Brazil's May Budget balance came in at 2.65 bln BRL excluding interest payments
somewhat short of the estimated level of 5 bln BRL. Including interest payments
this takes the monthly shortfall to -16 bln BRL and the trailing 12 month ma of
the deficit to -8.67 bln BRL. Given the public statements in recent weeks
regarding the intention to use aggressive fiscal stimulus to combat Brazil's
slowdown, tracking Brazil's public finances will become an important part of the
puzzle.

At present Brazil's deficit seems manageable but given the intention to raise
spending and the likelihood that tax receipts will come under pressure in the
months ahead, we do have some concerns that Brazil's fiscal position may look
significantly worse in 12-18 months time. - brazilprimarybudgetbalance.gif -
brazilbudgetbalance.gif

US Personal Income was estimated to have risen by 0.2% in May, matching
expectations. This takes Personal Income up to a new all time high of $13.334
trln and keeps the annual growth rate at 2.9%.

As with all "large statistics" the data offers little more than a snapshot of
the state of the key personal sector of the US economy. We would not rely on
monthly fluctuations for guidance, but we do take note of the fact that the data
shows US Personal Income to be about 5% higher than it was at its 2008 peak, a
key factor in allowing US consumers to repair their personal balance sheets.

Our main interest in the data is that it allows us to update our rough
estimation of Housing Affordability through May 2012, thus taking into account
the sharp drop in the 30 year mortgage rate that took place in May. The
attached chart shows the cost of debt service for Existing (using the FHFA
House Price Index) and New Homes (using the Census Bureau data). Both costs are
indexed so that Dec 31st 2000 = 100 (we use this date since it roughly
corresponds to the start of the housing boom). As can be seen the cost of debt
service has fallen by approximately 50% from the level of 5 years ago.

Over this period Personal Income has also increased considerably. Our
Affordability Index takes account of this by dividing Personal Income by the
cost of debt service for an Existing Home. Again we have rebased the data so
that December 31st 2000 = 100. As can be seen the index hit a new high of 216,
suggesting that housing is over twice as affordable as it was at the start of
the housing boom. The same is true of New Homes, and underpins the very strong
fundamental case behind our belief that we have commenced a new housing growth
cycle of exciting proportions. - personalincome.gif - housingaffordability.gif

As we enter the closing stages of the second quarter one potential loser from
quarterly allocation shifts is silver, which has performed poorly in recent
weeks. At the time of writing the metal has declined below $26.50 and is
pressing against a key support level that has been in place since January 2011.
This is the lowest intraday price since late December 2011 reflecting the fact
that silver has failed to live up to expectations thus far in 2012.

Our belief is that silver's weakness is probably a reflection of the fact that
it is now being liquidated in physical markets. Financial demand for silver can
be approximated by tracking total holdings of silver ETFs, which is helpfully
tracked by Bloomberg {ETSITOTL index}. As can be seen on the attached chart,
ETF holdings of silver currently total 575mm oz (worth about $15.25 bln at the
current price), down from a peak of 598mm recorded in April 2011 but up
approximately 7.6% over the last 52 weeks.

Apparently this pace of build-up, together with physical demand for jewelry and
industrial usage is insufficient to absorb new production and physical selling,
since the metal has been in a clear downtrend since its secondary peak in
August 2011. The clear danger is that a breach of key support could pressure
financial holders to start to trim their positions, leading to a more
disorderly decline in the metal. Our assumption is that a failure to hold $26
would lead to a fairly abrupt decline down to the point where silver commenced
its parabolic rise in late 2010, which is approximately $17.50. -
silveretfholdings.gif

The US Pending Home Sales report has been a useful guide to overall activity
during the current cycle with large moves in the index anticipating actual
sales by approximately 90 days. We were therefore pleased to see a very strong
May 2012 report which showed that the overall Pending Sales Index has risen to
101.1 (Jan 2001 level of activity = 100).

If one excludes the periods in which tax credits front loaded sales in 2009/10
this (together with March 2012) is the best reading since March 2007 at the
start of the subprime collapse. The most encouraging part is that this surge in
sales has come during the peak spring selling season. This can be seen in the
non-seasonally adjusted index which rose to 118.5 in May. Excluding tax credits
this is the best level of activity since June 2007 and an increase of over 15%
from May 2011. This report therefore underlines the extent to which the US
housing market has made significant progress over the last 12 months, and gives
reason to expect further improvement in sales and construction data later in
2012. - pendinghomesnsa.gif - uspendingmay2012.gif

The attached article contains a discussion about a warning issued by the BIS
regarding EM credit growth. The article concentrates on Brazil where clear
signs of stress are now visible within the personal loan market (as we
described yesterday).

Sometimes the shortest notes are the most apposite. The attached screen-shot
really tells its own story. - sg2012062729027.gif

Brazil's loan data continues to show a pattern of double digit credit growth
and accelerating personal loan defaults. Overall Private Sector loans
outstanding grew 0.98% to 1181 bln BRL. Housing loans once more outpaced this
gain growing by 2.84% and has grown 36.7% over the last 12 months. Housing
credit now represents 19.4% of Private Sector loans, up from 8% in 2008.

Our main focus however is on the Personal Loan sector where signs of serious
credit deterioration are now unmistakable. Overall Personal Loans grew by 1.15%
to 661 bln BRL and have grown by 12.5% over the last 12 months. Over this
period Personal Loan Defaults have increased from 6.40% to 8.00%, a default
rate last seen in November 2009 (when Personal Loans outstanding were only 458
bln BRL). As can be seen on the attached charts there is a fair degree of
momentum behind this move and we would expect it to extend up to a new record
high later in 2012.

For comparison's sake we have included a chart overlaying Brazilian Personal
Loan Defaults over that of US Mortgage Defaults during the US housing collapse
(Brazil's data is offset by -36 months to bring time frames into synch). As can
be seen the build-up of delinquency in Brazil is not quite as fast as that of
the US, but still can be expected to extend higher for several quarters. It
should be remembered that by mid 2008 when US defaults soared higher local
employment conditions were deteriorating rapidly, whereas in Brazil
unemployment remains very low. We would therefore expect Brazil's Default rate
to accelerate as an overall economic slowdown starts to sap employment. A peak
Default rate around the 10% level seems to us to be a reasonable expectation
later in this cycle, a level significantly worse than consensus view within the
local banking system. - brazilpersonalloandefaultmay2012.gif -
brazilusdefault.gif

This morning's release of the ECB's balance sheet suggests that a fair degree
of liquidity provision is being offered by that institution. The overall
balance sheet grew by €30.58 bln over the last week and has grown by €78 bln
(about 2.5%) since the start of June. This takes the total balance sheet
(ex-gold holdings) to a new all time high of €2,625 bln, an increase of just
over €1 trillion since this time last year. It is not yet clear whether June's
increase represents a deliberate or accidental change in policy by the ECB, but
in a sense this does not really matter since the overall increase in liquidity
still acts to stabilize the overall Euro-zone system. It remains true that the
current round of stress is largely contained within a limited number of
problematic sovereign debt markets, with other fixed income instruments well
bid at the current time.

It is interesting to contrast the largess of the ECB with the stand-still
policy of the FRB. Total liquidity provision by the FRB over the last 52 weeks
has dropped to $23 bln, which is entirely accounted for by the $24 bln
remaining in the CBLS (thus domestic liquidity provision over the last year is
just below zero). This underlines the cosmetic nature of Operation Twist (and
Twist Again), which has done nothing to add overall liquidity. Even so US
financial stress remains very modest at the current time with the Bloomberg US
Financial Conditions index at a modest -0.372, a reflection of the massive
boosts to liquidity provision undertaken between late 2008 and mid-2011. -
ecbfrbjune262012.gif

May's US New Home data supports the notion that a corner has been turned in the
US New Home market. Total sales were estimated at 369K, above the 347K
consensus while April's report was not revised at 343K. This means that sales
have risen by 61K or 21% since May 2011, making this the best spring selling
season since activity collapsed in 2007 (ignoring the distortion of tax
credits). Inventory remains extremely low at 145K, now well under 6 months of
supply. We would expect this metric to contract further as sales pick up pace.
Total sales are still short of the trailing 60 month ma (unlike existing home
sales which have passed this metric), but with the help of kinder seasonal
adjustments later this summer this indication should be crossed soon enough. We
have been using the ultra-long term 120 month ma as a reasonable recovery
target for this cycle, which would still imply activity will more than double
from May's pace in the coming quarters.

