Posts Tagged ‘Jimmy Rogers’

Serious vulnerability in the Australian banking system

Sunday, May 23rd, 2010

Last week, we witnessed one of the most rapid falls on the Australian dollar (AUD). In a matter of a couple of weeks, the AUD fell around $0.10 relative to the US dollar (to a low of above US$0.80).

There were many reasons offered for this rapid depreciation- one of them blames the Rudd government?s resource super-profit tax (see Why Rudd?s mining super-profit tax will encourage more commodity speculation). In reality, there?s probably no specific reasons why AUD fell so quickly for this specific instance. As we wrote in our report, How To Foolproof Yourself Against Salesmen & Media Bias, the desire to pin-point a specific reason is part of the human trait of falling for the narrative fallacy. The simplest explanation laid the blame on ?hedge funds? and ?speculators.?

In any case, in the minds of most lay-people, the AUD is seen as a barometer for the health of the Australian economy. If the AUD goes into a free-fall, many people will see it as a sign that the Australian economy is in trouble. Conversely, if the AUD appreciates strongly, it is seen as a sign of a ?strong? economy. In reality, the foundations for the strength/weakness of the economy has been set long before the currency appreciate/depreciate. Nowadays, with the rise of lightening-speed money, the currency exchange rate is more as a result of capital inflows/outflows from money shuffling and less as a result of the fundamentals of the economy.

For Australia, we are getting more and more nervous about a currency crisis someday (see Will there be an AUD currency crisis?). Jimmy Rogers concurs with our worry. As he said in a recent interview,

If the Australian economy keeps taking on debt, the next time there’s a bear market, the Australian dollar will collapse. And he sees a bleak future for any currency backed by massive debts. Top of his list of bad currencies is the once mighty greenback.


The only disappointment I’ve had is that your politicians are as bad as the ones in America. If the Australian government keeps running up such gigantic debts, the lucky country is going to run out of luck.

However, he reiterates his belief Australia will not be prepared for the next economic shock and for a commodities bear market if it keeps taking on debt.

One thing you have to note is that Jimmy Rogers is probably not talking about Australia?s government debt. Relative to basket case countries like US, UK, Japan and the PIIGS in Europe, Australia?s government debt is tiny. The problem for Australia is its private debt, which is reflected in the foreign debt. As long as foreigners wants to invest in Australia, it will be fine. But the moment foreigners change their mind, Australia will be in trouble (a crashing AUD will be one of the symptoms).

We believe Australia has a serious structural problem that can easily turn this lucky country into an unlucky country very quickly. Recently, we saw this presentation (that explains the problem) making its round around web sites:

How to Profit From the Coming Aussie Property Crash (and Banking Crisis)

Please note that we:

  1. Are not making any investment advice based on this presentation.
  2. Are not making any predictions based on this presentation (see Failure to understand Black Swan leads to fallacious thinking to understand what we mean).

There?s one point made in this presentation that we have not covered in this blog- there are AU$13 TRILLION worth of off-balance sheet liabilities in Australia?s banking system (you can see the figure yourself from the link to RBA?s web site). Inquiring minds should be asking questions about what these liabilities are all about. Does the Australian regulators and central bank (and perhaps the banks themselves) fully understand what sort of hidden risks the Australian economy is subjected to from these ?off-balance sheet? liabilities?

For us, the basic point to take away from this presentation is that:

  1. There is a serious vulnerability in Australia?s banking system.
  2. This vulnerability is simply too colossal to be bailed out by the Australian government (hence the threat to the AUD).

We are not trying to scare anyone here. But these are the sorts of questions investors have to ask.

What is the key risk faced by China (according to Jimmy Rogers)?

Friday, February 5th, 2010

Jimmy Rogers is a well-known long-term bull on China. He saw the potential of China long before the mainstream investment community even had China on its radar. Therefore, we can presume that he had already invested in China since very long time ago (say, 20 years ago perhaps??).

If you have already invested in China that long ago, the value of your investments would already have grown gigantically by today. In addition, if you hold a really long-term view on China, it does not make sense to sell your long-term investments on China (that you’ve made, say 20 years ago) unless your long-term view on China turns negative. Thus, from this perspective, any talk about impending major economic correction (see Is the Chinese economy a house of cards?) in China should not perturb you too much. On the other hand, if your investments in China are made just a few years ago, you would have missed out a lot on the way up. Consequently, you will be more concerned about any looming down-draft in the Chinese economy.

Jimmy Rogers, in a recent interview, said that he is not worried about any potential “economic hardships, civil wars and even wars” in China. He then told his listeners to look at America in the 19th century, when there were “15 Deflation, a civil war, lots of economic problems, no human rights, riots in the streets and massacres.” Yet “America emerged and became the most successful country in the 20th century.” In his opinion, all these are ‘temporary’ problems that countries can recover from.

