Sunday, July 31, 2011

Weekly Newsletter: Flight To Safety

Flight to Safety

Saturday, July 30, 2011

Currencies: Swiss Franc Love Is Everywhere

While the US Dollar Index remains above its 2008 lows, the Safe Haven currencies like the Japanese Yen and the Swiss Franc are close to or already hitting all time records. While looking at the chart above, one of my friends instantly said - "this is capitulation". I couldn't agree more...
Such is a love affair with these currencies that when I did a Google Trends search for "Swiss Franc", I noticed that the results of both the search volume as well as news references are also at an all time high, just like the price.
Extremely overbought on RSI in both the daily, weekly as well as monthly readings; much higher than two standard deviations above its 50 day moving average, extremely far from its 200 day moving average; 20 year highs in extreme bullish sentiment surveys; record volume readings on Google Trends; and parabolic price rise are amongst the reason I think Swiss Franc bullish trend is about to enter a very powerful correction. This is the most overcrowded trade in the financial markets right now!

Friday, July 29, 2011

Speculators Love The Franc & The Yen!


US Political Jokes, Gimmicks & Games


July 29 (Bloomberg) -- Futures on the Standard & Poor’s 500 Index dropped, indicating U.S. stocks will open lower on Friday, after chief U.S. House of Representatives vote counter Kevin McCarthy said there will be no vote on Speaker John Boehner’s debt-limit plan tonight.

S&P 500 futures expiring in September dropped as much as 1.1 percent in 4 minutes after McCarthy’s comments. The contract was trading 0.6 percent lower at 1,289.1 at 11:46 a.m. in Tokyo.

Centrals Banks vs Inflation



Source: Merrill Lynch Newsletter

Emerging Markets Relative To Developed Markets


Source: Citigroup Newsletter

Wednesday, July 27, 2011

The Grid Update

Cotton continues to remain the worst performer over the last 52 weeks, down over 50%. For those who have been following my blog, would know that I remain bullish on Cotton due to this reason amongst others. Currently, bearish sentiment is extreme and as of last night Cotton price put a outside reversal day, also known as a bullish engulfing candle at a very very oversold level. In the last two days, the price has staged a 9% rally so far.

I also have been a fan of Wheat and Silver, as already noted in previous posts, both of which have so far bounced of its lows. Silver has posted one of the strongest rallies since majority of the markets bottomed in late June 2011.

To the contrary, I have been noting for awhile that Gold's bullish COT positions, newsletter sentiment and ETF fund flows are very reminiscent of dumb money piling in. If Gold was to go down, Silver could follow. During that outcome, I plan to buy much more Silver, as the price will go much much higher during the course of this secular bull market.

Even though it might be early, one should also start looking at Coffee as a potential investment/trade, as the price is currently down almost 23% now. Sentiment on Coffee is reaching bearish levels as well, while speculators on the Commitment of Traders data shows rapid cuts in bullish net long contracts. All in all, majority are now being shaken out of the Coffee bull market. However, the price might drop a bit more, so stay patient here.

Swiss Franc At Extremes!

Sentiment is now extremely bullish on almost all safe haven assets, like the Japanese Yen and the Swiss Franc. Gold as well as Treasury Long Bond also fall into this category. All sentiment indicators I follow and look at, read extremely bullish levels for both the Yen and the Franc. As a matter of fact, when grouped together, the cumulative sentiment on these two safe havens is at one of the most extreme levels in over 20 years!
Therefore, I would be very very cautious to blindly bet against the US Dollar, when it comes to the Yen or the Franc right now. Both of these currencies have had an amazing run in the last 12 months or so. As a matter of fact, right here I would be looking for a unwinding and a potential reversal of these safe haven trades.

Personally, I am going to enter short Swiss Franc. Every single man and his dog on CNBC or Bloomberg is fascinated by the Swiss Francs appeal right now. Markets reasoning has been that the Swiss Franc cannot lose...
...because according to the consensus chit-chat on Bloomberg or CNBC, if the Greece defaults, Franc will gain, if Italy defaults, Franc will gain, if EU breaks up and Euro crashes, Franc will gain, if US defaults next week, Franc will gain, if North Korea attacks the South, Franc will gain, if Saudi Arabia has an uprising, Franc will gain, if the economy does not recover, Franc will gain and the Franc will rally during "Risk On" as well as "Risk Off" environments.
This is one of those times where the fear has completely gripped the market about some or all of the following:
  • Quantitate Easing 3
  • Federal Reserve ZIRP (Zero Interest Rate Policy)
  • Global Economic slowdown
  • Libyan & MENA Turmoil
  • Japanese Earthquake
  • European Debt Crisis
  • US Debt Default
  • Any other excuse to buy the Franc!
As I always say, when its obvious to the public, its obviously wrong. Almost everyone believes the Franc has only one way to go. When majority are on one side of the boat, almost always its much better to take the other side. Finally, I would expect riskier assets like stocks and/or commodities to stage at least a bit of a rally here, due to the unwind of capital which is currently parked in the safe haven space!

