Start of August is the celebration of the richness of harvest. It is a time for festivals. People step out and celebrate. This is seasonally a good time for food and beverage companies. It was during these weekend jaunts out of Cluj, back at the farm house about 80 kms away, we started picking plums and enjoying the natural inspiring beauty of corn fields and farm lands around us.

Did our city life really isolate us from the underlying agricultural economy? Did the harvest cycle stop affecting us? Or are the agricultural, climate, commodity, social behaviour and economic cycles somewhere connected? A common theme runs through all these cycles. They are all linked and have a distinct periodicity. The long term and short term climate cycles establish what we harvest and eat and what we eat is linked to our social, economic growth and expression. And a crisis or a down cycle on any one of these cycles affects all the rest. Though the modern economies are no more agrarian, the current food crisis is increasing inflation and pushing commodity prices higher. The unison of up and down cycles are changing how we celebrate (behave) and remain happy (prosper). Jacob J Van Duijn, talks about how a classified or phased approach to economic development is important to realise that human behaviour as producers, consumers, and investors create cycles. But still a majority of us are unaware of the economic consequences of this behaviour. For example, every generation comes with capital investment ideas and allocation as the previous capital investments become technologically obsolete. This leads to the repetitive investment cycle. But little is learnt from the past.

This creates a gap between our understanding of the economic future and the current socio economic perception. This is one of the reasons humans are generally under prepared for the future. We can’t understand how policy induces monetary cycles or how oil prices or shock induced boom bust cycles and over investment, under consumption, demographics and mass psychology driven cycles can influence and change a growth period into recession or vice versa. There is one more reason why we are cyclically blind. We relate or register more to short cycles. The fluctuations caused by Kitchen cycles (3-4 years) very much determine people’s mood and expectations regarding the short term outlook of the world economy. Because, in the short run it produces the dominant cyclical pattern, most observers tend to overlook the longer term developments which lie underneath. Needless to say, this form of myopia may cause rather wild swings of over optimism and over pessimism. This is why euphoria and pessimism repeat with such regularity.

As we move from short term to long term cycles the cycle applicability and debate intensifies. More so because what affects us in the long term is still unclear. In 1991, Richard Mogey, Cycle Guru said, “Many have been expecting a Kondrateiff wave (the long term 60-year cycle) to top for nearly twenty years, but it has yet to unfold.” This long-term cycle has been hotly debated and a few cyclists like Tony Plummer, Author and cyclist, suggest the Berry cycle (25-30 years) and Strauss and Howe cycle (90-99 years) as a more valid case over Kondrateiff cycle. Plummer’s case becomes more relevant if you connect power law relationship between Kitchen, Juglar, Berry and Strauss. All are linked with a factor of 3. Three Kitchen cycles make a Juglar cycle, three Juglars make a Berry cycle, three Berry cycles make a Strauss crisis cycle.

Small fluctuations caused by the Kitchen cycle sometimes go unnoticed by the masses. But it is the large Juglar, which registers in the long term memory. Average length of little less than a decade appear to be in conformity with the way people think of time spans, the swinging 60′s, the 90′s etc. Hence Juglar recessions have a deeper impact on mass psychology. Juglar recessions are also deeper than Kitchen recession just like Juglar upswings more sustained than Kitchen upswings.

Juglars are also considered as the most long standing, dominant and periodic. This cycle was identified by Clement Juglar, a French economist in the mid 1800′s. Juglar began his work with cyclical studies in French marriage, birth and death rates. These observations led to similar cyclical behaviour conclusions in interest rate, credit contractions and commercial crisis. His studies concluded that credit contractions and crisis occurred with an average periodicity of 9-10 years. Juglar cycle is also referred to as the pendulum swing of prosperities and liquidations.

A similar 9-12 year cycle is also witnessed in agriculture, social trend and is informally also labelled as the business cycle by economists. There is another business or trade cycle namely the 7-11 year investment cycle also known as the cast iron cycle, which existed 250 years ago and still exists today. Cyclists have discovered more clusters of 10 year cycles. The most reliable is the sunspot cycle of 11.2 years. Sunspot cycles are also known as prosperity cycles. Research by Garcia Mata and Shaffner suggested that low sunspots actually work on the human psyche to influence confidence. Kitchen and Juglar cycles have been known to work on yields also. And of the many other running cycles, Juglar and Kitchen cycles work best for stock markets.

For example, historic lows are generally made in the second year of the decade. 2002 was a historic low worldwide, be it Nikkei, Dow, Sensex, Brazilian BVSP, Russian IRTS, it was everywhere. Juglar slowdowns have also known to degenerate into real crisis and depressions. The Juglar recession cyclicality has been observed since 1721.

But recession is not a singular event. It is linked with both short term and long term cycles. And since excesses happen in stages, correction of market imbalances also does not get over just by price retracement. Hence real recessions generally take time to balance and get into the human psyche. This is why recessions are also about market mood and not just about prices. Prices are just one way to express it. Simply speaking Juglars are real recessions. Historically we have not seen a bigger than a Juglar recession globally. The great depression (1929-1937), the Japanese depression (1990-2002), the American bear market (1965-1975), the Sensex sideways action of the 90’s (1990-2002) were all of Juglar time frames. Shorter recessions are labelled as Kitchen recession. Some European countries experienced a Kitchen recession in 1987, when industrial production came to a standstill. Though irregular, only Kitchen and Juglar could explain the global recession of the 1970′s.

There are other inter-market aspects linked with Juglar cycles. The bond markets generally hit a low on every Juglar low. The bond market rise from 1921-1932 in America is a classic example that can explain how interest rates should behave. American bond markets also hit a low in 1990-1991, ushering in another decade of prosperity. If we consider the Sensex in a Juglar up starting 2002, the cycle should complete anytime between 2011-2013.

This means interests and inflationary conditions should continue to rise for the next 3-5 years. This observation is in sync with the other commodity cycles, which we see peaking around 2012-2015. This also means that what we just saw from January 2008 was a Kitchen or growth recession, the real bust or Juglar recession should start at least a year from now.

The cycle truth is hard to accept. Like technical analysis is a foot note in Elliott, both Elliott and economics is a foot note in cycles. They are larger than life, above any mathematics and fractal science. And this more than 200 years of observed cyclicality can’t be wished away, just because it does not fit our conventional beliefs.

Accepting that we are cycle blind is a step forward to understanding economic uncertainties that surround us. Just like it takes 10 years to become a glassmith, for a global analyst, it takes 10 years to witness the Juglar recession and cycle truth.

Author: Mukul PAL | Date: 09 August 2008 | Comments (0)

Categories: Performance Cyclicality

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I first read Nassim Taleb’s story on virtue of buying cheap options in 2000. It was a tough time for an option believer in those days in India. Out of my basement stint for an e broker, which was struggling under startup pressures with “nobody seems to be interested in futures” statement mailed to me, Taleb inspired me at a critical time. Eight years, I still believe his cheap option strategy is virtuous, but there is lot about Taleb’s random strategy that troubles me to the extent of challenging it. I have mentioned some of my disagreements prior, but the guru’s work deserves a serious debate.

First and foremost, Taleb makes no claims of being able to beat markets. What this means is that Taleb is not in the predictive business. His hedge fund Empirica was into hedging solutions and not into predictive forecasts. We at Orpheus are into the predictive business, but we also make no claims of beating the market. But there is a difference. There are many ways you can beat a market. You can either give more returns than DOW Jones or Sensex over a year. Or you catch every multi week move that the DOW or Sensex might make over the year.

