Tag Archives: Agriculture

article 3 months old

The Overnight Report: Muni Market Meltdown

By Greg Peel

Up by the stairs and down by the elevator - after a week of tentative gains Wall Street gave it all back on Friday as a wave of bad news hit the markets. If you want to make it sound really disastrous, it was the worst leap day on Wall Street since the nineteenth century, but in nominal terms that 's a bit sensationalist.

Friday saw a meltdown in the municipal bond market. The subprime mortgage crisis which the bulls called a storm in a tea cup last July has spread from CDOs into all asset-backed securities, private equity debt, all non-prime mortgages, corporate debt, credit default securities, bond insurance, and now municipal bonds. There are trillions of dollars of municipal bonds on issue in the US, and the asset class is considered in many cases to be second only to US Treasuries in terms of capital security.

Municipal bonds are issued at state and local level in the US to finance capital projects such as infrastructure or utilities. You might, for example, buy a New York State water & sewerage muni bond. Muni bonds came into the credit crisis frame in February as it became clear the big US monoline insurers, which insure everything from munis to CDOs, were under threat of losing their AAA ratings which would, in turn, cause the bonds insured to lose their AAA ratings and spark a massive sell-off. Government agencies and banks are currently in a race against time to come up with rescue packages for these insurers in order to avoid this disaster. It is the CDOs in insurers' portfolios that would trigger the downgrades. Munis would be collateral damage, if you pardon the pun.

But information is instantaneously discounted in financial markets and risk adjustments made accordingly. Under real threat of a potential sell-off, muni bond credit spreads have blown out meaning prices have already tumbled, if not yet crashed. But Friday saw the end of the month and that means margin calls. Many hedge funds have long been playing the long munis/short Treasuries spread as means of picking up a few basis points on the spread. That trade has now gone awry, and hedge funds were forced on Friday to unwind positions to try to make good on margins. The muni market took a big dive.

US Treasury yields had been ticking back up last week as inflation concerns blew out the long end and the possibility of the Fed suspending its rate cuts drove up the short end. But while we began the week with the two-years over 2% and the ten-years over 4%, a rush of buying in the last couple of sessions has seen the two-year yield fall to 1.65% - the lowest since the 2002 recession - and the ten-years to 3.5%. Money has flowed back into Treasuries as the Fed has made it clear another rate cut is coming and everything else has imploded in the meantime, including munis. And including stocks.

The Dow closed down 315 points or 2.5%. The S&P lost 2.6% and the Nasdaq 2.7%. After four consecutive down-months Wall Street was hoping earlier in the week February would break the run, but now it hasn't. Many traders have suggested Wall Street would need to retest the January lows before it could meaningfully begin a rally. The close last night was 12,266 - 296 points shy of that low in the Dow.

It wasn't a case of what was the bad news on Wall Street on Friday, it was a case of what wasn't. The session began with the news the Chicago purchasing managers' index fell to 44.5 in January, down from 51.5 in December. Economists were expecting a reading of 49.7. The index is based on 50 being the neutral point, and as such a number below 50 is recessive.

The Reuters/Michigan University consumer confidence measure for February fell to 70.8, down from 78.4 in January. This is the lowest measure in sixteen years, and represents a 30% fall in confidence from January 2007. Survey directors said falls off such magnitude have always preceded recessions, and noted the number of households reporting financial distress in February was greater than in any time in the depths of the 1991 recession.

Conversely, consumer spending rose by 0.4% in January against an expectation of only a 0.2% gain. A silver lining? No way. Inflation also rose 0.4% in January, meaning the increase in consumer spending was not a volume increase, but simply a price increase. Spending was thus actually flat.

A bagel seller interviewed on CNBC on Friday (bagels are the staple diet of cosmopolitan Americans) noted that last year he was paying US$12 for a bag of wheat. On his latest price enquiry he was offered US$68.

And the corporate news didn't get any better. Financial insurance giant and Dow component AIG announced a loss of US$5.3bn in the fourth quarter - much worse than analysts were expecting - blamed on mortgage security and credit default swap write-downs. AIG shares lost 7%.

News emerged the rescue package for monoline insurer Ambac, which was expected to be sealed during the week, was rejected by the ratings agencies as insufficient to prevent a downgrade from AAA. It's back to the drawing board for the banks involved.

UBS analysts issued a report suggesting total credit market write-downs would reach US$600bn. Only US$160bn has been written down to date.

The tech sector has attempted to be an oasis of stable offshore earnings and defensive quality to date, but Dell reported last night profits from computer sales had fallen 5% year-on-year in the fourth quarter. The market reacted by sending Dell's shares down 6%, and the Nasdaq was dragged down in sympathy. Or is that empathy?

Do we need to hear anymore?

The US dollar rose slightly against the European currencies last night, possibly reflecting Treasury buying, but fell heavily once more against the yen. At 103.7 yen this is the lowest level for the dollar in three years, and the dollar index again ticked down to a new low. This conspired to spark a rapid turnaround in the Aussie dollar's surge (yen buying implies carry trade unwinding), following on from preliminary GDP data which showed the Australian economy had slowed from 4.3% to 3.9% annual growth in the December quarter. The Aussie fell US1.76c in 24 hours to US$0.9312.

