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Posts Tagged ‘inflation’

1 May 13 2010 @ 9:58am by Matt Smith in Capital Markets, Crude Oil, Economy, Global Energy

A Little Trouble in Big China

Strike that, reverse it.

It’s a funny thing. China’s economic situation is like one of those salacious rumors you see on the cover of a glossy magazine at the grocery store; you never quite know if it’s true or not. Like the relationship of Brangelina, no-one really has a good handle on whether China is as perfect as everyone thinks. Sometimes we have to work from the facts that are available, while holding ourselves back so as to not fill in the blanks. So through proof and not the paparazzi, let’s take a look at the sleeping dragon. 

What has put China on the burrito chopping board in the first place was one of the ten simple points I outlined in last week’s post – about how Chinese oil demand will represent 10% of global oil demand this year, and how this will likely double by 2020 to 20% (and potentially surpass the US). While to truly understand this phenomenal rate of growth is a pinch unfathomable, the below chart provides a crystal clear picture of the trend for Chinese oil demand: 

 Just as celebrities inevitably face a backlash, China is receiving some negative attention from key market commentators, who are calling for a market crash in the next nine to twelve months. And this view isn’t completely without merit; cracks are appearing in the economy. This has recently manifested itself in Chinese stocks; the Shanghai SE Composite Index has now fallen over 20% from its highs made in August 2009 – statistically classifying it in a bear market. Then there are signs of slowing in data such as car sales, which are only up 34% year-on-year for April, when the previous month was up 63% (on the flipside, the number of households earning sufficient funds to buy a no-frills car, is estimated to nearly double over the next four years to 65.6 million). The manufacturing sector is also showing signs of slowing, although again it also remains expansionary. And then there is GDP, which is likely to have peaked for this year (albeit it at a nosebleed rate of 11.9% for Q1). The downside to China’s success means you essentially become a coconut shy for critics. 

As is common for fast-growing emerging market economies, inflation remains an ever-present threat. And China is well aware that an inflation rate at an 18-month high is a worry. But it is a tightrope that the Chinese authorities walk; the effect of raising interest rates or revaluing their currency is difficult to predict – it could quash growth rather than rein it in. Hence their enthusiasm to try such slowly slowly catchy monkey techniques such as incrementally raising the reserve requirements for banks (=essentially restricting bank lending), while trying not to halt expansion. It is easy to criticize China, but their reality is a case of tempering inflation while encouraging growth – like trying to open a can of soda with a hammer and a nail – it’s possible, but pretty darn hard. 

So, meanwhile, back at the chopping board, data show China to not be in bad shape, but with a clear need to remain vigilant on their economy. And like Brangelina, China needs to avoid the paparazzi and focus instead on themselves, because, afterall, we are all secretly envious of them.

2 Mar 18 2010 @ 6:33am by Matt Smith in Capital Markets, Crude Oil, Economy, Global Energy, Natural Gas, risk management, Risk Strategy

A recipe for disaster, or ingredients for success?

I really like the quote that says ‘an optimist invented the plane, whereas a pessimist invented the parachute’. I am not declaring myself in either of these camps (I am obviously a well-balanced realist), but believe it would be misguided not to consider the upside and downside risks to current commodity pricing. Admittedly, some of these issues apply more to some commodities than others, but essentially, the sentiment is an ever present theme. So, let’s kick off with looking at some of the ingredients that could derail markets:     

  1. Economic data turning for the worse, led by housing, manufacturing and employment
  2. A deflationary economic environment
  3. A falling equity market
  4. Excess supply
  5. Emerging markets successfully cooling their economies 

ECRI Weekly Leading Index

Let’s tackle each one of these individually (yet briefly too). First up, economic data turning for the worse. The chart (left) illustrates the ECRI weekly leading index, which takes the temperature of the US economy on a regular and timely basis (ie, erm, weekly). This index bottomed out at the start of the recession (which makes sense as it it is a leading index = forward-looking), and has moved higher at a fair clip ever since. That is, until the last 12 weeks, when it has turned decisively lower. This index is an aggregation of a number of data points, hence its weakness raises a rather large red flag. Next up, a deflationary environment. We are already seeing signs of deflation creeping into markets, be it through wages or rent, or through pricing pressure on everyday goods due to new-found frugality in consumers. And a falling equity market would likely occur through the simple equation of the above bullets: 1 + 2 = 3. As for commodity-specific data, serious risks of surplus supply exist across commodity markets; for US natural gas it is from shale plays and increasing rig counts, for crude oil it is from quota non-compliance by Opec, for UK natural gas it is from LNG; and the beat goes on. Then the final bullet: emerging market risk. This one is a toughie. Too much growth could power commodities to such a high price that they crimp potential growth in lagging developed markets. On the other hand, if governments in these emerging markets (especially India and China) go overboard in efforts to quell excessive liquidity and credit in their economies, they risk putting the brakes on growth, which would surely upset global markets. 

That was all a bit hectic. Let’s have a brief interlude of humor before we truck on with the flipside of the coin:

Alrightee. Now to the path that could lead prices higher. In all fairness, it is pretty much the polar opposite of the pessimistic points:      

  1. Improving economic data  – especially industrial production / manufacturing
  2. An inflationary environment
  3. Continuing strength in equities
  4. Continuing demand growth for goods / commodities
  5. Continuing emerging market strength
Bloomberg Financial Conditions Index (Mar 07 – Mar 10)

For the prosecution of falling prices, I would like to present exhibit number one – a chart which illustrates an improving environment in financial markets – aptly named the Bloomberg Index of Financial Conditions. This shows that financial conditions have continued to improve at a trampolining rate since the financial meltdown-panic heydays of late 2008, an indication that the market is continuing to normalize after the shocks of recent years. Essentially, we have clambered over the wall of worry and beyond the territory of financial woes.    

