FYI | Oct 04 2011
GaveKal offered the following observations this week: Through late July and August, commodities initially appeared resilient to the broader sell-off in risk assets. However, September has been far more cruel to 'real asset' investors, with the GSCI index now down in double digits for the month and at new lows for the year. So what explains this pullback? And does this represent a buying opportunity? As far as we can tell, there are three potential explanations to the recent poor performance of raw materials; and all three argue that staying on the sidelines may make more sense.
* The first and most obvious explanation is the unfolding Chinese liquidity squeeze. Indeed, from rising inventories and accounts receivables, to the start of missed interest payments by the more aggressive property developers, to a sharp drop in excavator sales, most data points now make the case for somewhat weaker growth from China. Of course, this slowdown is hardly surprising since driving the weaker developers into bankruptcy and removing the froth from the system has been official policy for at least the past year. But combine the official tightening of the liquidity valves with a clear crackdown against corruption (the focus of Hu Jintao's speech at the 90th anniversary of the founding of the CCP, the arrest of the Minister of Railways…) and all signs are pointing towards a slowdown in Chinese fixed asset investment (albeit no hard landing)… and, from there, weaker commodity demand growth. That said, commodities imports (coal, iron ore, oil, etc.) have recently been buoyant.
* The second explanation relates to the GaveKal theme of the summer, namely The Unfolding Liquidity Crisis. As we have repeated ad nauseam in recent months, when central banks reserves start to fall (as they have been doing since the spring), one of two things can happen: 1) world trade shrinks (i.e., global recession), or 2) someone running large negative cash flows (Latin America in the early 1980s, Asia and Russia in the late 1990s, Argentina in 2001, Southern Europe today?…) can no longer find financing and goes belly-up.
Now historically, liquidity crises have ended in one of two ways:
a) through a large expansion in the balance sheet of the US consumer and a widening of the US current account deficit, or b) through a collapse in commodity prices, especially oil. Of course, it may be different this time… but then again, it may not and oil/commodities could once again prove to be a key variable of adjustment for the global economic and liquidity cycle.
* The third explanation is far more tentative: it is the possibility that we have now witnessed a turn on the US$. Indeed, the general perception of most investors we meet, and one that we share, is that currencies have become little more than an ugly contest, with every central bank seemingly involved in a race to the bottom-and the Fed leading the pack down. However, we must admit that we are intrigued by the fact that the US$ has not stopped rising, and gold stopped falling, since John Boehner wrote Chairman Bernanke to ask him to stop debasing the US$. Will this letter, combined with the clear attempt by the GOP to constrain government spending (and note that, according to the BEA, real US government spending is now falling more than at any time since the end of the Vietnam War) mark a shift for the US$ and thus US consumption and investment? On that note, it is interesting to see that US core capital goods came out very strongly, raising our hopes that US growth may yet pull through.
In any event, if we are right that we are now entering a phase of weaker fixed asset investment growth in China, that the liquidity crisis has yet to be resolved and that the US$ is now on the uptick, then it seems obvious that the macro environment for commodities is by now far less propitious.
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
GaveKal is a financial services firm that offers institutional investors and high net worth individuals fund management, independent research on global macro-economic trends and events, and independent advisory work on China and its impact on the global economy.
For more information, visit www.gavekal.com