Gold rose slightly on Friday - up US$3.50 to US$973.60/oz.

Oil finally took a breather on Friday, but not before registering a new intraday high over US$103/bbl as news came in of a pipeline shut-down in Ecuador. Any little thing is going to send oil flying at the moment, but weak economic news finally gave some cause for profit-taking and oil fell US75c to US$101.84/bbl. The fall in the oil price also sparked selling in Exxon and Chevron, as if the Dow needed any more help in falling.

Base metals decided also to take a breather, as the buying frenzy gave way to profit-taking on the weak economic news in the US. Metals fell 1-2% with the exception of recent star nickel, which added another 1.5%.

The fall on Wall Street was accompanied by high volume - much higher than the average volume on the previous up-days. Despite the fact the muni crunch was put down to end of month margin calls, one trader commented that the end of month, and the fact it was a Friday, probably saved the Dow from falling over 500 points as speculators would have been less eager to increase short positions over the weekend and into March.

The SPI Overnight fell 144 points to 5420. This closing level implies that Monday will see the ASX 200 open below the significant support level at 5500. Friday's trade saw yet another attempt by the short side to push the index through this barrier, but like so many times in the past two weeks the strategy failed, and buyers turned the market around. Technicians suggest that a break of 5500 will see a sharp move to 5300, which on Friday's physical close is 272 points away. The January low is 5186.

article 3 months old

Are We Really Facing Stagflation?

 By Greg Peel

Under normal economic cycles, strong economic growth leads to increased inflation, as incomes and wages increase and demand for commodities and consumer goods pushes prices up. When this occurs, central banks raise interest rates to curb economic growth, demand falls, and prices begin to fall back, thus dousing the inflation threat. It usually follows that inflation, which has the power to undermine the value of all assets, falls when economic growth falls.

Early this month the US Federal Reserve cut its US economic growth forecast for 2008 from an average of 2.15% to an average of 1.65%. But many an observer believes the US is actually in recession already, suggesting a negative growth rate. The Fed also increased its core inflation forecast for 2008 from an average of 1.95% to 2.25%. But many an observer scoffs at such low numbers, given food and energy prices are not included in this core measure due to their volatility.

Either way, the Fed lowered its economic growth forecast while raising its inflation forecast. The Reserve Bank of Australia has similarly revised its forecasts recently, suggesting that while Australian economic growth should fall back to trend levels inflation is expected to continue rising into 2010 if monetary policy action is not taken.

In each case, growth forecasts are falling while inflation forecasts are rising. The RBA is tightening monetary policy by raising rates, but the US is easing monetary policy to save the economy. On one side inflation is caused by rising prices. On the other it is caused by increased money supply, which is exactly what the Fed is doing by easing monetary policy. Hence the US dollar is falling while the Aussie dollar is rising. In the meantime, the European Central Bank has also made similar economic growth and inflation forecast changes. The ECB has been concerned about inflation through the duration of the credit crunch, and as such has left its rates unchanged, despite pumping billions of euros into the banking system.

What we are seeing is a stagflationary scenario. In the last week or so, oil, natural gas, platinum, wheat, corn and tin have hit all-time highs. Copper and aluminium have rebounded to almost two-year highs. Commodities indices are also reaching all-time or multi-year highs. At the same time consumer confidence in the old-world economies of the US, UK and Europe has crashed. Indications are that all will suffer economic slowdowns, with some observers expecting Europe and the UK to be particularly badly hit despite the fact the focus has to date been on the US.

Stagflation implies that incomes will fall and jobs will be lost at the same time as prices increase. This is a double-whammy effect that was last experienced throughout the 1970s. Global recessions followed. Central banks have since changed their attitudes to monetary policy, realising that inflation cannot be allowed to run away at the expense of economic growth management. The challenge for central banks today is ensure inflation does not run away as the world deals with trying to ease the downward pressure on the global economy in the face of the credit crunch. But there is faith being placed in the expectation slowing economies will naturally affect a fall in inflation eventually. While stagflation may appear to be upon us right now, it may yet prove a short-term phenomenon. At least that's what central banks are hoping.

If they are wrong, then it's time to get out your bell-bottoms, body shirts and six-inch-wide ties, platforms and perms. Are we really facing a return to the seventies?

In 1973, Egypt and Syria launched attacks against Israel and thus began the Yom Kippur War. In retaliation for the West's support of the state of Israel, the Arab members of OPEC decided to embargo oil shipments. In the blink of an eye, the price of oil doubled, rising from US$20/bbl to US$40/bbl if measured in December 2007 US dollars. Suddenly the developed world woke up to the fact it was totally dependent on Middle Eastern oil. OPEC continued to keep the world at bay during the seventies, and between '73 and '78 the (real) price continued to drift up to US$50/bbl. In 1978, the Iranian Revolution deposed the Shah and sent oil production in the country into disarray. The oil price peaked in 1979 at just over US$100/bbl in real terms.

And here we are again.

