Greed And Fear's Chris Wood On The Timing Of The Euro Endgame

Tyler Durden's picture

From CLSA's Greed and Fear, by Chris Wood, December 23 edition.

The S&P500 remains at post-Lehman highs and GREED & fear remains nervous about a correction. But GREED & fear will also have to admit that the short-term technical indicators long followed here are not sending warning signals. Rather the message is bullish which is one reason why GREED & fear is not reducing the beta of the long-only portfolios.

It is also the case that the US continues to be cut relative slack because of the problems in Euroland. Here the ongoing noise from Brussels makes it clear that the final crescendo of this particular drama lies in the future. With Frau Merkel continuing to talk tough about the need for fiscal discipline, and rejecting euro bonds, it appears that there will have to be more market turmoil before the inevitable decisions are taken. GREED & fear says inevitable because it still seems likely that the end game will involve some form of German acceptance of collective fiscal responsibility and debt restructuring. This is partly because the German establishment is so committed to the euro and partly because of the practical fact that German banks have such big exposure to the debt of the European periphery countries.

The past week have seen further signals that the above will be the end game. Thus, an article in the pinko paper by Peer Steinbru?ck and Frank-Walter Steinmeier, the former minister of finance and former foreign minister in the last SPD government, proposed debt haircuts as well as the limited introduction of European-wide bonds (see Financial Times: “Germany must lead fightback”, 15 December 2010). Second, the ECB announced on 16 December that it decided to almost double its subscribed capital base from €5.76bn to €10.76bn, with effect from 29 December.

This suggests that there is an understanding, despite the official rhetoric, that there are losses that will need to be taken. Still it also seems clear that there needs to be more market panic for such decisions to be forced on the relevant authorities, most particularly Frau Merkel. All this suggests an opportunity for macro investors since it seems increasingly likely to GREED & fear that this drama is going to come to a head in the first half of 2011 and not in 2013 or later.

Moreover the moment some form of credible debt restructuring is agreed, in the form of a European version of the Brady Plan, a bid should come in for the euro against the US dollar and indeed against the Swiss franc which has been the major beneficiary of the systemic surrounding the euro to the chagrin of the Swiss National Bank. But all this lies in the future. For the moment the issue for investors is what will be the catalyst to precipitate the next wave of market turmoil. Will it be Portugal, will it be Spanish banks’ property exposure or will it be a new Irish Government’s desire to walk away from the massively costly bank guarantees committed to by its predecessor? GREED & fear has no idea which will be the precise catalyst. Indeed it could be all of them. But more turmoil is coming which is why the best hedge for those owning Asian equities remains shorting European bank stocks

Meanwhile, the risk to the above view remains that Frau Merkel remains hard line to the end and that German public opinion revolts against taking on any of the periphery’s debts. Clearly, this is possible. But it seems unlikely to GREED & fear given that all the empirical evidence thus far is that when push comes to shove, the Germans capitulate to the political mantra of maintaining the euro.

What about the Chinese inflation story? GREED & fear will not repeat the relatively sanguine view already articulated here. But what is worth re-iterating here is that mainland policymakers are not concerned. The past week has seen more evidence of this. Thus, the Chinese government announced on Tuesday another increase in gasoline and diesel prices. As noted by CLSA China macro strategist Andy Rothman, this is not a signal that the PRC is particularly worried about inflation. Second, the chairman of the China Banking Regulatory Commission (CBRC), Liu Mingkang, made a speech at a financial forum in Beijing last Friday stating specifically that inflation was not a problem because of China’s continuing excess capacity. Thus, Liu said that there remains overcapacity for most industrial goods in China and that it is difficult for upstream inflation to be transmitted downstream.

Clearly, the PRC policymakers could always be wrong. But in GREED & fear’s view the empirical evidence of the past ten years and more suggests they deserve to be given the benefit of the doubt. Still it is also the case that markets are likely to spend the first quarter of 2011 continuing to worry about inflation in China. This is because the mainland authorities are themselves now expecting inflation to peak at about 6% in the second quarter, primarily because of weather related seasonal pattern. Thus, January and February traditionally show strong month-on-month inflation pressures.

