If you have never been there, it is hard to do this country justice with simple prose – is special and it deserves to be seen that way. I am visiting the country soon, but on the southern province, which has been exudes an energy all its own since 1979. In short, China remains one of the very best profit opportunities of our lifetime.
A few months ago, China entered 22 year contract with Iraq that could worth up to US$3bn and the oil produced from the Ahdab field will help Iraq, a nation where electricity is in short supply, fuel a planned power plant that would be one of the largest in the country. For China, the deal offers a lucrative foothold in one of the most oil-rich countries in the world. In a bigger set of assumptions, this is part of the grand plan of China as a sign of a changing world.
Well now its time for Round 2 of this strategy to unfold. Russia and China recently signed a multi-billion dollar, intergovernmental agreement to construct an oil line from Russia that will supply oil directly to China – worth trillions of dollars with a 20 year oil contract to pump Russian oil and in return, China has agreed to provide a total $25bn in loans to Russian oil companies Transneft and OAO Rosneft Oil Co.
The terms of contacts are fascinating – it gives China roughly 15mn metric tons of crude per year from 2011 to 2030, flowing through the 1,030-km pipeline from the Skovorodino refinery in Eastern Russia to Mohe County in China’s Heilongjiang province. It is a branch of the even bigger 4,700-km East-Siberia-Pacific Ocean Pipeline that is currently under construction.
My sense this oil supply deal is just part of a much bigger strategic drama that is played out here, which the Western world have totally missed.
For China, the oil pipeline will greatly reduce the risks of its oil imports – the majority of which come through the Straits of Malacca and to Russia, it gives it a stable and reliable oil market in the East. Interestingly, China’s nuclear subs were just on parade for the first time ever as part of the 60th Anniversary of the founding of the PLA’s Navy in Qingdao, Shandong province.
If we read between the lines, comments made by leaders of both sides point to a desire to have an even tighter China-Russia relationship in the years to come and this will really lock the United States out of the game and will also wrest an increasing amount of energy-pricing control from OPEC cartel. The status-quo in the global oil game had changed and China is not afraid to do business with rogue nations like Iran, Sudan and Myanmar and has even gotten chummy with Venezuela and Russia.
Wednesday, April 29, 2009
Tuesday, April 28, 2009
Oil Price Bull
Since mid-February, oil has staged an impressive rally, soaring 42% in little more than a month to above $50 a barrel. There are people that asking me if prices will retreat further amid sluggish demand.
Here is my reply:-
There is no question that downside risk remains. On April 13, the Paris-based International Energy Agency (IEA) lowered its demand forecast by 1mn barrels a day and now expects the world will use about 83.4mn barrels per day in 2009. That would be 2.4mn barrels a day or 2.8%^ less than last year. So far, dwindling demand has failed to contain oil prices.
Having said that I take comfort for the fact that OPEC has made substantial progress in reducing the amount of oil on the market. It has issued three production cuts totaling 4.2mn barrels per day or nearly 12% of its capacity since September 2008. While this has yet to bring back oil prices to desired level of $60-$70 a barrel, the cartel abstained from making any further reductions at its latest meeting in March and even voiced optimism that crude would reach $60 a barrel by the end of the year. OPEC’s discipline has proven many critics wrong, despite foot-draging from Iran and Venezuela. OPEC has gotten about 80% compliance of the 4.2mn bpd production cut. Historically, the cartel only gets about 60% compliance on such cuts.
Also the fact that the US dollar has been made vulnerable by the US Fed Reserve’s aggressive policy of quantitative easing. From July 2007 to July 2008, the dollar plunged 16% against the euro and as the dollar became less valuable the cost of commodities around the world skyrocketed. The Fed’s cut in benchmark rate to a range of 0-0.25% and the $300bn purchase of longer term Treasury securities and $750bn of MBS, along with a corresponding rise in equities, this has been the driving force behind oil’s recent rally.
Last but not least, low oil prices and tight credit have reduced global energy investment, putting future supply at risk. Tighter lending conditions and a trough in oil prices have badly crimped investment and jeopardized future supplies. More expensive energy projects such as oil sands have been put on hold and the number of drilling rigs at marginal shallow-water fields around the world has been scaled back to a three-year low. Oil drilling activity dropped 43% in the 12-months through March, with year-on-year oil exploration in the United States alone down 38%.
Here is my reply:-
There is no question that downside risk remains. On April 13, the Paris-based International Energy Agency (IEA) lowered its demand forecast by 1mn barrels a day and now expects the world will use about 83.4mn barrels per day in 2009. That would be 2.4mn barrels a day or 2.8%^ less than last year. So far, dwindling demand has failed to contain oil prices.
