Archive for February, 2010

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.

News flash: Secret central bankers’ summit in Sydney

Sunday, February 7th, 2010

We just received this news tip from one of our readers: Secret summit of top bankers,

The world’s top central bankers began arriving in Australia yesterday as renewed fears about the strength of the global economic recovery gripped world share markets.

Representatives from 24 central banks and monetary authorities including the US Federal Reserve and European Central Bank landed in Sydney to meet tomorrow at a secret location, the Herald Sun reports.

This news article is reported on Rupert Murdoch’s Herald Sun on Friday/Saturday. Is this secret meeting organised in response to big trouble brewing on the horizon? That is what seemed to be implied in the article. Curiously, one paragraph reported,

Organised by the Bank for International Settlements last year, the two-day talks are shrouded in secrecy with high-level security believed to have been invoked by law enforcement agencies.

Was the meeting planned last year? Or perhaps it was brought forward because of the growing crisis in Europe? We don’t know. The central bankers’ club is certainly one of the most opaque organisations in the world- a fertile ground for conspiracy theories.

Anyway, the Greek fiscal crisis have the potential to break up the Euro i.e. currency crisis. If this turns out to be the outcome, then the trouble we wrote about in Currency crisis: first countries in the line of fire- PIIGS just a couple of weeks ago proved to be very timely.

So far, only Sydney’s Herald Sun is the only newspaper reporting this.

How is the Fed going to keep the lid on inflation? Part 1- Losing control of the Fed Funds Rate

Sunday, February 7th, 2010

Whenever we hear that the Federal Reserve is going to keep the interest rate close to zero, we may wonder what is meant by “interest rate?” Specifically, which interest rate does it mean? After all, there are many “interest rates,” from 30-day bank bill rates to 30-year Treasury bond yields. As it turns out, the “interest rate” that the Federal Reserve controls is the Fed Funds Rate.

The Fed Funds Rate is basically the rate that banks lend to each other overnight. Also, the Federal Reserve (so do many other central banks like our RBA) does not set the interest rate in the form of a decree to be followed. Instead, the Fed Funds Rate ‘sets’ the Fed Funds Rate by adjusting the supply of money such that it reaches a target that is intended (see How does a central bank ?set? interest rates?). The Fed Funds Rate in turn influences the interest rates in the market.

Well, not quite.

At least that’s true for the past two decades before the Panic of 2008. Ever since the September 2008 bankruptcy of Lehman Brothers, the Fed has lost control of the target Fed Funds Rate, as it begin to ‘print’ copious amount of money to save the world from a Greater Depression. As you may recall from How does a central bank ?set? interest rates?, the central bank can either control the quantity of money or the target Fed Funds Rate- it cannot control both. The GFC forced the Fed to flood the financial system with heaps of ‘printed’ money, which undermined its ability to control the target Fed Funds Rate.

So now the problem is to find another “interest rate” that is more relevant. As this Bloomberg article wrote,

Federal Reserve policy makers are considering adopting a new benchmark interest rate to replace the one they?ve used for the last two decades.

One of the “interest rates” that is under consideration is the interest rates paid by the Federal Reserve to commercial banks’ reserves. A simple way to understand what “reserves” are is to imagine the Federal Reserve being the bank of commercial banks. “Reserves” are simply the ‘cash’ that they ‘saved’ at the Federal Reserve.

Originally, the Federal Reserve did not pay any interests on reserves. After all, the whole point of banking is to get the banks to lend out their money to the wider economy. By not paying interest on reserves, they became unproductive assets. Thus, that prodded the banks to lend out their reserves to make their assets more ‘productive.’ As you can see by now, buying supposedly ultra-safe Treasury bonds at whatever yield was even better than keeping the reserves at the Fed at zero yield.

But the GFC messed everything up.