Still the longer investors want to look into 2011, the less likely they are to be worrying about inflation in China or the rest of Asia and the more likely they are again to be worrying about renewed deflationary pressures in the West. As for developed market equities, the best place to be remains in those companies whose revenue streams are geared to the emerging markets. This is certainly how GREED & fear’s Japan long-only portfolio is positioned. On that point, the Nikkei published last week an interesting survey of 420 nonfinancial companies that found that 36% of Japanese listed companies’ earning last fiscal year (ended 31 March) came from emerging markets, up from just 9% a decade earlier. The same story applies in the US and European stock markets. But the only domestic story GREED & fear really likes in the West remains Germany and even there the final drama of Euroland’s crisis has the potential to hit resurgent consumer confidence, at least for a while.

There have been interesting developments in the Korean peninsula in recent days. GREED & fear refers to South Korea’s so-called “live-fire drill” on Monday on Yeonpyeong Island and North Korea’s subsequent statement that the exercise was not worth reacting to. This suggests the North is hoping for a resumption of the six-party pantomime, or some variation of it, after the recent flurry of diplomatic activity. Thus, China’s leading diplomat, State Bingguo, has visited Pyongyang and Seoul in recent weeks while an unofficial US envoy, Governor Bill Richardson of New Mexico, also visited Pyongyang last week.

Still if Washington and Seoul decline to be pressured into more talks, the risk to GREED & fear remains of further escalation from the North. For the failure of the South to do anything to stop the death of four South Koreans on South Korean soil, as a result of the violent attack in November, has led to a long overdue wake-up call in terms of South Korean public opinion. The support for the so-called “sunshine policy” has now all but evaporated. Instead there has been rising popular demand, in response to the South’s evident lack of military preparation for the North’s November attack, that Seoul makes it clear to Pyongyang that the next time such an incident occurs there will be a more aggressive retaliation. Hence this week’s military drills.

This is why investors should understand that the risk of military escalation in the Korean peninsula has increased since the government of President Lee Myung-bak has now made it clear to the North Korean regime, via communications with the North’s main ally, namely China, that it has changed the rules of engagement. The message is that if the North launches another attack the response will be to retaliate by launching an attack on pre-targeted strategic assets such as missile sites in the North. The question then becomes the risk of escalation if the North responds in turn to such an attack. In this respect the ability of China, or the lack of it, will become a critical variable given the fact that Beijing was clearly not pleased with the North’s November provocation which put it in a difficult position diplomatically.

Still so long as China is willing to shore up the North, and it is estimated to supply about three quarters of North Korea’s food and oil, it is not clear to GREED & fear if Beijing really has any control over the North’s behaviour. For the Kim Jong il regime presumably calculates that China will continue to prop it up because the alternative is a collapse of the Pyongyang regime which would likely mean a united Korean peninsula coming under the control of a pro-American alliance.

Meanwhile the North Korean interest in launching the November attack was clearly to gain America’s attention. The ultimate goal is US acceptance of the North’s nuclear weapons programme. Hence the not coincidentally close timing in November of the shelling of the island and the decision to show the world the uranium enrichment facility. As for the investment implications, North Korea remains an impossible issue for markets to discount. It either does not matter at all or it is the only issue that counts.

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Mr Lennon Hendrix's picture

Germany is playing their cards tight but what are they holding?  I think FIAT has a weak hand and will get flushed!

Germany holding a high pair and gold has the flush!  Get monie!

High Plains Drifter's picture

Well they never got their gold holdings back , have they?

Mr Lennon Hendrix's picture

Good point.  They should try, if they are not, to get delivery on the gold they have on loan from the FRBNY before the Euro, not to metion all FIAT, cashes out.