Interestingly stronger volume has combined with a rising trend in new home
prices, indicating tight supply in many markets. The Median price of a new home
has been in a rising trend for several months and the trailing 6 month ma (we
would not rely on single month data due to volatility) has risen to 228K, the
highest since January 2009 (on the way down) and May 2005 (on the way up).
Meanwhile another leg down in interest rates means that affordability is at
record levels. Attached is a chart which shows the nominal cost of debt service
for 100% of the average price of a new home using a 30 year fixed GSE mortgage.
At approximately $10,000, it is as low as it was in late 1980 and late 1993 in
NOMINAL terms. Clearly in real earning power, $10K is a fraction of what it
represented 32 years ago, meaning that both volume and price have upside in the
current environment. This obviously represents a very favorable set of
circumstances for the better run public homebuilders, which remain a favored
group for us at the current time. - D-NHSLTOT_Index.gif -
newhomedebtservice.gif - newhomeprice.gif

With all eyes on Europe ahead of this week's summit this morning saw some
indications that one of the continent's worst hit property markets may finally
be bottoming. Irish home prices registered their first gain since September
2007, rising 0.2% in May.

As the attached chart shows this is a tiny gain compared to the brutal losses
of the last 5 years, which have seen Irish home prices fall approximately 50%
from their peak 5 years ago and 35% from the start of the index in 2005.
Nevertheless a stabilizing or modest improvement of house prices would still be
an encouraging sign, even at the current depressed level. Stable prices would
at least allow lenders to start to effectively appraise whatever deals remain
to be done and for buyers and sellers to agree on market prices. These are
necessary developments for a recovery from the difficulties that Ireland finds
itself in and we remain optimistic that Ireland will in the end navigate its
way through difficult waters. - irishhpi.gif

The concept that magazine covers can provide important contrary indicators has
been well established over the years. Business Week's "Death of Equities" cover
from August 1979 is perhaps the most famous (see link below to the actual
article)

http://www.businessweek.com/investor/content/mar2009/pi20090310_263462.htm

but there are numerous other examples to note.

The reason why front covers can so often prove to be signs of a turning point
in a cycle are that their function is to grab the attention of the casual
observer, and hence tend to appeal to emotions under the guise of intellectual
thought. An effective magazine cover needs to contain a message that is widely
accepted to both true and of immediate relevance, and then to simplify this
down to an obvious image with limited verbiage.

Of course magazine articles are only one example of how imagery is used to make
a strident point to observers. Advertising is also an excellent real-time source
of data regarding the common sense view at any particular point in time. With
this in mind we have attached the following image that we came across over the
weekend (ironically in Businessweek magazine) that underlines the extent to
which the "super-cycle" for emerging markets has now entered conventional
wisdom as being an inevitable progression.

The copy (which we have removed since it identifies the advertiser) includes a
reference to a study which suggests that by 2050, 19 of the top 30 countries
measured by GDP are forecast to be countries that are currently categorized as
"emerging". 2050 strikes us as a very long time to forecast ahead; indeed very
few things expected to occur in 1974 actually played out in the manner expected
over the next 38 years (the concept of China as the world's #2 economy would
have been fanciful back then).

Between now and 2050 numerous economic cycles will take place, some of which
will no doubt be navigated better than others. How things play out over the
next 38 years is therefore anyone's guess, but no one's analysis.

Rather than look ahead to 2050, readers would do better to pay attention to the
last 18 months, over which period the performance of emerging market equities
has been punitive to USD investors. Attached is a chart comparing the 4 BRIC
markets rebased in USD terms together with the overall MXEF index and the SPX
index since the start of 2011. As can be seen the SPX index has a modest
positive return of 6%, the MXEF index has lost -19% and the 4 BRICs between
-25% to -36.5% (Brazil being the worst performer).

It is our contention that the reliance on the EM "super-cycle", and the
"inevitable" rise in their economies over the coming decades has blinded
investors to the rapid deterioration of the cycle that began a decade ago.
Equity and currency markets have apparently been more perceptive, but their
message has been largely ignored by investors and commentators alike. We doubt
that this will continue for much longer and we would suggest that advertising
copy in a year or two's time will have a significantly different message to
tell. - 1497_001.pdf - bricperformance.gif

We have held a resolutely negative view on silver since it topped out just
below $50 just over a year ago, and have compared its performance in its final
run-up and subsequent decline to that of the NDX index in 1999/2000 (see
attached chart).

14 months into silver's bear market (assuming our assumption proves correct) we
can see that the speed of silver's decline currently lags that of the NDX index
by approximately 3 months. However, this does not negate the validity of the
comparison since we are only looking for a rough guide as to how an explosive
and popular trade climaxes and then unravels over a period of months.

The key point to absorb is that silver has been unable to recover from its
sharp fall last spring and autumn, with each attempt to push up above $30 being
met with staunch resistance between $30-$35. Thus far support in the $26-$27
range has been equally impressive. Eventually one of these areas will give way,
leading to a rapid and powerful move in the direction of the breakout/breakdown.

The lesson of the NDX index 12 years ago is that support is more likely to give
way than resistance. With silver currently trading at $26.66 the metal is
currently once more back in the danger zone at a time that the entire commodity
complex is under pressure. It should therefore be watched carefully in the
coming sessions with a breach of $26 opening the way for a rapid decline to
around $18, the level from which silver's parabolic gains were launched in the
middle of 2010. - silver2012ndx2000.gif

We have argued for several months that India's position as the largest domestic
market for gold is a source of significant potential weakness for the metal.
Central to our concerns are the fact that we believe the Indian economy to be
under increasing duress with liquidity tight and interest rates remaining high.

Since gold has been used as a store of the rapid build up of wealth over the
last decade, it is likely to be used as a key source of capital by households
whose income starts to become crimped by local economic conditions. As the
attached article makes clear, in recent years Indians have opted to borrow
money against gold as collateral rather than sell gold for cash. Although this
results in no selling pressure on the metal in the short term it does inject
significant margin risk into the equation over the course of an entire
investment cycle.

Complicating matters at the current time is the fact that the Indian
authorities have belatedly started to crack down on gold lending operations
(which operate outside of the banking system). This has started to limit their
expansion, which one assumes will cause some Indian households to be forced to
sell gold rather than borrow against it. Given the affinity of Indian farmers
for gold, agricultural prices may be an important factor with lower crop prices
causing a shortfall in income and greater gold selling pressure.

The final piece of the puzzle is the price of gold itself. Thus far 2012 has
been a disappointing year for gold bulls, but the price remains unchanged in
USD terms and about $250 lower than its September 2011 all time high. For
Indians, gold remains very close to that high in INR terms (see attached chart)
due to the fact that the INR has collapsed in value in recent months, reaching
a new all time low of 57.15 this morning. This is the first time in gold's 12
year bull market that the USD and INR price of gold has diverged meaningfully
and it means that India's gold loans (which are generally priced in INR) remain
well collateralized at the current time.

Nevertheless they still require payments to be made at high interest rates in
order to remain current, with the danger being that interest payments
themselves require a further monetization of gold either via loans or outright
sales. The decision of the RBI to keep interest rates on hold this week will
only serve to increase the pressure on conventional local financing, increasing
a reliance on gold holdings as a source of liquidity. We do not consider this
to be a stable situation and believe that the danger of a forced unwind of a
portion of Indian gold holdings undermines the credibility of gold as a "safe
haven" at the current time.

+------------------------------------------------------------------------------+

Gold Financiers’ Growth Stalls as Rules Tighten: Corporate India
2012-06-22 11:06:48.197 GMT


By Ameya Karve
June 22 (Bloomberg) -- India’s biggest lenders that use
gold jewelry as collateral say earnings may stall this year as
central bank regulation aimed at reducing risk in the banking
system chokes off growth.
Net income at Muthoot Finance Ltd. may rise 10 percent in
the year that started April 1 after surging an average 86
percent in the past five years, according to Managing Director
George Alexander Muthoot. Profit at smaller rival Manappuram
Finance Ltd. may be little changed, said I. Unnikrishnan,
managing director at the Thrissur, India-based company.
“Our loan disbursements have come down” due to the
regulatory changes, Unnikrishnan said in an interview yesterday.
“We see flat asset growth this year.”
Muthoot and Manappuram are losing clients to money lenders
after the Reserve Bank of India tightened rules to curb
expansion at the finance companies and reduce risk at their
creditors, mainly commercial banks. Manappuram, endorsed by
Bollywood actor Akshay Kumar, will add no branches on a net
basis this year while Muthoot will cut office openings by 75
percent. Manappuram has plunged 47 percent this year making it
the worst performing stock in the BSE200 Index.
The Reserve Bank of India ordered gold financiers to raise
Tier-1 capital to 12 percent by 2014 and cap loans at 60 percent
of the value of the gold used as collateral, according to a
statement from the regulator on March 21.
Bullion futures in India reached a record on June 19, while
global spot prices for gold were down 15 percent from a peak.
The metal, which surged 70 percent from the end of December 2008
to June 2011, is heading for its longest slump in a month.

Gold Stash

Business growth at these finance companies will decline
“significantly” in the short-term, Crisil Ltd., the Indian
unit of Standard & Poor’s said in a report on June 15. Sales
growth may stabilize at a “sustainable” level of about 20
percent in the medium term, the rating company said.
Indians, the world’s largest buyers of bullion, have
stashed 18,000 metric tons of gold in jewelry, coins and other
forms, according to data on Manappuram’s website. That compares
with 1,281.62 metric tons of gold held by the SPDR Gold Trust,
the world’s biggest exchange-traded product backed by bullion.
Gold financiers including Manappuram, which started as a
pawn broker in 1949, expanded as Indians started to unlock the
value of their gold to benefit from growth in Asia’s third-
largest economy and rising prices of the bullion. Finance
companies in the organized sector hold 1,000 tons of gold,
according to Muthoot.

