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Transcript of Warwick Investment Club
Summer in the Markets 1
Fixed Income: PIGS Fly 2
Currencies: Risk-On 5
Currencies Special Report:
Crisis & Opportunity
8
Commodities: Gold on a
Comeback
9
Equities: Eurozone Deal
Boosts Equities
11
Mergers and Acquisitions:
Energy Steals the Limelight
12
Analysts:
Anshul Kamath
Daryl Chia, PRM
Karan Shah
Kunal Shah
Vassil Kirtchev
Weekly Market
Wrap-Up
Week Ending
October 30, 2011
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 2
Overview
Summer in the Markets By Vassil Kirtchev
Summer 2011 will be remembered for the exceptional amount of volatility in the equity
markets – with stocks tumbling in bouts of global sell-offs – and perhaps as the start of a
new and persistent bear market. A number of factors could explain this declining trend,
and the primary ones are economic – a stagnant US economy (the absence of a
sustainable recovery), the European Debt Crisis and, less prominently, a decline in
productivity figures from China. Further contributing to the market rout was Standard
& Poor’s downgrade of U.S. government debt in August. In Europe, Greece has been
center stage. Questions have been raised about the viability of the European Monetary
Union common currency system, and fears of a default on Greek debt have been wide
spread. Particularly concerning is that it could well spark a chain of defaults within the
private sector – be it partial or complete – and is especially a worry for French banks,
which have significant exposure to Greece’s debt and their counterparties. Overall,
fiscal issues in Western economies and fears of a double dip recession worldwide have
led to heightened risk aversion, and at times the markets seemed to be driven by fear
and uncertainty more than fundamentals. It is such that we have witnessed a transfer of
funds from equities to safe-haven type assets such as gold and US Treasuries.
The major stock indices in the U.K. and U.S. – the FTSE 100 and S&P 500 respectively –
have between them displayed a similar downward trend over the summer, particularly
between July and August. The FTSE 100 lost approximately 1000 index points in that
period of time, in stark parallel with the plunge in the German DAX as investor
sentiment about future prospects waned – and not of help was declining consumer
confidence in Germany. Financial stocks in the EU have taken the brunt of the beating,
while across the Atlantic, Bank of America received significant attention over the
viability of its business. In addition to the weak prospects for economic growth, there is
also declining confidence in how policy-makers will deal with the problems,
particularly a loss in confidence of central banks and the tools they possess to stimulate
economies. All these factors have had a huge impact on investor risk appetite, and
hence this summer was a one of flight-to-quality.
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 3
Global Macro
Fixed Income: PIGS Fly
By Daryl Chia, PRM
Amid relatively tepid trading and falling volatility across all markets earlier in the week
– vis-à-vis the wide fluctuations seen during summer as economic data and
expectations deteriorated – risk-on trading and market euphoria was again in vogue as
the week came to a close.
Yields benefited broadly over the fixed income space after Thursday’s release of U.S.
GDP data, which confirmed the median Bloomberg survey estimate of a 2.5 per cent
annualised rise in third quarter growth, a significant improvement from the 1.3 per cent
growth rate posted in the second quarter and a comfortable distance from the 2.0 per
cent ‘tipping point’ which many economists believe draws the line between a U-shaped
recovery and a growth recession which could well evoke a vicious spiral into a double
dip. Even Friday’s U.S. PCE data from the commerce department – that consumers only
managed to increase purchases by 0.6 per cent over the same period through an
unsustainable cut in their savings rate from 5.1 to 4.1 per cent – failed to dampen the
mood, which was lifted immensely by an eleventh hour resolution at the Euro-Area
Summit.
EU leaders on Friday agreed at the Euro-Area Summit on a deal to recapitalize
European banks to a 9 per cent core tier one capital ratio, make them accept a 50 per
cent haircut on holdings of Greek debt and to leverage the €440bn of the EFSF by using
it as private debt insurance. Not less supportive was the discussed possibility that
China contribute between $50bn to $100bn to the EFSF in both Chinese Yuan and from
its $3,200bn of foreign reserves.