Having said that I take comfort for the fact that OPEC has made substantial progress in reducing the amount of oil on the market. It has issued three production cuts totaling 4.2mn barrels per day or nearly 12% of its capacity since September 2008. While this has yet to bring back oil prices to desired level of $60-$70 a barrel, the cartel abstained from making any further reductions at its latest meeting in March and even voiced optimism that crude would reach $60 a barrel by the end of the year. OPEC’s discipline has proven many critics wrong, despite foot-draging from Iran and Venezuela. OPEC has gotten about 80% compliance of the 4.2mn bpd production cut. Historically, the cartel only gets about 60% compliance on such cuts.
Also the fact that the US dollar has been made vulnerable by the US Fed Reserve’s aggressive policy of quantitative easing. From July 2007 to July 2008, the dollar plunged 16% against the euro and as the dollar became less valuable the cost of commodities around the world skyrocketed. The Fed’s cut in benchmark rate to a range of 0-0.25% and the $300bn purchase of longer term Treasury securities and $750bn of MBS, along with a corresponding rise in equities, this has been the driving force behind oil’s recent rally.
Last but not least, low oil prices and tight credit have reduced global energy investment, putting future supply at risk. Tighter lending conditions and a trough in oil prices have badly crimped investment and jeopardized future supplies. More expensive energy projects such as oil sands have been put on hold and the number of drilling rigs at marginal shallow-water fields around the world has been scaled back to a three-year low. Oil drilling activity dropped 43% in the 12-months through March, with year-on-year oil exploration in the United States alone down 38%.
Monday, April 27, 2009
US Dollar Bears
Let me reiterate my view that the dollar will weaken further and I would not be surprised to see the euro to breach 1.45 level. The aggressive quantitative easing in the US with the Fed’s balance sheet potentially doubling in size will be the key argument to support my arguments. Also is the fact that the return of risk appetite is positive for Euro now, as indicated by the tight correlation between the S&P 500 and Euro. The Yen weakened during the BoJ quantitative easing period in Mar 2001 to Mar 2006 even with a current account surplus of more than 3% of GDP.
Having said that, I am doubtful that the dollar will lose its reserve currency status. Clearly, this is an issue after China’s central bank Governor Zhou Xiaochuan called for the creation of a new non-sovereign official reserve currency. The IMF’s Special Drawing Right (SDR) could be a potential candidate to replace the dollar, but the lack of investible assets denominated in SDR makes this currency not as competitive against the USD and the Euro.
Private sector risk aversion and the tightening of lending conditions will, at times, overwhelm the Fed’s efforts. What’s more, the current situation shares eerie similarities with Latin America’s petrodollar crisis in the 1980s, which then get us to years of hyperinflation and sharp volatility.
Industrial commodities, which are having an inverse relation to US dollar, are bouncing off their bottoms and headed higher. Simply put, the Fed has cranked up the printing presses and the CRB index has pushed above overhead resistance and its 50-day moving average.
For the first time in history, US banks have suffered large, ominous losses and according to the fourth quarter report just released by the Comptroller of the Currency (OCC), commercial banks lost a record $3.4 billion in interest rate derivatives or more than seven times their worst previous quarterly loss in that category. Considering their far larger volume, any threat to interest rate derivatives could be far more serious than anything we have seen so far. Meanwhile, time bombs continue to explode in the credit default swaps as well, delivering another massive loss of nearly $9billion.
For now, the dollar stays under appreciation pressure from continued global de-leveraging and a global bid for scarce dollars to fund USD denominated assets. Having said that, I think it will be several months yet before the tide on the USD turning.
Having said that, I am doubtful that the dollar will lose its reserve currency status. Clearly, this is an issue after China’s central bank Governor Zhou Xiaochuan called for the creation of a new non-sovereign official reserve currency. The IMF’s Special Drawing Right (SDR) could be a potential candidate to replace the dollar, but the lack of investible assets denominated in SDR makes this currency not as competitive against the USD and the Euro.
Private sector risk aversion and the tightening of lending conditions will, at times, overwhelm the Fed’s efforts. What’s more, the current situation shares eerie similarities with Latin America’s petrodollar crisis in the 1980s, which then get us to years of hyperinflation and sharp volatility.
Industrial commodities, which are having an inverse relation to US dollar, are bouncing off their bottoms and headed higher. Simply put, the Fed has cranked up the printing presses and the CRB index has pushed above overhead resistance and its 50-day moving average.
