Posts Tagged ‘China’

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Political analysis required for investment decisions

Sunday, May 20th, 2012

We haven’t been writing for quite a long while and our dear readers may wonder why. One of the reasons is because today, economic and investment outcomes are increasingly being determined by politics instead of economics. Since we are no political analyst, we have very little to say. Back in 2006, when we first started this blog, we brought our readers through with great expositions on economic theory, particularly from the Austrian School of economic thought. Back then, economic analysis was the key to foresight. Today, the environment is different?there is a rising trend of government interventions, which results in more unintended consequences, which in turn led to more interventions. As Marc Faber said, having brilliant economic and financial analysis is not enough nowadays; we also need to enlist the help of political analysts in order to anticipate the next move by politicians.

As we all know, after months of calm in the financial markets, fear and panic are returning again, thanks to political upheavals in Europe. In this video, Stratfor made a very good point regarding the solution to this problem:

So, when ANZ’s CEO reckons that a euro-zone breakup is likely, he is in effect making a political judgment, which isn’t what bank executives are supposed to do in the first place. But we live in interesting times anyway, so this is hardly unreasonable. So, what will be the economic outcome for us in Australia should that happen? We don?t know but one thing we are sure: the euro-zone breakup is the most anticipated crisis. We have been talking about Greece since February 2010 (see European politicians hammered from both sides) and had repeatedly warned that the Greek crisis was far from over. So, we are not so concerned about this. That is not to say that we aren?t concerned at all, but we are saying this to remind our readers to keep things in perspective.

What we are more concerned are the unexpected and unanticipated mishaps. That could be war, geo-political tensions, which the financial markets are currently underestimating the likelihood. We have to include the economic (or rather, political) situation in China. It is well-known that China intends to transition its economy away from investment towards consumption. That will definitely result in Chinaslowing down and paring back their demand for Australia?s commodities. But as we said before, What Black Swan can hit China?, this too is also highly anticipated. But take note, the slowdown in the Chinese economy is a political event. The real estate crash that is happening inChina right now is an act of political will by the Chinese government. A lot of Chinese property developers are in financial trouble today because they failed to anticipate the determination of the Chinese government to burst the real estate bubble. Previously, the Chinese government was weak with regards to reining in the bubble and as a result, they lacked credibility when they announced the latest bubble-fighting policies. But unfortunately for the property developers, the Chinese government was serious this time and that was the Black Swan for them.

Regarding China, the million dollar questions that we would like to know are:

  1. Will the slowdown of the Chinese economy veer outside the designs of the Chinese government (i.e. crash)?
  2. When that happens, the Chinese government will definitely intervene. The question is, will they be successful in arresting the unanticipated crash?

In Australia, we already have our hands full dealing with the stress that is currently affiliating our economy (due to the effects of Peak Debt and the planned Chinese economic slowdown). A Chinese economic crash will be the trigger that breaks the straw.

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What Black Swan can hit China?

Wednesday, January 18th, 2012

We are now in 2012 and there are plenty of talks in the mainstream media about a possible hand-landing for the Chinese economy. In today’s article, we shall not go too deep into the details. This article by Paul Krugman explains the mainstream thinking very well. Nevertheless, despite the mainstream speculation of a possible hard landing, the financial markets are still pencilling in a soft landing. This may change as more data is released to indicate otherwise.

We don’t dispute Paul Krugman’s thesis of why a hard landing is coming. In fact, as we read his articles, we find his argument familiar- in fact, they seem to come from Michael Pettis, a professor at Peking University’s Guanghua School of Management. We read his articles regularly for insights, along with Patrick Chovanec’s. Even our favourite contrarian, Marc Faber is echoing warnings that while all eyes are looking at Europe’s problems, China may surprise on the downside.

Now, from all these ample warnings, we can establish the fact a Chinese economic hard landing will be the most anticipated ‘surprise’. We say it is a ‘surprise’ because 12 months ago, most mainstream pundits will scoff at the idea of China facing a hard landing. Today, they are talking about it. But you have to bear in mind that despite all these talk about it, the mainstream consensus is that whatever is happening to China’s economy today are well within the designs of the Chinese government (or rather, the Chinese Communist Party). The fact is, the Chinese government are engineering some sort of a landing for the Chinese economy. Maybe they may overdo it and err towards the territory of hard landing, giving the economy an extra dosage of tough medicine. But at the end of the day, the belief is that the government is still in control.

