Friday, May 25th, 2012
Why Invest in Asian Credit?
by Showbhik Kalra, PIMCO
- Asian sovereign and corporate credit offer more attractive yields than a number of other global fixed income sectors as investors take on additional risk.
- Given Asian markets’ diversity and the global macroeconomic environment, investors may wish to consider investment managers with a strong global macro process coupled with strong relationships with local stakeholders and experience in local portfolio management and markets.
- PIMCO believes in the resilience of emerging Asian countries and that leads us to be open to adding exposure in sovereign credit and high quality corporate credits as attractive opportunities arise.
In the current environment, growth in Asia is one of the most talked about macroeconomic trends. After all, the region is expected to contribute around half of global GDP growth and makes up a significant and growing share of global GDP output. Asian central banks collectively hold around half of the world’s foreign exchange reserves and a number of these countries hold a record amount of reserves. In contrast to the developed economies, which have increasing government debt-to-GDP ratios, strong initial conditions and a rapid return to strong growth have facilitated stability in debt levels (with much lower absolute levels) across the major Asian economies. Over the last few years these fundamental improvements have been well recognized and sovereign ratings upgrades have outpaced downgrades consistently since 1999.
How do we take advantage of the growth in Asia?
Unfortunately, investment managers cannot invest directly in a country’s GDP growth or its expected level of foreign exchange reserves. Instead, one can invest in sovereign debt and corporate credit in Asia as a way to take advantage of the region’s growth. Corporate issuers in the emerging Asia markets are either serving the increasingly affluent and growing local consumer base or exporting goods overseas and, as a result, becoming regional and in some cases global powerhouses. Asian currencies are also attractive as many are undervalued by numerous purchasing power metrics. Authorities are also more open to letting their currencies appreciate as a way to deal with inflation and to rebalance their economies to be more consumption driven, rather than investment driven as in the past few years.
The first pan-Asia credit benchmark was created following the Asian financial crisis in the late ‘90s, marking the first step toward establishing Asian credit as an asset class. The Asian U.S. dollar denominated bond market today, as measured by the market capitalization of the JP Morgan Asia Credit Index (JACI), has grown from $50 billion dollars around a decade ago to over $300 billion dollars in June 2011. This index includes sovereign, quasi-sovereign (entities majority-owned by the state) and corporate credit (see Figure 1 for recent issuance). In recent years, the asset class has expanded progressively to cover 14 fast growing countries in Asia with sovereign ratings from S&P ranging from AAA to B-, as countries and corporates across the region looked to broaden their sources of financing. The typical size of investment grade issuances has increased over time, to average deal sizes of $1 billion currently. These larger issues contribute to the overall asset class as they tend to help boost secondary market liquidity.
Investing in growth
A notable development in the Asian credit space is the advent of high yield corporate issuers. The high yield corporate sector is dominated by China and Indonesia, but also includes issuers in Korea, the Philippines and Singapore. The high yield portion of the index has also grown substantially over the years from 30% of the index at the end of 2006 to 40% at the end of 2011. However, following recent upgrades to Indonesia, the high yield portion of the index has moved back down to 30% of the index.
For example, take a deeper look at Indonesia. Robust commodity demand from China and India has been a boon for the resource-rich country, particularly its coal producers. Sustaining industrial production in Indonesia also requires significant capacity expansion in basic infrastructure. Because Indonesia is the world’s fourth most populous country but still has a low penetration rate for wireless connection, cell phone demand will likely remain robust in the medium term. Indonesia’s rate of electrification is about 65% which means around 90 million people still do not have access to electricity. Not surprisingly, commodity, utility and telecommunication companies have dominated Indonesia’s high yield corporate issuance. Compared to the developed world, companies in these sectors across the region are still experiencing strong growth (Figures 2 and 3 illustrate growing demand for the telecommunications and utilities sectors). Note that particularly across emerging Asia there is a trend towards using multi-SIM cellular phones and mobile cellular subscriptions understate the true growth potential.
Attractive yields and greater stability
Asian sovereign and corporate credit is also attractive from a yield perspective. They offer significantly more attractive yields than a number of other global fixed income sectors (Figure 4) as investors take on additional emerging market sovereign and credit risk. What about the relative value comparison between Asian corporate bonds and developed country corporate bonds? A look at the historical credit spreads (over comparable maturity U.S. swaps) of Asian corporate credit compared to those of BBB rated U.S. corporates provides a strong argument. Figure 5 shows that spreads on Asian corporate bonds have consistently been higher than comparably rated U.S. corporate bonds during the past five years. The gap widened to as much as 134 basis points during the post-Lehman Brothers crisis, and recently was 87 basis points as at the end of March 2012 (the gap was close to zero prior to the Lehman crisis). A big reason for this gap is likely higher sovereign spreads embedded in Asian corporate bond spreads. We expect this gap to narrow as markets continue to revalue Asian sovereign risk to reflect stronger balance sheets and economic growth prospects.
In addition to indicating financial health, debt ratios can help uncover value in corporate bonds. One way involves looking at the ratio between debt and one-year earnings before interest, taxes, depreciation and amortization (EBITDA). A one-to-one ratio between debt and EBITDA can be thought of as a single “turn of leverage”. Figure 6 shows corporate bonds from Asia tend to have higher spreads (over comparable maturity U.S. swaps) per turn of net leverage on compared to corporate bonds from the U.S. By this metric, the yield from Asian corporates is potentially more attractive.
Despite a challenging year for risk assets in 2011, including the downgrade of the U.S. and trouble brewing in the eurozone, the JACI index stayed in positive territory and returned 4.12%. The investment grade rated portion (61% of the index) returned 4.92% and the sub-investment grade rated portion (39% of the index) returned 2.85%. The index has returned 7% on an annualized based in the five years from 2007 to 2011. Figure 7 shows how some different liquid Asian assets performed over the last five years and in 2011.
