The Day After – Catalyst for resumption of Bull Market will be a surprise!

S&P correction Winter 2014I provided a rather winded explanation in my previous discussion about why the current correction was inevitable.  Since then, the S&P 500 has declined roughly 3%.  It is likely to get worse before it gets better? My own estimation was a 8% to 10% correction which would see the S&P 500 fall below the 1700 mark.  Of course a bout of strong earnings (or rising expected earnings) might dampen the damage but we won’t have that information for a few months.

In order to fuel a comeback (which I also expect) we need two things to happen:

1. We need to get through the uncertainty associated with tapering and the debt ceiling…yet again.

From CNN Money Jan. 16, 2014: “Treasury Secretary Jack Lew called on Congress Thursday to move soon to raise the nation’s debt ceiling to ward off any risk of a U.S. default, saying the crunch will come by the end of next month.”

2. Global markets need a new stimulant to offset the effects of rising interest rates.  In my experience the impetus to strong economic growth (and rising markets) comes from the least expected source.

A substantial decline in energy prices in my opinion just might provide the impetus needed.  Surprised?

Consider how insane things became just a few years ago.  I found the following – text and chart from 2007 – buried in Federal Reserve Bank of San Francisco publications:

Spot Oil Price 2007

(2007) Why are oil prices rising?

“Global demand for oil has been increasing, outpacing any gains in oil production and excess capacity. A large reason is that developing nations, especially China and India, have been growing rapidly. These economies have become increasingly industrialized and urbanized, which has contributed to an increase in the world demand for oil. In addition, in recent years fears of supply disruptions have been spurred by turmoil in oil-producing countries such as Nigeria, Venezuela, Iraq, and Iran.”

That was a bubble long forgotten.  The economies of China and India have slowed, and the U.S. is trending towards energy self-sufficiency thanks to production growth nobody envisioned back then.  The question today is why oil prices haven’t fallen further?  The current price certainly can’t be explained by inflation.  Picking a random starting point, say 1994 – inflation should imply a current price of crude about 124.2% higher today.  But since the price of oil in 1994 was $14 that would mean today’s price should be $32.

US Crude Production 1920-2014

Also, the U.S. remains (as of 2012) the largest consumer of world oil at 18.5%, with China having closed in to 10.3% according to the U.S. Energy Information Administration.  World Oil Surplus & DeficitWhen the oil price rocketed up a few years back, it might have been simply because demand had outstripped supply.  As the chart I whipped up (using EIA data) illustrates, there was indeed a sudden deficit in 2006 and 2007, in contrast to the surplus years of the mid to later 1990’s.

But what scenario is developing today?  With lacklustre economic growth elsewhere on the planet, not to mention ongoing energy-saving developments, this rapid growth in U.S. oil production might create a few years of surplus oil.  World Oil Production & ConsumptionThis would be bad news for the energy sector whose costs of production have increased over the years, but would be a welcome shot in the arm for global productivity and industrial profitability.

If I am right, then earnings estimates for the latter half of 2014 (most I’ve seen expect a modest increase of around 8%) are understated.  Sectors sensitive to energy costs (certainly NOT the recent darlings like technology and health care) stand to benefit the most.  Commodity producers for example might get the best of both worlds – higher commodity prices due to stronger demand but lower overall costs thanks to soft energy pricing.

But what about the “January” effect?  This quote is from CNBC:

“The January barometer has been right in 62 of the last 85 years, or 73 percent of the time. Since 1929, the index followed January’s direction 80 percent of the time when it finished positive, and 60 percent of the time, when it finished negative.” (Published: Friday, 31 Jan 2014)

As a lifelong student of investment and finance theory (and now a professor) the only thing I can definitively conclude is that statistics tell us zip.  In 2003 the market lost nearly -3% in January, but ended the year UP 50%.  Finding potential (and rewarding) exceptions to the rule is what investment research is all about.  THIS JUST IN:

Bloomberg: by Mark Shenk Feb 3, 2014 1:51 PM ET

West Texas Intermediate crude fell for a second day after manufacturing gauges in China and the U.S. declined, signaling reduced fuel demand.

Futures decreased as much as 1.3 percent. The Institute for Supply Management’s U.S. factory index dropped more than forecast last month. China’s Purchasing Managers’ Index slipped to a six-month low in January, a sign that government efforts to rein in credit will cool growth in the biggest oil-consuming country after the U.S. WTI’s discount to Brent shrank to the narrowest level since October today.

