Defending the Global Slowdown

I’ve taken a bit of heat over the last few weeks as I’ve suggested that we may be nearing the end of a very good bull run in all tangible markets. These include the stock and commodity markets which are at levels we haven’t seen since before the economic crisis began. More and more data has come out on the negative side of things going forward and it’s being discussed and given weight to, by several economists, central bankers, traders and hedge fund managers.

Here is a consensus survey of their bearish take on the global economic landscape:

China – Their economy is slowing down. I mentioned the declining velocity of trade in China a few weeks ago. This includes shipping, fertilizer sales, stock market turnover, raw steel manufacturing as well as other factors. China has also raised the required lending reserves on their banks as well as raising the outright interest rates at which they can lend to fight off inflation and cool down their economy.

United Kingdom – Their economy shrank by .5% in the last quarter of 2010.  Their unemployment rate is 7.7% and rising. They’ve yet to work through the excesses of their own housing bubble. Finally, the voting members of the Bank of England are already at odds over raising rates to combat inflation. High unemployment, high interest rates and declining production are spurring fears of stagflation.

Eurozone – Ireland and Greece have been forced to accept bailout money and enact austerity measures that would cause civil upheaval in the United States. Spain and Portugal are on the cusp of having bailout funds and austerity measures jammed down their throats and Italy is now on the short list, as well. Germany is the only Eurozone country that benefits from a strong Euro, which attracts capital to their value added manufacturing and technology industries. The agrarian and tourist based economies of southern Europe desperately need to weaken their currencies to allow them to compete in the global market. This is creating a huge political disconnect between Germany and the other members of the European Union.

India – India nearly doubled their interest rates in 2010 and just raised it another .25% on Tuesday. The sincerity of India’s government to get a grip on inflation dropped crude oil nearly $2 per barrel due to forecasts of declining Indian demand.

Brazil – Brazil’s currency has appreciated 40% since the bottom in 2008. The global surge in food prices is placing severe strain on the manufacturing and public service sectors. Brazil is using interest rate manipulation to cap currency valuation. This is effective on low value added agricultural exports but hinders the ability of the manufacturing sector by making capital more expensive. This also hurts the public sector as workers are laid off and look to more expensive government programs for support.

United States – The broad strokes are best covered by Gary Shilling in his January 2011 edition of, “Insight.” We look for slow U.S. economic growth of 2% or less this year. The post-recession inventory bounce is over. Consumers are probably more interested in saving and repaying debt than in spending. State and local government spending and payrolls are falling. Excess capacity will retard capital equipment spending while low rents curtail commercial real estate construction. Economic growth abroad is unlikely to kindle a major export boom. Housing is overburdened with excess inventories. QE2 will be no more effective than QE1 in spurring lending and economic growth, while net fiscal stimuli will decline $100 billion in 2011 compared with 2010.

These global factors all point to a pending slowdown in economic activity. Many of the discussions I’ve had recently have focused on the recognition of the turn. The simplest predictor I can share is when what has been making money quits working. We use pattern recognition to determine market setups and risk values. When the bullish patterns stop working and the bearish patterns start to pan out, the turn will be near. Fortunately, this tool can be used on everything from one- minute charts to weekly charts. We will watch for the turns in scale as they progress from minute to hourly, daily and weekly. This is not doom and gloom. It’s simply the ebb and flow of the markets and with these tools we hope to see the tide’s reversal.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

The Politics of Cocoa

The Ivory Coast is caught in the middle of a major struggle. They are the world’s largest cocoa producer and are believed to have some of the largest untapped oil fields in the world. The country should be laying the groundwork and creating the infrastructure to capitalize on their natural resources and developing as a nation. Instead, their nation is on the unsafe to travel list by the CIA and they are on the brink of declaring marshal law.

Laurent Gbagbo has ruled the former French colony for the last ten years. He has been accused of siphoning money from the country into his personal offshore coffers and silencing any political rivals quickly and ruthlessly. During his reign, he has sold approximately two billion worth of dollar denominated bonds on the world market. He has also actively solicited Russian investment in oil and mineral deposits. Russia’s number one private oil company, LUKoil has an estimated stake of nearly $800 million in oil drilling and development rights and plans with the Ivory Coast.

