The Chinese government repeatedly attempts to micro-manage the lives of its citizens. The effects of which continue to be unintended consequences both socially and economically. This week, we’ll discuss the citizens’ pool of money that the government continues to hold hostage and the mechanisms the Chinese government has employed thus far that have created a predictable ripple effect, visible to everyone but their own government. Somehow, they seem to be continually surprised by the unintended consequences of their own actions. We’ve watched Chinese investors’ money run from property to the stock market and now, to commodities. We’ll look at some of the massive scale of fairly predictable rookie trader outcomes that have been their unintended consequences.
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.
High grain and energy costs have finally generated enough momentum for the politicians to get involved. This past week, a paper was presented to Congress by Michael Masters of Masters Capital Management. He attributes the current price levels to creating an artificially high floor price due to the asset class categorization of commodities. The long only money that has poured into the markets is creating, “demand shock from a new category of speculators: institutional investors like
corporate and government pension funds, university endowments, and sovereign
wealth funds. He also, matter of factly states, “Index speculators are the primary cause of the recent price
spikes in commodities.”
One statistic that is being roughly, though widely, quoted, is the assumption that demand for exchange traded commodities over the last five years has increased equally between China and Commodity Index Funds. The CFTC is prepared to overhaul its system of reportable trading categories and players to try and pinpoint who is trading what and how much. The purpose is to differentiate between true physical price discovery and speculative froth.
Congress is prepared to assist the CFTC in outing the institutional speculative money by closing the swaps loophole that has allowed the billion dollar funds to enact futures transactions as swaps through their securities brokers (Merril, Goldman, etc.) who then hedge the swap in the futures market. This is how every individual fund has managed to stay off of the CFTC’s Commitment of Traders reports. The commodities are held assets with their broker while the broker executes the hedge and reports the position as their own.
The CFTC and Congress working hand in hand could bring an end to this bubble far quicker than peace in the Middle East or a bountiful global harvest.
Please, feel free to comment or, question. This is a small picture painted in broad brush strokes.
Have a wonderful weekend, Andy.