We must be mindful that Asia is not a homogeneous region and countries across Asia cannot be painted with the same brushstroke. India has fiscal challenges to deal with, China is going through a political transition and Vietnam is struggling to sustain growth while containing high inflation. Countries must make further progress on improving the quality of institutional frameworks, regulatory bodies and bankruptcy regimes. Given this backdrop and the global macroeconomic environment, investors may wish to consider investment managers that have a solid global macro investment process, strong relationships with local stakeholders and experience in local markets. PIMCO believes in the resilience of emerging Asian countries and that leads us to be open to adding exposure in sovereign credit and high quality corporate credits across portfolios as attractive opportunities arise.
Past performance is not a guarantee or a reliable indicator of future results.
Investing in the bond market issubject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Sovereign securities are generally backed by the issuing government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.
There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. The Barclays U.S. Treasury Index is a measure of the public obligations of the U.S. Treasury. The Barclays U.S. Fixed Rate Mortgage-Backed Securities Index is composed of all fixed-rate securitized mortgage pools by GNMA, FNMA, and the FHLMC, including GNMA Graduated Payment Mortgages. Barclays Global Aggregate (USD Hedged) Index provides a broad-based measure of the global investment-grade fixed income markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The index also includes Eurodollar and Euro-Yen corporate bonds, Canadian Government securities, and USD investment grade 144A securities The Barclays Global Aggregate Credit Index is the credit component of the Barclays Aggregate Index. The Barclays Aggregate Index is a subset of the Global Aggregate Index, and contains investment grade credit securities from the U.S. Aggregate, Pan-European Aggregate, Asian-Pacific Aggregate, Eurodollar, 144A and Euro-Yen indices. The HSBC Asian Local Bond Index (ALBI) tracks the total return of local currency denominated, high quality, and liquid bond in Asia ex-Japan. The index returns for each country-based sub-index are calculated in the respective local currencies and the return for the overall ALBI index is measured in US dollars. The J.P. Morgan Asia Credit Index (JACI) tracks total return performance of the Asia fixed-rate dollar bond market. JACI is a market cap-weighted index comprising sovereign, quasi-sovereign and corporate bonds and it is partitioned by country, sector and credit rating. It is not possible to invest directly in an unmanaged index.
This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Pacific Investment Management Company LLC.
Copyright © 2012, PIMCO.
Tags: Absolute Levels, Asia Markets, Asian Central Banks, Asian Economies, Attractive Opportunities, Corporate Issuers, Debt Levels, Emerging Asia, Exporting Goods, Foreign Exchange Reserves, Fundamental Improvements, GDP Growth, Gdp Output, Global Gdp, Global Macro, Investment Managers, Kalra, Macroeconomic Environment, Macroeconomic Trends, Rapid Return, Sovereign Ratings
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Wednesday, April 25th, 2012
Over the past decade, Asia’s transition to the leadership position in global oil consumption is well known. Starting in 2002, OECD countries slowed their consumption growth for oil and subsequent to 2005 actually saw their consumption decline. This process freed up limited oil supplies to Asia, which now accounts for 31% of total global oil use, as of the latest data. | see: Regional Share of Total Global Oil Consumption (as of Q4 2011).
Less discussed is the emergence of new oil demand from the Middle East and especially Africa. While oil demand from younger populations in the Middle East is subsidized, and offers the prospect that future subsidy removals could slow demand, Africa’s capability to hit the world with new demand looks particularly intriguing. With roughly 1 billion people on the continent, the trajectory of future African demand could follow the same path of other emerging Asia with a ferocious insensitivity to price rises as new users come onstream, consuming only a little oil individually. Moreover, as you can see in the chart, African demand accounts for less than 4% of world demand, even though it contains over 14% of world population. In other words, in a world of flat supply, in which crude oil production has been trapped below 74 mbpd of production since 2005, Africa could easily add 2-3 mbpd of new demand over the next several years. If not more.
A small amount of petrol is a life-changer to a new user, adopting short-trip motorized transport for the first time. There are myriad reasons to watch Africa, and many who are involved in everything from agricultural development to mobile communications already do. But Africa as an emerging source of oil demand, the kind that could rapidly escalate and catch the world by surprise, is another reason to study this emerging continent closely.
Copyright © Gregor Macdonald
Tags: Agricultural Development, Consumption Growth, Crude Oil Production, Emerging Asia, Global Oil, Gregor Macdonald, Insensitivity, Leadership Position, Mbpd, Mobile Communications, Myriad Reasons, New Oil, Oecd Countries, Oil Consumption, Oil Demand, Oil Supplies, Q4, Short Trip, Trajectory, World Population
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Tuesday, February 7th, 2012
This week, I’m updating my views on some of the emerging market countries in Asia.
While I’m upgrading Chinese equities from neutral to overweight, I’m downgrading South Korean and Indian stocks from neutral to underweight.
Starting with China and South Korea – the two countries are both highly exposed to global growth, but China currently appears to be the better positioned of the two and is likely to hold up much better from a growth perspective.
First, while Chinese equities have performed well year to date, they are down over the past 12 months. As a result, Chinese equities are cheap compared to other Asian emerging market countries, trading at 1.6x book value.
Recent economic data also suggests that growth in China is stabilizing and supports a soft landing. The most recent purchasing managers index, a key measure of manufacturing activity, came out last week at a better-than-expected 50.5, and retail sales growth is actually up to 18.1% year over year. Finally, Chinese inflation, which we all know was a big problem in 2011, is falling. It’s down to 4.1% from 5.5% in November and 6.5% in August.
To be sure, South Korean equities are also cheap compared to other emerging markets. This, however, is normal. South Korea typically commands a big discount due to ongoing uncertainty over North Korea. The cheapness of South Korean stocks is also justified given the country’s worsening economic outlook. South Korea’s economic readings have particularly suffered recently.
Finally, I’m downgrading India in response to the country’s recent surge in valuations and persistently high inflation. Indian stocks appear expensive once again. They are up more than 20% year to date and are currently trading at 2.6x book value. This compares with the Asian emerging market average of 2.4x book value.
