Archive for the ‘Market Observations’ Category

Bernanke warming up the printing press

Sunday, August 29th, 2010

Last month, we wrote in Prepare to pull the trigger on speculating! about the signs to watch out for the timing to speculate. Well, the sign arrived over the weekend.

Last Friday, Ben Bernanke gave the strongest hint about money printing. As this article reported,

Federal Reserve chairman Ben Bernanke has laid out four "unconventional" policy options to boost the US economy.

Top of the list is more "quantitative easing" – mass purchases of debt.

"Quantitative easing? sounds technical, but it basically means printing money. In another article, Bernanke is talking tough against deflation,

Federal Reserve Board Chairman Ben Bernanke said Friday that the central bank would not sit idly and let the U.S. economy sink into a period of deflation.

"The Federal Open Market Committee will strongly resist deviations from price stability in the downward direction," Bernanke said in a speech opening the Fed’s annual summer policy retreat.

The Fed would be "vigilant and proactive" if inflation falls by a significant amount, he said, though he downplayed concern that the economy would fall back into another downturn, or a double-dip recession.

As we wrote in our book, How to buy and invest in physical gold and silver bullion,

The United States, with ?helicopter? Ben Bernanke at the helm of the Federal Reserve, is committed to money printing to solve America?s economic woes. To the extent that the US dollar is the world reserve currency, it will affect the rest of the world.

In essence, for investors who still believe in deflation, Bernanke is saying, ?Try me. I dare you.?

Credit problems in China

Sunday, August 8th, 2010

Last Friday, we asked our readers: Do you think China will crash soon? The results are pretty interesting. Almost 29% of you reckon that China will crash in a few years time. Almost the same number reckon that China will not crash as far as the eye can see. The rest are scattered throughout the other response. From what we can see, most of you do not think that China will crash anytime soon.

Today, we will talk about credit in China?s banking system.

In Western countries, central banks cannot force the private sector to borrow.  As we wrote in What makes monetary policy ?loose? or ?tight??,

To understand why, we have to remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.

Apparently, this is not so in China. The Chinese government, which has greater administrative powers than Western governments, can force feed credit into the economy. The result: bad debts.

Professor Patrick Chovanec, professor at Tsinghua University’s School of Economics and Management in Beijing, has concerns about the Chinese banking system. He wrote two articles detailing its weaknesses:

Chinese Banks At Risk, Part 1
Chinese Banks at Risk, Part 2

The question is, can there be a Western-style credit crisis in China?

Are deflationists missing the elephant in the room? Or are they believing in something more sinister?

Sunday, August 1st, 2010

As you scour around the blogsphere, you will see that there are contrarians who still believe that it is impossible for the US to prevail against deflation. The most extreme of deflationists is Robert Prechter (from Elliot Wave International), who is still predicting that the Dow Jones will go all the way down to 1000. Up till March 2009, it seemed that the deflationists’ argument was correct. In the Panic of 2008, deflationary forces were so strong that asset prices were even more oversold than the infamous 1987 crash. Unfortunately for the deflationists, the subsequent rally (reflation) till May 2010 was so enduring that their argument was discredited in the eyes of many.

Our view, on the other hand, belongs to the inflationists’ camp. From what we can see, there is a big elephant in the room that deflationists miss. But as we think about the deflationists’ argument, it suddenly dawn on us that perhaps deep in the soul of the deflationists’ argument is the belief of what some may call a “conspiracy theory.” Of course, we guess not all deflationists hold (or even aware of) such a belief. But the more extreme and strident a deflationist hold on to the deflation argument, the more we suspect that they are holding on to the belief of the “conspiracy theory.” Although we do not know whether that “conspiracy theory” is true or not, it certainly helps to explain the extreme position held by some deflationists.

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Concerns about China’s slowdown

Thursday, July 22nd, 2010

Back in April, when economic ?experts? were expecting further growth in the Chinese economy, we wrote in this article that

Contrarian investors like Marc Faber believes that the Chinese economy will ?slow down regardless? any time from now on. Whether this slowdown will be a nice soft-landing or a gut-wrenching crash is another matter.