For example 2007 Sensex saw 6 major turns starting 07 Jan 2007 at 13,860, followed by a upmove to 14,538 on 11 Feb 2007, after which we saw a dip till 18 Mar 2007 till 12,430, from the week ending 18 Mar 2007 till 22 Jul 2007 Sensex pushed up till 15,565, a small dip followed till 19 Aug 2007 at 14,141 and then one way upmove above 20,000 till 13 Jan 2008. On a net basis though the Sensex moved up 50%, but on a gross basis markets move up 77% and down 23% in total six moves averaging 20% each.

A derivatives trader is not concerned about net yearly moves, but all tradable moves whether up or down. So beating the market would mean capturing the entire 101% gross move in Sensex for the year, a tall benchmark and a near impossible task to achieve. But capturing 50% of the net return of 2007 was easy for a buy and hold investor invested from 07 Jan 2007 till 13 Jan 2008. But this passive investor may have beaten the market in 2007, but the market is beating him in 2008 now that it’s down 28% for the year.

Beating the market hence is a misnomer, a jargon which does not mean anything. Any hedge fund that operated from 1975 till 2000 and caught the 1987 meltdown can claim to have beaten the market. It’s more about double digit or tripple digit returns that suggest predictive knowledge and trading expertise. Like what Robert Prechter did when he made 444% in a three month monitored options trading account. Just like many traders do, day in and day out, some survive and some shine. But then trading itself is a hard task, you can actively trade from the age of 26 to 45, like what Taleb did, but then market cycle overtakes the human cycle, the very reason we continue to live the illusion of beating the yearly return of a market and not some supernormal or triple digit returns. Taleb’s philosophy is not for the traders who want to beat the markets and want to make triple digit returns. Taleb’s 1987 jackpot was the one off event that he admits hit him from out of the blue and it had nothing to do with predictive value.

Second. His idea of Randomness is flawed. There is not one man who saw the 1987 crash (I know three of them), or one trader who saw the 2000 tech bubble bust, or one Goldman Sachs, which saw the subprime mess shorting opportunity, there were many who saw the real estate crash in US. Randomness is for the masses. As they don’t understand how markets work. Markets are clock work and not random as Taleb claims. Forecasters have proved it again and again giving not only great calls but also timing them. There are technicians who timed a short call two days before Sep 11, and there are technicians who said after Sep 11 that markets should bottom anytime soon. In 21 trading days DOW hit base and in 40 trading days markets were back above SEP 11 levels. Bill Sarubbi timed Gold for 2007. How can you time markets, if they are random.

Taleb’s hypothesis is weak and does not comprehend random events like earthquake and disasters that don’t affect the markets. Recent Chinese earthquake was all over the news, and the SSEC (Shanghai Index) went up for three days after the earthquake. Even the deadliest Tsunami, which killed more than 225,000 people in eleven countries, was followed by rise in stock market valuations around the globe. Assassination of presidents and prime ministers are random events with poor correlation with market crashes. Market randomness is predictable and has nothing to do with event randomness, which may or may not affect the market. All that does influence the market is non random in nature and is non linear mathematics, pure in its structure. Power law, Fractals, Cycles and sentiment measuring tools have high predictive power. And Black Swans have nothing to do why DOW goes up or down.

Third. Though recent broker inventiveness and rush for trading volumes have lead to the mushrooming of a zillion leveraged products (example 1 to 100 leverage), classically options offered a protected leverage compared to Futures. No wonder the upside was unlimited compared to the downside. The only catch was that 85% of the Options generally expired worthless. And if you are just buying cheap options, volatility or chance will definitely make you rich on that black day like 1987. Volatility is cyclical and starting 2007 is moving up in a 25 year cycle which should top somewhere in mid 2015. This means that chances for buying cheap options are going to be few, but profitable.

Good forecasts cannot be subdued with randomness talk. And there are living legends like Richard Russell forecasting markets day after day starting 1958. Options are versatile instruments that can do better than wait for that 1987 crash again. Being on the long side helps as option writing has unlimited risk that can implode and cause more than a Barings’ failure.
What we have been doing is for you reader’s to judge. But early 02 Jun we gave you a JUN strangle strategy. Markets were at inflexion points, with no clear supports and downward momentum pushed us to run with our negative broad market view. Barring CNXIT (Tech Index)

WAVES.IND.020608 was negative for every other market sector. The Strangle resulted in an 81 percent return without transaction costs. The illustrated chart highlights the decay in OTM call options, the fall of NIFTY over the last two trading weeks, the rise in OTM PUT option premiums and the resulting STRANGLE payoff premiums.

We still remain negative on the market. But considering prices have hit the previous iv wave supports for many of our covered indices, the early next week prices could attempt a sub minor bounce. Markets might get choppy for a few days before turning down again, pushing lower. We will review any new strategies on Wednesday in our mid week WAVES.IND issue. Till then we hope we clarified a part of The Taleb conundrum.

Author: Mukul PAL | Date: 16 June 2008 | Comments (0)

Categories: Trashing Rationality

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Intermarket cycles can change the way we look at asset cycles. Starting from 30 year mirroring commodity and equity cycles, inflation and deflation cycles, the subject also redefines Sam Stovall’s sector rotation structure giving new insights about the world order ahead.

It was not just investment gurus, but philosophers and painters who talked about simplicity being solved complexity and a very powerful investment approach. We also had a Nobel Prize awarded to a simple thought that there is no economics without psychology. Sentiment comes before rationality and human beings are nice and dumb and not profit maximizing smart souls. Crowds are accordingly involved primary with instincts, biological drives, compulsive behavior and emotions. Hence market success is less about economic but more about psychological competence.

Many experiments regarding crowd behavior also prove that an individual transforms into another being when he becomes a part of the crowd, so much so that he completely abandons the logical and rational thought. He does not think but herds. Solomon Asch, Harvard conducted the matching lines experiment (Fig 1.). Individuals and groups were asked to match the length of a line with three other lines. Individuals in isolation made a mistake less than 1 per cent. However, when placed in a group that had been instructed beforehand to claim the mismatched lines were actually the same, 75% of participants agreed with the majority. This was true even when the actual difference between the lines was very significant. Participants lacked the nerve to disagree with the majority. Another interesting experiment demonstrating the lack of rational thought was when a group exercise was conducted by Stanley Milgram of Yale. Individuals were ordered to inflict pain on an innocent victim (who was acting) in the interests of an important cause. More than 60% of the subjects were prepared to obey instructions and administer the highest and most lethal dose of electricity, even after the victim was, to all intents and purposes comatose.

And if all this infliction and pain seem closed door experiments different from the stock markets, we have numerous mathematicians and scientists proving the same simplicity mathematically. It was George Kingsley Zipf, an early twentieth century scientist who revolutionized our understanding of power law and revealed their astonishing presence throughout society and nature. Zipf’s law (Fig 2.) states that the most common word used in language is a constant factor (say two times) more common than the second most common, and the second most common word is twice as common as the third etc.

In 1955 Herbert Simon sought to unify the observations of Zipf and others by formulating a single common explanatory model for many of the systems displaying power-law behavior, including language, population and wealth. Stock markets around the world also work on a power law. In 2003 in a paper submitted to Econophysics, Kaushik Matia and I illustrated the Indian price fluctuations exhibiting an intermediate form between Power Law and Gaussian behavior. This aberration also did not last long when Sitabhra Sinha, re examined the prices in May 2006 finding the price fluctuations exhibiting a power law.

Another interesting aspect was that of Fractal geometry, published in 1977 when Benoit Mandelbrot (M SET fame Fig 3.), Mathematician, Yale proved that Fractal Geometry was mathematical. His work extended the area of late nineteenth century mathematicians like Giuseppe Peano who demonstrated the completed inadequacy of the common idea of dimension.

