From a near stall experienced at the end of 2008, Chinese growth has been improving with manufacturing surveys indicate expansion, residential property shows sign of stabilization, consumption has held up – stems from Beijing’s aggressive policy in response to the economic crisis.
Exports may have stabilized at a low level, but imports continue to be weak. Commodities have dominated Chinese imports, as China took advantage of cheaper prices. It may slow its purchases in 2H2009 as commodity prices now climbing and stockpiles filled. So far, commodity exporters have benefited most from the surge in Chinese commodity demand.
Thus far, government investment has driven growth acceleration while domestic private demand has weakened. So far, Chinese electrical demand has yet to match the surge in investment and industrial production.
In an effort to limit unemployment, the government has purchased excess output including metals, grains, and goods to refined fuels to processed metals. Chinese consumption has held up, but from a low base and the strong performance of retail and auto sales, prompted in part by incentives does illustrate the ability of the government to influence public and private consumption. It raises the possibility that China may have had a stronger underlying domestic demand dynamic than many credited.
Chinese bank lending has been particularly aggressive, reaching a value equivalent to 25% of China’s 2008 GDP. But this lending, whose pace reaccelerated in June 2009, might contribute to asset bubbles, especially in property and could increase non-performing loans in the future. Small and medium enterprises, however, still have challenges finding funds. Of late, officials have begun mopping up some of the liquidity through issuance of bills.
Given the still speculative nature of the Chinese markets and the influence of government policies, the equity market could be vulnerable for a correction. It is worth remembering that Chinese markets are buffered form foreign portfolio flows, given investment restrictions, and that the Chinese government is carefully restarting the IPO pipeline.
Thursday, July 30, 2009
Monday, July 27, 2009
RMB – A Managed Currency for Now
I am a bull for RMB as in the worst global recession since the Great Depression, China is the only large economy that is growing. It has over $2trillion in foreign exchange reserves, about 29% of all international reserve assets.
For now, China doesn’t want stronger RMB as it makes less competitive on a global stage for trade. It needs a relatively weak RMB to continue exporting its way to growth. That’s why the Bank of China manages the value of its currency. You see when dollar-based investments and revenues flow into China, converting these inflows to the RMB puts an upward pressure on the currency.
To offset the local demand to exchange US dollars to RMB, the Bank of China takes the other side of transactions – selling RMB and buying USD. This keeps the exchange rate stable and China builds vast amounts of dollar reserves.
For a decade, China maintained a fixed exchange rate policy – the RMB was pegged against the dollar at 8.27 RMB, and in 2005, China changed its currency policy. It abandoned the peg after political tensions rose between China and its key trading partners.
Under the ‘managed float’ policy, China agreed to let the RMB trade in a defined daily trading band while gradually allowing it to appreciate. This was China’s way of pacifying its trading partners while maintaining complete control over its currency. Over the next three years, the RMB climbed 17% against the USD and if the RMB was determined by market forces, it would trade around 5.80 to 6.00 level.
Since August 2007, RMB has been kept within tight trading band of around 6.80 level. Trading of RMB has been heavily restricted by the government – authorized only within mainland China and only through China’s agent banks.
Now for the first time, China is relaxing restrictions and allowing the RMB to trade off-shore with select Asian neighboring countries. This is the first step in China’s attempt to temper growth in its foreign currency reserves and to make the RMB a globally traded currency.
Despite China’s concern about the value of its large stock of US assets, reserve diversification will continue to be difficult, though the purchase of $50 billion in SDR-denominated bonds from the IMF will be only a small share of its $2 trillion in reserves. Investment in resource-rich countries will continue to be a major part of China’s asset allocation.
For now, China doesn’t want stronger RMB as it makes less competitive on a global stage for trade. It needs a relatively weak RMB to continue exporting its way to growth. That’s why the Bank of China manages the value of its currency. You see when dollar-based investments and revenues flow into China, converting these inflows to the RMB puts an upward pressure on the currency.
To offset the local demand to exchange US dollars to RMB, the Bank of China takes the other side of transactions – selling RMB and buying USD. This keeps the exchange rate stable and China builds vast amounts of dollar reserves.
For a decade, China maintained a fixed exchange rate policy – the RMB was pegged against the dollar at 8.27 RMB, and in 2005, China changed its currency policy. It abandoned the peg after political tensions rose between China and its key trading partners.
Under the ‘managed float’ policy, China agreed to let the RMB trade in a defined daily trading band while gradually allowing it to appreciate. This was China’s way of pacifying its trading partners while maintaining complete control over its currency. Over the next three years, the RMB climbed 17% against the USD and if the RMB was determined by market forces, it would trade around 5.80 to 6.00 level.
Since August 2007, RMB has been kept within tight trading band of around 6.80 level. Trading of RMB has been heavily restricted by the government – authorized only within mainland China and only through China’s agent banks.
Now for the first time, China is relaxing restrictions and allowing the RMB to trade off-shore with select Asian neighboring countries. This is the first step in China’s attempt to temper growth in its foreign currency reserves and to make the RMB a globally traded currency.
Despite China’s concern about the value of its large stock of US assets, reserve diversification will continue to be difficult, though the purchase of $50 billion in SDR-denominated bonds from the IMF will be only a small share of its $2 trillion in reserves. Investment in resource-rich countries will continue to be a major part of China’s asset allocation.
Profit on an Accounting Mirage
More investment banks are reporting windfall profits for the second quarter. That’s helped fuel advances in US and global stocks. Having said that these decidedly positive developments don’t necessarily indicate better days have arrived for the US banking sector.
I say these profits are merely a mirage created by an obscure accounting rule that allows banks to transform ‘toxic debt’ on their balance sheets into income. Also, the benefits of less competition, and favourable interest rates. Indeed, the Financial Accounting Standards Board has made it possible for the biggest US banks to book profits on loans that have not been fully repaid.
Banks will book income on loans that have ‘reduced credit quality’ by recognizing the value of the bonds on their balance sheets and the cash flow those securities are expected to earn.
