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Why you have to change your idea of ‘investing’ in the coming years to come

Wednesday, February 16th, 2011

The global economy is in a diabolical dilemma right now. If the world economy is paralysed by deflation (which is Bernanke’s nightmare), prices of many things will fall. For example, as we wrote in How to buy and invest in physical gold and silver bullion,

In the second half of 2008, the world experienced unprecedented asset and commodity price deflation. As noted earlier, oil prices fell from a high of almost US$150 to just over $30 over the space of months. Base metals and agricultural commodities plunged along with a panic in the stock market. The US dollar and US Treasury bonds surged (at one point, short-term US Treasury bonds had a negative yield). Statistically (in terms of price volatility), the panic in 2008 was worse than the crashes of 1929 and 1987.

Despite the mainstream commentary screaming “Disaster,” we believe such extreme deflation wasn’t that evil in the bigger scheme of things.

Why?

If you believe that burning fossil fuels causes climate change? or that Peak Oil is one of the greatest threat to humanity, wouldn’t such extreme deflation give planet Earth an urgently needed respite? Wouldn’t the collapse of global demand for goods and services save planet Earth for the sake of the next generation? Since 2008, the world witnessed a ‘recovery’ (that was brought about by massive money printing).

But what do we get out of that ‘recovery’?

Surging price inflation that threatens the poor with starvation and pushed many from middle-class to poor.

For example, as Food prices at dangerous levels, says World Bank reported,

The World Bank says food prices are at “dangerous levels” and have pushed 44 million more people into poverty since last June.

This, our dear readers, is just the beginning of a more serious global food crisis. Australia’s CSIRO scientist, Julian Cribb wrote a very sobering book, The Coming Famine: The Global Food Crisis and What We Can Do to Avoid it. As this New York Times book review wrote,

Like many other experts, he argues that we have passed the peak of oil production, and it?s all downhill from now on. He then presents evidence that we have passed the peaks for water, fertilizer and land, and that we will all soon be made painfully aware that we have passed it for food, as wealthy nations experience shortages and rising prices, and poorer ones starve.

This is the price that the this and the next generation will have to pay if we keep up the current way of exploiting planet Earth for the sake of economic ‘growth.’ Hardly surprisingly, a recent Wikileaks revealed that Saudi Arabia cannot pump enough oil to keep a lid on prices.

Dear readers, don’t you see that this economic ‘recovery’ is an illusion?

The ultra-rich, on the other hand, have less to worry about starvation and more to worry about how to preserve the purchasing power of their existing surplus wealth. Some of them will rush to hoard agricultural land and commodities, which will exacerbate the plight of the poor.

The middle-class will see their standard of living being eroded by rising food and energy prices. As we wrote in April 2007, Smart money in alternative energy?Part 1: current energy quandary,

The most important ingredient that drives the efficiencies, comforts, automation and wonders of today?s modern way of life is energy. The trains, cars, ships and aeroplanes that transport massive quantities of people and goods over vast distances quickly require energy in the form of fuel. The heavy machines that do heavy physical work far beyond the scope of human labour require energy too. The powerful computers that process and store vast amount of data and information as well as automate mental labour requires energy in the form of electricity. The heating in winter and cooling in summer of our abode requires energy too. Take energy away and our modern way of life will very much grind to a halt and bring us back to the hard life of our ancestors. In fact, contemporary life rests on the premise of abundant and cheap energy. Therefore, whoever controls the supply and provision of energy controls power and wealth.

When energy prices go up, the prices of everything else will go up. When the prices of everything else go up, your standard of living will go down.

Some of the poor, who are already spending a large portion of their income on food, will have to starve. But before that will happen, we will witness increased incidence of revolutions, wars and conflicts. What we see in Tunisia and Egypt is just the beginning- there will be more.

Dear readers, after reading all these, wouldn’t you come to the realisation that this will have grave implications on the idea of ‘investing.’ Normally, investing is associated with ‘making’ money. But in the context of surging price inflation, ‘making’ money becomes meaningless as the value of money diminishes.

