As Americans know all too well by this point, commodity prices — for corn, wheat, soybeans, crude oil, gold and even farmland — have been going through the roof for what seems like forever. There are many causes, primarily supply and demand pressures driven by fears about the unrest in the Middle East, the rise of consumerism in China and India, and the Fed’s $600 billion campaign to increase the money supply.
Nonetheless, how to explain the price of silver? In the past six months, the value of the precious metal has increased nearly 80 percent, to more than $34 an ounce from around $19 an ounce. In the last month alone, its price has increased nearly 23 percent. This kind of price action in the silver market is reminiscent of the fortune-busting, roller-coaster ride enjoyed by the Hunt Brothers, Nelson Bunker and William Herbert, back in 1970s and early 1980s when they tried unsuccessfully to corner the market. When the Hunts started buying silver in 1973, the price of the metal was $1.95 an ounce. By early 1980, the brothers had driven the price up to $54 an ounce before the Federal Reserve intervened, changed the rules on speculative silver investments and the price plunged. The brothers later declared bankruptcy.
Accusations that JPMorganChase and HSBC allegedly manipulated precious metal markets are worth looking into.
The Hunts may be gone from the market, but there are still plenty of people suspicious about the trading in silver, and now they have the Web to explore and to expand their conspiracy narratives. This time around — according to bloggers and commenters on sites with names like Silverseek, 321Gold and Seeking Alpha — silver shot up in price after a whistleblower exposed an alleged conspiracy to keep the price artificially low despite the inflationary pressure of the Fed’s cheap money policy. (Some even suspect that the Fed itself was behind the effort to keep silver prices low, as a way to keep the dollar’s value artificially high.) Trying to unravel the mysterious rise in silver’s price is a conspiracy theorist’s dream, replete with powerful bankers, informants, suspicious car accidents and a now a squeeze on short sellers. Most intriguingly, however, much of the speculation seems highly plausible.
The gist goes something like this: When JPMorgan Chase bought Bear Stearns in March 2008, it inherited Bear Stearns’ large bet that the price of silver would fall. Over time, it added to that bet, and then the international bank HSBC got into the market heavily on the bear side as well. These actions “artificially depressed the price of silver dramatically downward,” according to a class-action lawsuit initiated by a Florida futures trader and filed against both banks in November in federal court in the Southern District of New York.
“The conspiracy and scheme was enormously successful, netting the defendants substantial illegal profits” in the billions of dollars between June 2008 and March 2010, according to the suit. The suit claims that JPMorgan and HSBC together “controlled over 85 percent the commercial net short positions” in silvers futures contracts at Comex, a Chicago-based exchange on which silver is traded, along with “25 percent of all open interest short positions” and a “a market share in excess of 9o percent of all precious metals derivative contracts, excluding gold.”
In the United States, trading in precious metals and other commodities is regulated and closely monitored by a federal agency, the Commodity Futures Trading Commission. In September 2008, after receiving hundreds of complaints that silver future prices were being manipulated downward by JPMorgan and HSBC, the commission’s enforcement division started an investigation. In November 2009, an informant, described in the law suit only as a former employee of Goldman Sachs and a 40-year industry veteran, approached the commission with tales of how the silver traders at JPMorgan were bragging about all the money they were making “as a result of the manipulation,” which entailed “flooding the market” with “short positions” every time the price of silver started to creep upward. The idea was that by unloading its short positions like a time-released capsule, JPMorgan’s traders were keeping the price of silver artificially low.
Soon enough, the informant was identified as Andrew Maguire, an independent precious metals trader in London. On Jan. 26, 2010, Maguire sent Bart Chilton, a member of the futures trading commission, an e-mail urging him to look into the silver trading that day. “It was a good example of how a single seller, when they hold such a concentrated position in the very small silver market can instigate a sell off at will,” Maguire wrote.
On Feb. 3, 2010, Maguire gave the futures trading commission word about an impending “manipulation event” that he said would occur two days later, when the Labor Department’s non-farm payroll numbers would be released. He then spelled out two trading scenarios about which he had been told. “Both scenarios will spell an attempt by the two main short holders” — JPMorganChase and HSBC — “to illegally drive the market down and reap very large profits,” Maguire wrote in an e-mail to a trading-commission investigator.
On Feb. 5, Maguire took a victory lap, writing in another e-mail to the trading commission that “silver manipulation was a great success and played out EXACTLY to plan as predicted.” He added, “I hope you took note of how and who added the short sales (I certainly have a copy) and I am certain you will find it is the same concentrated shorts who have been in full control since JPM took over the Bear Stearns position … I feel sorry for all those not in this loop. A serious amount of money was made and lost today and in my opinion as a result of the CFTC’s allowing by your own definition an illegal concentrated and manipulative position to continue.”
In March 2010, Maguire released his e-mails publicly, in part because he felt the trading commission’s enforcement arm was not taking swift enough action. He was also unhappy over not being invited to a commission hearing on position limits scheduled for March 25. Then came the cloak and dagger element: the day after the hearing, Maguire was involved in a bizarre car accident in London. As he was at a gas station, a car came out of a side street and barreled into his car and two others; London police, using helicopters and chase cars, eventually nabbed the hit-and-run driver. Reports that the perpetrator was given a slap on the wrist inflamed the online crowds that had become captivated by Maguire’s odd story.
In any case, the class-action lawsuit contends that between March 2010 and November 2010, JPMorgan Chase and HSBC reduced their short positions in the silver market by 30 percent, causing the metal’s price to rise dramatically, but leaving them still with a large short position. Now, with the value of silver rising nearly every day, the two banks are caught in a “massive short squeeze,” according to one market participant, that appears to be costing them the billions they made originally plus billions more. Whether these huge losses will show up on the books of JPMorgan Chase and HSBC remains to be seen. (Parsing through the publicly filed footnotes of derivative trades is no easy task.)
Nonetheless, the conspiracy-minded have claimed that the Fed must have somehow agreed to make JPMorgan and HSBC whole for any losses the banks suffered if and when the price of silver rose above the artificially maintained low levels — as in right now, for instance. (About all this, a JPMorganChase spokesman declined to comment.)
Some two-and-a-half years later, the Commodity Futures Trading Commission’s investigation is still unresolved, and at least one commissioner — Bart Chilton — thinks that after interviewing more than 32 people and reviewing more than 40,000 documents, there has been enough investigating and not enough prosecuting. “More than two years ago, the agency began an investigation into silver markets,” Chilton said at a commission hearing last October. “I have been urging the agency to say something on the matter for months … I believe violations to the Commodity Exchange Act have taken place in silver markets and that any such violation of the law in this regard should be prosecuted.”
What’s more, Chilton said in an interview last week, that “one participant” in the silver market still controlled 35 percent of the silver market as recently as a few months ago, “enough to move prices,” he said, and well above the 10 percent “position limits” the commission has proposed to comply with Dodd-Frank financial reform law. Since that law’s passage last summer, the commodities exchanges have issued waivers permitting the ownership of silver positions above the limits the C.F.T.C. has proposed, and which were supposed to be in place by January of this year. Yet the waivers remain in place, and the big traders have not been penalized, much to Chilton’s frustration And the mystery deepens: last Thursday, the price of silver fell $1.50 per ounce in less than an hour before recovering. “This was robbery at its most obvious and most vindictive,” wrote Richard Guthrie, a London-based trader, in an e-mail to Chilton. “How many investors lost money and positions to the financial benefit of an elite few?”
It’s getting harder and harder to continue to brush off Andrew Maguire’s claims as the rantings of a rogue trader with a nutty online following. The Commodities Futures Trading Commission should immediately release the files from its investigation into the supposed manipulation of the silver market so the public can determine whether JPMorganChase and HSBC did anything illegal, with or without the help of the Fed. In addition, the commission should start enforcing the 10 percent threshold on silver positions it has proposed to comply with Dodd-Frank law. Basically, the other commissioners must join with Bart Chilton to do the job they are required to do: Protecting the sanctity of the markets and preventing the sorts of manipulation we’ve seen all too often.
http://opinionator.blogs.nytimes.com/2011/03/02/a-conspiracy-with-a-silver-lining/?hp
Showing posts with label commodity bull. Show all posts
Showing posts with label commodity bull. Show all posts
20 May 2009
Commodities will recover first and then roar on demand and inflation
This is my position, Don Coxe, Rogers and all those who recognise that the supercycle in commodities was about normalisation of prices, not high prices, historically speaking...
What some call the 'Commodity Super Cycle' is a simple rebound from extreme devalorization of commodities as an asset class over nearly 20 years. The process is intensified by extremely fragile and unrealistic world currency values, within which the Euro is likely the weak link, being a de facto money of resource-depleted Europe, forced into circulation in too many countries, too late. The US dollar’s plight needs no commentary.
Due to the massive fossil energy intensity of the current global economy’s structure, and low appreciation of the critical need for energy transition away from fossil fuels, we can be sure that near-term limits to world oil and natural gas supply capacity will have a strong impact on relative asset value sorting in a generally inflationary context. Even using IEA published data, world oil supply capacity could fall as much as 25 Mbd from now to 2025. Any small net increase in supply would need heroic investments, estimated by the IEA at about 26 000 Bn USD through less than 20 years. If we took an optimistic approach on the decline of world oil export supply or 'offer' from 2010, and assumed that net supply fell at a rate of 4% or 5% annual, perhaps due to energy saving and substitution programs in exporter countries (which at present is unlikely), this would translate to a long-term net annual decline in world export supply at well over 2.5 Mbd. This is close to German or South Korean oil import demand. Two years at this loss rate, would equal a little less than Japan's total import needs.
It is not difficult to identify what impact real structural undersupply will have on traded oil prices. The waiting period will be short. Oil prices can only show a massive rebound from almost the moment there is any sign of global economic recovery. The knock-on effect of higher energy prices on food prices will be rapid, as was shown in 2007-2008. This in turn and already poses a serious threat to the duration of sustainability of any global economic recovery, while also helping to rekindle inflation.
To be sure, this should also rekindle interest in Renewable Energy and Cleantech investing, itself a now highly financiarized asset sector, exposed to exactly the same tensions and volatility as 'mainstream' equities and other traded assets. The certain near-term return of Oil Crisis should however not mask the other resource-linked facets of the depletion crisis facing the straight majority of real resources – including the nominally renewable bioresources.
Raching its peak in the slow-growing real economy of the 1990s, an apparent oversupply of energy and natural resources helped push down the baseline for commodities relative to all other asset classes, in some cases to historic lows. This has dangerously masked the real, almost reverse video picture of hard asset production, supply and therefore price outlooks. To be sure, this ‘resource pinch’ is intensified by the extremely classic and conventional Henry Ford-style economic takeoff of the Emerging Economies. We therefore face accelerating depletion of key natural resources, plus structural resource-limiting factors like climate change and population growth.
Asset Value correlation
As already noted, the neat two-part division of hard asset commodities into ‘renewable’ and ‘non-renewable’ breaks down under the onslaught of current-structure global economic growth. Through 2005-2007, running at around 5%pa in a world of about 6600 million consumers and potential consumers, the pressure on real resource supply was easy to demonstrate. Conversely, equity and derived paper assets can be created in an electronic eyeblink, grow with little constraint, and avoid the problem of credibility as long as there is some growth of the ‘underlying security- - the global economy.
The unrealistic hopes embedded in the fragile ‘Chindia decoupling theory’ are based on the mirage of Decoupled Emerging Economy Growth at near double-digit annual average percentage rates, perhaps for 15 or 20 years, or more. In fact, this poses essentially impossible challenges for commodities production and supply. This concerns the near-term real world future, not some mythic Keynes-type long-term ‘when we are all dead’.
As noted above, there are decreasing numbers of ‘firewalls’ between the two theoretically-distinct asset classes inside the commodities sphere (i.e. renewable and non-renewable), as well as between Equities and Commodities. Due to present structure global economic growth, this trend is self-reinforcing. Thus price correlation and linkage, both inside the asset classes as well as between, is a strong real world trend. This again clearly supports the argument for near-term and possibly extreme of most Commodity prices.
This ‘re-linkage’ or new correlation can be observed with almost any real resource commodity. One example is the ags and softs, specially the grains and oilseeds, simply due to the 2005-2007 biofuels boom and slump. This left behind the price linkage of oil with food, but not the massive amounts of biofuels promised by various leaders, such as the RFS program of G W Bush. One major supply-side cause of this is the energy intensity of current agroindustrial production techniques, downstream processing, and transport of these commodities. For sugar and corn ethanol, and soybean or rapeseed biodiesel production, this’ energy price linkage’ is now powerful, providing another quick acting transmission vector for inflationary contagion within the real resources space.
To be sure there is considerable resistance on the part of economic and political deciders, but increasing reactivity and transparence in the pricing system, to pass-through upstream and absolute price rises for energy and food commodities. In other words this means there is now the certainty of ‘dam breaker’ surges in energy, food and fiber prices at the consumer level, both in OECD and in other countries. This sets the likely timeframe for a very sharp upturn in OECD country inflation, and fast growth of Commodity prices, to the near-term, probably Q2 2009 – Q2 2010. Prospects for the majority of real resource prices, as we noted in this article, include nearly stepwise upward change. Whenever there is clear break in price trends for Equities relative to Commodities – signaling deconvergence – this upward movement is likely to amplify and reinforce itself. This may start in Q3-Q4 2009.
span>
http://www.financialsense.com/editorials/mckillop/2009/0519.html
What some call the 'Commodity Super Cycle' is a simple rebound from extreme devalorization of commodities as an asset class over nearly 20 years. The process is intensified by extremely fragile and unrealistic world currency values, within which the Euro is likely the weak link, being a de facto money of resource-depleted Europe, forced into circulation in too many countries, too late. The US dollar’s plight needs no commentary.
Due to the massive fossil energy intensity of the current global economy’s structure, and low appreciation of the critical need for energy transition away from fossil fuels, we can be sure that near-term limits to world oil and natural gas supply capacity will have a strong impact on relative asset value sorting in a generally inflationary context. Even using IEA published data, world oil supply capacity could fall as much as 25 Mbd from now to 2025. Any small net increase in supply would need heroic investments, estimated by the IEA at about 26 000 Bn USD through less than 20 years. If we took an optimistic approach on the decline of world oil export supply or 'offer' from 2010, and assumed that net supply fell at a rate of 4% or 5% annual, perhaps due to energy saving and substitution programs in exporter countries (which at present is unlikely), this would translate to a long-term net annual decline in world export supply at well over 2.5 Mbd. This is close to German or South Korean oil import demand. Two years at this loss rate, would equal a little less than Japan's total import needs.
It is not difficult to identify what impact real structural undersupply will have on traded oil prices. The waiting period will be short. Oil prices can only show a massive rebound from almost the moment there is any sign of global economic recovery. The knock-on effect of higher energy prices on food prices will be rapid, as was shown in 2007-2008. This in turn and already poses a serious threat to the duration of sustainability of any global economic recovery, while also helping to rekindle inflation.
To be sure, this should also rekindle interest in Renewable Energy and Cleantech investing, itself a now highly financiarized asset sector, exposed to exactly the same tensions and volatility as 'mainstream' equities and other traded assets. The certain near-term return of Oil Crisis should however not mask the other resource-linked facets of the depletion crisis facing the straight majority of real resources – including the nominally renewable bioresources.
Raching its peak in the slow-growing real economy of the 1990s, an apparent oversupply of energy and natural resources helped push down the baseline for commodities relative to all other asset classes, in some cases to historic lows. This has dangerously masked the real, almost reverse video picture of hard asset production, supply and therefore price outlooks. To be sure, this ‘resource pinch’ is intensified by the extremely classic and conventional Henry Ford-style economic takeoff of the Emerging Economies. We therefore face accelerating depletion of key natural resources, plus structural resource-limiting factors like climate change and population growth.
Asset Value correlation
As already noted, the neat two-part division of hard asset commodities into ‘renewable’ and ‘non-renewable’ breaks down under the onslaught of current-structure global economic growth. Through 2005-2007, running at around 5%pa in a world of about 6600 million consumers and potential consumers, the pressure on real resource supply was easy to demonstrate. Conversely, equity and derived paper assets can be created in an electronic eyeblink, grow with little constraint, and avoid the problem of credibility as long as there is some growth of the ‘underlying security- - the global economy.
The unrealistic hopes embedded in the fragile ‘Chindia decoupling theory’ are based on the mirage of Decoupled Emerging Economy Growth at near double-digit annual average percentage rates, perhaps for 15 or 20 years, or more. In fact, this poses essentially impossible challenges for commodities production and supply. This concerns the near-term real world future, not some mythic Keynes-type long-term ‘when we are all dead’.
As noted above, there are decreasing numbers of ‘firewalls’ between the two theoretically-distinct asset classes inside the commodities sphere (i.e. renewable and non-renewable), as well as between Equities and Commodities. Due to present structure global economic growth, this trend is self-reinforcing. Thus price correlation and linkage, both inside the asset classes as well as between, is a strong real world trend. This again clearly supports the argument for near-term and possibly extreme of most Commodity prices.
This ‘re-linkage’ or new correlation can be observed with almost any real resource commodity. One example is the ags and softs, specially the grains and oilseeds, simply due to the 2005-2007 biofuels boom and slump. This left behind the price linkage of oil with food, but not the massive amounts of biofuels promised by various leaders, such as the RFS program of G W Bush. One major supply-side cause of this is the energy intensity of current agroindustrial production techniques, downstream processing, and transport of these commodities. For sugar and corn ethanol, and soybean or rapeseed biodiesel production, this’ energy price linkage’ is now powerful, providing another quick acting transmission vector for inflationary contagion within the real resources space.
To be sure there is considerable resistance on the part of economic and political deciders, but increasing reactivity and transparence in the pricing system, to pass-through upstream and absolute price rises for energy and food commodities. In other words this means there is now the certainty of ‘dam breaker’ surges in energy, food and fiber prices at the consumer level, both in OECD and in other countries. This sets the likely timeframe for a very sharp upturn in OECD country inflation, and fast growth of Commodity prices, to the near-term, probably Q2 2009 – Q2 2010. Prospects for the majority of real resource prices, as we noted in this article, include nearly stepwise upward change. Whenever there is clear break in price trends for Equities relative to Commodities – signaling deconvergence – this upward movement is likely to amplify and reinforce itself. This may start in Q3-Q4 2009.
span>
http://www.financialsense.com/editorials/mckillop/2009/0519.html
3 May 2009
China Shows the World How to Get Through a Crisis
By Jim O’Neill, FINANCIAL TIMES
Call me mad but this crisis is good for China. It is also good for China’s role and responsibilities in the world.
Yesterday, we upgraded our gross domestic product forecasts for China for 2009 and 2010; we are now looking for 8.3 and 10.9 per cent, respectively, up from 6 and 9 per cent.