In JP Morgan’s case, the firm took on $118.2 billion in toxic debt when it acquired Washington Mutual Inc last year. As a receiver of that debt, JP Morgan was allowed to mark that debt down to ‘fair value’, but now the bank says that those same debts may appreciate by some $29 billion over the life of the loans. And as those loans are paid back, that money is booked as profit.
Of course, this distorts banks’ earnings and camouflages the deterioration in other banking segments. Consumer and business loan losses continued to rise. Retail earnings were down sharply. Home equity charge-offs jumped and banks are warning that mortgage losses will continue over the next several quarters. Credit cards losses are highly dependent on unemployment situation – now at 9.5% in June, its highest level in two decades. The banking industry as a whole is getting pounded by rising consumer loan delinquencies, rising mortgage delinquencies, rising commercial real estate losses and more.
If you look no further than the huge divergence between Goldman Sach and CIT Group, you would realize the government is creating a two-class system of banks. Goldman, which received a large shot of TARP money and other supports, has generated a record profit in 2Q thanks to big gains in commodity, interest rates and stock trading.
On the other hand, the large commercial lender CIT was left to twist in the wind. The government refused to allow it to sell backstopped debt via the Temporary Liquidity Guarantee Program. CIT almost tumbled into bankruptcy before a group of bondholders agreed to bail it out with a $3 billion infusion.
Goldman shares have surged 89% and CIT shares have plunged 78% this year. Now that is a divergence!
I say these profits are merely a mirage created by an obscure accounting rule that allows banks to transform ‘toxic debt’ on their balance sheets into income. Also, the benefits of less competition, and favourable interest rates. Indeed, the Financial Accounting Standards Board has made it possible for the biggest US banks to book profits on loans that have not been fully repaid.
Banks will book income on loans that have ‘reduced credit quality’ by recognizing the value of the bonds on their balance sheets and the cash flow those securities are expected to earn.
In JP Morgan’s case, the firm took on $118.2 billion in toxic debt when it acquired Washington Mutual Inc last year. As a receiver of that debt, JP Morgan was allowed to mark that debt down to ‘fair value’, but now the bank says that those same debts may appreciate by some $29 billion over the life of the loans. And as those loans are paid back, that money is booked as profit.
Of course, this distorts banks’ earnings and camouflages the deterioration in other banking segments. Consumer and business loan losses continued to rise. Retail earnings were down sharply. Home equity charge-offs jumped and banks are warning that mortgage losses will continue over the next several quarters. Credit cards losses are highly dependent on unemployment situation – now at 9.5% in June, its highest level in two decades. The banking industry as a whole is getting pounded by rising consumer loan delinquencies, rising mortgage delinquencies, rising commercial real estate losses and more.
If you look no further than the huge divergence between Goldman Sach and CIT Group, you would realize the government is creating a two-class system of banks. Goldman, which received a large shot of TARP money and other supports, has generated a record profit in 2Q thanks to big gains in commodity, interest rates and stock trading.
On the other hand, the large commercial lender CIT was left to twist in the wind. The government refused to allow it to sell backstopped debt via the Temporary Liquidity Guarantee Program. CIT almost tumbled into bankruptcy before a group of bondholders agreed to bail it out with a $3 billion infusion.
Goldman shares have surged 89% and CIT shares have plunged 78% this year. Now that is a divergence!
Thursday, July 23, 2009
Making Sense of 2Q Earnings
So far, markets have been cheering the news coming from US financial firms – sparked by news that Goldman Sachs handily beat analysts’ profit estimates. And the party continued as JP Morgan, Bank of America, Citigroup and other institutions posted similarly upbeat reports.
But, wait a minute!
Aren’t these the same firms that were receiving billions and billions of tax-payers money just to stay afloat a couple of months ago?
Sure, Goldman has already repaid the $10bn it borrowed directly from Uncle Sam. That’s probably so just so it can hand out huge bonuses again this year.
Investors don’t really seem to care about such trivialities. They’re just cheering the news and move the stocks higher.
Here are the financial earnings hoopla – that the profits are largely based on government handouts used for big trading profits during self-inflicted volatility. Consider the fact that CIT – a major small business lender – just barely cleared a deal to keep itself out of bankruptcy. Not all financial institutions are smelling like roses.
Of course, profits came from the trading units, but not all units are winners. Goldman is still wrestling with a losing commercial real estate loan portfolio and slow investment banking operations. Meanwhile, JP Morgan, BAC and Citigroup are seeing deteriorating conditions in their consumer loan portfolios.
And with new legislation on the horizon – including the credit card reforms, possible caps on executive compensation and other major initiatives – it is hard to picture how these institutions will have a smooth sailing from here on out.
Consumers are changing their behaviour. Credit is unavailable and companies that produce frivolities are going to suffer the consequences. Consumer retrenchment is happening here. It is going to dictate how quickly or slowly the economy turns around and it has major implications for all stocks in your portfolio.
But, wait a minute!
Aren’t these the same firms that were receiving billions and billions of tax-payers money just to stay afloat a couple of months ago?
Sure, Goldman has already repaid the $10bn it borrowed directly from Uncle Sam. That’s probably so just so it can hand out huge bonuses again this year.
Investors don’t really seem to care about such trivialities. They’re just cheering the news and move the stocks higher.
Here are the financial earnings hoopla – that the profits are largely based on government handouts used for big trading profits during self-inflicted volatility. Consider the fact that CIT – a major small business lender – just barely cleared a deal to keep itself out of bankruptcy. Not all financial institutions are smelling like roses.
Of course, profits came from the trading units, but not all units are winners. Goldman is still wrestling with a losing commercial real estate loan portfolio and slow investment banking operations. Meanwhile, JP Morgan, BAC and Citigroup are seeing deteriorating conditions in their consumer loan portfolios.
And with new legislation on the horizon – including the credit card reforms, possible caps on executive compensation and other major initiatives – it is hard to picture how these institutions will have a smooth sailing from here on out.
Consumers are changing their behaviour. Credit is unavailable and companies that produce frivolities are going to suffer the consequences. Consumer retrenchment is happening here. It is going to dictate how quickly or slowly the economy turns around and it has major implications for all stocks in your portfolio.