Swiss Franc Long Term Chart

Tuesday, July 26, 2011

Treasury Long Bond Secular Bull Market

Everyone is focused on The Bernank, the Fed and the ZIRP - zero interest rate policy. However, traders and investors who focus on the Federal Reserve are once again failing to realise that the Fed is always behind the curve. Yes, they are keeping rates at record low levels and yes, that is keeping interest rates from rising. Does that mean we should keep buying Treasuries?
In my opinion, definitely not. The secular low in the Long Bond - yes the one that The Bernanke cannot manipulate. Therefore, the Long Bond is where market participants should focus on, and after a long bull market of 30 years since 1981 (first chart), in my opinion, the secular panic low is now in. The panic buying of Treasuries during the aftermath of Lehman Brothers forced every single man and his dog into the Long Bond, creating a huge blow off top. For the next 30 years or so, according to the Kondratiev Cycle, interest rates will rise much much higher from here... more than most expect it too!

Silver Secular Bull Market

In the last secular bull market from middle of 1960s to 1980, Silver went up 40 times, from $1.25 or so towards $50.00 in a final blow off top.

After a 20 year decline towards 1999, Silver finally bottomed once again and started a new secular commodity bull market. The bottom occurred at $4.00, so if we were to follow the old multiplier effect, would could make an assumption that Silver could once again go up 40 times and trade at $160.

I guess time will tell, but prices around $40 still remain 20% below the old high set in 1980. In other words, Silver still offers value and the price will still go much much higher as already written back on July 09th in an article called Investors Should Stick With Silver [and other commodities].

Monday, July 25, 2011

Gazprom Could Be A Buy Here!

I was looking at one of my favourite companies today and noticed a high probability setup when it comes to technical formations. Now, do not get me wrong, I do not just buy any company on technical setups like these, so a lot more thinking process comes into it.

For those who read my blog, they should already know I am very very bullish on commodities in the long run - secular bull market. Therefore, I am also bullish on commodity companies around the world, which stand at making large amounts of profit as commodity prices rise in the future. And we should all know that in the long run, it is earnings that drive prices. So lets get into a bit of a background on Gazprom thanks to Wikipedia:
Gazprom is the largest extractor of natural gas in the world and the largest Russian company. Gazprom was created in 1989 when the Ministry of Gas Industry of the Soviet Union transformed itself into a corporation, keeping all its assets intact. The company was later privatized in part, but currently the Russian government holds a controlling stake.

In 2008, the company produced 549.7 billion cubic metres (BCM) of natural gas, amounting to 17% of the worldwide gas production. In addition, the company produced 32 million tons of oil and 10.9 million tons of gas condensate. Gazprom's activities accounted for 10% of Russia's gross domestic product in 2008.

The major part of Gazprom's production fields are located around the Gulf of Ob in Yamalo-Nenets Autonomous Okrug in Western Siberia, while the Yamal Peninsula is expected to become the company's main gas producing region in the future. Gazprom possesses the largest gas transport system in the world, with 158,200 kilometres of gas trunk lines. Major new pipeline projects include Nord Stream and South Stream.

The company possesses subsidiaries in many different industry sectors, including finance, media and aviation. In addition, it controls majority stakes in various companies. Gazprom is publicly traded at stock exchanges as RTS:GAZP, MICEX:GAZP, LSE: OGZD, FWB: GAZ and OTC:OGZPY.
Before I continue, I would like to state that I own this company already under the OGZD pink sheet traded on the LSE (London Stock Exchange).
Looking at the daily chart above we can see that the price of Gazprom is currently consolidating in a triangle. Triangle consolidations are one of my favourite ways to enter a trade / investment, because I see them a pressure points. In other words, a consolidation like the one above is where bulls make higher lows and bears make lower highs. Eventually the pressure builds and a decision point comes. When the price breaks into a certain direction, majority of the time it tends not to be a false break out.
On the weekly chart we can see that the price is currently siting above its previous resistance at $13 and also bouncing of its bullish trend line. When RSI goes very quite like it currently has, it usually means it is a period of low volatility and indecision. In other words, something big is about to happen.

Markets tend to move in cycles of high volatility and low volatility. Studies have shown that a period of high volatility usually signals the end of a trend. On the other hand, low volatility usually signals the calm before the storm or the calm before a breakout in the share price and the beginning of a new trend. Therefore, periods of high volatility are usually followed by a period of low volatility and periods of low volatility are usually followed by a period of high volatility.

