News Column

Global currencies yield international trading ideas

June 30, 2014



Matein Khalid surveys the foreign exchange landscape's latest fluctuations



Foreign exchange is the prism with which I view the world and pirouette in the markets. The shock negative US GDP data and subsequent fall in the 10-year US Treasury note yield to 2.5 per cent has led to a yen breakout to 101.35 despite the Bank of Japan's two per cent inflation target and Shinzo Abe's Third Arrow. The VAT hike will hit Japan's consumer spending and thus growth momentum. This will force another central bank "shock and awe" asset purchase in the autumn. I remain short yen for a 105 target by October.







My Swedish friends who are experts in Chinese private equity tell me that we are in the early stages of an epic housing bust even as the Politburo's corruption programmes causes capital flight and potential distress in local government finances, though Beijing has tried to stabilise growth with fiscal and monetary stimulus. The "cockroach theory" is as relevant in the Middle Kingdom as in Wall Street now that we have seen the first defaults in the onshore Shanghai corporate bond markets and the shadow banking system. I expect the PBOC to target a summer Chinese yuan range in 6.15-6.25.







My call for a lower Australian dollar has not been successful, thanks to the slight uptick in oil, gold, LNG, iron ore and thermal coal markets and stable Chinese PMI data. However, CFTC data suggests the market is net long Aussie futures in the Chicago Merc. Australia's economic growth has been robust at near three per cent and the RBA target rate is 2.5 per cent. Still, Australia faces an epic decline in mining capex and Canberra needs to consolidate its fiscal stance. There is no reason for the RBA to go hawkish, so I doubt if the Aussie rises much above 0.9450. A dull 0.92-0.95 Aussie summer range.







New Zealand is on a roll, with a 12.5 per cent rise in construction due to post-earthquake reconstruction in Canterbury and the highest post-Lehman GDP growth rate at 3.8 per cent. This means the Reserve Bank of New Zealand must raise its cash rate by 0.25 per cent at its next monetary conclave. Thanks to housing and construction, New Zealand is overheating and the central bank could well raise its overnight cash rate to four per cent by Christmas. The kiwi dollar is far too high at 0.88 but I will still go short Aussie/kiwi on strength.







The MAS has turned hawkish on the Singapore dollar, though I see weakness in the domestic data, banking NPLs, consumption and exports. This means the MAS could well signal another policy shift and use Sing strength at 1.25 to short the Asian Swissie (heresy of heresies) for a 1.28 September target. Crude oil, Iraq, bad monsoons and slower capital flows into Dalal Street spell a 64-year end-target on the rupee. The South Korean won's strength is excessive. Intervention in Seoul is inevitable as the Hermit Kingdom is an export colossus. I would short the South Korean won at 1,015 for a 1,040 target. The Thai bhat and Malaysian ringgit are both neutral in my risk reward calculus this week.







The housing boom, robust High Street, Mark Carney's hawkish Mansion House speech, the absence of wage inflation and a consensus that the Scottish people will vote "no" in the referendum means my recommended buy level on cable last week at 1.6980 was a money maker. The path to 1.72 is clear. Britannia may no longer rule the waves but sterling rocks Planet Forex, duckies!







Helvetica's currency is as boring as its cities. The Swiss central bank in Berne is committed to its 1.20 floor. No interest in euro/Swiss for now as it is simply dead money. In Latin America, I expect the Brazilian real to depreciate due to election risk, soft data, widening current account deficit, World Cup protests, US funding risk and a soft-money Capcom. The real can well fall to 2.40 by December. Mexico is far more exposed to PRI reform and the US shale oil.







The West's failure to impose draconian economic sanctions on Russia after Putin's Crimea annexation and central bank tightening the repo rate to 7.5 per cent has led to rouble strength to 33.7. It is never prudent to short the rouble at a time when Iraq, Jordan, Libya and Yemen's civil wars threaten another oil shock. However, Russia is on the precipice of recession and offshore banks from Limassol to Lugano are flooded with Russian capital flight. This means 37 roubles by year-end.







Emerging Markets







Potential oil panics







The shock us gdp data, the rise in crude inventories to 388 million barrels, concern about Chinese and Indian growth and Secretary Kerry's olive branch to Iran during his Middle East diplomatic shuttle has all capped Brent crude at $115 a barrel. This does not mean the geopolitical risk premium in oil prices will fall. Au contraire. A prominent Libyan human rights activist was shot dead. Sectarian militias have again begun to evoke the tragic memories of Baghdad's "ethnic cleansing" massacres in 2006-07. Moqtada Al Sadr has threatened to "shake the ground" and unleash his Jaish Mehdi against the Isis. Boko Haram terrorism continues in north Nigeria. Ukraine has signed a trade pact with the EU, in defiance of the Kremlin's Putin Doctrine. The financial markets have begun to discount the risk of an oil panic. I disagree. Investors should be prudent and position for an oil panic, the reason I have waxed eloquent on my energy ideas ever since the Iraqi insurgents took Mosul and the Kurdish Peshmerga seized Kirkuk in the death rattle of the Sykes Picot pact that created the post-Ottoman Arab world.







