Archive for September 8th, 2012
Saturday, September 8th, 2012
China’s Next Act
August 24, 2012
By Frank Holmes, CEO and Chief Investment Officer
U.S. Global Investors
The ECB calmed the markets—will China act next?
After Mario Draghi announced the European Central Bank’s new bond buying program, I was the first guest on CNBC Asia’s Squawkbox to weigh in on this decision. I reiterated my stance that the endgame for Europe would be to print money, which will eventually lead to currency wars. These actions are positive for gold and also for increased economic activity.
China too has kept investors on the edge of their seats, as we wait for some monetary or fiscal action. Everyday that goes by with no significant policy decisions from the Asian giant causes the market to lose confidence in its ability to steer its ship. Even the most optimistic bull can be vulnerable to a loss of confidence.
It often helps to gain a different perspective, which is what a business trip halfway around the world can provide.
I’ve been traveling in Singapore (and then onto Hong Kong) and I continue to be amazed by the juxtaposition of the vibrancy of the Asian continent compared to investor sentiment in the States. It’s a subtle difference, but you can see it in the faces of people walking the cities, you can feel it when talking with local entrepreneurs and you can read it in a speech from local government leaders.
Singapore’s Prime Minister Lee Hsien Loong provided a beam of light to a Beijing audience only days ago. During his speech at the Central Party School, the prime minister discussed China’s significance in the world as it relates to political relations, government policies, and world trade. He also touched on his country’s role in facilitating a solid relationship between the Asian giant and the world’s largest economy.
By nature, public speeches are meant to be uplifting, as they tend to reflect on a long period of history and focus on positive solutions. However, I believe new opportunities cannot be found when all hope is believed to be lost.
The prime minister acknowledges China’s “serious and complex challenges” that it is facing after decades of significant growth. He says that its economic, social and political reforms are difficult for any nation to handle, “let alone one the size of China.” He believes it’s to be expected that “China’s leaders are preoccupied with these domestic priorities.”
However, China will not be tackling this alone, as the world has become so “inter-connected and inter-dependent,” with growing world trade, interlinked financial markets, and the growth of the Internet bringing one third of the world online today.
You can see how synchronized world economies are today by comparing manufacturing output. In August, China’s Government Purchasing Manufacturing Index (PMI) crossed below 50 for the first time since November 2011. (Remember that a reading of 50 marks the critical line delineating expansion from contraction.)
The U.S. ISM Manufacturing PMI also crossed below 50, with a reading of 49.6 in August. JP Morgan’s Global PMI came in at 48.1, and its been below 50 for the last three months.
Over the past decade, China has experienced incredible growth because of globalization. On one measure alone, the prime minister pointed out that more than one billion line workers, engineers, scientists and entrepreneurs are joining the international economy to develop, serve and produce goods for markets around the world.
Stephen Roach, a senior fellow at Yale University and author of The Next Asia, says China’s “grand plan” is to move from the “producer model, which worked brilliantly for 30 years” to one that needs to provide higher-paying, less labor intensive jobs, in new fully functional cities to the 350 million who are estimated to move to an urban area in China over the next 15 years. To paraphrase Marshall Goldsmith’s self-improvement book for business executives, what got China here, won’t get China there.
The Asian giant can take a few lessons from its developed neighbors, says BCA Research. China has already experienced a tremendous population shift from its farms and rural areas to the cities in search of higher paying jobs. But there comes a tipping point when labor supply in the cities goes from “feast to famine,” says BCA.
The research firm says in the previous cases of Japan, Korea and Taiwan, there have been similar employment phases. First, when industrialization just begins, “demand for labor is strong, but wages are low because of plentiful supply.”
Then, wages grow faster than labor demand. This is what we have been seeing in China today, as urban per capita income far exceeds rural incomes.
The last stage of this development that other Asian nations have experienced is when “wage growth accelerated and the wage gaps between the manufacturing and agriculture sectors disappeared,” according to BCA. Their research shows that cheap labor in manufacturing ends while growth of wages accelerates in both cities and farms.
It’s only a guess when China will make that labor shift to the stage where manufacturing sector competes with agriculture for jobs. BCA compared manufacturing employment to agriculture employment of Japan, Korea and Taiwan, looking at when these countries’ ratio rose above 1. In Japan, manufacturing labor shortages started in the early 1960s, for South Korea, it was around 1975-1976. Taiwan began experiencing this phenomenon around 1970.
Based on this ratio, it’s estimated that labor shortages could become more common around 2014-2015 for China, says BCA.
Until that tipping point is reached, China “will continue to need higher value-added, less labor-intensive production to sustain exports; policy and productivity will be critical to a continuation of the ‘growth miracle,’” according to BCA.