‘New Concept’

Gold loans grew as it “was a new concept to Indians, who
are known to sell gold only as a last resort,” Shashank Khade,
senior vice president at Mumbai-based Kotak Portfolio
Management, said on the phone. Demand for gold loans was also
triggered by investors who used these loans to invest back in
gold as it fetched them higher returns, he said.
The Reserve Bank set up a panel headed by K.U.B. Rao to
analyze the implication of gold imports for financial stability,
price trends and the role of non-bank finance companies in
influencing rates. The panel is expected to submit its report by
the end of July, the central bank said.
“All the uncertainty and speculations on whether there
will be more regulations will be over in the next two months
after the RBI comes out with its report on gold,” Manappuram’s
Unnikrishnan said. Muthoot expects a “partial” relaxation of
the rules within a year after the central bank “studies” the
gold-loan business, he said.

Shares Drop

Manappuram surged 6.7 percent to 24.55 rupees, the highest
since May 7 in Mumbai, while Muthoot, which has dropped 37
percent from its Aug. 11 record, rose 0.5 percent to 123.8
rupees. The BSE200 index has gained 13 percent this year
outperforming the decline in both the companies.
Profit growth at Muthoot may slow to a 4 percent gain in
the year ending March 31, according to a median survey of 7
analysts compiled by Bloomberg, while Manappuram’s net income
may drop 3.9 percent to 5.68 billion rupees, according to a
survey of 13 analysts.
“The assets are likely to fall in the first and second
quarters,” Himanshu Kuriyal, an analyst at Mumbai-based Marwadi
Share & Finance Ltd., said by phone. “Sequential growth may
return from the third quarter as uncertainty over the
regulations will subside.”
Muthoot, set up in 1939 in India’s Kerala state, charges as
much as 24 percent for lending against bullion for 24 months,
according to the company’s website. State Bank of India’s base
rate is 10 percent.
The company, which is the main sponsor for the Indian
Premier League’s Delhi Daredevils cricket team, plans to raise
15 billion rupees selling bonds this year to boost lending,
Muthoot said. The firm may also sell shares when valuations
become attractive, he said.
“There’s nothing wrong in the business model,” Muthoot
said. “If I had money, I would have invested in the company
now.”

For Related News and Information:
Muthoot Finance’s credit rating: MUTH IN Equity CRPR <GO>
Most-read India stories: MNI INDIA 1W <GO>
India’s rupee forecasts: FXFC INR <GO>
Top India stories: TIND <GO>
Global gold prices MTL GOLD <GO>
India momey market rates: MMR IN <GO>

--Editors: Arijit Ghosh, Abhay Singh

To contact the reporter on this story:
Ameya Karve in Mumbai at +91-22-6120-3668 or
[email protected]

To contact the editor responsible for this story:
Grant Clark at +65-6212-1101 or
[email protected]

- goldusdinr.gif

Although this morning's unemployment report for Brazil showed a drop to 5.8%
(this data typically falls in the 2nd and 3rd quarters) Brazil's Government
register of net job creation is starting to suggest a significant slowing of
job creation has taken place in recent months.

Known as the CAGED report (Cadastro Geral de Empregados e Desempregados) this
shows the total number of jobs registered with the government less job
dismissals for the month. It could therefore be viewed as the equivalent of the
US Non-Farm Payroll report although it is not seasonally adjusted (and much the
better for it).

May's report showed 139K jobs being created, well below expectations of 202K
and last May's total of 252K. This is the lowest May since 2009 (when Brazil
was rebounding from the Lehman crisis) and the 2nd lowest May data since 2002
(see seasonal chart). Nor is this disappointing report an anomaly. 10 out of
the last 12 months have seen the data decline on a YoY basis over which time
the trailing 12 month ma has declined from 160K to 104K jobs created each
month. This suggests that Brazil's ability to create new jobs has been
significantly diminished over the last 12 months, which has important and
negative implications for retail sales and credit quality going forwards. -
cagedjobcreationmay2012.gif - cagedseasonal.gif

May's existing home sales report is a solid collection of data that confirms
that the recovery of the existing home market has extended into the key spring
selling season. It is true that overall activity remains well below the levels
pre-crisis, but total annual sales seem to have stabilized around the 4.5mm
level, which seems to be enough to absorb the large supply of homes for sale and
in the foreclosure pipeline, and this is before the latest leg down in mortgage
rates has had a chance to further boost demand.

In terms of the data itself, total sales for May were at a 4.55mm SA annual
pace, just below expectations of 4.57mm and April's pace of 4.62mm (not
revised). This fluctuation is well within the error tolerance of the data.
Single Family home sales were 4.05mm, just below April's 4.09mm pace. This
keeps sales well above the trailing 60 month ma (see chart), which we have been
using as a recovery signal. Indeed the trailing 12 month ma has now also
crossed the 60 month ma, which again adds to our conviction that this recovery
is for real (the last two times this occured were late 1992 and early 1984,
both at the start of strong housing cycles). Inventory rose to 2.21mm homes,
but this is likely to be a reflection of higher listings during the spring
selling season rather than a permanent build-up. This keeps inventories above
the "healthy" 2.00mm level, but well below the dangerous excess levels seen
from 2006-2010.

Condo sales remain steady at 500K units (530K in April) while inventory fell to
281K. This is the lowest May inventory level since 2003 (condo inventory is
much more seasonal than single family home inventory), which suggests that
supply is starting to get quite tight in a number of regional markets. -
D-EHSLSL_Index.gif - M-ECSLHAFS_Index.gif -

As we noted in this morning's Weekly Speculator, WTI crude {CL1 comdty} has
moved down to test the $80 support level (this was briefly breached early this
morning). This still keeps WTI Crude above the level reached in October 2011,
and therefore it could be argued that this contract continues to meander
through a wide consolidation of $75 - $115 rather than the more negative
argument that a true bear market is underway. We lean towards the latter
largely because the supply US and Canadian crude oil has accelerated to the
point that demand is becoming overwhelmed (DOE inventories hit a new 22 year
high this week).

With regards to the Brent Crude {CO1 comdty}, recent price action has arguably
been more damaging. As has been widely documented, Brent and WTI crude prices
have diverged widely since late 2010 and during last summer's steep decline in
WTI crude, Brent never traded below $98.74, allowing the spread to WTI to widen
to as much as $27.88 in October. This spread is now down below $11.50 as Brent
crude has fallen as low as $91 in recent days, its lowest level since January
2011. This means that both crude contracts are currently testing key "round
number support" at the same time, which should both strengthen support but also
increase the significance of any violation in the coming sessions. -
D-CL1_Comdty.gif -

An excellent commentary on the Eurozone that makes several pertinent points
about the political origins of the current morass. As the author asserts, this
"crisis" is likely to be with us for a very long time. Although this may appear
to be troubling, our sense is that markets are starting to understand the long
term nature of the malaise and are starting to treat it as a "chronic"
condition rather than an "acute" one.

This implies that there will be plenty of periods of calm interspersed by
episodic breakouts of panic as specific issues suddenly demand attention. The
Eurozone may well have a long term "crisis discount" applied to it, but this in
itself would still allow for periods of appreciation of local financial assets.

FOMC Statement link:
http://www.federalreserve.gov/newsevents/press/monetary/20120620a.htm

In their June meeting the FOMC opted to take the path of least resistance and
"Twist Again". The accompanying statement makes clear that the Committee was
influenced by recent week employment data and fears that Household spending may
be slowing. Our own views are that the former is largely a reflection of faulty
seasonal adjustment and the latter is an illusion, but we do not get to vote on
such weighty matters, and are only able to react to the Committee's decisions.

In this regard we view this statement as something of a non-event. Although the
FRB will be extending the maturity of its treasury holdings (the FRB intends to
continue to purchase instruments with a maturity of 6 to 30 years and to sell
those of 3 years or less) it will not be increasing the overall size of its
balance sheet. This has remained virtually unchanged since the end of QE2, as
has the breakdown of the various facilities employed (see chart).

Regarding the effect of the decision to "Twist Again" we doubt whether this
will prove to be as important as the investment choices of private capital.
Although it is certainly true that the yield curve has compressed since
Operation Twist came into being last summer (see attached yield curve chart),
much of this compression took place in the last 3 months when "safe haven
flows" have been the dominant determinant of Treasury yields. There is still
some theoretical room to lower the spread between the 5 and 10 year notes (89
bp, purple) and the 10 and 30 year notes (109 bp, black), but it really is hard
to imagine the nominal 10 and 30 year yields falling much lower. Nor do they
need to do so, since any business activity that makes sense when the 10 year
treasury yield is 1.75% will still do so at 1.50% or 2.00%.