In the next article, we will talk more about this implication. In the meantime, have a think about it.

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Posted in Advertising/Affiliates, Commodities, Food, Looking Forward, Oil | 6 Comments »

Is China really the Saudi Arabia of rare earths?

Wednesday, November 3rd, 2010

It is no secret that China has a  stranglehold on rare earths. For those who are uninitiated, rare earth elements (REE) comprise 17 metallic elements with a variety of modern industrial and commercial applications ranging from petroleum refining to laptop computers to green energy applications to radar. It has been reported that China produces 95% of the world?s REE.

As a result of China?s monopoly in supplying the world?s REE, the recent alleged unofficial REE embargo against Japan had caused alarm among REE importer nations, of which Japan is the largest.

However, as investors, we have to understand clearly what China?s ?monopoly? on REE is and isn?t. Although it?s true that China has a commercial monopoly on rare earths, it does not mean that it is a real monopoly. To understand what we mean, consider this recent news article,

China has 30 percent of the world?s reserve of rare earths, but mines it cheaply and effectively. More than 90 percent of the world?s available supply is currently mined in China.

Basically, China has less than one-third of the world?s REE reserves but produces 95% of the world?s REE. Hence, do you see a problem?

REE are not as rare as their name suggests. There are plenty of REE scattered around the world. Before 1979, the US was the largest producer of REE. So, what happened? A recent report from Stratfor wrote,

The story of REE is not the story of cheap Chinese labor driving the global textile industry into the ground. Instead, it is a much more familiar story of the Chinese financial system having a global impact.

Unlike Western financial systems, where banks grant loans based on the likelihood that the loans will be repaid, the primary goal of loans in China is promoting social stability through full employment. As such, the REE industry ? like many other heavy or extractive industries ? was targeted with massive levels of subsidized loans in the mid-1980s. At the same time, local governments obtained more flexibility in encouraging growth. The result was a proliferation of small mining concerns specializing in REE. Production rates increased by an annual average of 40 percent in the 1980s. They doubled in the first half of the 1990s, and then doubled again with a big increase in output just as the world tipped into recession in 2000. Prices predictably plunged, by an average of 95 percent compared to their pre-China averages.

Most of these Chinese firms rarely turned a profit. Some industry analysts maintain that for a good portion of the 2000s, most of them never even recovered their operating costs. At the same time, an illegal REE mining industry ran rampant, earning meagre profits by disregarding worker safety and the environment and ruthlessly undercutting competing prices. With an endless supply of below-market loans, it did not matter if the legitimate mining concerns were financially viable. It was in the environment of continued Chinese production despite massive losses that nearly every other REE producer in the world closed down ? and that the information technology revolution took root.

In fact, if not for China?s massive overproduction, the technological revolution of the past 15 years would not have looked the same. In all likelihood, it would have been slowed considerably.

This is a classic predatory pricing. As we wrote in Chinese strategic plans: control of the supply of rare earth metals,

Predatory pricing is an anti-competitive practice by monopolies to bankrupt their competitors by slashing price so much that everyone makes a loss. Since the loss-making monopoly will eventually outlast their loss-making competitors, it is only a matter of time competition is eliminated and the monopoly can increase prices.

So, what this means is that China will only maintain its commercial monopoly on REE as long as prices remain uneconomically low.

Now, do you see a long term problem that China faces?

As we wrote earlier, China has less than one-third of the world?s REE reserves but produces 95% of the world?s REE. That means that they are supplying REE to the world by running down their REE reserves first before anyone else. Obviously, that will be problematic for them in the future because one day, the tables will turn against them as they start to run out of REE. From that perspective, it makes sense for them to curb REE exports to feed their own domestic needs first.

