GalaTime

Investors Intelligence: When the Chickens Come Home to Roost

The average hedge fund uses leverage, to the tune of about 1.4 times (see chart 6). This is down significantly from a year ago, but it still means that hedge funds need to liquidate investments of at least $500-550 billion in order to meet current redemption requests. And the real number is probably higher because some of the worst performing strategies this year are the ones using the most leverage. The real number is therefore more likely $600-800 billion.

Huge downward pressure for some time to come.

Since October F&O expiry, there’s been a sharp drop in futures & options turnover at the NSE; from 45000+ crores to ~35000 crores.

Daywise Turnover

Yesterday, F&O turnover was a paltry 30,000 crore. We can blame this on lower roll-over, margin calls, higher margin requirements, lack of institutional interest, whatever. Fact is - trading volumes are drying up.

The cash segment is no better; we are down to ~ 9000 crores this week.

Between lower volumes and high volatility (VIX has now closed above 60 for 10 days in a row, IVs on Nifty options are > 60), this market has become quite tricky to trade. Profits vanish in a matter of minutes, trends reverse abruptly and impact costs keep getting larger.

• Business Standard: Exports shrink in October: DGFT

Non-oil exports dipped 20 per cent in October against a small 3 per cent rise in September, he added. Gujral attributed the decline to waning demand from the United States and the European Union. In dollar terms, the two markets account for over 35 per cent of India’s total exports. The non-oil exports account for over 80 per cent of India’s export basket and industries like gems and jewellery and handicrafts have been the hardest hit.

• Bloomberg: Pakistan’s Inflation Jumps to 25%; Near 30-Year High

Pakistan’s inflation accelerated to near a three-decade high in October, placing further strains on a nation that the International Monetary Fund says needs $10 billion to avoid defaulting on its debt.

The nation’s foreign reserves have also shrunk to $3.71 billion on Oct. 25 from $14.2 billion a year ago, raising concern that Pakistan will not be able to pay its $3 billion debt servicing costs due in the coming year.

Conditions attached to an IMF loan would include an increase in the central bank’s benchmark interest rate to 15 percent from 13 percent, as well as a 31 percent rise in tariffs on electricity and other utilities.

Scary.

• Haaretz: Diamond prices fall by 5%

Diamond traders and the rest of the industry woke up Friday morning to a major shock. At 6:00 A.M. the semi-official price list for the diamond industry, the Rapaport Diamond Report, was updated and all prices were lowered by about 5%. The diamond industry, known for its secrecy and behind-closed-doors transactions, suddenly found itself in the spotlight. 

While Rapaport may have tried to calm fears, the sudden 5% loss on paper in the value of everyone’s merchandise did not sit well with the traders. This is a problem in particularly for those diamond traders who have used their gems as security for loans.

Wow. Even a near-monopoly couldn’t manage to hold prices up.

• Houston Chronicle: Oil prices low? Chevron CEO says no

O’Reilly tossed aside the notion that oil prices are low. Although half its unprecedented summer high of more than $145 a barrel, $60-$70 oil is still pricey.

On a global basis, it’s the equivalent of 240 million barrels of oil a day, if you can transfer all the energy into oil terms. Put it in gallons per second, it’s 120,000 gallons per second. That’s oil, coal, gas, nuclear, all the sources of energy that the globe uses.

At some point, inevitably demand growth will occur again. We’re in a demand shrink at the moment, based on all the data. Two things have to happen. The price has to stimulate that — that’s how markets work. And that in turn has to help stimulate economic growth.

• Bloomberg: China Announces 4 Trillion Yuan Economic Stimulus

China announced a 4 trillion yuan ($586 billion) stimulus plan to spur expansion in the world’s fourth-largest economy, helping sustain global growth as the U.S., Europe and Japan teeter on the brink of recession.

The funds, equivalent to almost a fifth of China’s $3.3 trillion gross domestic product last year, will be used by the end of 2010.

The package announced today, of which 100 billion yuan is earmarked for this quarter, will go toward low-rent housing, infrastructure in rural areas, as well as roads, railways and airports.

• Business Standard: Pantaloon’s turnover shoots up 87 per cent

Kishore Biyani’s Pantaloon Retail, the country’s largest listed retailer, has posted an 87 per cent growth in Diwali sales from its value retail formats — Big Bazaar and Food Bazaar — compared with the year-ago period, the highest growth rate in three years.

