Archive for May, 2007

What if there is a hard landing in the US?

Monday, May 14th, 2007

In US shooting own foot with tariff on Chinese goods, we mentioned, ?China and the US are locked in an embrace of unhealthy co-dependency with each other.? Basically, the US spends by printing its own dollars and using them to pay for Chinese goods. The Chinese manufactures those goods to keep its factories running and massive supply of labour employed.

What if the US is hit with a hard deflationary recession? There are two schools of thought.

The first school of thought believes that China can still continue to grow and thus, given its massive US dollar reserves, will continue to spend them for her own growth and developments. This means that demand for commodities will continue to grow, leading to the commodities ?super-cycle? theory.

The second school of thought believes that US demand for Chinese goods will collapse, resulting in Chinese factories becoming idle and her massive labour pool being unemployed. This will lead to a collapse of Chinese demand for commodities, which in turn will drag the rest of the world into a recession.

We are more inclined to favour the second school of thought. We believe that a hard deflationary landing for the US economy will result in a contraction in liquidity in China as well. This in turn will prick the grotesque Chinese stock market bubble. With a significant segment of the Chinese middle-class having converted their real wealth into paper assets, a stock market crash will result in a serious loss of wealth for them. Also, with the collapse in US demand, much of the Chinese lower class (e.g. rural migrants), which supplied most of the cheap labour for the Chinese factories, will be unemployed. You can imagine that with the Chinese middle-class losing a significant portion of their wealth to a stock market crash and the Chinese lower-class being unemployed, an extremely serious situation will develop in the Chinese domestic front. In that case, China will experience a hard landing as well. It must be noted that ?hard-landings? are relative?a hard landing for the Chinese can be a soaring growth for the US. We are sure that at least in the short to medium term, Chinese demand for commodities will be crimped, especially given that commodity prices had ran up hard enough. In the long run, we suspect the Chinese are arguably in a better position than the US to recover from a hard landing. In that case, the long-term Chinese demand for commodities will grow, along with many severe corrections along the way.

Thus, since Australia?s economy is running on resources as the engine of growth, she will not escape the effects of a US hard landing as well.

Can drought lead to a recession in Australia?

Monday, May 14th, 2007
In Can Australia?s deflating property bubble deflate even further?, we asked ?… what external forces beyond Australia?s control may tilt her into a recession?? In that article, we listed ?sustained uptrend in oil prices? as one of the possibilities. Today, we thought of another possibility: drought.

It is obvious that the drought will affect farm output in Australia. Although the farm sector will be severely affected, it is always assumed that it will not pull down the rest of the Australian economy into recession. However, something in the Sydney Futures Exchange gave us something to think about regarding that assumption.

In the last several weeks, electricity futures contracts (expiring all the way to 2011) in the Sydney Futures Exchange have been soaring. The drought was blamed for the declining electricity output?there is not enough water to (1) drive the turbines for hydroelectric plants and less importantly, (2) to cool coal-fired power stations.

If this is going to translate to a sustained uptrend in electricity prices, what will be consequences?

Firstly, electricity is a major input cost for many industries. As this article, Electricity futures shock as turnover quadruples, price doubles, in the mainstream news media said,

Electricity represents 15 to 20 per cent of costs for industries such as paper, cement and steel. The increased cost can be expected to flow through into economy-wide costs in the same way as last year’s oil price increase.

With higher input costs, we can expect them to be passed on to consumers. Also, higher electricity costs can have the effect of curtailing consumer spending just as higher oil prices do. The outcome will be price inflation, which may further pressure the Reserve Bank of Australia (RBA) to raise interest rates. Higher interest rates will definitely be a strain to an already highly indebted nation (see More pain for Australia), especially on the mortgage front (see this news article: Drought powers threat to mortgages).

Please note that we are not predicting that this will happen?we are only saying that this is a possibility. In the meantime, keep an eye on this development.

The Great Crash of 1929

Friday, May 11th, 2007

A few days ago, back in Crash alert?to short the stock market or not?, we issued our first crash alert. To be honest, we do not know exactly when a crash will occur. But we believe one is on its way. Also, the longer the coming crash is ?postponed,? the more devastating it will be when it finally arrives?the longer it delays, the greater the number of people who will be sucked into complacency.

Today, we will look a bit into history of the 1929 crash. Hopefully, we can learn from them and be better prepared for what is to come. Since most of us were not even born yet in 1929, the investors and traders of today largely forgot the lessons of that unprecedented crash.

Contrary to popular belief, the Great Crash of 1929 was not completely without any warning. As early as November 15 1925, Alexander D. Noyes, a highly respected financial editor of the New York Times, warned in a very long article that the ?speculative mania? of the 1920s was not unlike previous bubbles and that stock prices could not rise forever. Long before the Great Crash, the contrarians of the day were already sounding the alarm.

Also contrary to popular impressions, that Great Crash was not a one-day event. It was a series of events that marked the beginning of an even more devastating consequence?the Great Depression. In fact, it took a year after the Great Crash for the average person on the street to feel the effects of the ensuing Great Depression. Did the Great Crash cause the Great Depression or was it merely a symptom of it? We believe it was the latter.