The first open election in years has ousted Gbagbo and installed Alassane Ouattara as the President elect. The election results are supported by the United Nations and he is a former deputy managing director at the International Monetary Fund. However, Gbagbo has refused to acknowledge the results and still controls the military and the purse strings. Therefore, he has simply refused to make payments on the bonds they’ve issued to the global market unless he is recognized as the county’s leader and is using the military to enforce his rule.

Gbagbo has placed himself in the middle of an international trade dispute between two superpowers. His deal with LUKoil will most likely be renegotiated if Ouattara assumes leadership. LUKoil is using the Ivory Coast investment to lobby against domestic Russian production taxes. LUKoil has to show some production capability in these lands to maintain their leverage against Medvedev and the state run Rosneft. Therefore, it is in their best interest to covertly supply Gbagbo with any means necessary to fuel his standoff. This contingent is also supported by China. They are citing the recent election issues as the climax of 20 years of failed importation of western democracy, while also shoring up their own future natural resource acquisitions.

The United Nations recognizes Ouattara as the rightful leader. Western countries, members of the United Nations and hedge funds hold the vast majority of the outstanding debt. Furthermore, the Ivory Coast supplies one third of the world’s cocoa. In 2010, that cocoa was worth approximately $3.9 billion at exchange prices. London trader Anthony Ward who made the largest exchange purchase in history last July, now owns nearly $100 million of that warehoused cocoa. Ivory Coast cocoa is also traded actively in New York and its supply must be guaranteed in order to trade futures on either exchange.

The Ivory Coast is preparing for military action and the U.N. just sent 2,000 troops. Some are reporting that Gbagbo is simply stalling for time to fortify his defenses. Others are questioning whom he is preparing to defend himself against. Will the Ivorian people rise up in a unified democratic voice or, will there be direct foreign involvement and if so, on whose side? Will western forces step in to defend their financial interests and install democracy in the name of the people or, will Gbagbo hit for the cycle by guaranteeing the exchanges, the bondholders and LUKoil in return for not starting another global conflict?

My father never liked trading the cocoa market. He told me once when I was a kid that he didn’t like the idea of something happening halfway around the world and not knowing about it until it was too late. Trading used to be about gaining access to information. Now, it’s about interpretation.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Food Inflation is Here to Stay

Inflation is measured many ways. Government reports will talk about core inflation, inflation excluding food and energy, consumer price index, producer price index and so on. These measurements all exist in the academic world. Talking heads argue about it on TV. Real inflation, inflation that is felt throughout the world, is food inflation. Food inflation is here, it’s real and it’s here to stay.

The Food and Agriculture Organization in Rome tracks a basket of 55 commodities to measure global food prices. This month, it topped the June ’08 high due to regional production issues. Many domestic commodity markets are substantially below their ’08 highs. Remember $8 corn and $16 dollar soybeans? Lets not forget the input cost of $140 crude oil. The only reason prices didn’t sky rocket even more in 2008 is because the world was still reeling from economic meltdown. Savings rates were increasing and spending was declining. This kept fundamental demand in check. The 2008 rally was fueled by poorly timed commodity index fund buying coupled with rising fuel and fertilizer costs.

The commodity index funds were created to capitalize on the growing appetites of emerging markets. As foreign markets mature, their tastes will include a more western diet, which is heavily based on grain and meat consumption. For example, total United States meat consumption is approximately 250 pounds per person per year. China’s total meat consumption has nearly doubled in the last 10 years and is now around 100 pounds per person per year. This is still less than half of our consumption. Their population, which is four times larger than our own, could double their consumption again and still be below the average American’s.

The example above also translates into the grain markets. Think of soybeans in terms of vegetable oils and think of corn to feed the livestock. The USDA released their annual crop production report this week as well as their supply and demand reports. The United States planted and harvested more acreage than last year in corn and beans. The bean harvest was the second highest on record and rice did set a new record. Historically, these numbers would be seen as very bearish for the markets since they point to greater supply. However, looking deeper, we can see that ending stocks are near all time lows, which indicates exceptionally strong demand given the generous supply for 2010.