Why the optimism? It was clear that the massive rise in exports, the mainstay of the China growth model until 2008, was not sustainable. At one stage in late 2007, Chinese exports to the US alone were about 12 per cent of total GDP. This meant that exports would suffer badly in the event of something going wrong with demand in the US, and the risk of a protectionist backlash.
This led some of us to expect an end to the fixed Rmb8.28 exchange rate to the dollar and a gradual shift to a more flexible, stronger exchange rate a few years ago.
Fast-forward to the crisis. When this intensified post-Lehman, global trade suffered enormously and quickly, and it was clear that Chinese growth would suffer. It was also reasonably clear that, just as they did in response to the Asian crisis in 1997, Chinese policymakers would react swiftly and shift gears. That they have done.
Three policy initiatives stand out, and the results are starting to bear fruit, hence our upgraded forecasts.
First, in November the authorities announced massive fiscal expansion, centred on fresh infrastructure spending. While my industry has quibbled about its true size ever since, this misses the point. The statement of intent was clear; interestingly, the stock market noticed and has rallied since.
Second, and ultimately perhaps the most important development in the world economy, the government announced plans to develop a full medical insurance policy for the still vast rural community, the beginnings of which it plans to have fully implemented for 90 per cent of the rural community by 2011. This could result in an end to the excessively high Chinese savings rate and allow much stronger consumption.
Third, and critical to our forecast upgrade, the authorities, led by the People’s Bank of China, embarked on a timely reversal of tightening financial conditions of the previous two years. According to our Chinese financial conditions index, conditions have eased a huge 520 basis points since last October.
These three measures have set the scene for an acceleration of Chinese domestic demand for the rest of 2009 and 2010, just the right recipe for China and, critically, the world.
The next stage of China’s development has started and is likely to go on for years. It was partly in anticipation of this that we highlighted owning China "A" shares as one of our most favoured trades for 2009. As they have risen 50 per cent since the November stimulus announcement, the entry point is now less attractive but, as evidence of rising demand accumulates, many investors are rightly going to be attracted back to China.
The "C" in the Bric economies (Brazil, Russia, India, China) has always been the most important of the four and the events of the past five months continue to justify our excitement for the longer term.
Amusingly, in the past year many people have suggested that the Brics story is over. Nonsense - it is still in its infancy. Indeed, the updated longer-term projections we published last summer, suggesting that China could overtake the US by 2027 and that the Brics collectively could be as big as the G7 by 2027, still look decent bets to me.
At some stage in the coming months, once it becomes clear that Chinese GDP growth is safely back above 8 per cent, policymakers will allow for some tightening of financial conditions again, possibly led by the exchange rate.
In the next two years, China is very likely to overtake Japan to become the second-largest economy in the world. Some say that China might get old before it gets rich, but it is getting bigger and richer, that is for sure. One or two of its ageing G20 partners may wish to take a closer look at Chinese economic policy to see how it’s done.
INDIA
The Indian stock market has been doing well after the Satyam scandal. Now, the elections are underway and results will be made public May 16th. Some investors will wait until after the national elections to make sure the probable coalition government will be effective. If the parties on the left, the Marxists, communists, etc. are included, you could have an ineffectual government which could result in a market setback.
COMMODITIES
The U.S. Federal Reserve has tripled the size of its balance sheet in recent months. Deficits in the U.S., Japan, and Europe are at record percentages of GDP. This, plus the big money supply expansion in many parts of the world, both argue strongly for a resurgence of inflation, most probably by the second half of 2010.
Stock markets are discounting mechanisms. One need only look at the current stock market rally worldwide, while world economies continue to weaken, to see that they are discounting a recovery. Is the recovery one year away? Two years? The market thinks it is more likely 12 to 18 months. In any case, the eventual resurgence of inflation is good for commodities, especially gold, agriculture, and oil. We believe that the recovery will include a slow growing, but stable economy for a few years in the developed world, and steady growth in China, India, and a few other countries.
GOLD
Who holds the gold? Recently announced numbers show that China has upped their gold holdings to over 1,000 tons, making them #5, after the U.S., Germany, France, and Italy. India is #10. China’s recent announcement that they had increased their gold holdings indicates once again China’s efforts to strategically position themselves to be a leader in the community of nations. Remember the old cliché about the golden rule? He who holds the gold makes the rules.
http://www.learntotradefutures.com/dcforum/DCForumID27/693.html
Call me mad but this crisis is good for China. It is also good for China’s role and responsibilities in the world.
Yesterday, we upgraded our gross domestic product forecasts for China for 2009 and 2010; we are now looking for 8.3 and 10.9 per cent, respectively, up from 6 and 9 per cent.
Why the optimism? It was clear that the massive rise in exports, the mainstay of the China growth model until 2008, was not sustainable. At one stage in late 2007, Chinese exports to the US alone were about 12 per cent of total GDP. This meant that exports would suffer badly in the event of something going wrong with demand in the US, and the risk of a protectionist backlash.
This led some of us to expect an end to the fixed Rmb8.28 exchange rate to the dollar and a gradual shift to a more flexible, stronger exchange rate a few years ago.
Fast-forward to the crisis. When this intensified post-Lehman, global trade suffered enormously and quickly, and it was clear that Chinese growth would suffer. It was also reasonably clear that, just as they did in response to the Asian crisis in 1997, Chinese policymakers would react swiftly and shift gears. That they have done.
Three policy initiatives stand out, and the results are starting to bear fruit, hence our upgraded forecasts.
First, in November the authorities announced massive fiscal expansion, centred on fresh infrastructure spending. While my industry has quibbled about its true size ever since, this misses the point. The statement of intent was clear; interestingly, the stock market noticed and has rallied since.
Second, and ultimately perhaps the most important development in the world economy, the government announced plans to develop a full medical insurance policy for the still vast rural community, the beginnings of which it plans to have fully implemented for 90 per cent of the rural community by 2011. This could result in an end to the excessively high Chinese savings rate and allow much stronger consumption.
Third, and critical to our forecast upgrade, the authorities, led by the People’s Bank of China, embarked on a timely reversal of tightening financial conditions of the previous two years. According to our Chinese financial conditions index, conditions have eased a huge 520 basis points since last October.
These three measures have set the scene for an acceleration of Chinese domestic demand for the rest of 2009 and 2010, just the right recipe for China and, critically, the world.
The next stage of China’s development has started and is likely to go on for years. It was partly in anticipation of this that we highlighted owning China "A" shares as one of our most favoured trades for 2009. As they have risen 50 per cent since the November stimulus announcement, the entry point is now less attractive but, as evidence of rising demand accumulates, many investors are rightly going to be attracted back to China.
The "C" in the Bric economies (Brazil, Russia, India, China) has always been the most important of the four and the events of the past five months continue to justify our excitement for the longer term.
Amusingly, in the past year many people have suggested that the Brics story is over. Nonsense - it is still in its infancy. Indeed, the updated longer-term projections we published last summer, suggesting that China could overtake the US by 2027 and that the Brics collectively could be as big as the G7 by 2027, still look decent bets to me.
At some stage in the coming months, once it becomes clear that Chinese GDP growth is safely back above 8 per cent, policymakers will allow for some tightening of financial conditions again, possibly led by the exchange rate.
In the next two years, China is very likely to overtake Japan to become the second-largest economy in the world. Some say that China might get old before it gets rich, but it is getting bigger and richer, that is for sure. One or two of its ageing G20 partners may wish to take a closer look at Chinese economic policy to see how it’s done.
INDIA
The Indian stock market has been doing well after the Satyam scandal. Now, the elections are underway and results will be made public May 16th. Some investors will wait until after the national elections to make sure the probable coalition government will be effective. If the parties on the left, the Marxists, communists, etc. are included, you could have an ineffectual government which could result in a market setback.
COMMODITIES
The U.S. Federal Reserve has tripled the size of its balance sheet in recent months. Deficits in the U.S., Japan, and Europe are at record percentages of GDP. This, plus the big money supply expansion in many parts of the world, both argue strongly for a resurgence of inflation, most probably by the second half of 2010.
Stock markets are discounting mechanisms. One need only look at the current stock market rally worldwide, while world economies continue to weaken, to see that they are discounting a recovery. Is the recovery one year away? Two years? The market thinks it is more likely 12 to 18 months. In any case, the eventual resurgence of inflation is good for commodities, especially gold, agriculture, and oil. We believe that the recovery will include a slow growing, but stable economy for a few years in the developed world, and steady growth in China, India, and a few other countries.
GOLD
Who holds the gold? Recently announced numbers show that China has upped their gold holdings to over 1,000 tons, making them #5, after the U.S., Germany, France, and Italy. India is #10. China’s recent announcement that they had increased their gold holdings indicates once again China’s efforts to strategically position themselves to be a leader in the community of nations. Remember the old cliché about the golden rule? He who holds the gold makes the rules.
http://www.learntotradefutures.com/dcforum/DCForumID27/693.html
18 April 2009
Commodity outlook bullish on Inflation /1935-1945 record
Puru Saxena makes the case......
Today, there are many deflationists who are claiming that the prices will remain depressed for many years due to the weak economic activity. However, these folks should note that even during the Great Depression of the 1930's, prices of commodities stabilised and began rising in 1933. Figure 1 confirms that due to monetary inflation in the early 1930's, the CRB Index embarked on a secular bull-market which had a violent correction in 1937 (marked by purple arrow). Following that crash, commodities bottomed out in 1938 and thanks to the super-inflationary efforts of President Roosevelt, the CRB Index surged for more than a decade.
Figure 1: CRB Spot Index - (1930-2007)
Source: Commodities Research Bureau
Contrary to popular opinion, that huge commodities boom took place despite an economic depression. Furthermore, it is worth pointing out that commodities rose relentlessly despite the fact that private-sector debt and bank lending remained essentially flat until 1945. Back then, similar to the current situation, banks accumulated large reserves but didn't loan these reserves into the broad economy. However, from 1932 onwards, the US government borrowed so much new money into existence that prices began to rise way before private-sector credit started to expand.
A similar drama unfolded in the 1970's when commodities went through the roof. During that time, economic activity was dismal but governments decided to tackle the recession with money creation. The net result was surging hard asset prices and mind-numbing inflation!
Turning to the present situation, US private-sector debt is shrinking as banks remain fearful of lending. However, the US government (along with other nations) is borrowing and creating gigantic sums of money and this should cause prices to rise for the next 3-4 years. Accordingly, we are maintaining our positions in top-quality businesses in the resources sector.
http://www.safehaven.com/article-13104.htm
Today, there are many deflationists who are claiming that the prices will remain depressed for many years due to the weak economic activity. However, these folks should note that even during the Great Depression of the 1930's, prices of commodities stabilised and began rising in 1933. Figure 1 confirms that due to monetary inflation in the early 1930's, the CRB Index embarked on a secular bull-market which had a violent correction in 1937 (marked by purple arrow). Following that crash, commodities bottomed out in 1938 and thanks to the super-inflationary efforts of President Roosevelt, the CRB Index surged for more than a decade.
Figure 1: CRB Spot Index - (1930-2007)
Source: Commodities Research Bureau
Contrary to popular opinion, that huge commodities boom took place despite an economic depression. Furthermore, it is worth pointing out that commodities rose relentlessly despite the fact that private-sector debt and bank lending remained essentially flat until 1945. Back then, similar to the current situation, banks accumulated large reserves but didn't loan these reserves into the broad economy. However, from 1932 onwards, the US government borrowed so much new money into existence that prices began to rise way before private-sector credit started to expand.
A similar drama unfolded in the 1970's when commodities went through the roof. During that time, economic activity was dismal but governments decided to tackle the recession with money creation. The net result was surging hard asset prices and mind-numbing inflation!
Turning to the present situation, US private-sector debt is shrinking as banks remain fearful of lending. However, the US government (along with other nations) is borrowing and creating gigantic sums of money and this should cause prices to rise for the next 3-4 years. Accordingly, we are maintaining our positions in top-quality businesses in the resources sector.
http://www.safehaven.com/article-13104.htm
15 April 2009
Commodity supercycle thesis remains solid
Most prices for commodities are merely correcting there first massive upleg of a bull market that will be driven by infrastructure spends and chinese financed infrastructure in the third world, my contrarian viewpoint it looks as though things are lining up for the commodity market to regain momentum and continue in its secular bull. While the relative decline of the West is baked in the cake, the long term preasures of demand, future putative supply destruction due to the credit crunch, I would expect stronger commodity prices going forward. Kevin(New Kontent).
Zeal look at the case for copper..
"From a macro perspective copper, and commodities as a whole, will be long-term beneficiaries of the staggering inflationary actions of the world’s governments. Not only is there a massive pipeline of stimulus projects that will directly benefit the infrastructure build out, but rampant and careless monetary policies that have been set into motion will be a huge boon for commodities prices.
We also cannot forget where demand growth will come from in the future. Though this recession has slowed growth from the developing economies in Asia, these countries still have a long ways to go in their strategic development plans.
For example the Indian government says its recently completed fiscal year should see growth around 7%. And even with the current economic calamity it sees growth in the next year exceeding 5%. Moving to the northeast, according to one of China’s largest banks this growing economic powerhouse should see 2009 GDP growth of around 8%.
Interestingly the China Geological Survey is actually worried about commodities production shortfalls in 2009. And this has been evident in 2009’s activity so far at the Shanghai Futures Exchange. The SHFE saw record copper gains in Q1 as the metal has been trading at a premium to the LME in order to encourage producers to ship more copper to China.
Though China and India see growth at less than 10% in 2009, it is growth nonetheless and a lot of this will come in the form of infrastructure growth. China in particular has shouldered a larger portion of copper demand of recent, but when demand eventually picks back up in the rest of the world there will be fierce competition for what is likely to be a shrinking copper supply.
With copper near multi-year lows and demand growth slowing a bit, it is natural that the miners will eventually throttle back production. Production cutbacks are usually lagging and reactionary events in response to shifts in demand. And this is why we are seeing global stockpiles on the rise.
But many of the world’s top copper miners have already adjusted 2009 production forecasts to the downside. Some of these cutbacks are voluntary as a means to conserve copper for when prices and demand are higher. But some of these cutbacks are forced as a result of waning economics.
From mid-2005 to mid-2008 copper averaged over $3, thus prompting aggressive industry-wide exploration and development programs. These high prices also allowed the producers to profitably mine lower-grade ore within the confines of existing operations as well as bring past-producing mines back to life.
But these lower-grade, thus higher cost, operations and development projects that were economically feasible at higher copper prices are now losers. Production cutbacks, mine closures, and the scrapping of now-uneconomical exploration and development projects will eventually translate into materially lower mine production. Supply will eventually shrink enough to balance demand, even if demand stays weak for an extended period of time.
Regardless of where this balance is met, I believe copper has seen its low. And investors and speculators have taken advantage of this wildly oversold environment to reap fantastic gains as the markets bounce back to reality. As mentioned the futures traders have seen the metal pop 50%+ since the beginning of the year. But stock traders have fared even better.
By the time the dust settled at the initial panic low in November, the copper miners had leveraged copper’s losses to the downside in a big way. Even the world’s largest copper stocks had sold off by 80% or so from their highs. As mentioned earlier investors had discounted an apocalyptic ending to the commodities trade and sold their shares with reckless abandon. But in hindsight this November stock-market low was the time to load up on commodities stocks, especially copper stocks.
After coming to the brilliant conclusion that the world wasn’t coming to an end and we weren’t entering into the next Great Depression, buyers returned to commodities stocks and took advantage of their wildly oversold levels.
Copper stocks in particular have been among the best performers in the entire markets in the last 4+ months. Many have already seen triple-digit gains from their bottoms in the midst of an S&P 500 grind that had seen new lows set just last month."
Charts and data
Zeal look at the case for copper..
"From a macro perspective copper, and commodities as a whole, will be long-term beneficiaries of the staggering inflationary actions of the world’s governments. Not only is there a massive pipeline of stimulus projects that will directly benefit the infrastructure build out, but rampant and careless monetary policies that have been set into motion will be a huge boon for commodities prices.
We also cannot forget where demand growth will come from in the future. Though this recession has slowed growth from the developing economies in Asia, these countries still have a long ways to go in their strategic development plans.
For example the Indian government says its recently completed fiscal year should see growth around 7%. And even with the current economic calamity it sees growth in the next year exceeding 5%. Moving to the northeast, according to one of China’s largest banks this growing economic powerhouse should see 2009 GDP growth of around 8%.
Interestingly the China Geological Survey is actually worried about commodities production shortfalls in 2009. And this has been evident in 2009’s activity so far at the Shanghai Futures Exchange. The SHFE saw record copper gains in Q1 as the metal has been trading at a premium to the LME in order to encourage producers to ship more copper to China.
Though China and India see growth at less than 10% in 2009, it is growth nonetheless and a lot of this will come in the form of infrastructure growth. China in particular has shouldered a larger portion of copper demand of recent, but when demand eventually picks back up in the rest of the world there will be fierce competition for what is likely to be a shrinking copper supply.
With copper near multi-year lows and demand growth slowing a bit, it is natural that the miners will eventually throttle back production. Production cutbacks are usually lagging and reactionary events in response to shifts in demand. And this is why we are seeing global stockpiles on the rise.
But many of the world’s top copper miners have already adjusted 2009 production forecasts to the downside. Some of these cutbacks are voluntary as a means to conserve copper for when prices and demand are higher. But some of these cutbacks are forced as a result of waning economics.
From mid-2005 to mid-2008 copper averaged over $3, thus prompting aggressive industry-wide exploration and development programs. These high prices also allowed the producers to profitably mine lower-grade ore within the confines of existing operations as well as bring past-producing mines back to life.
But these lower-grade, thus higher cost, operations and development projects that were economically feasible at higher copper prices are now losers. Production cutbacks, mine closures, and the scrapping of now-uneconomical exploration and development projects will eventually translate into materially lower mine production. Supply will eventually shrink enough to balance demand, even if demand stays weak for an extended period of time.
Regardless of where this balance is met, I believe copper has seen its low. And investors and speculators have taken advantage of this wildly oversold environment to reap fantastic gains as the markets bounce back to reality. As mentioned the futures traders have seen the metal pop 50%+ since the beginning of the year. But stock traders have fared even better.
By the time the dust settled at the initial panic low in November, the copper miners had leveraged copper’s losses to the downside in a big way. Even the world’s largest copper stocks had sold off by 80% or so from their highs. As mentioned earlier investors had discounted an apocalyptic ending to the commodities trade and sold their shares with reckless abandon. But in hindsight this November stock-market low was the time to load up on commodities stocks, especially copper stocks.
After coming to the brilliant conclusion that the world wasn’t coming to an end and we weren’t entering into the next Great Depression, buyers returned to commodities stocks and took advantage of their wildly oversold levels.
Copper stocks in particular have been among the best performers in the entire markets in the last 4+ months. Many have already seen triple-digit gains from their bottoms in the midst of an S&P 500 grind that had seen new lows set just last month."