Arius's picture

the way i understand it (and of course its not the first or last time i am wrong) is that IT IS NOT german gold but it is US Gold which was allocated to germans after world war II to help them rebuilt their country...just accounting gimmics (we are so familiar these days) - thats the reason the gold still remains in NY.  well that's perhaps a fools view...

Mr Lennon Hendrix's picture

That is what the lease contract stipulates.

Hey what is gold doing?  What is silver doing there?  Hey little silver, what you doing there?

Arius's picture

the dolar used to this 1380 thought will be there forever...oopppsss...wrong again...

Mr Lennon Hendrix's picture

The dollar is a worthless napkin.  Gold will be thousands of dollars higher this year.  Silver will be hundreds of dollars higher this year.  '11 will be the year gold rectifies the system.

High Plains Drifter's picture

Gold and silver are going to explode upwards soon, imho. I sure hate it that bozo in chief, Dennis Gartman is making nice noises about the barbarous metal as of late, even though is a johnny come lately now.

Mr Lennon Hendrix's picture

People put their reps on the line by going toe to toe with gold.

Armchair Bear's picture

I think you are probably right about this - this will be an eventful year for those of us holding PMs...

TooBearish's picture

2011 is the year when systemic inflation blooms in full take the deflation and move on....

Quixotic_Not's picture

Can't wait!

Transferring to PMs enmasse on the next dip (did that 2X before in 2001 & 2003), should be a fun ride watching everyone chasing returns during out-of-control inflation...

Is quisnam panics primoris, panics optimus!

Quixotic_Not's picture

Charles Calomiris on Bloomberg TV today:

If rates rise 50 basis points more, the fed is insolvent.

Can't wait to see how they stick it to the taxpayers this go 'round...

Samsonov's picture

Why does this site have a "flag as junk" option but not a recommend option, such as "flag as awesome?"

margaris's picture

because there is always an abundance of junk in this world.

All the awesome stuff gets lost in the shuffle...

lunaticfringe's picture

Sorry, couldn't resist junking ya.

Eric The Red's picture

Because people on this site just Junk anything they disagree with regardless of whether its really junk or not.  Dissent is not accepted well on ZH.

So come on, junk me bitchez!!

vamsy's picture

People are using the 'junk' feature as a system to vote (similar to ' I agree/Disagree') instead of flaging conversations that are spam or mark the threads that have no relavance to the topics. I think Tyler should clarify the functionality.

I feel the reason most of the people are here in Zerohedge in the first place (atleast myself) is to read the comments that are posted.

lynnybee's picture

I'd also like an "applause" button or a "thumbs up" sign !!   so many great comments !

Arkadaba's picture

doing a applause button means signing in and doing a 'like your post' 

Arkadaba's picture

at least for tomorrow when most of Canada is still on holiday - boxing day - only in Canada.

Revolution_starts_now's picture

The thing that most don't seem to get is the future earnings. Sure you can buy gold and silver, and it's better than nothing. Take a minute next time you click the "add to cart button" and think about the raw purchasing power loss there. How many oz of silver and gold did your "labor" buy just 10 years ago?

The most heinous crime ever commited upon a fellow man is the devaluation of his current and future labor, and the labor of his kids. It is to sell the unborn into slavery, even if you could put yourself aside, how could anyone allow the very dilution of future fruit in perpetuity?  Who among us would allow this continue if the truth were known?

Let it be known and pass it on. We did not raise the 3rd world up, they sold us into the third world.

Welcome to the decade where chickens come home to roost.

Cockadoodle do, Bitchez

Quixotic_Not's picture

Who is this "they" you speak of?

Because from where I'm sitting the 'MeRiKan sheeple have consented for this at EVERY turn, by voting for (D) & (R) Kleptocrats at EVERY election...

When the dollar takes its sudden next drop, and the one after that, and the one after that, ad infinitum until it is totally worthless, I'll be sleeping like a baby!

2012 is gonna be a bitch for the 'MeRiKan sheeple, but I'm sure they'll just have to vote for Change you can bleed in liar again...

