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

[email protected]

Daryl Chia, PRM

[email protected]

Karan Shah

[email protected]

Kunal Shah

[email protected]

Vassil Kirtchev

[email protected]

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.



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



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.



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



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



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.



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.



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

http://www.ft.com/cms/s/0/9d2d2b36-f939-11e0-9d4e-00144feab49a.html



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.



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.



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



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.



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

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