Of course, if China halt all exports of REE tomorrow, it will cause immediate big problems to the rest of the world because there are not many functioning REE mines (and expertise) outside of China. But in the long run (say more than 5 years later), as new production come online, the world?s dependence on China for REE will decline.

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Posted in Commodities | 2 Comments »

Marc Faber: Beware of investing in Australia (as it follows the Chinese business cycle)

Monday, April 26th, 2010

Currently, economists in major institution in Australia are still forecasting growth in the Chinese economy. Even the Reserve Bank of Australia (RBA) are pencilling in further boost of the Australian economy because they expect continuing growth of Chinese demand for Australia’s commodities. With such rosy forecasts, the mainstream pundits believe that Australia’s economy will continue to power ahead, which will result in further “skills shortages,” inflation, and for the property spruikers, further growth in property prices. This is the reason why the RBA had the guts to raise interest rates.

But as contrarian investors, this should be the time for you to be more careful. As we warned our readers a few months ago in Hazard ahead for Australia- interim crash in China,

Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

In other words, the ups and downs of the Australian economy follow the business cycle of China. And yes, the business cycle still exists in China. As we wrote in Will the China boom go in a straight line?,

Put it simply, we do not believe that the rise of China will take on the path of a straight line. Instead, there will be ups and downs, booms and bust and progress and setbacks. Anytime when the path does not look like a straight line upwards and take a temporary dive, the market will flip to the other extreme of this story and project extreme pessimism into the indefinite future. In other words, the market always looks at one side of the boom and completely ignores the flip side.

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. This will have implications on the Australian economy, currency, stocks and property market. Make no mistake, this is what he said in an interview:

Mind you, 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.

A voluntary reining in of the runaway economy will definitely result in a smaller bust today (the alternative will be an involuntary and bigger bust tomorrow). That’s where the problem lies- the Chinese government lacks credibility in its will to cool down the economy. Within the circles of the Chinese property speculators, there’s an assumption that the Chinese government lack the guts to induce deflation in property prices (which will have negative effects on the rest of the economy). The reason is because once the deflation forces take hold, it will be very difficult to reverse. The same applies to the Australian government. The assumption is that at the end of the day, the government (whether it’s the Chinese or the Australian government) will indulge in moral hazards (e.g. bail out, print money, etc).

But dear readers, make absolutely no mistake about this: even if the government succeeds in avoiding a big bust today at all costs, this very success will result in more severe unintended side-effects and Black Swans. In Australia’s case, it will be a currency crisis (see Will there be an AUD currency crisis?) and/or social breakdown (because a policy of inflation is inherently unfair and widen the rich-poor gap). In China’s case, it will be complete social collapse, which is not uncommon for those who are familiar with China’s long history. Over thousands of years, China endured endless repeated cycles of corruption, dynastic collapse, followed by renewal through the birth of a new dynasty.

Hence, we will not be able to offer our readers the exact time-frame and predictions of what will happen next. No one can. But this is what you can do: be flexible and watch out for the signs and prepare the drills to be activated. So, bear this in mind: the moment the financial markets believe that the Chinese government’s talk about cooling its economy will be real concrete action, things will happen very fast.

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Posted in Advertising/Affiliates, Commodities, Currencies, Looking Forward, Market Observations | 1 Comment »

Five potential emergencies- energy crisis

Tuesday, April 13th, 2010

As you have read from our series on the self-sufficiency theme, the modern complex societies that we live in is not as robust as it seems. The reason why it seems robust is that (as we wrote in our ?How To Foolproof Yourself Against Salesmen & Media Bias? report), we have the habit of falling into one of the mental pitfalls. When you see that the tap flows and lights turn on reliably day after day, this mental pitfall will lull you into complacency. Then one day, when crisis happens, it will hit everyone on the head that modern life is fragile.

One of the main potential emergencies that can quickly disrupt our modern way of life is this: energy emergency. As we wrote in An Achilles Heel of modern society- specialisation and division of labour,

The crucial question to ask is this: what is the ?glue? that stick together all these specialised and divided labour into a system that we called the ?economy?? The answer is: energy.