It was the "oil shocks" of the seventies that caused stagflation. The sudden jump in the price of oil was immediately crippling for Western economies. Production costs went through the roof and consumer prices followed. Trade unions, at their most powerful in the seventies, pushed for higher wages to compensate for increased prices. The wage/price spiral ran out of control. The rate of inflation in the US reached over 13% in 1980.

It was a case of a "supply shock". The price of oil rose not because of increased demand, but because supply was suddenly curtailed. When the global economy receded, so too did the price of oil. And we all stopped driving V8 gas-guzzlers and embraced the toy cars being produced in Japan. OPEC could not hold out, and the oil price fell quickly back to US$20/bbl again.

But the oil shock was not the only reason inflation reached double digits in the seventies. Returning to those powerful trade unions, the seventies were a time of workplace reform which saw the collapse of the old production line system. Why this may have been to the benefit of downtrodden workers, it also meant a collapse in global productivity.

And prior to the oil shocks global central banks had not been concerned about inflation, they were only concerned with economic growth. Thus when inflation led to economic hard landing, central banks responded by putting interest rates down. Feeding money into the system only served to fuel inflation further. It was only when inflation rose into double digits that central banks realised they would have to abandon their attempts to stimulate growth and address the spiralling problem. They put rates back up, and inflation fell to 2% by 1986. Ever since 1980, global central banks have considered inflation as their biggest threat and thus attempted to control it.

The oil price is now again above US$100/bbl, but this time it has taken seven years to rise from US$20/bbl. This time it's not a supply shock, but a significant growth in demand stemming from the industrialisation of China and other developing nations. This industrialisation has also driven the price of hard commodities such as base metals and bulk minerals to never before seen prices.

The same effect has been felt in global food prices, but in the case of food there it is another double-whammy. The growing wealth of the populations of developing nations has meant a greater demand for food more favoured by the west, and a greater demand for meat, which was previously only an occasional indulgence for subsistence peasants. This demand has pushed up the price of grains and livestock, both directly and indirectly given the animals also eat grains. At the same time, global ethanol production has skyrocketed in response to the price of crude. Whereas once a growth in global food demand could be met by giving over more land to farming, today the amount of land farmed for food production has rapidly decreased in favour of growing grains for ethanol production. What is thus occurring is an oil-food spiral.

So if that's the case, why has inflation in the US remained in the low single digits since the early nineties? It is not because monetary policy has been restrictive all that time. Indeed, in 2004 the US interest rate was reduced to only 1%.

The answer lies in what is loosely described as globalisation, and in the technology revolution. The industrialisation of the economies of China et al has brought millions of new workers into the global economy at much lower wages than the West must pay. Hence there has been an enormous jump in global productivity as Western companies have outsourced their manufacturing processes to the much cheaper developing world. This has ensured price deflation of manufactured goods. The capacity to manage far-flung enterprises has been made possible by the internet, and the computer chip has served to reduce both the size and cost of goods. Remember the first mobile phones? The rapid transition from house-brick to Dick Tracy watch and the consequent reduction in cost is deflation at work. And one element that is easy to overlook is that of storage. With so much information being able to be stored on a chip, global storage costs have plummeted.

In simple terms, the inflationary force of rising global commodity demand has been met by the deflationary force of rising global supply of cheaper goods. The rapid growth of developing economies has both fuelled and quelled inflation.

But now it seems that all of a sudden inflation is a problem once more. 2008 alone has seen a substantial jump in commodity price indices. Central banks are quickly revising inflation forecasts and either raising rates or holding off on lowering them (with the exception of the Fed, which has its fingers crossed). What has happened?

Two things have happened. The immediate problem has taken us back to the seventies again in terms of the "supply shock". Wild weather in China and Australia and power outages in China and South Africa in particular have pushed up the prices of hard and soft commodities across the globe. In the case of oil, the Middle East is once again back in the frame with tensions in Iraq and Iran causing supply concerns and further problems have been experienced in the significant oil producing nations of Nigeria and Venezuela.

This is one reason why prices have made an alarming jump just recently, causing central banks to reassess their inflation outlooks. However, as the current problems are considered as "shocks" consensus among economists is that while higher inflation is now expected for longer, once such problems are addressed inflationary pressure should ease. The US economy is slowing, and a trickle-down effect should be felt across the globe, leading to more frugal consumers and ultimately falling prices.

But there is another problem. While the developed world is attempting to deal with headline inflation rates of 4% or more, China is looking at 7%, and rising. The Chinese growth engine has reached somewhat of a watershed. The productivity gains experienced in the twenty-first century have plateaued as wages have risen, while at the same time the renminbi is being quietly revalued. The artificial peg of the renminbi to the US dollar has been a significant reason why China has been able to export deflation. As both commodity prices and the renminbi rise, Chinese manufacturers are seeing their paper-thin margins vanish. The only solution is to raise prices.

The developing economies of the world are all now facing inflation problems. But at the same time, the developed world is suffering a credit crunch. The credit crunch began with falling house prices in the US. Falling house prices cause consumers to curb their spending, which is deflationary. House prices are now also falling in the UK and Europe. The credit crunch has also brought to an end, at least for the time being, out of control financial leverage. The US central bank not long ago stopped worrying about the money supply as an actual inflationary problem, given credit markets are far more influential in creating "money" through sophisticated derivative instruments and leverage. Now that the developed world has lost its appetite for risk, and particularly leverage, the resultant effect is deflationary.