In addition, growth in India is still strongly below trend and while the country’s profitability is respectable, it has been on a downward trend over the last couple of months. Finally, Indian inflation, while down from a couple of months ago, is still in the danger territory at 9.3%. All in all, Indian stocks are simply too expensive given current fundamentals (potential iShares solutions: MCHI, ECNS).
International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.
Copyright © iShares
Tags: 6x, Countries In Asia, Downward Trend, Economic Data, Economic Outlook, Emerging Asia, Emerging Market Countries, Emerging Markets, Global Growth, Growth Perspective, Indian Stocks, inflation, North Korea, Overweight, Profitability, Purchasing Managers Index, Retail Sales Growth, South Korea, South Korean Stocks, Valuations
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Friday, July 29th, 2011
by Lupin Rahman, PIMCO
- We forecast emerging economies will expand at a faster pace than advanced economies over the secular horizon.
- The challenge for emerging market central bankers is to remain ahead of inflation expectations and retain credibility on inflation targeting. We feel they are well positioned for this.
- We believe global investors remain significantly underweight emerging market assets. We expect this underallocation to decrease, providing multiyear support for the asset class.
Emerging markets are increasingly important drivers of growth for the global economy, though they face challenges to reaching parity with, or even surpassing, today’s developed nations.
In the final of a series of Q&A articles accompanying the recent release of PIMCO’s Secular Outlook, portfolio manager Lupin Rahman discusses growth dynamics, inflation and structural change in emerging markets (EM) as well as what all of this means for the global economy.
Q. Could you discuss growth dynamics in emerging markets and their share of the global economy?
Rahman: We forecast emerging markets to outperform advanced economies over the secular horizon (next three to five years) with growth averaging 6% vs. 2% in advanced economies. Significant transitions already underway in the global economy underpin this trend. Essentially we are seeing a shift from a unipolar world anchored by advanced economies toward a multipolar world with large emerging economies playing an increasingly larger role in the global economy.
Within EM we expect to see differentiation across economies. In Latin America and emerging Asia we forecast growth in the 6% to 7% range to be anchored by low leverage, strong structural demand for commodities and a soft landing in China. Meanwhile, countries in emerging Europe, and in particular those economies with high levels of leverage, are likely to experience a period of modest growth in the 4% range.
The relevance of this increasing importance of EM for investors lies in the remarkable divergence between current investor positioning and the economic realities of the postcrisis world. Specifically, we believe global investors remain significantly underweight emerging market assets in relation to both their current and future share of the world economy, as well as in relation to the trends in their relative credit fundamentals. We believe that as markets reorient to our New Normal view of the world this underallocation to EM will decrease, providing multiyear support for the asset class.
Q. How does the middle class in emerging markets compare to the developed world? And what are
current and anticipated domestic consumption patterns in EM?
Rahman: The growth of the emerging middle class is an important aspect of the EM growth story, particularly in the context of a deleveraging consumer base in advanced economies. If we take the World Bank’s definition, the global middle class is forecast to triple from 400 million in 2000 to 1.2 billion in 2030, with China and India accounting for most of this expansion, according to a December 2006 report. To put this into perspective, this means that by 2030 a significant majority of the global middle class will be from EM.
In addition to important strides in po verty reduction, this shift represents tremendous opportunities in new global consumer markets as EM consumption expands beyond food and shelter and towards consumer durables and services. In fact we are already seeing this trend with spending on automobiles, refrigerators and entertainment showing robust growth. We expect this to continue in the next decade and be underpinned by gains in real EM consumption growth which we estimate will increase by 50% in real terms.
Q. Shifting gears, could inflation cloud the outlook for emerging markets?
Rahman: There have been two important shifts in EM inflation dynamics over the past decade underpinned by more independent central banks, a reduction of fiscal dominance and a reduction in wage indexation. First, the levels of inflation in emerging markets have dropped from double-digit increases being the norm to headline inflation decreasing to the mid-single digits. Second, inflation volatility has decreased as a result of more anchored inflation expectations.
Looking ahead, the current 2 to 3 percentage point differential between emerging market and advanced
economy inflation will likely persist given our forecast of robust EM growth and debt deleveraging in advanced
economies. But importantly, we do not see a sharp secular increase in this differential. Of course there are risks to this baseline view from potential spikes in commodity prices and asset-market bubbles, but the fundamental shifts in inflation expectations mentioned before provide EM policymakers room to maneuver in tackling these shocks.
Q. What are central bankers in those countries doing to contain inflation, and what are the implications of
Tags: asset class, Brazil, Commodities, Credibility, Differentiation, Emerging Asia, Emerging Economies, Emerging Europe, Emerging Market, Emerging Markets, Global Economy, Global Investors, Growth Dynamics, India, Inflation Expectations, Latin America, Leverage, Market Assets, Multipolar World, Parity, Portfolio Manager, Unipolar World
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Saturday, May 14th, 2011
Emerging Markets Cheat Sheet (May 16, 2011)
- In spite of political uncertainty in Peru, Credicorp reported solid first quarter results with net income rising 40 percent year-over-year, well ahead of consensus estimates. However, the bank cautioned that its future performance will be linked to economic stability in the country that, in a large measure, will depend on the outcome of the forthcoming election on June 5.
- Mexican-listed airport groups have reported satisfactory traffic data for April: ASUR led with a 4.8 percent increase, while GAP/OMA registered a 1 percent rise in the number of passengers.
- The 2009 combined middle and affluent (MA) class population of Emerging Europe was equal that of China. Russia has the second largest MA emerging market population, and Poland’s rivals that of India. At $17,856, Turkey has the second highest MA class GDP per capita in emerging markets.
- Taiwan’s April exports rose 24.6 percent, driven by information and communication products, minerals, and machineries.
- National Bureau of Statistics of China shows real estate investments reached RMB 1.3 trillion for the first four months of this year, up 34.3 percent from the same period last year. New project starts were up 24.4 percent year-over-year; sales were up 13.3 percent to RMB 1.4 trillion.
- Korean central bank freezes benchmark interest rate at 3 percent, after inflation in April declines to 4.2 percent from 4.7 percent in March, indicating a direction that inflation might start to peak. Also, Indonesia froze its benchmark rate at 6.75 percent in the week after its inflation was stabilizing at around 6.5 percent. If this is a trend, emerging Asia countries might be successful at curbing inflation.