For the first time in history, US banks have suffered large, ominous losses and according to the fourth quarter report just released by the Comptroller of the Currency (OCC), commercial banks lost a record $3.4 billion in interest rate derivatives or more than seven times their worst previous quarterly loss in that category. Considering their far larger volume, any threat to interest rate derivatives could be far more serious than anything we have seen so far. Meanwhile, time bombs continue to explode in the credit default swaps as well, delivering another massive loss of nearly $9billion.
For now, the dollar stays under appreciation pressure from continued global de-leveraging and a global bid for scarce dollars to fund USD denominated assets. Having said that, I think it will be several months yet before the tide on the USD turning.
Wednesday, April 22, 2009
Another Round of Drugged Economy in China?
There are greater signs of economy recovery in March from the depths of Q42008, but some observers are arguing that the Chinese policy stimulus could turn out to be insufficient and further stimulus may be needed. They argued that the drugged economy – via easy money, loose fiscal policy and easy credit will lead to further over-capacity, rising non-performing loans, falling profits or rising losses.
I think exports on one hand to remain weak in the coming months, but it may get stabilize and become less of a drag on growth as expectations, trade finance and de-stocking are showing sign of normalization globally.
I was told by some friends with investment in China that the economic stimulus is already translating into a rebound in investor confidence – an increase in orders and production in some metal products and rise in infrastructure-related investment. The power of this combination in driving investment-led growth should never be underestimated.
The next 4-5 months would be a critical period if the stimulus program works in China. It is usually will take at least 4-5 months between policy announcements and actual construction leading to increased final orders. Going by this count, the Q2 2009 is a period to watch for.
The $585 billion Chinese stimulus plan is already creating an estimated 100mn tons of steel with $220 billion to be invested in infrastructure such as railways, roads and airports, and $150 billion used for post-earthquake reconstruction in Sichuan. Currently, Chinese steel inventories are estimated at less than one-third of what is required.
China is going on a global shopping spree that capitalizes on global weaknesses and generally low energy prices. Major integrated oil companies are cutting back spending in the face of lower oil prices. Copper stockpiles in warehouses monitored by the LME dropped to their lowest levels since February 2 as Chinese imports of refined copper topped 300,000 tons for the first time in March. At least 75,000 tons of that copper is going to the government’s State Reserve Bureau stockpiling agency. China plans to stockpile aluminum, copper, zinc and lead for its metals reserves over the next 3 years.
Plus, China’s nearly $2 trillion in reserves is the largest stockpile on the planet and maintain over 34% reserves in proportion to its GDP compared to less than 5% in the case of the United States. And that means that China stands to be the most important long-term investment opportunity for years to come. The sky is the limit!
I think exports on one hand to remain weak in the coming months, but it may get stabilize and become less of a drag on growth as expectations, trade finance and de-stocking are showing sign of normalization globally.
I was told by some friends with investment in China that the economic stimulus is already translating into a rebound in investor confidence – an increase in orders and production in some metal products and rise in infrastructure-related investment. The power of this combination in driving investment-led growth should never be underestimated.
The next 4-5 months would be a critical period if the stimulus program works in China. It is usually will take at least 4-5 months between policy announcements and actual construction leading to increased final orders. Going by this count, the Q2 2009 is a period to watch for.
The $585 billion Chinese stimulus plan is already creating an estimated 100mn tons of steel with $220 billion to be invested in infrastructure such as railways, roads and airports, and $150 billion used for post-earthquake reconstruction in Sichuan. Currently, Chinese steel inventories are estimated at less than one-third of what is required.
China is going on a global shopping spree that capitalizes on global weaknesses and generally low energy prices. Major integrated oil companies are cutting back spending in the face of lower oil prices. Copper stockpiles in warehouses monitored by the LME dropped to their lowest levels since February 2 as Chinese imports of refined copper topped 300,000 tons for the first time in March. At least 75,000 tons of that copper is going to the government’s State Reserve Bureau stockpiling agency. China plans to stockpile aluminum, copper, zinc and lead for its metals reserves over the next 3 years.
Plus, China’s nearly $2 trillion in reserves is the largest stockpile on the planet and maintain over 34% reserves in proportion to its GDP compared to less than 5% in the case of the United States. And that means that China stands to be the most important long-term investment opportunity for years to come. The sky is the limit!