Charts and data
4 March 2009
Asia's miners line up for Outback
SYDNEY - Asian mining firms are closely watching developments related to the US$19.5 billion bid by Chinese aluminum giant Chinalco for a stake in multinational Rio Tinto, amid a developing buying blitz on Australia's cheap resources stocks.
Corporate lawyers say that Japanese, Chinese and South Korean companies are locked in negotiations for equity in a host of mid-sized miners, but the fate of the deals may hinge on whether the Chinalco-Rio deal gets regulatory approval.
"You have a weak Australian dollar, very low price/earning ratios of resource stocks and a lot of cashed-up Asian firms that are underwritten - in some cases at least - by official reserves," said one lawyer involved in acquisition talks. "[But] it counts for nought if the [Australian] regulators start talking tough."
State-owned Chinalco have met with Australia's Foreign Investment Review Board (IRB) to push its case for the purchase of sizeable stakes in some of Rio's key ore, aluminum and power assets, including the vast Hamersley Iron operation in Western Australia.
Chinalco has offered US$7.2 billion in the form of convertible bonds which, once converted to shares, would increase its stake in Rio from 9.3% to 18%. The bonds, which have a 60-year term, would attract annual interest of 9-9.5% and would be redeemable after seven years.
Rio badly needs the cash injection to clear US$38 billion of debt incurred when the multinational bought Canadian aluminum producer Alcan Inc in 2007, and board members are expected to approve the bid when they meet in May. The company is committed to repay US$8.9 billion in October and a further US$10 billion next year.
But investors argue that Rio, Australia's second-biggest resources company, could mortgage its future by hiving off key assets. The Australian government also fears that a takeover could allow the Chinese effectively to dictate terms in their tortuous annual price negotiations with the resources sector.
Big exporters like Rio and BHP-Billiton benefited from annual increases of 80-90% in shipment value during the boom years of Chinese economic expansion. But they were told last week by Baosteel's Shanghai steelworks that they could expect cuts of 30-50% this year due to waning demand.
There is plenty at stake for the slowing Australian economy: the country earned A$31 billion from iron ore exports last year and A$46 billion from coal, and government leaders are anxious that the miners keep the upper ground in negotiations.
The new president of Chinalco, Xiong Weiping, said in Sydney the Rio would set up a separate committee of independent - that is, non-Chinalco - directors to handle price talks and avoid a conflict of interest. That might be enough to mollify the IRB, especially if the review board also imposes a limit on Chinalco's future stake and withholds a board seat.
But that may not satisfy the government. The Australian treasurer (finance minister), Wayne Swan, has said he will seek parliamentary approval to amend the Foreign Acquisitions and Takeovers Act so that access to resources firms is tightened.
The biggest change is likely to be that any investment - particularly those involving instruments such as convertible notes - would be treated as equity. Swan said that Australia welcomed investment but treated resources as a special category. Intending buyers would have to prove that investments in the mining sector were in the "national interest".
Shareholders, especially institutional investors, will also have a strong say in the outcome, as many have been angered that the offering was made to Chinalco at a premium - and that they were left out. There are reports that Chinalco might substitute a rights issue of US$10 billion, but Xiong said in Sydney the firm was unwilling to alter the terms.
"We do not want to see any changes to the packaged agreement. I think the Rio Tinto board and its management team will listen very carefully to the requirements and requests from the shareholders."
Yet while opening the deal to outside investors would water down Chinalco's stake, that might be the price the firm has to pay to force the deal through. And it might be vital if Rio is to keep faith with shareholders and rescue its floundering share price.
Market analysts say a substantial number of institutional investors were caught out when they shorted Rio shares in anticipation of a rights issue to cover the debts and they have lots to lose from the deal. So do Rio's board members, who are struggling to convince analysts the deal is the best option.
There has already been one casualty: the designated chairman, Jim Leng, quit two weeks ago when his case for a rights issue found no support with other board members.
Nationalist sentiment is unlikely to have much bearing with remaining board members, as only two are Australian. One of these, former Cathay Pacific and British Airways boss Rod Eddington, has said he will not vote on the deal due to a perceived conflict of interest: he chairs the Australian operations of investment bank JP Morgan, one of Chinalco's advisers.
Rio chief executive Tom Albanese, a US national, said he stood by the deal, saying it would allow Rio to reactivate iron ore, alumina and coal projects that had been put on hold due to the company's difficult financial situation.
There is still a possibility of a rival bid from another suitor, as the Chinalco deal has not yet been voted on by investors. BHP, which considered launching a formal bid last year, is one possible investor, though it would mean Rio would have to pay a US$195 million "break fee" to Chinalco.
Other Asian miners also cannot be ruled out. China Minmetals wrapped up a A$2.6 billion (US$1.7 billion) takeover of OZ Minerals earlier his month, and Chinese steel producer Anshan Iron & Steel Group will pay A$162 million for a bigger stake in Gindalbie Metals.
Legal firm Corrs Chambers Westgarth, which specializes in mergers and acquisitions, confirmed it had had inquiries from Korean, Japanese and Chinese investors looking to acquire gold, coal, uranium and iron ore projects in Australia.
The investors include Japan's Sumitomo, Mitsui and Mitsubishi UFJ. They are believed to be looking at medium-sized producers such as Aquila Resources, Felix Resources and Gloucester Coal.
Alan Boyd, now based in Sydney, has reported on Asia for more than two decades.
link
Corporate lawyers say that Japanese, Chinese and South Korean companies are locked in negotiations for equity in a host of mid-sized miners, but the fate of the deals may hinge on whether the Chinalco-Rio deal gets regulatory approval.
"You have a weak Australian dollar, very low price/earning ratios of resource stocks and a lot of cashed-up Asian firms that are underwritten - in some cases at least - by official reserves," said one lawyer involved in acquisition talks. "[But] it counts for nought if the [Australian] regulators start talking tough."
State-owned Chinalco have met with Australia's Foreign Investment Review Board (IRB) to push its case for the purchase of sizeable stakes in some of Rio's key ore, aluminum and power assets, including the vast Hamersley Iron operation in Western Australia.
Chinalco has offered US$7.2 billion in the form of convertible bonds which, once converted to shares, would increase its stake in Rio from 9.3% to 18%. The bonds, which have a 60-year term, would attract annual interest of 9-9.5% and would be redeemable after seven years.
Rio badly needs the cash injection to clear US$38 billion of debt incurred when the multinational bought Canadian aluminum producer Alcan Inc in 2007, and board members are expected to approve the bid when they meet in May. The company is committed to repay US$8.9 billion in October and a further US$10 billion next year.
But investors argue that Rio, Australia's second-biggest resources company, could mortgage its future by hiving off key assets. The Australian government also fears that a takeover could allow the Chinese effectively to dictate terms in their tortuous annual price negotiations with the resources sector.
Big exporters like Rio and BHP-Billiton benefited from annual increases of 80-90% in shipment value during the boom years of Chinese economic expansion. But they were told last week by Baosteel's Shanghai steelworks that they could expect cuts of 30-50% this year due to waning demand.
There is plenty at stake for the slowing Australian economy: the country earned A$31 billion from iron ore exports last year and A$46 billion from coal, and government leaders are anxious that the miners keep the upper ground in negotiations.
The new president of Chinalco, Xiong Weiping, said in Sydney the Rio would set up a separate committee of independent - that is, non-Chinalco - directors to handle price talks and avoid a conflict of interest. That might be enough to mollify the IRB, especially if the review board also imposes a limit on Chinalco's future stake and withholds a board seat.
But that may not satisfy the government. The Australian treasurer (finance minister), Wayne Swan, has said he will seek parliamentary approval to amend the Foreign Acquisitions and Takeovers Act so that access to resources firms is tightened.
The biggest change is likely to be that any investment - particularly those involving instruments such as convertible notes - would be treated as equity. Swan said that Australia welcomed investment but treated resources as a special category. Intending buyers would have to prove that investments in the mining sector were in the "national interest".
Shareholders, especially institutional investors, will also have a strong say in the outcome, as many have been angered that the offering was made to Chinalco at a premium - and that they were left out. There are reports that Chinalco might substitute a rights issue of US$10 billion, but Xiong said in Sydney the firm was unwilling to alter the terms.
"We do not want to see any changes to the packaged agreement. I think the Rio Tinto board and its management team will listen very carefully to the requirements and requests from the shareholders."
Yet while opening the deal to outside investors would water down Chinalco's stake, that might be the price the firm has to pay to force the deal through. And it might be vital if Rio is to keep faith with shareholders and rescue its floundering share price.
Market analysts say a substantial number of institutional investors were caught out when they shorted Rio shares in anticipation of a rights issue to cover the debts and they have lots to lose from the deal. So do Rio's board members, who are struggling to convince analysts the deal is the best option.
There has already been one casualty: the designated chairman, Jim Leng, quit two weeks ago when his case for a rights issue found no support with other board members.
Nationalist sentiment is unlikely to have much bearing with remaining board members, as only two are Australian. One of these, former Cathay Pacific and British Airways boss Rod Eddington, has said he will not vote on the deal due to a perceived conflict of interest: he chairs the Australian operations of investment bank JP Morgan, one of Chinalco's advisers.
Rio chief executive Tom Albanese, a US national, said he stood by the deal, saying it would allow Rio to reactivate iron ore, alumina and coal projects that had been put on hold due to the company's difficult financial situation.
There is still a possibility of a rival bid from another suitor, as the Chinalco deal has not yet been voted on by investors. BHP, which considered launching a formal bid last year, is one possible investor, though it would mean Rio would have to pay a US$195 million "break fee" to Chinalco.
Other Asian miners also cannot be ruled out. China Minmetals wrapped up a A$2.6 billion (US$1.7 billion) takeover of OZ Minerals earlier his month, and Chinese steel producer Anshan Iron & Steel Group will pay A$162 million for a bigger stake in Gindalbie Metals.
Legal firm Corrs Chambers Westgarth, which specializes in mergers and acquisitions, confirmed it had had inquiries from Korean, Japanese and Chinese investors looking to acquire gold, coal, uranium and iron ore projects in Australia.
The investors include Japan's Sumitomo, Mitsui and Mitsubishi UFJ. They are believed to be looking at medium-sized producers such as Aquila Resources, Felix Resources and Gloucester Coal.
Alan Boyd, now based in Sydney, has reported on Asia for more than two decades.
link
17 January 2009
Tough times for aussie mining sector as prices sink
First big commodity correction. They will surprise by staying strong even as the world slows. This commodity bull is secular and long term, but the next 12 months will be problematic......
For now, things are crook.
"THE nation's mining industry has had one of its darkest weeks in years as the global economic crisis bit harder.
More than 1000 workers were axed, or put on notice, and more than $US2 billion ($3 billion) of expansion shelved or slowed.
Plummeting mineral demand has combined with the drying up of credit to force previously high-flying miners like Rio Tinto, OZ Minerals and Xstrata to take the knife to growth, production and workers.
Since July, more than 5000 mining jobs, or 3.5 per cent of the nation's 140,000-strong mining workforce have been axed, with more job cuts to come in the next month.
Miners, who as recently as November were struggling to find workers in some sectors amid a boom-induced skills shortage, have been shocked at the speed with which the global credit crisis has hit the industry.
Rio is expected to have by far the biggest impact on the nation's mining workforce and growth programs, as the $US39 billion of debt it racked up in the 2007 purchase of Canada's Alcan cripples its growth plans and puts 14,000 workers out of a job worldwide.
Indicating how toxic the debt on a balance sheet has become, BHP Billiton -- which has little debt and similar operations to Rio -- has so far flagged minimal cuts to local operations and few overseas.
But it is not immune to the global economic slowdown and its overall production and financial figures are being affected.
BHP compounded Rio's problems in November when it walked away from its $140 billion hostile bid and sent the former target's share price plummeting.
So far, Rio has announced 600 workers and contractors will be out of a job at its Kestrel coal mine in Queensland, Northparkes copper mine in NSW and Argyle diamond mine in Western Australia.
If Rio's cuts are proportional to the total workforce it has here, however, the total could climb to 3000.
Rio chief executive Tom Albanese said conditions in the new year had shown few signs of sustained improvement and the miner was bracing for a long period of volatility.
"I think we'll see some improvements in some months and we should accept some setbacks in others," Mr Albanese said.
Rio is cancelling the vast majority of its growth projects by cutting back its 2009 capital spending budget by $US5 billion to $US4 billion.
Half of that $US4 billion will be on what Rio calls sustaining capital expenditure on postponed projects, meaning only $US2 billion will be spent on actual production expansion.
So far in Australia, Rio has suspended expansion programs at Northparkes and Pilbara iron ore operations as well as slowing the $US1.5 billion underground extension at Argyle.
Rio says it will announce where its job cuts and capital rein-in will come from with its full-year results on February 12.
Any prolonged downturn in the mining industry will flow on to the rest of the economy.
In a January research paper, the Reserve Bank said the mining sector had become so important to the Australian economy that the ripple effect from a downturn in its fortunes would be particularly pronounced.
"Other things equal, reduced spending by the mining sector, on both investment and inputs to production, would be expected to flow through to slower activity in other sectors of the economy," it said.
Mining investment over the past four years outstripped even the sector's revenue growth, pumping on average an extra $30 billion a year into the economy.
Last financial year, the sector accounted for about a quarter of all private business investment, surpassing the share recorded in previous booms in the early 1970s, early 1980s and mid-1990s.
ABN AMRO mining analyst Warren Edney said the mining sector was unlikely to show any signs of improvement until at least March and more production cuts could be on the way.
"Things have fallen a lot but companies and investors want some sign that at least things may have hit the bottom," Mr Edney said.
"There's a natural period of weakness in the first couple of months of the year from China where you don't get a clear picture of what's going on, so I think it's going to be March before we can say there's a reasonable case things are getting near the bottom," he said.
After Rio, the biggest job cuts so far have come from embattled local miner OZ Minerals and Swiss miner Xstrata, both of which are also struggling with debt problems.
OZ has flagged 559 staff and contractor job losses and its future is looking more and more questionable as it continues to miss deadlines to refinance debt and secure bridging loans.
Xstrata, whose shares slumped 80 per cent last year and which has $US17 billion of debt, has cut 580 local workers because of the global slowdown. Yesterday it threatened to lay off another 300 if the Rudd Government does not approve the stalled McArthur River zinc mine in the Northern Territory.
National Industry Skills Council chief executive Des Caulfield said the speed of the downturn had surprised nearly everyone.
"Nobody saw the depth of the cancer from the financial meltdown, just as when we spoke to people five or six years ago they hadn't seen the boom coming," Mr Caulfield said.
He said the outlook was not all bad for mine workers, especially in Queensland, where coal miners recently were concerned that civil infrastructure projects in Queensland would rob them of workers, and where the burgeoning coal seam gas sector is expected to require thousands of workers in coming years."
For now, things are crook.
"THE nation's mining industry has had one of its darkest weeks in years as the global economic crisis bit harder.
More than 1000 workers were axed, or put on notice, and more than $US2 billion ($3 billion) of expansion shelved or slowed.
Plummeting mineral demand has combined with the drying up of credit to force previously high-flying miners like Rio Tinto, OZ Minerals and Xstrata to take the knife to growth, production and workers.
Since July, more than 5000 mining jobs, or 3.5 per cent of the nation's 140,000-strong mining workforce have been axed, with more job cuts to come in the next month.
Miners, who as recently as November were struggling to find workers in some sectors amid a boom-induced skills shortage, have been shocked at the speed with which the global credit crisis has hit the industry.
Rio is expected to have by far the biggest impact on the nation's mining workforce and growth programs, as the $US39 billion of debt it racked up in the 2007 purchase of Canada's Alcan cripples its growth plans and puts 14,000 workers out of a job worldwide.
Indicating how toxic the debt on a balance sheet has become, BHP Billiton -- which has little debt and similar operations to Rio -- has so far flagged minimal cuts to local operations and few overseas.
But it is not immune to the global economic slowdown and its overall production and financial figures are being affected.
BHP compounded Rio's problems in November when it walked away from its $140 billion hostile bid and sent the former target's share price plummeting.
So far, Rio has announced 600 workers and contractors will be out of a job at its Kestrel coal mine in Queensland, Northparkes copper mine in NSW and Argyle diamond mine in Western Australia.
If Rio's cuts are proportional to the total workforce it has here, however, the total could climb to 3000.
Rio chief executive Tom Albanese said conditions in the new year had shown few signs of sustained improvement and the miner was bracing for a long period of volatility.
"I think we'll see some improvements in some months and we should accept some setbacks in others," Mr Albanese said.
Rio is cancelling the vast majority of its growth projects by cutting back its 2009 capital spending budget by $US5 billion to $US4 billion.
Half of that $US4 billion will be on what Rio calls sustaining capital expenditure on postponed projects, meaning only $US2 billion will be spent on actual production expansion.
So far in Australia, Rio has suspended expansion programs at Northparkes and Pilbara iron ore operations as well as slowing the $US1.5 billion underground extension at Argyle.
Rio says it will announce where its job cuts and capital rein-in will come from with its full-year results on February 12.
Any prolonged downturn in the mining industry will flow on to the rest of the economy.
In a January research paper, the Reserve Bank said the mining sector had become so important to the Australian economy that the ripple effect from a downturn in its fortunes would be particularly pronounced.
"Other things equal, reduced spending by the mining sector, on both investment and inputs to production, would be expected to flow through to slower activity in other sectors of the economy," it said.
Mining investment over the past four years outstripped even the sector's revenue growth, pumping on average an extra $30 billion a year into the economy.
Last financial year, the sector accounted for about a quarter of all private business investment, surpassing the share recorded in previous booms in the early 1970s, early 1980s and mid-1990s.
ABN AMRO mining analyst Warren Edney said the mining sector was unlikely to show any signs of improvement until at least March and more production cuts could be on the way.
"Things have fallen a lot but companies and investors want some sign that at least things may have hit the bottom," Mr Edney said.
"There's a natural period of weakness in the first couple of months of the year from China where you don't get a clear picture of what's going on, so I think it's going to be March before we can say there's a reasonable case things are getting near the bottom," he said.
After Rio, the biggest job cuts so far have come from embattled local miner OZ Minerals and Swiss miner Xstrata, both of which are also struggling with debt problems.
OZ has flagged 559 staff and contractor job losses and its future is looking more and more questionable as it continues to miss deadlines to refinance debt and secure bridging loans.
Xstrata, whose shares slumped 80 per cent last year and which has $US17 billion of debt, has cut 580 local workers because of the global slowdown. Yesterday it threatened to lay off another 300 if the Rudd Government does not approve the stalled McArthur River zinc mine in the Northern Territory.
National Industry Skills Council chief executive Des Caulfield said the speed of the downturn had surprised nearly everyone.