- China International Capital Corp (CICC) says China’s Internet revenue will grow to RMB 1.5 trillion by 2013, which equates to a compound annual growth rate of 40 percent and 6.5 percent of total retail in the country. Sina, in its first quarter earning release, said its Weibo membership has grown to 140 million registered users, adding 40 million since February. CICC also believes the growth in Internet users will drive Internet infrastructure investment. It is estimated that China has 450 million active internet users, the largest in the world.
- In April, China has achieved its targeted money growth rate of 15 percent, i.e., M2 money supply is at 15.2 percent. If maintained, China might be able to manage a soft landing for its high flying GDP growth.
- China’s macroeconomic numbers also show robust consumer spending with retail sales growing 17.1 percent in April.
- Investment momentum remains high in China. Urban fixed-asset investment growth surprised the market on the upside by strengthening to 25.4 percent.
- China’s April exports grew 29.9 percent, which is a desirable growth given the RMB appreciation pressure and cost increases for Chinese manufacturers.
- Power generation in China was up 11.7 percent in April, but it still faces power shortage across the country.
- Since 2004, public sector wages grew faster than wages in the private sector in Poland. Higher wages, combined with better social benefits and stable employment, lead many Poles to cast a wary eye toward privatization plans. Powerful unions were recently able to block initial public offering (IPO) plans.
- China’s consumer price index was 5.3 percent in April, slightly lower than 5.4 percent in March. Although the number is still above the government’s desired target of 5 percent for the year, a key component of the index, food, has declined 0.4 percent from March, indicating the government measures on price control have worked.
- Industrial production growth in China slowed to 13.4 percent year-over-year in April, compared to 14.8 percent in March, caused by government tightening of the housing market and inflation control.
- Auto sales in April fell 0.25 percent year-over-year in China, indicating a spillover effect from the government’s tightening on the housing market.
- China has just increased the reserve replacement ratio (RRR) another 50 basis points, reaching 21 percent for the large banks. Considering the fact that deposit growth year-to-date in China was 17 percent, the impact on the banks’ loan book is minimal.
- Chinese high speed rails are having a negative impact on airline traffic, particularly in the mid-to-short distance travel. According to the China Ministry of Railways, it takes four hours by high speed train from Wuhan to Guangzhou, while it takes three hours by airplane, including time spent traveling to the airport or train station and check-in.
- The number of listed airlines in Latin America increased this week with a successful IPO of Avianca from Colombia – the stock gained 18 percent on the first day of trading.
- There are indications that Mexico and Panama might be considering joining a combined equities platform (MILA) that will also include Chile, Colombia and Peru.
- Falabella, the Chilean retailer, has received a license to start banking services in Colombia.
- According to Metal Bulletin, Russian producers are looking for a $10 to 20 per ton increase in hot rolled coil export prices in June, which could signal some improvement in demand on the export markets. This could help maintain stable prices on the domestic market, while any signs of recovery in construction demand in Russia would be quite supportive for Russian steel companies.
- Deutsch Bank China Economist Ma Jun recently boosted his forecast of RMB deposits in Hong Kong to 2 trillion by the end of 2012, driven by rapidly rising trade settlement between China mainland and Hong Kong. RMB deposits soared to 407 billion in February 2011, six times the amount in the same period last year. Among the many opportunities arising from this growth is that Macau casino business will be the low hanging fruit for investors since it benefits directly from the RMB out-flows. The chart shows the correlation between RMB deposit in Hong Kong and Macau gaming revenue.
- A recent correction in commodities prices may be a headwind for resource dependent countries in Latin America, notably Brazil, Chile and Peru.
- A company press release by Magyar Telekom announced that the regulator in Hungary has obliged the operator to provide access to its passive network infrastructures, including ducts, poles, dark fiber, copper and optical local loops. It remains to be seen who will take advantage of this regulation to take share away from Magyar.
- April’s macro economic numbers show that the growth of the Chinese economy is slowing due to China’s monetary tightening. The market believes China will have one more interest rate hike in second quarter, and several RRR increases until inflation concerns subside. While the market is broadly predicting a soft landing in China, investors have yet to commit their money in the market, as shown by Hong Kong lower daily trading volume.
Tags: Asia Countries, Asur, Benchmark Interest Rate, Benchmark Rate, Brazil, Bureau Of Statistics, China International, China Russia, Cicc, Compound Annual Growth Rate, Credicorp, Emerging Asia, Emerging Europe, Forthcoming Election, Gdp Per Capita, India, Infrastructure, Internet Revenue, Market Population, National Bureau Of Statistics, National Bureau Of Statistics Of China, Political Uncertainty, Real Estate Investments
Posted in Brazil, India, Infrastructure, Markets | Comments Off
Thursday, February 17th, 2011
Food Chain: Do Spiking Food Prices Warn of Generalized Inflation?
February 14, 2011
- Food inflation heats up and incites global unrest.
- But for now, it’s unlikely to become a monetary phenomenon.
- Investors should expect geopolitical risk to stay elevated in 2011, with implications for emerging markets performance.
Inflation is back as a big concern … for some it never waned. The subject has headlined many of my reports during the past couple of years; since the Federal Reserve began pumping unprecedented sums of liquidity into the financial system in 2008.
Recently, it’s the shocking spike in food and, to a lesser degree, energy prices that has elevated the worries again that “core” (excluding food and energy) inflation will follow.
The recent troubling spike in food inflation, seen in the chart below, has its roots in major supply disruptions caused by extreme weather conditions in many of the largest food producing countries. But it’s also a function of booming emerging economies and the rise of their consumer population.
Skyrocketing Food Prices
Click to enlarge
Source: Commodity Research Bureau (CRB) and FactSet, as of February 11, 2011.
Rapidly rising inflation can be toxic not only to economies, but to profit margins and stock market valuations, as well. It’s also becoming toxic to the social fabric in countries where food is a large portion of consumers’ expenditures, like in emerging Asia (see chart below).
