Posts Tagged ‘India’

Are we in a long-term inflationary environment?

Monday, August 4th, 2008

In our previous article, Is the world already in recession?, we quoted Marc Faber that showed that he believes price rises is in for the long run due to the expected colossal increase in demand from China and India.

Now, you have to understand that Marc Faber is a very long term thinker because he is a student of history. When he talks about the long term, it is in terms of decades, not years. This does not mean that deflation will not occur in the meantime. For the sake of argument, let us assume that this will happen (i.e. if China/India falls into anarchy/chaos/revolution/etc, then this will not happen). This means that in the long run, there will be 3 billion more people in India and China joining the global economy. As we said before in Example of a secular trend- commodities and the upcoming rise of a potential superpower,

It has been said that today?s 21st century will see the secular rise of China. During the 20th century, China endured non-stop revolutions, civil wars, invasions, social upheavals, ideological experiments (e.g. Cultural Revolution, Great Leap Forward). It was the last couple of decades of the 20th century that China began to slowly emerge from her self-imposed shackles to catch up with the West. Napoleon once said that China is a sleeping giant that will shake the world when awaken. Today, despite the breakneck growth of the Chinese economy, China still have a lot of catching up to do in order to attain the same level of affluence, standard of living as the West- there are still hundreds of millions of peasants in China that is still relatively poor by Western standards.

Furthermore, as we said before in The Problem that can throw us back into the age of horse-drawn carriages,

China is growing rapidly in a massive scale. Such massive growth requires massive amount of metals for building skyscrapers and infrastructure. Mining and producing all these metals requires copious amount of electricity. Copious amount of electricity requires copious amount of energy. The recent snowstorms in China shows that the entire nation has a very narrow margin of energy supply before serious disruptions occur. If China is to grow further, its current supply of energy is inadequate. China has abundant coal (it used to export coal). But today, there is not even enough for her energy needs. By now, you should be able to appreciate what is involved (in terms of energy usage) to keep China in its trajectory of growth. And we have not included India into the picture.

To give you an idea of how much commodities and energy consumption will occur in the future, consider this: the amount of diesel Australia used in a year is in order of how much China use in a day! This is before China becomes a fully developed nation. And we have not yet include India into the picture.

This means that in the absence of a revolutionary technological break-through, the earth simply does not simply have enough natural resources to support India, China and the Western world based on the current standard of living of the developed Western nations! The implication is extremely unpalatable: some nations will have to rise at the expense of the others, which may result in armed conflicts (touch wood, heaven forbid!). There implies a shortage of resources, which means there will be immense pressure on commodity prices, notwithstanding the effects of monetary deflation in the coming years.

In such an environment, if central bankers around the world (not just the Federal Reserve) resort to the monetary printing press to pay for the looming shortage or fight deflation, the hyperinflation finale will be hastened prematurely.

In view of this, if we have to choose between investing in resource or financial stocks, we will be more inclined towards the former.

‘Making’ money or wealth preservation?

Sunday, April 20th, 2008

Over the past year, the many countries in the world had witnessed a substantial synchronised asset price deflation. In the US, the median property price is said to have fallen 10% over the past year. The property bubble in the UK and Spain is said to be bursting too. Stock prices in China had falling 50% since the October 2007 peak (see Chinese stock market overrun by bears). The Indian stock market is also falling. The Chinese property bubble in major cities such as Shenzhen is reportedly to be bursting as well. The Australian stock market had fallen 18% from its November 2007 peak, with its financial stock index falling 32%. The Japanese stock market is also in a bear market.

Back in March last year (when it was still a bull market), we said in How does the US export inflation?,

That is why when the US opens up their spigot of US dollars and engages in a global spending spree, foreign countries have to follow suit by inflating their own money supply so that their currencies will not be overly expensive relative to the US dollar. The result is worldwide synchronised price inflation and asset bubbles.

Today, the reverse process is active. With the US experiencing deflation (see How money & credit can shrink (i.e. deflation)?), liquidity is being withdrawn from the global financial system, resulting in a synchronised asset price deflation (see Marc Faber on why further correction is coming?Part 2).