Marc Faber was on record for saying that there?s a possibility that China may ?even crash.? How could the pundits missed the signs that something is really wrong with the Chinese growth in 2009? As we wrote back then, there were plenty of signs:

? there are massive excess productive capacities in the Chinese economy. As we wrote in Is China going to dump their excess metal stockpiles?, there are eye-witnesses? reports of ghost cities, vacant office blocks and apartments in China. It had been reported that China?s excess capacity for steel and cement production is around the current capacity of United States, Japan and India combined. All these points to a massive mis-allocation of resources in China, which according to the Austrian School of economic thought, a pre-cursor to a bust (see our free report, What causes economic booms and busts?).

That?s why, as we wrote in Chinese government cornered by inflation, bubbles & rich-poor gap, the Chinese government will have to rein in their runaway economy sooner or later (e.g. through administrative means, revaluation of the yuan). The longer they delay, the bigger the inevitable bust will be.

Today, the financial markets are finally noticing that China is slowing down more than expected. For example,

  1. Rate of decline for Chinese industrial production is more than expected.
  2. And if Chinese government statistics can be believed, even the inflation numbers were below expectation.
  3. Spot iron ore prices have been in free-fall since May.
  4. Steel production has now fallen to its lowest rate of growth since 2001.
  5. The Baltic Dry Index has lost more than 50% in one month.

Back in January, when we wrote Chinese government cornered by inflation, bubbles & rich-poor gap, we were wondering when the Chinese government will bite the bullet and rein in the runaway economy. We didn?t have to wait long to see it happening.

The question that the pundits and the financial markets will be wondering is this: will this unexpected rate of slowdown continue for rest of the year? Will it continue on to 2011? If they get it wrong (again), it goes to show that they have underestimated the resolve of the Chinese government to cool down the economy.

The risk is that the Chinese government may accidentally let the slowdown turn into a crash. We shall see.

If you want deflation, you would love Germany

Sunday, July 11th, 2010

From our previous article, one of our readers was very indignant at the current state of affairs. As he wrote,

During inflationary times, those who speculated made more money than those who held cash. so you could argue that those who held cash felt the "inflationary pain" but why wasn’t the government pressured politically to do something as they were when they get spooked by deflation?

Then when deflationary times come its the turn of those who held cash to benefit while those who already made their money out of speculation and over leveraging to feel the "deflationary pain", after all they did take too much risk.

I don’t think its fair or right for governments to manipulate the economy to prop up the prices of the investments of the speculators (who helped create all these bubbles in the fist place). Basically that means that they got to make a lot of money out of speculating but they didn’t take any real risk as government will step in to do "something" about the pain.

If the don’t feel the pain they will continue recklessly speculating.

Meanwhile that very same "something" the governments will do to help the speculators avoid pain will probably mean devaluation of the currency one way or another so that once again those who did not speculate and over leverage will feel the pain.

The governments actions will tend to encourage more people to speculate! I would like to see deflation happen, does anybody else feel the same way???

On the first point, why are governments more spooked by deflation than by inflation? The simple reason is that in a democracy, the mob rules. Unfortunately, the mob is heavily indebted as a whole. All we have to do is to look around and see that the culture of debt is deeply ingrained in society. For young people, not only is it fashionable to get into debt, it is very difficult not to get into debt. For example, buying your first home is enough to put you in debt for decades.

The last time governments became spooked by inflation was in 2008 when oil and food prices shot through the roof (see Who is to blame for surging food and oil prices?). If governments continue its policy of doing ?something? about deflation for a sustained period of time, we believe it will be a matter of time before prices of necessities will resume its surge again. As usual, the blame will be put on ?shortages? and ?speculators.?

But not all governments in the world are biased towards inflation. Germany is the exception here. The trauma of the hyperinflation during the Weimar times is seared into the German consciousness. As a result, they will avoid anything that hints of inflation. Unlike the English-speaking countries, politicians in Germany who stick to discipline, austerity, balanced budgets and stand against moral hazards see their popularity go up.

