Global Glut Going Nowhere

The drop in gas prices over the last month has been a relief to us all. The economic sanctions placed by the European Union, Canada and the U.S. on Iran has simply shifted the flow of Iranian crude oil from west to east. The net result has been more oil on the global market with China, India and Russia picking up cheaper oil from Iran due to the lack of competition from western buyers. One would think that cheaper oil to the BRIC countries would be just the catalyst needed to help them develop their own internal demand for goods and services through the creation and evolution of their own middle class. Unfortunately, we are in an economic phase of global deleveraging and even the stimulus of low fuel prices will not keep their engines turning fast enough to save us from a second half slowdown here in the U.S.

The thesis of those who run our economy has been: If we can just provide enough economic grease to keep our own wheels turning the development of BRIC economies will, eventually, create demand for our goods and services. This is still probably true in the long run and the forward demand projection can be used to our advantage through tracking commercial trader purchases via the commitment of traders report. What a different world it has become when our economic horse has become hitched to someone else’s wagon.

China has been trying to engineer a soft landing for their economy through government expenditures on infrastructure and the attraction of foreign direct investment. The struggle can be seen in their manufacturing output, which has declined for seven straight months. They’ve also lowered their lending reserve requirement to stimulate financing which has dropped by 19% year over year and is at its slowest pace since Q1 of 2007. This may simply add further capacity to an already slack market in the wake of China’s 15-year building boom. This is also a futile attempt to increase home ownership, as home ownership is one of the few ways Chinese people have been allowed to invest their newfound prosperity and therefore, already represents an outsized portion of their personal portfolios. The Chinese result will sacrifice its citizens as the high water mark buyers and lead to further class separation between the builders who profited and the people who got stuck with the bill. This will leave them with little disposable income to buy our Apple computers and Fords.

The Chinese situation looks hopeful compared to India. The trouble in India is as much political as it is structural. Indian politics are confusing even to the Indian newspapers. It’s easy to go from the Times of India to India Press or any one of their nearly 2,000 daily publications and find contradictory information. Foreign businesses find it nearly impossible to find the right agencies for the right permits. Even if one does, it is quite possible that the rules will not only change but, be made retroactive thus, invalidating the entire business plan of the entity that just put the whole package together. This is exactly what happened to Wal-Mart between December of 2011 and February of this year. Permits were voided and taxes created by the new policy were made retroactive. Foreign direct investment is drying up rather than fighting its way through the bureaucratic red tape.

This still leaves Brazil and Russia to save us. Brazil just passed England to become the sixth largest global economy. However, Brazil’s balance of trade slipped into negative territory early this year for the first time since the economic crisis and once again ten years prior to that. Furthermore, their latest GDP readings were just positive enough, 0.34% to escape the technicality of recession. They are battling the decline by cutting interest rates for the seventh time in a row. This easing cycle has seen their rates decline by more than 400 basis points, including May’s cut.

Finally, Russia’s economy is shepherded by the fluctuations of natural resource prices on one hand and Vladimir Putin’s political inclinations on the other. The Russian shadow economy remains one of the largest physical cash exchanges in the world. The government recently limited official cash transactions to approximately $20,000 U.S.  Dollars. The political confusion has led to a flight of foreign capital out of the country. Putin’s sincerest desire seems to be the development of a quasi socialist Russia in which the natural resources are shipped abroad by governmentally monitored, semi state controlled companies. Putin then wants access to these revenues to fund his own programs and basically, become the Arab peninsula of natural resources while triangulating politically with Iran and China.

It doesn’t matter whose horse we hitch our wagons to if we’re all headed down the same path. The global balance sheet expansion experiment that hasn’t worked worth a darn in Japan is now being replicated in Europe just as it has been put to work here in the U.S. The world will pull through it and those countries that have been willing to make the tough choices, either through an enlightened electorate body or, the tight fisted hand of an autocratic leader will be the first ones to rebound. Our future, I’m afraid, looks more like the path of Japan’s lost generation than ever.

Beaten Bean Bulls

The month of May has not been kind to the soybean market. In fact, I’d say it’s bearing the brunt of a perfect storm of bad news. Old crop, July soybeans are down more than 10% for the month while this year’s crop is fairing only slightly better. This beat down has come from all angles, including weather, speculative traders and the global economy. However, once the dust settles, this may prove to be the best buy of the summer.