If Iraq's sectarian civil war engulfs the southern oilfields or Basra's port complex (where 2.5 MBD light crude is exported), all bets are off in world oil. I expect $128 Brent, the level when Benghazi revolted against Colonel Gaddafi in April 2011, will be the base, not the ceiling, for black gold.







Oil prices doubled from the moment Iraq invaded Kuwait to the onset of Desert Storm five months later. The same sharp rise happened in late 2002, months before George W. Bush and Tony Blair prepared to invade Iraq. Oil prices quadrupled during the October 1973 war in the Suez Canal/Golan Heights and almost tripled after the Shah of Iran lost his imperial Peacock Throne. Oil panics are dangerous for investors unprepared to make money from the financial carnage they unleash. They lead to spasms of risk aversion on Wall Street, spikes in volatility (fear trumps greed when Brent goes ballistic) and leveraged mayhem in currency.







Historically, I am programmed to sell the Indian rupee, the Turkish lira, South African rand and the Brazilian real after an oil panic. I remember the steep plunge in the Indonesian rupiah in 2004-05 after the Asian tsunami, Hurricane Katrina and the second Bali terrorist bombing. I used the Libyan civil war oil shock in 2011 to short the lira, South Korean won, Taiwan dollar and rupee. In fact, my repeated calls to short the rupee at 45 against the dollar stemmed as much from India's multiple macro-Achilles heels as Bharat Mata's vulnerability to the Arab Spring oil shocks. It is no exaggeration to say that Saddam Hussein caused the rupee shock of 1991 (when India's gold was almost hawked to the IMF and Congresswallahs finally met their, but not Panditji's, tryst with destiny) and Gaddafi controlled the rupee bear market in 2011. When the world oil markets sneezes, the Indian economy catches influenza.







The lira is grossly overvalued even at 2.10 given its current account deficit (seven per cent GDP), overleveraged banking system, $250 billion consumer loan time bomb, economic exposure to Iraqi Kurdistan and Syria, dependence on offshore hot money inflows to finance government debt, political tensions between the AKP ruling elite and the military high command in Ankara. In a global oil panic, I would not be surprised to see the lira trade at 2.60 and the rupee 64 to the dollar.







Even though gold has risen to $1,325 an ounce, I see the rand as hugely vulnerable. Pravin Gordhan has slashed growth forecasts to 2.7 per cent. A sovereign credit rating downgrade is possible. The Reserve Bank has gone dovish. The post-Zuma ANC power struggle has begun. The townships and miners' unions are enraged. The Bantu-Xhosa tribal schisms are primordial. Twenty years after apartheid, South African unemployment is 25 per cent. I remember our idealism as we protested Afrikaner rule in Trafalgar Square. Amandla! Apartheid is gone but the beloved country still cries for justice.







Emerging Markets







Apache's shift from Egypt to West Texas







The shock us gdp data, the rise in crude inventories to 388 million barrels, concern about Chinese and Indian growth and Secretary Kerry's olive branch to Iran during his Middle East diplomatic shuttle has all capped Brent crude at $115 a barrel. This does not mean the geopolitical risk premium in oil prices will fall. Au contraire. A prominent Libyan human rights activist was shot dead. Sectarian militias have again begun to evoke the tragic memories of Baghdad's "ethnic cleansing" massacres in 2006-07. Moqtada Al Sadr has threatened to "shake the ground" and unleash his Jaish Mehdi against the Isis. Boko Haram terrorism continues in north Nigeria. Ukraine has signed a trade pact with the EU, in defiance of the Kremlin's Putin Doctrine. The financial markets have begun to discount the risk of an oil panic. I disagree. Investors should be prudent and position for an oil panic, the reason I have waxed eloquent on my energy ideas ever since the Iraqi insurgents took Mosul and the Kurdish Peshmerga seized Kirkuk in the death rattle of the Sykes Picot pact that created the post-Ottoman Arab world.







If Iraq's sectarian civil war engulfs the southern oilfields or Basra's port complex (where 2.5 MBD light crude is exported), all bets are off in world oil. I expect $128 Brent, the level when Benghazi revolted against Colonel Gaddafi in April 2011, will be the base, not the ceiling, for black gold.







Oil prices doubled from the moment Iraq invaded Kuwait to the onset of Desert Storm five months later. The same sharp rise happened in late 2002, months before George W. Bush and Tony Blair prepared to invade Iraq. Oil prices quadrupled during the October 1973 war in the Suez Canal/Golan Heights and almost tripled after the Shah of Iran lost his imperial Peacock Throne. Oil panics are dangerous for investors unprepared to make money from the financial carnage they unleash. They lead to spasms of risk aversion on Wall Street, spikes in volatility (fear trumps greed when Brent goes ballistic) and leveraged mayhem in currency.