Food prices are beginning to soar. Just as decent nutrition is the most basic of luxuries in a developing economy, so is it the most primal of necessities. We are already seeing riots in many third world countries over the price of sugar and grains. Developing nations are faced with a two-headed monster of rising food costs in the open market as well as food that is moving to the black market. President Clinton’s primary focus in Rwanda was to safely transport food aid past the warlords and to the people. Algeria, Haiti, Bangladesh, Senegal and Indonesia have all experienced civil unrest due to rising food prices just in the last week. It is much more difficult to contract one’s appetite than it is to expand it. Any planting issues in the U.S. this spring would douse the global embers of unrest with gasoline.

The United States is responsible for nearly 40% of the world’s soybean production and approximately 70% of its corn. These are the staples that feed the world’s people and its livestock. Our crops yield five times the global average. The U.S. will export our agricultural intellectual property as Brazil, Russia and the Ukraine expect to grow their output by 30% over the next ten years. Fertilizer, seed companies and biogenetic engineering will become the next wave of global financial players as mother Earth prepares to deal with the strain of a swelling and hungry population.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

China’s Economy is Hitting the Brakes

Much of the current global growth scenario is built upon the notion that China will continue to supply the fuel. Long term, this is a generational move that will happen as China demographically reinvents itself. However, I’m more interested in what may happen this year and how I can prepare myself for it. China’s economy has been growing at a break neck pace with several years of compounded double-digit returns. Even the economic crisis was merely seen as a speed bump on the way to 13% growth. However, over the last six months the make up of the top line growth numbers have been called into question.

The People’s Bank of China has become increasingly hawkish throughout 2010. They are concerned that their economy is overheating and they are actively attempting to pop the bubbles that have been forming as a result of the bifurcation of the economic policies of the government relative to the economic realities of its people. The Chinese people have increased their savings as their country’s trade surplus has grown and their personal savings rate now stands at 38% of their income. By comparison, our national savings rate shifted from negative to positive as a result of the economic meltdown and now stands at 3.8%.

Chinese government policy does not allow direct investment in foreign markets. Therefore, they are unable to repatriate, on an individual basis, their dollars for foreign stock and bond holdings. The Chinese population has been putting their money to work by investing locally in property, precious metals and the Chinese stock market in an attempt to cover the spread between the 2.5% Chinese banks offer on savings versus their inflation rate of 5.1%.

In response to their swelling domestic asset values, the Chinese government raised interest rates twice this year and increased their bank lending reserves six times in 2010, lowering their banks’ leverage by a total of 20%. They are also lowering their lending cap from more than 9 trillion RMB, approximately $1.36 trillion, in 2010 to a target of 6.5-7 trillion RMB for 2011. It is quite clear that they are willing to take whatever action is necessary to keep their economy from overheating while maintaining their domestic cash hoard.

These actions are starting to show up in their economic data. The Organization of Economic Development is pointing to a slowdown in China’s leading economic indicators. They’ve based their prediction on the declining velocity of shipping, fuel usage, fertilizer production, raw steel manufacturing, capacity utilization and stock market turnover. Rising interest rates and slower turnover are key signs of a slowing economy.

Albert Edwards of Societe Generale recently stated that the economic prosperity in China is without global precedent. He went on to say in England’s, Financial Times and The Guardian newspapers that China’s, “investment to GDP ratio is off the scale both in terms of size and endurance.” His investment group has been the top rated global strategy analyst for the last seven consecutive years.

This year, it is quite possible that China sees annual growth of less than 10%. While this is by no means a recession, if their economy slows down 4-6% it will have a global impact. Based on their holdings and consumption patterns we could see declines, in order of magnitude, precious metals, oil, mid level luxury brands and global interest rates. The continued development of the Chinese middle class will continue to support food and agricultural prices as well as textiles. In the U.S. investors, “don’t fight the Fed.” The globalization of the economy suggests, “don’t fight the central banks.”

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.