One of the reasons I would be buying this break out and not selling is because Gazprom is still down 17% since its recent high in April at $17.50 and is also down 55% from its 2008 peak at $30.40! So therefore, there is still a lot of value here.
Another reason I would be a buyer rather than a seller is because Gazprom is influenced by Russian Natural Gas prices, which are currently depressed when compared to their 2008 lows. As already stated numerous times, it is my opinion that all commodities, not just energy commodity prices, will go much much higher due to Asian demand and limited supplies.
With the reduction of reliance of Coal, China is moving towards more cleaner types of energy. One of these is Natural Gas, and Gazprom is in the perfect position as well as location to deliver on this huge appetite. But this is obvious strong fundamental outlook in the long term, while we are looking at a potential trade in the short to medium term, which could turn into a whole new up trend for all we know.
With winter in the Northern Hemisphere around the corner (the Summer is more than half way through now), we should note that Gazprom sales and therefore revenue is about to pick up from customer all over the world, including Western Europe and certain parts of Asia.
Furthermore, Gazprom balance sheet is in a very pristine condition. Its Capex level stands at 88% of its operating cash-flow, while its operating cost per barrel of energy is the lowest of all Russian energy companies. Therefore, high capital expenditure creates growth, growth creates revenue, and low costs turn majority of the revenue into profits.
No matter how you value energy companies, Gazprom's valuation is remarkably cheap. The standard method of valuing any company is a P/E Ratio - price to earnings ratio. In terms of these financial multiples, Gazprom remains one of the cheapest stocks in the energy sector, with P/E ratio sitting at 4.5. This is much much cheaper than companies like CNOOC, PetroChina, Sasol, Petrobras and Rosneft - which are all great energy companies. However, energy companies can also be valued in terms of reserves. Here too, Gazprom is also one of the cheapest stock in the energy universe.

Mark Mobius, smartest of smart money, taught by the man himself John Templton, is also a huge owner of Gazprom. Mark is currently in-charge of Temploton Emerging Markets Fund managing $50 billion in assets. This is what he said last week in regards to his investment thesis:
"Russia is at the top of our investment list these days, resources companies and the oil companies in particular", Mobius said, speaking to Investment Week.
The manager of the $50bn Franklin Templeton Emerging Markets fund said companies such as miner Norilsk Nickel, financial institution Sberbank and natural gas giant Gazprom were particular favourites within his portfolios!
Buying value on cheap is a smart way to invest - that is for sure! So when we look at the valuation of the company, depressed price, technical setup in both daily and weekly time frames, large reserves / stockpiles, and great strategic location being next to Asia including China - it should not be a surprise that Mark Mobius, one of the greatest investors of our time, own a large position in Gazprom!

Investors Raise Bullish Commodity Bets

Bloomberg reports better than I could:
Funds boosted bets on rising commodity prices by the most in almost a year on speculation that the global economic recovery will prove resilient. Speculators raised their net-long positions in 18 commodities in the week ended July 19, government data compiled by Bloomberg show. That’s the biggest gain since early August. Bullish silver holdings climbed to the highest since May 3.

Saturday, July 23, 2011

"Dumb Money" Piling Money Into Gold

According to the SPDR GLD electronic traded fund (ETF), retail investors poured in another $900 million this week into the Gold ETF, on top of last weeks inflows of $3.3 billion. The 4 week inflows stand at almost $6.5 billion, which is 11.3% of the fund. This is the largest monthly inflow since May 2010. Comparing that to the start of July, where GLD ETF held $57.47 billion in assets, we can see that retail investors continue to pile in.
On top of that, Hulbert Gold Sentiment Index stands at 67% bullish exposure and is starting to approach the extreme levels of 70% we saw earlier in May, when Gold dropped from $1577 to $1462 in a matter of days. On top of that, Gold speculators tracked by Commitment of Traders report, showed that contracts increased from 157,775 three weeks ago, to 219,297. That is almost a 40% increase and the highest level since December 2010, when Gold topped at $1432.
One positive aspect Gold has behind the current rally is that seasonality tends to be very positive during August and September. Both months tend to be positive at least 80% of the time since 1980s, with September positive 97% of the time.
Finally, for those who haven't read it already, I looked at the current bull market in Gold last week, coming to the conclusion that after 11 straight annual gains, a correction should be in the cards sooner rather than later. Obviously, this correction should represent a great buying opportunity.