The subject of fractal geometry can not only calculate coastline lengths but is used in Seismology and Helioseismology and in a host of other scientific applications today. The marine drive, Mumbai, coast line carries fractal drums to safeguard the coast. It is scientifically proven that rugged fractals are more efficient in saving coastlines than concrete walls. The fractal nature of the web is also behind Google’s success.

The worldwide web is in the form of a bow tie (Fig.4) with four components, a core, inbound links, outgoing links and the disconnected pages. Any way you slice the web, geographically, topic specific clusters, organizationally or into groups of pages owned by the same person, the bow tie shape emerges again and again. This is the same fractal behavior in nature, societies and price behavior that connects all of us. This is also a reason why Elliott’s wave principle and Dow’s theory has survived more than 125 years.

Fractal self affinity as Elliott said, is fundamental to nature and all human activity leads to a socionomic process. It follows a law, repeats in time, has a definite number and pattern (Fig 6) and covers areas as diverse as Gold prices, population movement, price of seats in stock exchanges, patent applications, commodity prices, epidemics real estate business, politics and the pursuit of pleasure. We have also talked about Malthus population curves redefined by Verhulst as S curves (Fig 5), another form of fractals.

All this fractaled nature of Economics, nature and universe has a fixed periodicity linked with it i.e. there are cycles running through them. Edward R Dewey started the Foundation of Cycles early 1940’s when he realized the uncanny similarity in data cycles found by Hyde Clark in business activity (Fig 7.), Benner in industrial prices and Seton in animal population cycles.

The 11 year sunspot cycles linked with human excitability and stock markets. The nine year cycles linked with religion and credit (Fig 7.), where rise of deposits every nine years is inversely linked to the rise in people going to church, 25 year volatility cycles (Fig 12), 17 year international battle cycles, dividend cyclicality etc. Interest rate cyclicality is a reality that flies in the face of believed truth that the central banker is in charge.

The current linear research model (Fig  8 ) fails to assume the cyclicality of the market. The model works on an assumption of an economic growth that leads the positive news which leads to price growth and prosperity. Robert Prechter’s socionomic model was the first to illustrate the social mood cyclicality.

The Alternative research cycle (Fig 10) considers the social mood at the start of all human action and activity. A positive mood reflects in productivity and creation which reflects in markets and finally confirms as the economic cycle turns up. The positive economic cycle creates positive news and hence the self feeding feedback loops. On the other hand owing to social negative mood, it’s the negative feedback loop which works.

Fundamental meets Technical. Sam Stovall, chief global strategist, S&P was recently invited to the MTA (Market Technicians association). He was wondering why he was invited as S&P already had a few CMT’s. The reason Sam was invited was because his sector rotation structure (Fig 11) are the first steps of a fundamental thought towards cyclicality, which is a technician’s domain. As we move ahead the thick line between fundamental and technical starts to erode. John Palicka’s Fusion analysis is another attempt to bridge the two subjects.

Stovall’s sector rotation identified five economic cycle stages in the market viz. early expansion, middle expansion, late expansion, early contraction and late contraction. The market sectors move within these five stages. Technology and Transportation perform in the early expansion, capital goods in the middle expansion stage, basic materials, energy, and consumer staples in the late expansion stage, utilities in the early contraction stage. And financials and consumer cyclicals in the late contraction stage.

Father of Intermarket analysis John Murphy, connects defines the four broad asset classed viz. bonds, currencies, equities, and commodities and there linkages. How bonds leads equity markets and how commodity upcylces are inverse of equity cycles.

Just like all other fractals, a link runs through market cycles which Tony Plummer defines in his book on Forecasting Financial markets. Plummer classifies the broad economic cycles into TRIADS with Base, trend and terminal cycles. Cycles are seen from low to low and not from high to high, as bullish market bias extends markets longer pushing the cycle top ahead of the symmetrical high. Bear markets correct faster. This is why the bear cycle tops are translated (biased) towards the left and lie before the symmetrical cycle tops. Plummer identifies behavioral traits linked with the respective base, trend and terminal cycles. Base cycles are characteristic of Indolence, recuperation and rejection. And trend cycles are characteristic of confidence, change and deception. Fear, resistance and accusation are characteristic of final terminal cycles. All these cycles have a three wave pattern labeled as 1-2-3 up and a-b-c down (Fig 7).

These triads build the economic cycles and exhibit a power laws behavior. Kitchen cycles last from 3 to 5 years and on average are 3.33 years long. These are knows as inventory cycles are closer to the popularly know US presidential cycles. The only cycles conventional economists believe to work. Next comes the Juglar cycle, which last for 7 to 11 years and average around 10 years. These are also knows popularly as the decade cycles. Juglar cycles, which are also known as the capital investment cycles, are three times Kitchen cycles. Then next power law that is three times Juglar cycles take us to Berry cycles also known as the infrastructure cycles. Berry cycles last for 25 to 30 years averaging around 30 years. We have seen 25 year cycles in commodities, gold and silver ratio, volatility etc. A step ahead on power law takes us to the Strauss and Howe cycles (crisis cycles) of 90 to 99 years. Plummer makes an interesting observation about Kondratyev cycles while classifying the triads from 3.33 years to 90 years. Kondratyev is not an economic cycle as Kondratyev saw prices rising and falling in long waves. Not all Kondratyev lows are major depressions because not all Strauss and Howe lows will coincide with a Kondratyev low.

Strauss and Howe crisis alternate between deflation and accelerating inflation. This is why Plummer believes we have finished the deflation Strauss and Howe metacycle in 1946 and now we are in the inflationary cycles that should push till 2030 marked by the world war III. A rough calculation and one can see that India’s first war of independence and US civil war of 1857 had an uncanny similarity. This we at Orpheus believe was the second 90 year metacycle. The first starting somewhere in 1720, the start of capitalism. Hence we are indeed in the revolution cycle which ends the 270-300 years of economic activity near 2030. We are not sure how inflationary things may get or whether we are indeed heading for hyperinflation and destruction of real money, the pointers more indicate at the latter than the former. The intermediate pause before the last 30 year cycle starts should be around 2012-2014. This should be marked by economic growth accompanied by continued rise in commodity prices, Gold at 3000 dollars and Oil potentially much higher. New sectors to watch should be the alternative energy and biotech till 2020 and beyond.

Intermarket cyclicality is a subject coined by us at Orpheus. This subject not only redefines SAM Stovall’s sector rotation. But it also attempts to extend market cyclicality from an intermarket perspective. Since cycles work on Triads, Sam’s sector rotation sectors can be reclassified in three broad sectors viz. early economic, mid economic and late economic cycle sector (Fig 11). Early Economic i.e. Financials, Information Technology and Discretionary. Mid economic i.e. industrials and Late economic consisting of Energy, Materials, Staples and Utilities. As we head into the terminal kitchen cycle and Juglar cycle low in 2010-2012 the late economic cycle should outperform the market.

This means Energy, utilities, staples and materials sector stocks has more upside left. According to intermarket cycles, the 30 year Berry cycles is linked to equity cycles. That means equity markets grow and decay in about 25-30 years cycles. This is what the gold-silver ratio (the metals maze) and volatility cycles highlight (25 yr cyclicality). This 30 year equity cycle is inverse of the 30 year commodity cycles (Fig 14.). This means when equity rises, commodities fall and vice versa. 1975-80 was a commodity market top and an end of equity bear market in US.