WTI price Feb-2014Unless there’s a meaningful disruption in oil supply or increased hostilities in the Middle East, the trend in oil prices should continue down.  Of course, conspiracy theorists might argue that turmoil in places like Iraq, Syria and Iran are orchestrated by Saudi Arabia, oil companies and the U.S. government in order to keep oil prices way higher than they should be.  High prices certainly help OPEC’s finances and make U.S. domestic production economic.

But prices can resist supply and demand dynamics only so long.  Will we see $30 oil?  Not very likely but $80 crude or better will provide enough fuel to bump corporate profitability.  Don’t be surprised to find S&P 500 earnings up 20% this year, and the index approaching the 2000 level BUT ‘after’ this correction is done – which is what I proposed in my previous commentary.

Whenever I think about U.S. domestic oil production, this (below) comes to mind…..can’t help it!

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First a correction; and then another banner year for stock markets!

Bear and the DeerIt shouldn’t be surprising that the current ‘mood’ just oozes caution.   The market is kind of like the bear (I met one face-to-face in Alaska many moons ago while fishing in ‘his‘ creek) – at one moment the bear seems content and not at all interested in us, then all of a sudden we’re mauled (the real bear I met graciously let me walk away).

Who would have guessed back in August of 2013 that the stock market would be where it is? Forget guessing.  I know a rather obscure business professor who called it precisely…and kind of by accident.  Below is an excerpt from the lecture notes I prepared before the fall term last summer.

A perpetuity is a stream of payments forever.  Once again, a formula can be derived from the formula for an annuity.  If “A” is the annuity value, “i” is the appropriate discount rate and n is the number of periods then:

PV (annuity) = A x ((1 – 1/(1+i) to the exponent n). AND if n = ∞ it REDUCES to:

PV(p) = A/i

This comes in handy.  For example say the S&P500 has a Price/Earnings ratio (we’ll get into this in more detail in future) of 18.59 = Index Price/Index Earnings

If at the same moment, the S&P500 Index price at the time was 1702, and we know the P/E ratio (from Wall Street Journal) is 18.59X.  can work out the earnings:

Solving for:  P(1702)/E = 18.59 = so E -= $91.55 (earnings of the S&P 500 Index).

If the index earned this forever (no growth) should at least be worth:

$91.55/.05 = $1831.  (PV of annuity, and earnings are the annuity).

Does it get any better?  S&P2Jan14You might think I’m being flippant, or worse (self-congratulatory).  I managed portfolios for over thirty years, and couldn’t be more humbled.  However the very few things I did learn have proven to be very robust.  If you scan through many of my past blogs, you’ll find that my rules-of-thumb have been pretty darn accurate – anticipating (rather than ‘predicting’) corrections, falls in commodity prices (gold especially which has neared my target of $1000 despite the condemnation I received in the many comments I received from various readers of my blurbs) and optimism about China.  There has been no shortage of pessimism about China’s economy, but ever since I wrote about it the news has been nothing but good even if their stock markets have not (yet) begun to reflect reality.

FordEquityJan-14There are of course far more sophisticated methods of determining value.  I’ve always been a big fan of Ford Equity Research.  In this chart, when their proprietary Price/Value Ratio = 1.00, stocks are fairly valued.  You can see that the market has in a short time gone from undervalued (when I did my own back-of-the-envelope calculation) to what seems to be pretty overvalued at present.  Of course, their modelling is far more intricate than my own, but the result is usually the same.

Ten Year TreasurySo what’s next?  Beware higher interest rates (BAD!!!!) and earnings expectations being revised downward (also BAD!!!).  If this is what’s in store for us over the next few months, then indeed the bear is about to maul the likes of us.

What do the soothsayers have to say?

I copied the following from Business Insider (Jan. 7, 2014) under the heading: “Wall Street’s Biggest Bear In 2013 Just Published Her 2014 Outlook, And It’s Wild.” Wells Fargo’s Gina Martin Adams had a 1440 target for the S&P 500 (ouch) all last year (ouch).

gina-martin-adams-2“Adams just published her 2014 outlook, and her new year-end S&P 500 target of 1850 — just above Monday’s close of 1837 — is once again the lowest on the Street (although this year, she’s joined at the bottom of the range of forecasts by Deutsche Bank’s David Bianco and Barry Banister at Stifel Nicolaus, who both share her new target).”