The way China will accomplish this is through good relations with the U.S., as well as taking an interest in making sure Asia is stable and prosperous. Loong believes the Chinese economy “depends on an open, inclusive and fair global trade system to thrive. It needs a stable external environment, and good relations with other countries, so that it can focus on economic development,” says Singapore’s leader. In Loong’s view, “China is no longer an isolated, self-sufficient Middle Kingdom.”
One example of how China will be engaging the world in its future growth is through its current energy policies. While 70 percent of the country’s energy consumption is coal, oil is the second source of energy, at nearly 20 percent of total energy consumption, according to the U.S. Energy Information Administration (EIA). In 2010, the country consumed an estimated 10 million barrels per day.
China only produces about 4 million barrels per day, and imports the remaining amount, making the Asian giant the second largest importer of oil, says the EIA. The largest importer of oil in the world has been the U.S., with an intake of 8.7 million barrels per day, according to the EIA. Japan imports the third most oil, at 4.3 million barrels per day.
The country currently has a diverse variety of sources from which it receives its oil, with most of the crude oil imports coming from Saudi Arabia, followed by Angola, Iran and Russia.
The country’s energy policies appear to be focused on three goals: 1) fulfill its growing demand for oil and reliance on oil imports, 2) diversify import sources to reduce its risk of supply disruption, and 3) develop technical expertise in unconventional resources. One way to accomplish these goals is through overseas acquisitions, which we’ve previously discussed. “China is taking advantage of the economic downturn to step up its global acquisitions and use its vast foreign exchange reserves (estimated at over $3 trillion in 2012) to help purchase equity in projects or acquire stakes in energy companies,” says the EIA.
A Hint of Action Arrives
World markets may not have to wait much longer for Chinese policymakers to act, as the government recently announced new infrastructure projects. According to Bloomberg, China approved 25 new subway construction projects, with related investments estimated to be more than 840 billion yuan. Railway, subway and construction stocks in China increased on the news.
Stephen Roach concludes his discussion about China this way: “A growth slowdown is hardly shocking for an export-led economy. But China is in much better shape than the rest of the world. A powerful rebalancing strategy offers the structural and cyclical support that will allow it to avoid a hard landing.”
Saturday, September 8th, 2012
U.S. Equity Market Radar (September 10, 2012)
The S&P 500 Index rose 2.75 percent this week as the markets embraced policy action from the European Central Bank (ECB) and expectations that the Fed will act next week. The ECB announced “unlimited” sovereign bond purchases out to three years for countries that meet certain conditions. This policy will allow troubled governments additional time to get their fiscal house in order. The other key element to this policy is it continues to build the ECB’s credibility, as it has been able to do what it outlined a month ago. Weak economic data here in the U.S. added to expectations that the Fed would implement a third round of quantitative easing next week, which boosted the market. These events allow the market to look across the valley and focus on improving fundamentals over the next 6-12 months.
- Financials rose 3.6 percent, leading the way with central bank policy as the primary driver. Morgan Stanley, Bank of America and Goldman Sachs all rose by more than 10 percent.
- Cyclical sectors were strong this week with the materials sector just a touch behind financials. Steel and metal related stocks tended to be the biggest gainers with Cliffs Natural Resources, Freeport-McMoran and Allegheny Technology all rising by more than 8 percent. The leader was Owens-Illinois whose new CFO confirmed the company’s third quarter guidance.
- Alpha Natural Resources was the best performer in the S&P 500 this week rising by 16.16 percent. Coming into the week the stock was down more than 70 percent year-to-date and this appears to be a “risk on” bounce.
- Defensive sectors were the laggards this week as the “risk on” trade roared back. Consumer staples rose 58 basis points this week in mixed trade.
- The utilities sector lagged for the fourth week in a row as the market continued to rotate into other areas.
- Advanced Micro Devices was the worst performer this week in the S&P 500, falling by more than 7 percent on news that Intel slashed third quarter revenue expectations by about $1 billion on weak PC sales.
- The market reacted very positively to this week’s ECB announcement, hitting a four-year high. If the Fed follows up with additional easing next week, the market would likely positively respond.
- Inaction by the Fed next week would be the short-term threat while Europe remains the longer-term wildcard.
Saturday, September 8th, 2012
The Economy and Bond Market Radar (September 10, 2012)
Treasury yields rose this week, largely in anticipation that the employment report released on Friday would be good news. The employment report showed non-farm payrolls growing a meager 96,000 and payrolls for the prior two months were revised down by 41,000. This was a poor report and well below analysts estimates, which improves the odds that the Fed takes action next week with another round of quantitative easing but Treasuries couldn’t recoup the loses suffered earlier in the week. Another factor at work was the ECB’s decision to implement unlimited European Union sovereign bond purchases out to three years. This action follows more than a month of building expectations and the ECB was able to follow through on its commitment to save the euro. This policy will give European governments more time to fix their fiscal situation.
