Notes From Underground

For all those who have ever been involved with American Youth Soccer Organization (AYSO), it is easy to see the similarity between the EBA‘s “stress tests” and a youth soccer game. Like AYSO, the Euro STRESS TESTS meant that everyone who plays gets a trophy for showing up. The philosophy is that every participant is a WINNER. Also, there is no keeping score for that would be bad sportsmanship. So, the EURO STRESS TESTS are treated in the same light.

Yes, EIGHT BANKS failed the tests but the total amount of capital at risk was so small as to make the eight failures to be inconsequential. The real question is: Where exactly was the stress as the weighting of sovereign debt is under great suspicion? Is there anybody who believed that the test results weren’t determined prior to the exam?

It is all moot as the EU leadership is going to meet on Thursday to discuss the next measures that will be needed to create a new round of “credibility” for the European financial system. As always, I advise watching the Italian 10-year note futures to the BUNDS to evaluate market sentiment about European efforts. Going forward, the Spanish and Italian TWO-YEAR NOTES will also become very significant as it seems the markets put the most pressure on the 2 YEAR when they wish to attack the credibility of European governments. Friday the 2/10 spreads of the most stressed–Portugal, Ireland and Greece–made all-time highs on their inverted curves:

Greece: -1450 basis points

Portugal: -570 basis points

Ireland: -785 points

These are huge moves in the curves and if one can access a BLOOMBERG terminal and see the charts of these curves you can ascertain that the 2-year note becomes the target of speculators and hedgers trying to protect themselves from further DEBT STRESS and sovereign debt price erosion. The ITALIAN curve is still positively sloped at 159 basis points and Spain is a robust 198 points positive, so at this moment the markets are selling the long end but the markets are not pricing in new strains from the austerity budgets as of YET.

If the Spanish and Italian curves begin to flatten due to a BEAR FLATTENER, it would be a sign of great concern. Otherwise, the markets will be going back and forth as the headlines will be driving moves in the DOLLAR and the EURO before the longer term fundamentals begin to reassert themselves. 

Let us leave EUROPE and WASHINGTON and analyze some other significant stories. The AUSTRALIAN DOLLAR came under pressure on Friday as some AUSSIE banks reevaluated the AUSSIE growth story and suggested that the RBA would be moving to lower rates as the global growth begins to slow. AUSSIE weakness was also a result of the ILL-CONCEIVED CARBON TAX PLACED UPON THE MINING AND ENERGY INDUSTRIES. Never underestimate the desire of governments to tax the life out of the GOOSE LAYING THE GOLDEN EGGS.

The natural resource sector of Aussie has driven so much growth during the last two years, Prime Minister Julia Gillard can’t help but raise revenues from the major driver of the economy. The Aussies are contributors of 1% of global pollution–hardly the amount to carbon tax a phenomenal growth story. By week’s end, the AUSSIE CROSSES were all being sold as investors were taking some long-held profits in the Aussie. A recipient of energy sector investment will be CANADA as it has huge reserves as well as good port access for exports to China and other parts of Asia.

In a rebuff to the U.S. EPA regulators, Joe Oliver, Canadian Natural Resources Minister, made it known that Canada was unhappy with the U.S. environmentalists complaining about the large carbon footprint of the Alberta TAR SANDS. Oliver said he plans a global campaign to challenge the “exaggerated rhetoric” coming from the environmental lobby in the U.S. Canada is blaming the EPA regulators for the failure of the State Department to approve the KEYSTONE PIPELINE, which is built to carry Canadian OIL to the U.S. GULF COAST refineries.

The U.S. had better coordinate its policies and determine if they want secure OIL from Canada or to become more dependent on the uncertain supply of the Middle East. China cares not a bit about environmental impact and looks to purchase its energy needs wherever it can find secure sources. It will be important to follow Chinese Sovereign Wealth Fund investments as Canada seeks other markets for its energy products.

An interesting aside: In a BLOOMBERG story by Christine Buurma, it was reported that U.S. natural gas exports to Mexico hit a record. The WAHA HUB in West Texas, about a 100 miles from the Mexican border, exports have increased 53% from April 2008 to April 2011. So as the U.S. challenges Canada on its energy exports, it is busy increasing its “clean” energy exports to Mexico. Is the increased need by Mexico an indication of manufacturing ramping up in the MAQUILADORAS? It is important to watch this development especially with the recent change in the U.S. trucking laws.

A QUICK HITTER: Readers of NOTES FROM UNDERGROUND know that I have railed against the U.S. CORN-BASED ETHANOL program. The ethanol program has driven world grain prices higher as so much corn has gone into ethanol production, putting demand pressure on other grains. Yes, I believe that the global supply/demand curve has changed dramatically as the emerging markets’ huge increase in wealth has meant a huge increase in demand for protein.

The ethanol lobby has maintained that the U.S. is not responsible for the higher grain prices as very little corn is lost in the ethanol production process. Hogwash! In a world of increased demand, anything that puts pressure on the food chain is bound to force prices higher. Sugar-based ETHANOL is a much more efficient method of production and also does not directly impact the major component of the FOOD CHAIN.

Grain prices have moved higher during the past five years even as the U.S. has produced record crops. The ETHANOL LOBBY is playing with fire as drought spreads through the grain-producing regions of the Midwest. A major disruption in supply will be a problem for food prices in the U.S. and the world and will mean that price increases are far from TRANSITORY. Just something to put on our radar screens, especially as President Obama has been a very vocal supporter of U.S. ethanol.

Tags: Aussie, Australian dollar, AYSO, bear flattener, Bunds, Canada, carbon tax, China, corn-based ethanol, Debt, Dollar, EU, Euro stress tests, Europe, food chain, Italian curve, Julia Gillard, Maquiladoras, Mexico, oil, stress, tar sands, transitory, two-year notes, U.S. EPA, U.S. Gulf, Waha Hub

This entry was posted on July 17, 2011 at 4:46 pm and is filed under Australia, Commodities, Europe, Oil. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.