Yet curiously, at the same time, despite the asset price deflation, the world is experiencing price inflation for gold, oil, metals, food (see Why are the poor suffering from food shortages?) and other commodities.

Dear readers, do you see that this combination of asset price deflation plus general price inflation is the worst possible combination for investors? The whole point of investing is to increase the investor’s purchasing power in the long run. This inflation-deflation combination works together to decrease investors’ purchasing power. In Australia, with its high and rising interest rates, a saver does much better than an average investor (assuming that the official CPI figures is a reliable measurement of price inflation- see How much can we trust the price indices (e.g. CPI)?). The worst off are those who borrow heavily to buy assets that are falling in value in a rising interest rate environment.

As we said before in Is this sub-prime or solvency crisis?,

The problem is that much of the economic boom that we enjoy over the past several years are financed by the explosion of credit (which is debt on the opposite side of the balance sheet). There is such a colossal amount of debt created and scattered throughout the globe that it does not take a genius to see that massive amount of bad debts have to accumulate and build up in the global financial system. Eventually, all bad debts will be exposed as what they truly are.

Now, we have a money-printer in the Fed who is answerable to the Congress, who in turn is answerable to the mob (see A painful cleansing or pain avoidance at all cost?), we have the situation whereby the US is attempting to print its way out of mass bad-debt insolvency. Adding fuel to the fire, we have two (one is already more than enough!) 600-pound gorillas, namely China and India, devouring the earth’s resources at a ferociously unprecedented rate.

Is this sustainable? The sky-rocketing gold, silver, energy, metals and food prices could be an indication that resource mis-allocation and mal-investments is accumulating in the global economy. If so, we cannot rule out at least one of the 600-pound gorilla stumbling, bruising its bloody nose and knocking things all over in the short to medium term (see Can China really ?de-couple? from a US recession?).

Our hunch is telling us that something just do not feel right. Thus, now is not the time to be greedy about ‘making’ money. Wealth preservation is our greater concern (see Why should you invest in gold?).

The Problem that can throw us back into the age of horse-drawn carriages

Tuesday, April 8th, 2008

In future, if we look back at 2008, will we find that it is the year of the turning point in terms of global growth? Right now, for all intents and purposes, the US is in recession. Japan looks like it is falling back into recession again. Western Europe seems to be sluggish. But there are other bright spots, namely the BRICs (Brazil, Russia, India, China and perhaps the Middle-East and Eastern Europe) countries. (We know we are generalising here, but we are doing so for the sake of brevity because the focus of today’s article is something else). Thus, there is little wonder that although the IMF is lowering forecasts for global growth, it is still positive (i.e. their forecast does not point to a global recession).

But what is the greatest danger facing the global economy today?

Recently, we read BHP to use half of state’s electricity in the news media:

BHP Billiton will need nearly half of South Australia’s current electricity supply to power its vastly expanded Olympic Dam copper and uranium mine.

China is growing rapidly in a massive scale. Such massive growth requires massive amount of metals for building skyscrapers and infrastructure. Mining and producing all these metals requires copious amount of electricity. Copious amount of electricity requires copious amount of energy. The recent snowstorms in China shows that the entire nation has a very narrow margin of energy supply before serious disruptions occur. If China is to grow further, its current supply of energy is inadequate. China has abundant coal (it used to export coal). But today, there is not even enough for her energy needs. By now, you should be able to appreciate what is involved (in terms of energy usage) to keep China in its trajectory of growth. And we have not included India into the picture.

Maintaining the way of life in the developed Western nations requires huge amount of energy. As we said before in 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.

To elevate the way of life in developing nations (e.g. India, China) to a level that is on par with the developed Western world requires a greater initial upsurge of energy use. After that, to maintain that level of way of life for all these additional billions of people, the world will see a permanently much higher plateau of energy usage indefinitely. It should be clear by now the gravity of the implications of such projections.