Of course, we are not going to argue for or against that. In fact, any self-respecting contrarian should already be preparing for a possible Chinese hard-landing the same way airline passengers prepare for mishaps by putting on seat-belts. In other words, it should be a routine manoeuvre. But what will separate the average from the excellent will be the look out for unanticipated Black Swans. For us, we are trying to evisage what kind of serious mishaps that are outside the designs of the Chinese government that can happen. We shall call that mishap a ‘crisis.’

As we mentioned before in Warning: China MAY be near an economic crisis, we mentioned that

The question was put forth to Victor Shih on what he thought may be the trigger for a financial/economic crisis in China. The usual suspects of what the trigger may be usually comes in the form of an external shock (e.g. collapse of Euro-zone, global recession) that crunch China?s export industry. Surprisingly, that wasn?t his consideration. Victor Shih offered his favourite theory (though he emphasised that it is by no means a prediction) that when it comes to the point when China?s elite begin to pull its vast wealth out of China, that will be the thing that trigger a crisis. This could happen, for instance, when the elite find that the returns on/of their investments inside China is floundering.

Already, there are some anecdotal evidence that this is already happening as this article from the Financial Times reported. On the macro level, we saw this article recently,

China?s foreign-exchange reserves dropped for the first time in more than a decade as foreign investment moderated, the trade surplus narrowed and Europe?s crisis spurred investors to sell emerging-market assets.

For now, the decline in China forex reserves are blamed on hot speculative money pulling out of China i.e. foreigners. But if it comes a day when China’s own elite are pulling out their wealth out of China en masse in sufficiently large volume, it has the potential to develop into a crisis.

How? Let’s imagine this scenario.

Let’s say the Chinese government get spooked by Europe and the collapsing real estate bubble in China. And let’s suppose the Chinese government decide to print copious amount of money and loosen the credit spigot in an attempt to re-stimulate the economy. What if this does not work? Then firstly, the liabilities of the People’s Bank of China will increase. As we wrote in Is China allowed to use its US$2.4 trillion reserve to spend its way out of any potential crisis?,

According to the chart provided by Pivot Capital?s report, only a little over 20% of China?s total currency (plus gross external debt) are ?backed? by their US dollar reserves, which isn?t spectacular compared to other emerging economies. In fact, South Africa is the winner in this aspect because their reserve coverage ratio is almost 160% i.e. it has $16 of reserves for every $10 of currency.

That aritlce was written in 2010. We believe that today, even less than 20% of China’s today currency are ‘backed’ by US dollar reserves. If China prints money even further in 2012, that percentage may go even lower. Now, combine that with capital flight out of China from China’s elite. Then China can face with two stark choices: (1) maintain the peg and have a currency crisis or (2) let the RMB depreciate further and risking a trade war with the US by pissing off Congress.

Now, we have to make clear that this is just a conjecture, not a prediction. It may not happen. Even if it will happen, it may not happen in 2012. But it is something we keep at the back of our minds. If our conjecture turns out true, this is a real Black Swan. Make sure you tell people that you read about it here!

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Posted in Economics/Finance, Looking Forward, Market Observations | No Comments »

Warning: China MAY be near an economic crisis

Monday, October 3rd, 2011

More than a month ago, we were listening to a video interview with Victor Shih, of Northwestern University, and Carl Walter, co-author of Red Capitalism, on China?s banking system. It is a very interesting interview by experts who really know their stuff.

In this interview, one thing stuck in our mind. The question was put forth to Victor Shih on what he thought may be the trigger for a financial/economic crisis in China. The usual suspects of what the trigger may be usually comes in the form of an external shock (e.g. collapse of Euro-zone, global recession) that crunch China’s export industry. Surprisingly, that wasn’t his consideration. Victor Shih offered his favourite theory (though he emphasised that it is by no means a prediction) that when it comes to the point when China’s elite begin to pull its vast wealth out of China, that will be the thing that trigger a crisis. This could happen, for instance, when the elite find that the returns on/of their investments inside China is floundering.

Indeed, we notice that one of our favourite China experts, Patrick Chovanec is getting more and more nervous about China over the course of past several months. Today, we read from his latest blog post,

For the moment, I?m reminded of that song: “Something?s happening here; what it is ain?t exactly clear.” But ? and this is the real point ? something is happening, and people both inside and outside of China are right to be nervous.