Even in the space of mortgage credit we are reaching the point where mortgage
rates are unlikely to fall meaningfully further. This is not to suggest that
monetary easing is futile, merely that a great deal of accommodation is already
being offered by the FRB and that it is already having a stimulative effect
(see our earlier comment of refinancing). The decision to "Twist Again" should
therefore be viewed as a largely cosmetic exercise that does little to change
the facts on the ground in either the US economy or its capital markets.

+------------------------------------------------------------------------------+

Federal Open Market Committee June 20 Statement: Full Text
2012-06-20 16:32:07.228 GMT


June 20 (Bloomberg) -- The following is a reformatted
version of the full text of the statement released today by
the Federal Reserve in Washington:

Information received since the Federal Open Market
Committee met in April suggests that the economy has been
expanding moderately this year. However, growth in
employment has slowed in recent months, and the
unemployment rate remains elevated. Business fixed
investment has continued to advance. Household spending
appears to be rising at a somewhat slower pace than earlier
in the year. Despite some signs of improvement, the housing
sector remains depressed. Inflation has declined, mainly
reflecting lower prices of crude oil and gasoline, and
longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee
seeks to foster maximum employment and price stability. The
Committee expects economic growth to remain moderate over
coming quarters and then to pick up very gradually.
Consequently, the Committee anticipates that the
unemployment rate will decline only slowly toward levels
that it judges to be consistent with its dual mandate.
Furthermore, strains in global financial markets continue
to pose significant downside risks to the economic outlook.
The Committee anticipates that inflation over the medium
term will run at or below the rate that it judges most
consistent with its dual mandate.
To support a stronger economic recovery and to help
ensure that inflation, over time, is at the rate most
consistent with its dual mandate, the Committee expects to
maintain a highly accommodative stance for monetary policy.
In particular, the Committee decided today to keep the
target range for the federal funds rate at 0 to 1/4 percent
and currently anticipates that economic conditions --
including low rates of resource utilization and a subdued
outlook for inflation over the medium run -- are likely to
warrant exceptionally low levels for the federal funds rate
at least through late 2014.
The Committee also decided to continue through the end
of the year its program to extend the average maturity of
its holdings of securities. Specifically, the Committee
intends to purchase Treasury securities with remaining
maturities of 6 years to 30 years at the current pace and
to sell or redeem an equal amount of Treasury securities
with remaining maturities of approximately 3 years or less.
This continuation of the maturity extension program should
put downward pressure on longer-term interest rates and
help to make broader financial conditions more
accommodative. The Committee is maintaining its existing
policy of reinvesting principal payments from its holdings
of agency debt and agency mortgage-backed securities in
agency mortgage-backed securities. The Committee is
prepared to take further action as appropriate to promote a
stronger economic recovery and sustained improvement in
labor market conditions in a context of price stability.
Voting for the FOMC monetary policy action were: Ben
S. Bernanke, Chairman; William C. Dudley, Vice Chairman;
Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto;
Jerome H. Powell; Sarah Bloom Raskin; Jeremy C. Stein;
Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.
Voting against the action was Jeffrey M. Lacker, who
opposed continuation of the maturity extension program.

--Washington newsroom +1-202-624-1820. Editors: James
Tyson, Gail DeGeorge
- frbbalancesheet.gif - yieldcurve.gif

The 2012 refi-boom continued through another week with the MBA Refinance Index
hitting 5385, its highest reading since April 2009. This shows the degree to
which any decision by the FOMC to "Twist Again" has been preempted by both the
bond market and individual home owners, who have been rushing to take advantage
of 30 year mortgage rates that are 275 bp below their level of 5 years ago.

Given that refinance activity has been elevated for several weeks (we use 4000
as the level that denotes a boom in activity) and that the appraisal process is
now much more predictable than the chaotic period in 2009 (when a large number
of applications were rejected) the refi-boom of 2012 should result in a
substantial reduction in monthly expenditure for a large number of US
households. We would expect this to help keep retail sales buoyant and aid the
recovery in the automobile market later in 2012.

The Purchase Application index by contrast remains muted, falling back to 188
this week after last week's strong 205 print. We have started tracking this
data using a 4 week ma which is currently at 190.38. A break of this average
above 200 would suggest that a meaningful upsurge in home sales using mortgages
(rather than all cash) is underway. - D-MBAVPRCH_Index.gif -
D-MBAVREFI_Index.gif -

Interview with Pimm Fox Bloomberg TV, June 19th. Interview concentrates on
today's FOMC meeting and current FRB policy. Link for non-Bloomberg terminal
users below.

http://www.bloomberg.com/video/94950583-fed-doesn-t-need-to-do-anything-shaoul-s
ays.html

Evidence continues to mount that the US new home industry has entered a new
growth cycle. Although this morning's headline Housing Start report came in
just shy of estimates at 708K vs 722K, this was made up for by a large revision
to April starts to 744K from 717K. In addition, Building Permit data (which we
prefer) was very strong at 780K vs 730K estimated and 723K in April (revised 8K
higher). This takes Total Permits through the trailing 60 month ma for the
first time since May 2006 and we view this as an important metric signalling a
true recovery rather than a "dead cat bounce". The fact that this is taking
place in the middle of the key spring selling season (and at a time that Census
Bureau seasonal adjustments are at their harshest) only adds to the sense that
a major corner has been turned.

Perhaps most excitingly, strength was not limited to the multi-family sector
which has thus far dominated the recovery in activity. Single Family starts
were 516K, the best level since April 2010 (when tax credits were in effect).
Permit data was equally impressive at 494K, the best data since September 2008
(ignoring tax credits). This still keeps this key metric below its 60 month ma,
but it looks quite likely that a breakout above this indicator will take place
later this summer. - M-NHSPATOT_Index.gif - M-NHSPA1_Index.gif -
housingstarts.gif

The June NAHB Homebuilder sentiment report showed the overall index at 29 in
line with expectations. May's report was nudged down to 28 from 29, a trivial
adjustment that keeps the recovery in the data intact through the key spring
selling season.

As can be seen on the attached chart all sub-categories of the data show a
sustained bounce. Present Sales (red) reached 32 (30 in April), which is the
strongest reading since April 2007. This is despite the fact that Traffic
(green) remains muted at 23 (it was 27 back in April 2007), suggesting that the
quality of visitor to home-sites remains higher than normal. Future sales (red)
remained steady at 32, reflecting the fact that homebuilders remain
conservative in their guidance.

All in all this is a solid report that justifies the robust (if volatile)
performance of US homebuilding equities during the current correction. -
nahbjun2012.gif

The Reserve Bank of India (RBI) sprung a surprise this morning by electing to
keep the local REPO rate at 8.00% when most had expected a drop of 25bp to be
announced. Persistently high inflation was the reason given for keeping
interest rates on hold, with inflationary concerns trumping data that suggests
a rapid decline in local economic conditions has taken hold in recent months.
Given that May's CPI was estimated at 10.36%, one could argue that the RBI has a
point, and clearly the very weak performance of the INR also influenced their
decision.

This keeps monetary conditions quite tight. As the attached chart shows, the 3
month interbank offer rate has remained above 9.5% in recent weeks while the
RBI has been required to inject an average of 1 trln INR into the banking
system over the last 50 days. It will be interesting to see if a further
deterioration takes place now the promise of a rate cut has been removed.

As we have argued before, India's economic cycle looks to be ending in a manner
familiar to anyone that experienced the 1970's boom and bust in Europe and the
US. The RBI's determination to keep monetary conditions tight suggests that
downside risks to activity now trump the upside risks to inflation. This is
probably bad news for local equity prices and for the INR, which should suffer
if foreign flows finally start to signal a liquidation of local financial
assets (thus far they remain stubbornly positive). - D-RBICRR_Index.gif -
W-SENSEX_Index.gif -

China's official home price data continues to show a significant deterioration
in home prices across a large proportion of urban markets. This data, combined
with the fact that the pace of both finished unit sales and land sales have
sagged over the last few months suggests that the Chinese real estate market
has become a key source of weakness for the domestic economy.

May's home price data showed the number of cities with rising YoY new home
prices has fallen to 15 (out of 70 cities surveyed), while the declining city
count has risen to 54. This creates a new record Rising/Falling spread of -39
cities. Wenzhou remains the worst city with a -14.2% YoY decline (-12.3% in
April) and a total of 5 cities have annual declines greater than -3% and 11
with -2% declines or greater. Only 3 cities have price increases greater than
1%, the best performing being Xining with a 1.4% annual increase.

Existing home price data is equally poor with 11 cities still in positive
territory and 58 declining, creating a Rising/Falling spread of -47. Wenzhou is
again the worst performing market down -17.1% YoY. 6 cities have declines
greater than -5% and prices in the 15th worst city (Qanzhou) have declined -3.5%
(our data cuts off here). The best performing city is Guiyang with a 2.9%
increase and 6 cities still have increases greater than 1%.