But let’s play the devil’s advocate here. These problems are ‘temporary’ in the bigger picture that can span many decades. They can easily last beyond an investor’s lifetime. You will only adopt Roger’s view if your investment horizon is so long that you’re investing no just for yourself, but for the next generation too.

But there’s one potential problem in China that Jimmy Rogers believes will alter his long-term views on that country.


Cities, societies, nations disappear because the “water disappears.” Indeed, China has a serious water problem, especially in the north. To date, China had spent “hundred of billions of dollars” trying to solve their water problem. In other words, if the Chinese does not solve their water, then the “China story is over.” From this, we can tell that Jimmy Rogers is probably influenced by this book, Collapse: How Societies Choose to Fail or Succeed. As that book argues, throughout history, environmental crisis are often the catalysts for the collapse of complex societies all over the world.

So, in future, we will look at water problems from an investor’s perspective.

Is the coming ‘crash’ in China not a real crash?

Thursday, January 14th, 2010

By now, you would have known that we have grave reservations on the quality of China’s post-GFC economic rebound. We are not alone in our reservations as there are many experts, both in the mainstream and non-mainstream media who share our view. But there are also many others who seems to hold the opposite view, including Jimmy Rogers.

For those who are looking for answers, all we can say is that China is very difficult to read. It is a country with many mirrors. When we Westerners try to interpret China through a Western lens, culture and context, we may end up misinterpreting, misunderstanding and missing the subtleties of China.

Economic data from China is something that investors should not swallow entirely without question as no one knows how accurate they are or how much of them are made up. As data flow from the bottom to the top layers of the vast Chinese bureaucracy, from the local government to the provincial government and finally to the central government, we wonder how much of the information are lost, misinterpreted, fudged, revised, falsified, misrepresented, hidden and added? Or perhaps we are too cynical?

But if you hold the view that a a big economic correction is coming to China and wants to ‘short’ the country, you have to be aware of what you are betting against. First, you are betting on deflation in China, symptoms of which include falling asset prices, rising unemployment and bankruptcies. Governments, on the other hand, would prefer to err on the side of inflation. When you have an authoritarian government that can make and change the rules, you can be sure that they will draw out the big guns to fight against deflation. For example, what if a trade war threatens to do serious harm to the Chinese economy and social stability? We wouldn’t be surprised if the Chinese government whips out nationalistic sentiments, point the finger at the nations that started the trade war and in the extreme case, start a shooting war. According to Marc Faber, he reckoned that the same would apply to the US too.

But let’s not get too carried away with expecting an almighty economic ‘crash’ in China Let’s play the devil’s advocate for now and examine the reasons why Jim Chanos (the guy who publicly wants to ‘short’ China) may be wrong.

As a whole, China is not too leveraged (unlike countries like Australia, US and UK). The people in major cities (especially Shanghai and Beijing) are highly leveraged and share many similarities with highly indebted Australians and Americans. For example, the housing bubble in Shanghai is much bubblier than the one in Australia. Credit card habits of the city young adults are just as bad as their Western counterparts. Since the financial system in China are still very much primitive compared to countries like Australia, US and UK (the financial sector in those countries are probably too big), the debt disease have yet to reach everyone in China, especially the hundreds of millions of rural peasants.

At the same time, the rich-poor gap in China is much wider than in Australia. For example, there are still hundreds of millions of poor peasants living in under-developed or undeveloped rural areas. Large swathes of China have yet to develop and catch up with the affluence of the coastal cities. A deflationary crash will affect the highly indebted city folks much more than the rural peasants. Since the fruits of China’s economic boom have largely bypassed the latter, they will hardly miss the loss of wealth due to an economic correction because they have not gained much in the first place. Whether boom or bust, these people will still go about their business everyday.

Deflation, in fact, will benefit those on the poor side of the rich-poor divide. The economic boom has a very detrimental effect on them as the price inflationary effects actually made them poorer (we heard stories of migrant workers in Shanghai who are too poor to even buy food). Deflation re-distributes wealth to these people. Currently, the Chinese government is in the process of developing the poorer regions in China. That, plus deflation may re-distribute economic resources and activities to those areas. For example, those same migrants workers who are too poor to buy food in Shanghai may want to return to their home villages because of better opportunities (from government development) and better standards of living (food are probably cheaper and affordable there).

If this theory is correct, it means that a ‘crash’ in China should not be interpreted in the same way as a crash in Australia, Japan or the US. In the Western world (including Japan), an economic crash means that the standard of living for everyone in general will decline. For China, because of its relatively wider rich-poor gap, it may just be a wealth re-distribution exercise in which some will be better off and some will be worse off. On paper, a Chinese ‘crash’ is bad in terms of GDP growth and demand for resources. But socially, it may not be such a bad thing as it may be China back into a more sustainable growth path.

That could be the reason why people like Jimmy Rogers are still optimistic on China. Investors like him are probably not investing their capital on the frothy affluent cities. Instead, he is probably investing in sectors of the Chinese economy that will still be humming along and going about their business even when the ‘crash’ hits the economy. Unfortunately for many investors, the ‘China’ that their investments are in will probably not survive the ‘crash.’