"Nobody saw the depth of the cancer from the financial meltdown, just as when we spoke to people five or six years ago they hadn't seen the boom coming," Mr Caulfield said.
He said the outlook was not all bad for mine workers, especially in Queensland, where coal miners recently were concerned that civil infrastructure projects in Queensland would rob them of workers, and where the burgeoning coal seam gas sector is expected to require thousands of workers in coming years."
20 December 2008
The Charm of Zapata George
He knows that peak oil is the real deal and that OPEC are covering their tracks with production cuts.
We are headed for a economic crash, yes, but commodities, due to world growth, fiscal policy lead investment demand in infrastructure and most significantly embodied energy content and implied future costs of production, are going nowhere but up when deleveraging is complete and a massive move down in the US dollar kicks off.
Zapata George keeps it simple. He's the man on oil.
"
A recent release by the International Energy Agency (IEA) – they’re year end report – was quite interesting. What was significant was their reversal of form when it comes to Peak Oil. After repeatedly trying to convince us that all is well in the land of cheap oil, they’ve now jumped from a horse riding full tilt in one direction to the back of another horse running in the complete opposite direction! (Do you think someone over there has been listening to me?...ha!) In our full radio report this weekend, we will discuss this report more in full, but I wanted to share their opening remarks with you now:
“The world’s energy system is at a crossroads. Current global trends in energy supply and consumption are patently unsustainable - environmentally, economically, and socially. But that can - and must - be altered; there’s still time to change the road we’re on. It is not an exaggeration to claim that the future of human prosperity depends on how successfully we tackle the two central energy challenges facing us today: securing the supply of reliable and affordable energy; and effecting a rapid transformation to a low-carbon, efficient and environmentally benign system of energy supply. What is needed is nothing short of an energy revolution.”
Isn’t this what I’ve been saying all along? Guess I was right…maybe?
It’s important, I think, to understand a little about the output of the world’s oilfields. Only 1% of the top 5 oilfields in the world are of the “super-giant size” and the majority of all of these fields has peaked and turned to the downside.
The important thing to know about an oilfield or a country that exports oil is when the peak oil production occurs. The discovery and number of barrels available for eventual production, which they calculate up front – a calculated guess, really – has no bearing on the number of barrels actually produced.
There are also a number of reasons why some fields last longer than others. Some fields are managed well and nursed along to a pretty consistent production output. However, some countries hit their resources hard, because they want the revenue. Take a country like Nigeria…you get a new ruler who three days ago was just an ambitious soldier, and the first thing he wants to do is stuff his bank account in Switzerland. He cranks up production to drain off as much as possible before the next coup hits and a new ruler kicks him out. Then the new guy does the same thing. No thought for sustainability…just greed.
However, the fields owned by the big companies, Exxon, BP, Shell, Conoco, Chevron, etc. are in general better managed and we can learn much from them. The decline of those kinds of large fields is approximately 4.7 percent per year. With a daily production rate of approximately 85 or 86 million, 4.7 percent of that comes out to about 4 million barrels a day per annum. So once you’ve peaked, the decline will be about that rate. Well, there’s four quarters so it is my contention that we are making a decline rate of 1 million barrels per day per quarter. I also believe that the recent announcement that OPEC was cutting production about 4.2 million barrels a day confirms my decline suspicions. What’s’ happening? They’re saying “Oh, the price is too low. We’re going to cut production.” What they’re really doing is that they’re covering their tracks. They know they’re going to see a decline in output that they can do nothing about so they’re going to claim that it is voluntary, rather than being imposed on them by Mother Nature. This is a complete cover story that has nothing to do with reality.
Okay, so the IEA says that the energy system of the world is at a crossroads. They have never, ever used that kind of language before. They’re right. We are truly at the crossroads and in my opinion, if we had not had the economic slowdown and decline in consumption, we would already be feeling the effects of Peak Oil. We will surely feel them in the coming two quarters. The question is, what can we do about it? What are our alternatives? The lead time on effectively developing biofuels is measured in decades, not years, so we’re already behind the curve on that resource. What are our other options? Please turn in to our Radio Show on Free Radio Zapata George this weekend as we discuss this report and what it means for us over the next few years. I thank you for your time, and hope you’ll join us."
link
We are headed for a economic crash, yes, but commodities, due to world growth, fiscal policy lead investment demand in infrastructure and most significantly embodied energy content and implied future costs of production, are going nowhere but up when deleveraging is complete and a massive move down in the US dollar kicks off.
Zapata George keeps it simple. He's the man on oil.
"
A recent release by the International Energy Agency (IEA) – they’re year end report – was quite interesting. What was significant was their reversal of form when it comes to Peak Oil. After repeatedly trying to convince us that all is well in the land of cheap oil, they’ve now jumped from a horse riding full tilt in one direction to the back of another horse running in the complete opposite direction! (Do you think someone over there has been listening to me?...ha!) In our full radio report this weekend, we will discuss this report more in full, but I wanted to share their opening remarks with you now:
“The world’s energy system is at a crossroads. Current global trends in energy supply and consumption are patently unsustainable - environmentally, economically, and socially. But that can - and must - be altered; there’s still time to change the road we’re on. It is not an exaggeration to claim that the future of human prosperity depends on how successfully we tackle the two central energy challenges facing us today: securing the supply of reliable and affordable energy; and effecting a rapid transformation to a low-carbon, efficient and environmentally benign system of energy supply. What is needed is nothing short of an energy revolution.”
Isn’t this what I’ve been saying all along? Guess I was right…maybe?
It’s important, I think, to understand a little about the output of the world’s oilfields. Only 1% of the top 5 oilfields in the world are of the “super-giant size” and the majority of all of these fields has peaked and turned to the downside.
The important thing to know about an oilfield or a country that exports oil is when the peak oil production occurs. The discovery and number of barrels available for eventual production, which they calculate up front – a calculated guess, really – has no bearing on the number of barrels actually produced.
There are also a number of reasons why some fields last longer than others. Some fields are managed well and nursed along to a pretty consistent production output. However, some countries hit their resources hard, because they want the revenue. Take a country like Nigeria…you get a new ruler who three days ago was just an ambitious soldier, and the first thing he wants to do is stuff his bank account in Switzerland. He cranks up production to drain off as much as possible before the next coup hits and a new ruler kicks him out. Then the new guy does the same thing. No thought for sustainability…just greed.
However, the fields owned by the big companies, Exxon, BP, Shell, Conoco, Chevron, etc. are in general better managed and we can learn much from them. The decline of those kinds of large fields is approximately 4.7 percent per year. With a daily production rate of approximately 85 or 86 million, 4.7 percent of that comes out to about 4 million barrels a day per annum. So once you’ve peaked, the decline will be about that rate. Well, there’s four quarters so it is my contention that we are making a decline rate of 1 million barrels per day per quarter. I also believe that the recent announcement that OPEC was cutting production about 4.2 million barrels a day confirms my decline suspicions. What’s’ happening? They’re saying “Oh, the price is too low. We’re going to cut production.” What they’re really doing is that they’re covering their tracks. They know they’re going to see a decline in output that they can do nothing about so they’re going to claim that it is voluntary, rather than being imposed on them by Mother Nature. This is a complete cover story that has nothing to do with reality.
Okay, so the IEA says that the energy system of the world is at a crossroads. They have never, ever used that kind of language before. They’re right. We are truly at the crossroads and in my opinion, if we had not had the economic slowdown and decline in consumption, we would already be feeling the effects of Peak Oil. We will surely feel them in the coming two quarters. The question is, what can we do about it? What are our alternatives? The lead time on effectively developing biofuels is measured in decades, not years, so we’re already behind the curve on that resource. What are our other options? Please turn in to our Radio Show on Free Radio Zapata George this weekend as we discuss this report and what it means for us over the next few years. I thank you for your time, and hope you’ll join us."
link
13 December 2008
Thanks for your Comments, Readers
I posted item to this blog since 2005 and didn't get any feedback for a year and a half at all. The insanity that 80% of the increases in the West's spending this century was driven by home equity withdrawl and the monitisation of what will prove to be have been largely illusionary appreciation of nominal asset values in everything from homes, commercial real estate and stocks escaped most people. It screamed bubble.
Anyway, its demise has made the blog more popular, but I not a complete gloom and doomer. I very much think that both hard and commodities, gold, silver, oil and alternate energy are very undervalued.
Commodity producers, energy and alternate energy services will the the cash rich core around which many economy's will rebuild and this will be reflected in the popular culture.
I agree with Jim Rogers.
Jim Rogers
"The commodities guru predicted two years ago that the credit bubble would devastate Wall Street.
We are in a period of forced liquidation, which has happened only eight or nine times in the past 150 years. The fact that it's historic doesn't make it any more fun, of course. But it is a pretty interesting time when there is forced selling of everything with no regard for facts or fundamentals at all. Historically, the way you make money in times like these is that you find things where the fundamentals are unimpaired. The fundamentals of GM are impaired. The fundamentals of Citigroup are impaired.
Virtually the only asset class I know where the fundamentals are not impaired - in fact, where they are actually improving - is commodities. Farmers cannot get a loan to buy fertilizer right now. Nobody's going to get a loan to open a zinc or a lead mine. Meanwhile, every day the supply of commodities shrinks more and more. Nobody can invest in productive capacity, even if he wants to. You're going to see gigantic shortages developing over the next few years. The inventories of food worldwide are already at the lowest levels they've been in 50 years. This may turn into the Great Depression II. But if and when we come out of this, commodities are going to lead the way, just as they did in the 1970s when everything was a disaster and commodities went through the roof.
What I've been buying recently is agricultural commodities. I've also been buying more Chinese stocks. And I'm buying stocks in Taiwan for the first time in my life. It looks as if there's finally going to be peace in Taiwan after 60 years, and Taiwanese companies are going to benefit from the long-term growth of China.
I have covered most of my short positions in U.S. stocks, and I'm now selling long-term U.S. government bonds short. That's the last bubble I can find in the U.S. I cannot imagine why anybody would give money to the U.S. government for 30 years for less than a 4% yield. I certainly wouldn't. There are going to be gigantic amounts of bonds coming to the market, and inflation will be coming back.
In my view, U.S. stocks are still not attractive. Historically, you buy stocks when they're yielding 6% and selling at eight times earnings. You sell them when they're at 22 times earnings and yielding 2%. Right now U.S. stocks are down a lot, but they're still very expensive by that historical valuation method. The U.S. market is yielding 3% today. For stocks to go to a 6% yield without big dividend increases, the Dow will need to go below 4000. I'm not saying it will fall that far, but it could very well happen. And if it gets that low and I'm still solvent, I hope I'm smart enough to buy a lot. The key in times like these is to stay solvent so you can load up when opportunity comes."
So please, feel free, ask and comment away and lets define together what we face and what individuals should do about it.
Anyway, its demise has made the blog more popular, but I not a complete gloom and doomer. I very much think that both hard and commodities, gold, silver, oil and alternate energy are very undervalued.
Commodity producers, energy and alternate energy services will the the cash rich core around which many economy's will rebuild and this will be reflected in the popular culture.
I agree with Jim Rogers.
Jim Rogers
"The commodities guru predicted two years ago that the credit bubble would devastate Wall Street.
We are in a period of forced liquidation, which has happened only eight or nine times in the past 150 years. The fact that it's historic doesn't make it any more fun, of course. But it is a pretty interesting time when there is forced selling of everything with no regard for facts or fundamentals at all. Historically, the way you make money in times like these is that you find things where the fundamentals are unimpaired. The fundamentals of GM are impaired. The fundamentals of Citigroup are impaired.
Virtually the only asset class I know where the fundamentals are not impaired - in fact, where they are actually improving - is commodities. Farmers cannot get a loan to buy fertilizer right now. Nobody's going to get a loan to open a zinc or a lead mine. Meanwhile, every day the supply of commodities shrinks more and more. Nobody can invest in productive capacity, even if he wants to. You're going to see gigantic shortages developing over the next few years. The inventories of food worldwide are already at the lowest levels they've been in 50 years. This may turn into the Great Depression II. But if and when we come out of this, commodities are going to lead the way, just as they did in the 1970s when everything was a disaster and commodities went through the roof.
What I've been buying recently is agricultural commodities. I've also been buying more Chinese stocks. And I'm buying stocks in Taiwan for the first time in my life. It looks as if there's finally going to be peace in Taiwan after 60 years, and Taiwanese companies are going to benefit from the long-term growth of China.
I have covered most of my short positions in U.S. stocks, and I'm now selling long-term U.S. government bonds short. That's the last bubble I can find in the U.S. I cannot imagine why anybody would give money to the U.S. government for 30 years for less than a 4% yield. I certainly wouldn't. There are going to be gigantic amounts of bonds coming to the market, and inflation will be coming back.
In my view, U.S. stocks are still not attractive. Historically, you buy stocks when they're yielding 6% and selling at eight times earnings. You sell them when they're at 22 times earnings and yielding 2%. Right now U.S. stocks are down a lot, but they're still very expensive by that historical valuation method. The U.S. market is yielding 3% today. For stocks to go to a 6% yield without big dividend increases, the Dow will need to go below 4000. I'm not saying it will fall that far, but it could very well happen. And if it gets that low and I'm still solvent, I hope I'm smart enough to buy a lot. The key in times like these is to stay solvent so you can load up when opportunity comes."
So please, feel free, ask and comment away and lets define together what we face and what individuals should do about it.
6 December 2008
Hamilton ~ Negative real rates drive Gold bull
by Adam Hamilton
It's been a tough year for gold investors. Instead of soaring during the great fear and uncertainty of the global financial panic as most gold investors expected, gold got caught up in the selling. Thus it is down 7.3% year-to-date. This is far-better performance than virtually everything else, especially the S&P 500's 40.7% YTD loss. Nevertheless, the lack of a flight to gold in such dire conditions remains disappointing.
Why didn't gold rally? Capital fleeing out of the imploding bond and stock markets flooded into US Treasuries at staggering rates. While Treasuries weren't yielding much, at least they sheltered capital from the surrounding universal panic selling. Before taking refuge in Treasuries, foreign investors first had to buy US dollars. This frenzied dynamic drove a monster dollar rally which hammered gold futures.
Since gold has been the financial-panic asset of choice for centuries, its lackluster trading action during the last couple months has really shaken gold investors' confidence. While physical-coin demand has been very high from small investors, big investors did not rush to buy gold as stock-market fear soared to unprecedented sustained levels. This is leading to questions about this gold bull's ongoing viability.
During times like these when the technical action and sentiment feel terrible, I find it useful to return to the core fundamentals. I started recommending physical gold coins to our subscribers back in May 2001 when gold traded in the $260s. In the 7+ years since, gold has seen plenty of good and bad spells. Yet one major fundamental driver remained steadfastly bullish throughout this bull, real interest rates.
Real rates are the returns realized by bond investors after inflation is subtracted out. If you earn 5% in Treasuries, and inflation is running 3%, then you earn a 2% real return. Much of the 1.05x growth in your nominal capital is eroded by the relentless loss of purchasing power in the dollar. What you could buy last year for $1.00 now costs $1.03, so in terms of real goods and services you aren't advancing as fast.
Normally real rates are positive. For putting their hard-earned capital at risk, debt investors deserve to earn a real purchasing-power return after inflation for their efforts. Even though they don't accept much risk compared to stock investors, they still need to be fairly compensated for this risk. If they are not, they will invest less over the long term because it is pointless to risk scarce capital for a guaranteed loss.
Would you loan money to anyone if you knew you would take a real loss for doing so? Not if you are rational. When nominal interest rates are forced so low by central banks that real returns plunge negative, debt investing becomes a losing proposition. In such a hostile environment, debt investors gradually turn to gold. While bonds guarantee them a real loss, gold will at least keep pace with inflation to preserve the purchasing power of their capital.
To understand the interaction between real rates and gold, you really have to take the long view. Since it takes years for investors to perceive the impact of inflation and change their behavior accordingly, gold doesn't react overnight. But eventually react it does, and this is very clear over a long-enough time slice. The longer real bond returns are poor or negative, the more capital gradually takes refuge in gold.
Interestingly I wrote my first essay in this series back in July 2001 when gold traded in the $260s. Back then real rates had yet to go negative but the Fed was hellbent on driving them there. At that time, we only had the example of the 1970s to consider. But now, the lion's share of a decade later, the real-rates-and-gold comparison is vividly apparent in the 2000s as well. Just as expected, when central banks attack debt investors they gradually forsake losing bonds and migrate into gold.
While researching real rates, I try to use the most-conservative-possible measures. While this really understates the bullish case for gold, it is much easier for mainstream investors to accept and very easy for contrarians to defend. Since most interest rates are still driven by the free markets despite all of Washington's incessant socialist meddling, the inflation measure used is where conservatism comes into play.
Wall Street believes the US government's Consumer Price Index is an accurate measure of inflation. Everyone accepts the CPI as gospel, so I've always used it in this research thread. Since inflation is truly defined as monetary growth, the growth rates in the money supplies are a far-superior measure. With the Fed running its printing presses like there is no tomorrow, relatively more money is chasing relatively less goods and services which drives up nominal prices.
Over the past year, the broad MZM money supply in the US has grown by 9.9%! This is much closer to true inflation than the CPI's modest 3.7% gain. For a variety of reasons including inflation-indexed welfare payments as well as inflationary perceptions' impact on the financial markets, the government statisticians intentionally lowball the CPI via mathematical wizardry. It is really a garbage indicator, but to most market participants the CPI is inflation. So I use it to be conservative, which really understates the case for gold.
To compute real rates, you simply take the nominal rate of return and subtract annual inflation growth. The purest and most-conservative interest rate to use is the yield on the 1-year US Treasury Bill. All over the world, short-term US Treasuries are considered "risk-free" investments that are the foundation for interest rates. Since Washington can create infinite fiat US dollars out of thin air to pay Treasury investors, there is really no risk of default unless a rebellion or invasion takes out Washington.
Also on real-rates analysis, synching up the time periods is crucial. Since interest rates are typically thought of in annual terms, a 1-year span is ideal. And 1y T-bill yields match up perfectly with the year-over-year change in the CPI. So 1y T-bill yields minus the YoY CPI growth equals real interest rates. Comparing these to gold over strategic time spans is very interesting.
In these charts, 1y T-bill yields are rendered in black. The YoY CPI change, which is only published once a month and hence looks stair-steppy, is drawn in white. The difference between this nominal yield and inflation is the real rate shown in blue. Finally gold is superimposed over the top of all this interest-rate data in red. As you'll see, low and negative real rates are very bullish for gold.
It always strikes me as ironic. Manipulation theorists spend endless hours railing about perceived manipulation in tiny subsets of the financial markets. But the biggest manipulation of all is out in the open. Like the old Soviet Politburo, the unconstitutional Federal Reserve meets in secret to set the price for money traded among banks. If the Fed was abolished as it should be, and overnight rates operated in a truly free market, the entire financial system would be infinitely more sound than it is today.