Unless food and fuel prices begin to ease, there are implications for Asia’s debt outlook and also for leaders hoping to prevent another Egyptian-style uprising; which had at its roots unrest about food prices and unemployment.
Emerging Economies’ Food Consumption
Click to enlarge
Source: Wolfe Trahan & Co. Portfolio Strategy, as of February 14, 2011. Chart uses region average.
The United Nations estimates that countries spent at least $1 trillion on food imports last year, with the poorest nations paying about 20% more than in 2009. Asian governments are expected to increase subsidies and cut import taxes, with potential important fiscal implications. This is on top of the social instability risks that the world watched in Egypt during the past several weeks.
Unlike the commodity price spike in 2008, that had a large speculative component to it, this one appears to be less cyclical and more secular. Asia’s diet is becoming more Western, with a greater focus on dairy and livestock, and less focus on its historic staples.
Rising commodity prices are making it difficult for China’s central bank in particular, but also in India and Indonesia, among others. Expect much tighter monetary policy in the region, which has implications for emerging markets performance. We continue to believe investors should not be overweight emerging markets relative to their strategic targets.
In fact, in addition to the fund flows coming out of bonds in reaction to the latest spike in Treasury yields, we think outflows from emerging markets could find their way to US stocks.
We do have some budding concern that there could be some upward pressure on core inflation in the United States, too, but think the implications of rising headline inflation will be felt more acutely in the emerging markets, both economically and socially.
Too much … too few
The late, great Milton Friedman once proclaimed that inflation is best defined as “too much money chasing too few goods.” Many are making the “too much money” argument because of the massive liquidity in the financial system. But that money remains stuck in the banking system, as we’ll discuss shortly.
Now it’s also the “too few goods” argument that is being made because of food shortages. But the real question for US monetary policy is whether the conditions are in place for general price inflation to take hold.
Given the tremendous amount of excess global capacity and limited upside wage pressures, core inflation risk in the developed world remains relatively benign.
The latest core inflation readings are:
- 0.8% in the United States (see chart below).
- 1.1% in the euro-zone.
- -0.7% in Japan.
- Even China’s core inflation, though higher than the aforementioned regions, is at a reasonable 2.1%.
Core Inflation in Check … For Now
Click to enlarge
Source: FactSet, as of December 31, 2010.
Many argue that it’s only a matter of time before core levels of inflation begin to heat up, given liquidity overflows. But Bank Credit Analyst (BCA) notes that developed world central banks have not been able to create a “money glut.” Money supply (M2) growth in the United States is up, but only 4.3% year-over-year. For the Organisation for Economic Co-operation and Development (OECD) as a whole, broad money is only growing at a 1.2% annual rate. An acceleration would likely put upward pressure on inflation expectations, so money supply growth rates need to be watched carefully.
More velocity needed
In reality, all that developed world central banks have accomplished is to free up reserves in their banking systems, little of which is getting passed through the lending channels to feed into the economy.
This is the concept of the “money multiplier” about which I’ve written extensively. The math behind what’s also called the “velocity” of money is dividing M2 money supply by the overall monetary base (currency in circulation plus banks’ required and excess deposits at the Fed).
When it’s low as it is presently, core inflation risk is benign. This is one of the key metrics we’re watching to see if inflation risk is increasing.
Velocity of Money on Floor
Click to enlarge
Source: FactSet and Federal Reserve, as of February 4, 2011.
No wage-price spiral in sight
Another precondition for core inflation to erupt is excess wage growth and/or rising unit labor costs. This is the so-called “wage-price spiral” inflation that characterized the late 1970s and early 1980s. As you can see below, neither is highlighting trouble on the horizon.
Muted Wage Pressures
Click to enlarge
Source: Department of Labor and FactSet, as of December 31, 2010.
No Unit Labor Cost Pressures
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Source: Department of Labor and FactSet, as of December 31, 2010.
As BCA points out, wage growth exceeding labor productivity is what triggered the wage-price spiral in the 1970s. In the mid-1970s, the difference between the two was 18%, while today it is barely in positive territory (up from negative territory in 2009).
The tax effect
Let me state the obvious by noting that rising food and energy prices do have an economic impact as they act as a tax on the consumer, which drains discretionary spending power. But as long as wage and unit labor cost growth is in check, there is unlikely to be widespread ability to pass along rising input costs to the end consumer. Rising commodity prices can’t create pricing power where it didn’t exist before.
That doesn’t mean there aren’t certain companies and/or industries that are having some success and this bears careful watching. The National Federation of Independent Business survey of small business price plans increased to 19% in January versus its recession low of 0% (it was 30% in 2007).
The airlines also announced price increases last week, along with a couple of large consumer products companies. Finally, University of Michigan’s survey of consumer inflation expectations rose to 4.5% in the first half of February versus its recession low of 1.7%.
What would trigger general price inflation?
We are starting to see an increase in bank lending, both for commercial and industrial (C&I) and consumer loans. A more sustained increase would cause the velocity of money to begin accelerating. Frankly, this is a necessity for a sustainable economic expansion, but it would also increase core inflation risk.
In addition, because emerging markets are behind much of the spike in commodity prices, it puts pressure on goods’ prices that are transported across borders. Clearly, producers of these goods have incentive to sell into inflating markets, so prices received are higher.
They will likely only sell to US dollar-based consumers if the US dollar price received is commensurate with the price in the inflating emerging markets. This could result in shortages, exacerbated by rumored hoarding, which would mean higher prices absent an increase in the velocity of money.
The hope is that the size dominance of the developed consumer markets versus the emerging consumer markets will prevent sufficient goods to flow to high-inflation markets to significantly increase generalized inflation risks globally.
The China Syndrome
China is at the heart of the inflation scare and bears close monitoring. Given its robust economic growth and excessive credit growth, the risk of food inflation passing through to general price levels is high and rising. It is somewhat tempered by monetary policy tightening and the fall in China’s leading economic indicators in reaction.