Are government interventions the first steps towards corruption & inefficiencies?

Tuesday, January 27th, 2009

The global financial crisis (GFC) has seen governments all over the world engaging in stimulus, special plans, guarantees, rescues, bailouts, nationalisation and other forms of interventions. The Australian government is no different. The first was the guarantee of all Australian bank deposits and loans. Next was the AU$10 billion economic stimulus. Then recently, there was a plan to set up a special purpose fund to help banks refinance as much as AU$75 billion worth of loans. Other plans include help for certain industries (e.g. car, construction, child-care, property sectors) cope with the global shortage of money (credit crisis). In addition, the Reserve Bank of Australia (RBA) is busy cutting interest rates. In the US and Britain, massive banks and GSEs were gobbled up through nationalisations while their limping peers have their incompetence covered by the monetary printing press. As Australia approaches a hard landing (see Realisation of hard landing ahead for Australia), we can expect what happened overseas to happen in Australia.

Among the various forms of government interventions, we have the strongest reservations against bailouts and rescues. While they ease the pain in the short term, they are detrimental to the economy in the long term. While the sting of this GFC may be soothed by each government intervention, there will always be longer term side-effects, many of which will be unintended and initially unforeseen. All these unintended side-effects will eventually accumulate and turn the GFC into a long-term economic malaise that result in a bleak future for the next generation. In other words, anyone who is concerned for the next generation will have strong reservations for today’s bailouts and rescues.

Here are some of the issues with bailouts and rescues:


They are inherently unfair because the government will have to act as the judge and decide which businesses/industries should live and which ones should die. Unfairness, by its very nature, implies preferential treatment. What is the government’s basis for favouring one business/industry over the other? Due to the ’emergency’ nature of bailouts and rescues, transparency over such government decisions will be in short supply. This will open the door for corruption as lobby groups and vested interests jostle and fight over the government’s preferential treatment. This is not to say that the current government is corrupt. Instead, our concern is that this will open the door for future governments to be corrupt.

Moral hazards

Bailouts and rescues introduce moral hazards because by not letting the free market punish incompetent, reckless and stupid business behaviours, they are making conditions ripe for more of such nonsense to continue. After all, why bother be good when bad behaviours are not punished?

The whole point of free market capitalism is to let the incompetent businesses be eliminated so that the competent ones can take over the incompetent ones and be rewarded. This competition forces the survival of the fittest and most efficient. By bailing out and rescuing, the government is taking precious economic resources (which is scarce in such a time) from the competent (via taxes) and awarding them to the incompetent. The net result is that the economy as a whole will become more and more inefficient. This is precisely the reason why communism ultimately fails.

Now, there are talks of the need for more government regulations to curb such nonsense in order to prevent future financial crisis. The idea is to bailout and rescue first, then come up with more rules and regulations to ‘prevent’ another global financial hazard from happening again.

The problems with rules and regulations are:

  1. Administering, monitoring and enforcing them are costly. They are a drag on economic growth as they introduce more red tape for businesses to handle.
  2. Rules and regulations may be so effective that while they prevent the bad things from happening, they cab also stifle the good things from bearing fruit too. Those entrepreneurs with brilliant ideas who have to battle government red tape to get their projects moving another step forward can relate to that.
  3. As we said before in Where do we go from here? A journalist?s questions…,

    … at the root of this Global Financial Crisis (GFC) lies the moral failure of humanity. Through this moral failure, the world is allowed to get carried away and believe in what it wants to believe.

    Rules and regulations can only work up to a certain extent because beyond that, it is impossible to legislate morality.

  4. No matter how tight and comprehensive rules and regulations are, there will always be loopholes and gaps to allow circumvention. For example, as Satyajit Das revealed in his book Traders, Guns & Money, derivatives routinely make a mockery out of laws. It has come to a point that poking holes at the legal system via derivatives has become a sport!

As we quoted Jimmy Rogers in Jimmy Rogers: ?Abolish the Fed?,

More regulations? You want Alan Greenspan and Ben Bernanke? These are the guys who got us into this situation. They are supposed to be regulating the banking system for the past 50 years. These are the guys who let it all happen. I don?t want more regulations. Let the market regulate it. If xyz needs to go bankrupt, let them go bankrupt. I promise you, that will send a very straight signal and you will have a lot of self-regulation when these guys start to go bankrupt.

If the Federal Reserve did not bail out LTCM in 1998 and let it go bankrupt instead, it would have sent a very strong signal to the market back then.


One day, the GFC will end. But this generation will leave a legacy of corruption and inefficiency for the next if today’s governments continue to intervene in such an unprecedented scale.

Is the Warren Buffett way dead?

Tuesday, December 9th, 2008

In a recent interview with Marc Faber, he said that

I think The Warren Buffett approach is dead, and it?s been dead for ten years, and it?s going to be dead for another ten years.