…

My experience, talking to numerous investors and economists, is as follows: the closer you are to running an econometric model, the better you feel about the Chinese economy; sure, there may be bumps along the road, the models tell us, but fundamentally the momentum is so strong that growth will stay on track. The more you go out and look around, and listen to your gut, the more worried you become. Something?s happening here, what it is ain?t exactly clear ? but it feels bad, very bad. The problem with models, and the reason I?m inclined to stick with my eyes and my gut, is that models work very well when prior patterns of perception and behavior remain constant, but are very poor at noticing inflection points where the way people think and act undergo a shift. In other words, they are very poor at identifying moments of crisis.

Indeed, some sort of a credit meltdown is brewing in Wenzhou. If you have friends in China, you can ask them about Wenzhou because it is in the Chinese media lately. We are heard a story that the Bank of China is offering an extremely high overnight interest rate for high net-worth investors with a big sum of cash.

There is another interesting observation that is quite unusual. China’s RMB is widely perceived to be undervalued. This can be seen by the fact that the RMB is always bumping against the upper band of the government-imposed US dollar exchange limit. But today, the RMB is bumping against the lower limit of the band. It looks like the RMB ‘wants’ to depreciate against the US dollar.

Why?

As Patrick Chovanec wrote,

Presumably because the capital account had flipped, and speculators were now rushing to turn their RMB into dollars in order to take their money out of China.

…

What the new downward market pressure on the RMB does indicate, however, is that China ? for so long a no-brainer destination for investment ? has turned into a big question mark. And it suggests that at least some domestic Chinese investors who have been inclined to sock their money into empty villas and condos ? or big stockpiles of raw materials ? are now looking for a way out.

That’s exactly Victor Shih’s pet theory about a possible trigger for a financial/crisis in China. Although Patrick Chovanec reckons that this does not mean a collapse in the RMB because China’s vast hoard (US$3 trillion) of US dollar reserve can allow it to defend the RMB, we aren’t so sure.

Why?

As we wrote early last year at Is China allowed to use its US$2.4 trillion reserve to spend its way out of any potential crisis?

According to the chart provided by Pivot Capital?s report, only a little over 20% of China?s total currency (plus gross external debt) are ?backed? by their US dollar reserves, which isn?t spectacular compared to other emerging economies. In fact, South Africa is the winner in this aspect because their reserve coverage ratio is almost 160% i.e. it has $16 of reserves for every $10 of currency.

Since China had been printing copious amount of money too, the People’s Bank of China’s (PBOC) liabilities (RMB) far exceeds its asset (US dollars). If say 30% of China’s RMB wants to exit China, this could easily trigger a currency crisis for China. Is this too far fetched? We don’t know and we do not have the data to give a definitive answer. But this is something you have to watch out for.

It is no secret that Australia’s economy is highly reliant on China. In light of what’s happening in China, Australian investors better be prepared. By the way, in this Youtube video, Marc Faber advised that some sectors of China’s economy may crash.

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Posted in Looking Forward | 9 Comments »

Is China’s electricity shortage be the trigger for a crash?

Tuesday, June 28th, 2011

As you read the mainstream media, you will find that more and more attention are paid to the fundamentals of China’s economy. Recently, reports of Chinese ghost cities made its way to the newspapers and TV news reports. Attention are brought into the inflation problem that China is facing, and the efforts by the authorities to clamp down on the property bubble that are brought about by real estate speculation. Then we hear reports on the MSM of characters like Jim Chanos, who famously made the claim that China is Dubai times 1000. So, it is fair to say the mainstream is catching on the scepticism of China’s economic ‘miracle’.

While it is true that the mountains of bad debts, excesses, bubbles, corruption and price inflation in the Chinese economy are unsustainable in the long run, it is another matter to predict when this unsustainable trend will result in an almighty crash. As Professor Chovanec put it astutely, China’s bubble is “extremely persistent,” though he is careful to qualify that that it is by no means sustainable.

So, a week ago, when we saw this news article about electricity shortages, we wondered whether a hard landing for China is near? As that BBC article reported,

Offices and shopping malls in the Chinese city of Shanghai will be urged to close their doors on the hottest days of the year this summer.

The power rationing is necessary due to the country’s shortage of electricity.

