Sunday, 29 March 2015

US sanctions on Venezuela may strengthen Maduro regime

This article originally appeared on Global Risk Insights

The US decision to impose sanctions on seven Venezuelan officials earlier this month seems innocuous enough. But the language accompanying the imposition does little to help US objectives, and may strengthen Nicol├ís Maduro’s authoritarian regime.

The effectiveness of sanctions has long been debated. At worst they can act as a useful signaling tool, but as with everything in international relations, timing is vital.

Coming one week after Venezuela ordered the US to remove the majority of its diplomatic staff from the Caracas embassy, the sanctions were not a major surprise. However, the exercise seemed to have backfired after the US described the declaration as an “emergency” and labeled Venezuela a “security threat.”

Such claims lack credibility and seem bizarre in the current climate. Officials from the Obama administration explained that the language was a legal formality necessary for the sanctions to be applied and that the assessment of the Maduro government is no more severe.

Even so, the presence of such inflammatory statements does not make the sanctions worthwhile. Relations between the two countries are already at their worst since 2010 when each nation called back their respective ambassadors. Yet, bizarre claims that Venezuela is a “security threat” provides Maduro with a vehicle to turn attention away from his declining popularity and the nation’s economic chaos.

Maduro has used the language as an opportunity to attack the US and its attempts to “govern Venezuela by decree.” In addition, it gave Maduro an excuse to allow the National Assembly to grant himself decree powers for the rest of 2015, under the guise that he needs such control to protect Venezuela against US aggression.

The ruckus has also given Maduro some respite from anger about 90% inflation and another currency devaluation. Polls this year indicated that Maduro’s approval rating had fallen to 22%, but it is not yet clear what impact recent developments have had.

While likely providing a short-term boost to Maduro, the US actions create a headwind to the opposition.

As Maduro rallies against the US, his political opponents find themselves in a difficult position. The US rhetoric has given Maduro a platform from which to spur nationalist anger, meaning that any criticism of Maduro from the opposition could be viewed as support for the US and an affront to Venezuela. Indeed, the opposition felt a need to denounce the US actions by issuing a statement that said “Venezuela is not a threat to any nation.”

National legislative elections are expected sometime this year. While there are some concerns that the socialist government may postpone the vote due to Maduro’s low popularity, the US-inspired tumult could see the newly confident administration proceed with a summer election.

This could be the opposition’s best opportunity to defeat the government. And even if the executive takes control of authority before the elections, a strong performance at the ballot box would increase pressure on Maduro to relent from his march toward dictatorship. But the opposition’s hopes have been dented over the last couple of weeks.

The needless sanctions and accompanying language used by the US have merely served to solidify Maduro’s grip on power, while leaving the opposition looking hamstrung. In addition, other Latin American leaders will be reluctant to speak out against Madura in the current environment, and the latest spat will be an unwelcome overhang at next month’s Summit of the Americas in Panama.

Sanctions can be useful, but this is another example of how bad timing can make them a liability to the imposing nation.

Thursday, 26 March 2015

Resurrection of the Machines?

From the 19th century Luddites’ destruction of labor-saving equipment to Deep Blue’s defeat of chess Grandmaster Garry Kasparov in 1997, humans have historically had an uneasy relationship with machines. So perhaps it should not have been a surprise that the plight of computer-driven hedge funds was welcomed with a sense of glee in recent years. Throughout 2013 and most of last year a plethora of press articles described how systematic trading strategies were “broken” and unable to interpret post-crisis financial markets.

Yet there are signs that the trading machines are ready to rise again. After three straight years of negative returns, performance rebounded in 2014 and has continued into this year, with the group gaining 17% over the past 12 months according to Hedge Fund Research’s HFRI Systematic Diversified Index. In contrast, the broader hedge fund universe returned 4%.

Proponents of these systematic or “trend-following” funds blamed easy monetary policies for the lackluster performance. They noted that the intervention of central banks created an artificial cushion that dampened market volatility and limited the sharp moves that these strategies typically capitalise on. Indeed, most gains in recent months came from the unexpected crash in oil and surprising decision by the Swiss National Bank to remove the franc’s peg to the euro.  

Also referred to as “quants” or “black boxes”, systematic funds occupy a niche space in the hedge fund world. The strategies, which manage a total of $317 billion according to BarclayHedge, generally trade futures contracts in financial and commodity asset classes and profit from sustained price trends. Whereas many traditional fund managers analyse economic data and scrutinize corporate balance sheets, systematic trend-following strategies largely focus on historic price behavior and are agnostic about the direction of markets.

It is sometimes forgotten that computerized systems often require vast teams of humans to improve their efficiency. One of the most successful systematic managers, Winton Capital, spends $30 million annually on research. Accordingly, there is little room for a macho trading-room culture, with the highest paid employees often programmers and quantitative researchers. Winton’s founder, David Harding, has no interest in giving opinions on markets and until his dog Cosmo’s passing, allowed the cocker-spaniel stay in the boardroom during meetings with investors.  

Aside from some eccentricity, many investors dislike the volatile returns from systematic funds; a consequence of the strategies staying in markets during tumultuous periods when most logically-minded humans get out. However, the absence of emotion paid off in 2008 as many high-profile systematic strategies made double-digit gains when stocks and commodities plummeted. Similar selloffs may not occur in 2015, but diverging monetary policies could lead to market disruptions and an extension of recent profitable opportunities, says Anthony Todd of Aspect Capital, which manages $5 billion.

Even so, investors will not easily forget painful memories of three consecutive losing years. Instead of a replacement for human managers, computer-driven strategies will likely be categorized as a good complement to investment portfolios. The machines are not ready to take over just yet.