Tuesday, July 21, 2009
The Next Hit
We have avoided Armageddon, at least for now and some have been loudly announcing the end of the recession. I am part of this and we are not out of the woods yet and there are a few more bumps in the road, and can be quite steep hills. As big as the sub-problem? Maybe.
When asked few weeks ago, what was my biggest concern – it would be European banks, which I have been highlighting many times the potential to create significant risk for the entire global system. This may be even dip us back into recession.
The insane lending policies in US mortgage banks has bring the world financial system to its knees, but one rarely knows the fact that Europe’s banks have been much aggressive in funding emerging markets expansion than US or Japanese banks. To compound the problem, the Europe’s banking system is in far worse shape than the US system. The losses may be bigger and their capital to meet those losses is certainly less.
Regulators in the UK allowed 20:1 leverage on a regular basis. It is now almost 40:1 and with tangible common equity (TCE), which includes preferred shares is around 55. This compared to US situation of which the average leverage of Tier 1 Capital of the five largest banks is in the range of 12:1 and is actually down from ten years ago. The assets of UK banks are about 5 times as large as UK GDP and by comparison, for the US, the ratio is barely 2:1.
And now turn to Eurozone. Leverage is now 35:1 and with TCE is almost 55. Now, this is the real issue and according to some Austrian-economist friends “Good, they should al be allowed to die” and this could potentially raise unemployment rate to something like 20%. This is a global risk, not just localized to Ireland or Spain or Austria.
I have some dealings with Swiss private bankers and they are known to be conservative. But somewhat, somewhere, some of them ran up a little leverage of nearly at nosebleed high 65%. According to a friend of mine, these banks are technically bankrupt.
Eurozone banks are already reeling from losses from US sub-prime related problems. Compounding this is Switzerland and Ireland’s bank assets are over 7 times, the UK is over 5 and the Eurozone on average of 4 times. Now, they have to face with even deeper losses from their own lending portfolios. Assuming that the losses were just optimistically 5% of the portfolio, it would be 20% of Eurozone GDP. The same goes for Portugal, Spain, Greece and Ireland. A 5% loan losses in Ireland would be 40% of GDP, the equivalent of US$5 trillion and I wonder where does Europe to find few trillion dollars?
After all, we are all connected, and what happens in Rome, no longer stays in Rome. Burn this into your mind!
When asked few weeks ago, what was my biggest concern – it would be European banks, which I have been highlighting many times the potential to create significant risk for the entire global system. This may be even dip us back into recession.
The insane lending policies in US mortgage banks has bring the world financial system to its knees, but one rarely knows the fact that Europe’s banks have been much aggressive in funding emerging markets expansion than US or Japanese banks. To compound the problem, the Europe’s banking system is in far worse shape than the US system. The losses may be bigger and their capital to meet those losses is certainly less.
Regulators in the UK allowed 20:1 leverage on a regular basis. It is now almost 40:1 and with tangible common equity (TCE), which includes preferred shares is around 55. This compared to US situation of which the average leverage of Tier 1 Capital of the five largest banks is in the range of 12:1 and is actually down from ten years ago. The assets of UK banks are about 5 times as large as UK GDP and by comparison, for the US, the ratio is barely 2:1.
And now turn to Eurozone. Leverage is now 35:1 and with TCE is almost 55. Now, this is the real issue and according to some Austrian-economist friends “Good, they should al be allowed to die” and this could potentially raise unemployment rate to something like 20%. This is a global risk, not just localized to Ireland or Spain or Austria.
I have some dealings with Swiss private bankers and they are known to be conservative. But somewhat, somewhere, some of them ran up a little leverage of nearly at nosebleed high 65%. According to a friend of mine, these banks are technically bankrupt.
Eurozone banks are already reeling from losses from US sub-prime related problems. Compounding this is Switzerland and Ireland’s bank assets are over 7 times, the UK is over 5 and the Eurozone on average of 4 times. Now, they have to face with even deeper losses from their own lending portfolios. Assuming that the losses were just optimistically 5% of the portfolio, it would be 20% of Eurozone GDP. The same goes for Portugal, Spain, Greece and Ireland. A 5% loan losses in Ireland would be 40% of GDP, the equivalent of US$5 trillion and I wonder where does Europe to find few trillion dollars?
After all, we are all connected, and what happens in Rome, no longer stays in Rome. Burn this into your mind!
Monday, July 20, 2009
Top 3 Forecasts
I love cycles and spend considerable time to understand it. I was exposed to this work when I had a chance of working with Geoffrey Moore, a leading guru in this field at the early part of my professional career. I heavily indebted to him, and thus far, his works have done pretty well for me.
As part of my half-yearly secular review, I put forward my Top 3 forecasts for those, who believe!
The first big move in gold in the late 1970s and now we are in the second big move. However, I see possible correction here in 2009, then I see gold moving higher in 2010 and still higher in 2011. The most recent peak, we saw in gold was in 2008 and already central banks around the world are fighting this economic crisis tooth and nail, printing money like there is no tomorrow, hence driving hundreds of billions, perhaps, trillions of dollars worth of frightened money into gold, silver, platinum, oil and other assets. So for short term traders, I think this is an opportunity to make money on the downside and for longer term investors, I think it is going to be an opportunity to add to the core holdings.
And in the case of US dollar, I have been the bear for as long as memory serves. Cycles suggest an 11-year decline of US dollar that does not end until 2012. Right now, in parallel with a gold correction, I see the likelihood of a dollar rally. In this regards, I would keep at least some portion of my money out of the dollar, putting it into stronger currencies like the AUD, NZD or the Swiss franc. The intermediate swings are too big and too regular to ignore.
I expect interest rates to move higher, especially those of high-grade paper but a new decline later this year and ending in 2012. Of course, low grade paper would probably move closely the pattern in the stock market in terms of price. In relation to the equity, I would take a very cautious, balanced, long-term to play the big sweeping negative trend in the stock market over the next several years.