The electricity grid serving China’s financial hub does not have the capacity to meet peak demand the authorities say.

China has been coping with power shortages since March, because of coal supply problems and a drought.

If you are curious about the answer to this question, our friend, Paul Adkins, from AZ-China had completed an in-depth study of the situation in China this summer, as the country runs out of electricity. (You can order this report by contacting them on their web site. And note that we do NOT receive any commissions for any sales of their report.) We have read the report and can only provide you with our interpretation of the most important facts…

This is not the first time China is suffering from power shortage. The last it happened was “especially in 2004, but also in 2006 and 2008.” Today, the primary reason for the electricity shortage is the high price of coal. Coal is the main input cost of producing electricity in China. Unfortunately for the power generator, the price of electricity in China is capped by government decree.

The result?

As AZ-China’s study reported,

High coal prices and relatively lower electricity price increases have combined to deteriorate the fiscal situation of power producers, making power plants lose motivation to increase capacity utilization.

Now, the current ‘shortage’ of electricity is not due to a real physical shortage. The power generators, in fact, have excess spare capacity. As the study continued,

The utilization of thermal generators has not reached the historical maximum point.

Utilization hours of thermal power equipment was 5,031 hours in 2010, 16% lower than 5,991 hours in 2004, indicating the [Independent Power Producers] IPPs can improve utilization. On a theoretical basis at least, they can fill the power supply gap; it should only be a matter of time before the National Development and Reform Commission releases policies for stimulating increased power generation.

And here is a very interesting dynamic that is happening in China. As Paul Adkins wrote in his blog article,

The electricity generation companies have been baulking at paying the high price, and running only on contract coal, which they purchase for a much lower cost.That?s on the surface, but there?s more to it. The power generation companies certainly buy coal at a lower price than the spot market. But here?s the rub. They are re-selling their coal back into the spot market. they take as much coal as the contracts allow, then sell ?surplus? coal. In some cases, their reported profits have come more from reselling than from power generation.

So, the power generator ran out of coal, but it becomes the Government’s problem.

Now, you may wonder, in an authoritarian country, why don’t the government order the power producers to produce more and solve the problem at a stroke?

Well, here is the power of incentive at work. As Paul wrote in his blog article,

Because the key people in every layer of management are measured by the Communist Party?s Organisation Department, using profit growth as the key measure. Careers are at stake, but they are built not by doing what is best for the country in some altruistic way, but through turning in a report card that shows you made money during your tenure in that job.

Once you understand the situation, you will be able to understand that the present electricity shortage is due to economic policy screw up, not due to an actual physical shortage.

Hence, the quickest remedy the government can make to alleviate the situation is to raise the price of electricity. But wouldn’t this result in rising price inflation? The short answer we can give you from reading AZ-China’s report,

A moderate power price rise won?t be a great influence on CPI.

That’s the good news. The bad news is that this is a temporary fix for 2011. The problem is in 1 to 2 years time,

… as the failure to keep investing in thermal power generation creates an ever-larger gap with demand.

That’s when the real physical shortage will occur.

So, if someone’s going to short China today on the basis of the present electricity shortage, we wish them good luck!

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Posted in Looking Forward | 2 Comments »

China is slowing down

Wednesday, March 23rd, 2011

Many things happened since we last wrote. The earthquake in Japan was the biggest news of the day. As Japan’s nuclear crisis unfolded, stock markets around the world panicked amidst screams of “nuclear meltdown.” Today, the nuclear situation in Japan seemed to be stabilising, even though the long-term radiation impacts are still unclear at this moment.

To help you keep things in perspective, please note one thing about Japan’s nuclear crisis: despite screams of “nuclear meltdown,” there is ZERO chance of a nuclear explosion. A nuclear reactor is NOT a nuclear bomb. Our guess is that this nuclear crisis is just a blip in the economic big picture, even though in some localised areas in Japan, it is the end of the world (e.g. some areas may not be habitable for a long time). Therefore, contrarian investors may use this opportunity to buy Japanese stocks (we know it is probably too late to do so now).

However, do not let the nuclear crisis distract you to a more important development that is already brewing for quite some time- the coming slowdown in China. This development is far more important than the Japanese nuclear crisis, which by now is no longer a crisis. Remembered we wrote in January last year at Chinese government cornered by inflation, bubbles & rich-poor gap,

By not allowing the yuan to appreciate, the Chinese government shows that at least for now, they fear unemployment and excess capacity more than inflation.