Sunday, 22 March 2015

Nuclear deal offers only a glimmer of hope for Iran’s economy

This article originally appeared on Global Risk Insights

Between crippling sanctions and plunging oil prices, Iran’s economy has been under severe pressure in recent years. While the potential for a nuclear deal has caused optimism, entrenched interests of the Revolutionary Guard will likely prevent Iranians from feeling the full benefit of sanctions being lifted.

While still volatile, Brent crude oil prices seem to have reached a floor around $50 a barrel. With renewed hope that a nuclear program agreement with the US could result in the lifting of sanctions, speculation grows over a potential resurgence in Iran’s energy sector and an influx of foreign inventors.

Holding the world’s second largest natural gas reserves, there is great potential for Iran to develop lucrative resources and diversify away from oil, which accounts for more than 40% of government revenue.

Aside from exporting gas, Iran has shown a desire to change its domestic energy mix from oil to gas and free up more crude for export.

However, the sanctions have limited the potential for energy investment and exports, as foreign investors have stayed away from Iran fearful that banking sanctions could lead to the freezing of assets.

Iran’s president, Hassan Rouhani, has said that he is seeking the removal of all sanctions if a nuclear agreement is to be reached. The apparent nearing of a deal by the end of March has led to hope of an imminent removal of sanctions.

Prospects of an agreement have stopped the free fall of the the TIPEX Index, a broad measure of Iran’s stock market.

Easing inflationary pressures have caught on, with the current rate now around 17%, down from 40% in 2013. Add to this the Iranian central bank’s claims that the economy has grown in the past year, and the end to two years of contraction set the stage for a positive turn in the immediate future.

Then again, such optimism seems excessive. Apart from the fact that Iran’s youth unemployment rate is around 24%, the lifting of sanctions may not be a dramatic tailwind. If a deal is reached at all, the lifting of sanctions could be a gradual process spread over many months.

And there is the Revolutionary Guard. Established to protect Iran’s Islamic system, the role of the Revolutionary Guard has morphed over the years to include deep interests in the nation’s business activities.

Under former president Mahmoud Ahmadinejad, the Guard’s influence grew markedly, while the impact of sanctions added to the group’s power. As foreign energy firms exited Iran, the Guard’s engineering companies stepped in to take control of oil resources.

It is unlikely that the Guard views the prospect of easing sanctions and return of foreign energy investors as a welcome development. Conservative Iranian hardliners have already been blamed for slowing progress in the nuclear talks, and have highlighted the ineffectiveness of last year’s partial easing of sanctions in alleviating hardships faced by average Iranians.

An inefficient energy sector free from foreign influence is much more desirable to the Guard than a flourishing industry that would benefit the broader economy.

Even if a nuclear deal is reached and sanctions are lifted, it is doubtful that the Guard will immediately give up its clout in Iran’s business affairs. Foreign companies should not expect a warm welcome back to Iran, despite the efforts of a pragmatic Rouhani to build relations with the West.

China forced to rethink role in Middle East

This article originally appeared on Global Risk Insights

In recent years, China’s presence in the Middle East has taken on greater significance through deepening economic ties. China is now the second largest trading partner with Arab nations, jumping to US $238.9 billion in 2013 from $25.5 billion a decade prior. A strategy of remaining agnostic to political ideology has helped China foster relations in the Middle East, but signs of growing instability in the region could force Beijing to rethink its approach.

Aside from its ability to use cash from $4 trillion of foreign currency reserves, China has been granted access to energy by a variety of Middle Eastern nations due to its perceived neutrality. A negligible military presence in the region, an absence of recent colonial history, and seemingly high regard for state sovereignty have all contributed to China’s burgeoning presence. Such factors have been particularly important in developing links to states that are ideologically opposed to each other, like Saudi Arabia and Iran.

Middle Eastern countries have appeared to welcome China as a diversifier to US influence. China’s willingness to do arm sales and bilateral trade with countries hostile to the US acts as a balance to US hegemony. Of course, access to energy is China’s primary goal. Roughly 60% of China’s oil imports, 2.9 million barrels per day, came from the Middle East in 2013 and the nation has increased its ties to the region via tools such as energy-backed loans and joint ventures involving investment in refineries, exploration and pipelines.

China’s rise in the Middle East is coinciding with a declining US presence. While that may not seem like a major issue to the US given the domestic oil boom, it must be remembered that net imports still account for about 30% of the petroleum consumed in the US, with 30% of those net imports coming from the Persian Gulf. Moreover, estimates generally see US energy independence as several decades away.

However, China still has the ability to expand influence in the Middle East and maintain relations with Washington. Its capacity to import oil from multiple ideologically diverse sources in the region means that Beijing can afford to suspend trade with a nation that falls severely afoul of the US, if it so chooses.

Despite a lack of clear policy, China seems to have an optimal setup in the Middle East – but there are signs that this could change. The fragile nature of some regimes could bring headaches to Beijing. An unwillingness to intervene in the region’s political matters does not suggest that China can escape criticism. After Gaddafi’s removal from Libya, the new leadership said that it would have difficulty dealing with China, given that Beijing did not support NATO involvement in 2011. And China’s veto on UN resolutions censuring Assad’s regime in Syria resulted in reports of Chinese flag burning in several Middle Eastern cities.

Moreover, China may have to react to the expansion of Islamic militancy. The nation already faces threats from radical Islam in its Xinjiang province, and would not welcome the spread of ISIS influence towards its borders. Western relations with the Middle East have centered on a challenging balancing act between political ideals and the realism of energy requirements. China has to-date focused on the latter, and it has paid off. But changes in the tumultuous region may force Beijing into making difficult decisions that risk upsetting its image as the antithesis to a meddling United States.