What we are witnessing today – right now – is merely the calm before the big hurricanes hit. The combination of the 20-year economic cycles and the 500-year geopolitical cycle – a major power shift from East to West and or West to East, which is now the case, both crushing down on the economy in one singular time frame.
I see this as one time in the lifetime when we can build a great fortune like a handful of smart investors did in the great bear market of the 1930s, and then build still another fortune in the great bull market that follows.
As part of my half-yearly secular review, I put forward my Top 3 forecasts for those, who believe!
The first big move in gold in the late 1970s and now we are in the second big move. However, I see possible correction here in 2009, then I see gold moving higher in 2010 and still higher in 2011. The most recent peak, we saw in gold was in 2008 and already central banks around the world are fighting this economic crisis tooth and nail, printing money like there is no tomorrow, hence driving hundreds of billions, perhaps, trillions of dollars worth of frightened money into gold, silver, platinum, oil and other assets. So for short term traders, I think this is an opportunity to make money on the downside and for longer term investors, I think it is going to be an opportunity to add to the core holdings.
And in the case of US dollar, I have been the bear for as long as memory serves. Cycles suggest an 11-year decline of US dollar that does not end until 2012. Right now, in parallel with a gold correction, I see the likelihood of a dollar rally. In this regards, I would keep at least some portion of my money out of the dollar, putting it into stronger currencies like the AUD, NZD or the Swiss franc. The intermediate swings are too big and too regular to ignore.
I expect interest rates to move higher, especially those of high-grade paper but a new decline later this year and ending in 2012. Of course, low grade paper would probably move closely the pattern in the stock market in terms of price. In relation to the equity, I would take a very cautious, balanced, long-term to play the big sweeping negative trend in the stock market over the next several years.
What we are witnessing today – right now – is merely the calm before the big hurricanes hit. The combination of the 20-year economic cycles and the 500-year geopolitical cycle – a major power shift from East to West and or West to East, which is now the case, both crushing down on the economy in one singular time frame.
I see this as one time in the lifetime when we can build a great fortune like a handful of smart investors did in the great bear market of the 1930s, and then build still another fortune in the great bull market that follows.
Friday, July 17, 2009
Mark for Recession – Unemployment Rate
In my opinion, if there is one indicator to demarcate a recession from a depression, it will be unemployment rate. It will be too shallow a thinking that after the stock market rallied off its March 2009 low, the media and many pundits seem to be fixated on the financial markets to determine the severity of the crisis and to call its end.
The crash of 1929 proved to be the only prelude to further heavy losses in 1930-32. After the initial crash from 381 to 199, a huge rally emerged – prices rose all the way back to 294 for a 48% bear market rally. Initial losses were roughly cut in half. As we all know now, this optimism proved to be, well, premature as it turned out just a bear market rally, soon the market started to tank again. Stocks tumbled back to the crash lows, market cascaded lower for another two years and from the high during the summer of 1929, the losses amounted to a staggering 89%.
Fast forward to the bear market rally of 2009 – the rising sentiment does not forecast a betterment of the economy. Instead, a rising stock market foregoes rising optimism. I think that the next few weeks and months will not only be very interesting, but also very important because hardly anybody that I talked-to seems to think about the possibility of a new stock market low.
If we look at unemployment rate of the 1930s, the official US unemployment rate rose from the cycle low of 3.2% in 1929 to 15.9% in 1931 before it peaked at 24.9% in 1933 and hovered around 20% plus over the next two years after that. Contrast with the current timing, the rate rose from the low of 3.4% in 2007 to a recent high of 9.5% as of June 2009. If we look at civilian employment to population ratio, the downtrend in job market had already started in 2000, then the stock market burst. This was just the first act in a much longer drama.
These statistics clearly show that the severity of the current situation. Here you can see why this rally is not a garden variety post World War II recession, but something very different. The current plunge is secular, not cyclical and the world economy has a lot of rebalancing to do and this process will last much, much longer than the ‘green shoots’ crowd deems possible.
The crash of 1929 proved to be the only prelude to further heavy losses in 1930-32. After the initial crash from 381 to 199, a huge rally emerged – prices rose all the way back to 294 for a 48% bear market rally. Initial losses were roughly cut in half. As we all know now, this optimism proved to be, well, premature as it turned out just a bear market rally, soon the market started to tank again. Stocks tumbled back to the crash lows, market cascaded lower for another two years and from the high during the summer of 1929, the losses amounted to a staggering 89%.
Fast forward to the bear market rally of 2009 – the rising sentiment does not forecast a betterment of the economy. Instead, a rising stock market foregoes rising optimism. I think that the next few weeks and months will not only be very interesting, but also very important because hardly anybody that I talked-to seems to think about the possibility of a new stock market low.
If we look at unemployment rate of the 1930s, the official US unemployment rate rose from the cycle low of 3.2% in 1929 to 15.9% in 1931 before it peaked at 24.9% in 1933 and hovered around 20% plus over the next two years after that. Contrast with the current timing, the rate rose from the low of 3.4% in 2007 to a recent high of 9.5% as of June 2009. If we look at civilian employment to population ratio, the downtrend in job market had already started in 2000, then the stock market burst. This was just the first act in a much longer drama.
These statistics clearly show that the severity of the current situation. Here you can see why this rally is not a garden variety post World War II recession, but something very different. The current plunge is secular, not cyclical and the world economy has a lot of rebalancing to do and this process will last much, much longer than the ‘green shoots’ crowd deems possible.
Thursday, July 16, 2009
Chinese Timber Dynamics
I had a couple of conversations with friends from China recently. One of the key outcomes is that China is facing a structural wood fibre deficit and is growing, given the rapid expansion of China’s urban population, which will translate into ongoing strong demand for housing and wood products. What is more, the Chinese government plans on moving 300 million rural people into the cities. China relies on imports for roughly 20% of its industrial round-wood requirements while imported lumber and plywood account for more than 40% of China’s total consumption. In essence, China is roughly accounts for about one-third of the global log trade.