Today, we can have 99% (a figure that we plucked from the sky, but you get the idea) of the population not working and yet not starve. That?s thanks to the Green Revolution that allows more and more food to be grown by less and less people.

But this comes at a cost- energy. As Sean Brodrick wrote in The Ultimate Suburban Survivalist Guide,

Energy consumption by agriculture has increased 100 times, or more. According to 1994 data, 400 gallons of oil equivalents are expended annually to feed each American. The energy consumption breaks down as follows:

  1. 30% for the manufacture of inorganic fertilizer
  2. 18% for the operation of field machinery
  3. 15% for transportation
  4. 12% for irrigation
  5. 7% for raising livestock (not including animal feed)
  6. 5% for crop drying
  7. 5% for pesticide production
  8. 8% miscellaneous

These estimates don?t include the energy used in packaging, refrigeration, transportation to retail outlets, and cooking.

At the same time, the vast majority of Americans have gotten further and further away from their food sources.

The implication is clear. As energy prices increase (and they will), prices for our basic survival need- food- will increase. If you believe in the China growth story (i.e. the secular rise of China), you will have to seriously question whether the global energy production can keep up with the colossal demand of a rising China (see The Problem that can throw us back into the age of horse-drawn carriages). Since most of our energy comes from fossil fuels (especially oil), the question is this: how quickly can the global economy restructure itself away from using oil? To retool and reconfigure the entire economy away from using oil is not that easy and it takes time.

This is just the best-case scenario- a gradual rising in oil prices over the years, resulting in a gradual declining in the standard of living. There are other worse possible scenarios?

Now, consider these facts (source: The Ultimate Suburban Survivalist Guide):

  1. 81% of the world?s discovered and useable oil reserves come from just 10 countries.
  2. 30% of the world?s oil comes from just 3 countries- Iraq, Kuwait and Saudi Arabia.

Now, look at the second point more carefully. What is common among the three listed countries?

All three of them are close neighbours of Iran. The Iranians, who are Shiites Muslims, have ambition of dominating that region. They are steering the Shiites in these three countries into their sphere of influence. No doubt, part of their plan for domination includes acquiring nuclear weapons. If the Iranians (who are led by their mad President Mahmoud Ahmadinejad) acquire nuclear weapons, it will significantly tip the balance of power in the region away from the US.

If you see how Russia uses the supply of natural gas as a tool against its neighbours (e.g. Ukraine), we can imagine the Iranians trying the same on the Western world.

There is a worse scenario than that. That region is a potential military flashpoint. What if Israel miscalculates (see New urgency for action against Iran) and plunge the region into war? In any shooting war involving Iran, we have no doubt that they will find ways to block the Straits of Hormuz, one of the energy chokepoints in the world. As the US Department of Energy reported,

Chokepoints are narrow channels along widely used global sea routes. They are a critical part of global energy security due to the high volume of oil traded through their narrow straits.

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The international energy market is dependent upon reliable transport. The blockage of a chokepoint, even temporarily, can lead to substantial increases in total energy costs. In addition, chokepoints leave oil tankers vulnerable to theft from pirates, terrorist attacks, and political unrest in the form of wars or hostilities as well as shipping accidents which can lead to disastrous oil spills.

A temporary disruption lasting not more than say, 40 days is manageable for the US because they can open up their Strategic Petroleum Reserve. But if the emergency last longer than that, then there will be a heavy price to pay.

That?s not all the Iranians can do in a shooting war. Since the oil fields of 30% of the world?s oil is so near Iran, our guess is that it would not take them too much to take down these oil fields? productive capacity. Back in 1990, Saddam Hussien sabotaged the oil fields of Kuwait by setting fire to them. An irrational Iranian President will surely think of trying something worse with missiles, artillery shells, ground troops or worse still, nuclear missiles. Although the Iranian may not have military technology as sophisticated the US (although the gap is probably closing with Russian help), they have a large pool of manpower to call up as canon fodder. During the Iran-Iraq war, the Iranians used human wave techniques to beat back the Iraqis.

