Right, so we’re going to… grudgingly… allow this Game of Thrones reference from David Cui at BofAML.
We will not be this forgiving again.
In the Game of Thrones, before someone declares interest of entering the game, he or she needs to think carefully because the consequences of losing can be extreme. The same could be said about the latest “game” of trading commodity futures on China’s three commodity exchanges, in our view. We believe that loose monetary/credit policies and moral hazards are the main drivers behind the latest sharp rally, rather than improving fundamentals.
We recently had a chance to chat with a senior Canadian economic policymaker. Among other topics — he estimated fiscal stimulus would boost growth by around half a percentage point in 2016 and by a full percentage point in 2017 — we discussed his belief the depreciation of Canada’s currency could help export growth offset some of the weakness in the oil economy. What follows is an attempt to assess Canada’s progress so far.
For context, the Canadian dollar has lost about 21.5 per cent of its value against the currencies of its trading partners since the most recent peak in mid-2011, although the loonie had dropped as much as 31 per cent before the recent rally in risky assets:
Australia has handled the commodity bust surprisingly well — so far, anyway. We’ve already looked at how a strong job market and a housing boom have helped offset some of the pain from cuts in mining capex.
Now we’re going to focus more on changes in the external balance, which has helped push the growth rate in total output significantly above domestic demand: Read more
Australia hasn’t had a recession in 25 years.
About 18 months ago, we wondered whether China’s slowdown might break this remarkable streak. The latest figures, released Wednesday, suggest not. Real output continues to grow around 3 per cent each year — significantly faster than the rest of the rich world. So far, anyway, Oz seems to be adjusting smoothly to a world of markedly lower Chinese demand for Australian dirt and rocks. Read more
There’s a funny fact (touted by gold enthusiasts) about the purchasing power of gold. For most of history — with few exceptions — an ounce of gold has been able to buy you pretty much the same sort of thing: a good quality pair of shoes, a belt and a suit.
Somewhere in our psyche, the suggestion is, that’s how much we’d ever really forgo to obtain a little lump of gold: the combined value of what it costs to clothe ourselves properly (since clothes wear and tear over time and always need replacing).
What it also suggests is that any time the gold price trades at more than the collective value of a good pair of shoes, a belt and a suit, chances are it’s massively overvalued. Eventually — bar some major technical innovation which finds a more pressing use for gold — the historical trend will reassert itself. Read more
Goldman Sachs created the GSCI commodity index back in 1991, with the intention of getting asset managers to use it as a benchmark for commodity investment, but also as an improved way of measuring inflation.
Specifically, the index was pitched as a better measure than that being provided by Commodity Research Bureau’s (CRB) futures index, because it included a mix of products that Goldman said better reflected real inflation.
In support of the countercyclical diversification case, back-tested returns from 1970-1990 showed the GSCI was negatively correlated with the S&P 500 and government bonds, meaning a basket of GSCI commodities could improve annual returns for investors. Read more
Which came first the commodity fall or the local currency collapse? And, more importantly, how far through the commodity supply/ demand adjustment are we?
The suggestion here from SocGen’s Kit Juckes and friends is that the causality runs from commods to currencies and that there is still a lot of pain to come:
My colleague Michael Haigh has done a lot of work on the overall state of supply and demand in commodity markets, and he makes one very striking observation: For all the fall in the prices of many industrial and agricultural commodity prices in USD terms, the prices in the currency of the biggest producers have not necessarily fallen much. Sugar prices have fallen by over 8% this year in USD terms, but the Brazilian real has fallen by 29%. Copper prices have collapsed, down over 20%, but the Chilean peso is down 15% and trying hard to keep up. Gold is down 9%, but the South African rand has fallen by twice as much and in rand terms, the gold price is near its highs. The fall in iron ore prices (over 30%) is twice the fall by the Australian dollar, but you get the picture (Charts 1 and 2).
Money printing was supposed to cause an inflationary collapse, right?
Except, points out Seth Kleinman at Citi on Wednesday, by encouraging investment in risky commodity ventures like shale, easy money has in reality ended up causing a deflationary feedback loop of hell.