Reacting to the devastating Yangtze River floods of 1998, the Chinese government summarily banned timber harvesting in large areas of the country. While the ban has improved forestry management in China, the government now goes elsewhere for the wood it needs, accelerating timber poaching in other nations and becoming the main hub of a global network of trade of timber. Imports of industrial wood -- used in construction, furniture-making and pulp mills -- have more than tripled since 1993. According to the World Wildlife Fund (WWF), China's demand for imported industrial wood -- timber, paper and pulp -- will grow by at least 33 percent within the next five years, from the current 94 million cubic meters to 125 million cubic meters.
China now trails only the US in wood consumption and with the country's projected growth rates, China is sure to soon surpass the States and Japan to frontrunner status for consumption. According to The Economist, The small town of Nanxum near the port city of Zhangjiagang used to produce only small amounts of wooden floorboards up until about five years ago. Today, there are 500 floorboard factories and about 200 sawmills, which the EIA says together process one merbau log -- a type of sturdy tropical hardwood -- every minute of every work day.
The value of trade in commodity tropical timber products (logs, sawnwood, plywood and veneer) has dropped by almost a third since the early 1990s, that of higher-value (or "downstream") products such as doors, windows, furniture and joinery, has grown almost five-fold.
China's increasing imports more than offset steady declines in Japan, traditionally a major player in the tropical timber market. Japan's imports had fallen for several years due to its sluggish economy, competition from China for available log supplies, and its increasing reliance on softwood logs for plywood manufacture.
Reacting to the devastating Yangtze River floods of 1998, the Chinese government summarily banned timber harvesting in large areas of the country. While the ban has improved forestry management in China, the government now goes elsewhere for the wood it needs, accelerating timber poaching in other nations and becoming the main hub of a global network of trade of timber. Imports of industrial wood -- used in construction, furniture-making and pulp mills -- have more than tripled since 1993. According to the World Wildlife Fund (WWF), China's demand for imported industrial wood -- timber, paper and pulp -- will grow by at least 33 percent within the next five years, from the current 94 million cubic meters to 125 million cubic meters.
China now trails only the US in wood consumption and with the country's projected growth rates, China is sure to soon surpass the States and Japan to frontrunner status for consumption. According to The Economist, The small town of Nanxum near the port city of Zhangjiagang used to produce only small amounts of wooden floorboards up until about five years ago. Today, there are 500 floorboard factories and about 200 sawmills, which the EIA says together process one merbau log -- a type of sturdy tropical hardwood -- every minute of every work day.
The value of trade in commodity tropical timber products (logs, sawnwood, plywood and veneer) has dropped by almost a third since the early 1990s, that of higher-value (or "downstream") products such as doors, windows, furniture and joinery, has grown almost five-fold.
China's increasing imports more than offset steady declines in Japan, traditionally a major player in the tropical timber market. Japan's imports had fallen for several years due to its sluggish economy, competition from China for available log supplies, and its increasing reliance on softwood logs for plywood manufacture.
Tuesday, July 14, 2009
Clues on Currencies
Investors are running for the doors and it is not easy anymore to get the direction right for currencies in this market environment. What I am attempting to do here is to find some clues of what’s happening in stocks and commodities to predict what next for currencies.
The relief rally of these two markets over the past four months appear to have run its course, which resulting in currencies like Euro, AUD, Pound and emerging market currencies to start falling as well. The tight correlation between these markets is because all of the risks that drove these correlations still loom, especially housing market is still a major problem with no relief in sight.
The bottom line – the global economy is mired by risks that could easily divert recovery and send things into further depths of contraction, which makes the risk-taking interest of recent months merely opportunism.
When crisis strikes, investors are in favour for safety of US dollar-denominated assets. However, this trend gradually retracted over the past four months as risk appetite rising.
Now, risk aversion is coming back. Stocks are breaking down again and crude oil has fallen nearly 20% in six trading days. The commodity rally looks exhausted too and China’s import of iron ore is subsiding. The Baltic Dry Index, a good gauge of global demand, has been falling for seven straight days.
Evidently, the Euro, Pound, AUD have all breached key technical support and are now in decline. And higher risk carry trades, funded by the favoured Japanese yen, are being reversed aggressively. The Russian rubble experienced its biggest fall in five months. The last time the ruble was falling at this rate, the Russian central bank was in the process of exhausting 220 billion dollars in foreign exchange reserve to defend the value of the currency.
With risk aversion picking up, the US dollar’s least ugly status comes back into focus and the dollar benefits. Despite all the recent debate about the future of its reserve currency status, viable dollar alternatives don’t exist, particularly in a highly fragile global economic recession.
The relief rally of these two markets over the past four months appear to have run its course, which resulting in currencies like Euro, AUD, Pound and emerging market currencies to start falling as well. The tight correlation between these markets is because all of the risks that drove these correlations still loom, especially housing market is still a major problem with no relief in sight.
The bottom line – the global economy is mired by risks that could easily divert recovery and send things into further depths of contraction, which makes the risk-taking interest of recent months merely opportunism.
When crisis strikes, investors are in favour for safety of US dollar-denominated assets. However, this trend gradually retracted over the past four months as risk appetite rising.
Now, risk aversion is coming back. Stocks are breaking down again and crude oil has fallen nearly 20% in six trading days. The commodity rally looks exhausted too and China’s import of iron ore is subsiding. The Baltic Dry Index, a good gauge of global demand, has been falling for seven straight days.
Evidently, the Euro, Pound, AUD have all breached key technical support and are now in decline. And higher risk carry trades, funded by the favoured Japanese yen, are being reversed aggressively. The Russian rubble experienced its biggest fall in five months. The last time the ruble was falling at this rate, the Russian central bank was in the process of exhausting 220 billion dollars in foreign exchange reserve to defend the value of the currency.
With risk aversion picking up, the US dollar’s least ugly status comes back into focus and the dollar benefits. Despite all the recent debate about the future of its reserve currency status, viable dollar alternatives don’t exist, particularly in a highly fragile global economic recession.
Monday, July 13, 2009
Oil Prices Due for Short Term Setback
I am still long term bullish on oil prices, but don’t be surprised to see a near term correction soon.
After tumbling to a low of $33.98 on February 12, crude oil more than doubled in prices before tumbling recently on a worse-than-expected jobs report. It is important to note that the recent rise in oil prices is not supported by supply/demand fundamentals. It is essentially the result of a shift in market sentiment and a corresponding reversal in US stocks, not a material change in the global economy.
And because of the five month rally has proceeded at an exceptionally quick pace, its is made prices more volatile, and that suggesting prices could experience a significant correction in the short term.
Historically, equities have been a leading indicator of economic growth and commodities have been a coincident indicator. Right now, we are seeing commodities and equities move together as money comes back in at the same time. Additionally, many speculators reversed their positions on oil from short to long, and that can also pull prices higher. Some US$3.8 billion has flowed into oil-and-gas exchange traded funds this year compared with US$1.4 billion in the first half of 2008.
Considering that supply seems ample and demand is weak, but those factors are being overwhelmed by a hugh sigh of relief that we are not going to have the Great Depression. A lot of money is coming out of mattresses.
The perception of the economic recovery may have changed, but the underlying supply and demand fundamentals have not. There is still a glut of oil in the market and not enough demand to soak it up.
In its five year forecast for the world wide oil market, IEA cut its five year forecast for global crude demand and predicted that consumption won’t rebound to last year’s levels until 2012 – at the earliest, based on the IMF forecast for global economic growth of 5% a year between 2012 and 2014.
If that is true, oil prices would only be setting themselves up for a bigger tumble when the economy slips back into possibility of recession later of the year.
After tumbling to a low of $33.98 on February 12, crude oil more than doubled in prices before tumbling recently on a worse-than-expected jobs report. It is important to note that the recent rise in oil prices is not supported by supply/demand fundamentals. It is essentially the result of a shift in market sentiment and a corresponding reversal in US stocks, not a material change in the global economy.
And because of the five month rally has proceeded at an exceptionally quick pace, its is made prices more volatile, and that suggesting prices could experience a significant correction in the short term.
Historically, equities have been a leading indicator of economic growth and commodities have been a coincident indicator. Right now, we are seeing commodities and equities move together as money comes back in at the same time. Additionally, many speculators reversed their positions on oil from short to long, and that can also pull prices higher. Some US$3.8 billion has flowed into oil-and-gas exchange traded funds this year compared with US$1.4 billion in the first half of 2008.
Considering that supply seems ample and demand is weak, but those factors are being overwhelmed by a hugh sigh of relief that we are not going to have the Great Depression. A lot of money is coming out of mattresses.
The perception of the economic recovery may have changed, but the underlying supply and demand fundamentals have not. There is still a glut of oil in the market and not enough demand to soak it up.
In its five year forecast for the world wide oil market, IEA cut its five year forecast for global crude demand and predicted that consumption won’t rebound to last year’s levels until 2012 – at the earliest, based on the IMF forecast for global economic growth of 5% a year between 2012 and 2014.
If that is true, oil prices would only be setting themselves up for a bigger tumble when the economy slips back into possibility of recession later of the year.
Wednesday, July 8, 2009
Commodities and US Dollar
It is well-known fact that there is a causation effect between commodities and US dollar. After all commodities, like gold, oil and grains are all priced in dollars. Moreover, the mainstream media has attributed much of the recent climb in commodities prices to recent weakness in the dollar. So all things being equal, the commodity should move in the directly proportional opposite direction of the dollar.
The only problem with this argument is that all things never remain equal. The stable cause and effect market relationships will only work up to a certain limit. That depends on the time period you look at.
From December 1989 to September 2000, the relationship of oil and the dollar was positive. When one when up, the other went up. On the other hand, since February 2006, the relationship has been negative. When oil was crashing, the dollar was rising sharply. And over the past four months, oil has recovered and the dollar has fallen.
The move in oil and other commodities, along with stocks, bonds and currencies, are tracking one key thing – perception of the health of the global economy. When the economic and financial crisis commented, the CRB Index fell 58% and the Dollar Index rallied 25% and that was because of fear and uncertainty. Capital fled all risky assets, commodities included, and found safety in US Treasuries and US dollar.
Now, oil is moving higher and the dollar has been moving lower. This time, it is a retracement of the flight to safety trade. Money flowing back into commodities and other higher risk assets and out of the safety of US dollars and longer term US Treasuries, coinciding with Fed Chairman Bernanke’s first mention of ‘green shoots’. The US stock markets ip 44%, the CRB Index climbed 33%, crude oil up 120% and copper rose 97% respectively.
But the Dollar Index has lost only 12%, not exactly tick-for-tick linkage that many would suggest. Also, gold, the notable inflation hedge, has risen only 3% and it seemingly to suggest that the entire move has little to do with inflation arguments.
For that reason, I think this run-up in commodities and stocks provides the perfect opportunity to reduce risk – not add it. Today’s winners could soon be tomorrow’s losers.
The only problem with this argument is that all things never remain equal. The stable cause and effect market relationships will only work up to a certain limit. That depends on the time period you look at.
From December 1989 to September 2000, the relationship of oil and the dollar was positive. When one when up, the other went up. On the other hand, since February 2006, the relationship has been negative. When oil was crashing, the dollar was rising sharply. And over the past four months, oil has recovered and the dollar has fallen.
The move in oil and other commodities, along with stocks, bonds and currencies, are tracking one key thing – perception of the health of the global economy. When the economic and financial crisis commented, the CRB Index fell 58% and the Dollar Index rallied 25% and that was because of fear and uncertainty. Capital fled all risky assets, commodities included, and found safety in US Treasuries and US dollar.
Now, oil is moving higher and the dollar has been moving lower. This time, it is a retracement of the flight to safety trade. Money flowing back into commodities and other higher risk assets and out of the safety of US dollars and longer term US Treasuries, coinciding with Fed Chairman Bernanke’s first mention of ‘green shoots’. The US stock markets ip 44%, the CRB Index climbed 33%, crude oil up 120% and copper rose 97% respectively.
But the Dollar Index has lost only 12%, not exactly tick-for-tick linkage that many would suggest. Also, gold, the notable inflation hedge, has risen only 3% and it seemingly to suggest that the entire move has little to do with inflation arguments.
