Sunday, January 23, 2011

Change of address

Dear Reader,

This humble blog is merging with several others to form a new superblog called MacroBusiness. You'll find me posting with similar regularity at the new address henceforth.



Saturday, January 22, 2011

Weekend reading: China's banks

China's problem. