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Weekly outlook: July 15 - 19 :

The dollar was higher against the other major currencies on Friday, recovering from a sell-off earlier in the week after comments by Federal Reserve Chairman Ben Bernanke saw traders reassess expectations on the timing of a possible reduction to the bank’s easing program.

The euro was lower against the dollar, with EUR/USD sliding 0.21% to settle at 1.3068, trimming the week’s gains to 1.62%.

The euro came under pressure after ratings agency Fitch downgraded France from its triple-A rating on Friday, citing growing government debt levels and the weak outlook for economic growth.

The dollar was also higher against the pound and the yen, with GBP/USD down 0.51% to 1.5107 at the close and USD/JPY climbing 0.28% to 99.25. The pound ended the week 1.16% higher, while the yen was up 1.68% for the week.

The dollar fell sharply on Wednesday after Bernanke said the Fed will continue to maintain accommodative monetary policy for the foreseeable future, citing low levels of inflation and the high unemployment rate.

Bernanke said the bank will not raise interest rates until the U.S. unemployment rate hits 6.5%.

The comments came after the minutes of the central bank’s June policy meeting showed that Fed policymakers remain divided over when to begin tapering its USD85 billion-a-month asset purchase program.

Around half of Fed policymakers believe the bank should start to scale back bond purchases by the end of the year, while many others believe the labor market still remains too weak.

Data on Friday showed that U.S. consumer sentiment ticked lower in July, with the University of Michigan’s consumer sentiment index slipping to 83.9 from 84.1 in June, compared to expectations for a reading of 85.0.

Elsewhere, the Australian dollar fell to three-year lows against the greenback on Friday amid concerns over a slowdown in growth in China.

AUD/USD hit session lows of 0.8999, the lowest since September 2010, before settling at 0.9050, down 1.52% for the day and ending the week 0.77% lower.

In the week ahead, investors will be looking ahead to U.S. data on retail sales, consumer inflation and housing sector activity. Monday’s data on Chinese economic growth will be closely watched and a monetary policy decision by the Bank of Canada on Wednesday will also be in focus.

Ahead of the coming week, Investing.com has compiled a list of these and other significant events likely to affect the markets.

Monday, July 15

Markets in Japan are to remain closed for a national holiday.

Australia is to publish government data on new vehicle sales, a leading indicator of consumer confidence.

China is to release official data on second quarter gross domestic product, the broadest indicator of economic activity and the leading measure of the economy’s health. Beijing is also to produce data on industrial production and fixed asset investment.

Switzerland is to publish government data on producer price inflation.

Later Monday, the U.S. is to produce official data on retail sales, the government measure of consumer spending, which accounts for the majority of overall economic activity. The U.S. is also to publish the Empire state manufacturing index and a report on business inventories.

Tuesday, July 16

New Zealand is to release official data on consumer price inflation, which accounts for the majority of overall inflation.

The Reserve Bank of Australia is to release the minutes of its latest policy meeting, which contain valuable insights into economic conditions from the bank’s perspective.

The U.K. is to release official data on consumer price inflation, as well as reports on producer price inflation and retail price inflation.

The ZEW Institute is to release its closely watched report on German economic sentiment, a leading indicator of economic health, as well as data on economic sentiment in the wider euro zone.

The euro zone is to release official data on consumer price inflation.
Canada is to publish official data on manufacturing sales, a leading economic indicator.

The U.S. is to release official data on consumer price inflation, industrial production and the capacity utilization rate.

Wednesday, July 17

The Bank of Japan is to release the minutes of its latest policy meeting, which contain valuable insights into economic conditions from the bank’s perspective.

The U.K. is to release official data on the change in the number of people unemployed and the unemployment rate, as well as data on average earnings.

The ZEW Institute is to publish a report on economic expectations in Switzerland, a leading indicator of economic health.

The BoC is to announce its benchmark interest rate and publish its rate statement, which outlines economic conditions and the factors affecting the monetary policy decision. The bank is to hold a press conference after the rate announcement.

Canada is to release government data on foreign securities purchases.
The U.S. is to release official data on building permits, a leading indicator of future construction sector activity, as well as data on housing starts. The Federal Reserve is to release its Beige book.

Thursday, July 18

Australia is to publish an index of leading economic indicators and a private sector report on business confidence.

The U.K. is to publish government data on retail sales.

In the euro zone, Spain and France are to hold auctions of 10-year government bonds.

Canada is to produce official data on wholesale sales, a leading indicator of consumer spending.

The U.S. is to release the weekly government report on initial jobless claims and the Philly Fed manufacturing index.

Friday, July 19

In the euro zone, Germany is to release official data on producer price inflation.

The U.K. is to release government data on public sector net borrowing.
Canada is to round up the week with official data on consumer price inflation.

Diamonds and Kazakhs and Bitcoins, Oh My: An ETF Parade :

There are 982 exchange-traded funds waiting to be approved by the Securities and Exchange Commission, according to Index Universe. In other words, there are nearly as many ETFs in registration as there are in existence. The good news for investors who shudder at the thought of yet more ETFs to sort through: only some of these will become reality.

The bulk of these filings are plain-vanilla ‘me-too’ products. Others, such as the Guggenheim Small-Mid Cap BRIC ETF, offer a slight variation on products currently on the market. Then there are a few that stand out like peacocks in a flock of crows. Here are some of the more intriguing ETFs awaiting SEC approval, along with ticker suggestions from yours truly.

1. Winklevoss Bitcoin ETF

The Winklevoss Twins propose to create an ETF that tracks the bitcoin, the crypto-currency, the same way that the SPDR Gold Trust (GLD) tracks gold. There has never been a more highly publicized ETF launch. The reason for the buzz are the three forces of nature coming together: the bitcoin, the ETF and the Winklevoss Twins.

Unfortunately for the Winklevii, most of those articles panned the filing, citing the dozens of risks outlined in 18 pages of the prospectus, such as possibility of government regulation, security concerns and the twin's lack of experience managing a trust.

Ticker possibilities: WINK, COIN, WTF

2. IndexIQ Physical Diamond Trust

This ETF would store diamonds in a small vault in Antwerp, Belgium, similar to the way gold is stored in a very large vault in London for GLD. There’s nothing like this fund on the market. The closest thing out there is the PureFunds Diamond/Gemstone ETF (GEMS), which tracks companies involved in the diamond business.

The biggest question here: How to value diamonds and make a net asset value investors can believe in? If the ETF can answer that question and establish a logical system, it could be attractive to commodity investors looking for an alternative to gold.

Ticker possibilities: ROCK, IDO

3. LocalShares Nashville ETF

Taylor Swift may be one potential investor in this ‘Music City ETF,’ which will track publicly traded companies that have corporate headquarters in the Nashville area, such as Dollar General (DG) and Cracker Barrel (CBRL). While this would be the first ETF ever to focus on a specific city, there were two state-focused ETFs back in 2009 that ended up closing up shop. The Texas Large Companies ETF (TXF) and the Oklahoma ETF (OOK) both opened and closed within a year for failing to attract assets.

Ticker possibilities: NASH, YALL

4. iShares Human Rights Index Fund

This ETF would start with the MSCI All Country World Index and then exclude countries associated with “widespread death, torture, rape, forced labor and forced displacement from communities.” While the name is catchy there are logical questions as to how this will benefit investors if a few stocks from Sudan or Iran are excluded from an index of 9,000 equities.

No socially responsible ETF has hit the big time yet. The most successful one thus far is the iShares MSCI KLD 400 Social ETF (DSI), which aims to invest in U.S. companies with positive environmental, social and governance characteristics. It has attracted $220 million in assets in seven years. However, iShares has the resources and marketing muscle to give this one the best fighting chance. That is, if it ever launches.

Ticker possibilities: HMAN, CARE

5. ProShares CDS Long North America HY Credit ETF

Many investors still cringe when they hear the words “credit-default swap,” which is why this ETF sticks out from the crowd. A credit-default swap, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, is a contract that pays the buyer face value if a bond issuer fails to meet its obligations, less what the now-defaulted debt is worth in the markets. There are eight CDS ETFs in this filing that would allow investors, for the first time ever, to bet on or against the credit quality of investment grade or high-yield issuers in North America and Europe.

Ticker Possibility: SWAP, UHOH

6. KraneShares CSI China Five Year Plan ETF

The People’s Republic of China has a series of social and economic initiatives called “five year plans” in which certain growth targets are set. This ETF looks to identify those companies that will benefit from Chinese government support as these five-year plans are enacted. For example, one recent plan for solar power development calls for adding 10,000 megawatts of solar power plants, which will benefit Chinese solar companies.

Ticker possibilities: PLAN, XIE

7. Global X Kazakhstan ETF

An ETF for the country made famous by Sasha Baron Cohen’s comic creation Borat could be a very nice investment vehicle -- Kazakhstan’s oil reserves rank tenth in the world, ahead of Nigeria and Qatar. In addition, the MSCI Kazakhstan Index is up 136 percent since November 2005. Global X has filed for many other unique single-country ETFs including Morocco, Slovakia, Qatar, Bangladesh, Sri Lanka, Pakistan and Hungary. Someday these may all make a lot of sense. The question is whether there's enough liquidity and/or investors for these markets.

Ticker possibilities: KAZ, KSTAN, NIICE

8. AdvisorShares TreesDale Rising Rates ETF

Doesn’t an ETF that benefits from rising rates sound good right now? It does, but good luck getting comfortable with how this thing works. It will invest in “agency interest-only mortgage-backed securities, interest-only swaps and certain other mortgage-related derivative instruments, while maintaining a negative portfolio duration with a generally positive current yield by investing in U.S. Treasury obligations and other liquid rate instruments.”

Okay then. Basically the fund managers want to create a portfolio where the risk of rising interest rates is effectively canceled out, while still getting the positive yield from the longer-dated bonds in the portfolio. Duration, by the way, is a gauge of a securities' price sensitivity to rate moves. If you're having trouble sleeping or hankering for penance, the prospectus is at U.S. Securities and Exchange Commission | Homepage.

Ticker possibilities: RISE, BENB, NOQE

9. Direxion Water Bull 3x Shares

Have you ever been so bullish on water you just couldn’t stand it? Didn't think so. But someday you may be, and on that day you may be able to go three times long (or short) water companies, which include pump and filter manufacturers, water utilities and irrigation equipment companies. In a future of too many people and too little water, this ETF could catch on, but right now there may not be the demand for a leveraged play on water. Even the most popular Water ETF on the market, the PowerShares Water Resources Portfolio (PHO), trades just 114,000 shares a day.

Ticker possibilities: DRNK, GLUG

10. Global X Top Activist Investor Holdings

After the recent much-publicized battle between Carl Icahn and Bill Ackman over Herbalife stock -- which is up 49 percent this year -- investors may respond well to this ETF. It will track an index comprised of the top U.S. listed equity positions held by a select group of the world’s premier activist investors. This ETF looks to be a kissing cousin to the Global X Top Holdings Guru ETF (GURU), which tracks hedge fund managers' 13F filings and is up 48 percent in the past year.

Technical Trading: Gold Bulls Eye $1,300, 'Green Light' Level For Another Rally Leg :

While gold prices firmed overnight in Asia and European action, pre-New York trading has seen August Comex gold futures erase gains and push to slightly weaker levels, on the heels of a stronger U.S. dollar index.
August gold futures have posted a solid near term rally in recent days, climbing from the June 28 low at $1,179.40 to $1,297.20 on Thursday. The minor uptrend pattern is bullish.

But, for now, the bulls are being turned away by a stiff psychological resistance ceiling at $1,300—and that will remain the key near term zone for traders to monitor.

So-called "round-numbers" like $1,300 often act as both magnets for price action and also resistance. Also, the contract marked out minor congestive resistance on June 21 and 24, with daily highs right around $1,300.

Gold traders take note—this is the make-or-break level for gold over the next few days.

Additionally, gold may be forming another "triangle" or consolidation pattern on the daily chart. Recently, gold has a propensity for triangles. A large one formed during the April-June period, which presaged the latest down-leg. Triangles are generally continuation patterns (meaning the previous trend will continue upon a breakout), but sometimes they can act as tops or bottoms as well.

In this case, traders should monitor triangle trendline resistance and triangle trendline support, seen on Figure 1 below. An upside breakout would be bullish, while a downside breakout would mean a continuation of the primary bear trend. The time period on this triangle is fairly short as the apex is approaching.

Very short-term, the August gold contract has edged just above its declining 20-day moving average, which has largely limited upside for months. That level comes in at $1,272.30 on Monday. If August gold were able to achieve several consecutive settlements above its 20-day moving average, then that would be an important bullish signal near term.

Bottom line? The key triggers for the bulls include sustained gains above $1,300 and sustained gains above the 20-day moving average. If that occurs early this week—gold bulls have the green light for another near term rally leg.

Finally, daily momentum, as measured by the nine-day relative strength index (customize setting to nine-period for less whipsaw), may be petering out. While it is an unconventional use of trendlines, sophisticated technical traders sometimes draw trendlines on momentum. The 53%-55% level has acted as a ceiling for momentum in recent months and has presages market declines. If that level holds firm again another dip in gold prices is likely. On the flip side, if the nine-day RSI can bust through the 55%-60% level that would prove to be a bullish momentum breakout as well.

On a different note, open interest data reveals that the "roll" from the August Comex gold futures contract to the December contract is on-going. Open interest simply represents the amount of total "open" or outstanding contracts in any given month. As of July 11, CME Group said open interest for August gold stood at 174,730, which was a decline of 11,773 contracts. The largest increase in open interest went to the December gold contract, which currently has 133,114 open interest and saw a rise of 10,614. The
Comex gold futures contract has a physical settlement.

Traders who are currently holding an August gold futures position and don't want to liquidate via physical settlement will need to consider a "rollover" plan over the next several days to weeks if the goal is to stay invested.

As always, watch the charts and trade "what you see" not what you think. The gold market will show you where it wants to go near term and these simple technical tools can aid in confirmation.

Forex focus: How central bankers pull the strings :

Sterling and the euro have been dancing to the tune of central bank puppet masters

Central bankers are pulling the strings these days, causing currencies to dance at the slightest hint of any change in policy. And no one has more pull than America's central bank, the Federal Reserve.

The supreme puppet master is Ben Bernanke, chairman of the Fed. Look what's happened in the past couple of weeks. First, the Fed announced that it will start to take its foot off and stop pumping billions of dollars into the US economy over the coming months.

The result was panic, with the dollar soaring as money poured into the "safe haven" currency. Realising perhaps that the reaction was too extreme, Bernanke then surprised everyone by doing a U-turn, indicating that there would be a prolonged period of monetary easing.

Even more surprising, last week both the leaders of the Bank of England and the European Central Bank (ECB) took the unprecedented steps of stating their intentions on interest rates and monetary policy. They both announced that any rate rise is a long way off and they'll keep supplying easy money funds.

"This was effectively forward guidance of further forward guidance," says Jeremy Cook of World First (Excellent Foreign Exchange Rates with World First). "The Bank of England also took the extraordinary step of chastising the market for pricing in a rate rise in 12 months' time, all of which was a recipe for weakening sterling."

P.M. Kitco Metals Roundup: Gold Ends Modestly Up Amid Lower U.S. Dollar; Bernanke On Deck :

Gold prices ended the U.S. day session modestly higher in quieter trading Tuesday. The precious metals were supported by a lower U.S. dollar index Tuesday. More short covering and bargain hunting were featured. August gold was last up $7.00 at $1,290.50 an ounce. Spot gold was last quoted up $8.60 at $1,292.25. September Comex silver last traded up $0.116 at $19.955 an ounce.

The world market place is looking ahead to Wednesday morning’s appearance by Federal Reserve Chairman Ben Bernanke before the U.S. House of Representatives, where he will report on U.S. monetary policy and the economy. Traders hope the Fed chief will offer fresh clues on when the Fed will start to back off on its monthly bond-buying program (quantitative easing). Many are still thinking the Fed will do such later this year and as soon as September. However, Bernanke in remarks last week hinted he wants QE to start to wind down later rather than sooner because he feels the U.S. economic recovery is still shaky.

There was a batch of U.S. economic data out Tuesday. The consumer price index for June came in a bit higher than expected, at up 0.5%, while industrial production and capacity utilization did not stray too far from expectations. This data had little impact on the market place or precious metals.

Reports overnight said demand for physical coming out of India and Asia is on the upswing, which is also supportive for the overall gold market. Some pundits are saying they believe central banks are stepping in to buy gold at the lower price levels.

The London P.M. gold fix is $1,291.50 versus the previous London P.M. fixing of $1,284.75.

Technically, August gold futures prices closed nearer the session high Tuesday. The bulls are still hanging on to some near-term technical momentum but need to show more power to begin to suggest the fledgling uptrend on the daily chart can be extended. The gold bears still have the overall near-term technical advantage. The gold bulls’ next upside near-term price breakout objective is to produce a close above solid technical resistance at $1,300.00. Bears' next near-term downside breakout price objective is closing prices below solid technical support at last week’s low of $1,214.40. First resistance is seen at last week’s high of $1,297.20 and then at $1,300.00. First support is seen at Tuesday’s low of $1,275.60 and then at $1,262.10. Wyckoff’s Market Rating: 3.0

September silver futures prices closed near mid-range Tuesday. Short covering was featured. Bulls have recently gained a bit of upside momentum but have more work to do to suggest a near-term market bottom is in place. The silver bears still have the overall near-term chart advantage. Bulls’ next upside price breakout objective is closing prices above solid technical resistance at $21.00 an ounce. The next downside price breakout objective for the bears is closing prices below solid technical support at last week’s low of $18.67. First resistance is seen at last week’s high of $20.25 and then at $20.50. Next support is seen at Tuesday’s low of $19.66 and then at $19.43. Wyckoff's Market Rating: 2.5.

September N.Y. copper closed up 355 points at 318.00 cents Tuesday. Prices closed nearer the session high and saw more short covering. Copper bears still have the overall near-term technical advantage. Copper bulls' next upside breakout objective is pushing and closing prices above solid technical resistance at 325.00 cents. The next downside price breakout objective for the bears is closing prices below solid technical support at last week’s low of 302.50 cents. First resistance is seen at last week’s high of 320.10 cents and then at 323.00 cents. First support is seen at 315.00 cents and then at this week’s low of 312.45 cents. Wyckoff's Market Rating: 3.0.

Crude-Oil Prices Settle Lower, Gasoline at Four-Month High :

• Nymex crude settled 32 cents lower at $106/barrel
• Analysts expect a draw in U.S. crude stockpiles
• Gasoline prices rise due to refinery issues

Crude-oil futures settled lower Tuesday, while gasoline futures rallied to a four-month high due to refinery outages.

Light, sweet crude for August delivery settled 32 cents, or 0.3%, lower at $106 a barrel on the New York Mercantile Exchange. ICE North Sea Brent crude oil for August delivery, which expired at the close of trading, settled 31 cents higher at $109.40 a barrel.

While oil prices snapped a two-session gain, edging lower along with broader markets, gasoline futures rose Tuesday. Analysts attributed the move to a series of refinery outages, which tightened gasoline supplies during the peak summer driving season.

Traders and brokers doing business with Irving Oil on Monday said Canada's largest independent refinery was forced to buy RBOB in the New York Harbor spot market for more than a week due to gasoline production problems. Meanwhile, planned maintenance continued at Phillips 66's Bayway refinery in Linden, N.J., spokesman Rich Johnson said.

The outages sent front-month August gasoline futures to their highest level since March 15, settling 3.14 cents higher at $3.1343 a gallon. The gains come on the heels of a sharp rally in gasoline last week, which was also driven by refinery glitches.

Later this week, oil traders will turn to the U.S. Energy Information Administration's weekly report on domestic oil inventories, with analysts expecting a third consecutive week of declines.

U.S. crude-oil inventories will show a decline of 2.2 million barrels in the week ended July 12, according to a survey of analysts by Dow Jones Newswires. Gasoline stocks are expected to fall by 400,000 barrels and distillate stocks, which include heating oil and diesel fuel, are forecast to rise by 1.7 million barrels. The survey estimated that refiners cut operations by 0.4 percentage point to 92% of capacity.

Traders will also look to a report on U.S. oil inventories by The American Petroleum Institute, an industry group, later Tuesday.

Additionally, the market is closely watching Federal Reserve Chairman Ben Bernanke's congressional testimony on the state of the U.S. economy. They will look for indications of a clearer timeline on when the Fed will begin curtailing its stimulus efforts that have so far boosted economic growth in the U.S., the world's largest oil consumer.

"Broader markets are drifting a little lower. Crude is also having a quiet trading day with a couple of tumultuous days ahead," said Matt Smith, commodity analyst at energy-consulting firm Schneider Electric.

August heating oil settled 2.08 cents higher at $3.0469 a gallon.

More information on settlements and highs and lows for futures on Nymex and ICE platforms can be found by searching for the following headlines:

Nymex Light Crude Oil Close
Nymex Harbor RBOB Gasoline Close
Nymex Heating Oil Close
ICE Brent Crude Oil Close
ICE Gas Oil Close

Dubai offers gold for citizens' weight loss :

Dubai's government will pay residents in gold for losing those extra pounds as part of a government campaign to fight growing obesity in the Gulf Arab emirate.

The 30-day weight-loss challenge was launched on Friday to coincide with the Muslim holy month of Ramadan, when the faithful refrain from eating and drinking during daylight hours.

Many eat too much after breaking the fast, tucking into traditional dishes loaded with fat and sugar that can push their daily calorie intake well above levels outside of Ramadan.

For every kilogram dropped by Aug. 16, contestants who register from Friday can walk away with a gram of gold, currently worth about $42, Dubai's civic authority announced as part of its ‘Your Weight in Gold' initiative.

The top three dieters can win gold coins worth up to 20,000 dirhams ($5,400). The contestant has to lose a minimum 2 kgs (4.4 pounds) to qualify for the contest.

“Participant must have excess weight to reduce and stay away from unhealthy methods to lose weight and should be present on the final day to measure weight,” Dubai Municipality said in a press release.

Health officials in Dubai, the commercial hub of the United Arab Emirates, and in neighbouring Gulf nations, are spending millions to control obesity among their citizens.

Oil wealth and high household incomes have led to overeating, high-sugar diets and a heavy reliance on cars for getting around, leading to an explosion of diabetes and other obesity-related illnesses.

Five of the 10 countries where diabetes is most prevalent are in the six-nation Gulf Cooperation Council, according to the International Diabetes Federation (IDF), an umbrella organisation of more than 200 national associations.

Child obesity is also a growing problem.

Dubai is known for its larger-than-life offers. It has a history of giving away luxury cars and yachts in lucky draws and is home to one the largest gold markets in the region. The emirate even has gold vending machines in shopping malls.

Detroit In Bankruptcy: What It Means For The Muni Bond Market

Detroit’s bankruptcy filing came as little surprise to many who had been watching the sad deterioration of the city’s finances over the years, and several say that Thursday’s move is just the beginning of a long path of shared pain for the broke municipalities creditors.

The filing came after emergency manager Kevyn Orr was unable to cut a deal with bondholders, labor, retirees and other creditors under a framework he proposed in mid-June, but it has been brewing for much longer.

Orr and Michigan Governor Rick Snyder described bankruptcy as a tool for reworking the city’s battered balance sheet Friday, and several observers noted that the issues that caused the filing have been mounting for years as the populations shrunk. The 2008 financial crisis and resulting recession hammered the auto industry, pushing General Motors GM -0.62% and Chrysler into bankruptcy, a fate Ford Motor F -1% avoided thanks to some fortuitous financing in the preceding years.

“This didn’t happen overnight, it was decades in the making,” says Warren Pierson, a portfolio manager of the $1.1 Baird Intermediate Municipal Bond Fund. For investors in municipal bonds outside Detroit, the city’s trials and tribulations should come as a wake-up call.

While Pierson is quick to make clear that he does not expect a wave of municipal bankruptcies, and that Detroit is a unique case, he does warn investors to be mindful that their municipal-bond portfolios may not be as bulletproof as believed.

“Investors have viewed munis as a close corollary to Treasury securities,” he says. “I think the market has been lulled into lending money to credits that are not as good as they appear.”

“I’m not saying investors should flee the muni market, but I hope Detroit raises the sensitivity to risk” in a space most investors look to for wealth preservation and income.

“You will see people lose money on general obligation bonds in Detroit,” says Pierson of the class of municipal bond typically viewed as the most secure, so investors need to make sure they are getting adequately compensated for the risks they take.

The advice from Pierson and other money managers who deal with municipal bonds is nothing new, but it does get added resonance after a bankruptcy like that of Detroit or the 2011 filing by Jefferson County, Alabama.

USAA’s John Bonnell believes credit quality remains generally strong in the municipal space, but stressed that intense credit research is essential to determine which credits are the best.

Both he and Pierson warn that other municipalities on the brink could look at Detroit as an example of a city that drew a line in the sand rather than meeting its obligations, ostensibly for the good of their citizens.

When “willingness to pay,” and not just capacity to pay, comes into the equation bondholders can bear the brunt, they say.

There could also be opportunities. Bonnell and Pierson each told Forbes that events like Detroit’s bankruptcy can spark tremors in the market and lead some assets to be mispriced. The key, the money managers say, is knowing which bonds are falling for a specific reason and which are just falling in sympathy with an unrelated event in the same asset class.

Capital Economics’ Paul Dales does not expect much of a shakeup in the municipal bond space though, writing that most cities “are now on firmer economic footing” by way of rising tax receipts in an economic recovery. The recent backup in municipal bond yields was driven more by talk of Federal Reserve tapering and fund flows than fears that a string of bankruptcies is in the offing.

Plus, Dales notes, less than half of Detroit’s $18 billion in total debt is made up of municipal bonds, the bulk of which, about $6 billion, have a good recovery track record in previous municipal bankruptcies. Even if the entirety of the debt was in muni bonds, $18 billion is barely a ripple in a market with $2.9 trillion in bonds outstanding, Dales writes.

The next phase of the bankruptcy process bears watching as a yet-to-be-appointed judge decides just who has legitimate claims to Detroit’s assets and how much they will receive.

Hedge fund manager David Tawil of Maglan Capital makes his living investing in distressed situations across asset classes and is familiar with Detroit’s failings dating back to his days at University of Michigan Law School in the 1990s.

While many distress specialists are likely poring over Detroit for potential opportunities, he isn’t touching any of the city’s debt.

“No way,” he says, likening the situation to GM’s bankruptcy filing in 2009 when the government, as he puts it, “ran roughshod over bondholders for the sake of pensions,” while arguing the situation was a “one-off” that wouldn’t be repreated.

“I think decision makers will let policy trump law because this is a unique situation,” he says, “that’s scary to me.”

As for any other hedge fund managers who own the bonds, Tawil doesn’t expect them to be in a rush to come forward and state their case. “Then it becomes Wall Street vs. Main Street,” he says, which is a different argument than saying mom and pop put their faith in the government through what they thought were tax-efficient, guaranteed securities.

The Markets’ Worst Kept Secret

• Lashing central bankers
• The math of debt
• Dreaded reform
• Risk of another debt bust?

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Here’s what your stockbroker and the media aren’t telling you: the world is more indebted now than it was at the height of the financial bubble in 2007. That’s right. Despite the extraordinary government intervention of the past six years. Despite continuing optimism of a recovery. Despite the reassuring words of central bankers. We’re worse off in debt terms.

From this, there are several inevitable conclusions that will be discussed in depth in this piece:

1. The policies pursued since the financial crisis haven’t worked. Otherwise, debt to GDP ratios would be decreasing, not increasing.
2. Interest rates can’t rise above GDP rates, otherwise debt to GDP ratios will climb further. If they do, you can expect more money printing, budget cuts and tax rises.
3. That means low interest rates are likely to stay for many, many years. It’s the only way to bring the debt down to more sustainable levels.
4. The startling thing about the past six years is the almost total lack of reform to fix the problems which led to the 2008 debt bust. It’s ironic that a paragon of communism, China, may well be the one to soon lead the way on substantive capitalist reforms.
5. Emerging markets, including my neighbourhood of Asia, may be better off than the developed world when it comes to debt, but rising asset and commodity prices have papered over several problems. And these problems are now coming to light.
6. Debt crises happen because incomes can’t support the servicing of the debt any longer. If there is any drop-off in economic growth, a 2008 re-run could well be around the corner. That’s not trying to be dramatic; it’s just the way the math pans out.

Lashing central bankers

It’s been surreal to watch news of Detroit’s bankruptcy this week. Once the bastion of a thriving American automobile industry, the city is now on its knees. Meanwhile, U.S. stock market indices are hitting all-time highs. Compare and contrast…

But it’s also been fascinating to see the commentary around the bankruptcy. Much of this commentary blamed a sharply declining population for the crisis and a host of other reasons. Less mentioned though was the real reason for the bankruptcy: Detroit simply spent far more than earned. And it went deeper into debt to finance the spending, until it could no more.

It’s not entirely surprising that this has been largely overlooked and that Detroit is being treated as an isolated case. That’s what politicians in the U.S. and across the developed world want you to believe. That debt isn’t a big deal and that they can help their cities and countries grow their way out of indebtedness, but they just need a bit more time to achieve this

However, a recent report by the Bank Of International Settlements (BIS) – often referred to as the central banks’ bank – shows how difficult this task will be. The BIS annual report outlines, in a clear and often confronting way, the realities of the world’s indebtedness and how current money printing and low interest policies won’t fix the problems emanating from 2008. The BIS has credibility as it was one of the very few institutions to warn of excesses in the lead up to the financial crisis. I can’t recommend the report highly enough.

Let’s have a look at some of the report’s key passages. First, the BIS details the extent of the world’s debt problem. It says total debt in large developed market and emerging market countries is now 20% higher as a percentage of GDP than in 2007. In total, the debt in these countries is US$33 trillion higher than back then. Almost none of the countries that it monitors are better off than 2007 in debt to GDP terms.

The BIS describes the level of debt as clearly unsustainable. The primary reason is that studies have repeatedly shown that once debt to GDP rises above 80%, it retards economic growth. Obviously, if money is being spent on servicing debt, then there’s less to spend on investment etc. Most developed market economies now have debt to GDP levels exceeding 100%.

The BIS says governments need to quickly get their balance sheets in order and does some math to prove why. It says current long-term bond yields for major advanced economies are around 2%, well below the average of the two decades leading up to the crisis of 6%.

If yields were to rise just 300 basis points across the maturity spectrum (and still be below average), the losses would be enormous. Under this scenario, holders of U.S. Treasury securities would lose more than US$1 trillion dollars, or almost 8% of U.S. GDP. The losses for holders of debt in France, Italy, Japan and the U.K. would range from 15% to 35% of GDP.

Being the primary holders of this debt, banks would be the biggest losers and ultimately such losses would pose risks for the entire financial system.

The BIS doesn’t let emerging countries off the hook either. It suggests that while debt may be lower in these countries, they’ve benefited from rising asset and commodity prices, which are unlikely to be sustainable. And therefore caution is warranted here too.

But now we get to the juicy bit where the BIS calls the extraordinary policies of developed market central banks into question. For a conservative institution such as the BIS, the language is nothing short of scathing:

“What central bank accommodation has done during the recovery is to borrow time – time for balance sheet repair, time for fiscal consolidation, and time for reforms to restore productivity growth. But the time has not been well used, as continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system. After all, cheap money makes it easier to borrow than to save, easier to spend than to tax, easier to remain the same than to change.”

And then this:

“Governments hope that if they wait, the economy will grow, driving down the ratio of debt to GDP. And politicians hope that if they wait, incomes and profits will start to grow again, making the reform of labour and product markets less urgent. But waiting will not make things any easier, particularly as public support and patience erode.”

The BIS recommends urgent, broad-based reforms which principally involve cutting back on regulation to allow high-productivity sectors to flourish and for growth to return. It also says households need to makes further cuts to their debts while governments also need to get their balance sheets in order. And regulators need to make sure banks have the capital to absorb any risk of potential losses of the type mentioned above.

The math of debt

It’s worth elaborating on why the current path appears unsustainable, as the BIS alludes too. Put simply, debt is a promise to deliver money. If debt rises faster than money and income, it can do this for a while but there comes a cut-off point when you can’t service the debt. When that happens, you have to cut back on the debt, or deleverage in economic parlance.

There are four ways to deleverage:

1. You can transfer money (Germany transfers money to Cyprus)
2. You can write down the debt. Note though, that one country’s debt is another’s asset.
   
3. You can cut back on the debt. These days, that’s looked down upon and consequently called austerity.
   
4. You can print money to cover the debt.
   

Since 2008, we have seen countries employ all four of these methods.

But the real key is to make sure that interest rates remain below GDP rates. If that happens, debt to GDP levels will gradually fall. If not, they’ll inevitably rise. So say bond yields rise to the post war average of 6% in the U.S., and interest rates increase to comparative levels, nominal GDP would have to be above 6% for debt to GDP levels to decline.

If you understand this, then you’ll realise that talk of “tapering” in the U.S. is likely a load of baloney. Real U.S. GDP growth is expected to be close to 1% in the second quarter, with inflation at around 1.1%, resulting in nominal GDP growth of 2.1%. Many expect this nominal GDP to rise to +3% over the next 12 months. But even at those levels, bond yields can’t be allowed to rise much further (with 10-year yields at close to 2.5%). Otherwise, debt to GDP ratios will rise, impeding future growth and making budget cuts, tax rises and more money printing inevitable.

If the U.S. does taper and bond yields there rise, this would put upward pressure on bond yields in Europe. With GDP growth near zero and still exorbitant debt levels, higher bond yields would quickly crush the Eurozone.

This is why central banks can’t allow higher bond yields and interest rates. Of course, central banks don’t control long-term bond yields; markets do. If central banks want low bond yields, markets will comply until they don’t. That is until they don’t trust that the current strategies of central banks are working. Given that investors are still enamoured with the every word and hint of Ben Bernanke and his ilk, it would seem that the time when bond markets do turn ugly is still a way off.

Dreaded reform

As the BIS points out though, reform is also critical to better economic growth for the developed world and lower debt burdens. On this front, it’s amazing how little restructuring has actually occurred in the U.S. and Europe.

In the U.S. for instance, can you name one piece of significant reform which has reduced regulation and led to growth in new prospective sectors? I can’t, but maybe I’ve missed something.

The trend of the U.S. results season seems to bear this out. U.S. banks have killed it, while many other sectors such as tech haven’t. It’s hardly surprising that current policies are benefiting banks at the expense of the real economy. After all, not only did banks get massive bailouts in 2008 but they’ve been given almost free money from the Federal Reserve via QE ever since. The banking sector is not back to 2007 levels but it’s gradually getting there. Who would have thought this would happen just six years after the biggest debt bust in more than 70 years?

It’s somewhat ironic that instead of the U.S. or Europe, it’s Asia which may be about to lead the way on the reform front. Late on Friday, China announced that it would scrap controls on lending rates and let banks price their loans by themselves. This means cash-strapped companies may have access to cheaper loans. This cheaper credit could further spur the current debt bubble. But the move is likely to have an adverse impact on the profitability of the state-owned banks, thereby making them more reluctant to lend.

It’s expected that the move will foreshadow a later, more important policy to remove controls on deposit rates. Higher deposit rates would increase household income and go some way towards the government’s goal to increase consumption and re-balance the economy.

These financial reforms are likely to be only a small part of a plethora of reforms that China will announce over the next 3 months. As I’ve said previously, I think investors are underestimating the pragmatism of the new leadership and their willingness to take short-term pain to reap later benefits. It won’t be enough to prevent a serious economic downturn but it bodes well for the long-term. The one risk to this scenario is if growth slows enough for unemployment to rise. If that happens, stimulus may again become the got-to tool at the expense of reform. But we’re nowhere near that point yet.

Japan is the other country which may go through with some significant reform. This weekend’s parliamentary elections should solidify Shinzo Abe’s power and give him the platform to pursue more deep-seated reforms. However, the big question remains whether any reform can prevent the country from being overwhelmed by its enormous debt. I’m in the minority suggesting that the debt is simply too large and reform will do little to prevent Japan from going insolvent, if it isn’t already.

Risk of another debt bust?

Which brings me to the key conclusion of this piece. That is, it’s hard to see the U.S, Europe, Japan and other developed world countries implementing reform in time to prevent their debts from rising further and possibly imploding. In other words, many of the fears of the BIS may well come true.

That may sound pessimistic and, to some, melodramatic. But the reality is that little has been done in the past six years to restructure economies and cut debt ie. learning the lessons of 2008. Because we’ve partially recovered from that traumatic period, that’s led to complacency. All the while, the debt that caused the bust in the first place has compounded and threatens to undo the world again.

Let’s hope it doesn’t come to that.