For that reason, I think this run-up in commodities and stocks provides the perfect opportunity to reduce risk – not add it. Today’s winners could soon be tomorrow’s losers.
Tuesday, July 7, 2009
Which of Commodities ahead of fundamentals?
My readers know I am a natural bull on commodity, but recent rally in commodity seems to suggest that it is getting ahead of fundamentals again. I think, the strong uptrend in commodity prices since February has been propelled more by technical than fundamentals and it could snap back to reality before resuming a more moderate uptrend in line with a ‘U’ shaped global growth path.
I am more concerned about base metals as it has posted the strongest rebound among the commodity groups, arguably due to China’s copper imports, which driven by strategic reserve buying and the re-stocking of deleted inventories to take advantage of low prices, not to reflect strong growth in global manufacturing or consumption.
No doubt, that China’s infrastructure heavy fiscal stimulus will provide some support to commodities but other private demand may continue to be weak, suggesting that China’s commodity demand may level off at somewhat lower levels than recent trends. Non-precautionary metal demand has been flat globally, leaving the metal prices uptrend without any real economic backing. Base metal demand tends to spike up in the spring as refiners stock up before metal producers primarily in Europe take their summer holidays. Demand for aluminum by beverage makers rise in the spring in anticipation of higher demand for canned beverages in the summer. After restocking ends, base metal demand will likely dip into a summer lull.
And in the case of iron & steel, contract bulks remain in limbo. Negotiations have already passed April 1 start of the 2009 contract year yet benchmark iron ore contracts are still to be settled. Steelmakers are demanding drastic price cuts (40-60%) back to 2007 levels, and sellers have been stalling for time in hopes that the market will improve. Producers have offered iron ore in the sport at temporary prices 20% below the 2008 contract levels, and the recent rebound in prices are on higher freight costs, not higher demand. The Baltic Dry Index was up 228% since the beginning of 2009.
Preliminary forecasts suggest hat oil in 2009 will mark the second back-to-back annual oil demand decline since the 1980s as industrial and residential demand slows and commercial inventories are high around the world. As such, spot and future prices are likely to face further pressure along with a return in risk aversion.
OPEC’s cuts have contributed to tightening supplies somewhat but have yet to lead to much of an erosion of stockpiles, particularly in the US, where crude oil inventories are just off the highest levels since 1990 and well above the 5-year average. In Europe and Japan, the supply overhang is less pronounced but stockpiles remain well above average levels, indicating no supply shortage. The recent data from the Department of Energy suggesting an 8% drop from early May 2008, with the decline in air traffic contributing to double digit declines in jet fuel demand.
In short, I am seeing commodity exporting economies and their currencies are like commodities, vulnerable to a reversal of risk appetite.
I am more concerned about base metals as it has posted the strongest rebound among the commodity groups, arguably due to China’s copper imports, which driven by strategic reserve buying and the re-stocking of deleted inventories to take advantage of low prices, not to reflect strong growth in global manufacturing or consumption.
No doubt, that China’s infrastructure heavy fiscal stimulus will provide some support to commodities but other private demand may continue to be weak, suggesting that China’s commodity demand may level off at somewhat lower levels than recent trends. Non-precautionary metal demand has been flat globally, leaving the metal prices uptrend without any real economic backing. Base metal demand tends to spike up in the spring as refiners stock up before metal producers primarily in Europe take their summer holidays. Demand for aluminum by beverage makers rise in the spring in anticipation of higher demand for canned beverages in the summer. After restocking ends, base metal demand will likely dip into a summer lull.
And in the case of iron & steel, contract bulks remain in limbo. Negotiations have already passed April 1 start of the 2009 contract year yet benchmark iron ore contracts are still to be settled. Steelmakers are demanding drastic price cuts (40-60%) back to 2007 levels, and sellers have been stalling for time in hopes that the market will improve. Producers have offered iron ore in the sport at temporary prices 20% below the 2008 contract levels, and the recent rebound in prices are on higher freight costs, not higher demand. The Baltic Dry Index was up 228% since the beginning of 2009.
Preliminary forecasts suggest hat oil in 2009 will mark the second back-to-back annual oil demand decline since the 1980s as industrial and residential demand slows and commercial inventories are high around the world. As such, spot and future prices are likely to face further pressure along with a return in risk aversion.
OPEC’s cuts have contributed to tightening supplies somewhat but have yet to lead to much of an erosion of stockpiles, particularly in the US, where crude oil inventories are just off the highest levels since 1990 and well above the 5-year average. In Europe and Japan, the supply overhang is less pronounced but stockpiles remain well above average levels, indicating no supply shortage. The recent data from the Department of Energy suggesting an 8% drop from early May 2008, with the decline in air traffic contributing to double digit declines in jet fuel demand.
In short, I am seeing commodity exporting economies and their currencies are like commodities, vulnerable to a reversal of risk appetite.
Monday, July 6, 2009
Europe’s fiscal dilemma
The announcement of a new and contrasting fiscal program in Germany and France is really puzzling and could be a fiscal drift for the zone.
It has indeed raised the eyebrows and markets are concerned if the Germany’s fiscal move could mean too soon to a restrictive stance, that it could be deflationary and potentially derail recovery. The European Commission explicitly asked EU members for a 1.5 percentage points or more discretionary fiscal boost last November.
On the other hand, France’s announcement that it is going to launch a new borrowing program to finance growth-enhancing measures is a concern for the opposite reason – that higher debt ratios may impart an inflationary bias.
The resulting debt dynamics need to be addressed. The implementation of multi-year deficit reduction plans seems unavoidable to prevent adverse market reaction as well as to comply with existing Stability and Growth Pact rules.
France appears to be an outlier at this stage. In addition to the announcement of a likely longer timeframe for reducing its deficit/GDP ratio, France has also announced its intention to launch a new borrowing program to fiancé ‘good’ public expenditure.
It has indeed raised the eyebrows and markets are concerned if the Germany’s fiscal move could mean too soon to a restrictive stance, that it could be deflationary and potentially derail recovery. The European Commission explicitly asked EU members for a 1.5 percentage points or more discretionary fiscal boost last November.