As a result, U.S. Treasury 30-year bond yields rose for a fifth week, the longest rise in
more than two years, while yields on 10-year notes closed the week at 2.31 per cent,
rising 8bp and once touching 2.42 per cent, the highest level since August 9 when
sharply falling expectations along with the Fed’s announcement of Operation Twist led
to one of the most spectacular bond rallies ever seen, driving 10-year treasury yields
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 4
Global Macro
Fixed Income (Continued)
below 2 per cent for the first time in 60 years. In line with rising yields, U.S. corporate
credit risk recorded its biggest weekly decline since June 2009, as measured by the
Markit CDX North America Investment Grade Index. Furthermore, just as one would
expect, the flight from quality also meant lower prices and higher yields in other major
benchmark 10-year government bonds: Gilts ended the week 2.63% (+10bp), Bunds
2.17% (+8bp) and JGBs 1.04%(+0.03).
In the peripheral Eurozone, government bonds were mostly trading higher – largely
expected given the inverse correlation between PIGS debt prices and that of core
government bonds, or more generally, risk appetite. 10 year yields on Greek debt
ended the week at 24.24% (-85bp), Spanish debt 5.52% (-5bp) and Portuguese debt
11.95% (-24bp), narrowing their spread and hence perceived risk premium between
their issues and that of Germany’s benchmark Bunds. An outlier of note was Italian
debt – yields initially fell 20bp on news of the EU resolution, but ended the week at a
euro-era high of 6.03% (+5bp) after an auction of March 2022 bonds was covered less
than 1.3 times. Market participants see Italy – an entity that is ‘too big to save’ – as the
linchpin for the health of the Eurozone, and with Italy required to roll over
approximately €300bn of its €1,900 debt burden in 2012, how it performs could very
well shape how the debt crisis plays out.
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 5
Global Macro
Currencies: Risk-On By Kunal Shah
Overview
This week has proved quite an eventful week for currency movements with global
investor sentiment improving after finally seeing what looks for now a comprehensive
solution to the Eurozone Debt crisis leading to more risk appetite globally. The US
Dollar has been in free fall in the last two weeks as capital from the safe haven assets
has begun to be deployed to riskier assets and currencies. Emerging Market and
Commodity currencies such as the Canadian and Australian Dollar have been main
beneficiaries of this phenomenon. However the Eurozone crisis is not yet over, credible
structural solutions still need to be implemented for likes of Italy and Spain. The US
Debt problem has not gone away and uncertainty with Washington & Brussels’ dealing
with political issues we advise caution since we are still not out of the woods and in an
environment of deleveraging and fiscal tightening global growth is still likely to slow in
the foreseeable future.
Europe
The British Pound has been gaining ground significantly in the last few days against
the dollar. Sentiment towards the pound has been earlier dampened by the BoE's
decision earlier this month to implement another round of quantitative easing to aid a
fragile economic recovery. Optimism that the EU’s plan to resolve the debt crisis will
stop the contagion spurred demand for both the euro and pound against the safe
havens of Japan and the US.
British Pound – U.S. Dollar Euro – U.S. Dollar
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 6
Global Macro
Currencies (Continued)
Asia Pacific
The Japanese Yen
The yen strengthened even after the Bank of Japan expanded its credit and asset-
purchase programs to a total of 55 trillion yen ($724 billion) from 50 trillion yen to damp
the currency’s appreciation, which harms exporters. It also kept the overnight lending
rate at zero to 0.1%. The Bank of Japan is the only central bank in the world whose
currency appreciates in the wake of more monetary stimulus because of its safe haven
status and expectation of the need for further more easing. Aiding Europe may
be Japan’s best bet for weakening the yen after an expansion of central-bank stimulus
yesterday failed to stop the currency from advancing to another post war high.