Therefore, a second oil crisis (the first one is in the 1970s) is definitely possible. The question is, are you ready?

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Posted in Advertising/Affiliates, Oil, Self-Sufficiency | 1 Comment »

Suspension of demand/supply law for base metals

Sunday, March 7th, 2010

According to the economic law of supply and demand, if there is more and more supply for a given commodity, the prices should decrease if everything else remains equal. Conversely, if the supply decreases, prices should rise.

Normally this is the case for commodities like base metals. The level of stock for a given metal in the London Metal Exchange (LME) should give a good indication of the quantity supplied. So, we invite our readers to take a look at the supply/demand situation for lead, nickel, zinc, copper and aluminium. In particular look at the 5-year charts for the trend starting in January 2009. What do you see?

When? you look at the charts, you will notice something very strange. Since January 2009, the prices of these base metals rose as the supply grew as well. What is going on? Had the economic law of supply and demand being suspended as well?

Good question.

Remember what we wrote in Does rising house prices imply a housing shortage??

The belief that prices will always go up forever and ever can create its own artificial demand. The insidious thing with this belief is that it is a self-fulfilling prophecy- belief leads to increased ?demand,? which in turn leads to higher prices, which reinforced the belief, which in turn leads to increased ?demand? and so on and so forth. When this happens, higher prices lead to even higher ?demand.? Such artificial demand can act as a sink-hole for whatever quantity of supply until money runs out in the financial system (which is not possible under today?s a fiat credit system).

Indeed, this is our interpretation of what happened to base metals as well. The expectation of rising prices acts as a sink-hole for whatever quantity of supply. The most common word used to sum up this phenomenon is “speculation.” Another word that is also often used is “investment demand.”

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When you look at the big picture, there is a big growth in “speculation” and “investment demand” over the past 10 years. From real estate, stocks, bonds, commodities, foreign exchange and even art-work (see Epic, unprecedented inflation). Today, with advances in financial engineering and information technology, it is possible to speculate in the global commodities market in the comforts of your home with the click of a mouse.

What is the root cause of this? As we wrote in Why oil cannot function as currency reserves?,

… when governments undermine the store-of-value function of money (something that can only be done in a fiat monetary system), investors will flock to useful, vital and scarce commodities to store their wealth. This in turn will result in those scarce commodities becoming scarcer. The food riots around the world in 2008 were an example of how this can happen (see Who is to blame for surging food and oil prices?).

For the fundamental economic law of supply and demand to work, prices have to convey accurate market information. Prices are expressed in terms of monetary units. That means the monetary unit is the yardstick which is used to measure the relative value of things. What if the integrity of this yardstick is being compromised? As we wrote in our book, How to buy and invest in physical gold and silver bullion,

Let?s suppose you want to compare the length of two boxes. You may use a ruler to measure their lengths and from the results of your measurement, conclude which one of them is longer. A ruler can do such a job 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 boxes? An elastic ruler is useless because you can always make up the measurement of the boxes 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?s take a look at oil prices. Since oil is priced in US dollars and if the supply of money and credit (in US dollars) can be expanded and contracted by monetary inflation and deflation, how useful do you think it is as a calibration for measuring the value of oil relative to other things?

The rise of “speculation” and “investment demand” is a sign of a funny monetary system.

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Posted in Commodities, Economics/Finance | 3 Comments »

Is China going to dump their excess metal stockpiles?

Tuesday, February 9th, 2010

Back in Will there be a commodity price crash?, we wrote about a curious phenomenon in China,

… as prices for base metals rebounded, so did their inventory stockpile levels. This is a tell-tale sign that much of the price rise are due to the rise in investment demand instead of real demand.