DoChenRollingBearing's picture


We can demand justice for the criminal acts of the banksters all we want, but the REAL heart of our problems is that we, the 'MeRiKan people elect the scum who have piled up deficits and debt.

StychoKiller's picture

Kinda hard to counteract the votes of the old, senile population that continue to vote for any id10t that "promises" not to cut Social Security/Medicare.  Until they all die off, we're screwed -- fortunately (or unfortunately, depending on how you look at it), the system will undergo the Great Implosion before that happens!

BigDuke6's picture

i think Revo star has nailed Bernanke and wall streets crime.


You've been wondering why the shock/horror at QE?

'My gold is up , why bother?  if he stops QE my gold will slow down going up'

'Don't stop Ben - we love it!' you say.

Well there's why it a crime

'The most heinous crime ever commited upon a fellow man is the devaluation of his current and future labor, and the labor of his kids. It is to sell the unborn into slavery, even if you could put yourself aside, how could anyone allow the very dilution of future fruit in perpetuity?  Who among us would allow this continue if the truth were known?


Let it be known and pass it on. We did not raise the 3rd world up, they sold us into the third world.'




lunaticfringe's picture

Cockadoodle do bitchez? Good stuff....

China is Europe's last hope. I wish the bastards would just let that eurotrash die a peaceful death.

Sudden Debt's picture

And if all the US Trash would also die peacefull, the 2 million who would survive would also prosper!


Aristarchan's picture

I'll flip a quarter into the hat to pay for your funeral.

Ahmeexnal's picture


China is Europe's last hope. I wish the bastards would just let that eurotrash die a peaceful death.


No. The Church of Rome or it's fully owned subsidiary -Submission- can pick up the tab in exchange of the eurosheeple's eternal submission.

RobotTrader's picture

Wouldn't surprise me to see BBVA, STD, HBC, etc. as the top percentage gainers in 2011.



Who is John Galt's picture

This GUY RobotTrader really is a dumb bitch isn't he?

DoChenRollingBearing's picture

@Who is JG,

My take is different on RobotT.  He is a TRADER.  It's in his name, and he likes charts & stuff.  Nothing wrong with any of that here in our ZH playground.

But, I am as BULLISH as almost anyone re the price of gold.

a 55,000 dolares, putaz!

Twindrives's picture

It would be a pleasant surprise to learn that you croaked Robo.  

Miles Kendig's picture

Your avi suits your sense of unerring judgment. 

STD, the new RBS, WhoT! 

Arius's picture

korean penninsula really a tender box

Revolution_starts_now's picture

"tender box" some prefer the term, "population control opportunity". Really depends on where you sit.

Aristarchan's picture

Care to give these "population control" folks your address?

DosZap's picture

I wish that "Tinder" box would just get it over with.

The Kim Dong Fool, has no way to deliver the nuke/s they have, I guess they could drive one up to the DMZ fence line, detonate it, and pray the wind is going South.

I am sick unto death of the little tin horn diktakers, that blackmail the world, with no HOLD cards.

And we let them.Pay them off every other year.

A couple of huge EMP's over them and their toast for years, or better yet, a few neutrons,and seal the deal.

DoChenRollingBearing's picture

Hey, my buddy DosZap.

I feel the same way about Kim "Mentally" Il Jong, but do remember that the NKs have THOUSANDS of rocket launchers and artillery pieces that would burn Seoul to the ground (Seoul is less than 20 miles from the border).

Yes, the SKs would beat them even without us, but they would lose their city of 16,000,000 people.  Too high a price to invite that war.

We should do a quiet deal with China...

DoChenRollingBearing's picture

A fun fact about North Korea.  It probably will be the first Communist country to have three generations right in a row running the joint.

Kim Il Sung, the Great Leader

Kim "Mentally" Il Jong

Next up, 3rd generation creepo Kim Dunghill (hey it's HARD keeping up with them).

Back in the past we called such governments Royalty...