And 2000 was an equity market top in US and a start of a commodity boom. The current commodity boom should end in the 2024-2030 (Strauss and Hauss) metacycle low with potential highs in the 2012-2015 time windows. It is in this time frame equity markets should make the decade low. Intermarket cycles can extend the cycle explanations to regional allocations between Asia and the west, between inflation and deflation and between interest rate and yield cycles.

Sector rotation remains a key intermarket strategy for portfolio allocation but in terms of early economic, mid economic and late economic than what is classified by Sam Stovall’s five stage economic cycle approach. Commodity and equity intermarket also suggests that materials, metals, chemicals, staples and Pharma could be defensive and relative performers. Our XTR products cover global sector rotation and intermarket cycles for emerging markets including India and Romania and for global sector indices. Intermarket cyclicality can also help move in and out of large and small cap sector stocks. The subject can also help create low correlation combination portfolios to better overall portfolio return to risk profile.

The current multi decade cycle is inflationary and of rising interest rates. Many emerging markets are between the late expansion and early contraction stage. This means that the sectors which will outperform are the Energy, Staples, materials and utilities. This should happen for atleast a primary (more than 9 months) time frame. The late economic sector cycle is in sync with the ongoing 30 year commodity cycle, which started in 1998-2000 and should top in 2012-2015.

This is another reason why food, material and commodity prices will continue to rise. However, we should not forget that this commodity cycle is a 1-2-3 structure up. And we have had no retracement of primary degree till now. The very reason a sharp retracement is pending before the CRB (Reuters Commodity Index) regroups again and heads higher. The real depression activities will start then.

The world in 2012 will be a stranger place with the lower billion of the world struggling for food and the top billion still getting richer. The hedge funds (the one’s that survive) which will create news then will be the ones doing Long Water – Short Oil strategies. The world beyond 2012 will be ruled by global macro funds, market psychology will gain more prominence, fractal forecasting might be taught at YALE, Cycles will get their place in statistics as the relentless cyclical change pushes ahead. And all this while we will wonder about the randomness of the world we live in, unaware of the simple structures that got us so far.

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Author: Mukul PAL | Date: 24 May 2008 | Comments (0)

Tags: alternative research model, Commodity vs equity, religion vs credit, s urve, sector rotation, web fractal

Categories: 2012 and Beyond

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Nothing can rise exponentially, even if it’s OIL. The asset’s exponential rise is more an indication of an ending trend and not vice versa.

We don’t have any chilly warning about OIL heading to dollar 200, like many in OPEC believe. Does OPEC really know? The axiom linked with 40 dollar plus OIL, as harbinger of recession has been long trashed and now not only we are waiting for recession but also for dollar 200 OIL. It all seems a bit strange to us.

OIL moved up 3 times from the 40 dollar mark and DOW is still at 13,000, just 7% lower than historical top. So either the other best indicator for recession that is S&P500 and DOW Jones have stopped working or econostats have blinded us.

For a start we have some common sense rules, which say rockets come down to earth and satellites remain in the sky. The way OIL is behaving makes it either a rocket potentially getting ready to become a satellite or this all is an illusion. OIL can never become a satellite, no asset can. And the almost ninety degree inclination to new highs is destined to collapse. And what will collapse along with this is the dream of OIL riches.

It’s how you look at it. Bloomberg Markets looked at it as the END of OIL era and a few Wall Street brokers looked at is a great time to solicit mass mailing lists for OIL CALL options. Well we don’t subscribe to the OIL end era yet, but if the best broker suggests buying CALLS with such confidence, we definitely don’t know something he knows or something everybody knows. But that’s good, if we don’t know, what everybody knows. Because if everybody knows something it’s already discounted and the truth is already out there that OIL is TOPPING.

Of course the reason of the fall, when it happens will be like this…”Winters were cold so OIL rose and summers are hotter so OIL is falling”. When OIL falls in winters, which it did from 2000 to 2002 and later in 2006 to 2007, the winters were warm. For us OIL is more than a climate barometer. It’s like all other assets, which are connected with 0.5, 4, 11, 30, and 90 year cycles. And all these time cycles can explain cycles of inflation, deflation, disinflation, food, gold, equity, recurring geopolitical crisis, interest rates and also how we should handle a portfolio within the year. It also tells us about what is going to happen to OIL in 2012. We will be discussing this next time when we talk about asset cycles in 2012.

At this stage what we can see is a sentiment euphoria which is hard to sustain. The five legged fractal structure both starting 1999 till 2008 and the smaller five legged sub structure starting in 2007 seems complete. And holding one’s impulses to ride on this rocket seems reasonable to us. FIB and CHANNEL targets lie at current levels. We don’t see OIL above $ 125 at this stage and our research IMPULSE (we are humans too) shows more of a PUT than a CALL.

What will happen can also be explained with another magical previous 4 rule. Price impulse moves in a five wave structure. And you can label them like a school exercise of counting 1 up, 2 down, 3 up, 4 down and 5 up. Now this exercise can be done on a large (multi year) time frame and a multi day time frame. This is what we keep mentioning as mass psychology fractals impulsing again and again at all degrees. It’s the magic human nature plays with precision.

After every impulse the markets take a pause and fall in three wave structure (a down – b up – c down) and then the impulse starts again in an unending process. That is why we say that world may never come to end, it’s just that some time the volatility of relentless market action becomes too much for a society looking one way. This always happens, like the subprime mess and the credit crisis. We all look up to OIL now and not NAT GAS, which is the next multi year outperformer. We love to see rockets and ride them, other things don’t excite us.

So whenever an impulse (five legs) takes a pause, they fall to the previous 4 wave. This is a much witnessed event in fractals. Previous 4 wave supports are also mentioned as the last supports standing. Prices should not fall below the previous 4 wave or rise above the previous 4, if the trend has to continue. Of course this is a guideline, but this appears more time than coincidence.

You can see this everywhere, BSE OIL, BSECG, BSE BANK, BSEAUTO, SENSEX, NIFTY and CNXIT (Indian Sector Indices). They are all full of previous 4 wave retests. OIL when it turns down could fall to first a previous 4 wave support at dollar 90. And if it indeed breaks that, we can be in for sub dollar 70 levels. And this we are talking about the next few months. We can be wrong. But not like the poor chicken, an anecdote quoted by the late A J Frost, Market Guru.

The chicken used to run at the presence of the man, but man’s appearance on the scene was linked with corn. This happened 999 times, till the Chicken went to thank the man and had his neck sliced. Though anatomy proves that we are more like sheep and herd, we indeed might be chickens when it comes to cause and event linkage. We are miserable here and believe summers and winters drive the Oil rocket. Indeed a poetic tragedy.

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WAVES.OIL is a perspective product published once a week. The report covers BRENT, WTM, XLE (Energy SPDR), top energy stocks, Natural Gas and related FUTURES. The product highlights Primary (Multi Month) and Intermediate (Multi Week) price trends. The report illustrates key price levels, price targets, price projections and time turn windows. The product uses Elliott waves, traditional technical analysis tools and sentiment indicators.

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Author: Orpheus | Date: 10 May 2008 | Comments (0)

Categories: Accuracy Energy, Energy

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THE STORY OF HOW GOLD FOOLED RECESSION. DID IT?

We are not in times of mess. We are in times of unprecedented mess. Not because people have lost lot of money, but because loss is messy, loss of jobs, loss of a house, loss of a client, loss of purchasing parity, loss of belief and confidence. We also lost benchmarks about what market acumen really means. Is it about J P Morgan’s quantitative skills costing taxpayers millions of dollars or about Northern Rock, the smart bank of United Kingdom which went bust? We are just witnessing economics the way Elliott once said, “Laws of economics are as they should be, ruthless”.