Prime Minister Yoshihiko Noda’s cabinet last week approved a 12.1 trillion yen
spending plan to rebuild after the March disaster and to help companies cope with the
currency. Politicians are spending 2 trillion yen to spur investment and hiring and are
also setting aside foreign-exchange reserves to aid exports and bolster overseas
acquisitions. The central bank increased its asset-purchase fund to 20 trillion yen from
15 trillion yen and kept its fixed-rate lending program unchanged at 35 trillion yen. All
of the additional funds will be used to buy Japanese Government Bonds. All of these
measures coupled with lower investor risk aversion should mean a greater supply of
yen in the market as companies are persuaded to make acquisitions abroad, re-building
accelerates demand for imported raw materials and the Bank of Japan’s increasing
willingness to intervene in the currency markets, we see the Yen weakening gradually.
U.S. Dollar – Japanese Yen
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 7
Global Macro
Currencies (Continued)
Americas
Improving industrial production and faster than expected GDP growth of 2.5% in the
last quarter is calming investor fears of a full-blown recession. With another round of
quantitative easing in the mix, and the Fed guaranteeing near-zero interest rates till
2013, the dollar is indeed likely to be the first currency sold off, with investors using the
low interest rates available on US denominated securities to finance carry trades for
riskier assets. Liquidity concerns that had been mounting all over the world that a
second credit crunch is on the way have been dispelling with extension of central bank
swap agreements and Eurozone agreement. In light of the above we expect the dollar to
continue a gradual downward spiral.
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 8
Global Macro
Currencies Special Report: Crisis & Opportunity
By Kunal Shah
Down south in Argentina, the Peso has depreciated over 7% & President Kirchner’s
election promises seem to be in doubt as runaway inflation estimated by economists to
be running as high as 24% have led to a capital flight. Argentina’s problems include
ultra-lax monetary and fiscal policies, galloping public spending, vast subsidies on
energy and transport, a blind eye to high inflation, and a determination to shore up the
peso currency at the expense of running down central bank reserves The country has
been losing competitiveness as the economy of Brazil – its top trading partner and a key
market for its manufacturing exports – has slowed.
Argentina stepped up its efforts to stem capital flight and shore up the peso by
tightening restrictions on foreign-exchange purchases. Capital flight prompted the
central bank to sell $2.7 billion of reserves in August and September to curb a slump in
the peso, which has weakened 6.1 % this year to 4.2358 per dollar, the worst
performance among six major Latin American currencies tracked by Bloomberg.
Reserves have fallen to $47.6 billion this year from a record $52.6 billion in January
while central banks in Brazil, Mexico and Chile build up savings.
Argentina, which has been blocked from international debt markets since its 2001
default on $95 billion of bonds, depends on its trade surplus as a primary source of
dollars. The government estimates that surplus will shrink to $8.6 billion next year from
$12.1 billion in 2010. Risks of more interventionist policies over structural reform like
subsidies in the energy and transportation sectors are causes for concern. Public
spending is growing at over 30 per cent; the trade surplus and central bank reserves are
shrinking and capital flight has accelerated to nearly $10bn in the first half of this year.
Look for signs of potential problems as the currency might plummet truly if structural
reforms are not carried out and indeed demand from the rest of the world starts
waning.
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 9
Global Macro
Commodities: Gold on a Comeback
by Daryl Chia, PRM
In the commodities complex, U.S. GDP data and the Euro-Area Summit (mentioned
earlier) were the highlights of the week, and their resultant positive tone overwhelmed
earlier negative news of China’s GDP.
China expanded 9.1 per cent in the third quarter from a year earlier, the slowest pace in
more than two years. A lynchpin in the global economy and a massive consumer of
industrial commodities, especially copper, it expanded 9.5 per cent in the second
quarter. At its BRIC counterpart India, industrial production expanded less than
expected in August, lagging a Reuters poll forecast for 5 per cent growth. On a brighter
note, industrial production in Europe unexpectedly rose for a second month in August.
Production in the euro area advanced 1.2 percent from July, when it rose 1.1 percent –
the biggest gain since November 2010.
All said, energy and metals ended the week broadly higher, with front-month WTI
closing at $93.32 (+2.32%), Brent1 $109.910 (-1.32%), Natural Gas $3.923 (+8.85%), LME
Copper $8,040 (+10.73%), Gold $1,747.20 (+5.75%) and Silver $35.288 (+11.32%).