Friday, July 22, 2011

Sentiment: Government Bond DSI


Source: Barclays Capital Newsletter

Merrill Lynch Fund Managers Survey - July 2011

Tail Risks
Fears over sovereign debt have fueled the highest level of European economic pessimism since depths of the credit crisis. Nearly two-thirds of the panel identified EU sovereign debt funding as the number one tail risk (64% compared with 43% in June). A net 22% of respondents to the Regional Survey expect Europe’s economy to weaken in the coming 12 months – the most negative reading since April 2009. European investors have sharply reduced positions across many sectors, but the most eye-catching position is in banks. A net 57% of the European panel is now underweight banks (versus 33% in June), leaving the sector at its lowest ebb since February 2009, just before the major low.

Monthly Question
As sentiment improves, desire for a third round of quantitative easing (QE3) remains low – 40% of respondents said in July that they are not expecting QE3. But 48% of the panel says that QE3 will be necessary if the S&P 500 falls by 20%. “Our question about QE3 this month shows that investors don’t want policy makers to panic now – but many expect the Fed to apply QE3 if the S&P 500 falls below 1,100,” said Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research.

Equities
A net 35% of asset allocators were overweight equities in July, up from a net 27% in June. While July’s survey shows that appetite for global equities rose, it also suggests that the desire to invest has been constrained by poor trading conditions. The BofA Merrill Lynch Risk and Liquidity Composite indicator remained stable at 38 – a little below the average risk benchmark of 40.
Cash holdings ticked downwards to 15% from 18% in June, while the overall level of risk increased, although it remained below average. Mean cash balance readings fell from 4.2% in June to 4.1% in July. A net 21% of the panel is taking below average portfolio risk relative to their benchmark, compared with a net 26% in June. Hedge fund activity also suggests a positive to neutral take on risk. According to the survey, hedge funds have increased their gearing levels but marginally lowered equity exposure, which means hedge fund managers are making fewer bets with increased levels of confidence, according to Partik Schowitz, equity strategist with BofA Merrill Lynch.
Sentiment towards GEM and Japan improves as the Eurozone suffers, Japan and Global Emerging Markets are the regions with the greatest positive sentiment momentum. A net 33% of asset allocators were overweight Global Emerging Markets (GEM) equities this month, a rise of 10 percentage points since June. Looking ahead, Global Emerging Markets is the region investors would most like to overweight. Allocations to Japanese equities received a large positive swing over the past month. A net 22% had been underweight in June, but that transformed to net 2% overweight in July. Expectations within Japan are also strong, especially regarding corporate performance. A net 76% of respondents to the Japanese Regional Survey expect corporate earnings to improve in the next 12 months, up from a net 54% in June. A net 56% believe that Japanese equities are undervalued.
Bonds
A net 45% of the panel was underweight bonds, up from a net 35% in June. Investors have indicated that liquidity conditions worsened over the past month. A net 20% of the panel described liquidity conditions as positive, down from a net 35% in July. Visibility has also deteriorated. A net 35% of investors describe their current investment time horizon as shorter than normal – up from a net 26% in June and the weakest reading since May 2010.
Commodities
Fund managers have called time on a withdrawal of cash in commodities, amid improved hopes for global economic growth, and reduced concerns for China. The proportion of asset allocators overweight in commodities, minus those with smaller-than-orthodox positions, rose to 13% this month, after declines in May and June, a survey for Bank of America Merrill Lynch showed. The rebound, from a reading of 6% last month, tallies with a revival in farm commodity prices from a liquidation heading into early July which drove Chicago wheat prices to their lowest for nearly a year.

However, it defied decreased expectations for rises raw material prices identified in the survey, which found only 6% of fund managers viewing commodity price inflation as the biggest economic threat. In April, commodity prices were viewed as the biggest danger, a position taken now by European sovereign debt, named as risk number one by 64% of investors. Concerns over growth in China – a huge buyer of raw materials, including cotton and soybeans - have eased too. A net 24% of Asian and emerging market fund managers see Chinese expansion slowing, down from 40% last month.

Summary
Allocation trends across asset classes, sectors and regions demonstrate that fund managers are maintaining their exposure to risky assets. Most notably, investors remain overweight global equities, commodities, technology and energy stocks; and underweight bonds, banks and utilities. With asset allocations placed cautiously near the long-run averages across asset classes, BofA Merrill Lynch’s survey is yet to yield a contrarian signal for risk assets.

In particular, and to nobody’s surprise, banks are furthest in the underweight corner both in Europe and globally. The extreme pessimism with which investors regard Europe in the July edition of the survey prompted Schowitz to suggest buying opportunities within the region as a whole. “The question is whether eurozone equities have been oversold,” commented Schowitz’s colleague Gary Baker, European equity strategist with BofA Merrill Lynch. “Europe has gone too negative” - the final word from Schowitz on this month’s survey results.