What’s funny is she admits that between now and the end of 2014, stocks could go up about 15%, AND could go down 18%.  I think its funny because it’s probably accurate but hardly useful.  Timing is everything!

Most ‘experts’ seem to be expecting 2014 earnings growth to be in the neighborhood of 8%.  This in my estimation is just too boring to take seriously.  Based on China’s continuing rebound and its global impact, I’d say 20% earnings growth is in the cards this year, with a substantial rebound in sectors sensitive to China – namely the dogs of 2012 and 2013.  (Yes, even gold seems close to its bottom).  BUT, the problem with ‘valuation’ is we also need to determine the interest rate environment.

Keeping it simple (like I would for my students), if long T-bonds are say 2%, and a less-than-normal equity risk premium of 4% is acceptable, I’d factor in (since tapering will be the norm globally) a discount rate of 6% (marginally higher than what I used 6 months ago).  Index earnings haven’t changed much yet (around $97) so $97/.06 = $1677.   That’s about 8% to 9% lower than its present value.  This correction is imminent.  BUT it’s not a longer term expectation because it assumes no earnings growth.  And earnings growth will come.

First, the climbing stock market (not analysts mind you) anticipated that 3rd Quarter earnings would be better than most expected.  The market was right!  This from Zack’s

For the Q3 earnings season as a whole, total earnings for the 484 S&P 500 companies that have reported results already, as of Thursday morning November 21st, are up +4.9% from the same period last year, with 65.3% beating earnings expectations with a median surprise of +2.53%.

Earnings Estimates 2013Nevertheless, optimism is already waning.  The fourth quarter earnings projections have been coming down (in November) while the most robust of all leading indicators (in my experience anyway) – the U.S. non-manufacturing ISM – unexpectedly fell in December, down 0.9 pts to a 6-month low of 53.0.

Bottom line?  Sure the FED can relax some of the easing – after all the employment data is very upbeat.  But we will price reduced monetary stimulus in (no, it isn’t priced in just yet) which should shake the 8% to 9% excess out of the market very shortly – so heads up!

The good news, is that estimates of future earnings growth remain far to conservative.  Once the consensus adjusts to the end of QE, economic momentum (Europe, China) will drive earnings growth (demand driven, rather than being driven by cost cutting) and before year-end 2014 the S&P500 should see $115 earnings or more.  What will this be worth?  This question requires some thinking.

Are we near a bubble?  Not even close.  Have a look at the below chart (courtesy TD Waterhouse Research).  Bubbles occur when the earnings yield on the market is lower than bond yields – a ridiculous scenario but a recurring one nonetheless.

Yields on Risky Assets

The financial crisis was a special case (liquidity crisis, not a stock market bubble) but clearly whenever the earnings yield for the riskiest asset falls below less risky asset yields, we experience the proverbial stampede to exit the market.  We’ve quite a long way to go before this cycle is over.

If inflation remains fairly benign, and the earnings yield were to fall to 6% then the ultimate market peak could be (with bumps along the road) north of 2500.  Because it’s likely that ‘some’ monetary easiness  (now that it is considered good ‘political’ medicine) will continue to prevail – commodity prices will bounce and present some inflationary threat.   So I’d begin to get a bit worried once we get closer to the 2000 level.  Rest assured that until you see people behaving like this (see video) there’s no bubble.

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Markets & September Heebeejeebies – Hide or Ride?

grizzlyWhat’s an investor to do when everything expected has already come to pass, and it’s time to strategize for the future – but the potential September/October abyss is in the way?

Having warned myself months ago about the coming rout in the bond market – see my post from June BONDS – Where we go from here! (And what about equities?) – I am sort of wondering why the consensus remains somewhat oblivious to the calendar.

The phenomenon isn’t imaginary. Have a look at the chart – click on it to enlarge – and read this true story (from my book) of what can happen quickly at this time of year:Septembers are the worst

During October of 1987, my wife and I were touring around Europe. Consequently, I had no idea about the market collapse that would be labeled the “crash of ‘87.” Upon my return to work, I was delighted to discover so many of the companies I had invested in (The Gap comes to mind as one of them) were ridiculously cheaper than when I had left for my vacation a couple of weeks earlier. The stock market seemed to me like a big warehouse sale……….When the boss came to my office, he was taken aback by my obvious jubilance. “What are you up to, Mal? How are you coping?” I responded, perhaps not wisely, that things were fantastic, and told him I was buying stocks like crazy. I later learned from my immediate supervisor that the big boss that same day suggested I should be fired immediately.