Coincidentally, Germany is also the most important member of the Euro zone. As a result, their attitude towards inflation is being imposed on Europe. In the recent G-20 meeting, the G-20 endorsed a halving of budget deficits by 2013 as the target.

But as George Soros wrote in a recent article,

The situation is eerily reminiscent of the 1930s. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banking system and the economy may not be strong enough to do without fiscal and monetary stimulus.

The Great Depression of the 1930s is one of deflation. In Soros? opinion, the G-20?s endorsement of government de-leveraging has increased the risk of deflation today.

So, in the coming months, we can see why the deflation argument will be gaining the upper hand.

Notice the change of narratives in the financial markets?

Tuesday, July 6th, 2010

At around January-February this year, when the global financial market first suffered a correction, the narrative was about the sovereign debt of Greece. That had the implication on the Euro. Back then, the US dollar rose and gold fell. The fact that gold fell was not something that can be rationally explained. That?s because if there?s a lack of confidence in a major fiat currency (the Euro in this case), then the alternative should be gold. But as we wrote in How To Foolproof Yourself Against Salesmen & Media Bias, there?s a difference between what should happen and what will happen. This is example of a divergence between the two.

In May this year, the narrative was again on Greece, the other PIIGS countries and by implication, the Euro. Gold and US dollar rose. This time round, gold?s move was rational.

Fast forward to today.

There?re a lot of indication that the narrative is back in the bears? favour (see Mr Market is in the bear camp). But this time round, there?s a difference between May?s bearish narrative and today?s bearish narrative- European sovereign debt (and by extension, the Euro) story is no longer part of the narrative. The more prominent story is the growing expectation of a double-dip recession. As we wrote in Keep up spending- Who?s right? Europe or America?,

The expected (assumed is the more accurate word) recovery in the United States seems to be stalling. China is enacting policies to slow growth. Europe is mired in sovereign debt problems.

This narrative carries the implication of a return to deflation. The signs of deflation include rising US dollar and falling asset prices. Our guess is that in the context of this new narrative, gold in US dollar terms may be under pressure. A rising USD implies a falling AUD, which will mitigate some of the falls in gold price in AUD terms.

In the near term, stocks may be oversold and may rebound slightly. But according to the narrative of the bigger picture, the bears are still in charge.

Hidden weak foundations covered by high tide of debt

Thursday, June 17th, 2010

Today, we read this interesting article, Nothing can save Spain,

"Greece is not Spain", has been how European politicians have been trying to reassure the markets. Once analysts had a closer look at the Spanish figures they concluded that this was indeed true ? Spain?s troubles are much worse.

?

In fact, before the crisis struck the Spanish were seen as Europe?s model citizens. Public debt was low, the economy grew rapidly, and in 2007 the government could still report a healthy budget surplus of 1.9 per cent of GDP. There was no sign of grave economic mismanagement, let alone on a scale comparable to the Greek basket case.

So what turned the Spanish miracle into an economy on the abyss? How can a country be regarded as a role model one day and almost a failed state the next?

?

But whereas in Greece the lower interest rates were taken as an opportunity to incur greater public deficits, in Spain it was the private sector which accepted the invitation to go deeper into debt.

One sector in particular benefited from this injection of cheap cash thanks to the euro: real estate. For many years, Spanish house prices only knew one way, and that was up. Between 1998 and 2007, property prices increased by about 10 per cent per year on average.

When the global financial crisis struck, the bubble burst. Since 2008, Spanish house prices have declined 15 per cent and there is no end in sight to the correction. Some real estate experts are predicting further falls of up to 35 per cent.

Suddenly, the weak foundations of Spain?s economy are exposed, especially its over-reliance on debt coupled with low productivity.

Consequently, the pristine clean Spanish public debt turned into deficit as unemployment rate soared to 20% and bad debts plagued the banking system.

Note that we highlighted the word ?suddenly? in the final paragraph.

The key to remember is that the economy looked rosy until something suddenly gave way. The high tide of debt kept the weak foundations hidden under the water. Finally, when the debt tide receded, the weak foundations were exposed. With the weak foundations in full view, the financial market reacted in horror accordingly.