Of special note are crude oil and gold. The West Texas Intermediate (WTI) blend hit
US$93/b on Tuesday, 25 October – its highest level in 12 weeks – on the back of
perceived tightness in the U.S. market, as oil and distillate inventories drew down to
below their five-year average. Conversely, Brent crude1 suffered ahead of the Euro-
Area Summit, as summit representatives were not expected to come to a conclusive deal
on Greece. The two blends soon rose along with general market sentiment late in the
week, but the front month WTI-Brent spread still closed significantly higher at -$16.59,
its highest since civil strife in Libya cut Libyan production of 1 million barrels per day
and threatened oil production in other politically volatile Middle Eastern states, leading
to a hugely unexpected spike in the price of Brent vis-à-vis WTI, and large hedging
losses amongst many refiners and airlines. On the weather front, the threat posed to oil
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 10
Global Macro
Commodities (Continued)
production in the Gulf of Mexico by Hurricane Rina is also exerting upwards pressure
on prices.
As for gold, following its meteoric rise to a record of above $1,900 in September and
subsequent savage fall of more than 15% within a month, it closed this week at
$1,743.40, a reprieve from the lows seen earlier in the week when it threatened to
plunge through the $1,600 mark and test its 200-day simple moving average support in
the $1,500 region, a feat which gold – to the delight of its bulls – has failed to perform
since the early days of its decade long rally. For some investors and analysts this
indicator of technical strength and gold’s reduced correlation with equities – its
correlation with the S&P500 index has reduced from positive during the previous five
weeks to zero this week – was a signal that gold was resuming its role as a haven asset.
1Brent crude is a ‘lower’ grade of crude oil versus WTI (i.e. Brent is more viscous and
has a higher Sulfur content than WTI’s Light Sweet Crude). Brent hence costs more to
refine and, ceteris paribus, should cost less than WTI – usually $2/barrel less (i.e. a WTI-
Brent premium of +$2). However, it is trading at a premium to WTI this year (a
historical abnormally) due to oversupply in landlocked Cushing, Oklahoma, and the
ability of Brent to be transported by supertanker (which WTI lacks, since its storage is
landlocked). The premium in the front-month futures contract has in fact hit a low of -
$26 earlier this year. This has called into question the status-quo of having the WTI
contract, which trades on the NYMEX, as a globally recognised benchmark for crude oil
prices.
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 11
Equities
Eurozone Deal Boosts Equities… But Only
Temporarily By Vassil Kirtchev
The Eurozone deal to contain the European debt crisis gave equities a temporary boost
across the world’s indices. The FTSE 100 peaked at close to 5750 points, while the
German DAX rose 3.5% upon announcement of the plan. This also had an effect on US
equity markets. The S&P 500 rose 3.4% and the Dow Jones Industrial Average gained
2.9%. Financials in general saw an increase in investor support (however, this receded
on Friday, particularly in the UK market), most notably benefiting Bank of America
and Citigroup.
However, on Friday the rally wore off and the FTSE, for instance, saw a decrease, as
investors grew wary of the lack of detail in the implementation of the Eurozone deal.
Much of the implementation details remain unclear and more of a concern was that it
may only patch the system up and not deal with the real problems in a more permanent
manner. In order for the world’s equity markets to see pre-2008 levels at a more
consistent basis, there has to be a sustained economic recovery in Europe. This is
painful in the short run, and given the short-term nature of politics, such policies are
unlikely to be implemented. Going forward, the package needs to be scrutinized and
worked on further in order for investors to establish that it is a viable solution to
Europe’s problems, but that is assuming that nothing else goes wrong and disrupts
market calm in the interim (think: Italy). Only time will tell.
