The Overnight Report: Middle East Getting Uglier

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By Greg Peel

The Dow closed up 29 points or 0.2% while the S&P gained 0.3% to 1340 and the Nasdaq added 0.2%.

It was only last week I said “what about Libya?” and sure enough another piece of the jigsaw has fallen into place. So now we have (from west to east) Algeria, Tunisia, Libya, Egypt, Jordan, Yemen, Bahrain and Iran. If Egypt is East Germany, then the fall of its Berlin Wall is reverberating rapidly around the Arab (and Persian) world just as it did in the FSU twenty years ago. But while the fall of Egypt's dictatorship has been relatively swift, the scenes are ugly in Bahrain and apparently so in Iran and Libya where the internet has been shut down. The transition to some form of democracy, if ever, will not be a smooth one.

Of the nations above, Iran, Algeria and Libya are oil producers of note. Bahrain has no oil but is the Middle East's major “Western-style” financial centre. Of the tiny population, 50% are ex-pats. Meanwhile, Egypt is still assessing Iran's application to sail two warships through the Suez and on to Syria. Under the rules, if Egypt is not at war with Iran then it can't block passage, but so far no approval has been granted. One assumes Tel Aviv has been on the phone.

The escalation in unrest did not see oil jump again last night, and indeed profits were taken in Brent crude which fell US$1.15 to US$102.59 after an earlier rally. WTI nevertheless rose by a similar amount, closing the Brent/WTI spread from around US$16 to around US$13.

How the world is responding to this “Arab crisis” is interesting. Money is not flowing directly into the safety of the reserve currency as it might have previously, probably because QE2 undermines its value. Instead the Swiss franc has reemerged as the safe haven currency of choice. This has pushed down the US dollar – last night the index fell 0.3% to 77.99 – while gold continues to tick up and it gained US$8.50 to US$1383.30/oz overnight. But on the safe haven/inflation trade, silver is leaving gold for dead. It jumped 3.5% last night to US$31.77/oz. Silver has been seriously outperforming gold recently and we recall that silver also has industrial applications for which it is also in high demand.

The Aussie jumped up 0.8% to US$1.0119, but while the US dollar itself may be out of favour, US Treasuries are still playing a safe haven role. Last night the benchmark ten-year yield fell five basis points and is now at 3.57% compared to over 3.70% a couple of weeks ago. Usually if bonds are being bought stocks are being sold, but that is not the case at present. The US stock market is finding it very difficult to do anything but rise quietly on local influences despite whatever might be going on elsewhere.

Not that the sellers haven't being trying. Wall Street dipped on the open last night in response to the release of the January CPI. It rose 0.4% at the headline compared with 0.3% expectation. Food and energy prices were the main drivers, but the core rate rose 0.2% compared to 0.1% expectation.

But as we know Ben Bernanke is not the least bit concerned about inflation, and why would he be when the 12-month core CPI is at only 1.0%.

Initial weakness nevertheless gave way quickly on the release of the Philadelphia Fed manufacturing index, which surged from 19.3 in January to 35.9 in February to mark the highest level since 2004. Economists had expected this zero-neutral index to mark only 20.8.

From there on it was simply a quiet rise to the close, albeit a slight dip was felt on the death. Every index rally at the moment is fresh post-GFC “blue sky”. Wall Street is concerned, nevertheless, that recent trading volumes have remained stubbornly low. Mutual funds are reporting money flowing in steadily for the first time since the GFC, yet it doesn't seem to be impacting on volumes. The explanation is simple.

The inflows are still a trickle compared to the heady days pre-GFC, and more modest risk/reward profiles post-GFC will no doubt keep a lid on. However the big difference is the current lack of intraday volatility which is keeping high frequency traders out of the game. In the turmoil of the past three years, HFT was accounting for up to three-quarters of daily turnover but none of the open positions. Without the big triple-digit Dow movements we had become used to, the computers are silent.

Base metals are currently playing a game between genuine buying interest below today's levels and traders ready to sell above on an “overbought” basis. Metals again closed relatively steady in London.

The SPI Overnight rose 11 points or 0.2%.

Highlights today in the local reporting season include Billabong ((BBG)) and James Hardie ((JHX)).

Just as a footnote, I read with interest a newspaper op-ed piece a couple of days ago which noted that the Chinese populace is blissfully unaware of anything having happened in Egypt. Beijing has censored all news coverage. Clearly the Communist Party has not forgotten Tiananmen.

I will be guest star on Business View today on Sky Business at 2pm. (Late call up. The canteen lady was already booked).

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