As BCA notes, if history is any guide, inflationary pressures could crest sooner than later alongside a slowing economy. China’s wage growth is about 16% year-over-year, roughly in line with productivity growth in the modern sector. This is the principal reason why core inflation has stayed low.
Fed reaction function
Traditional monetary inflation is not yet spreading in the global economy with limited wage growth not only in the Untied States, but in the G7 more broadly. And G7 productivity growth remains healthy. This should keep developed country central banks largely accommodative.
We do worry the Fed will remain accommodative too long though. As we’ve noted, we believe the US economy is well past the emergency phase that pushed the Fed to lower short rates to zero.
Expect the criticisms about too-easy monetary policy to persist with every uptick in commodity prices. Cries of the Fed being “behind the curve” will likely get a volume boost this year.
In the shorter term, it’s likely the social and economic implications of what we’re seeing with commodity prices that will continue to be the big story.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative (or “informational”) purposes only and not intended to be reflective of results you can expect to achieve.
Tags: BRIC, BRICs, Charles Schwab, Chief Investment Strategist, China, Commodity Research Bureau, Consumer Population, Crb, Currency, Egyptian Style, Emerging Asia, Emerging Economies, Emerging Markets, energy, Energy Prices, Extreme Weather Conditions, Factset, Food And Fuel, Food Consumption, Food prices, India, Liz Ann, Portfolio Strategy, Senior Vice President, Social Fabric, Stock Market Valuations, Trahan
Posted in Credit Markets, Emerging Markets, India, Markets, Outlook | Comments Off
Friday, July 23rd, 2010
China was crowned the world’s top energy consumer earlier this week but demand growth in all parts of the world except Western Europe has pushed global oil demand growth past pre-financial crisis levels. Oil-industry analyst PIRA is forecasting demand growth will exceed 2 million barrels per day by mid-2011.
As you can see from the chart, demand growth in emerging Asia has remained steady throughout the crisis except for a hiccup in early 2009. Meanwhile, the U.S., Japan and the rest of the world experienced substantial contractions in demand.
PIRA says strong global economic growth—it estimates 4.2 percent GDP growth in 2010—will push global oil demand 1.95 million barrels per day higher than it was a year ago. More than 60 percent of this growth will come from China, India and other developing areas of the world such as the Middle East. The U.S. will kick in an additional 20 percent—adding 400,000 barrels per day in year-over-year demand growth.
That’s a strong pace that may slow down next year.
The International Energy Agency (IEA), the Paris-based agency that broke the news on China’s top status this week, is heading in the opposite direction. The IEA sees world oil demand increasing by 1.3 million barrels a day (1.6 percent) in 2011. That’s a slowdown from 2010 but close to the average 1.7 percent annual growth rate we saw from 2000-2007.
The pace of oil demand growth is going to depend on the pace of the recovery. If some of the economic fears come to fruition in Europe and even China, we could see global demand for oil suffer some setbacks.
Tags: Contractions, Crisis Levels, Emerging Asia, Energy Consumer, Exceed 2, Fruition, GDP Growth, Global Demand, Global Economic Growth, Global Oil, Hiccup, India, Industry Analyst, International Energy Agency, oil, Oil Industry, Pira, Setbacks, Slowdown, Top Energy, Western Europe, World Oil Demand
Posted in China, Energy & Natural Resources, India, Oil and Gas | Comments Off
Monday, May 24th, 2010
- Thanks to a strong rebound in global trade and the mainland Chinese economy, Taiwan’s GDP expanded 13.3 percent year-over-year in the first quarter. This better-than-expected pace is the fastest in more than 30 years. During the same quarter, mainland Chinese visitors to Taiwan outnumbered Japanese for the first time due to relaxed travel rules.
- Robust Asian demand and a recovery in the U.S. helped Singapore’s GDP rise 15.5 percent in the first quarter from a year earlier. The rise was stronger than market expectations and the government estimate.
- Dubai World announced on Thursday that it had reached an agreement in principle with 60 percent of creditors regarding $14.4 billion in outstanding bank debt. The deal will also pave the way to the injection of $9.1 billion in fresh funds by the Dubai Financial Support Fund (DFSF) into Nakheel and Dubai World. This will provide a much-needed boost to the construction and real estate sectors in Dubai.
- Indonesia, one of the best performing markets over the past 12 months, was one of the worst performers in emerging Asia this past week, as foreign investors were active in taking profits.
- Hungary and Czech Republic are the most dependent of Eastern European countries on exports to the European Union and recent euro weakness negatively affects profitability of those exports, according to Citi research.
- Investor risk aversion has surged globally in the last two weeks and may continue to benefit defensive sectors and those sectors receiving government policy support. The Chinese healthcare sector qualifies for both. Government healthcare spending is still less than 5 percent of GDP in China, compared with 8-10 percent in developed countries and 6 percent on average in emerging markets. Secular growth opportunities exist due to the significant role healthcare plays in facilitating China’s transition from investment /export-led economy to a consumption-led one.
- Citi research suggests that any euro-to-zloty exchange rate above 3.6 makes Polish exports competitive in foreign markets. The rate currently stands at 4.1, which should help boost exports in the coming months.
- While the decline in Chinese residential property transaction volume has accelerated in the first half of May, prices have managed to remain stable, suggesting only limited success of government intervention since mid-April. The gridlock might persist in the short run, as potential buyers are not in a rush to purchase. In addition, developers flush with cash would prefer to wait and see through this cycle. The European situation brings hope that the Chinese policymakers might ease tightening measures but the longer the status quo is kept, the less assurance the market receives.
After an 18 percent rise in April, activity in the construction sector of Poland and the Czech Republic is likely to slow due to heavy rains and flooding. The area affected by floods in Poland is responsible for 35 percent of the country’s gross domestic product.
