China Said to Be: "Hand to Mouth"; No, That's Not an Old Chinese Saying, It Means the Commodities Bears Are Feeling Their Oats (If Bears Eat Oats)

Sometimes it just seems as though Groundhog Day got it right.  Almost exactly one year ago, I wrote the following blog post, which soon enough proved highly accurate:  Goldman Wrong on Rates, Zero Hedge Wrong on Oil As Deflationary Side of Biflation Begins Its Ascendancy (June 8).  Well, Zero Hedge might be correct that 2011 is being repeated this year... but it's possible that presidential election years could be starting a new pattern.  Heavens forfend, it could be more like 2008.

Here's a new reason why:

Today (May 21) we see this breaking article from the Financial Times.  Its  focus is on raw materials but it also contains bearish commentary about China’s overall economy.  Here are excerpts:

Singapore/London: Chinese consumers of thermal coal and iron ore are asking traders to defer cargos and – in some cases – defaulting on their contracts, in the clearest sign yet of the impact of the country’s economic slowdown on the global raw materials markets.
The deferrals and defaults have only emerged in the last few days, traders said…

“China is hand to mouth at the moment.”...

Other key economic indicators followed by Chinese policy makers, including electricity consumption, rail cargo volumes and disbursement of bank loans, point to a sharper slowdown, suggesting the risk of a hard landing.

Soft commodities such as soyabeans and cotton have also seen Chinese customers default in the past two weeks, a trader at a third global trading house said…

Highlighting a “worrying” weakness in consumer spending inside China, Kim Youngha, the head of Samsung’s China operations, said he expected the domestic market for technology goods to grow 7 per cent this year in China, down from 10 per cent last year.
Yu Song, analyst at Goldman Sachs, told clients last week that Chinese economic activity was “exceedingly weak”. 

A number of the individual commodities that I follow on the futures boards look technically poised for a relief rally.  The biggie, oil, does not look as promising-similar to last spring.  And, gold is trading at a massive premium to platinum- that should be bearish for gold.  It is indeed possible that since gold trades as a currency and platinum is an industrial metal with important jewelry and investment uses, the traditional discount that gold has carried to platinum ever since catalytic converters came into use may be fading away.  Nonetheless, I'm not brave enough to be favorable to gold prices unless I were even more bullish on platinum.  And all I'm willing to say about platinum is that it's had a huge price drop recently, so short-term it probably a good trade, but given the above news out of China (which echoes the thrust of a NYT article published within the past week), I'm wary that we're going to face a 2008-style commodities liquidation event.  So I'm basically waiting until I see the whites of the oil market's eyes before arguing with the FT per the above report. 

It's the nature of markets to condition investors/traders to one pattern, then do something different.  The resilience of the markets the past three years may simply be failing as real European economic activity continues to surprise to the downside.

Not to overdo the bearishness, but I've been in the markets well over three decades, handled my portfolio well in the 1987 crash and got completely out of stocks in 2000 and again in summer 2007.  So for the many mistakes I've made, I've been lucky re crashes and want to post this from this week's Hussman Market Comment which I just noticed before posting the above:

As John Kenneth Galbraith wrote in 1955, "Of all the mysteries of the stock exchange there is none so impenetrable as why there should be a buyer for everyone who seeks to sell. October 24, 1929 showed that what is mysterious is not inevitable. Often there were no buyers, and only after wide vertical declines could anyone be induced to bid ... Repeatedly and in many issues there was a plethora of selling orders and no buyers at all. The stock of White Sewing Machine Company, which had reached a high of 48 in the months preceding, had closed at 11 on the night before. During the day someone had the happy idea of entering a bid for a block of stock at a dollar a share. In the absence of any other bid he got it."

When the Financial Times publishes the above article on a Sunday, it's my opinion that this news has not made its way into speculative commodities prices.  "Deflation" might be afoot.  Keeping dry investment powder, and being patient with it, is my major current strategy.  To paraphrase Louise Yamada reminds investors (she said it before Jim Cramer):  there's always a bull market somewhere during a decent tape and decent economy.  In other words, prices can rise, and it's OK to be in cash at that time.  I just don't like to lose the most precious financial asset of all:  capital.   
 

Whither the Markets?

Yours truly has been following the news and much Internet/blog commentary lately with interest and calmness. On The Daily Capitalist website, we have seen Econophile opine about a stagflationary outcome, and Keith Weiner provide a futuristic view of some sort of hyperinflationary "crack-up boom", a term used by von Mises.

My view is more toward Econophile's but with some differences in the short term. Here's why. Mr. Weiner suggests that we watch, some years from now, for gold to trade at a higher price in the near-term months on the futures market than in the more distant months (i.e. "backwardation"), and that this will be a warning sign of what he calls a coming financial Armageddon. Without beating a theoretical horse that may or may not occur, I can think of a number of reasons why gold could go into sustained backwardation without leading to a breakdown of trust in the financial system. Reasons could include demonetization of gold, manipulation, mania, off-market contracts for gold delivery, and a general deflationary trend in prices of tangible goods, as well as the possibility of centrally-dictated negative interest rates.

In any case, perhaps a hyperinflationary depression is in our future, as Mr. Weiner posits. Shorter-term, I think we truly need to worry about a global industrial recession. My read of the commodity markets is consistent with that.