This statement lies in the context of extreme market volatility described in our earlier article, Real economy suffers while financial markets stuff around with prices,

Right now, deflationary forces are acting on the economy while at the same time, central bankers and governments are attempting to inflate. Consequently, the result is extreme volatility in prices.

In Marc Faber’s latest Gloom, Boom & Doom report, he wrote

In the next few years I expect asset markets to favor aggressive traders and not long term investors…

In my life I experienced two major trading markets (1968 – 1982) and Japan post 1992 (see Figure 9). I can assure my readers that during these trading market conditions (no net gain for the indices and in the case of Japan new lows) hardly anyone except very smart (lucky) traders made any money.

Above I tried to show the existing connectivity between global liquidity (coming from the US current account deficit), asset markets, and currency movements. To navigate successfully between all these volatile and often unpredictable market movements you need to be a genius. And whereas I am sure that my readers are all above average investors (80% of investors think they are above average investors), I am not and, therefore, in very volatile periods I try to avoid losses and look for a safe heaven such as physical gold…

In the global stock, commodity, forex, bonds and credit markets, prices are very volatile and unstable. The sudden price deflation of commodities over the past few months caught many by surprise. What’s surprising is not just the fact that prices declined. The speed of price collapse is the phenomena that shocked many investors (even Jimmy Rogers admitted to not expecting that). It was only not long ago that oil was US$147 and the Aussie dollar close to parity with the US dollar. A 70% fall in oil prices in just a few months was something that we did not anticipate too.

In the real economy, many businesses, especially the resource companies, will fail because of this unexpected surprise. Therefore, the effects of such price volatility are still yet to be permeated to the rest of the economy.

Coming back to value investing, one of its root activity is business calculation. But if prices are unstable and unpredictable due to monetary deflation/inflation, this root activity cannot be performed reliably. As we said before in How is inflation sabotaging our ability to measure the value of things?,

If you want to measure the length of a box, you may use the ruler to do it. The reason why a ruler can do such a job is because its length is reasonably consistent for the foreseeable future. Now, imagine that ruler is as elastic as a rubber band. Do you think it is still a useful tool to measure the length of the box? An elastic ruler is useless because you can always make up the measurement of the box to whatever you please just by stretching the ruler such that the edge of the box is aligned to any intended measurement markings in the ruler.

Now, let come back to measuring the value of oil. Since oil is priced in US dollars and if the supply of US dollars can be expanded and contracted, how useful do you think it is as a calibration for measuring the value of oil?

If business calculations cannot be performed reliably, then business valuation cannot be ascertained reliably too. Without a reliable business valuation, long-term buy-and-hold value investors are investing in the dark.

That’s the dilemma facing value investors right now.

Is this the beginning of the loss of confidence in fiat money?

Sunday, September 21st, 2008

Events from the past week are tumultuous. It started from the nationalisation of Freddie and Fannie (we were mulling about the implication of nationalisation 2 months ago in How do we all pay for the bailout of Fannie Mae and Freddie Mac?). Then came the bankruptcy of Lehman Brothers and takeover of Merrill Lynch. Then we have the nationalisation of AIG. Gold prices surged by more than US$100 in two days (it had declined since), which was the most rapid surge in 26 years. At the same time, the Dow plunged by more than 400 points. It looked as if there was a panic from stocks straight to gold, which meant even cash was distrusted.

Then we have another massive rally in stocks for the past two days when there was hope that the US government, in conjunction with the Federal Reserve are doing something to solve the root of the rot in the financial system. Reports come out that they are planning to use taxpayers’ money to buy up bad assets at sale price. As always the case, the devil is in the details. At this point in time, there is no definitive figure on the cost. Make no mistake about this: this is no trivial task. As this New York Times article reported, Ben Bernanke warned the Congressional leaders,

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program ?Good Morning America,? the congressional leaders were told ?that we?re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.?

Mr. Schumer added, ?History was sort of hanging over it, like this was a moment.?

When Mr. Schumer described the meeting as ?somber,? Mr. Dodd cut in. ?Somber doesn?t begin to justify the words,? he said. ?We have never heard language like this.?

By now, it should be clear that this global financial disaster has the potential of even surpassing the Great Depression of the 1930s!

Is this crisis a surprise? If you listen to the mainstream economic schools of thought, central bankers, mainstream financial media, captains of the financial industry and so on, it looked as if this looming financial disaster is something that no one can see coming. The common underlying excuse (that was un-said, un-written but implied) goes something like this: “No one could ever foresee this! It’s impossible! Only hindsight can tell!”