Consumers are spending more on value for money products. All categories in food and fashion are doing well. In fact, the same store growth of 50 per cent in value formats is a record increase for us,”

One of the few retailers who’s got it right in India.

• Financial Express: Realty prices to fall 50%, says SBI chief

OP Bhatt, chairman of State Bank of India (SBI), the country’s largest bank, expects 50% correction in the housing sector prices in the country. “In India we may witness up to 50% correction in pricing in the mortgage markets. If that happens, it’s good news for the Indian banking system as NPAs would reduce and new business would fall-in,’’.

Joydeep Sengupta, director, McKinsey & Compan said the overall impact of the global volatility would enhance the capital requirement of the Indian banking system, which will need $70-80 billion in the next four years to sustain the India growth story. 

• Economic Times: Slowdown is here: Morgan Stanley

The investment bank’s sample of 105 companies reported a 29% fall in net earnings for the quarter ended September 2008, an all time low. This compares with a trailing five-year quarterly average growth of 28%.

. . . at the sector level, the best performances came from Utilities and Technology. The laggards versus the aggregate numbers were Consumer Discretionary, Energy, and Healthcare. Save for Technology and Financials, all sectors reported a slippage in operating margins YoY.

• Hindu Business Line: Slowdown effect: Container train operators start ‘parking’

Many operators now prefer to park their rolling stock assets in their own terminals or the Indian Railways’ yards — rather than running empty rakes (since cargo availability has gone down).

. . . while companies such as Concor, Gatewayrail (a subsidiary of Gateway Distriparks) and Adanis have their own terminals where they can park their rakes, others have to depend on the Railways infrastructure.

. . . two container train operators whom Business Line spoke to pointed out that compared to the cargo availability in September, in October it has decreased by about 20 per cent for their companies.

Background:

• Aug 1 - Steel production, consumption & price trends
• Sept 18 - Steel Stocks & Prices - Mittal vs Market
• Sept 25- Steel prices - Anyone feeling bullish yet?
• Oct 3 - Steel stocks - Cramer disses them too!

A complete turn-around in 4 months: ArcelorMittal to cut 30% output

ARCELORMITTAL, the world’s largest steelmaker, reported on Wednesday profits rose 29 per cent in the third quarter but said it would cut output by nearly a third as a sharp economic slowdown dampens demand for the steel used in houses and cars.Warning of tougher times ahead, ArcelorMittal said it needed to ‘rebalance supply and demand’, putting on hold an ambitious expansion plan that would have increased steel shipments by a fifth by 2010. 

India steel makers have also (finally) gotten the market’s message: SAIL, Tata Steel stay put, others cut output

While JSW Steel has said it would cut output by 20% from November, Ispat Industries will slash 15%. Essar Steel said it’s looking at ‘rationalising’ production, while Bhushan Steel Ltd will chop galvanised steel output by 20-30%.

JSW Steel’s new 3-mtpa blast furnace in Vijayanagar, which was to kick off in October, has been delayed by two months.

These guys were planning to hike steel prices only a couple of months ago. Badly in need of a reality check.

The last hope for steel makets remains infrastructure. But with China & ME/GCC beginning to bust, and Indian infrastructure projects bound to get delayed, I doubt there’s much hope there. But we’ll have to wait for a few more months before steel (and cement) manufacturers accept that as well.

• Bloomberg: Bloomberg Sues Fed to Force Disclosure of Collateral

Bloomberg News asked a U.S. court today to force the Federal Reserve to disclose securities the central bank is accepting on behalf of American taxpayers as collateral for $1.5 trillion of loans to banks.

The lawsuit is based on the U.S. Freedom of Information Act, which requires federal agencies to make government documents available to the press and the public, according to the complaint.

The Fed staff planned to recommend that Bloomberg’s request be denied under an exemption protecting “confidential commercial information,”.

Now who’s going to sue the RBI?

• Bespoke: Country Default Risk

• Financial Times: The oil-major prop desks cometh
  

Prop desks largely depend on four different strategies to outperform the market.

(1) Superior access to information (both from greater proximity to the market and other players, as well as the type of “inside information” that the regulators frown upon but which has proved the lifeblood of markets and impossible to eradicate).

(2) The ability to dominate pricing by running large positions relative to the size of the overall market and therefore move the market in the traders’ own direction (either taking big enough prop positions, or drawing a large volume of customers into reinforcing trades).

(3) The ability to run complementary and reinforcing positions in related markets (eg cash, physical and derivatives) so positions in one can be used to support positions in another.