The U.S. agricultural markets are all well ahead of schedule thanks to the exceptionally warm spring. The most recent crop reports show that soybeans are 76% planted. This record high is 34% above the five-year average for this time of year and 31% ahead of last year’s pace. These figures account for the 95% of U.S. acreage. This amazing crop progress has taken the starch out of the spring planting fear premium we normally see.

The crop progress reports signaled a cautionary note to the upward trend that began in earnest this past February. The early rally was fueled by the tightening global supply and exports to China far ahead of schedule. Small speculators and managed funds jumped on this rally in record numbers. I posted the overbought nature of the bean market when they set their first long position record in the March 20th Commitment of Traders report at 385,619 contracts. This compares to a net position of just 18,082 at the end of January. I think it’s safe to assume that last week’s record position of 480,586 will set the high water mark as many of these traders have been forced out of the market during the course of its 10% decline.

The final straw that’s broken the soybean bull market’s back has been the increasing concerns of a fractious European Union and its effect on the U.S. Dollar as a safe haven currency. The month of May has seen currency fly out of the European Union pushing the Euro to its lowest levels since September of 2010. Considering that the European Union is now China’s largest trading partner, it’s no wonder that China’s economy has also shown unexpected weakness. The last link is that China is our number one soybean export market. Therefore, it is expected that China’s purchases may slow, as U.S. beans become more expensive on the global market.

Now that we’ve identified the causes of the decline, let’s focus on where the bean market is headed. The early plantings were no free lunch. The early spring and the continuation of the same weather patterns are now raising concerns. The lack of rain is causing a crust to form in the fields and hinder the germination process. Furthermore, farmers who intended on growing early wheat and late soybeans (double cropping), need more moisture in the soil to get their late beans in the ground. Estimates vary as to how much double crop beans will add to total U.S. output but there is certainty that the weather is the key for next couple of weeks.

Finally, now that the froth is off the top we can return our focus to the supply and demand factors that called so many speculative dollars to the market in the first place. Soybeans and more specifically, high protein soybean meal are near record low supply levels. The decline in South American production has amplified the emphasis on this summer’s U.S. crop. Bellies must be filled regardless of the economic uncertainties. Global demand for food will be the last of the cutbacks made. Therefore, this decline is fortuitous for patient traders. There is strong technical support for this year’s crop near current prices of $12.50 per bushel. There is the possibility that a complete, “risk off” event could push the market to $12.25 or lower. Either way, the supply and demand numbers certainly suggest a test of the all time highs above $16 per bushel is well within the realm of reality.

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.

Greek Default Imminent

The Greek elections were confusing on multiple levels and this may be the catalyst that pushes Greece out of the European Union. Aside from the obvious economic issues, which was my primary focus, the confusion created by the press questioning Greece’s ability to form a new government left me positively dumbfounded. Here in the U.S. it’s a simple matter of counting up the votes and inaugurating the winner. Greece is a parliamentary republic, which means the President is ultimately decided by the 300 member Parliament.

Greece’s top vote getter in the election was Antonis Samaras of the New Democracy Party. However, he won less than 20% of the popular vote and his party only secured a third of the Parliamentary seats. The Parliament holds their Presidential vote after the popular vote determines the Parliament’s makeup. Thus the Presidential vote should be proportional to the Parliament’s popular vote. Typically, Greece’s elections are very similar to ours in that there have only been two parties with any real shot at gaining power. The second leading vote getter, Evangelos Venizelos, of the PASOK party, Greece’s other dominant political party was able to garner 13% of the popular vote and a mere 41 Parliamentary seats.

The inability of either of the primary parties, who both favor austerity measures, to win a majority of Parliamentary seats further muddies the political waters and this is the cause of the, “Greece has failed to form a government” confusion. Greece is now going through the bargaining process with each candidate trying to win enough Parliamentary votes from the other parties to meet the two third’s vote necessary to become President. Currently, neither of the primary parties, New Democracy or Pasok has been able to do it. The anti austerity radical and left wing parties that secured a record proportion of the popular vote have also failed in their turns to corral the necessary votes. This forces a second round of voting, which will require three fifths of the vote to win and will be held next month. Finally, if they are unable to reach a three fifth’s majority, the Parliament is dissolved and a new election is held. The new President will be the one who gets the most votes.