I wasn’t fired, and the bargains I picked up turned my portfolio into a gem. I was assigned more funds to manage a year later.

From 1987 to 1990 Canada bond yields rose from 8% to nearly 11% (roughly). The Toronto Stock Exchange (sensitive to materials & resources) and the S&P rose 34 – 35% (both expressed in $US).

Date Rate
Low 1987-11-05 $1 CAN = $0.7510 US
High 1990-08-23 $1 CAN = $0.8859 US

However, the $C appreciated about 18% over the same time period. Despite the October’87 Crisis, a bet on resources and materials when they were cheap and the economy transitioning into a ‘growth’ mode was quite rewarding. And it was at a time when rates were rising. Rates have been rising of late too, but it’s hard to say when they get to natural levels versus artificially depressed levels.

bonds - outsized increase in yieldsThere should be a shock to the system (October?) as the cost of capital for industries continues to rise:

From WSJ August 22nd: Moody’s said its ratings for Goldman Sachs, J.P. Morgan, Morgan Stanley and Wells Fargo are on review for possible downgrade. Bank of America and Citigroup are on review, direction uncertain, the agency said. Both banks have improved standalone ratings that could offset the effects of the removal of government support.

In all likelihood, the interest-sensitive sectors (financial, insurance) will suffer selling, bonds won’t attract money and economy-sensitive sectors will become in vogue. This can all happen – bigger caps going down while smaller cap materials firming up – while the overall market appears to be in decline. Admittedly, I may have been too early (a curse of much younger men usually) when I wrote about it in March – Global resources boom imminent! but the wheels now seem to be turning.

I love it when I see stuff like this:

Brent crude Aug-2013EIA Expects Brent Prices to Decline through End of 2013…” (from their August 21st This Week in Petroleum Production newsletter) while pointing to temporary ‘disruptions’ to explain recent strength.

These agencies are almost always wrong when it comes to predictions, and in this case the EIA is (still) underestimating the impact of rising demand, focusing too much on the supply-side.

As I’ve published previously (see China will be the next big surprise!) stronger demand in China (as well as North America and Europe) will drive growth, and the FED & ECB won’t have to fuel it….the heavy lifting has already been done.

Whether it’s energy (stocks like Suncor) or base metals or other commodities, the time to buy is during the frantic months of September and October and Christmas will be merry indeed. It’s no wonder that Warren Buffett has elected to buy a big stake in Suncor.

SUNCOR August 23rd-2013

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Earnings surprises impotent; Earnings shocks potent!

surpriseEvidence supports the notion that strategies targeting ‘earnings surprises’ are relatively impotent these days.

I remember twenty years ago (long before these stats were tracked with near precision using quantitative techniques) it became abundantly clear to me that accurately predicting earnings (the occupation of all professional financial analysts) did not help one make extra money (‘alpha’ in industry parlance). This excerpt from A Maverick Investor’s Guidebook (Insomniac Press, 2011) is a true story:

“Once upon a time, I made a speech to an audience of young aspiring financial analysts, hoping to point them towards the maverick way. Using data from an ancient article published in the Financial Analysts Journal, I pointed out a disparity in the expectations of investment analysts. Companies that were expected to have outstanding earnings growth actually underperformed (by a very wide margin) those companies that were expected to continue to report disappointing earnings. You may want to reread that sentence.

The study simply determined that optimistic earnings forecasts by research analysts usually turned out to be wrong, and the stock prices went down after it happened. Alternatively, analysts were generally too pessimistic about some companies, and after they were proven wrong, the stocks went up and by a lot. Opportunities are created when expectations are either too pessimistic or too optimistic. When a company simply keeps on delivering what is expected of it, the news is generally benign (having no significant effect) in terms of its impact on the stock price.” A Maverick Investor’s Guidebook (Insomniac Press, 2011).