Tuesday, April 21, 2009
US Banking Results Commentary II
Confidence on banking sector was already reflected in the 30% stock rally in the run up to the Q1 earnings season. The authorities say all of the 14 largest banks have earned a ‘passing’ grade in their just-completed ‘stress-test’. But just six months ago, the authorities swore that without a massive injection of taxpayer funds, those same banks would suffer a fatal meltdown.
Was the bad-debt disease magically cured? Did the economy miraculously turn around? Strike up the band, let the good times roll, banks are making money again (or not losing quite as much)?
A look below the surface reveals some caveats to this positive picture. Banks are benefiting from close to zero borrowing costs and fewer competitors with a massive transfer of wealth from savers to borrowers given a dozen different government bailouts and subsidy programs for the financial system. The recent mark-to-market accounting changes by FASB helps to inflate the value of many assets, hence in my view, this accounting trick helps to minimize reported losses and maximize reported earnings. It is no surprise if someone told me that banks are not properly making provision for massive future loan losses. Not long ago, Fed Chairman Bernanke declared that the total losses from the debt crisis would not exceed $100bn and also at the same time, the IMF estimated the losses would be $1 trillion with only a small percentage written-off. Now, the IMF’s latest estimate: $4 trillion in losses, with only one-third of those written-off so far.
Many of these banks were the main recipients of AIG bailout funds in previous months e.g. Goldman Sachs ($12.9bn), Merrill Lynch ($6.8bn), Bank of America ($5.2bn), Citigroup ($2.3bn), and Wachovia ($1.5bn), according to New York Times data. These firms, however, dismiss this factor as immaterial for 1Q earnings.
On the real economy side, credit growth has continued to slow down at a fast pace in the US as well as in Europe. Moody’s predicts the charge-off rate index will peak at about 10.5% in the first half of 2010, assuming a coincident unemployment rate peak at 10% respectively.
Was the bad-debt disease magically cured? Did the economy miraculously turn around? Strike up the band, let the good times roll, banks are making money again (or not losing quite as much)?
A look below the surface reveals some caveats to this positive picture. Banks are benefiting from close to zero borrowing costs and fewer competitors with a massive transfer of wealth from savers to borrowers given a dozen different government bailouts and subsidy programs for the financial system. The recent mark-to-market accounting changes by FASB helps to inflate the value of many assets, hence in my view, this accounting trick helps to minimize reported losses and maximize reported earnings. It is no surprise if someone told me that banks are not properly making provision for massive future loan losses. Not long ago, Fed Chairman Bernanke declared that the total losses from the debt crisis would not exceed $100bn and also at the same time, the IMF estimated the losses would be $1 trillion with only a small percentage written-off. Now, the IMF’s latest estimate: $4 trillion in losses, with only one-third of those written-off so far.
Many of these banks were the main recipients of AIG bailout funds in previous months e.g. Goldman Sachs ($12.9bn), Merrill Lynch ($6.8bn), Bank of America ($5.2bn), Citigroup ($2.3bn), and Wachovia ($1.5bn), according to New York Times data. These firms, however, dismiss this factor as immaterial for 1Q earnings.
On the real economy side, credit growth has continued to slow down at a fast pace in the US as well as in Europe. Moody’s predicts the charge-off rate index will peak at about 10.5% in the first half of 2010, assuming a coincident unemployment rate peak at 10% respectively.
Monday, April 20, 2009
Beginning of a Bull or Breather for the Bear?
S&P 500 hit 12-year low on March 9 – since then the index gained close 25% - the best rally since 1933. Question – is this the beginning of a bull market or just a breather for the bear?
One thing, we should be very clear that the 1933 rally came after a record-breaking decline. Real GDP fell 25% during the Great Depression and Dow fell by almost 90%. In 1949, the Dow was selling at P/E of just 7 times. And this time around, the S&P 500 fell 58% from its 2007 peak to its March 9 bottom.
So, the happy days are not here again, at least not yet.
In this market, the Dow was above 7,000 – within 50% of its 14,164 peak – continually from May 1997 until February 2009 and the current rally has been based on signs that the US banking system is not about to expire – a development that worry me hell a lot. With short-term rates well below long term rates, banks’ on-going lending business is currently exceptionally profitable and the economy may actually be beginning a lengthy ‘bottoming-out’ process.
With imbalances in size of expansive monetary policy and record peacetime deficits – deficits that are more than double the previous peacetime record, there can no assurance that a recessionary bottom will be followed by recovery, quite the opposite, I think.