The Greek people appear to be ready to default on their debt. The ability of the radical parties to gain such tremendous support, and possibly the Presidency, is a clear illustration that the Greek people are tired of living under German rule. The austerity cuts that we hear about on TV are very different to the Greek people who have seen their pensions cut in half, government payrolls and compensation slashed as well as nearly 10 tax hikes in the last two years.

The outflow of funds from Greek banks is accelerating at an alarming rate. Businesses and private citizens alike are scrambling to pull every Euro they can get their hands on out of their banks and into another country for safekeeping. Corporate and private deposits have fallen by 20% over the last year and more than 30% since 2009. The inability to form a government over the last week has accelerated the withdrawals to the tune of $700 million in the last week alone. That panic has caused the head of the Greek Central Bank to issue a statement suggesting that there is plenty of liquidity within the banking system and that there is no need to withdraw cash. Obviously, he’s trying to quell the fears of his countrymen by whistling past the cemetery in the dark.

Greece did repay $556 million in foreign notes due to private investors who refused the 53.5% haircut on the brokered swap agreement. However, the situation is unraveling quickly. The rescue fund administrators have already begun withholding funds because the Greek vote drastically reduces their willingness to adhere to current austerity measures. The next line in the sand comes before the end of June when Greece is due nearly 40 billion Euros. The fear is spreading as Spanish yields are now above 6.5%. We stated 6% as their tipping point and now, even the Italian bonds are above that number. Finally, a Greek default will trigger losses around the world and due to the interwoven nature of swaps and derivatives, we don’t really know what that will look like…..no matter what we’re being told.

Austerity Rebellion

Far too many market events transpired this week to focus on any single event. The general consensus of the week’s events can be summed up as deflationary. Unfortunately, this bodes poorly for global economies and unravels the tenuous global grasp on a Greek default and European Union unrest. We’ll take a brief look at the Greek and French elections, their effect on deflation and social unrest and finish with three places to invest that should beat negative yield Treasuries and deflationary assets.Francois Hollande of the Socialist party, was elected as the next French President. He was widely expected to win and yet the realities of his policy intentions are just beginning to sink in. France has been the peacemaker in the European Union’s economic crisis between the austere and fiscally solvent Germans and the spendthrift southern European nations like Spain and Portugal. France is far from altruistic in their pursuit of bailout money. The fact is France is already at 85% debt to GDP and their balance of trade has been negative for 8 years. President elect Hollande understands that his nation is next and wants to ensure a bailout path for his own people. France is the 10th largest global economy and is too big to bail out economically and too entrenched in their ways to elicit any sympathy from the hard working Germans. President elect Hollande won the election on the basis of remaining French, which means increasing government expenditures. He is in favor of retaining the 35-hour workweek, returning retirement age to 60 and adding 60,000 government paid teachers. His Keynesian approach to the economy will not fly with the austere Germans.

Meanwhile, the Greek elections have led to complete rejection of austerity and economic reforms by its election of two primary winners from parties that have been peripheral parties for the last 40 years. Imagine a runoff here in the U.S. between Ron Paul and Ralph Nader and you’ll get an idea for how strongly the Greek people have rebelled against the two mainstream parties that have been the negotiators of their bailouts. The Greek people have thoroughly rejected the bailout parties leaving Germany’s Chancellor Angela Merkel to reiterate her position that Greece must make its budget targets or Germany will not allow the next bailout of 30 billion Euros to flow through in the next quarter. The Greek people would rather be broke and miserable by their own choice rather than broke and miserable under someone else’s thumb. Some estimate that there is now as much as a 75% chance that Greece will leave the Euro in the next 12 months.

The effect of the French and Greek elections has caused the U.S. equity markets to stumble and U.S. Treasury yields to hit historic lows. Currently, only the 30yr Treasury Bond offers a real rate of return above 0. Those moves have behaved in their normal relationship. Uncertain equity money moves to the safe haven of Treasuries. However, the behavior of other safe haven investments suggests much deeper economic concerns. Gold has begun to lose its status as a safe haven investment as it has declined more than 4% since the election results. We’ve also seen the currencies of commodity based countries fall relative to the U.S. Dollar. Previously, these declines have been buying opportunities as the liquidity that has been pumped into the global economy has been viewed as commodity inflationary.