This realization helped the performance of portfolios I managed early in my career immensely. I’d deliberately seek out companies whose stocks were washed out and tried to identify trends that would change/improve earnings and future expectations.

earnings surprise scatterJump ahead twenty plus years and companies’ efforts to manage earnings, and incentives for analysts to be as close as humanly possible to getting it right mean it has become almost impossible to earn the excess return that used to be available immediately following the earnings announcement – even if it is a surprise. The scatter diagram illustrates that although there seems to be a positive correlation between announced earnings surprises and returns, the statistical fit is simply awful. In English – not worth a bet.

“There exists indeed a positive relationship meaning that a higher earnings surprise leads to higher excess return and vice versa. The problem is just that the R-squared is only 0.09. In other words, the earnings surprise only explains nine percent of the variation in the excess return. So even if you were the best earnings forecaster in the world you would not be able to make consistent trading profits.” Business Insider, July 22, 2013.

earnings shocks diagramThe only approach that might work is hoping to identify what I call earnings shocks! Of course this supports good old fundamental analysis rather than quantitative techniques. Predicting massive errors in expectations requires much experience, although data mining can help get a grip on measuring true (if incorrect) expectations or consensus thinking.

An example might help. Below is the chart of Canadian forest products company Canfor. Largely forgotten over the past several months and with lumber and paper products far from the focus lists of investors and investment bankers, look what happens when earnings are shockingly better than expected.

Canfor

Trying to predict huge potential errors (that may result in shocks) is controversial. There is great personal risk since if you get it right there’s little glory but if wrong you are put under a microscope (remember Kerkorian and his Ford position?), even if there is very little in the way of actual financial risk. There’s also a bit of an embedded contradiction – similar to what modern day physicists – trying to model the universe – are dealing with. In order to be successful, you have to accept that the end result is based on any number of probabilities and unknown expected returns. This involves some assumptions and (like all good mathematicians) we hate assumptions.

BUT, if you have to make them then you make them. For instance, my own (still waiting for my Nobel Prize) model assumes:

  • The probability of making money betting on a positive earnings surprise diminishes as the number of investors/analysts that are optimistic grows.
  • The reward for betting on an a positive earnings shock increases the more pessimistic and disinterested investors/analysts become and vice versa.

earnings surpriseMany would argue that it is impossible to predict anything. However, at the time I wrote A Maverick Investor’s Guidebook (summer of 2010) I predicted a huge market rally. Why? Simply because an optimistic earnings expectation was nary to be found. Analysts’ forecasts were widely dispersed as well. My model suggested the potential reward for betting on positive earnings ‘shocks’ must be large because investors weren’t at all interested in the stock market at the time. You can see (with a magnifying glass) that the S&P 500 earnings did “shock” for quite awhile following the financial crisis, until expectations began to be more aligned (like today) with reported earnings (fewer shocks).

  • 2010 – Beware of too much pessimism
  • 2013 – Beware of too much optimism

Where is the potential for excess returns over the next 6 months to a year? You should be able to figure it out based on this quote I found today.

Over the past month, analysts covering the materials sector have lowered their 2013 estimates by 4.6%, while those covering energy and tech have cut theirs by 1.7% and 1.5%, respectively. In the case of materials and tech, much of that has come in the past two weeks during the peak of earnings season, with materials estimates down 3.4% and tech estimates scaled back by 1.3%, according to data compiled by Morgan Stanley. On the other hand, estimates for the telecom and financial sectors are up. MarketWatch (WSJ) July 30, 2013.

Expectations for materials, energy and tech are eroding, increasing the probability that once the dust has settled there will be some profitable earnings shocks.

For a fun read, click on this pic to visit my latest blog “How to tell the difference between investing and gambling.”

gambler

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China? No need for worry in the year of the snake!

China-year-of-the-snake2It’s the year of the snake, which seems appropriate since everyone is worried about the slowing of the Chinese economy.

In previous posts, I’ve described why the economic course of action China has adopted is brilliant – the country’s only real option is to fight the urge to take drastic (and potentially damaging) policy measures. I discussed this is a previous post called China’s Catch-22. An avid fan of democracy, I do have to admit that a political system that actually allows the government to ‘manage‘ its affairs has its advantages. Just like in everyday life, often the wisest course of action is to simply be patient. A virtue we all learn much too late in life.