In real-rates analysis, we have to start with nominal interest rates. And the shorter the term of a debt instrument, the more the Fed's heavy-handed manipulation influences its yields. 3m Treasuries usually trade in lockstep with the Fed's target overnight bank rate (fed funds), while 30y Treasuries largely ignore it. Since 1y Treasuries are relatively short on this time scale, they are heavily influenced by Fed manipulations.
The black 1y Treasury yield line above looks very similar to the Fed's fed-funds-rate target. Since the Fed dominates the short end of the yield curve, it also dominates real rates. When the Fed drives its own interest rates to artificially-low levels, 1y T-bill yields follow. And if these nominal returns fall below the rate of headline inflation growth, all of a sudden debt investors are losing purchasing power by investing.
Back in 2000, Treasury yields were reasonable near 6%. Investors earned a fair return on their precious capital while debtors paid a fair rate to borrow it, above inflation on both fronts. But in early 2001, the healthy post-tech-stock-bubble bear spooked Alan Greenspan into sowing the seeds for today's calamity. To try and reinflate a stock bubble, the Fed drove nominal rates down to inflation rates so real rates fell to zero.
Note above that gold was languishing, consolidating after a multi-decade bear, until real rates fell decisively under 1%. And gold really didn't start accelerating until real rates went negative in 2002. Negative real rates drive investment demand for gold because bonds become unattractive. Investor preference gradually switches to gold, which will keep pace with inflation, instead of falling behind in under-yielding bonds.
Of course the Fed's monetary inflation never goes where the Fed wants it to. In trying to reinflate the stock markets, Greenspan instead ignited the housing bubble. Its terrible aftermath is apparent today. Never learning any lessons from history, the Fed is doing the same thing today that it did in the early 2000s. It just forced nominal rates down near 1% again to attempt to reinflate the housing bubble. Of course this new monetary inflation will go elsewhere to.
Between 2001 and 2006, with real rates at +1% or lower, gold thrived. It wasn't until real rates decisively headed over 1% again in mid-2006 that gold finally stopped advancing to consolidate. But as soon as the Fed panicked again in late 2007 and started slashing rates, real rates plummeted. Not surprisingly, gold simultaneously soared. More and more bond investors grew discouraged by the Fed's attack on them and bought gold.
Now realize there are many short-term forces acting on gold, such as the US dollar's behavior, general commodities trends, and overall financial-market sentiment. So there are many short-term places in this chart where gold and real rates are not tightly correlated. But if you filter out technical noise and examine this decade as a whole, it is crystal clear that gold has been very strong during a time of low and negative real rates. They spark big gold investment demand.
In late 2007 real rates plunged negative again as Ben Bernanke failed to learn the lessons from Alan Greenspan's disastrous easy-money inflationary orgy. By early 2008 they were -2%, the lowest levels seen in decades. Naturally gold was rocketing higher and headed above $1000 by March. And while gold did get caught up in the brutal commodities correction and global stock panic since, it remains near nice high levels in the context of its secular bull.
And check out real rates in the last 6 months or so. They have been -2% at best, falling to under -3% at times to their lowest levels since summer 1980! This is incredibly bullish for gold. Once the stock panic fades and the dollar-buying frenzy abates, fundamentals will again drive gold. And a negative-real-rate monetary environment hostile to bond investors is the most-bullish-possible environment for gold.
History is very clear in illustrating this fact, which we'll get to shortly here. But first consider the likely future course for real rates. CPI inflation growth is in a clear uptrend as rendered above. While prices for many things plunged during the panic of October and November 2008, prices will quickly stabilize as fear evaporates. So odds are this CPI uptrend will continue. With the Fed's incredible monetary growth, 10% in MZM compared to 0% growth in the US economy, higher general prices are absolutely inevitable.
And if CPI inflation remains at 4%+, heck even 3%+, real rates will stay negative. Failure is an important part of capitalism as it moves assets from incompetent managers to competent managers to keep the economy fresh and vibrant. But for some reason, those traitorous scum in Washington have decided no one should fail. They are hellbent on keeping interest rates artificially low forever if necessary so failed companies and managers can sit on and lock up stagnating assets. Karl Marx would be very proud.
Imagine what would happen if the Fed actually had the courage to quadruple interest rates to make the bond markets mutually beneficial to both investors and debtors again. Overextended debtors would actually fail! Oh the horror! Until nominal rates get up to the 4%+ range again, real rates will remain negative. And I can't see any way our cowardly Fed can raise rates substantially for a long time to come.
With a brutally negative real-rate environment here now and likely to persist for years, the monetary case for gold is exceedingly bullish. If bond investors can't earn a real return after inflation for the risks they take, they will be much better off holding gold. Sure, it doesn't pay a yield. But bonds really don't pay much today either. And unlike bond yields, gold will rise to keep pace with monetary inflation. Investors' purchasing power will be preserved.
All these monetary truths are readily apparent now, proved again in this past decade. But in mid-2001 when I started this thread of research, all we had to rely upon was history. Looking at gold and real rates since 1970 is fascinating. This chart is similar to the prior one except the gold price is adjusted for CPI inflation. Negative real rates helped drive the famous 1970s gold bull, which was far larger than today's so far.
Once again, there are a myriad of short-term factors that affect the gold price. So if you look closely, you can find short-term exceptions to the negative-real-rates-are-great-for-gold rule. But if you carefully consider this chart as a whole, the strategic implications of negative real rates become very apparent. In a secular sense gold does best when real rates are low or negative, and worst when they are healthy.
The 1970s was a time of inflation exceeding the nominal returns available on bonds. So debt investors, acting totally rationally, gradually shifted capital into gold. These investors drove a strong gold bull that speculators ultimately flooded into at the very end, igniting a legendary gold bubble. While the monthly data in this chart doesn't show the daily high, in today's 2008 dollars gold approached $2400 an ounce in January 1980! Today's gold bull isn't even close to seeing a similar blowoff top yet.
That 1970s gold bull only ended when Paul Volcker courageously hiked short-term interest rates dramatically until real rates shot positive to healthy levels again. With excellent 4% to 8% real returns available in bonds, investment demand for gold collapsed. And it didn't reignite again until decades later when real rates finally threatened to once more plunge decisively negative.
By foolishly deciding to bail out speculators in the housing bubble, including highly-leveraged banks and highly-leveraged house "owners", the Fed has trapped itself. Interest rates are way too low, they do not offer realistic returns for bond investors. Yet if the Fed raises rates to more rational levels, the speculators it is trying to bail out are going to fail. While healthy over the long term, this is apparently unacceptable politically.
As long as the Fed strong-arms nominal rates to levels under headline inflation, real rates are going to remain negative. Instead of sitting in bonds and losing real purchasing power year after year, increasing numbers of bond investors are going to park capital in gold to protect it from all this monetary inflation. Even though gold doesn't pay a yield, as long as it merely paces inflation it is a much better investment than bonds lagging behind inflation.
This argument certainly isn't new today. Back in 2001, the coming negative real rates were one of the main fundamental reasons I recommended our subscribers buy physical gold coins for core long-term investments. When the price of money isn't set by the free markets, when it isn't mutually beneficial and robs from investors to subsidize debtors, investors gradually pull out of the debt markets.
In July 2001 I opened my first essay in this series with a 1993 quotation from a Federal Reserve official. He said, "The Fed's attempts to stimulate the economy during the 1970s through what amounted to a policy of extremely low real interest rates led to steadily rising inflation that was finally checked at great cost during the 1980s." Sounds like today, no? Bernanke is doing the same thing done in the 1970s, and his endless easy money will ultimately lead to the same result, massive inflation.
Of course gold is the ultimate asset in highly inflationary times. And the unfathomable quantity of fiat-paper dollars the Fed is creating out of thin air to force-feed into the financial system these days is going to eventually manifest itself in tremendous inflation. This will drive great investment demand in gold and lead to gold's gains not only pacing inflation, but far exceeding it as more and more investors buy.
Gold didn't look great in the last few months, I agree. But don't let technical and sentiment anomalies cloud your perceptions of secular fundamental realities. Today's negative-real-rate environment courtesy of the Fed is the most-bullish-possible monetary environment for gold. Thus at Zeal we have been adding gold and gold-stock positions lately despite all the carnage. Contrarians buy when no one else wants to.
If you are wondering what to do with your capital after weathering the worst of the stock panic, the gold realm is a great place to put a sizeable chunk of it. I don't know of any more-bullish asset class in today's environment. I am more excited about gold today than I was in early 2001 before it quadrupled. To learn about and navigate these treacherous markets, and thrive as this panic abates, subscribe today to our acclaimed monthly newsletter.
The bottom line is negative real rates are one of gold's most powerful fundamental drivers. And thanks to the Fed refusing to let housing speculators fail as they should, negative real rates are going to persist for a long time to come. Maybe years. But bond investors are not dumb. They won't invest for long in an environment where their capital is guaranteed to lose real purchasing power. Some will migrate into gold.
Negative real rates were the monetary foundation of the biggest secular gold bulls in modern history, the 1970s and the 2000s. And just as it took radically high 6%+ real rates to end that 1970s gold bull, this bull isn't likely to end until we see sustained hugely positive real rates as well. In the meantime, gold will continue to thrive on balance despite big pullbacks from time to time driven by capricious sentiment.
Da Man
It's been a tough year for gold investors. Instead of soaring during the great fear and uncertainty of the global financial panic as most gold investors expected, gold got caught up in the selling. Thus it is down 7.3% year-to-date. This is far-better performance than virtually everything else, especially the S&P 500's 40.7% YTD loss. Nevertheless, the lack of a flight to gold in such dire conditions remains disappointing.
Why didn't gold rally? Capital fleeing out of the imploding bond and stock markets flooded into US Treasuries at staggering rates. While Treasuries weren't yielding much, at least they sheltered capital from the surrounding universal panic selling. Before taking refuge in Treasuries, foreign investors first had to buy US dollars. This frenzied dynamic drove a monster dollar rally which hammered gold futures.
Since gold has been the financial-panic asset of choice for centuries, its lackluster trading action during the last couple months has really shaken gold investors' confidence. While physical-coin demand has been very high from small investors, big investors did not rush to buy gold as stock-market fear soared to unprecedented sustained levels. This is leading to questions about this gold bull's ongoing viability.
During times like these when the technical action and sentiment feel terrible, I find it useful to return to the core fundamentals. I started recommending physical gold coins to our subscribers back in May 2001 when gold traded in the $260s. In the 7+ years since, gold has seen plenty of good and bad spells. Yet one major fundamental driver remained steadfastly bullish throughout this bull, real interest rates.
Real rates are the returns realized by bond investors after inflation is subtracted out. If you earn 5% in Treasuries, and inflation is running 3%, then you earn a 2% real return. Much of the 1.05x growth in your nominal capital is eroded by the relentless loss of purchasing power in the dollar. What you could buy last year for $1.00 now costs $1.03, so in terms of real goods and services you aren't advancing as fast.
Normally real rates are positive. For putting their hard-earned capital at risk, debt investors deserve to earn a real purchasing-power return after inflation for their efforts. Even though they don't accept much risk compared to stock investors, they still need to be fairly compensated for this risk. If they are not, they will invest less over the long term because it is pointless to risk scarce capital for a guaranteed loss.
Would you loan money to anyone if you knew you would take a real loss for doing so? Not if you are rational. When nominal interest rates are forced so low by central banks that real returns plunge negative, debt investing becomes a losing proposition. In such a hostile environment, debt investors gradually turn to gold. While bonds guarantee them a real loss, gold will at least keep pace with inflation to preserve the purchasing power of their capital.
To understand the interaction between real rates and gold, you really have to take the long view. Since it takes years for investors to perceive the impact of inflation and change their behavior accordingly, gold doesn't react overnight. But eventually react it does, and this is very clear over a long-enough time slice. The longer real bond returns are poor or negative, the more capital gradually takes refuge in gold.
Interestingly I wrote my first essay in this series back in July 2001 when gold traded in the $260s. Back then real rates had yet to go negative but the Fed was hellbent on driving them there. At that time, we only had the example of the 1970s to consider. But now, the lion's share of a decade later, the real-rates-and-gold comparison is vividly apparent in the 2000s as well. Just as expected, when central banks attack debt investors they gradually forsake losing bonds and migrate into gold.
While researching real rates, I try to use the most-conservative-possible measures. While this really understates the bullish case for gold, it is much easier for mainstream investors to accept and very easy for contrarians to defend. Since most interest rates are still driven by the free markets despite all of Washington's incessant socialist meddling, the inflation measure used is where conservatism comes into play.
Wall Street believes the US government's Consumer Price Index is an accurate measure of inflation. Everyone accepts the CPI as gospel, so I've always used it in this research thread. Since inflation is truly defined as monetary growth, the growth rates in the money supplies are a far-superior measure. With the Fed running its printing presses like there is no tomorrow, relatively more money is chasing relatively less goods and services which drives up nominal prices.
Over the past year, the broad MZM money supply in the US has grown by 9.9%! This is much closer to true inflation than the CPI's modest 3.7% gain. For a variety of reasons including inflation-indexed welfare payments as well as inflationary perceptions' impact on the financial markets, the government statisticians intentionally lowball the CPI via mathematical wizardry. It is really a garbage indicator, but to most market participants the CPI is inflation. So I use it to be conservative, which really understates the case for gold.
To compute real rates, you simply take the nominal rate of return and subtract annual inflation growth. The purest and most-conservative interest rate to use is the yield on the 1-year US Treasury Bill. All over the world, short-term US Treasuries are considered "risk-free" investments that are the foundation for interest rates. Since Washington can create infinite fiat US dollars out of thin air to pay Treasury investors, there is really no risk of default unless a rebellion or invasion takes out Washington.
Also on real-rates analysis, synching up the time periods is crucial. Since interest rates are typically thought of in annual terms, a 1-year span is ideal. And 1y T-bill yields match up perfectly with the year-over-year change in the CPI. So 1y T-bill yields minus the YoY CPI growth equals real interest rates. Comparing these to gold over strategic time spans is very interesting.
In these charts, 1y T-bill yields are rendered in black. The YoY CPI change, which is only published once a month and hence looks stair-steppy, is drawn in white. The difference between this nominal yield and inflation is the real rate shown in blue. Finally gold is superimposed over the top of all this interest-rate data in red. As you'll see, low and negative real rates are very bullish for gold.
It always strikes me as ironic. Manipulation theorists spend endless hours railing about perceived manipulation in tiny subsets of the financial markets. But the biggest manipulation of all is out in the open. Like the old Soviet Politburo, the unconstitutional Federal Reserve meets in secret to set the price for money traded among banks. If the Fed was abolished as it should be, and overnight rates operated in a truly free market, the entire financial system would be infinitely more sound than it is today.
In real-rates analysis, we have to start with nominal interest rates. And the shorter the term of a debt instrument, the more the Fed's heavy-handed manipulation influences its yields. 3m Treasuries usually trade in lockstep with the Fed's target overnight bank rate (fed funds), while 30y Treasuries largely ignore it. Since 1y Treasuries are relatively short on this time scale, they are heavily influenced by Fed manipulations.
The black 1y Treasury yield line above looks very similar to the Fed's fed-funds-rate target. Since the Fed dominates the short end of the yield curve, it also dominates real rates. When the Fed drives its own interest rates to artificially-low levels, 1y T-bill yields follow. And if these nominal returns fall below the rate of headline inflation growth, all of a sudden debt investors are losing purchasing power by investing.
Back in 2000, Treasury yields were reasonable near 6%. Investors earned a fair return on their precious capital while debtors paid a fair rate to borrow it, above inflation on both fronts. But in early 2001, the healthy post-tech-stock-bubble bear spooked Alan Greenspan into sowing the seeds for today's calamity. To try and reinflate a stock bubble, the Fed drove nominal rates down to inflation rates so real rates fell to zero.
Note above that gold was languishing, consolidating after a multi-decade bear, until real rates fell decisively under 1%. And gold really didn't start accelerating until real rates went negative in 2002. Negative real rates drive investment demand for gold because bonds become unattractive. Investor preference gradually switches to gold, which will keep pace with inflation, instead of falling behind in under-yielding bonds.
Of course the Fed's monetary inflation never goes where the Fed wants it to. In trying to reinflate the stock markets, Greenspan instead ignited the housing bubble. Its terrible aftermath is apparent today. Never learning any lessons from history, the Fed is doing the same thing today that it did in the early 2000s. It just forced nominal rates down near 1% again to attempt to reinflate the housing bubble. Of course this new monetary inflation will go elsewhere to.
Between 2001 and 2006, with real rates at +1% or lower, gold thrived. It wasn't until real rates decisively headed over 1% again in mid-2006 that gold finally stopped advancing to consolidate. But as soon as the Fed panicked again in late 2007 and started slashing rates, real rates plummeted. Not surprisingly, gold simultaneously soared. More and more bond investors grew discouraged by the Fed's attack on them and bought gold.
Now realize there are many short-term forces acting on gold, such as the US dollar's behavior, general commodities trends, and overall financial-market sentiment. So there are many short-term places in this chart where gold and real rates are not tightly correlated. But if you filter out technical noise and examine this decade as a whole, it is crystal clear that gold has been very strong during a time of low and negative real rates. They spark big gold investment demand.
In late 2007 real rates plunged negative again as Ben Bernanke failed to learn the lessons from Alan Greenspan's disastrous easy-money inflationary orgy. By early 2008 they were -2%, the lowest levels seen in decades. Naturally gold was rocketing higher and headed above $1000 by March. And while gold did get caught up in the brutal commodities correction and global stock panic since, it remains near nice high levels in the context of its secular bull.
And check out real rates in the last 6 months or so. They have been -2% at best, falling to under -3% at times to their lowest levels since summer 1980! This is incredibly bullish for gold. Once the stock panic fades and the dollar-buying frenzy abates, fundamentals will again drive gold. And a negative-real-rate monetary environment hostile to bond investors is the most-bullish-possible environment for gold.
History is very clear in illustrating this fact, which we'll get to shortly here. But first consider the likely future course for real rates. CPI inflation growth is in a clear uptrend as rendered above. While prices for many things plunged during the panic of October and November 2008, prices will quickly stabilize as fear evaporates. So odds are this CPI uptrend will continue. With the Fed's incredible monetary growth, 10% in MZM compared to 0% growth in the US economy, higher general prices are absolutely inevitable.
And if CPI inflation remains at 4%+, heck even 3%+, real rates will stay negative. Failure is an important part of capitalism as it moves assets from incompetent managers to competent managers to keep the economy fresh and vibrant. But for some reason, those traitorous scum in Washington have decided no one should fail. They are hellbent on keeping interest rates artificially low forever if necessary so failed companies and managers can sit on and lock up stagnating assets. Karl Marx would be very proud.