And that brings us back to the US economy, which may or may not actually fall into recession but at the very least is slowing considerably. The sheer size of the US economy, and power of the US consumer, who represents 70% of that economy, means that a US slowdown must have a deflationary effect across the globe. It then becomes the sixty-four million dollar question as to whether the slowing US economy will affect  slowing in China and other developing nations. It's a toss up between the global power of the US economy and the sheer pace of Chinese growth which has now shifted its focus from the export to the domestic economy.

If the US slowdown does cause a flow-through slowdown across the entire globe, then inflation should only be a short term issue. If developing nations remain relatively unaffected, then inflation pressures will remain at least until monetary policy tightening has its desired effect. The Fed is still in cutting mode, but it has indicated that rates will be quickly shifted back up again at the first sign the US economy has stabilised. In the more recent era of central bank inflation control, double-digit inflation levels are no longer thought possible.

And then there's those short term supply shocks. When the snow melts in China, the floods subside in Australia, and the power comes back on in South Africa, relevant commodity prices will once again fall. And when there's peace in Iraq, peace in Nigeria, Iran and the US resolve the nuclear issue and Venezuela reaches an agreement with the US on nationalised oil production, there will be nothing left to hold up the oil price.

The only problem is, out of all of the above the only real possibility of a deflationary force in the short term is the Australian situation. Supply constraints in the coal industry have come about just as coal contracts are being renegotiated for the year with Japan and Korea. At the same time, China is looking at becoming a net importer of coal. One reason for this is the country simply needs more power. The snow will surely melt, but the lack of sufficient power in China will persist. And the power outages in South Africa have nothing to do with weather. South Africa simply needs more power. India also needs more power. Demand for commodities will persist.

In the case of oil, well Middle East peace is, of course, but a pipe dream. There is also a strongly held belief that OPEC does not actually have any room to increase production in any meaningful way. We're not here to get into a discussion about peak oil, but oil supply is not a given irrespective of whether demand falls. And China has discovered the car.

Another factor to consider is the US dollar, for the greenback is the global currency by which commodity prices are measured. A falling dollar means higher prices, and the dollar has now fallen to new lows on an index basis. If the US economy does indeed recede and the Fed continues to cut rates, the US dollar should fall lower, pushing prices higher. That is, unless the rest of the world slows, causing monetary policy easing elsewhere. In that case, the US dollar will rise again, and commodity prices fall. But while inflation persists, other countries will not cut rates. There's really a lot of Catch-22 going on here.

So, are we facing persistent global stagflation? Or will the current spike in commodity prices prove only a short term phenomenon? At present, the weight of argument favours the latter. In contradiction, the US bond market currently does not. Nor does the gold market. Volatility of financial markets is a clear and present indicator there is a great deal of uncertainty in the world at present. The game has yet to play out.

article 3 months old

The Overnight Report: Insurers Keep Their AAAs

By Greg Peel

The Dow closed up 189 points, or 1.5%, last night. The S&P gained 1.4% and the Nasdaq 1%.

Early strength on Wall Street had begun to wane in its usual fashion last night as once again any attempt at a rally lacked support. The economic data of note up to that point had been the January existing home sales number, which fell for the sixth straight month to a nine-year low. However, at 0.4% the fall was not actually as bad as consensus expectation. While it implies the US housing slump is not yet over, traders are beginning to suggest the slump may at least be slowing. Clutching at straws?

It mattered little, however, when at around 2.15pm the announcement came out that ratings agency Standard & Poor's had decided to let large monoline bond insurers Ambac and MBIA keep their AAA ratings for now. This is a great relief, as it avoids the wholesale selling of various bond classes, including trillions in municipal bonds.

Both Ambac and MBIA - America's two biggest bond insurers - had been on "negative review", pending a possible ratings downgrade. Last night S&P announced that after reviewing the companies' books it had decided MBIA could keep its rating while Ambac would keep it for now, but remains on "negative watch". The industry in general would also remain on "negative outlook". The news came as the announcement of a rescue package for Ambac appears to have been postponed for a week. Now that Ambac has been given a stay of execution, does it need the banks to stump up billions to rescue it? One presumes the answer is "absolutely" - Ambac is still on a fine line.

When the news broke the Dow jumped from up 50 to up 150 in a heart beat. Ambac shares jumped over 10% and MBIA over 15%. Therein followed a stumble, as the market waited to see whether any momentum could be established, but soon more buyers emerged to send the Dow up 189 points, having peaked at up 200. One might have expected the financial sector would have enjoyed a renewed boost of buying interest too, but earlier in the day various broking houses had been downgrading first quarter profit outlooks and recommendations for various institutions. Thus financials still finished the day in the red.