Spain?s situation reminds us very much of Australia. As the Reserve Bank of Australia (RBA) governor hinted in a speech last week,

Markets can happily tolerate something for an extended period without much reaction, then suddenly react very strongly as some trigger brings the issue into clearer focus.

Again, we highlighted the word "suddenly.? As we wrote in Serious vulnerability in the Australian banking system, there is a serious weak underbelly in the Australian economy. All we need is a trigger for all eyes to be on its weak foundation (see Will there be an AUD currency crisis?).

However, many pundits in the mainstream media are still putting on Turkey Thinking (see our book, How To Foolproof Yourself Against Salesmen & Media Bias for more information on Turkey Thinking).

Is the Chinese export surge really good news?

Monday, June 14th, 2010

Last week, the mainstream financial news media was cheering on the news that China’s exports surged on a year-on-year basis. This led to the belief that China’s economic recovery is on track, which implies that the recovery in commodity demand will be sustained, which will then flow on to the Australian economy. As a result, according to media narrative, the stock market rose on that ‘good’ news.

But before we get carried away with this bout of optimism, let us put on our thinking caps and consider the bigger picture. Firstly, is the surge in Chinese exports and imports really a good news for Australian mining companies? To answer this question, consider this news article,

But rising textiles and electronics exports will do little to offset the slump in Chinese demand for Australian commodities that will come with an expected construction slowdown.

Construction starts for government infrastructure projects have slowed sharply and private sector transactions have been bludgeoned by government measures.

Private sector measures show real estate transactions fell by as much as 70 per cent from April to May in Beijing, Shanghai and Shenzhen, where policy restrictions have been most severe.

To put it simply, China’s demand for Australian commodities post-GFC is mainly influenced by China’s construction ‘boom’ in 2009. It is open knowledge that there’s overcapacity in China’s steel and cement industries. As we wrote in Marc Faber: Beware of investing in Australia (as it follows the Chinese business cycle),

It had been reported that China?s excess capacity for steel and cement production is around the current capacity of United States, Japan and India combined.

A rise in Chinese exports will not be likely to offset the slump in construction.

Next, when you look at the big picture in mind, an export surge is the last thing the world needs. In the this post-GFC world, where growth is anaemic and unemployment is stubbornly high, countries are covertly engaging in competitive currency devaluation in order to prop up their exports in order to prop their economies. The Americans wants to re-balance their? economy with more exports, which implies other countries have to import more from America. Yet, on the other side of the Atlantic ocean, as Niall Ferguson said in this recent interview, the Germans are shedding crocodile tears over the falling Euro because that would boost their exports, which in turn is good boost for their economy. As Marc Faber said in this interview, a falling Euro (i.e. rising US dollar) will give the Americans the excuse to print money to give their economy another adrenaline boost.

Unfortunately, growth-via-exports is a zero-sum game because a for every export, there is an import on the counter-party. If every country wants to increase their exports to boost economic growth, who’s the one doing the importing? Thus, China’s export surge is one step in the wrong direction. The world needs a rebalancing of exports and imports, not more of the same unsustainable imbalance.

Already, the Americans are murmuring about this ‘good’ news. As? China export surge stirs U.S. anger reported,

A surge in Chinese exports and rising anger in the US Congress will put renewed pressure on China to allow its currency to rise against the US dollar.Chinese trade figures showed exports leaping by 48.5 per cent in May over the year before, way ahead of analysts’ forecasts. Data released in the US showed America’s trade deficit widening slightly in April, with some economists arguing that the improvement in net trade and its contribution to US growth appeared to have stalled.

The data gave more ammunition to China’s critics in the US Congress, who have said they will proceed with legislation to restrict Chinese imports to correct the perceived misalignment of the country’s currency. The US Treasury has been pursuing quiet diplomacy with Beijing to allow the renminbi to rise, but lawmakers said they were losing patience.

In the bigger picture, rising trade tensions between the US and China is moving them towards trade war. This can hardly be good news.