This brings us to three places where money can be placed and be expected to hold its own and then some. First of all, the U.S. Dollar is going to benefit as the safe haven for the tremendous amounts of cash that get pulled from foreign equity and bond markets as the result of a disorderly Grecian default and an unraveling commitment to German austerity measures. Secondly, as people decide what to do with their money foreign denominated CD’s will become more favorable. For example, Australian Dollar CD’s can yield better than 2.5% and they’re one of the few countries that are both economically developed and debt free. Finally, there are still some supply and demand relationships in sugar, soybeans and platinum that should hold true without too much correlation to the global economic disaster. After all, economic depression has to be pretty serious before people stop putting syrup on their pancakes.

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 Bernanke Put – Euro Style

The Spanish debt auction proceeded in an orderly fashion
even as yields crept higher. The general consensus appears to be that Spain is
too big to fail. I would suggest that Spain might be too big to save. Spain is
the European Union’s fourth largest economy and 14th largest in the
world. Last week, their credit rating was lowered to BBB+ by the Standard &
Poor’s rating agency. This week, they announced that their GDP had contracted
by 0.3%. This quarter’s decline marked the beginning of Spain’s second recession
since 2009. Finally, the composition of their debt makes any positive economic
headway in the next few years nearly impossible.

The interest rate benchmark is the 10-year bond or note.
Spain saw full participation at yields of 5.82%. There are two important points
to be made here. First, the participation rate is measured by the bid to cover
ratio. It was quite a bit stronger than the last auction in March, coming in at
2.9 compared to 2.4 for the last auction. The second point is the yield of
5.82%. The alarm bells sound when Spanish debt yields hit 6% on the 10-year
note. That’s the magic number at which Spain can no longer afford to refinance
or, rollover the financing of their budget. Spanish yields have solid
resistance between 6.125% and 6.25%. They peaked at 6.625% in November 2011.

The International Monetary fund released a report on the
European Union and the global debt issues entitled, “Global Financial Stability
Report.” Spain’s BBB+ credit rating is three notches above junk status. According
to the IMF the probability of default on BBB+ credit has risen from 0.734% in
2007 to 6.05% at the end of 2011. I believe that the recent pitches by the
BRIC’s (Brazil, Russia, India and China) to contribute to the bailout funds and
push the total available reserves to $430 billion has been received by the
markets as restoring confidence, rather than preparing for financial
Armageddon.

Spain’s primary source of trouble is the bursting of a
housing boom bubble. Sound familiar? Here in America we struggled through the
economic crisis as unemployment peaked at 10%. Meanwhile, the number of homes
in foreclosure peaked at 8.12 million in January of 2010 and drove home values
here down approximately 25%. Spain’s unemployment rate is nearly 25% and close
to 50% for people under 25. The Spanish real estate boom put 80% of the
population in home ownership. Foreclosure rates are now topping 10% at some
banks and the unemployment situation is creating a death spiral. This is
leading to marked to market values on repossessed homes as much as 60% below
their peak. Marked to market values leave the repossessing bank with an
over leveraged asset and reduces their capital base further constricting their
economy.

Spanish banks packaged their loans for resale on the
commercial credit market as mortgage backed securities. These securities were
prime at the time of origination. However, as their economy has declined the
nonperformance of these loans has placed more of them in the default category.
Some of these mortgage pools now contain up to 14% of mortgages more than 90
days over due. The obvious conclusion is that many Spanish banks are in
trouble.

The European Central Bank and the IMF have teamed up to try
and save Spain from themselves. The Troubled Asset Relief Program (TARP)
committed $470 billion to U.S. banks and the auto industry in order to keep
people in their homes and on the job. The $430 billion that has been pledged to
save Spain will not be enough to cover the mortgage losses. Furthermore, the
average Spaniard’s primary asset is their home, which accounts for
approximately 80% of their net worth. The Spanish debt will be hard to spread
around.

This leads to the IMF report on national household
deleveraging within the constructs of a banking crisis, which found that the
deleveraging process trims an average of 1.45% of GDP. European corporations
are already hurting. The lowest levels of corporate credit have skyrocketed
from 2% of total corporate credit to almost 16% of total corporate credit in
the last 5yrs. How will the ECB decide which ones are worth saving and how will
Spain feel about relinquishing their sovereignty to the decisions of the ECB
and the IMF? Government has never been very successful at manipulating markets
over the long haul. I believe the bond auction was palliative only because
investors are certain the ECB will backstop their purchases just as we have
grown accustomed to the Bernanke Put here in the U.S. Finally, when government’s
lose control of the markets they have been manipulating, the disaster is
spectacular.

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.