- The ECB announced a sovereign bond purchase program this week which continues to solidify the reputation of the ECB as finally truly doing what it takes to adequately address the current crisis.
- U.S. auto sales rose by nearly 20 percent from a year ago with broad-based gains among most of the global auto makers. Auto production in Brazil rose 10.6 percent in August vs. July and sales rose 15.3 percent to a record 400,000 units, driven by tax cuts and lower borrowing costs.
- The ISM Non-Manufacturing Index rose and beat expectations for August, indicating expansion.
- The August employment report was weak and it is difficult to identify a near-term catalyst that will change that situation.
- The August ISM Manufacturing Index remained in contraction territory for the third straight month.
- Eurozone retail sales fell 1.7 percent in July and economic data coming out of Europe has been very weak.
- The ECB acted this week to address liquidity and confidence issues in the marketplace and the Fed appears likely to act next week on an additional round of quantitative easing.
- With further weak economic data out of China, odds of additional easing measures continue to move higher.
- Interest rates are likely to remain very low for the foreseeable future.
- Europe remains a wildcard with the markets shifting focus on a weekly basis.
- China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.
Saturday, September 8th, 2012
Gold Market Radar (September 10, 2012)
For the week, spot gold closed at $1735.65, up $43.64 per ounce, or 2.58 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 5.16 percent. The U.S. Trade-Weighted Dollar Index lost 1.29 percent for the week.
- Gold surged on Friday to close at $1,735.65—up 2.58 percent for the week—primarily on the heels of a poor jobs report and the accompanying expectation of quantitative easing and the debasement of the U.S. dollar. Technically, gold extended its recent rally above the 200-day moving average, and is now within striking distance of its February highs. The dollar, on the other hand, plummeted below its 200-day moving average on Friday. If the price action is allowed to speak for itself, the question is not whether there will be QE, but when.
- Significantly, a number of analysts raised their year-end forecasts for gold prices. A quick survey: J.P.MorganChase called for gold to close the year at $1,800; Goldman Sachs said $1,840; Bank of America Merrill Lynch suggested $2,000 in the event of QE, and one Citigroup analyst called for gold to reach $2,500 by the end of the first quarter 2013, and even higher in the event of geopolitical conflict.
- The fall seasonality trade looks to be in full swing. This historically strong period of the year for gold prices is supported by a weakening dollar, a strengthening euro, and seasonally strong demand.
- AuRico Gold decreased its production guidance substantially at its Ocampo project: 2012 guidance was essentially halved, 2013 guidance cut by 25 percent, and the stock finished down for the holiday-shortened week, off about 14 percent.
- Continued strikes in South Africa are problematic. While the unions were said to be close to a deal this week, sending troubled Lonmin up midweek, the deals fell through, and strikes are ongoing with very few workers returning to work.
- Global accommodative monetary policies remain very much in play. The Fed meeting next week—on the heels of a poor jobs report—offers the possibility for further easing and may be an additional catalyst for gold prices.
- Gold, as priced in euros, is rapidly approaching its all-time highs.
- We mentioned last week that the dollar’s 200-day moving average might be defended from a technical standpoint. A decisive break below that average, as occurred on Friday, likely signals further weakness in the dollar to come and possible gains in gold.
- India—the world’s largest importer of gold—may raise the import duty on gold for the third time this year, potentially curtailing some Indian demand. Bloomberg reported that, “The government may look at increasing the duty to 7.5 percent,” according to the president of the Bombay Bullion Association. The time frame on this potential policy change remains unclear at this point.
- There remains the risk that an inflation premium is cooked into the gold price, which, in the event of no quantitative easing, would cause prices to react negatively. The Fed’s next meeting is September 12-13.
- A rapid move upward in gold and gold equities which does not successfully trigger meaningful short-covering might invite resistance, or additional short positions. The ultimate identifiable catalyst for short-covering remains government policy a la quantitative easing in the near term.
Saturday, September 8th, 2012
Energy and Natural Resources Market Radar (September 10, 2012)
- The Global Resources Fund (PSPFX) moved above its 200 day moving average this week.
- After China approved new infrastructure projects which supported the demand outlook in the world’s biggest consumer of copper, the metal gained over 3 percent this week making this the biggest weekly gain in 10 weeks.
- The Chinese government backed construction plans including roads and warehouses, according to statements on the National Development and Reform Commission’s (NDRC) website. Copper also rose after the ECB announced a bond- buying plan on Thursday to combat the debt crisis that threatens demand.
- Consol Energy (CNX) announced it is idling two Appalachian coking coal operations in response to the slump in hard coking coal prices. U.S. coking coal exporters are the marginal cost producers for the seaborne market, so coking coal prices could start to see some support if further Appalachian shutdowns are announced. The current hard coking coal spot price is $159 per ton and has fallen 30 percent since mid-June.