For five years leading to the Great Crash, the stock market had an amazing run. By the beginning of September 1929, the stock market had reached a peak. Then for the next month, the stock market fell 17% for a month, before rallying for the next two weeks, recovering half of the initial fall. Then it fell again, culminating in a ?Black Thursday? of October 24 1929, in which a then record of 13 million shares were traded. On the afternoon of ?Black Thursday,? a rally reduced the losses. That rally continued on to Friday, which was then followed by weak actions on Saturday. On Monday, the market fell 13% in one day. The next day, which was known as the ?Black Tuesday? of October 29 1929, the market fell another 12% in another record volume of 16.4 million shares.

By November 13 1929, an interim bottom was reached, followed by several months of rally, resulting in an interim peak on April 1930. Then it was downhill again, reaching a bottom in July 1932, which was 89% down from the then record high in 1929.

Can it happen again today? Can the Federal Reserve save us from such a disaster? Remember, almost 80 years ago, people had the same faith in that institution. In the next article, we will extract lessons that we can learn from the Great Crash. Keep in tune!

What will the Federal Reserve do tomorrow?

Wednesday, May 9th, 2007

We are glad that we are not in Ben Bernanke?s shoes. Back in March, in Federal Reserve trapped in a box, we mentioned about the Fed?s predicament. Today, they are still in the same situation. What will they do this time regarding interest rates? There are only 3 possibilities: hold, raise or cut. Let us look at each possibility.

Will the Fed raise interest rates? At this rate that money and credit is expanding in the US economy, there is little wonder that price inflation is a threat. Worse still, nowadays, central bankers control very little of the financial system?s generation of liquidity (see Prepare for asset repricing, warns Trichet and How dangerous are credit derivatives?). On one hand, they have to maintain reputation as inflation ?fighter.? As we said before in Cause of inflation: Shanghai bubble case study, the idea of a central bank ?fighting? price inflation is nonsensical?they are the source of inflation in the first place. Yet, they have to keep up the semblance of ?combating? price inflation to keep its expectation at bay (see Price inflation expectation will pressure RBA to raise interest rates). Other than raising interest rates to drain liquidity, the Fed can only talk tough when dealing with the ghost of price inflation.

Since raising interest rates is politically suicidal. If the Fed does so, they risk pricking the debt-fuelled asset price bubbles (that was caused by ?printing? of money), which can trigger a deflationary spiral?the US housing market is already deflating. The masses will hang Ben Bernanke for ?causing? an ensuing recession. Unfortunately, a recession is exactly what the US needs. The longer the US delays the inevitable recession, the more severe and painful it will be when it finally comes. This is the prognosis of the Austrian School of economic thought. If the unavoidable is put off for too long, the outcome can even be an economic depression. A recession is required to clean up the mal-investments and excesses of the preceding boom, which will pave the way for more sustainable economic growth in the future (you may want to read up on the Austrian Business Cycle Theory here: The real story behind the phenomena of booms and busts).

Will the Fed cut interest rates? Politically, this is more satiable. The stock market definitely loves an interest rate cut. The idea of pumping more liquidity (i.e. ?printing? of money) into the financial system to prop up asset prices and bad debts is indeed appealing. But this action will be highly inflationary in nature. Already, with the US dollar in a downtrend, we can expect price inflation to be a more severe problem (see What can we expect in a US dollar decline?). Add in interest rates cut and the risk of total loss of control of price inflation increases!

Ben Bernanke must be in a terrible dilemma. Chances are, they will hold interest rates. If not, a cut is more likely than a rise.

Gold investments: forms of gold

Wednesday, May 9th, 2007

Note: This article is written for paid advertisers. See Announcements: Advertising referrals.

In our previous article, What should be your fundamental reason for accumulating gold?, we wrote about the root reason for accumulating gold:

If you cannot remember anything else, please remember this: gold is a hedge against loss of confidence in fiat paper currencies.

Given that the history of human civilisation lasted for several thousands of years, the use of fiat paper currencies is a blip in history. As we mentioned before in A brief history of money and its breakdown- Part 2,

… gold was not any arbitrary choice by the government. Rather, it was the choice of the free market over the course of centuries as the best money.

Gold had been around since the times of the ancient Romans, Greeks and Egyptians civilisations. We doubt it is likely to go away soon, as seen in the big picture context of human nature. The natural propensity of humans towards greed, power, selfishness and stupidity means that fiat paper currencies cannot work in the long run (as shown by the witness of history?see our previous article, Ancient Chinese fiat paper money). The very nature of gold makes it immune to the power of the printing press as it cannot be ?printed? and made legal tender the way fiat paper currencies are.

So, let?s say you have decided to accumulate gold. What forms of gold are available?

One form of gold can exist in the forms of stocks in gold mining/exploration companies. If you know how to analyse mining companies properly, gold stocks can be a highly leveraged instruments to gain an exposure to gold. But you have to know what you are doing.