When we wrote that article, we should have used the word “speculative” instead of “investment.” Indeed, back in September last year, there were signs of base metal speculation in China, as this Bloomberg article reported (China?s Pig Farmers Amass Copper, Nickel, Sucden Says)

Private investors in China, the world?s largest metals user, have stockpiled ?substantial? quantities of copper as the government ramps up stimulus spending to spur the economy, according to Sucden Financial Ltd.

Pig farmers and other speculators may have amassed more than 50,000 metric tons, Jeremy Goldwyn, who oversees business development in Asia for London-based Sucden, wrote in an e- mailed report after a visit to China. That?s about half the level of inventories tallied by the Shanghai Futures Exchange, which stood last week at a two-year high of 97,396 tons.

Sucden?s estimate underscores the difficulty analysts face in gauging metals demand in China amid increased speculation by retail investors, whose holdings remain outside the reporting framework undertaken by exchanges. Private investors in China also had as much as 20,000 tons of nickel, Goldwyn wrote.

This is a tell-tale sign that the ‘demand’ for base metals from China is not fully substantiated by the demand from the real economy. Even the demand from the real economy are not fully substantiated by the real needs of the people. To understand what we mean by that, think of where all these credit and stimulus money has gone to in China. It has been reported that most of them had gone to fixed asset investments and infrastructure. But according to Marc Faber in a recent interview (and many eye-witness report), there’s an oversupply of apartments and commercial real estate in China i.e. vacancies are already too high. Therefore, the pace of China’s fixed asset investments have to slow down. Should that happen, you can be certain that demand for steel and cement will fall substantially. That means the demand for Australian iron ore is going to fall as well.

Now, we are hearing rumours that the Chinese are trying to offload their excess metals. As this article reported (Rogue Aluminium Shipments Suggest Chinese Metal Stockpiles are Being Re-Exported),

Something strange happened in Japan in December. Shipments of aluminum from Mozambique and Brazil showed up in the northwestern ports of Fushiki and Fukui.

Shipping aluminum to Japan isn’t weird. The nation is an important consumer. But shipping South American and African aluminum to northwest Japan is strange.

These are minor ports. Usually such imports would be unloaded on the Pacific side, at Yokohama, Osaka or Nagoya.

Where did this “rogue aluminum” come from? Traders think it might be from China.

Not only that, according to that article, there’s a divergence between the Baltic Dry Index and Chinese Shipping Index.

Next, listen to what Marc Faber has to say:

What is the implication for Australia? If you accept the theory that Australia owes much of its economic rebound from Chinese demand for Australian resources, then what follows will be very negative for the Australian economy. As we wrote in Hazard ahead for Australia- interim crash in China,

Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

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Posted in Commodities, Looking Forward, Market Observations | 22 Comments »

Shift in market psychology

Tuesday, December 15th, 2009

The 4th December 2009 should be noted in your diary as the day where the market psychology has changed.

Prior to that day, any economic numbers that was better than expected will be interpreted by the market as being ‘good’ for commodity prices. The idea is that ‘good’ numbers imply economic recovery, which implies increased demand for commodities, which in turn implies rising commodity prices. As a side effect, the US dollar trends lower. The converse is true for economic numbers that was worse than expected.

After that day, there is a major shift in the market psychology. As we wrote in What happened to gold prices?, when the market believes that the economy is going to recover, it will anticipate and speculate on interest rate hikes by the Fed, which is bad for stocks and commodities and good for the US dollar. The logic, as we wrote in November 10 at Booming real economy, falling stock market?, goes like this:

A truly recovering real economy will result in liquidity draining out of the system. Since the current rally is fuelled by massive loosening of liquidity, draining liquidity will imply that the stock prices will fall and the US dollar strengthens. As the US dollar strengthens, then the short squeeze in the US dollar will happen (see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar), which implies that the Aussie dollar and stock prices will tank.

Right now, the market is believing in the economic recovery story (which we are sceptical). This belief is not that strong yet because there is yet to be a large scale move in unwinding the US dollar carry trade.