Now, we would like to make it clear that this is completely false. Please note that we are not accusing individuals of lying. Instead, our point is that this excuse is a sign of collective mass delusion. If you look at the 6000 years worth of the history of human civilisation, you will find that humanity is repeatedly capable of mass delusions. Always, only the minority could see through the lie. In this case, students and practitioners of the non-mainstream Austrian School of economic thought SAW IT COMING. Some of them sounded the alarm as early as 2004! To press our point further, let’s us show you the chronicle of our warnings in this blog since 2006…

  1. In May 2008, when the world was in denial about the precarious state of the global financial system, Satyajit Das warned that the credit crisis was just the end of the beginning (see Is the credit crisis the end of the beginning?).
  2. Back in November 2007, if you look at the list of major US financial institutions that was compiled by Nouriel Roubini at How solvent are some of the major US financial institutions?, only half of them are left standing. Interestingly, Merrill Lynch was the safest among the insolvents and today, it failed to live. If Merrill Lynch was insolvent, what about the remaining ones today (i.e. Goldman Sachs, Morgan Stanley, Citigroup)?
  3. In June 2007, in Epic, unprecedented inflation, we warned that

    How much longer will the roaring global economy fly? We do not know the answer, for this boom may last longer than what we anticipated. However, please note that in the entire history of humanity, all bubbles (and we repeat, ALL) burst in the end. Thus, a global painful hangover will ensue?the greater the boom, the more painful the eventual bust. This is the theme that we had repeated many times.

    Thus, do not be surprised if a second Great Depression were to strike.

  4. In the same month, the Bank for International Settlements (BIS) warned that the world was in danger of another Great Depression (see Bank for International Settlements warns of another Great Depression).
  5. Back in January 2007, in Spectre of deflation, we wrote that

    But we smell danger.

    It is a danger in which many in the finance industry failed to fully appreciate?deflation. Such complacency is beyond our belief. In the 1990s, Japan experienced it, with dire consequences for their economy. At least, the ordinary Japanese had their savings to fall back on. For many Americans, with their negative savings rate, what can they fall back on? Have they not learned from the mistakes of others in the past?

  6. In the same month, Trichet, the president of EU central bank warned of a coming asset re-pricing (see Prepare for asset repricing, warns Trichet).
  7. Back in November 2006, in How will asset-driven ?growth? eventually harm the economy?, when the global economy was still booming in apparent ‘prosperity’, we quoted the late Ludwig von Mises (the in which the Mises Institute of the libertarian Austrian School of economic thought is named after) and warned that

    That collective error in judgement resulted in the economy misallocating scarce resources into housing sector?in the case of the US, a significant proportion of the jobs created during the asset-driven ?growth? was related (both directly and indirectly) to the housing boom. Since economic resources are always scarce, any misallocation of it implies an opportunity cost on the other sectors of the economy. The result is a structural damage to the economy that can only be corrected through a recession.

    This is the reason why we believe a recession is on its way.

  8. In October 2006, we quoted the late Dr. Kurt Richebächer (an Austrian School economist) and questioned in The Bubble Economy,
  9. These are some of the serious questions we would like to ask:

    1. As the US spends its way into economic ruin, its economy is being damaged structurally. How much longer can the US sustain its colossal debt?
    2. Right now, the US housing bubble is deflating. Will it eventually burst and wreck havoc on the rest of the economy?

Other contrarians who sounded the alarm long ago (and we quoted often) include Marc Faber, Jimmy Rogers, Robert Shiller, Peter Bernstein, Nouriel Roubini and our local Aussie economist, Professor Steve Keen.

Our readers should, by now, appreciate the colossal magnitude of this financial crisis. When you listen the media, the phrase “since the Great Depression” is often mentioned. Make no mistake about this, this has the potential to be worse than the Great Depression (note: we are NOT predicting that it will happen).

The world’s stock market is rallying in the hope that the US government’s plan to nationalise the financial industry will be successful in stopping the core of the rot. New legislations has to be rushed through Congress by the end of next week to change the rules to make the plan legal. As in everything done in haste, we believe there will not be enough thought put into them to understand the long-term ramifications. It is probable that once the changes are in place, they will not be revisited again.

As we warned in Recipe for hyperinflation,

There is no way any politician can sell the message that America needs a severe recession (or even a depression) to cleanse the economy from the gross excesses, imbalances, blunders and mal-investments. Thus, it is very likely that they will have to fight deflation till the very bitter end, till the last drop of blood from their last soldier. Since the current structure of ?rules? will be too restrictive in such a war against deflation, there will be popular momentum towards the bending and rolling back of these ?rules.? If they press on relentlessly till the final end, there can only be one outcome: the US dollar will be joining the long list of failed fiat paper money in the annals of human civilisation.

What is the meaning of ?oversold?? Part 2: Value perspective

Tuesday, September 16th, 2008

Continuing from our previous article, What is the meaning of ?oversold?? Part 1: Technical analysis perspective, we will explain the meaning of “oversold” from the value-investing perspective.

In Are some Aussie resource stocks oversold?, Pete, our regular reader commented that,

So on one hand, if demand is the same, then they are oversold, but on the other hand, if demand is decreasing, then even though they are currently oversold, the current oversold price may become a nominal price in the near future?
Eg: BHP shares may be worth $40 now, but trade at $35 or so. But due to lack of demand, by December, they may only be ‘worth’ $35. Although by then my guess is that they would be oversold even more to $30, etc.