The next form of gold is ?paper? gold, which is basically a ?paper? financial asset that represents an interest in physical gold stored somewhere else. In stock exchanges around the world, there are gold Exchange-Traded-Funds (ETF) which makes purchasing gold as easy as trading in stocks. Of course, the security of ?paper? gold lies in the reliability on its representation on the underlying physical gold.

Finally, you can buy physical gold for yourself. Usually, they exist in ingot or coin varieties. To buy physical gold, you will have to find a gold dealer. An example of a gold dealer is the Monex Deposit Company (MDC), which specialise in ?immediate personal delivery or arrange for convenient and safe storage at an independent bank or depository.? Please note that this is not our endorsement for MDC?we mention them as an example of a gold dealer.

Announcements: Advertising referrals

Wednesday, May 9th, 2007

From today, we will add a new articles category: ?Advertising.? Basically, any articles that are under the category of ?Advertising? are written for paid advertisers. We disclose this to you so that you will be warned beforehand that such articles may not be fully independent.

Podcast on the Great Depression

Monday, May 7th, 2007

Here is a MP3 from a podcast in the Mises Institute on Herbert Hoover and the Great Depression.

Crash alert?to short the stock market or not?

Monday, May 7th, 2007
Back in October last year (see Strange rally), we were suspicious about the stock market?s optimism. Other then a short correction in February this year, the market had been in a strong upward trend since then. Were we wrong?

Well, yes and no.

There is a saying in the market: ?Never predict the timing or price target because eventually, you will at least get one or the other wrong.? At least, we got the timing wrong. Also, since we did not offer any price (or index points) target, we could not be wrong on that. But we are very sure of one thing: this limitless optimism will sooner or later end in tears. Why?

Think about it: for the US economy, had anything fundamentally improved since last October? No, in fact, the bad news tells us that the US economy is in a downtrend. But the stock market behaved as if the US economy is in an uptrend. It has come to the point that market commentators had to find excuses to ?explain? this strange behaviour of the stock market.

For the Australian economy, though the news were not as dire as the US economy, it is clear that it is at the top of the business cycle. As we said before in Where are we in the business cycle?,

If we assume that the current trend of companies? profit growth will extend indefinitely into the future, we will be in for a nasty surprise.

As we explained in that article, in order for the Australian economy to grow further, it needs to rebuild and expand on its capital stocks. The only way for it to do so is to:

… increase our national savings… we need to restore and rebuild our stock of capital goods to ensure our future prosperity. Already, the quality of our education, health, telecommunication and transport infrastructures are in decline and they are in need of repair and upgrade. This means that the only way we are going to achieve that is to reduce our current consumptions and cut down our debt. When that happens, the economy will slow down and many businesses and investments will fail as a result. Since most of the Australian (and the US as well) is made up of consumer spending, in which much of it is funded by debt, we can see that this remedy will be painful.

Yet, despite all these bad (or at least lacklustre) economic reports, we keep on hearing news of record highs for the Dow and ASX 200 indices. The US S&P500 index is nearing its record high too. Even the dangerously bubbly Shanghai stock market is at or near record highs too.

All these boils to one point: it is the spigot of liquidity that is driving stock markets around the world, not fundamental valuation (see Marc Faber on why further correction is coming?Part 1). The danger is that the global financial system is vulnerable to a contraction in liquidity, which will set off a spiral of deflation (see Spectre of deflation). A ?crash? is what you will see in such a scenario. Today, with the stock market at such an extreme end of upward momentum (see Dow… since 1929), we feel very tempted to short the stock market (i.e. bet that the market will go down). Should we?

Well, if you decide to short the market, remember that you are going against the trend of the market. Many short sellers lost their shirts by being wrong on the timing of the coming crash and were forced to buy back stocks in panic to cover their short positions. Perhaps it has come to the point that almost all short sellers are driven out of the market and almost everyone is taking long positions (i.e. making bets that the market will go up)? Maybe right now, there is an overwhelming concentration of bets that the market will go up?

When you see that, a crash is probably nigh. This is because if everyone is betting that the market is going up and no one is betting the opposite, any downdraft will catch everyone by surprise. This will result in everyone rectifying their wrong bets simultaneously, resulting in a self-reinforcing feedback loop of falling prices (see Crowding at the exits for an example of how it will work out in real life). The outcome is a crash.

The problem is, we cannot predict the exact moment when this will happen. But at the very least, we have already anticipated this.

Residential property investments’ danger signals

Saturday, May 5th, 2007

In yesterday?s Eureka Report, it reported that:

Simon Ibbetson says that compared with the sharemarket, investing in residential property makes little sense and that many investors face tough times.

Indeed, we concur. See our previous article, Australian property good investment? Part 4?rising rent good reason to ?invest??.

Dow… since 1929

Friday, May 4th, 2007

The Dow had rallied for 22 out of the past 25 sessions. This is reportedly to be the longest sustained upward momentum since 1929. In case you do not know, 1929 was the year of the Great Crash that preceded the Great Depression.

Be prepared.