Can the earth supply enough energy fast enough to allow the developing world to embark on such a path? The earth may have plenty of energy under the ground (i.e. coal, oil and gas), but can humanity extract them fast enough for such unceasingly growing usage? An analogy for this question would be to imagine yourself trying to breathe through a straw. Yes, there may be plenty of air around you, but if you have to breathe through a straw, there is no way you can do strenuous exercise without turning blue. There are two big-picture issues with regards to the world’s energy supply:

  1. Peak Oil. As we said before in Is oil going to be more expensive?,

    Put it simply, the Peak Oil theory states that the world?s oil production has reached the peak and is entering the stage of terminal decline. One common misunderstanding of Peak Oil is that the world is running out of oil. No, the world is not running out of oil?the world is running out of easily accessible oil.

  2. Energy production capacity Even if you do not believe in the Peak Oil theory, there is another problem. There is not enough infrastructure to extract oil and natural gas from unforgiving and inhospitable terrains (e.g. Arctic, Siberia, undersea). Oil extraction is one problem. Refining them is another infrastructure challenge.

Next, even if energy supply is not a problem, there is another headache- global warming. Burning all these oil, natural gas and coal will release colossal amount of carbon dioxide into the earth’s atmosphere. It will be a sad irony if China and India achieves the same level as the West in the way of life, only to face environmental disasters that will drag them down again.

In summary, supplying environmentally sustainable energy indefinitely at a rate fast enough is a colossal global problem that must be solved. If not, the latter generations will not live better than the current generation. That is where the best investment opportunities lie.

Example of a secular trend- commodities and the upcoming rise of a potential superpower

Wednesday, March 19th, 2008

In the 19th century, Great Britain was the superpower of the day. She was an empire with colonies, commercial interests and trading posts all over the world. Her navy was unrivalled, patrolling the world’s seas. Her currency, the Pound Sterling, was much of the world’s primary reserve currency during the 18th and 19th century.

The 20th century saw the secular decline of the British Empire. Two world wars and economic weakness resulted in the Pound Sterling losing the reserve currency status. At the same time, the 20th century saw the secular rise of the United States into an arguably, empire.

It has been said that today’s 21st century will see the secular rise of China. During the 20th century, China endured non-stop revolutions, civil wars, invasions, social upheavals, ideological experiments (e.g. Cultural Revolution, Great Leap Forward). It was the last couple of decades of the 20th century that China began to slowly emerge from her self-imposed shackles to catch up with the West. Napoleon once said that China is a sleeping giant that will shake the world when awaken. Today, despite the breakneck growth of the Chinese economy, China still have a lot of catching up to do in order to attain the same level of affluence, standard of living as the West- there are still hundreds of millions of peasants in China that is still relatively poor by Western standards.

Now, take a look at the United States today. With only a few hundred million people, the US consumes more oil than any other country in the world. China, with four times the population of the US, still does not consume as much natural resources as the US. What if China is to attain the same level of affluence and standard of living as the US? Imagine the amount of natural resources that will be consumed! We are not even sure whether the earth has enough resources to accommodate a nation that is equivalent to four United States in terms of population.

At this point, we still have not yet included Russia, Eastern Europe and India into the picture. Assuming that all these nations are to rise towards the level of the West as China is doing right now, imagine the strain their demands will be imposed on Mother Earth!

It has been said that demand for commodities follow a cyclical pattern. During recessions, the demand for commodities decline and during booms, demand rises. For example, copper is nicknamed the metal with ‘PhD in economics.’ The demand for copper is said to follow the business cycle.

Then there are people like Jimmy Rogers who believe that commodities are now in a upward super-cycle. Of course, there are sceptics to this super-cycle theory because of their underlying conviction that commodity demand still follows a cyclical trend. But what is the underlying belief of the commodity super-cycle theory?

Armed with the understanding from our previous article, Understanding secular vs cyclical, you can see that the rise of China (and India, Russia, etc) that we just described is a secular trend. Thus, the demand for commodities that supports this secular trend must also follow a secular trend too.