Tags: Bank Debt, Bill Gross, China, Chinese Economy, Chinese Visitors, Dfsf, Eastern European Countries, Emerging Asia, Emerging Markets, Foreign Investors, Government Estimate, Government Healthcare, Growth Opportunities, Healthcare Sector, Investor Risk, Market Expectations, Nakheel, Real Estate Sectors, Research Opportunities, Risk Aversion, Secular Growth, Travel Rules
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Rosenberg: “Greece Is The Same Coalmine Canary As Thailand Was To LTCM And As New Century Was To Lehman”
Tuesday, May 11th, 2010
David Rosenberg is out with some very fitting analogies of the current sovereign crisis. If he is proven prescient, which we have no doubt he will, the Greek near-default will have massive repercussions to the entire developed world when all is said and done.”In my opinion, Greece is the same canary in the coal mine that Thailand was for emerging Asia in 1997, which ultimately led to the Russian debt default and demise of LTCM; the same canary in the coal mine that New Century Financial in early 2007 proved to be in terms of being a leading indicator for the likes of Bear Stearns and Lehman. So, the most dangerous thing to do now is to view Greece as a one-off crisis that will be contained.” Furthermore, as he makes all too clear, if a $1 trillion bailout can only buy 400 points in teh Dow, Europe, aside from all the other fundamentals which confirm the same, is doomed, and even the ever-optimistic market now realizes it. Lastly, should Europe pursue the required austerity measures, the hit to European GDP will be massive, and is certainly not being priced in European stocks, but certainly not in US stocks, whose primary export market is about to disappear.
From today’s Breakfast with Dave.
Well, I think the turbulent global events of the past few weeks underscore the reason why I have maintained a cautious investment approach for the past year, notwithstanding the massive recovery in risk assets we saw from the March 2009 lows, which from my lens bore a huge resemblance to the bungee jump in the market back in 1930. In fact, at one point two weeks ago, at the highs, the stock market had already achieved, in barely more than a year, what took five years to accomplish in the 2002 to 2007 bull market, and at least that market wasn’t being fuelled by unprecedented government intervention in the economy and incursion into the capital markets.
The dramatic government stimulus was global in nature, and this was the primary prop behind the rally in equities over the past year and change, and the message coming out of Greece, and not just Greece but many other governments in the European Union and across the globe, is that governments are probing the outer limits of their deficit finance capacities. History does indeed show that it is quite common to see sovereign default risks follow on the heels of a global banking crisis, which was the story for 2007 and 2008; it took a respite in 2009 and we are now in a new chapter of this prolonged debt deleveraging story. These cycles of balance sheet repair, alternating between the private and public sector, typically lasts 6 to 7 years. We are barely into year three, and what is extremely important in this roller coaster ride is to focus on capital preservation strategies that minimize the volatility in the portfolio, which is one reason why I have favoured long-short income and equity strategies.
In my opinion, Greece is the same canary in the coal mine that Thailand was for emerging Asia in 1997, which ultimately led to the Russian debt default and demise of LTCM; the same canary in the coal mine that New Century Financial in early 2007 proved to be in terms of being a leading indicator for the likes of Bear Stearns and Lehman. So, the most dangerous thing to do now is to view Greece as a one-off crisis that will be contained. Even with this new and aggressive EU-IMF financing arrangement that has managed to trigger a wild short covering rally yesterday, the risks are still high that the contagion spreads to countries like Portugal, Spain, Italy and even the U.K., which has already received some warnings from the major rating agencies and is gripped with political gridlock in the aftermath of last week’s uncertain election results.
The problem of there being far too much debt on balance sheets globally has not gone away and in many cases has become worse, and the ability to service these debts especially in countries that have weak economic structures like Greece, Portugal and Spain has become seriously impaired. It remains to be seen how Greece and the other problem countries in the euro area will manage to cut their deficits without, at the same time, controlling their monetary policy and their currency, which of course we were able to do here in Canada during the 1990s but with the help of a 30% currency devaluation.
Speaking of Canada, the downdraft in our market and our dollar shows once again that we can be doing everything right, and in terms of fiscal policy we still look good on a relative basis. However, being a small open economy sensitive to commodity prices, this is one of those times where sudden shifts in global economic sentiment can hit us disproportionately.
Even before this latest leg in the European financial crisis, China was already tightening monetary policy aggressively to lean against what appears to be a property bubble in various urban centers. One has to consider what the outlook is for the global economy in general, and near-term prospects for the resource sector in particular, when the Shanghai equity index is down more than 20% from the nearby highs; yet something else to add to the concern list.
Recall that we headed into this latest round of turmoil with the equity markets priced for a return to peak earnings as early as next year, bullish sentiment on the stock market and institutional investor cash ratios at levels we last saw in late 2007 when the market was just rolling off its highs, and measures of volatility at extremely low levels, the VIX index was a mere 15 as an example, a sign of widespread complacency. It is at times like that, when all the good news is priced in and then some, and the exact opposite of what was happening at the lows just over a year ago, that the markets are most susceptible to a pullback.
With the benefit of hindsight, it is clear that the time to start to wade into the risk asset pool was a year ago after a 60% plunge in equities. However, 80% later on the upside, it’s time to get more defensive and less cyclical with a keen eye towards taking advantage of this crisis if it presents opportunities in the equity market as the panic in the corporate bond market presented to us back in early 2009. I, for one, am looking forward to having my temptation level tested if this market heads back into undervalued or even fair-value terrain, which it only managed to achieve for a few months early last year.
While the coincident economic indicators, such as employment, have improved in recent months, many of the leading indicators have begun to roll over. In fact, these indicators are pointing towards a discernible slowing in economic and earnings growth in the second half of the year and into 2011 when we will see the stimulus shift to significant fiscal restraint in both Canada and the U.S., and the lagged impact of the Chinese policy tightening.
In addition, while the periphery of Europe received a financial lifeline package, the conditions for accessing the funds will require massive fiscal tightening and it will be interesting to see how countries like Spain, let alone Greece, can cut spending and raise taxes at a time when the unemployment rate is at a sky-high 20%. Remember, 20% of the global economy is going to be slowing down going forward, the question is by how much and this in turn will impact North American exports. On top of that, the equity and debt cost of capital, which had been on a declining path for much of the past year and has very supportive of risk appetite, is now going on the opposite path. This is not necessarily a double-dip recession scenario, but I would not rule it out.