China: gigantic property bubble in the midst of exploding supply of vacant brand new homes

Thursday, May 13th, 2010

Today, we planned to continue from our previous article (Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market). But one of our readers, Paul, emailed us a couple of very informative comments (which we’ve posted on the comments section of that article). With his comments, we feel that we have further points and observations to add, which requires a separate article. Please note that our observations of the Chinese property market are made from the point of view of a foreigner, which may not be entirely accurate or correct. So, please feel free to correct us if we are wrong.

In Paul?s second comments, he wrote

Personally, I find it amazing that they would not want to have a tenant in the apartment and collecting rent on their investment, but no, most private landlords look only at the long term capital appreciation.

To add to his comment, we have some interesting observations that may perhaps explain such strange behaviour in China’s property market. You see, in Australia, when you buy a brand new home, it is mostly done up (e.g. complete with kitchen, oven, tiles) and ready to move in. In China, brand new homes are usually ‘raw’ (e.g. no tiles, concrete walls)- you need further renovations before that home is ready for moving in. Obviously, landlords cannot rent out ‘raw’ homes because they are unliveable. That’s where the Chinese mindset differs- if the ‘raw’ home gets renovated (so that it is ready for moving in), that ‘raw’ home is no longer ‘brand new.’ As our reader said,

… it is very difficult to negotiate deals in the secondary market or rental market.

Once a home loses its ‘brand new’ status, it loses value and goes to the secondary market. Given that the secondary market is extremely weak in China, it explains why Chinese property speculators rather keep their apartments ‘raw’ and un-renovated than to renovate it and rent it out (unless the rent is high enough to offset the loss in value).

Furthermore, we guess that the domestic rental market in China must be very weak because of the “account” system. In Chinese cities, families must own an city residency “account,” which qualifies them for government services, school enrolment, etc. The “account” is defined by the address of your owned home. The implication is that if you sell your only home (and consequently, have to rent another home to stay), you lose your “account,” which will be very disadvantageous to you. That probably explains why the rental market seems to be non-existent in China (except for foreigners and maybe for migrant workers who don?t have their own ?account? anyway). These characteristics explains why in China, there can be a gigantic property bubble in the midst of exploding supply of vacant brand new homes. It is very similar to what we wrote in Why oil cannot function as currency reserves?

Then the demand for tooth pastes will rise to the moon, not because the demand for oral hygiene increases, but because the demand for tooth-pastes as money increases. Not only that, no matter how much tooth-pastes Colgate produces, there will always be shortages because there will be mass-hoarding of them as money.

That is the consequence of monetary inflation, which undermines the store-of-value function of money. When residential property takes on the store-of-value function, the result is a gigantic price bubble in the midst of over-supply.

In the next article, we will continue the story from the previous article. Keep in tune!


P.S. Paul has this comment regarding this article:

Your comments about the condition of the home or office when sold new are true.?? For homes however, it is more usual to dress them.?? For offices, no.

But I want to pick up on your second part.?? By “account” I assume you mean “hukou”.?? If so, your facts are wrong.?? It is not based on the address of your owned home, but on where you were born.?? The original purpose of the hukou was to identify and control peasants.?? A person’s hukou identifies
whether they are a city person or a rural one, and is based on the province in which they were born.?? My Chinese wife was born in Xinjiang, but her parents came from Anhui and Henan.

Every Chinese citizen has a hukou.?? Rural migrants coming into the cities to find work still have a hukou.?? But it identifies them as being not from the city, making them ineligible for social security, schooling or other benefits.?? People with hukous from outside a city can buy property in that city.??? But the vast majority can’t afford to, because they are rural migrants looking for work.

One more point.?? Anecdotal evidence, but I present it just the same.?? My Chinese friends, and indeed my wife’s family, all wonder why I rent instead of buy.?? If possible, Chinese people will buy, as they see renting as a waste of money.??? They would rather scrape together the money from the family to buy a modest place than to rent.?? By the way, my wife’s brothers
own their own homes here in Beijing, despite them all having Anhui hukous.

