Financial markets reach the ‘melt-up stage’

Economic growth

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D'turn 18May13.pngA month ago, the blog highlighted the potentially major implications of the Bank of Japan’s (BOJ) push to devalue the yen as follows:

“However, the BOJ has a slightly different agenda. It aims to devalue the yen, not the US$. And the yen has already fallen close to $1: ¥100 compared to $1: ¥93 before the new policy was launched on 4 April. If it succeeds, then clearly US pension funds will have no further reason to buy crude oil. And so prices could easily start to reconnect with fundamentals. At the same time, the S&P 500 could continue to rise, as yen-based investors seek their own ‘store of value’.”

Today, the story is still developing as expected:

• The yen has fallen 5.6% through the $1: ¥100 level to close at $1: ¥103
• The S&P 500 has jumped 5.4% from 1582 to 1667

Of course, central banks will take this as proof that their policies are finally producing the desired recovery. But the rest of us will regard this as wishful thinking.

What we are instead witnessing is the final ‘melt-up‘ phase of the $7tn liquidity programmes. Originally, this pushed up all asset prices, but reality has since begun to set in:

• 4 years ago, most investors assumed stimulus would quickly lead to recovery
• But since then, they have gradually become wiser, if poorer
• Cotton, for example, jumped from 46c/lb to 227c/lb, but is now back at 86c/lb
• Copper jumped from $3330/t to $9880/t, but is now $7330/t
• Gold went from $880/oz to $1920/oz, but is now $1360/oz
• Brent went from $44/bbl to $123/bbl, but is now $105/bbl today

Cotton was the first to collapse as it became clear people would not suddenly be buying vast numbers of extra clothes. More recently, investors have realised copper’s boom has ended, with China’s economy now slowing fast. Whilst there is little need to buy gold as an inflation hedge, with today’s weak demand levels.

But as they retreat from these assets, the banks are still pumping out more cash. This can only go into the remaining few assets in which investors still have confidence. So these assets go even higher, temporarily, in a version of ‘last man standing‘. Thus oil may well now start to slide, as investors decide the S&P 500 index is their one and only true love.

As Gillian Tett noted in Friday’s Financial Times, today’s “bizarre conditions”, where financial markets are completely divorced from fundamentals, may last for some time. But she goes on to warn, “as those equity markets soar, investors would do well to ponder on the data dislocations. Nobody can afford to feel complacent”.

This sensible advice seems certain to be confirmed by the blog’s quarterly review of company earnings reports, to be published on Saturday. Chemicals, as the world’s 3rd largest industry, have long since ceased to feel any benefits from the liquidity programmes. Instead companies are suffering the negative impact of today’s artificially high oil prices – and may well face further pain as and when these return to more realistic levels.

The chart shows benchmark price movements since January, and latest ICIS pricing comments are below:
PTA China, red, down 11%. “Polyester makers offered price discounts in a bid to encourage sales”
Naphtha Europe, black, down 9%. “Arbitrage to the US is closed, while domestic petrochemical demand remains weak”
Brent crude oil, blue, down 8%
Benzene NWE, green, down 7%. “Values remained range-bound”
HDPE USA export, orange, up 4%. “Fresh offers were limited in the market”
S&P 500 stock market index, purple, up 14%
US$: yen, brown, up 17%

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