The access to cheap financing that low rates and QE generated has been deflationary in two key ways: 1) the growth of shale and the sanctioning of very high breakeven projects that cheap financing made possible has glutted the markets with oil; and 2) the rampant growth of shale, which is located in the middle of the cost curve and has significantly shorter lead times for first oil versus conventional production, acts as a buffer against price rises. Furthermore, given how much of the EM growth story of the previous decade has been driven by the rise of commodity exporters, the negative growth shock from lower commodity prices is compounding the first order deflationary impact in the US and Europe.
A certain blog seems to think they’re the ones who first exposed the topic of China’s commodity-financing deals in May 2013 (despite the exposé borrowing heavily from, as usual with this blog, other people’s work — namely the analysts at Goldman, weird because they also usually love to hate Goldman).
So, we think it’s about time to give credit where it’s due. Read more
From Alberto Gallo, at the Global Macro Credit team at RBS, comes the next instalment in what we are now inclined to start calling the “petrodollar feedback revival” phenomenon. The least welcome 70s revival since … err, bell-bottom trousers?
Nicely depicted by Gallo and team as follows:
About a year ago — a few days before Opec spooked the world with its decision to wage war on shale producers with an oil production race to the bottom, but following a few months of steady oil declines post the Fed’s decision to start signalling an upcoming tightening path — we speculated regarding a what if scenario based on the hypothetical eventuality of no petrodollars :
When is a yieldco actually a money-printing device? And when is it not?
Or put differently: how sensitive are yieldcos to interest rate and tax changes?
[Yieldcos are pitched to investors as dividend growth-oriented companies which distribute predictable cash-flows to investors on tax efficient terms.] Read more
In our Christmas podcast and this post, we warned of the eery similarities between the oil market of today and the oil market of JR Ewing and Blake Carrington in the 1980s.
We even predicted that if history tells us anything we might soon be blessed with a modern equivalent of a Dynasty and Dallas TV series, something along the lines of “North Dakota Millionaires”. Read more
Banks have been pulling out of direct dealings in physical commodity markets ever since the Senate Report on Wall Street Bank involvement in the market outed a spree of systemic risks, competitive advantages and general concerns last November.
The question is, has this had any impact on commodity prices or even the ability of major commodity traders to get financing? Read more
This is how Glencore stock ended on Wednesday:
At FT Alphaville we’ve flagged concerns about the perfect storm of declining petrodollar/sweatdollar recycling flows, a Fed tightening schedule, and a regulatory environment increasingly averse to cross-border repos and funding, with potential unintended (or perhaps intended but grossly under appreciated) effects for offshore dollar liquidity.
Why dollar liquidity, not euro, sterling or yen? Well, obviously, because the dollar remains the premier global reserve asset. Read more
When people start worrying about commodity traders in bear markets, the commodity traders themselves tend to reassure the market with comments like: “Ha! This clearly demonstrates you don’t understand our business at all. Lower commodity prices are GRRREAT for us. They liberate our balance sheet on a working capital basis and allow us to focus on our real value add, which is… spread trading.”
Though, if you’re Glencore, you tweak the comment so it goes something like:
“Prices are still not making sense where they are … it’s the funds driving it where it is today, not the actual demand,” Mr Glasenberg argued. “They believe demand for commodities is going to fall and continue to fall and that’s their view. Our view is what we see on the physical movement of commodities and it’s not too bad. We see the flows are still pretty strong.”
Here follows the second in a series of posts explaining why this week’s RMB depreciation is akin to the Great China Money Market fund breaking the buck.
But first a disclaimer! Whilst our analysis errs to the view that the depreciation was driven by market forces and thus inevitable, that’s not to suggest China “the market economy” is bust or about to face a hard landing. We’re very specifically talking about the state-managed part of the external capital account.
So, let’s continue from where we left off, namely, the point when the commodity super-cycle was sending the message that for China to have its rebalancing cake and eat it some major global restructuring probably would have to take place. Read more
When we bang on about there being a seismic shift going on in the world of commodity financing on account of the hypothetical eventuality of no more petrodollar or sweatdollar recycling, we too are talking about a negative feedback loop of worrying consequences for commodity/sweat-power producing emerging markets. Read more
Back in November we meandered through the possible implications of there being no more petrodollars in the system (on account of US shale oil energy liberation).
Since then, we’ve also been thinking about the possible implications of there being no more sweatdollars in the system (on account of US re-shoring and digital manufacturing trends).
