDP. Meanwhile, China was investing 11 per cent of GDP in low-yielding foreign assets, via its current account surplus. Remember how poor hundreds of millions of Chinese still are. Then consider that the net transfer of resources abroad was equal to a third of personal consumption.

This is surely indefensible. The premier may even agree. In Dalian, Mr Wen remarked that “we should focus on restructuring the economy, and make greater effort to enhance the role of domestic demand, especially final consumption, in spurring growth”. An appreciation of the real exchange rate, ideally via a rise in the nominal exchange rate, would help. Not the least of the distortions of the current regime is the need to keep interest rates low, to curb capital inflows. This shifts massive amounts of income from households into corporate profits.

Whether China’s partners will raise the issue of exchange rate policy in Pittsburgh, at the summit of the G20, is, alas, unclear. The Chinese are probably powerful enough to prevent it. But President Hu Jintao will surely complain about US protectionism. I sympathise with him. I would sympathise far more, however, if China’s foreign currency interventions, combined with the sterilisation of their natural monetary effects, was not such a massive subsidy to its exports.

The big point for China is that, like it or not – and it is perfectly clear to even the casual visitor that many Chinese dislike it intensely – the explosive rise in trade and current account surpluses of the mid-2000s is an unrepeatable event.

The short-term rebalancing of this year, via a huge credit expansion and surge in fixed investment, is a temporary expedient. It must lead to a rebalancing of the Chinese economy towards consumption. This is in China’s interests. It is also in the interests of a better balanced world economy. If the successful response of this year leads in this direction, the crisis will have brought great long-term benefit.

“A crisis,” as they like to say in Washington these days, “is a terrible thing to waste.” They may be ungrammatical. But they are right – and not only for the US.

Julian Robertson: We put ourselves into this terrible position…

Julian Robertson, former hedge fund manager of Tiger Management, shares his insights about the future of the US economy. He repeated this many times, “Our leadership failed and put ourselves into this terrible position that if Chinese and Japanese don’t buy our bonds anymore, we are doomed…interest rates could easily go up to 15-20%.”

The excess had been building up over the years and reached to such a unsustainable level (see the graph below); It’s hard to imagine how the US economy could get back on track without a serious sacrifice from the US consumers.

The efforts of government and the Fed to prop up the economy through printing money and more government debt are just trying to stop the pain for a short while. It’s delusional to think we will get over this and get back to party again.

Watch this interview from CNBC:

One thing Robertson didn’t mention is: If Chinese stop buying US bonds, where can they put their money? At least I don’t see China has that figured out. Not yet.

Peter Schiff: Gold could hit $5,000

I am not as bold as Peter in predicting Gold price, but I think there is a good chance that gold price will go even higher than today, either because we will have a surge in consumer price inflation when the economy snaps back quickly, or we’ll have an asset bubble, most likely in all kinds of commodities, even when the economy still remains slack. The latter is a more likely scenario.