But there will be a day when they have to tackle the inflation problem. As long as the inflation problem is not solved, there will be rising prices and bubbles in the asset markets.

Today, we can say that the Chinese government are tackling the inflation problem. 2009 and 2010 was the year when they pumped in steroids into the economy. Today, they are dealing with the effects of the steroids- price inflation. China is tightening monetary conditions (e.g. rising interest rates, increasing bank reserves requirements) for quite some time already. They are serious about dealing with price inflation, at least for now. Premier Wen Jiabao had already declared that China’s target for economic growth will be lower (see China lowers growth rate target in sustainability drive), from 8% to 7%. Incidentally, the lower target of 7% is pretty close to Gary Shilling’s (a respected bear on China) definition of a ‘hard landing’ in China, which is a growth rate of 6% or less.

So, it should be extremely obvious by now that China’s economy will slow down this year. In other words, China is aiming for a soft landing.

The big question is, when the slowdown begins to bite, will China step on the accelerator again? Our belief is that there’s too much vested interests in China to keep the growth going and to prevent the bubble from bursting spectacularly. Also, the central bank in China is not independent. Thus, as we wrote in Why should central banks be independent from the government?, without an independent central bank, the bias in China is towards more inflation.

The risk for China (and by extension, Australia- see Turkeys fattened for slaughter in the Chi-tralia bubble) is that the control freaks in Beijing may stuff up and either turn the soft landing into a hard landing or losing control of inflation.

Watch this space.

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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 »

China’s Aluminum Industry – where to from here?

Sunday, October 17th, 2010

Today, we will be having a guest post by Paul Adkins, Managing Director of AZ China Limited. Paul lives in Beijing and thus, has a first hand view of what is going on in China. Many of our readers appreciate the insights offered by Paul that can be found in no where else.

One issue facing China?s government as it mulls the next five-year plan: What to do about the country?s aluminium industry? While this might seem a minor matter, it symbolizes a major dilemma that faces the country, namely, how to balance concerns for economic growth with those for energy use and environmental protection.

China is now the largest single producer?and consumer?of aluminium and will make about 17 million tonnes this year, up 20 percent from last year. But that record comes at a steep price. Aluminium production not only consumes about 8% of all electric power in China, but also is responsible for large amounts of carbon dioxide (CO2) emissions.  And the electricity needed to power the industry has a multiplier effect on pollution problems because 70% of China?s electricity comes from coal, a major contributor of CO2 emissions.

The China Nonferrous Industry Association (CNIA), which represents the aluminium industry, recently published a draft plan calling for aluminium capacity to be limited to 20 million tonnes in the next five-year plan. But China is already over that cap, with about 21 million tonnes right now. Given the new smelters already under construction, total capacity could reach as much as 28 million tonnes by 2012.

Beijing recently indicated it is serious about reducing energy intensity ? the amount of energy consumed per unit of GDP ? and sees aluminium as a major culprit. As an example, it takes at least 12,000 kilowatt hours (kwh) to produce one tonne of metal. But so far, the authorities have chosen to target the steel and cement sectors, and largely left aluminium untouched.

The choices now in front of the planners and politicians are profound. They could simply allow market forces to dictate the industry?s future, with the laws of supply and demand determining not only metal production, but also energy use and CO2 emissions. Then again, the China aluminium industry has not shown itself to be totally subject to such forces. Smelter capacity has run well ahead of consumption, especially in the last few years. Meanwhile, proprietors have struggled to make a decent return on the huge investment needed for a smelter, as the price of aluminium is determined on the Shanghai Futures Exchange, and may have no relation to operating costs, much less capital costs.  Because of the huge capital costs, long-term contracts for electricity and other key inputs, and the cash flows involved, producers often run at full operating speed to maximise efficiency, despite apparent losses on the metal price.

Alternatively, they could put limitations on the aluminium industry, with the caveat that such efforts can have unintended repercussions. In 2003, for example, the Government decided to crack down on old inefficient smelters and ordered those with less than 50,000 tonnes of annual capacity to shut by the end of 2004.  Many proprietors simply built expansions or upgraded their technology, and industry capacity shot up, not down.. Indeed, even the CNIA has admitted that it is virtually impossible for the government to control the industry. One risk is that Beijing could be left embarrassed if the industry ignores new edicts.