China Investor SentimentIn the short-term, you would think that all this worry would impact investor sentiment and it surely has. This chart illustrates that in a very short period of time that the investing community, or at least a sample of 238 funds polled by BofA Merrill Lynch in July (managing a combined $643 billion), has grown extremely anxious about the prospects for the Chinese economy and how it might affect global markets.

I can’t count how many times (in print media, television or in this Website) I’ve demonstrated that poor investor sentiment about a security, an asset class or a country almost always indicates an opportunity to “do-the-opposite” and make money. For instance, on May 29th my article High Consumer Confidence is bad news for stock market! is evidence (again) that the inverse is just as true – when sentiment seems too good, it usually is too good. The summer correction followed almost immediately.

The really smart money is always those in the survey who are outliers – they carry no weight and therefore don’t influence the summary statistics. This is why data must always be examined with a grain of salt. What are they doing with their cash? Read this quote:

BEIJING | Wed Jul 17, 2013 1:23am EDT

(Reuters) – Foreign direct investment in China in June jumped 20.12 percent from a year ago, the Commerce Ministry said, the quickest gain since March 2011, showing that investors are still confident about the world’s second-largest economy even as growth slows.

Summer 2013 S&PNegative consensus sentiment (emotional) combined with evidence of smart investor (minority) money flows is what I call an opportunity-in-your-face. I forewarned about the market correction – and recommended buying back once summer was underway. That ship may have sailed, but there are also times when market leadership shifts behind the averages.

China stocks,brent,copperI’m on record believing that China will be the next big surprise! And China needs resources. Energy, copper, fertilizer and in due course even iron ore will enjoy a cyclical bounce – and the stocks. Strength in the oil patch seems ignited already. But should one bet on China now or wait until September (historically the worst month of the year and thus the cheapest entry point for buyers?) Hard to decide admittedly, but the U.S. market seems long in the tooth (again) and China’s economy isn’t necessarily slowing…it may be done slowing (i.e. did slow – past tense) which is reflected in the recent data. Maybe China’s growth is poised to strike – like a snake in the grass in the year of the snake.

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Jim Rogers stealing my thunder? GOLD!

Jim-Rogers-1I can’t help but admire anyone who rides a bike for long distances, and Jim Rogers is one of those who takes the cake. I met him in Scotland at the Chartered Financial Analysts Institute’s Annual Conference (2010). Although my own journeys have hardly been as worldly as Jim’s has, I also have a pic of the “Kangaroo Crossing” sign in my own trip-photo collection.

At the conference, I told Jim that i was concerned about the high-flying commodity (resources in particular) sector. Mr. Rogers, in his usual ‘abrupt’ fashion more or less suggested I knew nothing about commodities and said I was simply wrong.

Roughly a year later, the S&P500 Metals & Mining sector had fallen roughly -30%, Energy was in the red with Oil & Gas Exploration and Production down >-15% and Coal related stocks off a whopping -50%. I was right after all? Well Fertilizer & Agriculture (his favoured commodity play) managed to do well over the same time period, so Jim was sort of right also. We may have been talking apples and oranges in that instance, but more recently we both seem to have been expecting the fallout in gold.

I saw this quote this morning:

“Jim Rogers Correctly Predicted Gold Would Fall To $1200, And Now He Thinks It Could Go As Low As $900.”

goldbarsI am on record for having been bearish gold since the peak of its popularity (and perhaps even a bit early but there’s a price to pay when one leaves a raucous party too late). On January 8th I published a commentary entitled: Why the price of gold skyrocketed and why it’s over! The gold price had just begun it’s decline from the $1800 level. In April I posted a follow-up discussion with more precise targets. Here’s what got me in trouble with a whole bunch of the gold bugs that read my blog:

“As I type this, gold is $1424/oz. and silver is $23/oz. Therefore the ratio of gold to silver is >60. I find that 40 to 1 has got to be coming (no real reason, why not?) suggesting a target price for gold of $920/oz.” April 24, 2013.

Gold bugs are a stubborn lot for sure. Most of the comments I received were similar to this one:

“Dear Mal,

You are wrong. The global financial system and the whole planet is going into a major depression.

Silver will be at 40$ and gold at 2000$ within 18 months”

This comment was from a respected and very bright senior financial advisor. For some reason, folks become emotionally attached to gold and perhaps this clouds their judgement to some degree.