Although the PBOC has finally started a monetary easing cycle, we do not expect
this to reverse the deteriorating cycle in local real estate markets. Instead
we expect to see a familiar cycle where lower prices destroy demand, leading to
a rapid build-up of housing inventory. Later in 2012 this should mean the pace
of construction starts to slow sharply, which is the time that the full force
of housing's woes will start to be felt in the local Chinese and global
economy. - D-.CHREPINC_Index.gif - D-.CHEPINC_Index.gif -

One of the few solaces from a financial panic is that the associated collapse
of US interest rates sparks off a scramble for refinancing. Indeed this time
around, a US homeowner has had to experience only a modest decline in the local
equity market for a very sharp reduction in yields (unfortunately if they
diversified abroad or into commodities this will not have been true), making it
a relatively benign "crisis" at this point in time.

Meanwhile the traditional response to collapsing mortgage rates has taken
place, with the MBA Refinance index reaching 5334 this week, its highest level
since April 2009. It is interesting to note that the peaks of 2010 and 2011
have already been exceeded, making this potentially a bigger refinance wave
this time around (remember applications do not necessarily get turned into
mortgages, with rejection rates still much higher than they were 5 years ago).
As we have explained before, a surge in refinancing creates the need for large
holders of MBS to step into the long end of the curve and purchase treasury
securities to replace the yield lost from refinanced mortgages, and this
process has clearly added to demand for US treasuries in the last couple of
weeks.

Perhaps more exciting for the overall housing market is the fact that the MBA
Purchase index has also made a response to the drop in yields. This index
reached 205.60 this week, its highest level since December 2, 2011 and the 2nd
highest since April 2011. As the attached chart shows, this takes the index
above its trailing 150 week ma for the first time since January 2008. This
suggests that the seasonal pick up in home sales has continued to gather pace
in recent weeks, with affordability gaining a further boost from the drop in
mortgage rates. We will be watching this index closely in the coming weeks to
see if it can decisively break out of its 2010-2012 range. 220 would seem to be
the key figure to be reached in this regard, although the readings tend to be
quite volatile from week to week, meaning that a 4 week ma (currently 190) will
have to be used for a definitive indicator. - W-MBAVPRCH_Index.gif -
D-MBAVREFI_Index.gif -

A very interesting article that accurately describes growing funding and
delinquency issues in Brazil's "secondary" banks. Many of the issues described
are reminiscent of the last US mortgage lending cycle, including "no doc loans"
leading to fraudulent applications and the securitization of loan pools
allowing large earnings to be booked via "gain of sale accounting". In the case
of Brazil, many of these securitized pools appear to have either been sold to
3rd parties and bank proprietary funds. Although this may act to limit the
direct credit losses from the loans, blowing up your own customer base is
rarely advisable and likely to lead to considerable regulatory scrutiny.

We appear to have reached the point in the cycle where delinquency levels have
risen to the point that the demand for the end-paper has started to soften,
leading to the first wave of lender defaults (roughly Q1 2007 in the US cycle).
As was the case in the US 5 years ago, arguments are being made that the
problem is limited to a few rogue lenders, or perhaps to a small portion of the
overall loan market (the sub-prime problem is "contained" was a popular refrain
in the US back in 2007).

Unlike the US cycle, we currently doubt that consumer credit losses will rise to
the level that they imperil Brazil's entire financial system, but a repeat of a
problem on the scale of the US Savings and Loan crisis in the late 1980's or
the UK's "Secondary Banking Crisis" in the mid 1970's does seem to be quite
likely to take place over the next 12-18 months. Both of these were considered
to be extremely difficult periods to navigate, and both involved losses many
times greater than were estimated at the early stages of the crisis. We would
expect to see significant losses taken in equity and debt instruments (issuance
of which has been considerable) of second tier Brazilian banks. Although we do
not currently expect problems to rise to the level that they threaten the
actual solvency of Brazil's largest banks, given the fragility of confidence
globally towards the financial sector, a significant widening of large bank
credit spreads and a further drop in equity prices can be expected to take
place if events follow the path we outline above.

India's Industrial Production for April 2012 was estimated to have grown by
0.1% from April 2011, once more missing consensus of 1.7% annual growth. As the
attached chart shows, India's Industrial Production has experienced a rapid and
persistent deceleration with the trailing 12 month ma of growth falling to 2.6%
in April.

At this point of the cycle, bad economic news is often welcomed over the short
term by the local market as making stimulus more likely. India's SENSEX rose by
1.17% to close at 16,892 this morning following the IP report, taking the index
up to what should be very strong resistance at 17,000. The RBI are due to meet
next Monday, June 18th and although it is quite possible that a cut in interest
rates and/or reserve requirements will be announced at that time, we would be
sellers into any rally that unfolded. - indiaipapril2012.gif

China's monthly data-dump was spread over 3 sessions with the national real
estate sales and completion data issued last night. This extended the recent
trend in data showing residential real estate sales (measured in square meters)
slowing substantially on a YoY basis. May's reading of -13.5% is the 4th
consecutive drop in this metric and we would expect to see this trend continue
to show a sharp decline in sales.

Meanwhile the Completion Rate of residential real estate continued to show
annual growth of 26.5% in May. This reflects the long lead time for real estate
construction with projects being completed in May having been started sometime
in late 2010 or early 2011 well before the slowdown in sales took hold. As a
result 2012 is on track to show the fastest ever acceleration in completions,
which should lead to a significant excess of completed unsold units. We suspect
the rate of new project starts has already collapsed (hence the change in
regulations last week threatening to seize undeveloped land), but this will not
show up in the completion statistics for several months. Actual construction in
progress is another matter, and this may already be starting to shrink in
certain regions at this point of the cycle, although we have no reliable data
on which to base this conjecture (other than some significant reported weakness
in machinery and cement sales). - chinaresidentialre.gif

We have spent a great deal of time looking at EM car sales this morning
(hopefully with good reason) and our final comment on the May car sales series
will focus on Mexico, whose domestic car cycle is completely out of phase with
other large emerging markets.

Mexico's market closely resembles the US car market, with a deep and protracted
draw-down in sales taking place in 2009 and 2010 that is yet to be entirely
repaired. This means that Mexican car sales exhibit non of the excess growth
experienced in the 4 BRIC economies and are instead in the middle of a decent
and sustainable recovery.

This recovery appears to now be accelerating, with May's sales growing by
11,600 Yoy (16%) to reach 80,300 units. This is slightly above the trailing 12
month ma at 78,700, which compares to a level of pre-crisis sales averaging
95,00 per month. This tallies with our belief that investors should be far more
patient with the local Mexican economy than that of most other large emerging
markets. - mexicocarsales.gif

Russia also reported significant economic data over the weekend (with a
fraction of the attention that China received). This contained some evidence
that the domestic Russian economy may have slowed considerably in recent
months. Russia's imports for May were estimated at $26.9 bln, which means that
they have shrunk by $250 mln over the last year. Although the drop is trivial
in size, it is the first YoY decline since December 2009. The flattening of the
12 month ma shows that this is not a freakish single set of data, but part of a
clear trend.

Meanwhile domestic car sales showed an 11% gain from May 2011. Although this is
still a decent rate of growth it is somewhat slower than the 15% gain which had
been anticipated. Again we see a clear trend of slowing growth on the attached
chart of car sales. Although Russian car sales are still much more likely to
finish 2012 still in positive territory than either Indian or Chinese data, this
is simply because their sales cycle decline began roughly 6 months later. All 4
BRIC economies appear to have substantial issues with their local new car
market, which tells you everything you need to know about where the EM
"super-cycle" is heading. - russiaimports.gif - russiacarsales.gif

An interesting regulatory change in China took place last week, which places
pressure on developers to make progress with stalled real estate projects. As
the article makes clear it is not certain that developers will actually be
forced to develop land that they are sitting on, but the fact that this change
in rules has been passed is a signal that authorities are starting to fret
about the pace of local real estate development.

Domestic car sales are starting to become problematic in a number of key
emerging markets. We described earlier today a rapid build up in Chinese new
car inventories and it would appear that a similar problem faces Indian car
manufacturers unless production starts to be cut back.

May's passenger car sales came in at 163K, a drop of -3.0% from April and an
increase of 2.8% from May 2011. This pace of change is substantially below the
annual 12% increase in sales that the Society of Indian Automobile
Manufacturers (SIAM) had estimated for 2012 as recently as April and SIAM
announced that this figure is subject to downward revision. We would expect
sales to actually slip into negative territory later this year, and for local
manufacturers to then start to cut back considerably on vehicle production,
exacerbating the slowing trend of Indian economic growth. - indiacarsales.gif

Following the release of May's economic data on Saturday night, China released
its monthly loan and money supply data this morning. This showed little change
from the prior month in the aggregate monetary statistics. YoY M2 growth picked up
a little to 13.2% (from 12.8% in April) but this statistic has been fluctuating
between roughly 12.5% and 13.5% for several months and so we would not make
anything of this small uptick.