Note: An overall total 265 panelists with US$792 billion of assets under management participated in the survey from 8 to 14 July. A total of 196 fund managers, managing a total of US$631 billion, responded to the global FMS questionnaire. A total of 149 managers, managing US$409 billion, responded to the regional FMS questionnaire. The survey was conducted by BofA Merrill Lynch Research with the help of market research company TNS-BRMB.

Sentiment: Commodity Fund Flows

Consider the large outflows in the commodity complex which occurred over the last two months. Barclays Capital Commodity Investor Newsletter wrote in July that:
The mixed picture is typified by the $3.9bn Q2 net outflow of institutional and retail investments funds from commodities, the largest quarterly outflow since Q3 2005. The bulk of that is attributable to commodity indices, which saw withdrawals of $5bn in Q2. In contrast, the more flexible structured products sector saw issuance of $3.5bn, the highest for three years, while precious metals ETPs reversed their negative trends of Q1 with $0.4bn of fresh inflows.
I think the about outflows have actually been very bullish for commodities from the contrarian point of view. Those following my blog should have noted already, that I was calling for a bottom in the overall commodities complex back on 24th of June in a post entitled Time To Step Into Commodities Including Wheat. Back than I wrote:
For me, I prefer Rogers International Commodity Index, which is a basket of all commodities including Crude Oil, Brent Oil, Wheat, Corn, Soybeans, Rice, Cotton, Coffee, Sugar, Cocoa, Copper, Aluminium, Gold, Silver and many others. I believe that the best way to play the secular commodity bull market is to accumulate the index like this one, when majority are bearish and panic selling. Therefore, as of last night I have opened up substantial amount of RJI shares.
Personally, I added to my overall position of commodities on 24th of June, two days before an intermediate bottom at around $9.00. I believed back than and still believe today that the overall commodities complex is in a secular bull market, which still has several years to go due to extremely powerful growth in Asian demand and neglected global supply. The most important key to executing this bull market is to try and buy low. Remember, commodities will not go up in a straight line, so there will be corrections, consolidations and even panic sell offs, like the one we have seen in Silver over the last few months. But when they do happen, step up when all others are selling and buy some more.

Wednesday, July 20, 2011

Biggest Tail Risks

According to the Citigroup newsletter, traders, investors and fund managers think constant Government intervention is the biggest tail risk in the next 12 months. I have to agree with this.

Source: Citigroup Newsletter

Jim Rogers Interview On Reuters & RT



Silver Technicals

Broad US Dollar Weakness

Due to the ongoing Eurozone Debt Crisis, the European Euro as well as the British Pound remain relatively weak. In other words, there are periods like the current one, where the US Dollar tends to rally against these currencies. Therefore this US Dollar strength is presented in the US Dollar Index (DXY) out of which the Euro and the Pound make up for over 66% of the weighting.

With that in mind, we can look at the above chart, where the DXY is overlapped against two currencies indices I created, we can broad US Dollar weakness. The US Dollar has made new lows against both the Commodity Currency Index (CCI), as well as the Asian Exporters Currency Index (AECI).
Having said that, there are still quite a few bears on the US Dollar, so that does not mean one should blindly enter a short US Dollar trade right here, right now. The unwinding of short bets has been in progress since early May of this year, as seen by the 3 month moving average.

Euro Bears Out In Full Force

What do you get if you mix the possibility of a Greek default fears, sovereign bond haircut fears, debt contagion fears, Eurozone break up fears, collapse of the Euro fears and all other type of European fears?

An extreme reading in Puts relative to Calls on the Euro Dollar exchange rate that rivals November 2008 and June 2010, both of which marked significant bottoms.

Every New Worry Is Linked To Lehman Brothers!

Interesting chart from Nomura's Newsletter shows the important events, most of which hit crisis level, over the last two decades.

Source: Nomura Newsletter

Tuesday, July 19, 2011

Market Sentiment Update

Retail investors (yellow) and advisors (purple) remain neutral on the equity market, economist's (red) expectations of the US economy remain extremely low, precious metals investors are extremely bullish with fund flows into GLD ETF (orange) hitting the third highest reading ever, futures speculators have cut substantial amount of bullish bets on commodities (blue) and while removing bearish US Dollar bets (green).

