Please, click here to read this article in pdf format: december-15-2009

The big news yesterday was the $10BN bailout of Dubai World by Abu Dhabi, through a Financial Support Fund. However, on the other side of the emerging markets spectrum, Mexico’s sovereign debt rating was cut one level by S&P to BBB from BBB+.

All in all, the general picture is of even higher liquidity. The 3-mo Libor -OIS spread reached another record, falling to 8.78bps. In corporate credit, the IG13 Index (125 investment grade names from North America) fell to 91.5bps, getting us closer to a 2010 that may see a huge wave of capital structure financings, where firms minimize their cost of capital.

Thanks to the news out of Dubai, gold managed to close higher at $1,124/oz, after having fallen as low as $1,110/oz. The intraday chart below on gold (source: Bloomberg) is very descriptive. Thus, I invite you to go back to my comments of Nov 27/09 (refer: www.sibileau.com/martin/2009/11/27 , “Some thoughts on Dubai”), when according to our Thesis No. 2 (on gold) the fact that gold had not rallied when the news of the debt restructuring went out, suggested that a “timely hand” was on its way. We wrote that that suggestion was “inductive” and flawed, but we acknowledge it anyway, with the caveat that it was too early to draw conclusions. Well, the timely hand came and gold is now a bit more stable. Why is it not rallying? Because of the widespread perception (or knowledge?) that interest rates are on their way up in 2010. On the other hand, sovereign risk seems to be well contained, after so many negative news out of emerging markets and Europe failed to disturb the status quo, with a Euro still surviving the storm.

This last point (interest rates increase) brings me back to a point I made last Friday (www.sibileau.com/martin/2009/12/11 ), when I wrote: “…All one can ask for is consistency, and so far, we have not seen it (…)I am confident we will see effective policy action on all of these fronts. But, muted volatility? I don’t think so (…) On this basis, in 2010 I am tempted to slowly shift my investments to USD denominated assets and give equities a chance (I see credit/fixed income a bit rich vs. equities)…”
Interestingly enough, Mr. Gartman arrived to the same conclusion, in his note (see “The Gartman Letter”, Dec 14/09) published yesterday. I do not know whether that is a good thing. Briefly, this is the line of reasoning: As liquidity continues to flood the market, credit spreads will continue to compress, reaching a point where investors will need to exit credit into equity, to earn higher returns. To me, I think the story is not so much demand driven. I think equity will appreciate to a good extent because of supply factors, one of which is the capital structure changes that will take place as the cost of debt falls (i.e. equity buybacks). But I will elaborate more on this tomorrow, because the analytical framework behind this story is full of inconsistencies.

Martin Sibileau