On the other hand, France’s announcement that it is going to launch a new borrowing program to finance growth-enhancing measures is a concern for the opposite reason – that higher debt ratios may impart an inflationary bias.
The resulting debt dynamics need to be addressed. The implementation of multi-year deficit reduction plans seems unavoidable to prevent adverse market reaction as well as to comply with existing Stability and Growth Pact rules.
France appears to be an outlier at this stage. In addition to the announcement of a likely longer timeframe for reducing its deficit/GDP ratio, France has also announced its intention to launch a new borrowing program to fiancé ‘good’ public expenditure.
Sunday, July 5, 2009
Nasdaq’s fortunes?
If the last three months are any indication, the US tech sector has possibly shaken off its recession-heightened late-winter doldrums. The technology-laden Nasdaq was at the forefront of the most recent market rally, having soared more than 45% since hitting its 52-week low on March 10.
Relatively, it outpaced Dow Jones Industrial Average, which up 30% and the Standard and Poor’s 500 Index, which rose 37%.
Some analysts that I talked to argued that technology tends to be a leader in the early stages of an economic turn. If that is right, then this could be a confirmation of a sustainable rally-money rotating into the sector that historically is seen as consumer and business sensitive and requiring more leverage in terms of borrowed money, or perhaps this could be just another blip for the next couple of months.
Microsoft beat analysts’ expectations, helping the company’s stock to surge more than 50% from its mid-March low and earlier this month, Texas Instruments sharply raised its second quarter financial guidance as customers had slowed the rate at which they were reducing chip inventories – a signal that the market for semiconductors may be stabilizing.
The long suffering PC maekt may get a shot in the arms with the October 22 release of Microsoft’s Window 7, which claimed to be better than its predecessor Windows Vista, based on the pre-release versions being publicly tested. Also driving it, the company is offering cheaper upgrades to those who pre-order Windows 7 between June 26 and July 11. History shows that a release of new operating system will usually translate into only a slight increase in PC sales and the main issue now will the release will get drowned by the macro-economic environment.
The tech sector is anticipating a slew of product releases – many of them in the $22 billion video-game sector with activision Blizzard Inc – the largest third-party game publisher in the world to lead the way with the latest in its rock music game series. Activision’s rival, Electronic Arts Inc also has some potential big hit titles coming in the year’s second half and most game publishers are looking to cash in on the holiday shopping season – primetime for consumer spending.
Relatively, it outpaced Dow Jones Industrial Average, which up 30% and the Standard and Poor’s 500 Index, which rose 37%.
Some analysts that I talked to argued that technology tends to be a leader in the early stages of an economic turn. If that is right, then this could be a confirmation of a sustainable rally-money rotating into the sector that historically is seen as consumer and business sensitive and requiring more leverage in terms of borrowed money, or perhaps this could be just another blip for the next couple of months.
Microsoft beat analysts’ expectations, helping the company’s stock to surge more than 50% from its mid-March low and earlier this month, Texas Instruments sharply raised its second quarter financial guidance as customers had slowed the rate at which they were reducing chip inventories – a signal that the market for semiconductors may be stabilizing.
The long suffering PC maekt may get a shot in the arms with the October 22 release of Microsoft’s Window 7, which claimed to be better than its predecessor Windows Vista, based on the pre-release versions being publicly tested. Also driving it, the company is offering cheaper upgrades to those who pre-order Windows 7 between June 26 and July 11. History shows that a release of new operating system will usually translate into only a slight increase in PC sales and the main issue now will the release will get drowned by the macro-economic environment.
The tech sector is anticipating a slew of product releases – many of them in the $22 billion video-game sector with activision Blizzard Inc – the largest third-party game publisher in the world to lead the way with the latest in its rock music game series. Activision’s rival, Electronic Arts Inc also has some potential big hit titles coming in the year’s second half and most game publishers are looking to cash in on the holiday shopping season – primetime for consumer spending.
Wednesday, July 1, 2009
US – swing towards state capitalism?
I am foreseeing that Barack Obama administration is likely to substantially increase the government’s share of GDP, taking the US economic picture closer to that of Europe.
In words of George Soros…`having gone too far in deregulating - which contributed to the current crisis - we must resist the temptation to go too far in the opposite direction. While markets are imperfect, regulators are even more so. Not only are they human, they are also bureaucratic and subject to political influences, therefore regulations should be kept to a minimum’
Obama now wants to make the Fed an ‘uber-regulator’ in order to head off any future systemic risks. Throughout the 1990s and early 2000s, Fed worship was widespread in Washington and the Treasury Secretary Geithner has put a lot of faith in the Federal Reserve’s ability to spot risk and exercise its power to prevent the next crisis.
This could be a potentially dangerous drift toward American state capitalism – a threat to the economy’s free market foundation. Allowing the pendulum to swing too far in the direction of government control subjects the democratic capitalism model to attack by socialist influences. And that assault is already underway.
My view is that by keeping the old guard on duty and only giving them new binocular, we may well see the next set of failures on the horizon – but will be powerless to stop them.
In words of George Soros…`having gone too far in deregulating - which contributed to the current crisis - we must resist the temptation to go too far in the opposite direction. While markets are imperfect, regulators are even more so. Not only are they human, they are also bureaucratic and subject to political influences, therefore regulations should be kept to a minimum’
Obama now wants to make the Fed an ‘uber-regulator’ in order to head off any future systemic risks. Throughout the 1990s and early 2000s, Fed worship was widespread in Washington and the Treasury Secretary Geithner has put a lot of faith in the Federal Reserve’s ability to spot risk and exercise its power to prevent the next crisis.
This could be a potentially dangerous drift toward American state capitalism – a threat to the economy’s free market foundation. Allowing the pendulum to swing too far in the direction of government control subjects the democratic capitalism model to attack by socialist influences. And that assault is already underway.
My view is that by keeping the old guard on duty and only giving them new binocular, we may well see the next set of failures on the horizon – but will be powerless to stop them.
Subscribe to:
Posts (Atom)