Imagine what would happen if the Fed actually had the courage to quadruple interest rates to make the bond markets mutually beneficial to both investors and debtors again. Overextended debtors would actually fail! Oh the horror! Until nominal rates get up to the 4%+ range again, real rates will remain negative. And I can't see any way our cowardly Fed can raise rates substantially for a long time to come.
With a brutally negative real-rate environment here now and likely to persist for years, the monetary case for gold is exceedingly bullish. If bond investors can't earn a real return after inflation for the risks they take, they will be much better off holding gold. Sure, it doesn't pay a yield. But bonds really don't pay much today either. And unlike bond yields, gold will rise to keep pace with monetary inflation. Investors' purchasing power will be preserved.
All these monetary truths are readily apparent now, proved again in this past decade. But in mid-2001 when I started this thread of research, all we had to rely upon was history. Looking at gold and real rates since 1970 is fascinating. This chart is similar to the prior one except the gold price is adjusted for CPI inflation. Negative real rates helped drive the famous 1970s gold bull, which was far larger than today's so far.
Once again, there are a myriad of short-term factors that affect the gold price. So if you look closely, you can find short-term exceptions to the negative-real-rates-are-great-for-gold rule. But if you carefully consider this chart as a whole, the strategic implications of negative real rates become very apparent. In a secular sense gold does best when real rates are low or negative, and worst when they are healthy.
The 1970s was a time of inflation exceeding the nominal returns available on bonds. So debt investors, acting totally rationally, gradually shifted capital into gold. These investors drove a strong gold bull that speculators ultimately flooded into at the very end, igniting a legendary gold bubble. While the monthly data in this chart doesn't show the daily high, in today's 2008 dollars gold approached $2400 an ounce in January 1980! Today's gold bull isn't even close to seeing a similar blowoff top yet.
That 1970s gold bull only ended when Paul Volcker courageously hiked short-term interest rates dramatically until real rates shot positive to healthy levels again. With excellent 4% to 8% real returns available in bonds, investment demand for gold collapsed. And it didn't reignite again until decades later when real rates finally threatened to once more plunge decisively negative.
By foolishly deciding to bail out speculators in the housing bubble, including highly-leveraged banks and highly-leveraged house "owners", the Fed has trapped itself. Interest rates are way too low, they do not offer realistic returns for bond investors. Yet if the Fed raises rates to more rational levels, the speculators it is trying to bail out are going to fail. While healthy over the long term, this is apparently unacceptable politically.
As long as the Fed strong-arms nominal rates to levels under headline inflation, real rates are going to remain negative. Instead of sitting in bonds and losing real purchasing power year after year, increasing numbers of bond investors are going to park capital in gold to protect it from all this monetary inflation. Even though gold doesn't pay a yield, as long as it merely paces inflation it is a much better investment than bonds lagging behind inflation.
This argument certainly isn't new today. Back in 2001, the coming negative real rates were one of the main fundamental reasons I recommended our subscribers buy physical gold coins for core long-term investments. When the price of money isn't set by the free markets, when it isn't mutually beneficial and robs from investors to subsidize debtors, investors gradually pull out of the debt markets.
In July 2001 I opened my first essay in this series with a 1993 quotation from a Federal Reserve official. He said, "The Fed's attempts to stimulate the economy during the 1970s through what amounted to a policy of extremely low real interest rates led to steadily rising inflation that was finally checked at great cost during the 1980s." Sounds like today, no? Bernanke is doing the same thing done in the 1970s, and his endless easy money will ultimately lead to the same result, massive inflation.
Of course gold is the ultimate asset in highly inflationary times. And the unfathomable quantity of fiat-paper dollars the Fed is creating out of thin air to force-feed into the financial system these days is going to eventually manifest itself in tremendous inflation. This will drive great investment demand in gold and lead to gold's gains not only pacing inflation, but far exceeding it as more and more investors buy.
Gold didn't look great in the last few months, I agree. But don't let technical and sentiment anomalies cloud your perceptions of secular fundamental realities. Today's negative-real-rate environment courtesy of the Fed is the most-bullish-possible monetary environment for gold. Thus at Zeal we have been adding gold and gold-stock positions lately despite all the carnage. Contrarians buy when no one else wants to.
If you are wondering what to do with your capital after weathering the worst of the stock panic, the gold realm is a great place to put a sizeable chunk of it. I don't know of any more-bullish asset class in today's environment. I am more excited about gold today than I was in early 2001 before it quadrupled. To learn about and navigate these treacherous markets, and thrive as this panic abates, subscribe today to our acclaimed monthly newsletter.
The bottom line is negative real rates are one of gold's most powerful fundamental drivers. And thanks to the Fed refusing to let housing speculators fail as they should, negative real rates are going to persist for a long time to come. Maybe years. But bond investors are not dumb. They won't invest for long in an environment where their capital is guaranteed to lose real purchasing power. Some will migrate into gold.
Negative real rates were the monetary foundation of the biggest secular gold bulls in modern history, the 1970s and the 2000s. And just as it took radically high 6%+ real rates to end that 1970s gold bull, this bull isn't likely to end until we see sustained hugely positive real rates as well. In the meantime, gold will continue to thrive on balance despite big pullbacks from time to time driven by capricious sentiment.
Da Man
4 December 2008
The Value of Money
BY JAIME E. CARRASCO CFP
The global financial storm that we have entered is causing much worry and concern throughout the world. I too have stayed awake many a night reviewing this tempest so that I can decide on our best course of action. So far, I have only been surprised by the speed by which it has unraveled — never in my wildest assumptions did I think the system was this weak. Through recent careful study of the situation, I believe I can see how this financial mess may unravel and what course of action the rational investor might take.
Inflation or deflation? — that is the question as to how the mess will unravel. It is extremely important that we understand this debate as its outcome will have serious implications for your financial wellbeing. My observations and conclusions are that the outcome of this mess will lead to inflation. I believe "the deflationists" are wrong. The main arguments for the deflationists are based upon two premises: first, the fact that deflation was the outcome of the Great Depression of the 1930s and of Japan in the 1990s; second the argument that the levels of debt are so big that the Central Banks could never print as much to offset the deflationary effect of unwinding the debt. A historical study of these arguments reveals that deflation is a rarity. Furthermore, we have the experience of all other financial storms over the past century (apart from The Great Depression and Japan in the 90s) creating inflation. Inflation has been the historical norm. It is important to understand why so that one can make rational investments decisions.
Mervyn King, Deputy Governor of the Bank of England, wrote a very good paper on the subject in 2001. In this paper, King traces the effect of money and inflation all the way back to 1885. His main conclusion is that the ability of Central Banks to create money always leads to inflation. This was not the case during the Great Depression as the US Fed was unable to print money because the currency was pegged to the gold standard; thus it was impossible to inflate the money supply. This is the topic of Ben Bernanke's thesis: if the Fed had had the ability to print money in the 30's, they would have been able to inflate and avoid the deflationary pain. In the words of the Maestro himself, Ben Bernanke;
"Suppose that, despite all precautions, deflation were to take hold in the US-economy and moreover, that the Fed's policy instrument, the federal funds rate, were to fall to zero. What then? Well, the US government has a technology, called a printing press, or today, its electronic equivalent, that allows it to produce as many US-dollars as it wishes at essentially no cost."
It is important to understand that deflation is the Central Banks' greatest fear as it is the one thing they cannot control. Furthermore, one must also understand that the Central Banks' sole aim right now is inflation through their monetary control — an outcome that is easier to control down the road. In this context the Central Banks will continue to increase the money supply and inflate.
As I wrote earlier, I was surprised by the rapidity of the unwinding yet now realize that all that has happened is a fast forwarding to a point we all will have reached anyway. To explain, if Lehman Brothers had been bailed out like the other financial institutions, the world would never have witnessed the massive liquidation of assets that has taken place over the last two months. In this alternative scenario the Fed would have been able to slowly control the process through money creation in order to fund the bailouts needed to slow the unraveling of its financial system, all the while with inflation rising. However the Fed took a detour and institutions have been forced to liquidate their holdings so that they can pay back their obligations, resulting in some great assets being thrown out with the dirty bath water. What many have mistaken for deflation has only been a forced liquidation by hedge funds and financial institutions trying to meet their financial obligations. The question we must ask is why this was allowed. Oddly enough, everything that is required to best deal with this mess is happening.
If there was a central banker manual the best solution to this mess would require an extension of these bad debts as long as possible, 10 to 30 years is preferable. Next it would be great if this could be facilitated with as low a rate as possible in order to reduce the already enormous cost to the taxpayer. And finally, if the currency was to decline as much as possible the problem would be inflated away. And wouldn’t you know it, thirty year bonds at 3.19%, wow! What are the chances that the dollar goes next? However, this route will result in inflation like we have never seen before, and the rational investor must prepare in order to benefit.
ENERGY
In November the International Energy Agency issued its November report on the status of the global energy complex. This was a very important report as the IEA finally did a study of the long term supply of world energy, and the conclusions are not good. What I find amazing is how the Wall Street pundits and the media completely neglected to mention 99% of the 400 page report and only concentrated on the fact that the IEA now expects global oil demand to grow by only 120,000 b/d in 2008, to 86.2m b/d, the lowest annual increase for 23 years. Of greater importance to me were the warnings in the remainder of the report of a coming perfect storm in the energy sector. The report is sounding the alarm that our ability to supply the world with the needed energy to meet global demand is in dire straits due to three factors: 1. ongoing and accelerating reservoir depletion, 2. lack of capital investment, and 3. continued global demand for energy.
In this environment Canada looks very bright as, net of new discoveries, we are the only producing oil country that can actually increase oil production, and with no political risk. Yet our oil companies are trading as though oil is going to $35 and with tax free yields above 11%. I love the irrational decisions people make due to fear. My convictions of investments in the Canadian oil sector were once more confirmed at a recent meeting with John Priestmam, Manager of the Guardian Monthly High Income Fund. In his opinion the current pricing of Canadian energy income trust is presenting a great opportunity for the rational investor, from a valuation and income perspective. It is my conviction that all evidence points to the fact that this is the last time we will see these low prices and yet irrational short term sighted investors are giving these assets away at liquidation prices.
AGRICULTURE
Another sector with similar characteristics as energy is agriculture. One need only look at a company like Agrium to understand the current irrationality of investors. Agrium is currently trading at a ridiculous 3.5 P/E, yet its sales increased from $900 million Q3 2007 to $3,200 million Q3 2008, and management is telling us that they have very good visibility of earnings for the next two years. I urge you to listen to the latest quarterly Webcast for both Agrium and Potash. The rational investor will very quickly realize why they should consider investments in this sector.
The current financial mess has not resolved the fact that we are currently using 98% of the planet's arable land to feed the world, and that global food stocks are still at all time lows and not increasing. In addition, as the energy issues progress, our ability to grow food will also be affected for two reasons: 1. diversion of food stocks to ethanol production, and 2. increases in the price of natural gas to meet energy needs will lead to higher fertilizer costs. For some reason we have forgotten that the Green Revolution was due to the discovery of hydrocarbons and that as these decline our ability to feed the world will decline. As matter of historical fact, in the late 1800's Chile fought Peru and Bolivia over control of the nitrate fields in what is today northern Chile. Today I believe Potash and Agrium are investments with great outlooks on earnings for many years to come due to the need to feed a growing world, and yet they are currently priced as though the world is on a diet.
US 30 YEAR BONDS
Having been an institutional bond trader, it is absolutely unbelievable to me that the 30-year US bond is trading at a yield of 3.19%. In light of the current liabilities facing the US government (discussed below) and the fact of the coming Baby Boomer cohort's retirement, I can't help but conclude that the final credit bubble to burst is the US long bond. Yields will greatly increase sooner than later as all these liabilities are assumed by the US tax payers.
From an investment perspective this represents another great long term opportunity for the rational investor as today we have the ability to participate on the increase in yields of US debt. The strategy is simple as we are witnessing a change in the direction of declining interest rates for the last 20 years, and are about to embark on a steady climb for many years. Stated in a more fundamental way, the US debt is the last remaining credit bubble and rates have to climb from now on. This is one more good reason for increasing inflation as the US knows that the only way to deal with this tsunami of debt is to inflate the debts away at the expense of their creditors. This is normal Central Bank procedure, especially when one understands that the only thing that Central Banks can control is inflation. It was done in Russia, Argentina and all other over indebted countries. The simplest way to reduce debt owned by foreigners is to devalue the currency, either overnight or over a longer span of time. Which leads one to conclude that the recent rise of the $US is unsustainable and will reverse sooner than later. As a side note, understand that this sudden rise is the $US is the last thing the US needs at this time, and the US Fed will do what it needs to do to lower its currency.
PRECIOUS METALS
I have often observed that one of the problems with today's society is that we have lost the ability to assess the value of things, especially the value of money. If you really think about it, the financial mess we find ourselves in is about empty financial promises made over things that were in the end not worth anything. As a matter of fact the world would not find itself in this mess if currencies were pegged to gold, as we would never have been able to create debt of such levels without acquiring the necessary gold to back the obligations. Gold allows us to peg the value of money to a constant, so that the financial system does not get into this kind of situation.
I have never been a "Gold Bug," I just have a great understanding of human history and know that today we are at a crossroad. To a large extent this last summer will mark a very important change in the way the global system works. We are witnessing the beginning of a new transitional period that will require us to re-evaluate the value of things. In a world where we have endless amounts of money we will have to re-evaluate what things are really worth. I noticed this first hand in Chile as the things that were necessary to maintain your Quality of Life became very dear. Likewise, today, we are witnessing the rapid rise of new economies at the expense of the old ones. Throughout history this process has never been a smooth one as it usually requires a cleansing of the financial system. I see the same changes starting to take place and from a financial perspective gold will increase as we re-define the value of money.
From a fundamental perspective wealthy individuals around the world have been buying gold and today we find ourselves with global shortages for the physical metal. The US mint has announced that they will not be selling gold and silver coins until the spring of 2009, South African gold producers do not have any to meet the demand for Krugerrands, and most dealers are about 16 weeks behind in meeting orders. Bank lease rates have greatly increased as financial institutions start to husband their gold, and more importantly for December delivery the COMEX has registered sales for 15 million ounces against inventory of only 8.5 million. Once again gold is signaling a very different picture than deflation.
SUMMARY
Going forward we will see the global banking system normalize. The banking system will solve the illiquidity issues through global money creation. Central Banks now know what deflation means and will do whatever they can to prevent it: they will inflate. And who better at the helm than the inflation expert himself Chairman Bernanke? The US dollar will resume its decline and within the next three to nine months we will see prices rising and inflation returning to the headlines—this inevitable as the US needs a lower dollar. Supply destruction of the things we need will have worked itself into the system, further supporting rising prices. Deflation, which always appears prior to an inflationary wave, will be a thing of the past and those who position themselves appropriately will be very well rewarded. In this new reality Canada will be one of the best performing economies, not only because we have very little US debt, but also because we have what the world needs.
Jaime E. Carrasco CFP
excellent work
© 2008 Jaime E. Carrasco CFP
Contact Information
Jaime E. Carrasco CFP
Investment Advisor, Blackmont Capital in Toronto.
181 Bay Street, Suite 3200 BCE Place, P.O.Box 779 Toronto, ON M5J 2T3
The global financial storm that we have entered is causing much worry and concern throughout the world. I too have stayed awake many a night reviewing this tempest so that I can decide on our best course of action. So far, I have only been surprised by the speed by which it has unraveled — never in my wildest assumptions did I think the system was this weak. Through recent careful study of the situation, I believe I can see how this financial mess may unravel and what course of action the rational investor might take.
Inflation or deflation? — that is the question as to how the mess will unravel. It is extremely important that we understand this debate as its outcome will have serious implications for your financial wellbeing. My observations and conclusions are that the outcome of this mess will lead to inflation. I believe "the deflationists" are wrong. The main arguments for the deflationists are based upon two premises: first, the fact that deflation was the outcome of the Great Depression of the 1930s and of Japan in the 1990s; second the argument that the levels of debt are so big that the Central Banks could never print as much to offset the deflationary effect of unwinding the debt. A historical study of these arguments reveals that deflation is a rarity. Furthermore, we have the experience of all other financial storms over the past century (apart from The Great Depression and Japan in the 90s) creating inflation. Inflation has been the historical norm. It is important to understand why so that one can make rational investments decisions.
Mervyn King, Deputy Governor of the Bank of England, wrote a very good paper on the subject in 2001. In this paper, King traces the effect of money and inflation all the way back to 1885. His main conclusion is that the ability of Central Banks to create money always leads to inflation. This was not the case during the Great Depression as the US Fed was unable to print money because the currency was pegged to the gold standard; thus it was impossible to inflate the money supply. This is the topic of Ben Bernanke's thesis: if the Fed had had the ability to print money in the 30's, they would have been able to inflate and avoid the deflationary pain. In the words of the Maestro himself, Ben Bernanke;
"Suppose that, despite all precautions, deflation were to take hold in the US-economy and moreover, that the Fed's policy instrument, the federal funds rate, were to fall to zero. What then? Well, the US government has a technology, called a printing press, or today, its electronic equivalent, that allows it to produce as many US-dollars as it wishes at essentially no cost."
It is important to understand that deflation is the Central Banks' greatest fear as it is the one thing they cannot control. Furthermore, one must also understand that the Central Banks' sole aim right now is inflation through their monetary control — an outcome that is easier to control down the road. In this context the Central Banks will continue to increase the money supply and inflate.
As I wrote earlier, I was surprised by the rapidity of the unwinding yet now realize that all that has happened is a fast forwarding to a point we all will have reached anyway. To explain, if Lehman Brothers had been bailed out like the other financial institutions, the world would never have witnessed the massive liquidation of assets that has taken place over the last two months. In this alternative scenario the Fed would have been able to slowly control the process through money creation in order to fund the bailouts needed to slow the unraveling of its financial system, all the while with inflation rising. However the Fed took a detour and institutions have been forced to liquidate their holdings so that they can pay back their obligations, resulting in some great assets being thrown out with the dirty bath water. What many have mistaken for deflation has only been a forced liquidation by hedge funds and financial institutions trying to meet their financial obligations. The question we must ask is why this was allowed. Oddly enough, everything that is required to best deal with this mess is happening.
If there was a central banker manual the best solution to this mess would require an extension of these bad debts as long as possible, 10 to 30 years is preferable. Next it would be great if this could be facilitated with as low a rate as possible in order to reduce the already enormous cost to the taxpayer. And finally, if the currency was to decline as much as possible the problem would be inflated away. And wouldn’t you know it, thirty year bonds at 3.19%, wow! What are the chances that the dollar goes next? However, this route will result in inflation like we have never seen before, and the rational investor must prepare in order to benefit.