One of the reasons brokers were downgrading their counterparts and banks was on an assessment of the state of the IPO industry. IPO's have all but come to a standstill in 2008, with only a paltry total having been issued to date. Underwriting share issues is the bread and butter of broking houses, beyond trading commissions. However, news came out last night that credit card giant Visa was planning an IPO of its own. Were Visa to list it would be valued in the US$15-18bn range, making it the largest IPO in US history, and second only to China's ICBC Bank IPO on a global basis. Goldman Sachs and JP Morgan are said to be lead underwriters.

Nevertheless, shares in neither Goldmans nor JPM ended in the black last night. It is interesting that Visa should choose now to go public. After eight months of credit crunch and a possible US recession, credit card debt is an area of concern that ranks second behind mortgages on a consumer basis. Is Visa cashing in while it can? Readers may remember the public offering in leading private equity specialist Blackstone mid last year. Even Blackstone admitted at the time it could take a long while for shareholders to see a profit in the business, particularly if tax laws were revised. Nevertheless, the shares came on at a massive premium, the subprime crisis hit, private equity deals all but ceased, and Blackstone shares have dropped like...well, like a black stone.

What does Visa know?

The oil price pushed higher again last night - up US42c to US$99.23/bbl. Not only is there concern surrounding Turkey's incursions into Iraq, we now have Iran back in the frame, threatening retaliation against anyone supporting new sanctions against the country in response to its ongoing nuclear program. If it's not one thing it's another - Iraq, Iran, Nigeria, Venezuela, and maybe throw in Palestine, Israel, Lebanon and Syria - which makes it hard to see just when a US slowdown might actually have the downward effect it should have on the oil price. In the meantime, wheat hit an all-time high last night. The CRB index continues to trade at new multi-year highs, despite platinum actually having a rare down-day.

The US dollar was mostly higher, sending gold lower. However, the US$5.10 fall in gold to US$939.50/oz was aided by news the US Treasury had changed its mind and would now support gold sales by the IMF. The IMF needs to sell gold because its operational costs have become crippling (some would say the IMF is now an anachronism, with a burgeoning bureaucracy and too many pigs in the trough), and some 12.9moz have been flagged. Mind you, the IMF was threatening to sell gold just before The Flood and hasn't yet.

The Aussie continues to creep northward, aided by a falling yen against the US dollar and the prospects of more interest rate rises. It's now at US$0.9273.

An unexpected jump in copper inventories saw the bellwether metal pull back a bit in London last night, dragging the rest of the complex down somewhat as well. Tin was the exception however, as it pushed on to set a new all-time high.

The SPI Overnight rose 71 points.

article 3 months old

Barclays Remains Positive On Outlook For Commodity Prices

By Chris Shaw

Even with no shortage of indicators suggesting the US economy is slowing there has not been any acompanying slowdown in commodity prices, Barclays Capital noting supply side concerns have contributed to price strength and driven gold, platinum, oil and soybean prices to all-time highs this week.

With grain prices also stronger Barclays suggests the implication is investors are not convinced a slowing in global growth will translate into lower commodity prices thanks to the structural shifts of the past couple of years. These shifts have seen developing nations contributing to commodity demand growth at the same time as supply constraints are increasing, the recent price gains suggesting these are becoming a bigger issue than slower global economic growth.

Looking at the various sectors, the group suggests the recent strength in oil prices is partially a response to the weakness that preceeded it. Oil prices tested and failed at US$100 per barrel before and the failure at that level produced a sell-off that continued until solid buying emerged at levels a little below US$90 per barrel, helped by expectations OPEC was willing to defend the price at around US$85 per barrel.

The change in sentiment prompted a spurt of short-covering, reinforcing the group's view shorting oil based on an expectation of slowing global growth is a risk as demand appears likely to remain solid. Consolidation in the high US$90 per barrel range appears the most likely short-term outcome in the group's view, with a number of moves above US$100 likely.

Lost production has been the driver of the base metals suite, with aluminium seeing the most significant impact thanks to power generating problems in South Africa. While a slowing in global growth would normally suggest underperformance in base metal prices Barclays takes a similar view to the oil market in suggesting shorting the market at present is not recommended given the ongoing supply side issues.

On fundamentals copper looks the best placed for gains in its view as a significant market deficit appears likely to form in the current half, which should be enough for prices to again test all-time highs. The balance of risk in the aluminium market also appears weighted to the upside as production losses continue to increase, while tin inventories are seen as tightening further and this should support higher prices.

A gradual pick-up in stainless steel activity should see the nickel price push higher in the first half of 2008 but Barclays is not so positive on zinc given its weak market balance, which it suggests will see prices fall below recent support at around US$2,200 per tonne.

The South African power supply issues are similarly positive for precious metal prices as production is likely to be impacted for some time, with platinum the most at risk to lost output. Similar supply side interupptions should also prove supportive for gold prices in the group's view, especially as investment demand remains solid even at higher prices.

Risk appears to the upside across the agricultural sector as well in the group's view thanks to low inventories and increasing demand not only from the food sector but also from the energy sector as buyers look for alternative sources for fuel.