Historically, I am programmed to sell the Indian rupee, the Turkish lira, South African rand and the Brazilian real after an oil panic. I remember the steep plunge in the Indonesian rupiah in 2004-05 after the Asian tsunami, Hurricane Katrina and the second Bali terrorist bombing. I used the Libyan civil war oil shock in 2011 to short the lira, South Korean won, Taiwan dollar and rupee. In fact, my repeated calls to short the rupee at 45 against the dollar stemmed as much from India's multiple macro-Achilles heels as Bharat Mata's vulnerability to the Arab Spring oil shocks. It is no exaggeration to say that Saddam Hussein caused the rupee shock of 1991 (when India's gold was almost hawked to the IMF and Congresswallahs finally met their, but not Panditji's, tryst with destiny) and Gaddafi controlled the rupee bear market in 2011. When the world oil markets sneezes, the Indian economy catches influenza.







The lira is grossly overvalued even at 2.10 given its current account deficit (seven per cent GDP), overleveraged banking system, $250 billion consumer loan time bomb, economic exposure to Iraqi Kurdistan and Syria, dependence on offshore hot money inflows to finance government debt, political tensions between the AKP ruling elite and the military high command in Ankara. In a global oil panic, I would not be surprised to see the lira trade at 2.60 and the rupee 64 to the dollar.







Even though gold has risen to $1,325 an ounce, I see the rand as hugely vulnerable. Pravin Gordhan has slashed growth forecasts to 2.7 per cent. A sovereign credit rating downgrade is possible. The Reserve Bank has gone dovish. The post-Zuma ANC power struggle has begun. The townships and miners' unions are enraged. The Bantu-Xhosa tribal schisms are primordial. Twenty years after apartheid, South African unemployment is 25 per cent. I remember our idealism as we protested Afrikaner rule in Trafalgar Square. Amandla! Apartheid is gone but the beloved country still cries for justice.







Stock Pick







Apache's shift from Egypt to West Texas







Apache has been the Cinderella of energy E&P shares, thanks to its 25 per cent production exposure in Egypt's Western desert and its huge capex spending relative to free cash flow. Egypt's protracted political crises since 2011 took its toll on Apache's valuation. However, Apache sold one-third of its Egyptian assets to China'sSinopec for $3 billion, reduced capex by selling its concessions in Argentina and the North Sea, reinvesting in drilling ventures in the Gulf of Mexico and onshore West Texas (the Permian Basin) and New Mexico. The Houston energy financier (the real-life JR Ewings of the oil patch, wildcatters I am proud to have met in their Stetsons!) grapevine argues that Apache's net asset value is north of $130. Makes perfect sense to me since Apache traded at $135 in mid-2011 when its production footprint in onshore Texas/deepwater Gulf of Mexico was barely a third of output, not 85 per cent as it is today. The Permian Basin is the Prize for Apache with crude, gas liquids and gas condensate output of 250,000 barrels a day with an annual output growth rate of 15 to 18 per cent.







Apache trades at a mere 1.2 times book value versus two times for its GOM/America-centric domestic E&P peers. In essence, Wall Street has ignored or dissed one of the most compelling strategic transformations in American oil and gas. Apache is no longer a hybrid global driller saddled with Peronista/Egypt risk but a high-growth, largely domestic producer. In any case, Field Marshal Sisi's election as the new president of Egypt reduces the risk of terrorist sabotage, nationalisation and government insolvency/royalty demands. The divestitures have strengthened the balance sheet and are catalysts for a $2 billion share repurchase programme/dividend hike.







Apache CEO Steve Farris is dead right to buy the shares at a 38 per cent discount to NAV. The Graham/Dodd DNA in my soul argues that the new Apache is value at its current price, value in the Oscar Wilde sense, especially since the Canadian and Australian LNG cash hemorrhage is over. Thankfully, its Wheatstone (Australia) LNG stake is on the block.







Apache is inexpensive on both historical and relative valuation metrics I track. Apache trades at 14 times earnings when pure play domestic E&P shares command multiples near 18-20. I remember T. Boone Pickens telling me at a Philly dinner two Texan/Okie adages I have never forgotten. One, look boy, I was born at night. I just wasn't born last night. Two, if you want to drill for 60 cents to the dollar oil, take your drill bit to Wall Street. T. Boone Pickens is my inspiration and my hero, his Mesa Petroleum greenmail deals Capital Cities, Philips Petroleum, Gulf Oil mesmerised me even when I was a mere student at Wharton.







Apache can easily deliver 10 to 12 per cent production growth in its global oil, gas, liquids and condensate portfolio. Apache can well divest $11 billion in assets by end-2014 and finally finance projected lower capex via higher operating cash flows. The share purchase patterns suggest it is not unrealistic to expect another three or even four per cent reduction in the share count by Christmas. Egypt geopolitics risk? Lower, now that Saudi Arabia, UAE and Kuwait have given a $20 billion financial lifeline to the military regime and the insurgency in the Sinai is largely tribal/low key.







The Permian Basin, Alaska and Eagle Ford are the key to Apache's future, not the Argie pampas or the North African desert. The upstream portfolio (apart from, naturally, Misr) is the low geopolitical risk US, Canada, Britain and Australia. Gross acreage in the US alone is 12 million acres. Apache has downside risk to 90-92. Upside? A $130-$135 on NAV. I bet we get there.












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Source: Khaleej Times (United Arab Emirates)


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