Although a 13% annual growth in M2 may seem to represent very loose conditions,
it should be noted that overall economic conditions have deteriorated against
this backdrop. One sign that monetary conditions are actually quite tight is
the sharp divergence between "broad" and "narrow" monetary statistics. The
latter, measured by M1 grew by a mere 3.5% over the last year, and has
fluctuated in a range between 3.1% and 4.4% since the start of 2012. This is in
spite of the fact that overall lending in the Chinese banking system has been
growing at a steady pace of around 15.5% YoY. May's data showed total CNY
lending of 793 bln CNY, up sharply from 681.8 bln CNY in April. We note however
that "Entrusted Loans" dropped by -80.3 bln CNY from 101.5 bln in April to 21.2
bln in May and so we wonder if the apparent expansion of local bank lending may
be more of a re-categorization than anything else.

In any event at 793 bln CNY bank lending growth is within the range of recent
readings, and so should not be expected to be fueling any change in local
monetary conditions. Our sense is that these remain tight and that the large
gap between M1 and all measures of economic growth suggests that the latter
will continue to disappoint going forwards. - chinaloansm1.gif

Last week's rate cut by the PBOC sparked some concerns that May's data-dump of
Chinese economic statistics would show a marked deterioration from prior data.
We never bought into this specific concern, since official Chinese data seems
to be substantially more inert than the economic activity it purports to
measure (to be fair we assume this was true in the boom of 2009/10 when data
possibly understated activity).

In any event May's data showed CPI slowing to 3.00%, a reflection in part of
lower commodity input costs. This in theory opens the way to further stimulus
should the PBOC be in favor of such a move, but our sense is that they remain
committed to a gradualist path at the current time, with perhaps a small cut in
the Reserve Requirement on the table in the next month or so. It is likely to
take a substantial and obvious deterioration in conditions to jolt the PBOC
into taking the sort of measures that may begin to address the issues (no
different to the FRB in the last 2 US down cycles)

Measures of domestic economic activity show Industrial Production grew 9.60%
YoY, a little below consensus of 9.8%. Even though a clear decelerating trend
is in place this remains a vastly faster pace of growth than most other
emerging market economies, a substantial number of which have seen IP shrink in
recent months. Whether this reflects an issue with measurement or a truly more
robust economy is open to question. Retail sales remain buoyant at 13.8% (14.2%
consensus), while Fixed Asset Investment has been trimmed to 20.10%.

As we have argued before, relying on Chinese official data to gauge the economy
is unlikely to give much insight as to the genuine level of activity. Retail
sales in particular will be best assessed by the reported earnings of large
foreign corporations active in China. Thus far we have seen some spotty reports
of weakness, but nothing to suggest a wholesale change in direction. For
instance Friday saw MCD suggest that conditions for Western fast food companies
(what we would term a "status staple good" in China) have deteriorated in
recent months. The semi-annual earnings season may throw up more information in
this regard, and we would imagine that questions regarding Chinese demand will
be frequent in corporate conference calls.

A further concern is how much growth in economic activity actually represents
the production of useful goods and services, rather than simply feeding inventories
of unsold goods and services. We have previously voiced our concerns regarding
housing (May's RE data is still to be released at the time of writing) but
a similar pattern has started to build in the local car market. Car deliveries to
dealers remained very strong in May but a clear problems with inventories
have arisen. The China Association of Automobile Manufacturers estimate these
have grown from 45 to over 60 days of sales during May. This implies that either
sales need to be boosted quickly or production will have to be significantly reduced,
which is obviously incompatible with a 9% Industrial Production growth rate
(see link for Bloomberg users {NSN M5FFFX6KLVR4 <go>} ).

Our view remains unchanged. China's unbalanced economic growth has resulted in
substantial overproduction of key goods and services. The painful process of
adjustment has begun, and the PBOC is likely to chase events rather than lead
them with monetary policy. - chinacpi.gif - chinaipfaretail.gif

A fascinating article that outlines how Eurozone liquidity is pooling within
the German banking system. As well as depressing German interest rates, this
process should over time increase the willingness of German banks to lend out
their bloated deposit base (we suspect that mortgage credit will be the primary
beneficiary of this process). This is in line with our thesis that the
Eurocrisis may actually be a "net win" for the domestic German economy.

The other point made by the article is one that we had not really considered,
namely that German subsidiaries of non-German banks have started "fishing in
the same pool" for deposits. This then allows them to recycle German savings
back into local liquidity via an internal transfer. To the extent that European
banks under pressure from domestic deposit flight are able to use this tactic,
the danger of a local run on the bank can be averted. Clearly this cannot be
assumed to be a panacea, but it is a reminder of the complexity of the issues
involved, and the distortions that have been created by shifts in capital
allocation over the last 24 months.

Following yesterday's surprise rate cut by the PBOC, we can expect greater
scrutiny of China's economy for hints of weakness that go beyond the illusory
"soft landing" consensus. In our opinion any sensible investigation of China
needs to look beyond the official statistics (which are due to be released in a
large batch this weekend) and must include data from other closely linked
economies and (perhaps most importantly) corporate data from multinational
companies with substantial Chinese subsidiaries.

Taiwan clearly has the closest of links with China and May's export data, which
was released this morning, certainly suggests that Chinese demand for Taiwanese
exports has sagged considerably. Overall Taiwanese exports fell by 6.3% YoY to
$26,097. China remains the largest export market with a total of $10,073, which
is -10.2% below the level of May 2011. As can be seen on the attached chart
this is the 7th month out of the last 8 with a drop in exports on a YoY basis
(the outlier being February which benefited from Chinese New Year hitting
January's data this year) and the 12 month ma of this measure has itself
entered negative territory this month. The message from this data seems fairly
clear, Chinese demand for Taiwanese exports have started to shrink and can be
expected to continue to do so going forwards despite yesterday's 25 bp cut in
the local lending rate. - taiwanchinaexports.gif - taiwanexports.gif

This morning saw the publication of the FRB's quarterly Z-1 report for Q1 2012,
a lengthy summary of statistical data centered around the banking and credit
system. The report is best known for its summary of total debt outstanding in
various categories including Federal Debt (up 3.11% for the quarter at $10,778
bln), Business Credit (up 1.25% for the quarter at $8,166 bln) and Household
Credit (down 0.08% for the quarter at $12,919.2).

Household Credit is made up of Consumer Credit ($2,544.4), which is now growing
quite quickly at 1.44% for the quarter (largely due to student and automobile
loans) and the much larger category of Mortgage Credit, which continues to
shrink, falling -0.73% to $9,747 bln, its lowest level since Q3 2006 (it should
be noted that Mortgage Credit is not actually measured by the Fed but is
imputed as a "residual item" left over from other data inputs from banking
system data).

This drop in the estimation of Mortgage Credit Outstanding finally takes this
number back below that of Outstanding M2, which at the end of Q1 2012 stood at
$9,798. Back in 2007 at the start of the housing crisis, this spread was above
$3,000 bln, a reflection of excessive credit growth and a lack of monetary
creation by the FRB. At the time we used this spread as a reasonable proxy for
the degree of excess in the mortgage credit system and suggested that a
recovery from the coming collapse (the very existence of which was still hotly
contested in 2007) would have to wait until this spread was closed. We
continued to track the spread for several quarters as the scale of destruction
from the US housing market spread out into the wider financial system (See Bloomberg
link {NSN KEYLTW1A74E9 <go>})

In the spirit of full disclosure we expected Outstanding Mortgage Credit to
fall further and M2 to rise less (I seem to recall we expected a cross to take
place between $8,500 bln and $9,000) but this was because we underestimated the
degree of emergency policy the FRB would undertake and frankly we are happy to
have been proved wrong in this respect. The bigger issue though, is the fact
that sufficient monetary creation and debt writedowns have taken place to put
these two metrics back in historic balance. This is a big deal in our opinion
and we are unsurprised to see this take place against a backdrop of a moderate
but persistent recovery in both new and existing home sales. -
D-DOUTMORT_Index.gif -

Chairman Bernanke's Testimony to the Joint Economic Committee this morning was
a fairly bland restatement of the FOMC's position on current monetary policy
(see link)

http://www.federalreserve.gov/newsevents/testimony/bernanke20120607a.htm

One of the side-shows to the current Eurocrisis has been the heroic attempts by
the SNB to prevent an appreciation of the CHF above 1.20 vs. the EUR. This
"line in the sand" was put into place last summer and has remained in place
ever since. Over this period the EUR has slipped against the USD from roughly
1.35 to 1.25, which has required ever greater intervention by the SNB to keep
the CHF/EUR cross rock solid at 1.20 (see chart).