Even if Beijing were successful in reducing aluminium capacity, it would come with economic costs. In addition to the loss of thousands of jobs in the country?s 120 smelters, it would cause ripples in associated businesses, including raw materials suppliers, downstream factories, and the many support industries that surround a smelter. For stockholders, any limitation on capacity would cause the share price of China Aluminium (Chalco) and other publicly listed smelters to soften. Investors needed to see growth strategies, which would not be available in the Aluminium industry. (Chalco has already started alternative strategies, embarking into iron ore, copper, gold and now rare earths.) As well, such a decision could affect billions in loans outlaid for the many new projects currently under construction.

There is also a global dimension to this dilemma. Russia stands poised to sell aluminium to China in the event of supply shortages. The world?s aluminium companies source many of their raw materials from China. If Chinese smelters are constrained, the value of China’s exports of raw materials will decline.

In the end, the decision on aluminium might come down to one of the country?s scarcest commodities: energy. Aluminium is called ?frozen electricity? because of the huge amounts of electricity needed to produce it. It seems more sensible for China to import aluminium, even at the cost of lost jobs, to gain the benefits of saving energy and limiting pollution.

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Posted in Market Observations | 2 Comments »

What can you do to protect yourself from increasing currency volatility?

Sunday, September 19th, 2010

Six months ago, we wrote about America’s consideration to label China as a “currency manipulator” in Watch April 15 2010: simmering tensions between US and China. Just before the deadline, China appeared to make a little concession about their RMB, thus avoiding the “currency manipulation” label.

Today, currency tension between the US and China is rising again. The little concession that the Chinese government made was simply not enough. American lawmakers are getting impatient and are itching to enact laws to slap China with trade sanctions. Should that happen, it will be the beginning of a damaging trade war between the world’s largest economies. Their charge is that China’s artificially low currency is responsible for (or at least contributed to) America’s economic woes. But as we wrote in Watch April 15 2010: simmering tensions between US and China,

But the mob wants to find a scapegoat to blame for their woes. It so happens that the most convenient scapegoat is China (specifically, China?s policy of artificially holding its currency down) because at this point of the cycle, China is looking very good. It is perceived that this policy worsen America?s unemployment rate. By implication, it is perceived that with China?s official unemployment rate much lower, China is ?prospering? at America?s expense.

Currency tensions between China and the US are nothing new. As we wrote in that article, it’s been around for the past 3 to 4 years. Many times, the rhetoric about America labelling China a “currency manipulator” came and went away without eventuating into reality. However, that does not mean that it will never happen. As America’s economic woes worsen, the pressure to find a scapegoat will increase. As a result, the probability of a trade war will increase.

The Chinese, on the other hand, are not standing idle, waiting for a trade war to happen. For starters, they are establishing trade and investment links with Asia, Middle-East and Africa. Secondly, it is no secret that they have been diversifying their colossal hoard of reserves away from the US dollar. Given the well-known intention of the Federal Reserve to print more money, diversification has become increasingly urgent. But that in itself is not easy because given the colossal size of the money involved, any whispers and hints about any particular Chinese diversification strategy will move the markets quickly in a big way. For example, the recent rumours that China was buying up Japanese government bonds probably helped to contribute to the surging yen. As a result, the Japanese government became very unhappy because a very strong yen will negatively impact on their export-oriented economy. In response, the Japanese government may take concrete actions (beyond just talking about it and taking token measures) to weaken the yen, in which the end result is more Japanese purchase of US government debt.

In such an environment of competitive currency devaluation and price volatility, what should investors and savers do?

To us, it is clear that having all your savings and investments confined to a single country or currency is an increasingly risky proposition. Currency exchange rates will become more volatile, with implications on asset values, price inflation and economic growth (see Real economy suffers while financial markets stuff around with prices). For example, in Japan, real businesses are suffering as a result of the rising yen. The Germans, on the other hand, are secretly gloating whenever the euro weakens. In Australia, should the banking system fall into a crisis as a result of the bursting of the property bubble, the consequence of a resulting collapsing Australian dollar will be price inflation (see Can price inflation occur in the midst of debt deflation?).

If currency volatility goes to the extreme, investors will even have to question the idea of national currency as a store of value. So, what can investors and savers practically do to mitigate against this?