There is one very interesting topic in Econophile's linked post that I will address. That point relates to his statement that not all capital was consumed by the crash. I wonder. Certainly the physical structures of the United States were not damaged. There were no enemy bombs bursting in air, no giant toxic radioactive leaks, etc. But what if all banks, more or less, were bankrupt? Then, all the fiat claims and counterclaims tied into worthless bank deposits.

The way I am putting the Armageddon-lite events of the 2008 era together is as follows. The U. S. and Britain suffered a collective financial major myocardial infarction following Fannie and Freddie going into receivership in late summer 2008. This was followed by Lehman's collapse, Sunday evening panicky special broadcasts starring Hank Paulson and the like, President Bush admitting he was violating capitalist principles to save capitalism, and crony capitalism the likes of which America had not seen for many decades. The serial bailouts and intense subsequent money-printing just might be because the authorities took a look at the 40:1 leverage of the investment banks, the (perhaps) 100:1 leverage of the GSEs, and the unknown but high leverage of the other large financial institutions and realized that there was no equity left.

Therefore they just decided to create enough new dollars ("fiatscos") as were needed to begin the cycle anew. Of course, under a debt-based system of money creation, this could only be accomplished with ultra-low interest rates. Thus, "ZIRP". Thus, the Bank of England and "the Bernank" were charged with inventing any excuse to not see price inflation that the whole world sees, or to call it transitory. Thus, periodic endings of money printing, QE 1, QE1.5, QE 2.0, etc., in order to see if the economy was self-sustaining yet. Sort of like a cook taking a dish out of the oven to see if it needed more cooking. If no self-sustaining recovery, well, OK, let's cook it some more (i.e. print more money).

Thus, biflation, as the massive and leveraged capital that went into building too many homes, and too expensive homes, had perhaps destroyed all financial capital in the country, after accounting for debts to foreigners, and without selling the physical country and its mineral rights etc. to the foreigners.

Of course, this is just a theory, and I'm interested in comments. To me, it fits the facts as I see them, and it explains why hyperinflation has not happened and why we may be entering into a period of general disinflation and commodity price deflation as an industrial recession looms. The human, physical and intellectual capital exists, but when the accounting is/was done properly, perhaps the value of all those assets expressed in terms of the money stock that existed as of the summer of 2008 was zero.

If I am correct that the cyclical economy is on the rocks, stocks that will rise or at least hold steady will be few and far between over the next months. These may include utilities, McDonald's and retail discounters. Personally I have taken several short positions to offset my few longs, but mostly I am in cash with a reserve of gold. If I am correct, oil could easily hit $80/bbl on the downside this summer/fall and perhaps could go much lower. $60 has very strong support if $80 decisively fails. If we see $60/bbl, watch for gold to test $1000/ounce before, perhaps, doubling in short order to $2000+. If oil hits $80 and holds, then rebounds on an economic rebound plus QE 3.0 or its equivalent, then gold might hold above $1400 at its worst and then head to new highs by year-end.

Thus I am presenting a somewhat different potential scenario for the months ahead. Let's see what happens. As always, I am data-driven. Anybody who has a high degree of confidence in any sort of prediction and who lacks inside information is in my view overconfident.

Copyright (C) Long Lake LLC 2011

Energy Glut?

Just as I hear from Nashville, TN and Madison, WI that they are having the coolest summer in over a century, the media report evidence of oil over-supply and decreases in energy demand.

1. From the WSJ today: OPEC Braces for Decline in Crude Prices

The Organization of Petroleum Exporting Countries is bracing for a sharp drop in crude prices in coming weeks, as huge reserves of oil-based fuels continue to pile up and the space to store them runs out.

Stockpiles of fuels such as diesel and heating oil are at a 24-year high in the U.S. because of tepid demand from industries and consumers hammered by the global economic downturn. . .

The enormous supplies are pushing available storage capacity to its limit, with some traders reportedly resorting to barges and tankers at sea.

"Inventories are at just ridiculously high levels," said Kevin Rooney, chief executive of the Oil Heat Institute of Long Island, a trade group for heating-oil wholesalers. "I would imagine that just about every available barrel of storage is full."

2. From Bloomberg.com, July 16: Verleger Sees $20 Oil This Year on 'Devastating' Glut

Crude oil will collapse to $20 a barrel this year as the recession takes a deeper toll on fuel demand, according to academic and former U.S. government adviser Philip Verleger.

A crude surplus of 100 million barrels will accumulate by the end of the year, straining global storage capacity and sending prices to a seven-year low, said Verleger, who correctly predicted in 2007 that prices were set to exceed $100. Supply is outpacing demand by about 1 million barrels a day, he said.

“The economic situation is not getting better,” Verleger, 64, a professor at the University of Calgary and head of consultant PKVerleger LLC, said in a telephone interview yesterday. “Global refinery runs are going to be much lower in the fall. If the recession continues and it’s a warm winter, it’s going to be devastating.”

3. Mish had an interesting post yesterday titled Electrical Demand Plunges in Ontario, Canada; US Demand Expected to Drop 2%.

You will likely find it illuminating.

GENERAL COMMENTS:

The 2-year chart of Exxon Mobil Corp. stock is shown. There is no hint of rampant strength. With this price decline and regular dividend increases, the yield is only 2.4%.

Of course, who's to know, but as this blog has documented, economic weakness continues whether or not the "Great Recession" has finally ended.

Forget oil in the twenties: if prices were to merely break
forty on the downside, I would expect XOM's price to fall a good deal more and Treasury prices to move strongly upward (that is, yields would drop in that scenario).

Food for thought.

Copyright (C) Long Lake LLC 2009