The scale of this intervention can be seen by tracking Switzerland's FX
reserves. These ballooned by 66.185 bln CHF (27.86%) in May to a record 303.773
bln. This is an increase of over 121 bln CHF (66.5%) from their level of July
2011 prior to the intervention program being put into place. Thus in seeking to
control the level of its currency, the SNB has abdicated its traditional role of
controlling its money supply and local interest rates. The danger is that this
massive influx of liquidity will spark off a local asset bubble. We have
commented before on the sharp appreciation of Swiss real estate in recent
quarters, and the dangers are growing that an unhealthy speculative cycle is
taking hold at the current time. - chf-eursnbintervention.gif -
swissfxreserves.gif

As we have explained before, during Phase 2 of a typical bear market economic
data and financial asset performance deteriorates to the point that monetary
policy moves towards a significantly looser stance.

This morning China's PBOC became the latest central bank to fall into line with
this template, with an announced reduction in the local deposit and lending
rate of 25 bp. This takes the 12 month lending rate down to 6.31%, a level from
which it was raised almost exactly 12 months ago. It should be noted that even
after this move both local interest rates and reserve requirements remains
substantially higher than they were at the start of the tightening cycle in
2010 (see chart).

No doubt this morning's move will be greeted with enormous relief by equity and
commodity markets. Commentary will reflect the view that the immense firepower
of the PBOC will now simply reverse the powerful deceleration of the local
Chinese economy, causing a return to the happier times of 12 - 18 months ago.
History suggests a rather more disappointing outcome. This morning's step is
typical of the gradualist easing measures taken at the start of monetary easing
(see the FRB in January 2001 and September 2007) and while the precise timing
of the move may have come as a surprise, its size and consequence were far more
predictable.

We still expect the deterioration of China's economy to gather pace following
today's move, and for this to demand a greater response by the PBOC. We do not
have much doubt that the PBOC will oblige (its sole mandate ultimately being to
keep the political status quo intact), but we expect it to be increasingly vexed
at the unresponsiveness of economic activity to its monetary easing. This is
because China's economic cycle is in a radically different place today than
where it was in 2008/9. The over-investment and concentration of activity in
certain sectors has led to current malaise and in our experience it will take
time (and some distress) for this excess activity to be digested. -
chinaratesreserves.gif

Brazilian Auto Sales data continues to suggest that demand for this key
consumer item has started to slip. May auto sales were 287K, up from 258K in
April but down from 319K in May 2011, a drop of -9.75% YoY. This is the 7th
month out of the last 8 with negative YoY growth in sales, which suggests to us
that a meaningful deceleration began in late 2011. The trailing 12 month ma
also shows this declining trend by falling from a high of 308K last September
to 297K in May.

We are particularly interested in Brazilian auto sales at present since not
only are they a key industrial good, but because some significant delinquency
problems have been experienced in auto credit in recent months. It is therefore
unclear whether the drop in sales represents a drop in demand for autos or a
restriction of credit to less credit-worthy potential borrowers (or a mixture
of both). In any case, we expect sales to slip further in the months ahead.

This implies continued downward pressure on Brazil's industrial production,
which is already shrinking YoY. Additional pressure has also come from a
significant slippage in exports. May's exports were a surprisingly low 26.7K,
well below April's 48.7K and May 2011's 44.6K. In fact this is the lowest level
of exports for any May since 2003. We are not aware of any special factor
restricting exports but would still expect a decent rebound in June (export
data is more volatile month to month), but this does not disguise a clear trend
of deterioration that has been in place for several quarters. -
brazilvehicleexports.gif - brazilvehiclesales.gif

This is the first high profile story which suggests that India has seen
substantial selling of gold by its retail population. Although the article
mentions the price of gold as triggering sales, our suspicion is that it is
actually the liquidity needs of retail households forcing sales. As the
attached chart shows gold is currently at just under 90,000 INR, no higher than
it was in late December when there was still substantial positive demand from
Indian retail buyers. If anything, the deterioration of the local currency
should be leading to an INCREASE in demand for the metal at the current time
and not prompt retail selling.

Our view for several months has been that Chinese and Indian retail demand is a
significant potential source of weakness for the metal (the opposite of most
observers' belief). Should this story prove to be correct it would seem that
our thinking has been along the correct path. In India's case a large portion
of bullion sales have been made on margin via non-bank "gold lenders",
suggesting that liquidation could prove to be quite fierce if gold's price were
to start to sag under pressure of sales. Key support remains at $1,520 for the
metal.

+------------------------------------------------------------------------------+

BN 06/05 07:39 *CONSUMERS IN INDIA `AGRESSIVELY' SELLING GOLD, GROUP SAYS
BN 06/05 07:39 *RECORD INDIA GOLD PRICE SPURS SCRAP SALES THIS WEEK, GROUP SAYS
BN 06/05 07:39 *ALL INDIA GEMS & JEWELLERY FEDERATION'S BAMALWA SPEAKS BY PHONE


+------------------------------------------------------------------------------+

Gold Being Sold Aggressively in India as Prices Near Record (2)
2012-06-05 11:23:43.570 GMT


(Updates with comment from Morgan Stanley report in eighth
paragraph.)

By Madelene Pearson
June 5 (Bloomberg) -- Gold consumers in India, the world’s
biggest importer, are “aggressively” selling the metal after
prices surged to a record, an industry group said.
“In some areas consumers are selling more than jewelers,”
Bachhraj Bamalwa, chairman of the All India Gems & Jewellery
Trade Federation, said today in a phone interview. “They are
selling aggressively.”
Gold in India climbed to a record on June 2 after the rupee
fell to an all-time low against the dollar, while global prices
are down 16 percent from a peak reached in September. The jump
in scrap sales adds to evidence of slowing demand in India that
may lose its spot as the world’s largest bullion market in 2012
to China, according to the World Gold Council.
“Physical buying is not there, because prices are very
high,” said Ketan Shroff, a director with Pushpak Bullions Pvt.
in Mumbai. “Everybody is selling. Even retail investors, who
had invested at lower levels, are sellers right now.”
Futures for August-delivery rose 0.6 percent to 30,104
rupees ($540) per 10 grams on the Multi Commodity Exchange of
India Ltd. at 3:52 p.m. in Mumbai, near last week’s record
30,156 rupees. Global prices for spot gold traded at $1,619.27
an ounce, down from an all-time high of $1,921.15.
Scrap sales in India may more than double to about 300
metric tons in 2012 from 130 tons a year ago, Prithviraj
Kothari, president of the Bombay Bullion Association, said on
May 29. Gold demand will be “very poor” in the next two
months, he said today.

Monsoon Dependence

“Demand in June and July is always very poor in any
year,” Kothari said by phone from Mumbai. “Imports are always
down as there are no festivals, no marriage season and
everything depends on the monsoon and lots of farmers are
selling their gold in the market to purchase their new crops.”
India’s gold demand may fall 4 percent by volume in 2012
and gain 4 percent by value, Morgan Stanley said in a May 31
report. Volume demand will decline 13 percent in urban areas and
4 percent in rural areas, it said.
Scrap sales will continue until prices come down, the
jewelry federation’s Bamalwa said by phone from Kolkata.
On the National Spot Exchange Ltd., India’s biggest bourse
for physical metal contracts, demand for gold and silver fell by
about 20 percent to 25 percent this year because of higher taxes
and prices, Chief Executive Officer Anjani Sinha said today.
“At this level demand is low,” he said in a phone
interview from Mumbai. “It will only pick-up when the marriage
seasons starts,” in September, he said.
Gold demand in India fell to 207.6 tons in the quarter
ended March 31 from 290.6 tons a year ago, after the government
increased import duties, the World Gold Council said on May 17.
Investment demand dropped 46 percent and jewelry demand fell 19
percent, it said that day.

For Related News and Information:
Top commodity reports: CTOP <GO>
Top metal and mining stories: METT <GO>
India market monitor: OTC IN <GO>
Credit Markets News: TOP CM <GO>
Top currency news: TOP FRX <GO>

--Editors: Thomas Kutty Abraham, Abhay Singh

To contact the reporter on this story:
Madelene Pearson in Mumbai at +91-22-6120-3652 or
[email protected]

To contact the editor responsible for this story:
James Poole at +65-6212-1551 or
[email protected]

- goldinr.gif

As markets continue to digest Friday's unpleasant payroll shock (followed up by
a poor set of Factory output data this morning) it would appear that 2012 is
setting up for a similar cycle of poor spring time and early summer data. We
have argued since late 2010 that the collapse of certain seasonally sensitive
industries (most importantly construction) in 2008/9 has significantly changed
the typical ebb and flow of the US economy over the course of the calendar year.

Unfortunately the seasonal adjustment process is blind to this change,
resulting in some very poor springtime data and very strong fall and winter
reports. Over the course of the year this evens out, but as we saw on Friday by
that time the damage to investor psyche (and portfolio returns) is already
done. One clear example of this problem was shown in Friday's NFP report which
estimated that -28K Construction jobs were lost. This was a primary cause of a
very sharp decline in homebuilding shares, which have continued to lose ground
today. A closer look at the data shows that in fact +16K Construction jobs were
estimated to be added in May, but a seasonal adjustment of -44K was applied.