And if you think flunking finance will teach us, you are mistaken, the fool’s gold is a mirage which will continue to occur with cyclical precisions, just a few learn, rest perish. Abraham Lincoln said, you can fool some people most of the time, all the people some time, but you cannot fool all the people all the time. Markets will thrive till it can fool all the people some time. Markets have to live you see, so it will keep fooling a few of us all the time. We at Orpheus know that the challenge is to be fooled less, as it’s the human destiny to be fooled sometime, as you can not fool the market anytime.

What Gold is doing now, seems another mirage that could surprise us in the short term, say more than a few months. A few weeks are enough for markets to destroy 80% of wealth. It took three years to destroy 70 years of wealth creation from 1857-1929. But what we are talking here is about Recession. How Gold’s rise is connected to destruction of paper money and everything non tangible, be it stocks or CDO’s and swap options. Gold’s rise and dollar’s fall started taking a universal truth status. And when a thought reaches epic proportions on mass psychology, market twists the axiom. So if Gold is going up because of a crisis, a fall here on Gold should end the same crisis. No?

The Gold-Silver ratio, we highlighted last time (The Metals Maze) gave no signal of a collapse. Rather the sentiment indicator has moved unfazed despite millions going homeless and more than 100,000 losing their financial jobs (more serious than the tech bust). This means two things, one that the Gold-Silver ratio has stopped working after predicting the 1980s and 2000s crash or second the crisis has not yet started. So if the crisis has not started, we might have a respite coming before the real mess starts. We at Orpheus at this stage don’t know what real crisis the indicator is suggesting, but it definitely seems more than just linked to Gold and dollar.

We kept track on Gold, publishing short term updates. However, it’s been exactly a year since we published an exhaustive Elliott counts on GOLD. WAVES.GOLD published on gold on April 21 2007 made a few projections. One of them was that above dollar 690, its 1000. We have juxtaposed the cases from the old report with the new ones before making projections ahead in time. We have also updated the channeling system, which we explained last time when we talked about CHANNEL psychology when we talked about Jesse Livermore.

‘Anticipated’ and ‘Happened’ cases have stopped surprising us and fractal watching is slowly and surely increasing. Somebody asked us at a recent conference on Elliott Waves. What if Elliott and fractal watching becomes popular. Will it stop working? Well on the upfront this gave us some joy, as the question regarding Elliott’s wave performance assumed that it worked. About the other part, whether it will stop working, the answer was simple. We humans are so focused on short termism than long term asset watch, long term investments are left to gurus like WARREN BUFFET. Well Buffet went over 3 decades, but the long termism we are talking about is more than a few months, maybe more than a year. Wars and battles for profits are short term in nature that is why even if the number of Elliotticians increases globally, it’s only the short term counts that may get more chaotic and confusing. On the longer term there are always opportunities few look at.

Coming back to Gold, now that prices have hit the anticipated targets, we are on another alert now. Is it over for the Gold rush for a few weeks, or is Gold ready to fall for a few months, till where? And if it’s indeed over that’s bad time for Recession watchers. Falling Gold prices mean, dollar strengthening and dollar strengthening means new high on DOW. This might confound many and common sense might catch up finally that if US markets are rising why BRAZIL, RUSSIA, INDIA, CHINA and ROMANIA should keep falling.

According to the TIME and PRICE symmetry, it seems Gold has topped and is ready to come down back to dollar 800 levels and potentially lower sub 800. The funny part is that if we indeed are on the smart side, new highs on DOW will have new excitement linked with it, new patriots, new bloggers, new fool’s looking for the new gold.

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WAVES.GOLD is a perspective product published on Monday and Wednesday. The report highlights GOLD and other precious and base metals. The product highlights Primary (Multi Month) and Intermediate (Multi Week) price trends. The report illustrates key price levels, price targets, price projections and time turn windows. The product uses Elliott waves, traditional technical analysis tools, sentiment indicators and other alternative research tools like INTERMARKET to spot outperformers.

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Author: Mukul PAL | Date: 21 April 2008 | Comments (0)

Tags: gold

Categories: Forecasts

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The “R” word is everywhere. It’s being discussed at World Economic Forum at Davos and now we have clients calling in at Orpheus asking us about Recession and how bad it is. And is there a chance that the global depression might be starting. Such worries though important and critical do highlight the mass psychology and how it reads the Federal interest rate cut and subprime crisis as a start of something bigger and problematic.

First and foremost recession is not an event it’s a process. It happens again and again. And when the recession lasts for more than three successive quarters of negative growth and prolongs we call it a depression. We have had one depression in USA and one in Japan from 1929-1932 and 1980-1993 respectively.

A part of market sees this as a sectoral crisis just in the financial sector. But crisis is never sectoral, it’s always linked to credit and is across market. This is why a financial crisis is also called a confidence crisis, as liquidity dries the counterparties panic and everyone wants out at the same time. This is the reason a onetime write-downs might not be enough. New trader’s from Europe keep falling out of the closet. Markets need confidence more than write-down’s. It’s like saying if the FED cuts the benchmark again things will be fine. Some might however look at it differently i.e. if the FED cuts it again we have a more serious problem. In any case FED cut does little to boost confidence, the most needed commodity today. Markets follow their own rhythm, no wonder S&P 500 has rallied on the same day as a Fed rate cut only six of the last 13 times. And if all this was not enough we have Alan Greenspan doubting FED’s ability to avert a recession, everybody seems ready.

But the recession or great depression does not start till we have these negative quarters. All we are doing now is anticipating. And even if we are anticipating are we not a bit too late? The housing crisis started more than a year earlier and has already pushed prices substantially lower. We have more than a million foreclosures. The Philadelphia housing index (HGX) has dropped by 60% from 2005 high and sales of new houses are at 25 year low. Even the subprime has seen a lot of wealth erosion. The overall economic loss is estimated at $ 2.3 trillion. The third indicator, considered as the most reliable predictor of US slow down is the S&P 500, which is still negative for the last seven years as it failed yet again when it reached previous 2000 highs. This suggests that the slow down what we talk about today is already under play for the last few years and that is why anticipating a recession is different from what is happening.

Robert Prechter market thinker compared Dow Jones with Gold and proved that the slowdown is already happening as Dow Jones has crashed 67% compared to Gold over the last 8 years. This he calls as the silent crash. We have mentioned it so many times prior in our write ups saying that though history repeats itself it never repeats in the same way. And this time the slowdown is happening without people around realizing how our real purchasing power is eroding. Gold is near the $ 1000 mark, and Bill Sarubbi, market thinker and world renowned time cyclists puts it at $ 3000 in years to come. What would that mean? That would mean that even if markets locally or globally don’t really crash, the effective value of money will become a fraction of it. And Gold will become the most valuable asset more valuable than real estate or stocks as they are all denominated in paper money. This is already happening not only in America, but across the world. The real value is shifting to Gold and even though we don’t realize this. And we should consider our self lucky if Gold gives us a last dip back sub $ 600 before starting the next big leg up till 2013.

So though America and emerging markets might be witnessing a fall in value compared to Gold, the relative performance still points positively at what has been created over last seven years in emerging markets is more valuable than what America created in the same time. Plus the level of financial securitization in America or leverage as I might like to call it is much higher in the developed world compared to emerging markets. So even if we may seem to come down together there is always a relative performance. And the adjustments to US slowdown are dynamic and happening all the time. Over the last eight years the US dollar has depreciated 87.5% against the Euro. The slowdown is already taking a toll on the purchasing power parity of Americans. So markets around the world cannot be really clubbed together with looming asteroid and recessions, we do need to factor in local relative currency strengthening also.