On that note, when we say the resource stocks might be oversold, is it perhaps a bit like real-estate, where they are in fact not oversold at their current prices, but were in fact ‘over-bought’ in the first place, and are now returning to more normal levels? Perhaps they are still overbought now, just less so?

Before you read on further, please make sure that you understand the concept of value investing in our guide, Value investing for dummies. Particularly, pay attention to the first 4 articles. What follows will assume the pre-requisite understanding of these articles in the guide.

The important things to understand about the mining business is this:

  1. It’s revenue is very much dependent on the price of the commodities it sells (this is a very obvious point).
  2. It’s a price taker in general. In other words, most mining businesses do not have the market power to affect prices. The exception will be BHP and Rio Tinto as they have enough market power to affect the price of iron.
  3. It’s products (e.g. copper, zinc) is relatively very much un-differentiable from those of their competitors unlike the more traditional businesses.
  4. A mining business do not have an theoretical infinite life as some other traditional businesses. That is because ALL mines have a finite amount of the commodity that can be economically extracted. In other words, there is a finite life to every mine/oil/gas field at a specific rate of extraction.

The problem is, the future earnings of a mining company is notoriously difficult to predict. For example, these factors will affect the future earnings:

  1. Commodity prices (that’s obvious point).
  2. Cost of its input (energy is one of the major inputs and that in itself is a commodity whose prices are at the mercy of the markets).
  3. Exchange rate. Since commodity prices are denominated in US dollars, an Australian mining business’s earnings will be dependent on the exchange rate.
  4. The future quantity of the commodities it will produce. Obviously, profits rise when the sale price increases or the quantity of the produce increases. That will depend on the outcome of the development and exploration projects of the mining business.

Within point (1) i.e. the commodity price, there are many factors that will have impact on it:

  1. Underlying demand- this is the real physical demand of the commodity needed by people and nations.
  2. Investment demand or hoarding- This is the second type of demand in which the buyers and sellers do not have interests in the physical commodity. Instead, they trade the commodity in the context of money shuffling.
  3. Physical supply of the commodity- for example, as commodity prices collapses, some mines become uneconomical and close down as a result. This will reduce the supply of commodity produced. Other supply disruptions include strikes, natural disasters and so on. Or there may be new mining projects that start to produce and increase the supply to the market.

Now, let us look at point (1) and (2) that affects the price of commodities. As we explained before in Analysing recent falls in oil prices?real vs investment demand,

Now, let?s go back to oil. What makes up the demand for oil? There are basically two types of demand for oil: (1) The physical demand where the real side of the economy uses for its everyday needs and (2) The investment demand where the financial side of the economy shifts the money here and there from one asset class to the other. We need to ask ourselves the following question: Has the physical demand for oil changed? Will it change in the long run?

In today’s globalised financial system, the investment demand (we like to call it “hoarding” instead) has increasingly significant impact on prices. To complicate the issue, it is very difficult (or impossible, depending on your theoretical inclination) to sift between investment demand and physical demand as the commodity trades are made through complex web of intermediaries and relationships. As we questioned in Price fluctuations and hoarding

In today?s context, does a sudden fall in the price of a commodity (e.g. oil, iron, grain, wheat) mean that its underlying demand has suddenly fallen or its supply has suddenly increased? Obviously, the answer is no.

Let’s say that prices were originally too high because of the artificial demand from investment (or rather, hoarding). Now that the de-leveraging process (see Is the credit crisis the end of the beginning?) is under way, forced liquidation and flight from commodities from these investors/hoarders will send prices down very rapidly. As the change in physical demand/supply of commodities tend to move very much slower (relatively) than the change in investment demand/supply, we believe that this forced selling will tend to cause prices to undershoot (i.e. drop to too low) in the short term.

Now, consider this: as price falls by a lot all of a sudden (due to the sell-off by investors/hoarders), guess what will happen to the physical demand? Obviously, physical demand will increase. To a certain extent, this sell-off will result in a change in the composition of demand (between physical and investment demands). If the miners can increase production in response to increased demand, this will counteract the negative effects of falling prices on profits.

Next, as we mentioned before in Are some Aussie resource stocks oversold?, although commodity prices are falling in US dollars, it has not fallen as much in Aussie dollars.

Another consideration: as investors/hoarders sell commodities indiscriminately, the prices get undershoot. The stock market tends to overreact and price the business as if the prices of commodities will fall even further as rapidly as before. That is, it extrapolates the direction and speed of further commodity price falls too far out. It also tends to ignore the positive counteracting effects on profits as well (e.g. increased physical demand and falling Aussie exchange rate). Now, we will have a second ‘layer’ of price undershooting.