This would make sense if we were in a "normal" housing construction cycle, but
we are not. Total Housing starts in April 2012 were 717K annualized. This
compares with average activity for April of 1790K in the 2005-7 period when
seasonal adjustments ran only slightly higher at -64K. Thus from the
Construction sector alone we could estimate that around 20-30K jobs went
missing from Friday's NFP report.

This is only one example of what we suspect is a much broader problem. It is
clearly shown on the attached seasonal chart of the Citigroup Economic Surprise
Index, which has dipped in the April-September period of the last 3 years only
to recover in the next 6 months (right in line with an annual construction
cycle). Note that this seasonality was absent prior to the crisis as the chart
of the CESIUSD from 2005 to 2007 demonstrates.

Of course it is possible that 2012 is different, and that official data is
picking up a genuine deterioration in US economic activity (but Friday's ISM
report certainly does not support that view). But based on the experience of
2010 and 2011 and our own internal work we would rather believe that seasonal
adjustment is a much greater driver of the clear deterioration of US economic
data this spring time. - cesiusd2010-2012.gif - cesiusd2005-2007.gif

Since the ongoing Eurocrisis is the subject of endless commentary elsewhere, we
have chosen to monitor it silently rather than repeat the obvious. However,
there are a couple of points that are worth making at the current time.

Most clearly, France's treasury market seems to have made an important
transition from being viewed with suspicion to treated as a safe haven (albeit
a second class one). This is in marked contrast to what happened in 2011, when
the French 10 year yield stopped declining in the middle of the summer leading
to a yawning 189 bp spread with German 10 year yield by mid November (see
chart).

The current leg of the crisis started off in similar vein, with the German bund
yield falling sharply in March and April while France's 10 year yield remained
flat and the spread pushed out as wide as 140 bp. However, once the bund yield
fell below 1.50% it would seem that significant demand for the higher yielding
French note was triggered, with the yield collapsing to 2.26% on Friday, a drop
of 90 bp over the month. This has caused the France/Germany spread to actually
tighten in the middle of a corrective phase in local financial assets, which is
a distinct change in circumstance from 2010/11. Indeed this spread by itself is
no longer useful as a real time indicator of financial stress and perhaps this
is the clearest positive outcome of the massive injection of Eurozone liquidity
made by the ECB last year.

The implications of this are both political and economic. In political terms
the reduction of French yields should soothe some of the tensions with
Germany that arose in late 2011 (although it may also cause France to be
tempted to take a more assertive role).

The economic implications are perhaps more important. German bond issuers and
borrowers benefited substantially from a massive drop in local interest rates
in 2011 and will have done so again in 2012. French borrowers saw no such
benefits from the messy crisis but potentially may do so this time around. Of
course this would still require bond markets to permit new issuance and banks
to be willing to lend but the potential benefits to financing French domestic
economic activity at lower rates should not be ignored.

None of this will matter while the crisis still rages and this morning's sentix
© poll of Investor Sentiment showed a very low reading of -28.9 (see chart).
This takes sentiment roughly to where it was at the bottom of the 2002/3 bear
market, but still somewhat above the levels seen in 2008/9. Investor sentiment
is therefore approaching the sort of levels that typically accompany a major
bottom in local equity markets. Our guess is that 2012 will see sentiment
bottom somewhere between these two extremes, suggesting that we still have a
hard few weeks ahead of us for European equities. - eurosentiment.gif -
francegermany.gif

Brazil's Q1 GDP report showed QoQ growth of 0.2% and YoY growth of 0.8%, both
worse than expectations of 0.5% and 1.8% respectively. Although we ourselves
don't find the exact level of GDP to be a useful measure a prolonged trend of
deterioration (such as exists in Brazil) is much more meaningful and this
supports our notion that the Brazilian economy has sharply decelerated over the
last 12 months.

Perhaps more importantly GDP is the sort of number that politicians take very
seriously (one of many reasons why they tend to be so poor at economic
management). Brazil's current administration has already leaned hard on the
local central bank to ease policy and has started to pull fiscal levers aimed
at revitalizing the economy. The publication of GDP showing the economy on the
verge of contraction together with a sharp drop in local asset prices is likely
to see a much more proactive stimulus package introduced (or at least publicly
debated) in the coming weeks, in line with our expectations about the manner in
which "Phase 2" of this bear market will proceed. - W-IBOV_Index.gif -

One minor data point that we have been following in recent months is Mexican
Worker Remittances. While this may seem to be of little importance on a day
that Non Farm Payrolls and ISM Manufacturing were announced it is still a
useful alternate guide to the state of employment in US Manufacturing and
Construction since both industries are key employers for Mexican workers.
April's data saw a remittances of $2,025 mln reported, a modest drop from
March's $2082 mln but well above expectations of $1,948 mln.

(April always sees a dip in remittances which historically then peak for the
year in May). This is an 8% improvement of the level of remittances a year ago,
which tallies with a broad and steady improvement in US employment over this
period of time. The trailing 12 month ma of remittances is now $1,929 mln,
equivalent to its level in mid 2006. - M-MXRETOT$_Index.gif -

The ISM Survey has always been one of our favorite monthly data points and so
it is something of a relief to see a healthy set of data for May that fully
supports our view that we are in the middle of a decent Manufacturing cycle in
the US.

The overall index fell to 53.5 from 54.8 (consensus 53.8) but this shortfall
was entirely caused by the Prices Paid index, which fell very sharply to 47.5
(this is not surprising given the drop in industrial commodities but consensus
expected a reading of 57). Of course lower input prices are positive for
Manufacturers provided they are combined with robust activity and this seems to
be the case in the US at present.

The key New Order index (red) rose to 60.1, its highest level since April 2011
suggesting that the Manufacturing pipeline remains healthy. Production (blue)
fell to 55.6 but is still expanding and in any case is ultimately driven by New
Orders and Inventories (olive). The latter fell to 46 the lowest level since
June 2010 and suggesting that Production really needs to be ramped up further.
The ISM specifically commented on a very wide spread between New Orders and
Inventory (+14, the widest since May 2010) stating that this was a very
important relationship in their experience for predicting future activity (for
obvious reasons).

Employment (pink) remained very strong at 56.9 (57.3 last month) and this ties
in the NFP report that we commented on earlier (where at least Manufacturing
employment remained strong). All in all this is an important report that
justifies the resilience of the US equity market during the recent sharp
corrective moves elsewhere (what we have dubbed the "Panda Bear Market"). We
doubt it will fully repair the immediate damage from the earlier NFP report but
in our experience it makes much more sense to follow the ISM than the BLS when
tracking the health of the US economy. - ismreportmay2012.gif -
ismpricespaid.gif

As if clear evidence of an emerging market slowdown and Europe's woes were not
enough to contend with, the market will now have to digest one of the nastier
non-farm payroll reports we have seen in recent months.

In terms of the numbers themselves the overall gain to US payroll was estimated
at 69K, well below the 150K consensus. April's data was revised 38K lower to
77K and March trimmed by 12K. Private Sector payroll gains were estimated at
82K (164K consensus), while April was trimmed by 43K to 130K. The Unemployment
rate was also estimated to have risen marginally to 8.2% from 8.1%, the first
rise since June 2011 (when the rate rose 0.1% to 9.1%).

Given the fragile state of global markets at the current time we expect to see
this data poorly received by global equity and commodity markets and barring an
exceptional ISM report (due out at 10.00 today), it is likely to be a long
session followed by a miserable weekend's reading. However, it is important to
interpret this report intelligently given the long history of erratic readings
generated by Non Farm Payrolls.

As the attached chart shows the last 3 spring times have seen very poor payroll
reports with May & June 2010 (84K & 90K), May & June 2011 (108K & 102K) and
April & May 2012 (87K and 82K) all producing Private Sector readings well below
consensus (see green circles on chart). The problem would seem to be generated
by seasonal adjustments rather than a sudden deceleration of hiring
practices. Evidence of such problems in the current report is most clearly
provided by the estimation that -28K Construction jobs were lost in May. Since
we know that we are in the middle of a building boom for multi-family units and
have finally seen some life in single family starts, it is barely credible that
Construction payrolls would have been trimmed in May.

In the end these adjustments tend to even out over time but rather like bad
refereeing decisions, this does not provide much solace in the short term. We
ourselves simply follow a 12 month ma and even after this report this remains
at 162K, down from a peak of 189K in January but up 3K from the level of May
2011. This is in line with a steady growth in US employment that will be
sufficient to gradually eat into unemployment.

There was some positive data in this month's report from the (much less
followed) Household Survey showed 422K jobs added (compared to -169K in April
and 180K in May 2011). Again this is a very erratic report but the 12 month ma
of this data has actually risen to 206K which is the highest reading since
March 2007 (see chart). The fact that this data is much less widely followed by
Wall Street and the media does not mean it is any worse than the headline NFP
report (which is based on a survey of establishments) at estimating the true
underlying state of the economy. Manufacturing employment also remains quite
robust with 12K jobs added, this keeps the 12 month ma at 19K, well above
anything seen since the late 1990s. - manufacturingpayroll.gif - nfppch.gif -
householdsurvey.gif