I personally think that over the coming weeks the 30 Yr Treasury Bond has room to fall and the S&P 500 has room to rally. All investors should keep their eye out on the risk on / risk off waltz between Euro Dollar exchange rate, which is dominating the CRB Index. While the shake out of contracts in the CRB Index (mainly Oil and Agriculture) has been relatively large, we do not yet know if we are at the bottom. Finally, I think Gold, in particular is now becoming very overbought and I'll explain why:
Gold tends to move separately from Industrial and Agricultural commodities majority of the time. Gold is trading more as a currency. As Central Banks keep devaluing and inflating their debt problems away, the precious metals secular bull market is not finished. However, I do admit that Gold is currently extremely overbought. Daily Sentiment Index last week stood at 94% bulls, while fund inflows into various ETF are close to breaking records (first chart above). Other statistics:
  • Price is more than 2 SD away from its 50 day MA
  • Price is 11% away from its 200 day MA
  • Price is up 10 years in the row, an extremely rare event
  • Price is up 11 quarters in the row, a very rare event
  • Price is up 12 days in the row, longest stretch 1980
  • Weekly RSI & MACD are extremely overbought
What I am trying to say is I wouldn't blindly just go and buy some Gold right here. It is very rare for something to go up 10 years in the row, 10 quarters in the row, 10 days in the row and then keep moving up like that...

Other perceived safe havens, like Swiss Franc, aren't much better either. Similar to Gold, Franc's trend is also extremely overcrowded. For me, it makes no sense buying this late in the rally. Currently, these moves, some of which stated in late 2008, are now overstretched, overbought and over-reconginsed. While price might go up more in the short term, I am not interested in buying or selling these asset classes at present and chasing the momentum. A substantial pullback will bring these assets back on my radar.

Until then remember... you're either a contrarian or a victim. The choice is yours!

Monday, July 18, 2011

Keeping One Eye On The PIIGS

By now we should all know the story about PIIGS, so I will spare you the introductions other than say one phrase: debt contagion. If you are smart enough, you probably figured this out back in late 2009, but if you haven't then just have a look at the picture above. Therefore, lets move on from the obvious reasons of why Eurozone is trouble towards when the debt crisis problem could really spark an event. In the markets, certain things are obvious, but that doesn't mean that they are about to occur tomorrow or two weeks from now. In other words, timing is everything.

With that in mind, I thought I put forward recent developments in the Eurozone Debt & Credit markets, due to various alarm bells ringing last week.

We all know Greece is bust. I could just end the post here and it would make a lot of sense to everyone without a question. However, up until today the EU has refused to let Greece default on its debt and bond holders to take a haircut. With debt so interlinked through Europe, this event could and possibly would trigger our key phrase mentioned above: debt contagion.

The spread between Greek and German bonds remains extremely elevated, as investors dump Greek bonds and rush into German Bunds. Greek 10 Year Yield, which is currently sitting at 17.6%, is flashing warning signals that there is a very large possibility of a Greek default, but its just a matter of when?

If we look at the credit market, then we could gain some form of an answer. Greek Credit Default Swaps (CDS), an insurance mechanism used for protection against sovereign default, has pretty much gone parabolic since early April. The Greek CDS market is in panic, that is for sure!

Now, some investors would say, Greek default has been talked about for months and months, actually years now. They would argue that this is priced in, at least to some degree. While I could agree to a certain extent, this posts focus is on debt contagion, so therefore I would argue that while Greek bond haircut might be priced in... to a degree, a total spiral of defaults across Europe is definitely not.

I don't want to scare you here, my fellow reader, so do not misunderstand me. I am not saying that this event will happen, because one should not underestimate European politic will power to kick the can down the road until 201x year. However, I do want to place this possibly on a radar because even if it does not happen, the market itself could overreact and turn into a panic that spreads like a wild Australian bush fire.

Spread where you might ask?

Ireland and Portugal is the first and most obvious answer. The spread between Irish and Portugal's 10 Year Yield against German 10 Year Bund is currently sitting at 11.3% and 10% respectively. Not a mild risk, is it? And it seems that majority of the panic selling in these two countries Bonds is occurred just recently. The short squeezes (also known as pullbacks) seems to be getting smaller and smaller. Yields are rising in a parabolic fashion here as well.
If we look at the credit market here as well, the story is following Greek CDS blueprint. The vertical panic rise in both Irish and Portugal's CDS makes me think that there is a decent possibility of something awful happening just around the corner. Media is running stories around in circles of how Greek and Portuguese debt has been downgraded to "Junk" (thanks Moody's - as if we didn't already know this years ago), while rumours are spreading of Ireland needing another bailout... come on guys, its been ages since the last bail out in December!

Greek default is one thing, while Greek, Portugal's and Irish default at once is a completely different thing all together. This is known as debt contagion. Obviously, European Stability Fund and its political generals will not allow for this to occur, at least not right now. So the fears could be overblown and investors could be overly pessimistic on the Eurozone area once again.