On October 6 2008, the Fed announced that they will be paying interests on banks’ reserves. The reason for doing so is to allow the Fed to control market interest rates and the quantity of money (reserves) via its various liquidity facilities. As the Fed said in that announcement, it

… give the Federal Reserve greater scope to use its lending programs to address conditions in credit markets [e.g. banks refusing to lend to each other] while also maintaining the federal funds rate close to the target established by the Federal Open Market Committee.

In other words, the interest rates on reserves is now the only tool at the hands of the the Fed to influence market interest rates. (Note: if you want to understand why, you can read this paper from the Federal Reserve here).

Now, there is a worry that with so much excess bank reserves (thanks to money printing) in the financial system, inflation will take hold once banks start lending them out again. What is the Fed going to do to restrain the banks from lending, thus causing inflation?

We will look into it in the next article.

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.

Does gold hedge against inflation/deflation?

Tuesday, February 2nd, 2010

It is often parroted by mainstream media that gold is a hedge against inflation. Sometimes, you will hear that gold is a hedge against deflation. Also, from our previous article (Will gold mining shares hedge against deflation again since the Great Depression?), we established that even though gold stocks hedges against deflation during the Great Depression, it does not necessarily apply to today’s situation. However, one of our readers said that Marc Faber reckoned that gold and gold stock hedges against deflation.

Isn’t this very confusing? How does gold hedges against inflation and deflation?

The answer is explained clearly in our book, How to buy and invest in physical gold and silver. For those who have not read that book, we will give some hints to the answer.

First, “inflation” and “deflation” are over-generalised words. Gold is a hedge against a narrow subset of “inflation” and “deflation.” The corollary is that in certain cases of “inflation” and “deflation,” you will lose using gold as a hedge. In page 20 of How to buy and invest in physical gold and silver, we have a story of Mr Goldberg who died a miserable man because he had nothing to show for his long-term commitment to gold.

As we said in How to buy and invest in physical gold and silver, the fundamental reasons for accumulating gold as a hedge are:

  1. Lack of confidence in fiat money (to function as money)
  2. Lack of trust in the financial system

Inflation is only one of the possible symptoms of point 1. Likewise, deflation is also one of the possible symptoms of point 2. The implication is that it is possible to see these two symptoms without holding those two fundamental reasons in your heart (i.e. see some forms of price inflation/deflation and yet still trust in fiat money and the financial system). Indeed, inflation has been with most of the world in the past 20 years. Deflation has been with Japan for the past 20 years. That is why there are many people (especially those from the mainstream media) who are deriding gold and gold-bugs.

But any time you have good reasons to lack confidence in fiat money and/or trust the financial system, it will be the time you will want gold as a hedge before the symptoms show up unmistakably as inflation/deflation.

To help you understand, we will give an example. During the Great Depression, banks were collapsing en masse. If your bank fails, then your cash at bank disappears into thin air. If everyone’s cash at bank disappears, then you can be sure there will be falling prices because there will be a sudden shortage of cash- everyone will want to hoard whatever physical cash they have on hand. In such a situation, if you own lots physical gold then you need not fear. You can always go to the Federal Reserve (remember, it was still the gold standard back then) and exchange your gold for physical cash. Or in theory, you can transact in physical gold only.

Today, during the Panic of 2008, banks were dropping dead like flies. That’s also a good reason to own gold or government bonds (we imagine that you can insist that the government pays you the yields with physical cash instead of depositing them at a wobbly bank). But then someone like Kevin Rudd announced that the government is going to guarantee all cash at bank. If there’s going to be falling prices (deflation) and if the financial system is going to function, then government bonds and term deposits will be better than gold. If there’s going to be mild inflation and if everything is going to be fine and benign as in the past 20 years (e.g. no currency crisis, no collapse in the financial system), then cash at high-yield bank accounts will be better than gold too.

Remember. as we wrote in our book (How to buy and invest in physical gold and silver), gold will only do exceptionally well at the extremes.

Here is a quiz question for you: if there’s going to be a collapse in the global financial system (as Marc Faber described as “deflation could only be triggered by one event: a total collapse of the existing global credit bubble”), would you rather own physical gold or gold stocks?