If I may make one final observation, based on the work I do here.?? In a falling market, the Chinese will stay away in droves.?? They much prefer to wait and see how far it will fall, before making an investment or purchase decision.?? I consult to the global primary aluminium industry, and I see the same thing when it comes to raw materials.?? Any hint of softness in
price will cause the Chinese to stop buying.?? Conversely, any hint that the price is set to rise, and they will rush in.?? Hence why the Shanghai index has such wild swings.

Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market

Tuesday, May 11th, 2010

In our previous article, What if China crashes?, we wrote,

? the Chinese government seemed to be getting really serious about cracking down on property speculation, even to the extent that it is giving the impression that it wants the property bubble to burst.

Will the Chinese then rush to gold should their government succeed in cracking down in property speculation? To answer this question, we must first understand some things about the Chinese mindset on property and investments. Currently, interest rates in China are pathetically low- so low that they are below the price inflation rate. Because of their currency peg, the People?s Bank of China (PBOC) is constrained from raising interest rates (see Can China raise interest rates to control its property bubble?). Also, the Chinese are known to be savers.

So, that creates a problem. Imagine you are a typical Chinese saver. What if you want to save and the cash at bank is yielding returns that are below the rate of price inflation? That results in a very great disincentive to save your money in the bank and pushes you to ?invest.?

The next question is where can you ?invest? your money? Remember, a lot of other people are facing the same problem because the Chinese government?s policy of force feeding credit into the economy is creating a gigantic rain of freshly printed money- a lot of people are having too much money on their hands. Unfortunately, in China, with its underdeveloped financial system, there is not much avenue to ?invest? your money.

The range of financial instruments in the stock market is limited. There are hardly any derivatives available for you to short the market (but currently, stock index futures are on the trial phase). Not only that, the standard of disclosure and reporting has too much to be desired. Most average mum and dad stock investors in China can only take long positions on a stock market that is highly volatile and speculative (due to lack of disclosure). No wonder investing in stocks is not that popular in China.

Thus, the only investment outlet for this mountain of freshly printed money is the property market. There are a few characteristics of the Chinese property market that most foreigners will not know. Perhaps these characteristics explain why the property bubble in China is so enduring.

Firstly, the Chinese property bubble is definitely bigger than the property bubble in Australia. But you may be surprised to learn that the consumer leverage in the residential property market in China is in fact smaller than Australia. In China, you need at least 40% deposit to qualify for a mortgage loan. As Patrick Chovanec wrote here,

According to the latest statistics I?ve seen, approximately 50% of all residential purchases in China today are financed with mortgages, which are mainly provided by the big state banks.  That?s a sharp increase from just a few years ago, when nearly all such purchases were made in cash.  In theory, the rules allow 30-year mortgages, but anything longer than 20 years is rare, and the presence of high prepayment penalties tend to push buyers towards mortgages with even shorter terms (our own mortgage was, believe it or not, 3 years, which is more like an instalment plan!).

A lot of residential real estate transactions in China are made in cash!

Secondly, the secondary market for residential real estate in China is extremely weak. As Patrick Chovanec wrote here,

What we see in China, though, is an extremely weak secondary market.  In the U.S., the ratio of secondary to primary residential property transactions for the first half of 2009 was 13.45; in Hong Kong it was 7.25.  In China as a whole, that ratio was 0.26 (four times as many new home purchases as secondary sales).  Even in China?s most developed markets the ratios were just 1.30 for Beijing, 1.56 for Shanghai, and 1.35 for Shenzhen.

If you combine these two characteristics together, you can conclude that a lot of real estate purchases in China are made with relatively little borrowing (or none at all) on brand new homes. As a result, the Chinese are, as Patrick Chovanec wrote,

? in that sense, the people using real estate as a store of value, a place to stash their cash?

That explains why there is a lot of idle and empty apartments in China as more and more of them are being built by property developers.

But the fact there is relatively little consumer leverage in the Chinese property market does not mean that there?s little leverage in the property sector. In China, the leverage is placed on the shoulders of property developers. In other words, the Chinese property ?investors? are de-leveraging the developers!

Now, what if the Chinese government succeeded (whether accidentally or deliberately) in smashing the store-of-value function of property? We will go into that in the next article. Keep in tune!