Barclays expects corn prices to move higher given this scenario, while lower production also puts something of a floor under soybean prices. Wheat prices have gained from poor weather conditions and this trend appears likely to continue, the experts believe, while reduced growing acreage in the US and stronger demand from China is expected to support the cotton price.
article 3 months old

The Overnight Report: Dreary End To A Dreary Week

By Greg Peel

There was not a lot to be encouraged about on Wall Street this last week, as thin-volume rally attempts continually gave way to heavier-volume selling. The Dow closed down 64 points, or 0.5%, on Friday, finishing the week down over 4%. This was the worst week of trading, percentage wise, since March 2003.

The index did not finish on its lows, however, as a mark of -144 was made earlier in the session, but the gains of the previous week, in which the Dow bounced out of its January slide, are slowly being erased. The S&P closed down 0.4%, but one little ray of hope for the session was the announcement by Amazon.com of a US$1 billion share buyback. This helped the Nasdaq to actually close up 0.5% on the day.

Elsewhere the mood was mixed to sombre as the quarterly result season pushed on. There were some good results, including that of Dow component McDonalds, but mostly reports were sour and guidance concerning. In discussing their round of weak numbers released this week, retailers suggested that it was not only mortgage problems keeping the customers away, but the impact of high oil and food prices. And as these comments were being made, news of further supply disruptions in Nigeria sent oil soaring back US$3.66 to US$91.77/bbl.

Oil appears to be attached by a bungy cord to US$90/bbl at present. By rights the commodity should be trading lower, given the sheer weight of recession speculation, but the demand/supply balance is the reality that won't allow this to happen. Now that oil has come off at least from the US$100/bbl mark, talk is that OPEC will decide to trim back production at its meeting next month. For some reason this is seen as important, despite the fact OPEC countries only ever say one thing and do another.

And agricultural commodities continued to push into record territory this week, again with little sign of ultimate respite from this upward trend. A bumper crop or two might take the heat out of the market temporarily, but it is the "feed the world" theme driving high prices, along with sanctioned biofuel substitution.

Overlaying the problems of weak results and inflation concerns is the ongoing despair surrounding the potential downgrading of bonds and bond insurers by the ratings agencies. Some smaller insurers have now been downgraded, with the big two of MBIA and Ambac still hanging in the balance.

It was time for the US dollar to slip back again last night, following a round of mostly short-covering. Gold responded by rising US$14.30 to US$922.90/oz, spurred on by news that two major global gold producers were looking to close out their hedge books, and by technical triggers that sent commodity funds back into buying mode. The Aussie continues to tread water (US$0.8955) amidst the counter influences of the US dollar and the yen.

Asian traders returned to the base metals market last night after their holiday break. It was a rush to cover positions as ongoing supply disruptions, particularly in South Africa, maintained their influence. Throw in a weaker dollar and a technical scramble ensued, as most of the complex followed the lead of bellwether copper. Copper traders have been surprised by falling inventories. The catch-up saw copper trade up another 2% in the late London session, while nickel added 3.5%, zinc 4% and lead 7%.

The SPI Overnight fell 5 points.

article 3 months old

Sugar Trending Higher But No Consensus On Outlook

By Chris Shaw

Following weakness over much of 2007 sugar prices picked up in the December quarter, breaking through US12c per pound for the first time since the end of 2006. For Barclays Capital the price gains were the result of a number of factors, chief of which was an improvement in sentiment as the global sugar market’s balance turned more positive.

UBS also points to an increase in fund flows into agricultural commodities as a reason behind sugar’s recent strength, a view Barclays shared in noting speculative interest in the sugar market has turned long in recent months after having been net short in the September quarter.

While the two groups agree on this point they disagree on the outlook for sugar prices, with Barclays clearly the more bullish of the two. Its view is centred on the expectation the huge market surplus last year on the back of strong production growth won’t carry through 2008 given an expected slowing in output growth.

This anticipated tightening of the market will make sugar prices more susceptible to any disruptions to supply, Barclays pointing out this has already occurred this year with India indicating its output would be down by as much as 12% in 2008.

The group also suggests while the long speculative position is a risk for prices there should be enough news in the market to keep investors' interest, especially as there are indications an increased proportion of Brazil’s output will be diverted to the ethanol industry.

Barclays also points out higher oil prices should support the ethanol industry generally, which in turn will support sugar prices. UBS though takes the view capacity constraints in the Brazilian ethanol industry will limit how much sugar will be diverted, so even allowing for disappointing Indian output there is scope for Brazilian production to offset this.

On the broker’s numbers it sees a market surplus of at least 10 million tonnes both this year and in 2009, which should keep a lid on prices. Its assessment is the market looks interesting at prices between US8-10c, but above US10.5c per pound India becomes a more willing seller into Asian markets in particular where it enjoys a freight advantage over the Brazilian producers.

As a result the broker suggests prices may peak around March or April this year, which is just prior to the start of the 2008 harvest in Central and South America.

Exposure to sugar via the Australian market is best achieved through either CSR ((CSR)) or Maryborough Sugar ((MSF)), though the former is less of a pure sugar play and so has additional risks.

The FNArena database shows CSR scoring two Buys and one Accumulate rating compared to four holds and two Sells, while Maryborough Sugar scores just one Buy rating from ABN Amro.

article 3 months old

The Overnight Report: The Rise Of The I-Word

By Greg Peel

More rumours are created and perpetuated on Wall Street than in the offices of any celebrity trash-rag. Last night saw another good one, which resulted in an attempted, but finally failed, rally.