JimRogersPostCardI am in the same camp as Jim Rogers, and not just because he seemed to like my own book about riding and investing. There are situations when the urge of investors to own a security (Apple?), a sector (Real Estate?) or a currency (Gold?) becomes overzealous to the point of ridiculous (anyone remember Cabbage Patch Dolls?)

The reverse is also true. I believe we are on the cusp of another boom in commodities fueled by the slow recovery in the global economy. Will gold prices stop falling and rise with the prices of energy, copper, nickel and other economically-sensitive commodities? Most probably! and It is not altogether impossible that the price of gold does reach $2000 within 18 months as my gold bug-friend suggested. I’d just rather sell when the bugs are swarming and buy when its as low as it can go….and we will get there.

The market correction will be done very soon, and it might be useful for you to read again:

“Global resources boom imminent!”

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China’s Catch-22

I considered the title “bad news is good news” but it seems the phrase ‘Catch-22’ from Joseph Heller’s book is more appropriate. A dictionary describes it as “a problematic situation for which the only solution is denied by a circumstance inherent in the problem or by a rule.” For example, (from the book as I recall it) say a pilot pretends to be crazy to get out of military service altogether. The very motive – wishing to avoid combat and stay alive by pretending to be insane – is the antithesis of crazy, proving he is quite sane indeed.

Baby Panda BearChina’s situation is similar. It may very well seem sensible at this stage for the Chinese government to aggressively create liquidity and stimulate growth – following in the footsteps of North America and Europe.

This quote is from the Business Insider’s The Closing Bell summary for 24 June, 2013:

The sell-off really started in China, where the Shanghai Composite fell 5.2%, sending the index into a bear market. This was triggered by hawkish comments from the People’s Bank of China, which refuses to ease up despite surging interest rates. Here’s Nomura: “The guidance note stated that “overall bank liquidity conditions are at a reasonable level” and asked banks to “prudently manage liquidity risks that have resulted from rapid credit expansion”, “appropriately contain the pace of loans and bill financing” and “utilize the stock of money and credit to support the economy.”

China Growth SlowingSeemingly prudent, the result is a very real slowing of economic growth. I agree that China is being prudent but because they have no real sensible alternative.

China owns 1.2 trillion of $US debt securities. In fact China holds 7.5% of all US government debt. Since the entire Chinese GDP is $US 8.2 trillion then its investment in United States treasuries is a hugely significant asset equal to 15% of their country’s total wealth.

Deliberately depreciating the renminbi (RMB) in order to fuel economic growth would seriously bolster the value of the those US assets held in such abundance, and provide a shot it the arm to exports as well. But now that China is doing so much international trade with the U.S. and especially Europe, this sort of government initiative would simply damage those stumbling economies and encourage those who would introduce politically-motivated barriers to trade.

Chinese Yuan Renminbi, US Dollar - X-RatesOn the other hand, doing Obama a good turn and allowing the RMB to appreciate in value would hurt the value of those assets and slow down what growth is already occurring.

The Catch-22? Doing either would not result in the desired outcome. Staying the course means the RMB can depreciate at a lacklustre (non-threatening) pace, and nobody can blame the government for excessive stimulus. Strangely, the RMB is depreciating despite what can only be interpreted as a prudent economic policy. Normally, such an approach should cause their currency to strengthen but instead in May alone the RMB depreciated 0.9% against the Greenback. Chinese economic policy plays right into Obama’s hands; even if the end result is not what should happen. Bottom line is you can’t blame them for not trying.

Chinese Proverb: Do not fear going forward slowly; fear only to stand still.

In my book Resources Rock (Insomniac Press 2004 with Pamela Clarke) there’s just a hint of the ingenuity and doggedness China demonstrates when it comes to business. There was a ‘raging bull market for fertilizer stocks between 1993 -1996′.

“China imported huge quantities of fertilizers, primarily urea and DAP, to support new policy initiatives designed to move the country towards agricultural self-sufficiency.”

but in due course,

China used to consume 20% of the nitrogen fertilizer produced in North America. But by 2000, the Chinese banned urea fertilizer imports, and instead became a leading producer of nitrogen fertilizers.”

The Chinese have always been calculated and patient. As I mentioned in my previous commentary: China will be the next big surprise! By doing nothing at present (the only path available) inflation remains controlled, their housing bubble stalls and thanks to a modestly depreciating currency exports and economic growth will gradually resume. Do not fear going forward.

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