Some of you (who are trading in paper gold) may be concerned about what’s happening to the gold price lately. But remember, the main story is the reversal of the US dollar carry trade (which will result in a rising US dollar). Gold (or whatever commodity you are trading) is not the lead actor in this story. If you notice, not all commodity prices are moving down in unison, unlike the great de-leveraging of 2008-2009. Falling commodity, gold, silver and stock prices are just the symptoms of the reversal of the carry trade. To the extent that the rise of the Aussie dollar is the result of the carry trade, this will imply a weakening Aussie dollar (see Return (and potential crash) of the great Aussie carry trade).

If you are investing in physical gold bullion, there is nothing to worry about (see our book, How to buy and invest in physical gold and silver bullion).

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Posted in Commodities, Currencies, Gold, Market Observations | 6 Comments »

Will there be a commodity price crash?

Thursday, December 3rd, 2009

Remember, back in January 2007, in Analysing recent falls in oil prices?real vs investment demand, we discussed about the difference between investment and real demand for a commodity,

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.

Lately, we are asking ourselves the same question for the broader range of commodities, particularly base metals. In particular, we draw your attention to this news article,

London Metals Exchange (LME) inventories for most metals have been rising strongly of late. For example, aluminium LME inventories are 75 per cent higher than the prior 20 year high set in May 1994. Nickel inventories are only 6 per cent below the 20 year high set around the same time. Zinc inventories have risen six fold since the start of the subprime crisis in September 2007. Lead inventories are up five-fold over the same period. While not at a record, copper inventories have increased for 20 consecutive weeks and are up 70 per cent since 30 June.

Now, this is a curious phenomenon- as prices for base metals rebounded, so did their inventory stockpile levels. This is a tell-tale sign that much of the price rise are due to the rise in investment demand instead of real demand. This investment demand is based on the same idea in Does rising house prices imply a housing shortage?,

The belief that prices will always go up forever and ever can create its own artificial demand. The insidious thing with this belief is that it is a self-fulfilling prophecy- belief leads to increased ?demand,? which in turn leads to higher prices, which reinforced the belief, which in turn leads to increased ?demand? and so on and so forth. When this happens, higher prices lead to even higher ?demand.? Such artificial demand can act as a sink-hole for whatever quantity of supply.

So, base metal prices are vulnerable to a correction. Current prices are based on the belief on the exaggerated sense of the China (and India) growth story. If this belief is ever molested by some reality check (e.g. see Is the Chinese economy a house of cards?), chances are, base metal prices will fall. There are even reports that China is pretty stocked-up with those commodities as we speak and may be going through a de-stocking phase next year. At the very least, base metal prices may be pretty subdued next year.

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P.S. Check out Economy to ride a second wave of China stimulation. The Chinese are preparing to fire a second stimulus that is aimed at boosting consumption. Our interpretation is this: the Chinese government needs to flood the economy with more money, otherwise the bubble will burst. Result: more corruption, speculation and inflation.

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Posted in Commodities, Market Observations | No Comments »

Is the world really running out of oil?

Sunday, November 15th, 2009

Many of us would have heard of the threat of Peak Oil to our way of life. To put it very simply, according to the Wikipedia, Peak Oil is the

Peak oil is the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline.

Unfortunately, there is a lot of misunderstanding as to what Peak Oil is. For example, in our quote of the news article in our previous post, it reported that

The world is much closer to running out of oil than official estimates admit, says a whistleblower at the International Energy Agency…

This is an example of how the mainstream news media can oversimplify things and subtract knowledge from their readers’ minds. Please note that we are not saying that the news media is useless, but it pays to be careful with what you read, especially with so much vested interests wanting to control public opinion through control of the media.