Finally, we will provide a qualifier: it is still possible for commodity prices to fall further in say, 2009 and 2010. But assuming that:

  1. Central bankers will eventually resort to money printing (see Understanding the big picture in the inflation-deflation debate) in the context of…
  2. long-run growth in Chinese and Indian demand (see Are we in a long-term inflationary environment?) and
  3. Physical demand will not collapse as much and as suddenly in the longer term as the short-term prices seem to suggests, …

… we believe that the long-run earnings of some mining businesses may not be as devastating as what their stock prices suggests. If these resource stock prices continue to plunge further, it will come to a point that it will be priced as if there will be a devastating world-wide Greater Deflationary Depression along with perpetual Chinese/Indian anarchy/revolution/chaos.

But having said that, remember that as we said before, all mines/oil/gas fields have a finite life. In the absence of potential new production from future exploration and mining development projects, a mining business will cease after an estimated number of years, after the supply of commodities are being exhausted. The implication is that if the downturn is severe and long enough, some mining businesses may not last long enough to be able to realise the value of the long-term inflationary trend of commodities. On the other hand, a mining business may choose to ‘extend’ the life of its mines by hibernating (e.g. laying off workers, entering maintenance mode and doing nothing) and waking up when commodity prices are more favourable for production.

A warning though: we are not suggesting that you go out and throw all your entire life-savings into any resource stocks now. Not all resource stocks are undervalued right now. And there is still scope for further commodity price deflation in 2009 and 2010. You have to do your homework and look at each company on a case-by-case basis. Even then, after you have decided which stock to buy, you still have to decide at what price you think it is a bargain. Even then, you still have to decide when to buy. And yet even then, this does not mean that stock prices will not fall further.

We will finish this article with an interesting quote on Jimmy Rogers (see Jim Rogers Talks About Latest Investment Activity) for you to think about:

The bull market [in oil] will not end until somebody finds a lot of oil, or unless we have worldwide economic collapse, perpetual economic collapse…

I will tell you I’ve not sold any oil. Even if it goes to $75, I don’t plan to sell any oil.

Do NOT see it as a recommendation for oil or oil stocks (note that Jimmy Rogers has an interest in oil). Rather, see it as window to his line of thinking.

Falling currency and inflation

Monday, September 1st, 2008

Back in February this year, while the US dollar was still in a downward trend, Jimmy Rogers made a scathing remark about Ben Bernanke here:

We know now he doesn?t even know about economics. I mean, he?s got a PhD in economics and he was a professor of economics, but he doesn?t have a clue about economics.

I will quote you – I hate to quote you, but one more time – I was watching him testify before congress and I almost fell out of my chair. He said under oath, so we presume he wasn?t lying, that he was just a fool, he said if an American only buys American products, it does not matter to him if the value of the U.S. dollar goes down. He will not be affected. I was looking at the man to see if he was lying, giving government propaganda, but then I could see he didn?t even really understand.

He didn?t understand if, you know, even if say I?m an American, Lindsay, and I only buy American tires. Well if the price of foreign tires goes up, obviously the price of American tires are going to go up too. Plus, if the dollar goes down, the price of rubber?s going to go higher, etcetera, etcetera, etcetera.

So the man doesn?t even understand economics. He?s going to print money. He?s going to throw money out the window. The dollar?s going to go down further and further and further. Inflation?s going to get worse and worse and worse throughout the world – the world, not just America – and we?re going to have a worse recession in the end.

What happened was that Ben Bernanke swore under oath that a falling US dollar would not hurt Americans as long as they buy only American products. But as we explained before in Is the falling dollar good for the economy?, a falling domestic currency will result in a

… divergence between the internal and external value of the dollar. Since in the short term, the domestic economy cannot increase its production, effect (1) will be the result.

Since the American economy is very much dependent on imports, a fall in the US dollar will result in an increase in demand for American-produced goods. Without increased capacity in the short-term, this will almost certainly result in price inflation.

Now, we will look at the context of Australia, which is another import-dependent country. A rapid depreciation of the Aussie dollar will result in rising price inflation for the same reasons stated above. To make matters worse, the Australian economy is already at full productive capacity, due to reasons that include full (or almost full) employment, inadequate infrastructure, skills shortage and so on. Therefore, in order to take advantage of the increased demands for Australia’s commodities in the longer term, there will be a need for a restructuring of the Australian economy. As we explained in Is the falling dollar good for the economy?,

This means a restructuring of the economy whereby some industries will have to decline in order for the export industry to expand. This is effect (2).

The restructuring process is where the pain lies. It is a time where certain industries decline, unemployment rises and people returning to university and TAFE to retool and retrain on other skills and professions. The problem with Australia is that with far too many people and businesses filled with too much debt, such restructuring process can be too painful to be contemplated.