(4) Using significant leverage to magnify marginal trading advantages on thousands of trades (the strategy of picking up nickels in front of steamrollers).

• Bloomberg: Crude Oil Falls Below $60 in New York, Lowest Since March 2007

Crude oil fell below $60 a barrel in New York for the first time since March 2007 as a global economic slowdown cuts demand for fuels. Prices, which have tumbled 59 percent since reaching a record $147.27 on July 11, are down 37 percent from a year ago.

U.S. fuel demand during the past four weeks averaged 19.1 million barrels a day, down 6.7 percent from a year ago.

Who would have thought?

• Bronte Capital: Berkshire Credit Default Swaps
  

I am quite familiar with Berkshire - about as familiar as you can get by reading stat statements and the like . . . If 9.11 had been nuclear they might have had problems - but as my “Risk Aversion Berkshire Style” post makes clear fat tail risk is not part of the formula.  

So why is the five year credit default swap spread on Berkshire over 200bps?  I have no idea and it makes no sense to me.  Maybe it is just irrational bearishness about everthing (ie BUY HARD) or maybe there is something I do not know.

Now that’s scary.

• Prudent Bear: Rate Cuts everywhere

ECB cuts rates by 50 basis points, more action expected

UK interest rates slashed to 3%

Bank of Korea Lowers Rates for Third Time in a Month

Swiss central bank cuts interest a half point

• Naked Capitalism: Roubini Foresees Chinese Hard Landing

There is thus now a growing risk of a hard landing in China. Let us be clear what we mean by hard landing. In a country with the potential growth of China hard landing would occur if the growth rate of the economy were to slow down to 5-6% as China needs a growth rate of 9-10% to absorb about 24 million folks joining the labor force every year.

The decline in total orders has been even stronger than in export orders, thus suggesting a weakening in both domestic and export demand.

Chinese exports to the U.S. were growing at an annualized rate of over 20% a year ago; while the most recent bilateral trade data from the U.S. now show that this export growth has now fallen down to 0%.

• NY Times: In Modeling Risk, the Human Factor Was Left Out

“The price of an asset, like a house or a stock, reflects not only your beliefs about the future, but you’re also betting on other people’s beliefs,” he observed. “It’s these hierarchies of beliefs — these behavioral factors — that are so hard to model.”

The quantitative models typically have their origins in academia and often the physical sciences. In academia, the focus is on problems that can be solved, proved and published — not messy, intractable challenges. In science, the models derive from particle flows in a liquid or a gas, which conform to the neat, crisp laws of physics.

• VC Circle: Brokerages Feel The Heat; Q2 Profits Down By 57%

F&O turnover has been < 40,000 crores over the past few days. Margin calls & higher margin requirements have destroyed volumes.

• Paul Kedrosky: Top 20 CDS by Net Exposure: Italy/Spain Rule

Source: DTCC’s weekly CDS update

• Financial Times: Concern over shipping derivatives losses

Traders in forward freight agreements (FFA) – derivatives based on short-term charter rates – could owe significant sums if they were betting on a rise in charter rates for ships carrying coal, iron ore and other commodities.

The sector’s Baltic Dry Index of charter rates started the month at 3,025 points and closed on Friday at 851. The 80 per cent of trades made through clearing houses were being settled on Monday, while traders who bought cash-settled products through private transactions, known as over-the-counter trades, have until Friday to settle.

It is widely expected that hedge funds could be particularly badly hit.

No respite in bad news for hedge funds.

• Morgan Stanley: RBI’s Swift Policy Response to Large FX Outflows

India’s FX reserves declined by US$15.5 billion during the week ended October 24. This is the highest weekly fall in FX reserves on record. FX reserves have been declining since the last week of May 2008 and have cumulatively fallen US$57.7 billion from the peak to US$258 billion currently.

Our conversations with real estate market players indicate that many developers are facing serious financial management challenges. Some are borrowing at a cost of over 30% to complete their projects. Private sector banks already face a significant rise in NPLs on their unsecured loan portfolio. Banks also have exposure to non-banking financial companies, who, in turn, are also likely to face higher NPLs.

Some SMEs had not hedged the foreign exchange risk or had hedged under ‘knock-in knock-out’ (KIKO) agreements. Many hedges made under these KIKO contracts are lapsing, due to the sharp movement in the rupee in such a short time span. This has meant that many SMEs have seen losses on foreign external liabilities increase significantly.