To add to the confusion, the debate on Peak Oil is as polarising as the inflation/deflation debate with both sides having different motives and vested interests. There are some experts who do not believe in Peak Oil (we are not geologists here, so we shall not get involved in this debate). For example, one of our readers forwarded us this news article by an expert (Leonardo Maugeri, the senior executive vice president of the Italian oil company Eni, and a visiting scholar at the MIT), who believes that there will still be plenty of oil in the 21st century and we need not fear losing our way of life as we know it.

First, let us understand what Peak Oil is not. It does not mean that the world is running out of oil. There are still plenty of oil on this earth. The last drop of oil will not be used up any time soon. But there is a problem. The cheap and “easy to get” oil is getting harder and harder to find and extract.

The best way to understand this problem is to use an analogy. Imagine we have a fruit tree that has plenty of fruits. We have been consuming the low hanging ones for quite a while and are realising that our daily supply of fruits are in decline. No doubt, there are plenty of fruits on the tree. But the problem is, the low hanging ones are getting fewer and fewer and the ones left are hanging higher and higher. That means, we have to expend more work (e.g. using a ladder) to get those higher hanging fruits if we want to maintain or increase (with China & India coming) our daily supply of fruits.

The point of contention is what is means by “low hanging” fruits. Critics of Peak Oil believe that new technologies will help us to extract the higher hanging fruits more easily than before. They believe that mankind will find new ways to extend the lifespan of existing oil fields, extract non-conventional oil (e.g. get the oil from the tar sands), find new oil fields in previously infeasible locations (due to technical and economic reasons) and so on.

As usual, we have to cast a skeptical eye on whatever we read. For example, the news article by Leonardo Maugeri is full of optimism with regards to mankind’s ability to pluck the higher hanging fruits. Perhaps he is a little too optimistic? As we read his article, we can’t help but notice that he is using some kind of turkey thinking- mankind’s ability to innovate in the past with regards to oil-related technologies will see that further innovations is the default result for the future (see Failure to understand Black Swan leads to fallacious thinking). For example, he wrote,

But when new exploration technologies do take root, the results are remarkable.

…

Fifteen years ago, all this was simply unthinkable.

Of course, being an oil industry executive, he has to walk the talk and be optimistic. We are not saying that he is lying or wrong. We are just exercising our skepticism. We certainly hope he is right. If not, this is a BIG problem for mankind.

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Posted in Oil | 33 Comments »

Aborted correction?

Thursday, November 12th, 2009

Eleven days ago, when we wrote Stronger signs of a coming major correction, it looks as if the long-awaited major correction was on its way. It turned out that it was a very shallow correction. Gold prices, on the other hand, are hitting record highs in US dollar terms. Commodity prices are in a much weaker up-trend than gold prices. Even silver, gold’s sister, are not as strong as gold.

Indeed, this is a very trying period for investors. In the US, with short-term interest rates at zero, it has become very difficult to value your investments. If cash is yielding nothing (and losing value due to price inflation), how different is it from gold, which also yields nothing? In fact, with gold prices in such a strong up-trend, it is doing much better than cash. In fact, anything is better than cash (US dollar) right now and it has become a very crowded trade, with speculators shorting it into a gigantic bubbly carry trade (Return (and potential crash) of the great Aussie carry trade).

Today, China is hinting that it is allowing the yuan to appreciate (see China hints at resumption of yuan appreciation). Speculators who are already betting on a yuan appreciation will be well rewarded. Very likely, more latecomer speculators will try to squeeze its way into this carry trade too as this sure-profit trade looks too tempting to miss.

Meanwhile, there is a danger ahead- peak oil. As this recent news article reported,

The world is much closer to running out of oil than official estimates admit, says a whistleblower at the International Energy Agency who claims it has been deliberately underplaying a looming shortage for fear of triggering panic buying.

Assuming that the world is past its peak oil production and what follows is a downward sloping decline, it can only mean one thing- more price inflation ahead.

And this will break the global economy once again. Meanwhile, be alert for a currency crisis.

Posted in Currencies, Oil | 9 Comments »

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