The high stock prices of 1996-2008 have gone. Take the 1949 P/E multiple of 7, and apply it to a recovering earnings level of say $60 on the S&P 500, and you get an S&P of 420 – an equivalent to a Dow of around 4,500 level. We can expect an eventual low well below the 6,547 the Dow reached last month, and any rally to be temporary.
Don’t get sugarcoated and the unmistakable reality is that, despite any government guarantees, there is no question that downside risk remains. The perplexing divergence between growing investor optimism and the fundamentally abysmal economic situation will continue to build and this tells me a top of this wave of risky assets is near, if not already here, and a sharp reversal will follow.
One thing, we should be very clear that the 1933 rally came after a record-breaking decline. Real GDP fell 25% during the Great Depression and Dow fell by almost 90%. In 1949, the Dow was selling at P/E of just 7 times. And this time around, the S&P 500 fell 58% from its 2007 peak to its March 9 bottom.
So, the happy days are not here again, at least not yet.
In this market, the Dow was above 7,000 – within 50% of its 14,164 peak – continually from May 1997 until February 2009 and the current rally has been based on signs that the US banking system is not about to expire – a development that worry me hell a lot. With short-term rates well below long term rates, banks’ on-going lending business is currently exceptionally profitable and the economy may actually be beginning a lengthy ‘bottoming-out’ process.
With imbalances in size of expansive monetary policy and record peacetime deficits – deficits that are more than double the previous peacetime record, there can no assurance that a recessionary bottom will be followed by recovery, quite the opposite, I think.
The high stock prices of 1996-2008 have gone. Take the 1949 P/E multiple of 7, and apply it to a recovering earnings level of say $60 on the S&P 500, and you get an S&P of 420 – an equivalent to a Dow of around 4,500 level. We can expect an eventual low well below the 6,547 the Dow reached last month, and any rally to be temporary.
Don’t get sugarcoated and the unmistakable reality is that, despite any government guarantees, there is no question that downside risk remains. The perplexing divergence between growing investor optimism and the fundamentally abysmal economic situation will continue to build and this tells me a top of this wave of risky assets is near, if not already here, and a sharp reversal will follow.
Sunday, April 19, 2009
US Banking Results Commentary
US banks’ quarterly results came in with an upside surprise. Goldman Sachs are positioning for TARP payback with another round of aggressive legacy asset write-down. Wells Fargo bank reported a ‘record’ profit with earnings of 55 cents a share after paying preferred stock dividends of US$372mn on its US$25bn of preference share from TARP and latest JPMorgan reported 1Q EPS of $0.40, driven by solid investment banking revenues partially offset by higher credit costs.
Hmm, I wonder if this is true or an extreme exaggeration of the truth, especially after the FASB reverts to mark-to-myth accounting, receive billions of taxpayer money including financial assistance acquiring Wachovia and then turn out to not need it, right? In an another word, we are robbed! So which is it?
But as long as half truths pop the indices, nobody is going to complain. People only want the truth when the market is going south, not when it is climbing, right? It is maddening, whether it is perception or reality and bad news is simply shelved for a later date. I am just interested to know what will cause the Street to stop ignoring lies and bad news.
Nouriel Roubini said that last September’s spree of bank takeovers deepened the crisis because it made the already-too-big banks even bigger. He may well be right, more interesting is what this tells us about the future of US banking industry.
Nor did the trouble stop with the banks. Two of the US Big Three automakers – General Motors and Chrysler LLC moved closer to bankruptcy as the government rejected the American carmakers’ plan for reorganizing. But then, funny thing happened with each banks to-date announcing promising results, surprising investors and igniting a late-quarter stock market rally.
Hmm, I wonder if this is true or an extreme exaggeration of the truth, especially after the FASB reverts to mark-to-myth accounting, receive billions of taxpayer money including financial assistance acquiring Wachovia and then turn out to not need it, right? In an another word, we are robbed! So which is it?
But as long as half truths pop the indices, nobody is going to complain. People only want the truth when the market is going south, not when it is climbing, right? It is maddening, whether it is perception or reality and bad news is simply shelved for a later date. I am just interested to know what will cause the Street to stop ignoring lies and bad news.
Nouriel Roubini said that last September’s spree of bank takeovers deepened the crisis because it made the already-too-big banks even bigger. He may well be right, more interesting is what this tells us about the future of US banking industry.
Nor did the trouble stop with the banks. Two of the US Big Three automakers – General Motors and Chrysler LLC moved closer to bankruptcy as the government rejected the American carmakers’ plan for reorganizing. But then, funny thing happened with each banks to-date announcing promising results, surprising investors and igniting a late-quarter stock market rally.
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