We saw all of this before... remember June 2010 when EU was about to split up? And remember January 2011 when Ireland was about to leave the EU? Both events resulted in huge short squeezes against speculators betting against the Eurozone Crisis. So yeah, one could say the fears could be overblown... until last weeks events in Italy and Spain.
Bang! Just like that, Spanish and Italian 10 Year Yield surged vertically. Spreads between these interest rates and German Bunds blew out to over 3% in both case. While this might not seem extreme when compared to spreads on the other PIIGS featured above, bond vigilantes would nonetheless yell out: debt contagion in progress. Besides, Italian debt is bigger than the rest of the PIGS put together. At one point in time Italian rates were above 6% and Spain was reaching levels where Portugal was only months ago. It seems that the shit is really starting to hit the fan, excuse for the language.
Also to note is that Italian CDS closed at all time new highs. The Global Financial Crisis of 2008/09 is now starting to look like a walk in the park for both Span and Italy. The real test is either here or coming up real soon.
Both the Euro Dollar exchange rate, as well as the Eurozone 50 equities index are flirting with major supports, which if breached, could spell more downside. Keep in mind that with high volatility in progress, false break downs also known as "bear traps" are very common during these periods. Last week we already experienced that once in both EUR/USD below $1.40 and in Euro 50 below 2,600.
I do have to admit that 2008 fears are in the back of all of our minds. And that is precisely the problem I have with all this. Even though I do not doubt for one second the whole of Europe could turn into a massive Australian bush fire by tonights market open, in the same time I get this feeling that things are just a little to obvious right now. Now, obviously I could be very very wrong here, but consider the following:
U.S. Stocks May Slide 24% as Recession Looms, GMI’s Pal Says

July 15 (Bloomberg) -- The Standard & Poor’s 500 Index may fall as much as 24 percent and the euro might tumble to $1.20 if the U.S. economy slows further and Europe’s debt crisis widens, said Raoul Pal, the former GLG Partners Inc. fund manager currently writing the Global Macro Investor strategy sheet.

“I think with the European situation seemingly unresolvable, it’s likely we will see accelerated downside in the latter part of the summer,” Pal, who also worked in hedge- fund sales for Goldman Sachs Group Inc. and predicted the financial meltdown of 2008, said in a phone interview from Javea, Spain. “It does all depend on the U.S. economic data, but the highest possibility for me is we are going into a recession.”

Writing in the July edition of GMI, published July 1 and updated this week, Pal said the current situation resembles the conditions in early 2008, when the Institute for Supply Management’s U.S. manufacturing gauge was at 51.1, before it collapsed to 33.3 by the end of that year.

The S&P 500 may reach 1,000 by the end of 2011, Pal said, though the index has a support level about 1,250, which technical analysts who follow charts say can act as a floor limiting losses. If economic reports improve, equities may rebound as they did last summer, he said.

The euro may fall to $1.20 from $1.41 yesterday as the region’s debt crisis worsens, Pal wrote this week, citing technical analysis charts. The move will be followed by a bounce, and the currency will then “finally roll over and head well below parity,” he wrote. He said he’s bullish on the dollar and Treasuries.

“Deficit reduction in a slowing economy is next to impossible,” Pal wrote. “This is a real vicious circle. Delaying an eventual default is actually making things in Greece much, much worse.”

Problems facing the banking system and real-estate market in Europe are particularly noticeable on Spain’s Mediterranean coast, where he lives, the strategist said. “The property market is still awful,” Pal said. “Properties are being sold at a 40 to 50 percent discount. Apartments don’t sell at all, at any price.”

“Spain is Lehman Brothers, whilst Greece is Bear Stearns,” Pal wrote in the report. “Once Spain goes I think we will be heading into the vortex of multiple sovereign defaults,” he wrote.
It seems that perma-bearish deflationists, who have been calling for the end of the world the whole way up from March 2009 lows, are constantly in love with phrases like "This and that resembles 2008" and "Lehman Brothers this, Bear Sterns that". Now, consider the next article:
Forint, Zloty Most Vulnerable in a ‘Lehman II,’ Citigroup Says

July 15 (Bloomberg) -- Hungary’s forint, Poland’s zloty, South Africa’s rand and Brazil’s real are the emerging-market currencies most vulnerable to credit crisis, like that sparked by Lehman Brothers Holdings Inc.’s collapse, from the European Union’s fiscal problems, according to Citigroup Inc.

“The European crisis is at a critical point” in which either its leaders come “up with a shock and awe package or the situation deteriorates significantly,” analysts at Citigroup led by Monty Gandhi wrote in a research report dated July 14. “If it became more certain that the EU is not going to act in a more pro-active way, we would expect most currencies to sell off, but would expect” the zloty, forint, rand and real “to perform the worst.”