Simply putting, all this talk of crisis together is a mass psychology creation. And even if we leave the Gold peg behind, the correlations between Global and local markets is an overplayed statistics. What works is only the short term correlations in contagions, rest correlations are weak and flawed predictability indicator. The world will not come to an end even if the US plays down, as adjustments are happening consistently.

In conclusion, we don’t believe anticipating recession can bring over a more serious chaos than what is already happening. Rather we think the mass psychology element highlights an inbuilt positivity to the whole thing. We in emerging markets are still low on critical mass to get seriously burnt with any global slowdown. And the real crisis may still be months away. And even the worst comes earlier, we can laugh about these terms like the late president Reagan did, when he said, “A recession is when your neighbor loses his job, a depression is when you lose yours”.

Author: Mukul PAL | Date: 01 February 2008 | Comments (0)

Categories: Performance Cyclicality

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A pension fund losing money is the last thing the retirees want to hear. But with the pension funds losing money in USA, golden times are getting trickier. The Fund managers assumed that they understood the asset classes they were investing in when markets surprised them. According to NASR (National Association of State Retirement Administrators) Public funds increasingly don’t have enough money to pay future benefits. The conservatism of yester years has lead to a vicious cycle which has made pension funds more like high risk funds. The Pension funds have deteriorated from a $20 billion surplus in 2001 to a $381 billion deficit.

Market risk, has moved beyond local rationales as poor portfolio performance has forced stock pickers and fund managers to employ new analytical tools to understand market risk. Unlike bottoms up approach of stock picking, the top down approach times market risk. However, top down approach needs thorough understanding of the macro picture, sector rotation, inter-market linkages, inter-market cyclicality and relative strength.

According to Ian Notely, the legendary time cyclist, playing with an asset trend and against it can seriously determine your chances of success. The odds can move up from 3/1 to 20/1 if you are against the trend. This simple logic of playing counter trend can determine the success of any investment strategy. Markets are changing so fast that by the time you realize that your understanding of the “familiar” asset class is limited and incomplete, it might be too late. This is what bottom up stock pickers are facing now with recurring market risk, which they don’t know how to diversify out off. The parameters influencing local valuations have just increased multifold. This is why any pure regional bottom up approach of stock picking is like playing against the trend with huge odds.

However, its all not gloom, there are always outperformers. Jim Simons, world’s best Hedge Fund manager has produced net annual returns of 37% since 1989. While some funds were cracking under the subprime crises, some of these high fee charging funds were already short on the ABX Sub Prime Index. Looking for negative correlation and acting on it in time pushed up the profitability for the respective fund.

But it’s not easy to find negative correlation or understand correlation in the first place. In times of contagion correlation are found to be high. But according to Invesdex, an alternative investment firm, correlations are not just high in period of panic but are generally positive. And barring dedicated short bias strategies and managed futures all other strategies viz emerging market, equity market neutral, event driven, global macro, long short equity have a correlation between 0.6 and 0.1, clearly positive. So finding negative correlation to reduce risk is not easy. However, strategy styles like pattern recognition, mean reversion and short term momentum can help reduce portfolio risk.

Sam Stovall’s sectoral rotation has an inbuilt risk mitigation factor. Sam linked the stock market or economic cycle with relative sectors explaining when a sector leads and lags. Why Energy sectors are leaders in the late expansion stage? And why when the market in early contraction of the economic cycle consumer staples and utilities take over? He also explains how technology and financials are late economic contraction and early economic expansion sectors.

The current market situation in India clearly exhibits where technology, energy and staples stand today versus the broad market Index. Technology and staples underperformed in 2007. Playing with or against emerging sectors can be a key profitability differentiator for a fund. And since sectoral underperformance can not last forever, knowing when the cycle is turning can really push the fund up in relative rankings.

Macro economic trends can also assist in sector selection. According to the recent IMF report the rising food costs impact headline inflation to as much as 55.9% for developing Asia. Rising food can have a direct impact on the staples sector. And Indian companies featuring in Business Week Asia’s top 50 today might change tomorrow with performers still coming from pharma, alternative energy and consumer companies like Cipla, Sun, Suzlon, and ITC rather than the banking, auto and tech majors like HDFC, Tata Motors, Hero Honda and TCS that also feature in the list.

Above sectoral cyclicality we have the asset cyclicality, which illustrate the intermarket relationship between commodities, bonds, currencies and stocks. Why bonds generally go up with stocks? Why commodity prices generally move opposite to the stock prices? Why value of cash is cyclical too? And why deflation or stagnation risk is a part of the credit cycle? Asset cycles are larger than sectoral cycles. The commodity cycles turned down in 1980s for nearly 20 years as equity cycles rose during the same period. The commodity cycles turned up in 2000 and we witnessed the equity market turbulence. The healthy disinflation and high saving rates in Asia might have delayed the deflationary effects. But as baby boomers retire and inflationary pressures increase, the sectoral cycles and existing assets trends will change. And if the interest rates cycles end, as they are anticipated to do so around 2009, top down investment approach might come a lot handy to find assets for capital conservation and growth.

And then we have the Climate cycles, which are linked with economic cycles just like wheat cycles. Institutions are already waking up to this link of environment, carbon and economics which they are redefining as green finance. Stock picking without understanding long term climate change on economics is another under utilized strategy, which is not only negatively correlated to traditional assets but is also extremely profitable. According to Nicholas Stern, the author of the famous report on economics of climate change, the benefits of strong and early action far outweigh the economic costs of not acting. The Review estimates that if we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever. The author even mentions of major disruption to economic and social activity, on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century.

Capital markets have already started acting. We have a whole new suite of products designed to finance projects such as green buildings, clean energy, plants or low emission means of transport, capex in large alternative energy projects have enabled investors to participate in green finance. This has lead to the new green stock picking. The climate awareness is reshaping industries as Virgin gets into fuels, green grids define which auto company is better than the other. Barring Nissan and Toyota a majority of car manufactures are still far away from a cleaner technology focus.

After 10 years weather derivatives are picking up and playing a bigger role. The urgency in essentials like water and energy is visible. Markets don’t see 1 billion people in the world with no access to electricity and 2 billion people with no access to clean water as a crisis, but as a price inefficiency which will eventually correct as players jostle for 1% of the planet’s fresh water. The cost of drinking water is expected to increase 5 to 10 times in the next 15 years.

There are long only funds for alternative energy, healthcare, environmental services, finance, micro finance and water mgmt. And there are funds shorting the non environmentalists something like long a solar energy stock and short a company selling coal fired generation equipment. Markets are changing the way we look at energy, the way we look at banking, the way we look at cars, the way we look at correlation and the way we look at equity. By the time nuclear energy companies list in the global exchanges, Uranium would go through the roof and by the time we look away from the rising Oil, John O Donnel, CEO Ausra might have changed the world with his solar mirrors. Wealth creation is easy if we come out of the extreme short termism and all that bottom up mirage.

Author: Mukul PAL | Date: 01 December 2007 | Comments (0)

Categories: 2012 and Beyond

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The S-curve, which is mainly used in population studies, is now redefining business strategy and stock market forecasting.

“The history of the world is nothing but the biography of great men,” said Thomas Carlyle, the 19th century historian. It’s strange but the more we try to understand markets, the more it pushes us back to econohistory. In March this year we had written about Thomas Malthus (1766-1834), economic history’s greatest pessimist who talked about hunger and starvation. Though the science of forecasting is still young and underdeveloped, Malthus made an amazing forecast of a crisis by the middle of the 19th century. And his population studies are turning things upside down more than 150 years after his death.