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 12
Capital Markets
Mergers and Acquisitions: Energy Steals the
Limelight
by Anshul Kamath
Sector in Focus – Oil and Gas
In the biggest week for oil and gas sector M&A since the peak of the economic cycle in
2007, Kinder Morgan’s $38.5 billion – of which $21.5 billion comprises of equity –
purchase of El Paso Corp took center stage. Barclays Capital advised Kinder Morgan
and retains the top spot for oil and gas M&A. Evercore Partners, which advised El Paso,
have secured yet another large deal this year after an impressive performance in the
first half of 2011 with 25 deals totaling $83 billion. So far this month, oil and gas M&A
totals $55.4 billion, accounting for 45% of monthly volume. Year-to-date, deals total
$412 billion, an increase of approximately 7% over 2010.
Deal in Focus: Heiwa Corp’s Acquisition of PGM Holdings
Overview and Rationale
Heiwa Corp, a Japan-listed pachinko machinery manufacturer, made a conditional
tender offer to acquire PGM Holdings KK, a Japan-listed golf club operator in an all
cash deal.
Heiwa is a manufacturer of pachinko machines in the Japanese leisure market and it has
considered a priority to build a new profitable business to diversify its business. The
firm believes the inclusion of PGM into its business portfolio will enable the group to
transform itself into a full-scale leisure business.
Deal Fundamentals
Deal value: $2,190 million
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 13
Capital Markets
Mergers and Acquisitions (Continued)
Equity: The final valuation resulted in an offer of JPY 52000 cash per PGM share valuing
the entire share capital at JPY 61.5bn (USD 806.3m). The offer price represents a 28.6%
premium over the last closed price of JPY 40,450 (normally friendly takeovers have
premiums of approximately 35%.)
Debt: Heiwa made an offer to acquire each PGM Euro Yen Convertible Bonds for JPY
1,523,281 per bond. The Euro Yen CB was issued in the amount of JPY 10.05bn with a
maturity date of May 1 2012. The firm also made an offer to cancel all the outstanding
options of PGM in the series of 4,5,7 & 8 for JPY 1 each (PGM has 5476 stock options
outstanding.)
Other Noteworthy Deals
Sony Corporation, the Japan-based consumer electronics company, has agreed to
acquire the remaining 50% stake in Sony Ericsson Mobile Communications AB (Sony
Ericsson) from Telefonaktiebolaget LM Ericsson (Ericsson) for a cash consideration of
$1,460 million.
In a North American cross-border deal, MOSAID Technologies Inc, a Canadian
intellectual property company has signed an agreement to be acquired by Sterling
Partners, a Massachusetts based private equity firm with approximately $5 billion of
assets under management. The total deal was agreed at a value of $589 million.
Cigna Corp, the fifth-largest U.S. insurer agreed to buy Healthspring Inc, a Tennesse
based health-maintenance organization, for $3,827 million in cash. The synergies
resulting from the deal include tripling the number of Medicare customers Cigna
serves.
October 30, 2011 Weekly Market Wrap -Up
Warwick Investment Club Research Team 14
Note from the Team
We are always looking to improve; our team of analysts is dedicated not only to
producing exceptional research but also to tailoring information to what best suits our
readers.
We would appreciate any helpful feedback you may have as we strive to grow the
quality and usefulness of our weekly market wrap-ups.
Please send this feedback to [email protected] and the subject as ‚Weekly Wrap-
up Feedback‛.
Many thanks.
The Warwick Investment Club Research Team
Disclaimer
This document was produced by Warwick Investment Club for information purposes only and for the
sole use of the recipient. The analysis contained in this document has been procured, and may have been
acted upon, Warwick Investment Club and connected societies for their own purposes, and the results are
being made available to you on this understanding. To the extent permitted by law and without being
inconsistent with any applicable regulation, neither Warwick Investment Club nor any connected society
accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person
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investment or strategy is suitable or appropriate to your individual circumstances. The price and value of
investments mentioned and any income that might accrue can go down as well as up, and you may not
recover the amount of your original investment. Past performance should not be taken as a guide to
future performance. Where investments involve exposure to a foreign currency, changes in rates of
exchange may cause the value of the investment, and the income from it, to go up or down. The
information in this document is believed to be correct but cannot be guaranteed. Opinions and forecasts
constitute our judgement as at the date of issue and are subject to change without notice.