Last night the rumour went around the NYSE that the shocking ISM non-manufacturing index numbers were actually an error, and that ISM was about to come out and correct its mistake. ISM did make an announcement, but only to say the numbers were real, there would be no revisions, and please get a life. The Dow had rallied 132 points on the rumour, but fell quickly into the red in the afternoon on the facts.

Take out that anomaly and Wall Street really only banged around the flat line last night, ultimately finishing up 47 points, or 0.4%. The S&P rose 0.8% and the Nasdaq 0.6%. Not that long ago +47 would have been considered a strong day, but in the context of recent index volatility it's as if no one much bothered to turn up to trade. Australia's ASX 200 similarly finished down only 13 points yesterday, and those who only read the final score could be forgiven for thinking perhaps they left accidentally off a zero. We do know, however, that the Australian index dipped rapidly again before recovering yesterday.

Which might suggest we've once again hit a point in which the margin-call forced sellers meet the genuine bargain hunters coming back, or is it just the short-coverers? Each time we try this little exercise a good bounce is extinguished by some new bad news, and we fall once more. The bears will tell you this is classic ursine behaviour, and all rallies are presently an opportunity to sell. The bulls, at the moment, seem a bit betwixt and between.

It was a similar situation on Wall Street last night. The most important data in the session were a series of same-store sales figures for January released by various US retailers. And they were pretty bad. Wal-Mart managed a 0.5% rise, but analysts expected 1.5%. As you can buy anything from breakfast cereal to a couch at Wal-Mart, cereal held up against falling couch sales. But the likes of Macy's, Target, JC Penney, Nordstrom, Limited Brands and Gap posted falls. There were also gains, however, and a UBS survey of 43 retailers actually netted a 0.5% increase. But the expectation was again for 1.5%, and this was January. January is the time of post-Christmas madness, bargain hunting for discounts and the spending of Christmas present vouchers. A poor January does not augur well for February and beyond.

Nevertheless, most retail names rose on Wall Street last night. This might seem counterintuitive, but it was just a reversal of the old adage. In this case it's "sell the rumour, buy the fact". The retail sector has been one of the most heavily sold since the R-word surfaced, and shorts like to cash in on the expected bad news.

Again this tends to throw up the idea that maybe the market has been sold down as far as it possibly could be, but every time someone makes this suggestion, to do so he has to step over the corpse of the last guy who made such a suggestion.

It was a similar story in the US dollar last night. The Bank of England surprised no one by cutting 25 basis points off its rate, taking it back to 5.25%. But all eyes were on Monsieur Trichet at the ECB. Surely he must cut this time?

Nope. Trichet stood firm at 4%. While the US dollar reacted as expected against the pound by rising, one might have expected no ECB rate cut would cause the dollar to fall against the euro. But it rose instead, given the whole world is short. The Aussie's rather confused at the moment, so it barely moved to US$0.8926.

Trichet is still on inflation watch, which is why he wouldn't budge. And last night the president of the Dallas Fed came out to explain why he was the only committee member to vote against the last Fed 50 point cut. He, too, is worried about inflation, and would have liked to have seen the Fed stand back after the 75 point cut just to let the system work it through. To cut too fast is to risk money-base inflation on top of existing food and energy inflation. This followed the Philly Fed president's similar warnings made the day before. Is there a growing dissention in the Fed ranks?

If the Fed is in two minds, the bond market is not. Last night saw double digit (basis point) moves on the yield curve which sent the 10-years up to 3.7% and the 30-years up to 4.5%, while the 2-years hand around 2% in anticipation of more Fed cuts. This steepening of the yield curve has inflation fear written all over it. And if any more confirmation was needed, it came in the form of gold - once the great inflation haven - which rose US$9.00 to US$908.60/oz against a rising US dollar.

Apart from inflation concerns per se, it has to be remembered that a generic prime mortgage rate in the US is based not on the cash rate but on the 30-year rate. So while the Fed might be pumping money in at the short end to encourage banks to lend, and banks gain a benefit from lending at higher mortgage rates, the potential homebuyers themselves are going to back off because their cost is actually rising. This crisis is in the mortgage market, yet that's not where the relief is reaching.

Nevertheless, from a fiscal point of view the Senate last night not only indicated it would pass the Bush stimulus plan, but it threw in some extra for veterans and the aged to take the total hand-out up to US170bn. Cheques will rain from the sky, as one commentator put it, but can you make Americans buy that couch?

In other news, Standard & Poors announced it had come up with 27 changes to its rating methods which would tighten its systems. Once again, it's all well and good but the horse has had time to apply for a passport and buy air tickets. And the gate may not be fully shut anyway, as S&P was a bit vague on whether under the new rules the CDO debacle could have been prevented. It wouldn't want to say so really, as it is about to be hit with a legal tsunami.

Oil turned around and went back up last night, rising US97c to US$88.11/bbl, largely due to unscheduled production cuts in the North Sea and Nigeria. The rally was undermined, however, by the retail sales figures and ongoing R-word fears.