- The worst U.S. drought in more than half a century helped drive down rates for Panamax vessels shipping grains to the lowest rates in more than 3 1/2 years as the drought results in a slump in cereal cargoes. The ships hauling about 60,000 metric tons of grains and other commodities including coal and iron ore slid 5.7 percent to $5,141 a day, the lowest since January 2009, according to data from the Baltic Exchange in London. The Baltic Dry Index, a wider measure of costs, fell 1.3 percent to 684 points. Global grain exports will fall the most in 27 years in the 2012-13 marketing year as the drought curbs shipments from the world’s largest supply country, according to U.S. Department of Agriculture data.
- China steel futures fell to an all-time low as poor demand in the world’s top steel market kept the pressure on prices, sending iron ore further below $90 a ton to its weakest level since October 2009. Iron ore prices have dropped 36 percent since early July, the main casualty among industrial commodities of China’s slowdown, and analysts say they have further to fall.
- China’s central government has announced an estimated $156 billion in infrastructure approvals in an effort to stimulate a stagnating domestic economy. The projects, spanning subway, highway, port, waterway, airport, and energy investments are scheduled to progress over the next four years.
- Meat consumption in China will continue to expand even as the economy slows, sustaining demand for feeds made from corn and soybeans, according to Cargill Inc., the biggest U.S. agricultural company. “We are looking at a mega-trend of increasing consumption of meat, milk, eggs,” Christopher Langholz, president of Cargill Animal Protein China, said in an interview, without giving specific forecasts. Rising incomes in China, the world’s second-largest economy, have increased demand for meat including pork, making the nation the largest buyer of soybeans, which are crushed to feed pigs and chicken. Soybeans and corn surged to records in Chicago last month as the worst U.S. drought in half a century cut supplies.
- China’s coal prices, already near a two-year low, are likely to fall further as industrial demand growth slows and imports add to pressure on domestic stocks, industry officials said Tuesday. Hou Wenjin, a coal industry official with the Shanxi provincial government, the country’s second biggest coal producing region, predicted China’s 2012 imports could top 200 million tons as coastal utilities lock in cheaper foreign supplies. “Overall inventories, at over 80 million tons, are still much higher than normal levels, so I don’t think there will big demand even for winter restocking,” he said.
- Peru’s mining industry will invest 33 percent less than previously expected next year as social unrest delays projects, according to the country’s National Society of Mining, Petroleum & Energy. Miners including Aluminum Corp. of China and HudBay Minerals will invest about $4 billion next year, compared with $6 billion planned previously and down from $7.2 billion this year, according to a presentation by the industry group. “We’re worried by what’s happening,” the group’s President Pedro Martinez said. “If investment continues to be scared away, many mines will reach the end of their productive lives and there will nothing we can do about it,” he added.
Saturday, September 8th, 2012
Emerging Markets Radar (September 10, 2012)
- China’s NDRC announced city subway projects worth RMB 8.4 trillion, and highway and port projects worth RMB 1.2 trillion.
- Hong Kong August home sales rose to HK$39.7 billion from HK$31.77 billion in July.
- The government of Thailand is moving forward with next season’s rice-pledging program, which proposes Bt405 billion to buy rice. Inflation in Thailand was steady in August, up 2.69 percent versus 2.73 in July.
- China’s August PMI was 49.2 versus the estimated 50, which indicates that the economic activities are contracting. HSBC’s final August flash China PMI was 47.6 versus previous 49.3.
- Taiwan and Philippines both saw their August inflation spike due to summer floods, which caused shortage in many consumer goods.
- Malaysia exports in July were down 1.9 percent versus the consensus up 3.5 percent. Exports in July were up 5.4 percent. The Malaysia central bank left the benchmark interest rate unchanged at 3 percent this week.
- Thailand also left its policy benchmark interest rate unchanged at 3 percent this week.
- As the chart below shows, the China region still has high potential for further smartphone penetration, which will bring about many business opportunities for internet and smartphone suppliers.
- Russia’s Bazhenov foundation, which lies just below conventionally producing layers is holding anywhere between 80-140blln of hydrocarbons according to various estimates. While low permeability and porosity prevented oil extraction previously, advent of horizontal drilling, fracking and Western expertise are likely to repeat the success of unconventional oil development in the U.S. and Canada.
- China August PMI showed contraction in new orders and employment, but expansion in raw material and finished goods inventory or de-stocking.
- Hungarian Prime Minister Viktor Orban said he will present a brand new set of terms to the International Monetary Fund and the EU in upcoming aid talks. If the lenders insist on the conditions currently on the table, he said, the deal is off.
- A recent European Court ruling told Russia to compensate pensioners who had the purchasing power of their savings ruined by the hyperinflation of the 1990s. Total debt owed to households is at $786 billion, or 10 percent of the country’s GDP.