So what happens if key dollar recycling pathways were to be significantly closed off or contracted?
Privately, we’ve speculated the situation could over time lead to the rise of a new international funding currency front runner. (Though, certainly not because the US is losing influence. More because, shale oil and a labour surplus means it may not be in America’s interest to defend reserve-currency status at all.) Read more
Here’s something that doesn’t happen every day.
The price of propane in Edmonton, Canada — home of Tar Sands production — is trading at a negative price. Read more
Some highlights from the FT Commodities Summit, which is taking place in Lausanne, Switzerland this Tuesday and Wednesday.
Oil production is becoming more of a manufacturing activity Read more
The FT’s Martin Wolf led a stellar panel on the global economy and the outlook for commodities featuring China expert Michael Pettis, BP’s group chief economist, Spencer Dale (formerly chief economist at the Bank of England), and Goldman’s chairman of global natural resources Brett Olsher.
As one might expect there was a difference of opinion on the panel about China’s future growth path. Goldman’s Olsher said he was confident that China would be able to maintain 6.5 per cent to 7 per cent growth in the near term, whereas Pettis suggested that even 3-4 per cent should be considered a successful adjustment. Read more
FT Alphaville is in Lausanne, Switzerland, for this year’s Commodities Summit. The conference is taking place at the Beau Rivage — a hotel so good that John Oliver has even expressed a desire to have intimate relations with it — and the opening keynote from Ning Gaoning, chairman of China National Cereals, Oils and Foodstuffs Corporation (COFCO) is about to begin.
Here are some scene setter pics: Read more
Ever wonder what the collapse of a commodity means for the hegemonic order that controls access to it?
Look no further than the sugar trade of the 1800s.
A new paper by Christian Dippel, Avner Greif, Daniel Trefler entitled The rents from trade and coercive institutions: removing the sugar coating examines the effect of the sugar price collapse on wages and incarceration rates in colonies established for sugar cane cultivation. Read more
As Paul Krugman always likes to recount, strange things happen at the zero bound. Macroeconomics gets weird. Liquidity traps prevail. And a whole slew of paradoxes come into being.
And that’s largely because below the zero bound things get even stranger still.
What you think should happen, doesn’t, and what you think definitely won’t happen, does. Furthermore, negative interest rates don’t just kill off the traditional point of banking, they encourage bad incentives and dubious market practices for all purveyors of capital. Read more
A few weeks ago, Michael Masters, of the eponymous US investment firm, made the point to FT Alphaville that bad things can happen whenever investors mistake the fruits of production for the means of production, and apply long-standing “long only” strategies (more suited to equity index markets) to assets like commodities.
Earlier this month, Nomura put out a note that observed much the same point.
Specifically, they argued that commodities should be treated like currencies and valued with macro-trading tools that incorporate the concepts of carry, value and momentum. Read more
One for the FT Alphaville historical log.
The CME announced on Wednesday that it would be closing most open outcry futures trading pits in Chicago and New York as of July. Only options on futures contracts and S&P 500 futures pits are to remain open.
That makes it a sad day for anyone who was inspired to become a futures operator because of, you know, that film.
It also contrasts with the LME’s decision to bring their open-outcry ring trading practices (along with their red benches) with them to their new corporate location in Finsbury Square.
Most importantly, however, it marks the end of a visual indicator for how the market is really trading, or any insight into “mood”. Once all contracts transact in the digital ether, all panics will be resigned to pixelated flash crash form visible only on screens or broker terminals. Gone forever will be the distressed pit trader photos. Read more
We’re all about unexpected consequences of “liquidity illusion-syndrome” these days, so it was exciting to discover a liquidity-focused assertion from Citi’s Edward Morse and team on Monday about the recent oil price decline, one that ties together a few ideas about how commodity markets relate to bank intermediation.
As a reminder, we have postulated that much of the decline is less related to sudden spot imbalances as it is to the curve’s “definancialisation”. The connection Citi has now made is between the commodity sell-off and regulatory burdens placed on banks’ commodity operations.
It adds to a discussion developed in an April paper by David Bicchetti and Nicolas Maystre, which questioned whether the recent correlation reversal in commodities was indeed connected to the closure of banks’ commodity departments. Read more