ENERGY
In November the International Energy Agency issued its November report on the status of the global energy complex. This was a very important report as the IEA finally did a study of the long term supply of world energy, and the conclusions are not good. What I find amazing is how the Wall Street pundits and the media completely neglected to mention 99% of the 400 page report and only concentrated on the fact that the IEA now expects global oil demand to grow by only 120,000 b/d in 2008, to 86.2m b/d, the lowest annual increase for 23 years. Of greater importance to me were the warnings in the remainder of the report of a coming perfect storm in the energy sector. The report is sounding the alarm that our ability to supply the world with the needed energy to meet global demand is in dire straits due to three factors: 1. ongoing and accelerating reservoir depletion, 2. lack of capital investment, and 3. continued global demand for energy.
In this environment Canada looks very bright as, net of new discoveries, we are the only producing oil country that can actually increase oil production, and with no political risk. Yet our oil companies are trading as though oil is going to $35 and with tax free yields above 11%. I love the irrational decisions people make due to fear. My convictions of investments in the Canadian oil sector were once more confirmed at a recent meeting with John Priestmam, Manager of the Guardian Monthly High Income Fund. In his opinion the current pricing of Canadian energy income trust is presenting a great opportunity for the rational investor, from a valuation and income perspective. It is my conviction that all evidence points to the fact that this is the last time we will see these low prices and yet irrational short term sighted investors are giving these assets away at liquidation prices.
AGRICULTURE
Another sector with similar characteristics as energy is agriculture. One need only look at a company like Agrium to understand the current irrationality of investors. Agrium is currently trading at a ridiculous 3.5 P/E, yet its sales increased from $900 million Q3 2007 to $3,200 million Q3 2008, and management is telling us that they have very good visibility of earnings for the next two years. I urge you to listen to the latest quarterly Webcast for both Agrium and Potash. The rational investor will very quickly realize why they should consider investments in this sector.
The current financial mess has not resolved the fact that we are currently using 98% of the planet's arable land to feed the world, and that global food stocks are still at all time lows and not increasing. In addition, as the energy issues progress, our ability to grow food will also be affected for two reasons: 1. diversion of food stocks to ethanol production, and 2. increases in the price of natural gas to meet energy needs will lead to higher fertilizer costs. For some reason we have forgotten that the Green Revolution was due to the discovery of hydrocarbons and that as these decline our ability to feed the world will decline. As matter of historical fact, in the late 1800's Chile fought Peru and Bolivia over control of the nitrate fields in what is today northern Chile. Today I believe Potash and Agrium are investments with great outlooks on earnings for many years to come due to the need to feed a growing world, and yet they are currently priced as though the world is on a diet.
US 30 YEAR BONDS
Having been an institutional bond trader, it is absolutely unbelievable to me that the 30-year US bond is trading at a yield of 3.19%. In light of the current liabilities facing the US government (discussed below) and the fact of the coming Baby Boomer cohort's retirement, I can't help but conclude that the final credit bubble to burst is the US long bond. Yields will greatly increase sooner than later as all these liabilities are assumed by the US tax payers.
From an investment perspective this represents another great long term opportunity for the rational investor as today we have the ability to participate on the increase in yields of US debt. The strategy is simple as we are witnessing a change in the direction of declining interest rates for the last 20 years, and are about to embark on a steady climb for many years. Stated in a more fundamental way, the US debt is the last remaining credit bubble and rates have to climb from now on. This is one more good reason for increasing inflation as the US knows that the only way to deal with this tsunami of debt is to inflate the debts away at the expense of their creditors. This is normal Central Bank procedure, especially when one understands that the only thing that Central Banks can control is inflation. It was done in Russia, Argentina and all other over indebted countries. The simplest way to reduce debt owned by foreigners is to devalue the currency, either overnight or over a longer span of time. Which leads one to conclude that the recent rise of the $US is unsustainable and will reverse sooner than later. As a side note, understand that this sudden rise is the $US is the last thing the US needs at this time, and the US Fed will do what it needs to do to lower its currency.
PRECIOUS METALS
I have often observed that one of the problems with today's society is that we have lost the ability to assess the value of things, especially the value of money. If you really think about it, the financial mess we find ourselves in is about empty financial promises made over things that were in the end not worth anything. As a matter of fact the world would not find itself in this mess if currencies were pegged to gold, as we would never have been able to create debt of such levels without acquiring the necessary gold to back the obligations. Gold allows us to peg the value of money to a constant, so that the financial system does not get into this kind of situation.
I have never been a "Gold Bug," I just have a great understanding of human history and know that today we are at a crossroad. To a large extent this last summer will mark a very important change in the way the global system works. We are witnessing the beginning of a new transitional period that will require us to re-evaluate the value of things. In a world where we have endless amounts of money we will have to re-evaluate what things are really worth. I noticed this first hand in Chile as the things that were necessary to maintain your Quality of Life became very dear. Likewise, today, we are witnessing the rapid rise of new economies at the expense of the old ones. Throughout history this process has never been a smooth one as it usually requires a cleansing of the financial system. I see the same changes starting to take place and from a financial perspective gold will increase as we re-define the value of money.
From a fundamental perspective wealthy individuals around the world have been buying gold and today we find ourselves with global shortages for the physical metal. The US mint has announced that they will not be selling gold and silver coins until the spring of 2009, South African gold producers do not have any to meet the demand for Krugerrands, and most dealers are about 16 weeks behind in meeting orders. Bank lease rates have greatly increased as financial institutions start to husband their gold, and more importantly for December delivery the COMEX has registered sales for 15 million ounces against inventory of only 8.5 million. Once again gold is signaling a very different picture than deflation.
SUMMARY
Going forward we will see the global banking system normalize. The banking system will solve the illiquidity issues through global money creation. Central Banks now know what deflation means and will do whatever they can to prevent it: they will inflate. And who better at the helm than the inflation expert himself Chairman Bernanke? The US dollar will resume its decline and within the next three to nine months we will see prices rising and inflation returning to the headlines—this inevitable as the US needs a lower dollar. Supply destruction of the things we need will have worked itself into the system, further supporting rising prices. Deflation, which always appears prior to an inflationary wave, will be a thing of the past and those who position themselves appropriately will be very well rewarded. In this new reality Canada will be one of the best performing economies, not only because we have very little US debt, but also because we have what the world needs.
Jaime E. Carrasco CFP
excellent work
© 2008 Jaime E. Carrasco CFP
Contact Information
Jaime E. Carrasco CFP
Investment Advisor, Blackmont Capital in Toronto.
181 Bay Street, Suite 3200 BCE Place, P.O.Box 779 Toronto, ON M5J 2T3
11 August 2008
Dox Coxe
Investment Recommendations
1. This is not the end of the commodity bull market. Bear
Stearns, F&F and other crises will one day seem trivial. The
new global middle class that is repricing commodities never
will.
2. Remain underweight the banks and financial stocks that
invested heavily in the asset classes that collectively created
a global financial crisis. Despite the frantic efforts of the
Fed and Treasury, new challenges appear each week. The
deleveraging process is accelerating. Those peddling bank
paper perversely insist that these writedowns and bailouts
are now so gigantic that a turning point is near. We think
serious investors should compare this sordid story to the
SARS epidemic: When the number of infected people was
rising sharply and rapidly, cautious flyers asked themselves,
“Is this trip necessary?”
3. We recommend that clients begin taking preliminary
positions in companies which stand to benefit most from the
possible onset of realism in US energy policies. When—not
if—offshore drilling finally gets the nod, the majors and
service companies should benefit enormously. Arctic drilling
could be next, from which some important Canadian
companies would benefit, although the technological
problems are formidable, and the pipeline issues are not fully
resolved.
4. As for corn ethanol, the producers have been lucky: they
benefited from $125 oil, which has largely offset $5.50
corn. They have also benefited from the plunge in natural
gas prices. As if those weren’t enough to save an industry
whose fundamentals had become so controversial, they
also benefited from the collapse of Doha, because the
embarrassing tariff against Brazilian sugar ethanol
survived.
5. Natural gas supplies have exceeded expectations because of
the Barnett Shale and coal bed methane booms, and because
this summer has not been as hot as had been feared. We
recommend the natural gas-oriented producers with aboveaverage
reserve life indices.
6. The fertilizer companies have delivered the most impressive
earnings gains of any commodity group. Nevertheless, their
share prices have fallen in recent weeks along with other
commodity groups on days when traders have been buying
banks and dumping commodities. They probably have
the most predictable earnings of all the major commodity
sectors, and should be cornerstones of any resource portfolio.
As for the bricks, they are the farm equipment companies.
The roof and windows are the logistic companies and seed
manufacturers.
7. The continuation of the wide spread between Libor and
the fed funds rate, despite the best efforts of Messrs.
Bernanke and Paulson, suggests that the real US economy
will begin to show serious strain because banks are cutting
back on making traditional loans—they have squandered
their resources in untraditional products they never really
understood. Hoarding liquidity is like hoarding corn or
wheat: it triggers shortages and punishes the weakest
consumers.
8. Gold remains the asset that offers unique risk reduction
features in equity and balanced portfolios. As to investment
strategies, the ETF outperforms during gold bullion selloffs,
but the stocks outperform when bullion rallies. We believe
investors should have exposure to both kinds of asset, but
leave the weighting to be resolved on individual portfolio
risk/reward considerations.
9. We keep reading forecasts predicting falling inflation and
gold prices because of a US recession, but insisting that the
recession will be neither deep nor long. Recession actually
proved to be an aphrodisiac for gold lovers in the Seventies:
Each of the recessions back then was accompanied by
higher inflation rates than almost any prominent economist
predicted. We do not expect a recession so deep that it will
stop the march to higher inflation, with the band music and
drum beats coming from the major emerging economies. We
remain negative on longer-term dollar-denominated nominal
bonds. We prefer mid-term, inflation-protected bonds in
strong currencies
1. This is not the end of the commodity bull market. Bear
Stearns, F&F and other crises will one day seem trivial. The
new global middle class that is repricing commodities never
will.
2. Remain underweight the banks and financial stocks that
invested heavily in the asset classes that collectively created
a global financial crisis. Despite the frantic efforts of the
Fed and Treasury, new challenges appear each week. The
deleveraging process is accelerating. Those peddling bank
paper perversely insist that these writedowns and bailouts
are now so gigantic that a turning point is near. We think
serious investors should compare this sordid story to the
SARS epidemic: When the number of infected people was
rising sharply and rapidly, cautious flyers asked themselves,
“Is this trip necessary?”
3. We recommend that clients begin taking preliminary
positions in companies which stand to benefit most from the
possible onset of realism in US energy policies. When—not
if—offshore drilling finally gets the nod, the majors and
service companies should benefit enormously. Arctic drilling
could be next, from which some important Canadian
companies would benefit, although the technological
problems are formidable, and the pipeline issues are not fully
resolved.
4. As for corn ethanol, the producers have been lucky: they
benefited from $125 oil, which has largely offset $5.50
corn. They have also benefited from the plunge in natural
gas prices. As if those weren’t enough to save an industry
whose fundamentals had become so controversial, they
also benefited from the collapse of Doha, because the
embarrassing tariff against Brazilian sugar ethanol
survived.
5. Natural gas supplies have exceeded expectations because of
the Barnett Shale and coal bed methane booms, and because
this summer has not been as hot as had been feared. We
recommend the natural gas-oriented producers with aboveaverage
reserve life indices.
6. The fertilizer companies have delivered the most impressive
earnings gains of any commodity group. Nevertheless, their
share prices have fallen in recent weeks along with other
commodity groups on days when traders have been buying
banks and dumping commodities. They probably have
the most predictable earnings of all the major commodity
sectors, and should be cornerstones of any resource portfolio.
As for the bricks, they are the farm equipment companies.
The roof and windows are the logistic companies and seed
manufacturers.
7. The continuation of the wide spread between Libor and
the fed funds rate, despite the best efforts of Messrs.
Bernanke and Paulson, suggests that the real US economy
will begin to show serious strain because banks are cutting
back on making traditional loans—they have squandered
their resources in untraditional products they never really
understood. Hoarding liquidity is like hoarding corn or
wheat: it triggers shortages and punishes the weakest
consumers.
8. Gold remains the asset that offers unique risk reduction
features in equity and balanced portfolios. As to investment
strategies, the ETF outperforms during gold bullion selloffs,
but the stocks outperform when bullion rallies. We believe
investors should have exposure to both kinds of asset, but
leave the weighting to be resolved on individual portfolio
risk/reward considerations.
9. We keep reading forecasts predicting falling inflation and
gold prices because of a US recession, but insisting that the
recession will be neither deep nor long. Recession actually
proved to be an aphrodisiac for gold lovers in the Seventies:
Each of the recessions back then was accompanied by
higher inflation rates than almost any prominent economist
predicted. We do not expect a recession so deep that it will
stop the march to higher inflation, with the band music and
drum beats coming from the major emerging economies. We
remain negative on longer-term dollar-denominated nominal
bonds. We prefer mid-term, inflation-protected bonds in
strong currencies
3 August 2008
Rethinking China's Tight Monetary Policy
Facing so many variables -- credit control, price distortion, export pressure, and more -- should policymakers change course?
By staff reporters Zhang Huanyu, Li Zengxin, Zhao Hejuan, You Shanshan
Midway through what Premier Wen Jiabao called “the most difficult year,” China has now reached a critical point where economic planners must decide whether the tight monetary policy in place since December 2007 should be relaxed to prevent an economic downslide before 2009.
Against the backdrop of Beijing policies that tightened credit and forced banks to raise reserves, China's economic position has worsened since last year. It's facing weaker external demand tied to financial turmoil and economic slowdowns around the world, combined with soaring prices for energy and other inputs. Winter storms, an earthquake and floods made things worse. Industrial profits fell, the stock market turned bearish, and real estate sales slumped.
China's gross domestic product maintained a robust 10.4 percent growth rate in the first half, while growth in the consumer price index moderated to 7.9 percent, reflecting the tighter monetary policy. Yet GDP growth has been slowing. The rate was 10.6 percent in the first quarter, 0.7 percent below the same period 2007, and 10.1 percent in the second quarter.
Slower growth has been a natural consequence of the government's tightening. But a question remains: Is this an appropriate slowdown, or does it foreshadow a deep recession? To find an answer, policy orientation based on good judgment is needed during the second half of the year.
A heated debate now rages between those who think policymakers should shift the nation's priority to economic growth and ease credit controls, and others who say controlling inflation is still a top priority, given the variety of pressures pushing prices higher.
Beijing is seeking solutions. Premier Wen, Vice Premier Wang Qishan, Vice Premier Li Keqiang and other top ministers recently visited coastal provinces and municipalities to get a closer look at economic conditions. Meanwhile, a recent conference of the State Council Standing Committee emphasized the importance of maintaining stable economic growth and anti-inflation targets, slightly modifying the call to make “combating inflation a top priority” first heard at the beginning of the year.
Some think yuan appreciation may slow in the second half following a decline in China's trade surplus due to weaker export demand. And many believe export tax rebate rates for some products soon will be increased.
Tighter policy has effectively controlled inflation, and for now economic overheating is not a major threat, said Song Guoqing, a professor at Peking University's China Center for Economic Research. A moderate slowdown is a normal growth fluctuation, he said.
Mounting Challenges
Nevertheless, concern over the economy's current status is overshadowed by worries about future economic growth. The Shanghai Composite Index has plummeted in recent weeks to below 3,000 from a high of more than 6,000 last autumn, reflecting dim investor confidence in the profit potential of listed companies.
Industrial production slowed notably. The aggregate value added by upscale industrial enterprises grew 16.3 percent in the first half 2008, down 2.2 percent from the same period last year. Profit growth slowed significantly to 20.9 percent, down more than 21 points year-on-year.
Caijing learned that enterprises are experiencing major challenges stemming from rising prices for raw materials, labor and financing. Yuan appreciation is also a threat to corporate profitability.
A series of uncertainties will make it hard for industrial profits to gain momentum in the second half, said Gao Shanwen, chief economist with Essence Securities. The profit slowdown may extend into the first half of 2009, he said.
China is also at the mercy of weakening external demand. Recession risks continue to mount in the United States, where even institutional pillars such as Fannie Mae and Freddie Mac are in trouble. Statistics for the euro zone and emerging markets are worrisome as well, said Shen Jianguang, an analyst with Citic Securities.
A U.S. recession would spill into other countries, lowering demand for Chinese goods in many areas. Already, Chinese exports to Russia and South Asia countries are growing at slower rates, according to China International Capital Corp.
Macroeconomic policy is countercyclical. Tightening measures are designed to fight inflation at a cost of growth. But policymakers must be extremely cautious to avoid credit controls that are too tight and strangle small enterprises, experts warn.
What, then, is the proper speed for growth? Some speculate the country's 9.8 percent average annual growth rate for the past 30 years should be a bottom line. Others say lower rates are acceptable.
Tough Times for Enterprises
It's been reported that many coastal export manufacturers are already bankrupt, and that local financial institutions have been hit by bad loans. Because many small- and medium-sized enterprises (SMEs) in Zhejiang Province usually provide loan guarantees to each other, there may be a domino effect of insolvency, and the unofficial “civil” financing system could collapse.
There is no solid data on this civil financial system. After speaking with officials at dozens of SMEs in Zhejiang, Caijing reporters felt the situation may be better than many believe.
Cai Zhangsheng, administrative director of Zhejiang Small- and Medium-Sized Enterprise Bureau, criticized rumors about a large number of SME bankruptcies in his province. “There always have been new entrants and dropouts,” he explained.
Manufacturers in Guangdong Province agreed. Wu Hang, secretary of the Guangdong Association of Shoemakers, said that bankrupt companies “are mainly the less competitive ones.”
Still, research by the Economic and Trade Commission of Wenzhou, a major export city in Zhejiang, said 6.3 percent of the 23,570 surveyed enterprises in 26 industrial categories have suspended or partially suspended production.
Caijing learned that the closed SMEs in Wenzhou and Huzhou represent a small portion of the sector. Many factories that produce textiles, garments, shoes, hats and other light goods are small, family workshops. A daily list of closures and startups is normal. Workers cut loose by closures, especially in counties and villages, may quickly find jobs at bigger factories.
Nevertheless, SMEs have been squeezed by reduced loan opportunities. The government's tight monetary policy set strict loan quotas and “window guidance” that encouraged big banks to support large companies and government projects, leaving some SMEs to fend for themselves.
Meanwhile, a problem with excess investment has been exposed. According to the central bank, loans to Zhejiang companies grew 22 percent annually between 2003 and '07 -- far above the 16 percent national average. Apparently, they went too far.
Cai explained that companies in the province flush with cash have tended to increase investments and expand production, instead of enhancing management, upgrading product structures or improving risk and cost controls.
“They have invested too much in too many fields,” said an executive at a major shoemaker. “Once credit conditions are tightened, they have trouble raising funds.”
The good news is that total lending has not fallen since last year. So, because companies usually do most of their borrowing in the first half of the year, and credit has been tightly controlled in the past six months, loans may be easier to get in the second half. Thus, many experts see no reason for major credit control adjustments.