As you well know from my rants, markets are all interlinked, hence bullets 1,3, 4 and 5 go essentially hand-in-hand here. Improving economic data (1) will undoubtedly be driven by higher demand for goods (4), boosting equities (3), while continuing emerging market strength (5) from domestic growth will too spur on global investor sentiment (back to 3, then 4, then 1). It is as inevitable as wrinkles and gray hair that inflation will once again rise up, although when this will arrive it is impossible to say. But one thing is for sure, a commodity rally will be a natural by-product of both an inflationary environment or an improving economic environment. It is on the horizon. 

I don’t know what’s going to happen. I can make a guess, but that is all it would be – a guess. It is much more important to to keep an open mind, but also be aware of all eventualities. So I sign off as I began; with a good quote – ‘the pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails’. I believe we are poised between the devil and the deep blue sea, and all we can do is hang in there, and sail broad reach. Ahoy.

0 Feb 25 2010 @ 7:40am by Matt Smith in Capital Markets, Economy, Global Energy, Random, risk management

Negative inflation starts with a ‘d’ and ends in tears

a deflationary environment would make it cheaper to phone home.

I made the above comment in my daily market update last Friday, before realizing the gravity of the adverse CPI (= consumer price index, aka inflation) number released that morning. The core CPI index (which differs from the ‘headline’ number, as it removes two of its most volatile components – food and energy prices) showed a negative print. ‘Big deal, burrito boy’, I hear you cry. But wait, my friend; this was a doozie of a print because it was the first negative print since 1982. Yep, we’re talking the year of E.T., the album Thriller, and the birth of Ben Roethlisberger. Let’s take a quiet moment reflect on how really, really long it has been since then.

Ok, lets move on.

Last week actually saw a double doozie of data releases – the first being the aformentioned 28-year breaking of a duck, while the second designated doozie was from the Federal Reserve (= the Fed), who raised the discount rate from 0.5% to 0.75% late Thursday evening. The discount rate is the interest rate charged to banks for direct loans, so although it doesn’t necessarily directly impact us mere mortals, it does issue a battle cry from the Fed that they are ready to fight the enemy – whatever form they may take.

But herein lies the problem: armed with the weapons to fight inflation doesn’t mean you can do the absolute opposite to avoid deflation. War against inflation lends itself to raising interest rates or decreasing the money supply as two of the more common weapons wielded (incidentally, the latter is where Ben Bernanke got his ‘helicopter Ben’ moniker from; back in 2002 he said the best way to invoke inflation was to throw money from a helicopter). On the flip side, the onset of deflation can be staved off through the promotion of confidence in an economy, but like a bite from a vampire, once deflation sets in, all you can do is let it run its course (ie – become undead).

Japan proffers a deflationary horror story twicefold; not only because it suffered a ‘lost decade’ starting in the early 1990’s, but because the US is on a similar trajectory (a real estate bubble + equity market bubble = zero interest rates and quantitative easing….sound scarily familiar??). That’s not to say the Fed are not aware of the perils of their decisions – quite the opposite. And that’s why we should worry – if we can see them using their silver bullets, we know all too well how many they have left.

deflation = more zombies, less thrills

Now, to wrap this up in our all-encompassing tortilla. Deflation, by its very definition, is a general decline in prices. I am not declaring that we have lost the battle to deflation, I am merely highlighting that deflation is a real and potential risk to our economy. And if this were to happen, energy commodity prices would be dragged lower with every other asset class. Even worse, if the engine-room of the current global recovery – emerging markets – were to avoid such a deflationary environment, it would only exacerbate the problem in the US by continuing to boost global commodity prices. A horrifying prospect indeed. On that bombshell, I’ll leave you with this; the conundrum of how to deal with deflation reminds me of Woody Allen…he once said ‘I got this powdered water – now I don’t know what to add’. The answer for this is the same as it is for deflation…….silence.

11 Jan 22 2010 @ 10:25am by Matt Smith in Capital Markets, Crude Oil, Economy, Natural Gas

Burrito bites

Welcome to another set of snacks from the finger-food bowl of life, as we charge full pelt toward another weekend. As for this week’s highlights (or lowlights, depending on your point of view), the whipsaw action in equity markets has taken center stage, spurred twice fold: by concerns of China reining in their runaway economy, and by Mr Obama’s proposal of increased regulation of  banks to curb their evil risk-taking ways. As for our dearly beloved commodities, crude has pulled back to the mid-$70s with risk aversion and dollar strength swirling around, while natty has staunchly defended $5.50 and moved higher. Here are this week’s bites, get them while they’re warm (and still relevant):

— Why natural gas under the Gulf may not be a good thing.

— Michael Pento and his teepee-shaped recovery.

— I have applied to do this as my second job – hotel chain offers human bed warmers.

— Surreally screwed up…Afghans pay 25% of their GDP in bribes.

— The top 280 energy projects in the world today.

— More oddness – a couple who share their bed with a deer.

— An utterly, utterly brilliant piece by John Hussman on inflation myths and reality.

This week’s Burrito Deluxe Award goes to China. They printed 10.7% economic growth in Q4 2009, their highest level of growth since 2007. China may end up spurring a double-dip recession due to their insatiable appetite for commodities such as steel and coal, but without their blistering growth, would we have stood a chance of recovering in the first place? 

This week’s Burnt Burrito Award goes to equity markets as they have got toasted.

Question of the week: what noise does a bull make? A bear goes ‘grrr!’, a cow goes ‘moo!’, but I have no idea how to articulate the noise of a bull. The best answer (entered as a comment) will win a prize. Rock on!