Quite some time ago, we talked to the guys at GoldMoney.com and learnt of how a lot of their clients (presumably the “rich”) use them. In case you do not know, GoldMoney.com (a regulated company operating in the financial services industry) enables

… you to hold gold, silver & platinum that is fully insured and stored securely in specialised bullion vaults in London, Zurich and Hong Kong. All metal is owned directly by you with no counterparty risk.

You can “easily buy gold, silver & platinum and take delivery of physical bars of gold.”

What their clients did was to use their GoldMoney.com account as a conduit to link their bank accounts all over the world. This strategy makes sense as it gives investors and savers the flexibility to shift their savings all over the world, using gold, silver and platinum as an anchor for the store of value. In an environment of currency volatility, this flexibility is a valuable aid in helping to protect your hard-earned savings from hare-brained government interventions.

However, for those who are ultra-pessimistic and distrust any assets that have any hints of paper, the only way to go is to take possession of physical gold and silver (see How to buy and invest in physical gold and silver bullion).

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Posted in Advertising/Affiliates, Currencies | 4 Comments »

Is Chinese iron ore demand going to crash (thereby crashing the Australian economy)?

Sunday, September 12th, 2010

Last Thursday, an article in the Sydney Morning Herald screamed, Slump likely in iron ore demand,

Chinese demand for iron ore seems set to slump after Beijing’s extraordinary move to turn off the power supply to its industrial heartlands.

There seemed to be fears in the industry that the Chinese government is slamming on the brakes on their economy. As the article continued,

Radical power cuts across the country reflect the promise of the Premier, Wen Jiabao, to use an "iron fist" to achieve tough, five-year energy intensity targets that expire this year.

There seemed to be an air of incredulity floating around. Is the Chinese government really hell-bent in crashing their own economy? As one of Macquarie Bank?s commodities analyst said,

You can’t just turn steel production off and expect the economy to function – it’s insane.

If the Chinese government are really that insane, then it doesn?t take a genius to figure out that iron ore prices will slump significantly going forward. Share prices of companies like BHP will follow as well.

But are they really that insane?

To answer this question, we recalled a comment by one of our readers (Paul in Beijing) in Concerns about China?s slowdown,

Put this in your diary. The restrictions will last until November. By December this year, production of key items such as steel and cement will be returning to full pelt.

As Paul said in Do you think China will crash soon?, we are now at the final months of China?s 11th five-year plans.

The first is that the 11th 5-year plan is now just a few months away from concluding. As in all political situations, it is of paramount importance for the current leadership to return an unblemished report card at the next Plenary meeting of the Communist Party. Hence the attacks on inflation, energy intensity and other issues.

What we think has happened is that on the issue of emission targets, the Chinese government realised that they were not going to reach it at that rate it was going. They had a set of numbers for the targets to reach by the end of this year and they realised that they weren?t going achieve that based on the status quo. Hence, the urgency to slam on the brakes so that at least where the aggregate numbers were concerned, they had done their job.

Why is it so important to reach the targeted numbers? Some say it?s a matter of saving face. That is, not reaching the targeted numbers is humiliating for the government. Others say it is a matter of having a perfect report card for the Hu-Wen team. That is, reaching the targeted numbers is another tick in their report card.

But assuming that by December, the restrictions are relaxed, the Australian economy is still not out of the hook yet. As Paul said,

The second point is that the 12th 5-year plan has not yet been promulgated. Already there are rumblings as to what it might include. The China Nonferrous Industry Association, for instance, has drafted a plan that would limit the capacity of alumina, aluminium and copper over the next 5 years. If such a plan were to be introduced, it would have massive repercussions for the world (buy UC Rusal shares for a start!).

In hand with this is the fact that the current leadership has only 18 months left in their tenure. The next generation of leaders has apparently been tapped and is being groomed. But unlike the present pair, the next generation come from opposite factions within the CPC. their ability to lead harmoniously may well be sorely tested! (Should they fall out, it would leave the Howard-Costello schism, or the Gillard-Rudd antagonism, for dead.

This is what we have to watch out for!

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Posted in Looking Forward | 2 Comments »

Credit problems in China

Sunday, August 8th, 2010

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

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

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

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

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

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

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

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

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Posted in Market Observations | 2 Comments »

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