What’s important from an investor standpoint is that the uncertainty surrounding the macro outlook is much wider now than it was before. Over the near term, there is still more downside but the main message is that one should be prepared to take advantage of the springtime selling by using cash and near-cash as part of a tactical asset allocation strategy because one of the best way to make money in this tumultuous environment is not to lose it, but to have it ready to put to use once things get really cheap.
At the same time, we are confronting a deflationary shock at a time when most measured rates of underlying inflation in most parts of the world, especially the U.S. are already extremely low, barely 1%, and in such an environment, having an income theme as a core component of the portfolio makes a whole lot of sense.
As for the GDP impact on Europe now that all the dirty laundry is out int he open, here is why it will get very ugly:
We did some in-depth analysis on how the economies of the “PIIGS” (Portugal, Italy, Ireland, Greece and Spain) countries (and the rest of Europe) would fare if deficit-to-GDP ratios were to revert back to the Maastricht criteria of 3%. The adjustment will be painful for Europe in general, slicing off about 1% GDP growth annually over the next three years, and very painful for the PIIGS specifically. If these countries’ fiscal ratios were return to 3%, Ireland would see four percentage points (ppts) shaved off nominal GDP annually over the next three years, Greece 3.5ppts, Spain 2.8ppts, Portugal 2.2ppts and 0.8ppt for Italy.
It would not be a picnic for the rest of Europe, where many countries were running deficits greater than 3% of GDP in 2009. We estimate that fiscal cuts will shave about 1.5ppts off France’s nominal growth, 1.0ppt for Belgium, and 0.8ppt for the Netherlands. Austria and Germany would only have to endure 0.2ppt and 0.1ppt lower GDP growth, respectively, to bring their ratios back in line with targets. Finland is the only country with a GDP deficit under 3% (using 2009 data). Note that the starting point for our analysis was 2009 — the adjustment could be more painful as deficit-to-GDP ratios look to have deteriorated further in 2010.
Lastly, it appears that even Rosie has had it with the unbearable hypocrisy of our “leaders.”
Maybe it’s all about false pride. The need to counter-attack those who would dare to attack the Euro. How interesting was it to see the sharpness of the political rhetoric over the weekend from the European political elite. Please, fund our lifestyle, Mr. Market, but don’t hold us to our commitments:
“ … a battle of the politicians against the markets. I am determined to win” (German Chancellor Angela Merkel).
“… unfounded off-the-wall suggestions and speculation” (EC President Jose Manuel Barroso).
“… confront speculators mercilessly … know once and for all what lies in store for them” (French Present Nicolas Zarkozy).
It is a sad deflationary reality when a trillion dollars can only buy you 400 points on the Dow. What can the politicos do for an encore?
Tags: Austerity Measures, Bailout, Bear Stearns, Bungee Jump, Canadian Market, China, Coal Mine, Coalmine, Dangerous Thing, David Rosenberg, Debt Default, Dow Europe, Emerging Asia, European Stocks, Export Market, Global Events, Government Intervention In The Economy, Investment Approach, Leading Indicator, Massive Repercussions, New Century Financial, Russia, Russian Debt
Posted in Bonds, Canadian Market, Energy & Natural Resources, Markets, Oil and Gas, Outlook, US Stocks | Comments Off
Saturday, April 24th, 2010
April 23, 2010
by Frank Holmes, CEO, US Global Investors
Emerging markets are changing the way the world works by developing into global powerhouses. The latest edition of our “What’s Driving?” series identifies the six key drivers and the effect they have on the economic vitality of emerging markets.
- Rapid Economic Growth: In the coming years, growth in emerging economies is expected to outpace that of the developed world. This growth is fueling an increase in household income in places like China and India where nearly 60 million people—roughly the combined populations of Texas and California—are joining the ranks of the middle class each year.
- High Savings Rates in Asia: Despite rising consumption, households in emerging Asia save 17 percent of disposable income—that’s roughly four times what is saved in the U.S. and much higher than the developed world. These high savings rates allow them to meet the higher requirements for home ownership—many require at least 20 percent down—and have larger amounts of funds to invest in capital markets.
- Urbanization: The world’s urban population is growing by more than 70 million people each year. China already has over 100 cities with 1 million people and is expected to have over 200 of them by 2025. This urban migration has overwhelmed existing infrastructure like roads, sewers and electrical grids. The buildout of this critical infrastructure will require vast amounts of copper, steel and increase demand for all commodities.
- Desire for Social Stability: One main goal of emerging market governments to remain in power is to keep the public happy. They are doing this by increasing personal freedoms for citizens and providing them with opportunities to increase their quality of life. Many governments have found the key to social stability is focusing on job creation which establishes a path of upward mobility for citizens.
- Natural Resources Wealth: Many of today’s most promising emerging nations sit atop some of the largest oil, metal and other valuable resource deposits in the world. Many of these nations have teamed up with private and/or foreign enterprises to bring these resources to market. Revenue generated through taxation and direct ownership allows for these governments to build infrastructure, create jobs and pursue other economic opportunities.
- Corporate Transparency: A history of corruption and political turmoil has given way to higher standards of corporate governance in today’s globalized world. Though still far from perfect, the improved transparency and oversight has made important information available to investors and reduced uncertainty. By aligning themselves with international business standards and requirements, emerging nations will attract more foreign capital and better integrate themselves into the global marketplace.
These six drivers have helped emerging economies weather the financial crisis and provided them with a blueprint for success as they continue to strive to build economic wealth.
Tags: China, Commodities, Copper Steel, Critical Infrastructure, Disposable Income, Economic Vitality, Emerging Asia, Emerging Economies, Emerging Market, Emerging Markets, energy, Frank Holmes, Global Powerhouses, Household Income, India, Job Creation, Main Goal, Natural Resources, Personal Freedoms, Rapid Economic Growth, Social Stability, Upward Mobility, Urban Migration, Urban Population, Us Global Investors
Posted in Commodities, Energy & Natural Resources, India, Infrastructure, Markets, Oil and Gas | Comments Off