The base metal market was relatively quiet with the glaring exception of copper. Copper inventories fell for the first time in three months, catching the market short, and sending the price up through technical stop-losses. Copper put on some 5%.

The SPI Overnight rose 28 points.

And the last word on inflation today is an acknowledgement that wheat has hit an all-time high.

article 3 months old

Australian Agribusiness Conditions Improving

By Chris Shaw

While recent rains have improved conditions the drought remains a key concern for Australia’s agricultural sector, National Australia Bank’s latest Quarterly Agribusiness Survey showing 7% of respondents saw it as impacting on trading conditions.

Despite this the survey shows an improvement in agribusiness conditions over the December quarter, reflecting stronger demand, improved profitability and a more stable employment environment.

The survey found the improved conditions were spread across most sub-sectors, with the strongest gains being recorded in transport and manufacturing, while conditions in retailing and wholesaling continue to prove difficult.

Outlook comments were also generally positive, the bank noting agribusiness respondents continue to have relatively strong capital expenditure plans for the coming year.

While costs pressures remain the bank points out this was to some extent at least offset by higher prices, while an expected moderation in cost pressures in the coming quarter should in its view reduce the downward pressure on margins being experienced, driving a small increase in profitability in the sector.

The drought and a lack of demand continues to prevent a better improvement in profitability according to survey responses, while interest rates and the availability of suitable labour are also seen as hurdles to be overcome this year.

In actual numbers the survey showed a three point drop in agribusiness confidence to a reading of 0, with the wheat, beef and cotton sectors all recording relatively sharp falls on the back of poor seasonal factors. In contrast dairy rose three points while the sugar sector showed only a minor change in outlook.

A number of operators in the sector took out hedging during the period to offset concerns over the direction of the Australian dollar, though the bank notes the proportion reporting favourable hedging positions fell from around 45% in the previous quarter to around 22% for the December quarter.

article 3 months old

Drought Conditions Suggest Downside Risks To NZ Growth

By Chris Shaw

While Australia has suffered from a drought for several years there are signs emerging of similar conditions across the ditch, with TD Securities senior strategist Joshua Williamson suggesting there is scope for any drought in New Zealand to impact on economic growth.

January rainfalls in many areas of the country were the lowest or second lowest on record, while temperatures have been warmer than usual and soil moisture levels are falling.

This is impacting most on the dairy and sheep sectors, as a lack of feedstock is causing sheep farmers to sell stock early and dairy farmers are recording lower production as farmers are forced to dry off stock.

While the rural sector makes up only around 6% of GDP Williamson points out the impact of any downturn is likely to be more broadly felt, as for example the dairy industry has downstream impact on a number of sectors from transport to medical research.

This means as much as 10% of total economic output could be impacted, which has growth implications as the recent rebalancing in the economy away from domestic consumption requires stronger net exports to maintain GDP and the dairy sector has driven the recent increase in total exports.

Consumption growth itself may also come down as the wealth impact farmers have enjoyed in recent years may be reversed, so Williamson expects economic growth in New Zealand will slow this year.

His forecasts calls for GDP growth or around 2%, but with risk to the downside and a corresponding increased risk of a reversal in monetary policy in or around the third quarter of the year if the drought does impact on growth.

article 3 months old

Keep Commodity Exposure During Periods Of Volatility

By Chris Shaw

In line with the performance of equity, currency and bond markets commodity prices have been very volatile over the past few days, a trend Barclays Capital expects will continue for the shorter-term at least given ongoing concerns over the global growth outlook.

A look back at previous periods of equity market volatility shows investors tend to lower their exposure to the commodities sector during such times, but Barclays takes the view this is the wrong approach as both spot prices and returns in the sector tend to increase when equity market volatility is high.

Taking the period from 1993 to the end of last year into consideration the group notes periods of negative returns on the S&P have coincided with quarterly commodity returns of around 5.9%, showing while equity markets can impact on sentiment in the sector commodity prices are not strongly correlated to equity market returns.

Looking at the current situation the group suggests the precious metals are best placed to continue to perform well (as evidenced by the strong gains in the gold price overnight) so Barclays recommends staying long of gold.

Fundamentals support such a view as the market remains tight, the US dollar appears headed lower given further cuts to official interest rates in the US are seen as likely and investor interest in the metal remains high.

The agricultural sector also looks attractive as the group notes demand is likely to be relatively immune to the goings on in financial markets, while the combination of low inventories and growing demand is an attractive one.

Base metals in contrast appear vulnerable as the latest rate cut has provided some short-term support but concerns over global growth prospects remain. Copper in particular is supported by a relatively tight market but in Barclays view there needs to be some improvement in the market’s outlook for economic growth before prices can move higher.

Zinc prices are likely to fall further in the group’s view as the market prices in additional supply, while aluminium appears set to continue range trading in coming months as there is no shortage of the metal. The fundamentals offer some support for tin prices, while the group suggests further downside for nickel appears limited.

A consolidation is likely in the oil market shorter-term in the group’s view as while the market remains tight a seasonal fall in demand in the June quarter should cap prices to some extent, though longer-term there remains upside risk from growing demand and weak non-OPEC output.