In 1838 after reading Malthus’s essay on the principle of population Pierre F Verhulst, a Belgian mathematician, published the Verhulst equation. However, it was only in the 20th century that Alfred Lotka of Johns Hopkins University and Vito Volterra of University of Rome generalised Verhulst’s growth equation to model competition among different species.

These are the origins of the S-curve. S-curve fitting, a natural and fundamental approach to forecasting, is reliable with high confidence levels. Physicists have shown that everything in nature can be quantified, from matter to light. Spectacular consequences of putting natural law descriptions in a discrete form have been the subject of chaos and fractals. I had a chance to meet Theodore Modis, a physicist from Growth Dynamics Inc, recently in Vienna. Along with Alain Debecker, a mathematician from Lyon University, he wrote about the S-curve and the bridge between continuous and discrete formulations spanning 150 years of developments in mathematics. They also wrote about how it starts with Verhulst and finishes with Mandelbrot, intricately linking order with chaos. The paper also mention how chaos-like states can be expected before and after logistic growth ie historical picture is nothing but an alternation of logistic growth with periods of instability. The chaotic fluctuations belong to the end of a growth phase as much as to the beginning of the next one. A well established S-curve will point to the time when chaotic oscillations should be expected. What’s more interesting about this paper is that it sites the Kondratieff cycle (56 years) as a way to position growth periods.

According to the S-curve, society pushes natural growth factors to an invariant status such as income spent on travelling at 15 per cent, sleep to work ratio of eight hours, mammal heart beats of 1 billion in a life, hospital infections at 14 per cent, average car speed at 30 miles per hour etc. These invariants happen as respective growth curves hit respective ceilings. In competing products, these ceilings and invariant status can also explain substitution. For example, when wood usage hits a ceiling, coal takes over; as coal fails, oil takes over and as oil will exhaust, it will be substituted by natural gas and so on. There are some rules to the S-curve growth. It proceeds in stages and each stage represents the filling of a niche with limited capacity. And just like economic growth, political growth also shows alternation between order and chaos. According to the curve, logistic growth is natural growth in competition.

Modis has extended the S-curve model to stock markets assuming stocks to be species competing for investor resources. He trashes the Gaussian bell curve since there is no natural law behind it and suggests that all marketers using bell shaped curve for strategy are headed for failure. Cyclicality can give strategy answers regarding cannibalisation and future growth. The author also junks the goodness of exponential fits and proves how correlation does not imply good fit. Exponentiality according to him means extrapolation on a log scale, which can’t predict. He also goes ahead and says that a pattern can be used to make forecasts, as long as it represents a natural law that guarantees invariability.

According to Modis, volume and value obey the law of competition directly. He also made some bold prediction on the Dow Jones starting June 2008. He predicts prices not higher than 14000 with lower targets lying at 8000. Other forecasts are about world population, which he claims should have a final ceiling at nine billion people, cumulative oil production in the US should hit a ceiling at 220,000 million barrels by 2030, Microsoft needs to undergo a major change for survival and the next energy growth assets should be natural gas and nuclear power. The substitution aspect of the curve is clearly cyclical and it seems we have no choice but to move to renewable energy source after hydrogen nears a ceiling on the S-curve.

Despite a thorough track record and mathematical grounding, the S-curve suffers from a few kinks. It really does not account for any other fractal apart from the S-curve. It does not take into account Fibonacci numbers or ratios, seems more for investment than trading, has a clear disbelief on price patterns, looks for parameters that intimately relate to competition and fundamental mechanism, saw the post-1999 period as one for stagnation than the one for crash, accepts sunspot cyclicality as a good predictor but not fractals or Elliott Wave, which are cyclical by nature.

Walter E White’s contribution in 1968-70 only reinforces the gaps in the S-curve. White said that Elliott Wave analysis suggests a general relationship between static forms in plants and animal life and dynamic waves of time. The origins of this relationship may be found in fundamental ideas of arithmetic, logic, algebra, geometry and trigonometry dating back to 500 BC. Elliott Wave has a cross-subject application and the idea of shock or chaos is fundamental. White’s contribution quotes Kierkegaard (teacher of Neil Bohr of quantum mechanics fame) saying that “in life only sudden decisions, leaps, or jerks can lead to progress”. All this brings Elliott waves in sync with the chaos and order that mathematicians have been talking about for over 150 years. Above this the relationship between the logarithmic spiral, the Fibonacci series and the golden ratio has been known for about 2,500 years, making Elliott pattern based on a natural law.

What’s strange is that while mathematicians were working on a growth decay natural model, Ralph Elliott was refining Charles Dow’s market fractal theory. The noise against Elliott keeps rising everyday while pure Elliotticians keep defending it. In August 2007, Robert Prechter highlighted the comparisons and improved predictability of the wave principle over Sornette’s log periodic cycles. According to Prechter, Elliott is a science with clear rules though practicing it is a craft.

The S-curve also offers competition to the wave principle. However, with the open gaps and the new school of thought that economics and finance are two different subjects altogether, the challenge is alive. After all, double decimal accuracy forecast delivered by Elliotticians over the last 60 years on all trading time frames and with practitioners like Hamilton Bolton delivering as much as 11 accurate yearly forecasts in 13 years, the S-curve has a tall benchmark to compete. The only research aspect which really suffers with the S-curve gaining ground is the investigative equity research, the last vestige of equity research which still holds some water, while the Fibonacci reality of markets remains a notch ahead of the S-curves.

Author: Mukul PAL | Date: 16 November 2007 | Comments (0)

Categories: Dow, Elliott and the TRIADS

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Water, a key renewable resource, has just started a multi-year boom which should leave even oil behind.

Throwing out the baby with the bath water is an idiom that has its origins on the monthly bathing ritual in Europe before the 16th century. The bath tubs were few and seniors of the house were the first to take bath, the children of the house came last. The very reason: the baby was thrown with the muddy and dirty bath water on occasions. It’s tough to validate this socionomic anecdote. But the question is that were some of our ancestors really low on hygiene or was it about water scarcity and economising of a resource? Well, the fact is that water has moved from abundance to scarcity through history and our ancestors did face a water scarcity in the past which might have forced them to change their habits. This also involved economising on bathing water and hence throwing the baby out.

The question of water is more relevant than the energy question which faces the world today. It’s just that water economics has not been understood by the speculator yet as he is busy with other assets. And, water has traditionally been a state domain and inefficient. The very reason it’s discussed less. Just to put things in perspective water outperformed oil from 2004 till 2006 and 2007 is not over yet. Water averaged 21 per cent returns a year over the last three years. The returns might look meagre if you compare it with the 40 per cent average returns for the Sensex. But equity vs water looks comparable if you take the average return on the Sensex from 1990. The benchmark gave an annual return of 22 per cent over the last 17 years. And the way things appear, water may not just outperform oil but the Sensex as well.

Water, a part of the alternative energy sector, is just one of the many thriving assets today. Alternative energy is not new anymore. Solar Index, Bio Energy Index, Renewable Energy and Water Index are some of the benchmarks listed and traded today. And renewables already take care of 13 per cent of the world energy needs, 34 per cent is oil, 21 per cent is gas, 25 per cent is coal and 7 per cent nuclear. This places renewables ahead of nuclear fuel today. Wilderhill Clean Energy Index is the first ETF for renewable sector with $800 million under management with 42 stocks.