Rolling back the rules against money printing

Thursday, July 17th, 2008

Yesterday, we discussed about the importance of central banks being independent from the government in Why should central banks be independent from the government?. In particular, we mentioned that

Our fear is that with this credit crisis worsening by the day, deflation may prove such a unthinkable threat (e.g. see How do we all pay for the bailout of Fannie Mae and Freddie Mac?) that the government will ?roll back? all these rules one by one in order to keep the entire financial system solvent. As the ancient Chinese saying goes, the journey of a thousand mile begins with the first step. Therefore, the journey towards a hyperinflation hell will begin with such measures (see Recipe for hyperinflation).

Incidentally, Jimmy Rogers said in a video interview, Rogers Calls Fannie, Freddie Rescue Plan a `Disaster’ that

This is a disaster for America. This is a disaster for the world. Ben Bernanke and Paulson are bailing out their friends on Wall Street, but there are 300 million of us Americans who are going to have to pay for this and there are six billion people in the world who are going to have to pay for this. And they are doing it with no authorization from anybody.

Paul Volcker said a couple of weeks ago that perhaps what the Federal Reserve has done is illegal. I would submit it is illegal what they have done and what they are doing. They are saddling all of us with hundreds of billions of dollars of debt that they have no authorization to do.

We are no legal experts here and thus, we have no say on the legality of what the Federal Reserve and Treasury is doing (or about to do). But we are confident of this: IF this is illegal, then emergency laws will be passed to legalise them. As we said before in Recipe for hyperinflation,

Now, imagine that those above-mentioned ?rules? are being relaxed such that the government can order the central bank to bail out everyone and every business that is financially insolvent by giving them freshly printed money. Overnight, this will solve the problem of bad debts and we will not have any credit crisis to worry about. Everyone will be happy right?

Indeed, Wall Street may be happy, but the rest of us will not be. As Marc Faber said in this video interview,

Let?s say if I?m a manufacturer and I?m a bad businessman and I go out of business, who?s going to help me? But Bear Stearns and the Wall Street elite because they?re tied into the Treasury and the Federal Reserve and they lunch together, it?s a club… and they?re bailed out. I mean it?s a joke.

It is no coincidence that the world is facing accelerating inflationary problems (see Who is to blame for surging food and oil prices?).

What should the RBA do?

Monday, June 23rd, 2008

Yesterday, our article What is a crack-up boom?, resulted in many interesting responses and questions from our readers. Each of these questions requires very long and thoughtful response. Therefore, we will slowly answer each question chronologically one at a time. If we have not answered all your questions today, please be assured that we will do so in the days to come. The answers come in a first-come-first serve basis.

Today’s article will answer this question:

Do you think that the RBA is doing the right thing then? It has raised interest rates, although it has also bailed out financial institutions.

Let’s start off with what we would do if we were the RBA (and the Federal Reserve). Not only would we raise interest rates, we would have done so very early to prick the emerging asset price bubble right at the start. So, why didn’t the RBA do that? As Ian Macfarlane, the former head of the RBA, said here,

Many people have pointed out that it is difficult to identify a bubble in its early stages, and this is true. But even if we can identify an emerging bubble, it may still be extremely difficult for a central bank to act against it, for two reasons.

First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in one sector, for example, house prices, the whole economy is affected. If confidence is especially high in the booming sector, it may at first not be much affected by the higher interest rates, but the rest of the economy may be.

Second, there is a bigger issue which concerns the mandate that central banks have been given. There is now widespread acceptance that central banks have been delegated the task of preventing a resurgence of inflation, but nowhere to my knowledge have they been delegated the task of preventing large rises in asset prices which many people would view as rises in the keeping of his wealth. Thus if they were to take on this additional role, they would face a formidable task in convincing the public of the need.

The last sentence is where the problem lies. The masses have not given the RBA the mandate to spoil the asset price inflation party. Although, Ian Macfarlane acknowledged that asset price bubbles can be very dangerous for the economy, his hands were tied. Elsewhere, Coalition opposition politicians were toeing the populist line by demanding that Glen Stevens (the current head of the RBA) be grilled more frequently in order to pressure him against hiking interest rates.

The next question is: should the RBA raise interest rates aggressively now? University of Western Sydney Professor Steve Keen reckoned that it is too late to do so now. His reasoning is because at this point in time, deflation is the greater danger and that inflation, though also an evil, should be left alone for now. We believe his view is that when debt deflation takes hold, it will drag consumer price inflation along with it. Is he right? Well, we are right now experiencing asset price deflation plus commodity price inflation. If the RBA leave inflation alone, our fear is that the seeds of the crack up boom can eventually grow up to become a hyperinflation dragon.

Next, should the RBA bail out financial institutions? So far, they have not officially bail out one yet in the same way the Federal Reserve had bailed out Bear Stearns. But it has certainly absorbed some of the bad debt assets and provided more liquidity. Our view is best summed up by what Jimmy Rogers said in Jimmy Rogers: ?Abolish the Fed?,

If xyz needs to go bankrupt, let them go bankrupt. I promise you, that will send a very straight signal and you will have a lot of self-regulation when these guys start to go bankrupt.