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August 27, 2005

Euphoria! Sudden Loss of Liquidity?
by Bob Hoye

Great rushes of market euphoria have inevitably been followed by sudden loss of bids, overall liquidity, as well as the discovery that financial concerns have displaced celebration.

Naturally, early symptoms of such fateful transitions are worth monitoring.

These include the yield curve flattening with the boom and then reversing to steepening. The U.S. curve is still flattening, but the U.K. curve reversed in July.

Another indicator of change is widening credit quality spreads. For high-yield corporates, the spread, over treasuries, resumed widening at 301 bps on August 2 and so far has reached 315 bps. Through 320 bps would lock in the trend towards concerning conditions.

One of the more interesting such indicators is not widely followed. At times, the gold/silver ratio seems to act like a credit spread in anticipating or confirming a boom by decreasing, or the same for contraction in increasing.

The ratio increased to 81 in June, 2003 and, as it reversed, it confirmed that the boom would soar. The chart follows and the main thing is the decline to 55 on June 1 (the spike-down to 51 in 2004 seems anomalous in the context of this discussion).

However, since early June the ratio has had a significant recovery and today's swoon in silver popped it above resistance at 64 to 65.5. Technically, this is breaking out of a reverse "head and shoulders" pattern which is opposite to that at the top in 2003.

At this stage of speculative euphoria, typically its exhaustion is signaled by dramatic plunges in silver relative to gold.

This seems to be starting and it is worth noting that currently Brazilian and Indonesian credit spreads have been widening. The latter reminds of the Asian Crisis that started with the Thai baht on July 1, 1997.

Buying of lower grade credits has been ambitious, if not reckless. On August 18, the Wall Street Journal headlined "Binge in Purchases of Corporate Debt". There has been similar buying of low-grade emerging debt bonds.

At times of almost relentless euphoria in lower grade bonds, it is worth reviewing the consequences of previous examples.

Bob Hoye
Institutional Advisors

The opinions in this report are solely those of the author. The information herein was obtained from various sources; however we do not guarantee its accuracy or completeness. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each securitys price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.

Neither the information nor any opinion expressed constitutes an offer to buy or sell any securities or options or futures contracts. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk.

Moreover, from time to time, members of the Institutional Advisors team may be long or short positions discussed in our publications.

Copyright © 2003-2008 Bob Hoye

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