The renewable sector components consist of harvesting, energy storage, cleaner fuels, energy conservation, greener utilities, etc. We have a wind energy global major in India (Suzlon), which has sprung up to global scale in about two decades despite all negative issues against wind and the safety aspect and questions like “what if a wind mill comes crashing down?” According to statistics, for every 10,000 birds killed by human activity, less then one death is caused by a wind turbine. Today 1.6 million homes are served by wind energy and this number is expected to rise to 25 million by 2020. Wind turned out to be a better performer than even water as it doubled returns as compared to oil over the last seven years. Then we have the solar energy, where we have a Chinese global major (Yingli). Even Vatican opted for solar power in June this year. Solar energy has outperformed oil by a multiple of 10 since 2000. So what we might be really fighting for is not that oil stock but real scarcity of water and few stocks in a high potential alternative energy sector.

Al Gore’s Nobel Prize winning work also makes a strong case for understanding the alternative energy and water sector. The opportunity in a crisis, he mentions in his work, is for real. Water is linked with crisis and opportunity. And it’s also linked with our food and the consequences of global warming. Food as we talked last time is so critical for prosperity and water is essential for the agro sector. The book An Inconvenient Truth: The Planetary Emergency of Global Warming and What We Can Do About It clearly mentions submerging of parts of Bangladesh, Kolkata and some American and European cities. These are facts known to climate watchers from many years, but we have just started noticing it now. And with more than a billion people worldwide without access to adequate supplies of safe water, the scarcity is for real.

So what are we doing about it? United States, the great champion of free-market capitalism delivers water by the public sector. In France, private companies have been distributing water for 150 years and Suez is a global sector leader. Water is capital intensive and not an easy sector to understand and invest in.

The industry in developed countries used more than 40 percent of total water withdrawals versus 10 percent in developing countries. If pollution is not controlled in these countries, and water consumption not regulated, clean water becomes even scarcer. The developing world will need about $600 billion or more to augment water reserves and meet water quality needs. And the rate of return constraint, where utilities are limited to a 5 per cent return over costs, fails miserably. Markets remain the best mechanism for allocating resources.

So where does India stand? India scores low on the water poverty index, which is a holistic water management tool developed by Centre of Hydrology and Ecology. Lower the ranking, bigger the problems. And unlike Europe we have few water utility companies. It’s the local Jal Board or the municipality that is in charge. This leaves us under-prepared, a kind of crisis, but an opportunity if we are in the alternative energy business. There are many instruments available today globally which allow you to take exposure to the respective sector. And it should be a matter of time when a water index starts trading even locally. Till then conser

Author: Mukul PAL | Date: 03 November 2007 | Comments (0)

Categories: 2012 and Beyond

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Cash conservation becomes strategic, as the healthy disinflation era is challenged by rising food prices.

“We learn from history that we do not learn from history,” these famous words of George Bernard Shaw are a befitting reality for mankind. These people he talked about also dabble in stocks and commodities. And a majority of them are oblivious to these written words of fate. It’s the few who understand while the majority perishes owing to short sightedness. The rush of greed has historically overshadowed sanity. Personal skill and the power of state have always been overestimated. Great nations have failed along with revered geniuses in front of market cyclicality. And till the time humans last, our love for speculation and war, boom and busts, creation and destruction, celebration and vilification will continue. The great Manmohan of yester years is the weakest PM ever, says Advani. It is this cyclicality of mass psychology — cheerful today and depressed tomorrow — that pushes us to extreme behaviour where we don’t know how to stop and hence the violent pause, which econohistory quotes as crash.

The ideal time to study econohistory is when sanity matters most and greed busters are needed. We really need them today. And nothing busts greed better than a pinch of econohistory. Spirituality can, of course, do it better than econohistory, but then use of religion to bust greed, seems a tall shot in the age of speculation.

We will stick to econohistory, which exhibits very well how long the current boom will last. The subject relies a lot on cyclicality and makes some bold findings. It proves that every generation has its war. Every market has its crash, big and small. It also proves that economics cycles are driven by credit, which itself inflates and deflates cyclically. There is a shift from paper to hard assets and vice versa.

There are three stages linked with the credit cycle viz hyperinflation, disinflation and finally deflation. Disinflation is a period of low inflation and low prices for food and essential goods. This leads to economic growth. While there is little literature available on the chronology of events, disinflation is the one preferred most by investors and market participants. Disinflation is generally perceived as beneficial. However mass psychology extremes have been know to stretch the benefits to an extreme causing deflation. The most visible example of deflation is the 13-year slowdown of the Japanese economy. The deflation period is one of decrease in the general price level over a period of time. Deflation is the opposite of inflation. During deflation the purchasing power of money increases. Many still consider deflation as a problem of the modern economy because the phenomenon can spiral into a depression.

Hyperinflation on the other hand refers to a period when inflation goes “out of control,” as cash or currency rapidly loses its value. A monthly inflation rate of 20 per cent or more is hyperinflation time. Although there is a great deal of debate about the root causes of hyperinflation, it becomes visible when there is an unchecked increase in the money supply or drastic debasement of coinage, and is often associated with wars, economic depressions, and political or social upheavals.

The worst case of hyperinflation happened in erstwhile Yugoslavia where inflation doubled every 16 hours. Hyperinflation destroys real money. So the talk of hyperinflation in India or the US is a clear misinterpretation. There is a crisis of confidence in hyperinflation. China between 1939 and 1945 is a classic example of government printing money to pay civil war costs. By the end, the currency was flown in over the Himalaya to be destroyed. The chaos often ends with a civil conflict. And there are a lot of zeros in the currency and they keep adding. A majority of countries around the world have experienced this phenomenon. In recent times, itʼs happening in Zimbabwe. There is a crisis of confidence under Mugabe and the country is in a civil strife witnessing the biggest modern-day exodus.

So all our good times rest on how sustainable this current disinflation is, the good inflation. According to a research paper by Marc Hofstetter, Universidad de los Andes , very little is know about the sustainability of disinflations. The paper dispels misconceptions about disinflation and points food as the most essential sustainer of prosperous times. One cannot blame the low sustainability of disinflations during the seventies on rising oil prices as Yale professors Boschen and Weiss state that world food prices are a significant predictor of inflation in OECD nations. And food inflation plays a bigger role in undermining positive disinflation than oil prices. In fact, the significance of oil shocks turns out to be weak. The paper also comments on exchange rate regimes saying that an increase in exchange rate flexibility reduces the sustainability of disinflations.

Disinflations that bring inflation down to low rates of 5 per cent or lower (like we have today) are more likely to succeed in keeping those gains in place. Rogoff (2003) and Razin (2004) add the idea that globalisation played an important role in the recent worldwide disinflation. Since the early nineties, an increasing number of developed and developing countries have adopted inflation targeting regimes to conduct monetary policy, which is ineffective in determining sustainability of disinflation. Politics also seemed to have little effect. The most interesting aspect was the linkage of whether US inflation had something to do with worldwide prosperity since the nineties. Boschen and Weiss found strong evidence that US inflation plays an important role in triggering inflation abroad and US monetary shocks have important consequences abroad ie a higher US inflation reduces the sustainability of disinflations abroad.

What all this means is that if food prices donʼt stop going up, the good times will come to an end. And there is nothing the central banker or the politician can do to sustain it. Grains are up and so are other agro products and this is just the beginning. We are looking at multi-year rises on food prices. We are not bears at Orpheus. And it was here in this column we talked about energy outperformance and software underperformance in Jan 2007. It happened. We also gave you sectoral winners like Reliance Energy which moved up 300 per cent since it appeared in The Smart Investor on June 25, 2007. We highlighted many other outperformers like Reliance Natural Resources and underperformers like Hindustan Zinc which we suggested exiting near Rs 1,000. But unfortunately we see a lot of unsustainable greed at current levels. And highlighting the importance of cash before the crash cycle can never be overstated.

Author: Mukul PAL | Date: 21 October 2007 | Comments (0)

Categories: Performance Cyclicality

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