Distorted Inputs
Another key issue for Beijing policymakers concerns price controls. Since China's economic reforms began in 1978, price distortion has been never more serious. The situation has encouraged irrational economic behavior.
Consider coal prices paid by power generators. Government controlled prices have led to shortages of power -- and inefficiencies. Some power companies can make more money by reselling coal than generating electricity. In addition, low caps on industrial power prices effectively subsidize foreign producers and consumers. Domestic steelmakers, for example, export products made with cheap power after importing high-priced iron ore from abroad.
Other irrationalities can be found in the energy sector. For example, the smuggling of crude oil and oil products out of China is on the rise, encouraged by Chinese price controls. Freight transportation price controls give companies little incentive to increase fuel efficiency. Moreover, environmental costs are not built into corporate spending.
Such is the distorted fruit of price controls. Consumers, enterprises and foreign investors are taking advantage of low input prices. As a result, some companies survive with abnormally low spending levels, while others are reluctant to upgrade technology and product structures. As a result, China is home to excess investment, overcapacity and rapid GDP growth.
Controlled input prices and near-zero environmental costs have encouraged excessive investment, resulting in high resource consumption and environmental damage, said Xu Xiaonian, a professor with China Europe International Business School. The 10 percent GDP growth level is too high, he said.
“Raising resource and environment prices, and lifting salary standards, is a substitute to yuan appreciation,” said one analyst. Furthermore, he said, lifting price controls can be seen as a cost normalization process.
Inflation: Here to Stay
Here's another question: How would a price normalization process add to inflationary pressure? Lifting price controls can be expected to push prices even higher. “The key is to keep the money supply under control,” said Shen Mingao, Caijing's guest economist.
Excess liquidity has been blamed for inflation, while the trade surplus is said to be a major liquidity driver. To maintain a stable yuan exchange rage, the central bank -- the People's Bank of China -- buys with U.S. dollars, putting another 7 yuan into circulation for every dollar. To soak up trade surplus liquidity, the central bank raised the required reserve ratio for commercial banks six times this year to 17.5 percent, and continued issuing central bank bills. Now, there is less room for reserve hikes, and bill issues are less effective.
The central bank usually looks at curbing loan and M2 growth to control money supply. Some think the broader M3, which includes domestic loans plus foreign exchange assets, should be monitored as well. But as long as forex assets are seen as an “uncontrollable” external variable, the focus will remain on domestic loan growth.
There has been speculation in recent months that the central bank may soon raise interest rates for the first time this year. Some experts suggest raising rates while relaxing quantitative controls to test and filter out the most competitive companies.
However, risks have kept the central bank from making such a move. Higher rates attract more “hot money,” raising finance costs and adding interest burdens for real estate buyers. Therefore, the central bank is unlikely to raise interest rates this year.
“I hope for no further tightening, nor relaxing,” said Shen. “Stick to the original plan and there will be changes.”
Structural Transformation
Fortunately, some entrepreneurs have started to adjust. Years ago, Zhejiang and Guangdong provinces decided to encourage enterprise transformations based on a “rebirth” idea for private enterprises. Now, companies that find yuan appreciation and input price normalization trends irreversible have started shifting their focus to domestic sales from exports, or adding new products to existing production lines. A “manufacturing services” sector is also emerging.
Caijing found many merchants in the Zhejiang city of Yiwu talking about increasing exports to Russia, South Korea, the Middle East and European Union countries less affected by the sub-prime crisis. New language training courses are getting popular. Other SMEs have started shifting sales to the domestic market, said Zhou Wenbin, an official with the Yiwu Foreign Trade Bureau.
China's manufacturing sector has entered a “high-cost” period, said an entrepreneur from Zhejiang's city of Shaoxing. Primary product manufacturers are unable to transfer higher cost burdens to downstream enterprises by raising prices. These upstream companies have started selling on the domestic market or diverting to the import business to benefit from yuan appreciation.
Meanwhile, downstream SMEs with single and simple products are having more trouble than those with a long production chain. But in general, there are still obstacles preventing downstream private SMEs from acquiring companies in upstream industries such as energy and resources. If these sectors are open to private investment, SMEs will have more room and chances for structural transformation, many company officials said.
There is no doubt the process is painful and needs time. Some entrepreneurs expect a “convulsion” period to last until at least 2009. “Worries among these SMEs are right about the hope for industrial upgrades and economic structural transformation,” Xu said.
Pressure for Policy Adjustment
Faster yuan appreciation in the second half is less likely because policymakers have noticed falling export growth and enterprise failure problems. Slower appreciation also discourages inflows of short-term speculative capital. External pressures that promote a “hot money” influx in China may decrease, experts say, while internal inflation pressures remain.
Facing worsening export prospects, many experts suggest raising export tax rebates for several industries. As a result, the government reportedly may lift the rate for textiles by 2 percent and clothing by 4 percent.
However, Caijing found most of the interviewed company officials think such a raise would bring limited benefits to domestic producers. Some are even opposed.
If export rebate rates were now increased, after several cuts since 2007, Chinese exporters overall could be more competitive with companies in other countries, since lower production costs would lead to lower prices for customers. But companies catering to the domestic market would see little impact.
Some large companies prefer no adjustments, admitting their profit margins have been small. They hope for a “reshuffling” in their business fields, fearing a higher export tax rebate may bring small, low-cost and low-profit competitors back to the market.
But most Chinese textile and clothing makers are original equipment manufacturers whose products are sold abroad under brand names. Foreign buyers closely watch Chinese regulations, and they know immediately when export tax rebate rates change.
“You need to fight for a bigger share of profit brought by the 2 percent more rebates, and you may possibly get the smaller share,” said an official at one clothing maker, who expects Chinese companies profit less than one-fourth of the amount.
“If you don't give away the profit, another Chinese company may offer a lower price and take all your orders.”
Relaxing credit controls may help private SMEs with fund-raising troubles, company officials told Caijing. These include companies accustomed to loans from civil financing sources, whose bad debts cannot be resolved with commercial bank loans.
Some experts think that the second half of 2008 should be marked by initiatives that control the nation's money supply, relax price controls and cut tax burdens.
Money supply control would target aggregate demand and general price levels; releasing price controls refers to abolishing limits for input prices, especially coal, power and transportation; and cutting the tax burden is all about enhancing competitiveness by reducing payment obligations for companies.
Either a minor or a major makeover for the tight monetary policy in place since December could help China's economy survive --even prosper -- during the current global downturn, and into 2009. This has already been a difficult year, as the premier said, and it doesn't have to get worse.
By staff reporters Zhang Huanyu, Li Zengxin, Zhao Hejuan, You Shanshan
Midway through what Premier Wen Jiabao called “the most difficult year,” China has now reached a critical point where economic planners must decide whether the tight monetary policy in place since December 2007 should be relaxed to prevent an economic downslide before 2009.
Against the backdrop of Beijing policies that tightened credit and forced banks to raise reserves, China's economic position has worsened since last year. It's facing weaker external demand tied to financial turmoil and economic slowdowns around the world, combined with soaring prices for energy and other inputs. Winter storms, an earthquake and floods made things worse. Industrial profits fell, the stock market turned bearish, and real estate sales slumped.
China's gross domestic product maintained a robust 10.4 percent growth rate in the first half, while growth in the consumer price index moderated to 7.9 percent, reflecting the tighter monetary policy. Yet GDP growth has been slowing. The rate was 10.6 percent in the first quarter, 0.7 percent below the same period 2007, and 10.1 percent in the second quarter.
Slower growth has been a natural consequence of the government's tightening. But a question remains: Is this an appropriate slowdown, or does it foreshadow a deep recession? To find an answer, policy orientation based on good judgment is needed during the second half of the year.
A heated debate now rages between those who think policymakers should shift the nation's priority to economic growth and ease credit controls, and others who say controlling inflation is still a top priority, given the variety of pressures pushing prices higher.
Beijing is seeking solutions. Premier Wen, Vice Premier Wang Qishan, Vice Premier Li Keqiang and other top ministers recently visited coastal provinces and municipalities to get a closer look at economic conditions. Meanwhile, a recent conference of the State Council Standing Committee emphasized the importance of maintaining stable economic growth and anti-inflation targets, slightly modifying the call to make “combating inflation a top priority” first heard at the beginning of the year.
Some think yuan appreciation may slow in the second half following a decline in China's trade surplus due to weaker export demand. And many believe export tax rebate rates for some products soon will be increased.
Tighter policy has effectively controlled inflation, and for now economic overheating is not a major threat, said Song Guoqing, a professor at Peking University's China Center for Economic Research. A moderate slowdown is a normal growth fluctuation, he said.
Mounting Challenges
Nevertheless, concern over the economy's current status is overshadowed by worries about future economic growth. The Shanghai Composite Index has plummeted in recent weeks to below 3,000 from a high of more than 6,000 last autumn, reflecting dim investor confidence in the profit potential of listed companies.
Industrial production slowed notably. The aggregate value added by upscale industrial enterprises grew 16.3 percent in the first half 2008, down 2.2 percent from the same period last year. Profit growth slowed significantly to 20.9 percent, down more than 21 points year-on-year.
Caijing learned that enterprises are experiencing major challenges stemming from rising prices for raw materials, labor and financing. Yuan appreciation is also a threat to corporate profitability.
A series of uncertainties will make it hard for industrial profits to gain momentum in the second half, said Gao Shanwen, chief economist with Essence Securities. The profit slowdown may extend into the first half of 2009, he said.
China is also at the mercy of weakening external demand. Recession risks continue to mount in the United States, where even institutional pillars such as Fannie Mae and Freddie Mac are in trouble. Statistics for the euro zone and emerging markets are worrisome as well, said Shen Jianguang, an analyst with Citic Securities.
A U.S. recession would spill into other countries, lowering demand for Chinese goods in many areas. Already, Chinese exports to Russia and South Asia countries are growing at slower rates, according to China International Capital Corp.
Macroeconomic policy is countercyclical. Tightening measures are designed to fight inflation at a cost of growth. But policymakers must be extremely cautious to avoid credit controls that are too tight and strangle small enterprises, experts warn.
What, then, is the proper speed for growth? Some speculate the country's 9.8 percent average annual growth rate for the past 30 years should be a bottom line. Others say lower rates are acceptable.
Tough Times for Enterprises
It's been reported that many coastal export manufacturers are already bankrupt, and that local financial institutions have been hit by bad loans. Because many small- and medium-sized enterprises (SMEs) in Zhejiang Province usually provide loan guarantees to each other, there may be a domino effect of insolvency, and the unofficial “civil” financing system could collapse.
There is no solid data on this civil financial system. After speaking with officials at dozens of SMEs in Zhejiang, Caijing reporters felt the situation may be better than many believe.
Cai Zhangsheng, administrative director of Zhejiang Small- and Medium-Sized Enterprise Bureau, criticized rumors about a large number of SME bankruptcies in his province. “There always have been new entrants and dropouts,” he explained.
Manufacturers in Guangdong Province agreed. Wu Hang, secretary of the Guangdong Association of Shoemakers, said that bankrupt companies “are mainly the less competitive ones.”
Still, research by the Economic and Trade Commission of Wenzhou, a major export city in Zhejiang, said 6.3 percent of the 23,570 surveyed enterprises in 26 industrial categories have suspended or partially suspended production.
Caijing learned that the closed SMEs in Wenzhou and Huzhou represent a small portion of the sector. Many factories that produce textiles, garments, shoes, hats and other light goods are small, family workshops. A daily list of closures and startups is normal. Workers cut loose by closures, especially in counties and villages, may quickly find jobs at bigger factories.
Nevertheless, SMEs have been squeezed by reduced loan opportunities. The government's tight monetary policy set strict loan quotas and “window guidance” that encouraged big banks to support large companies and government projects, leaving some SMEs to fend for themselves.
Meanwhile, a problem with excess investment has been exposed. According to the central bank, loans to Zhejiang companies grew 22 percent annually between 2003 and '07 -- far above the 16 percent national average. Apparently, they went too far.
Cai explained that companies in the province flush with cash have tended to increase investments and expand production, instead of enhancing management, upgrading product structures or improving risk and cost controls.
“They have invested too much in too many fields,” said an executive at a major shoemaker. “Once credit conditions are tightened, they have trouble raising funds.”
The good news is that total lending has not fallen since last year. So, because companies usually do most of their borrowing in the first half of the year, and credit has been tightly controlled in the past six months, loans may be easier to get in the second half. Thus, many experts see no reason for major credit control adjustments.
Distorted Inputs
Another key issue for Beijing policymakers concerns price controls. Since China's economic reforms began in 1978, price distortion has been never more serious. The situation has encouraged irrational economic behavior.
Consider coal prices paid by power generators. Government controlled prices have led to shortages of power -- and inefficiencies. Some power companies can make more money by reselling coal than generating electricity. In addition, low caps on industrial power prices effectively subsidize foreign producers and consumers. Domestic steelmakers, for example, export products made with cheap power after importing high-priced iron ore from abroad.
Other irrationalities can be found in the energy sector. For example, the smuggling of crude oil and oil products out of China is on the rise, encouraged by Chinese price controls. Freight transportation price controls give companies little incentive to increase fuel efficiency. Moreover, environmental costs are not built into corporate spending.
Such is the distorted fruit of price controls. Consumers, enterprises and foreign investors are taking advantage of low input prices. As a result, some companies survive with abnormally low spending levels, while others are reluctant to upgrade technology and product structures. As a result, China is home to excess investment, overcapacity and rapid GDP growth.
Controlled input prices and near-zero environmental costs have encouraged excessive investment, resulting in high resource consumption and environmental damage, said Xu Xiaonian, a professor with China Europe International Business School. The 10 percent GDP growth level is too high, he said.
“Raising resource and environment prices, and lifting salary standards, is a substitute to yuan appreciation,” said one analyst. Furthermore, he said, lifting price controls can be seen as a cost normalization process.
Inflation: Here to Stay
Here's another question: How would a price normalization process add to inflationary pressure? Lifting price controls can be expected to push prices even higher. “The key is to keep the money supply under control,” said Shen Mingao, Caijing's guest economist.
Excess liquidity has been blamed for inflation, while the trade surplus is said to be a major liquidity driver. To maintain a stable yuan exchange rage, the central bank -- the People's Bank of China -- buys with U.S. dollars, putting another 7 yuan into circulation for every dollar. To soak up trade surplus liquidity, the central bank raised the required reserve ratio for commercial banks six times this year to 17.5 percent, and continued issuing central bank bills. Now, there is less room for reserve hikes, and bill issues are less effective.
The central bank usually looks at curbing loan and M2 growth to control money supply. Some think the broader M3, which includes domestic loans plus foreign exchange assets, should be monitored as well. But as long as forex assets are seen as an “uncontrollable” external variable, the focus will remain on domestic loan growth.
There has been speculation in recent months that the central bank may soon raise interest rates for the first time this year. Some experts suggest raising rates while relaxing quantitative controls to test and filter out the most competitive companies.
However, risks have kept the central bank from making such a move. Higher rates attract more “hot money,” raising finance costs and adding interest burdens for real estate buyers. Therefore, the central bank is unlikely to raise interest rates this year.
“I hope for no further tightening, nor relaxing,” said Shen. “Stick to the original plan and there will be changes.”
Structural Transformation
Fortunately, some entrepreneurs have started to adjust. Years ago, Zhejiang and Guangdong provinces decided to encourage enterprise transformations based on a “rebirth” idea for private enterprises. Now, companies that find yuan appreciation and input price normalization trends irreversible have started shifting their focus to domestic sales from exports, or adding new products to existing production lines. A “manufacturing services” sector is also emerging.
Caijing found many merchants in the Zhejiang city of Yiwu talking about increasing exports to Russia, South Korea, the Middle East and European Union countries less affected by the sub-prime crisis. New language training courses are getting popular. Other SMEs have started shifting sales to the domestic market, said Zhou Wenbin, an official with the Yiwu Foreign Trade Bureau.
China's manufacturing sector has entered a “high-cost” period, said an entrepreneur from Zhejiang's city of Shaoxing. Primary product manufacturers are unable to transfer higher cost burdens to downstream enterprises by raising prices. These upstream companies have started selling on the domestic market or diverting to the import business to benefit from yuan appreciation.
Meanwhile, downstream SMEs with single and simple products are having more trouble than those with a long production chain. But in general, there are still obstacles preventing downstream private SMEs from acquiring companies in upstream industries such as energy and resources. If these sectors are open to private investment, SMEs will have more room and chances for structural transformation, many company officials said.
There is no doubt the process is painful and needs time. Some entrepreneurs expect a “convulsion” period to last until at least 2009. “Worries among these SMEs are right about the hope for industrial upgrades and economic structural transformation,” Xu said.
Pressure for Policy Adjustment
Faster yuan appreciation in the second half is less likely because policymakers have noticed falling export growth and enterprise failure problems. Slower appreciation also discourages inflows of short-term speculative capital. External pressures that promote a “hot money” influx in China may decrease, experts say, while internal inflation pressures remain.
Facing worsening export prospects, many experts suggest raising export tax rebates for several industries. As a result, the government reportedly may lift the rate for textiles by 2 percent and clothing by 4 percent.
However, Caijing found most of the interviewed company officials think such a raise would bring limited benefits to domestic producers. Some are even opposed.
If export rebate rates were now increased, after several cuts since 2007, Chinese exporters overall could be more competitive with companies in other countries, since lower production costs would lead to lower prices for customers. But companies catering to the domestic market would see little impact.
Some large companies prefer no adjustments, admitting their profit margins have been small. They hope for a “reshuffling” in their business fields, fearing a higher export tax rebate may bring small, low-cost and low-profit competitors back to the market.
But most Chinese textile and clothing makers are original equipment manufacturers whose products are sold abroad under brand names. Foreign buyers closely watch Chinese regulations, and they know immediately when export tax rebate rates change.
“You need to fight for a bigger share of profit brought by the 2 percent more rebates, and you may possibly get the smaller share,” said an official at one clothing maker, who expects Chinese companies profit less than one-fourth of the amount.
“If you don't give away the profit, another Chinese company may offer a lower price and take all your orders.”
Relaxing credit controls may help private SMEs with fund-raising troubles, company officials told Caijing. These include companies accustomed to loans from civil financing sources, whose bad debts cannot be resolved with commercial bank loans.
Some experts think that the second half of 2008 should be marked by initiatives that control the nation's money supply, relax price controls and cut tax burdens.
Money supply control would target aggregate demand and general price levels; releasing price controls refers to abolishing limits for input prices, especially coal, power and transportation; and cutting the tax burden is all about enhancing competitiveness by reducing payment obligations for companies.
Either a minor or a major makeover for the tight monetary policy in place since December could help China's economy survive --even prosper -- during the current global downturn, and into 2009. This has already been a difficult year, as the premier said, and it doesn't have to get worse.
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