But does that automatically mean that commodity prices will go up and up for ever and ever for a very long period of time? From the short-term bubble in metal prices in 2006, it is obvious that there are many speculators who misapplied the commodity super-cycle theory to the extreme. For example, copper prices climbed so rapidly in the short-term that by mid-2006, after having risen in a parabolic path, its prices suffered a major correction.

Now, cast your eyes back to the 1930s in the US. With hindsight, we can easily see that the Great Depression was a traumatic setback in the secular rise of the US in the 20th century. But in the end, the US survived and went on to become a world superpower. The same goes for China. Although we believe China may be facing a major correction down the years (see Can China really ?de-couple? from a US recession?), it does not necessarily mean that her secular rise in the 21st century will come to an end, unless something really drastic happens to plunge China back into the dark ages of the 20th century. As such, her demand commodities will always rise in the long run. The best phrase that explains this point is from our previous article, Understanding secular vs cyclical:

 Sometimes, within a larger secular trend, there are cyclical sub-trends.

As long-term investors, we should not lose sight of this big picture. Sure, commodity prices can even correct 50% in the short to medium term, but do not let the cyclical sub-trends cloud your understanding of the underlying secular trend.

Is oil going to be more expensive?

Friday, November 10th, 2006

For the past couple of months, oil price had fallen from a high of US$78 to a low of US$57. Many reasons were given, ranging from rising US oil inventory to quieter than usual hurricane season in the Caribbean. Consequently, that gave the Dow Jones an excuse to rise on the back of an ?improved? consumer sentiment.

But what are our convictions for oil prices? We have no confidence in predicting the price of oil in the immediate short term. But we have an opinion on where oil prices are heading in the long term?we believe the direction is up. What is the basis of our conviction?

Firstly, we look at the fundamentals?the dynamics of supply and demand.

On the demand side, the rises of China and India in the 21st century, with their massive populations, will have an immense impact on the world?s total demand for oil. As the East (China and India) get wealthier by the day (see our article, Transference of wealth from West to East), you can expect the rise (in numbers and prosperity) of their middle-class to increase the strain on the earth?s resources. Today, the US, with a population of only a fraction of China and India, consumes far more than its proportionate share of the earth?s resources. Imagine how much China and India will consume as they attain towards the current living standards of the US! Next, we have to ask ourselves another question: will the increase in usage of alternate and renewable energies eventually supplant the usage of oil? While we do not know how the usage of such energies will turn out in the future, we can be sure that it will take quite a long time for the world economy to retool and wean itself from oil. This is because the world economy is running on the basis of cheap and abundant energy.

Now, let?s look at the supply side. According to a growing consensus in the scientific community, the world is approaching the stage of Peak Oil. Put it simply, the Peak Oil theory states that the world?s oil production has reached the peak and is entering the stage of terminal decline. One common misunderstanding of Peak Oil is that the world is running out of oil. No, the world is not running out of oil?the world is running out of easily accessible oil. This factor, along with the inadequacy of the world?s oil infrastructure led to dwindling of the global spare oil capacity to a 20-year low. With razor thin spare capacity, all the world needs is an unexpected supply disruption to cause oil prices to shoot up as it had happened recently. Thus, as the article in the Sydney Morning Herald said, there is an urgent need to increase global oil production capacity:

THE world’s top finance ministers and central bankers will meet in Melbourne next week to discuss attracting $US8 trillion ($10.4 trillion) in energy investments to avoid production shortfalls.

The startling forecast of the 30-year investment funding needed to bolster inadequate oil and gas capacity – which implies that the oil price could soar far above yesterday’s $US59 a barrel – is in an International Energy Agency report commissioned by the G20, which is to meet on November 18 and 19.

A third factor may lead to increase in oil prices?monetary inflation. Since oil is priced in US dollars, any deterioration in the quality of the US dollar will have an upward effect in the nominal price of commodities, oil included. We will discuss this issue in more detail in the future.