Citigroup measured vulnerability by taking foreign-exchange reserves divided by the sum of the current-account deficit and debt maturing in one year. It also analyzed net monthly long positions, or market bets that a currency will strengthen. Foreign-currency flows into the bonds of Poland, Hungary and South Africa were still the “major catalysts” behind the positioning in the zloty, forint and rand, the note said. In Latin America, the highest positioning is in the real followed by the Mexican peso, according to the report.
Well, if we were to follow a mad dog investor like Raoul Pal, we would have to also side with Citigroup. They too are saying that the current problems feel "like that sparked by Lehman Brothers in 2008". They have their own nickname to it - Lehman II. Consider the next article:
SocGen, UBS Say Buy Protection Against Euro Breakup Scenario

July 15 (Bloomberg) -- Societe Generale SA recommended buying insurance against a euro “meltdown,” and UBS AG said the Danish krone may offer protection as Europe’s debt crisis threatens to deteriorate.

“It is not too late to get hedges,” SocGen strategists David Deddouche and Olivier Korber wrote in an investor report dated yesterday. “We simply cannot rule out entirely a further dramatic collapse” of the euro against the dollar, and a rebound in the 17-nation currency to above $1.40 “provides a fresh opportunity to hedge against such an event through tail options,” they said.

UBS currency strategist Chris Walker said “a significant escalation in the euro-zone debt crisis, to the extent the existence of the euro is itself threatened, could lead to the abandonment” of Denmark’s currency peg to the euro. Though this would cause short-term volatility, longer term the krone would likely appreciate against other Scandinavian currencies and the euro, he wrote.
Well, it wasn't long before the "EU Break Up" bears came out once again. And just like before, they are once again siding with the US Dollar and against the Euro. Have these people lost their minds? Even if the Euro does collapse, I am pretty sure it would still hold its own against the confetti paper, like King Dollar. Consider the next article:
Traders See 41% Chance of Lehman-Style Cut: Australia Credit

July 15 (Bloomberg) -- Traders are adding to bets Australia’s central bank will repeat its emergency interest-rate cuts of 2008 as the economy falters and concern intensifies that U.S. and European debt burdens will derail global growth.

The yield on December cash-rate futures was 4.345 percent as of 4:45 p.m. in Sydney. That implies the Reserve Bank of Australia will lower its benchmark of 4.75 percent to 4.5 percent by year-end, and a 41 percent chance of a reduction to 3.75 percent. Ten-year government bond yields fell the most this week since since December 2008.

Stevens slashed the cash rate to 3 percent from 7.25 percent between September 2008 and April 2009, in a record stretch, to counter a global credit freeze. The RBA’s post- Lehman reaction included three rate cuts of 100 basis points each, the first time the central bank had moved by more than 25 basis points at a time since 2001.

Australia’s 10-year yield fell as low as 4.90 percent today, the least since Sept. 8, from this year’s high of 5.84 percent on Feb. 8. It dropped 32 basis points, or 0.32 percentage point, this week to 4.91 percent as of 4:59 p.m. in Sydney, or 2 percentage points more than similar-maturity Treasuries.

Two-year Australian yields fell to 4.33 percent, down 41 basis points since June 30, and are set for a third monthly drop.

“The move to lower yields at the front of the curve has been the real pain trade and a lot of people have lost a lot of money,” said Auld. “That means the appetite to put on any risk is very minimal, especially in a world where you really don’t know what’s going to happen one day to the next in Europe.”
Lehman Style, post-Lehamn reaction, Lehman II, Spain is Lehman... do you guys notice a trend here? As Hugh Hendry famously said once... these guys keeping coming on TV, and they keep saying the same thing.

Am I just imaging things or are these humans once again engaging in their favourite activity - herding? It sounds to me like everyone is thinking the same thing along the lines of Lehman No. 2 event. And we all know what they say about those herders:
"If Everyone Is Thinking The Same Thing, Then No One Is Thinking" ~ George S. Patton
I do not own a crystal ball, nor am I good enough to tell you if there is going to be a debt default within the next few days/weeks. There are some very serious risks out there, that is for sure. And the equity markets in the US are almost 100% from their March 2009 lows. We are eventually due for a bear market and it is not about why, just a matter of when as stated above. (For those wondering why, the answer is because US equities are in a secular bear market)

However, having said that, a lot of market participants are expecting a Lehman style event right here, right now. We do have one advantage in the market place and that is being contrarian. It doesn't always work, but as a famous investor once said - you're either a contrarian or a victim. The choice is yours!

p.s. I must have said debt contagion about a trillion times. Just as much as EU will need in bail outs.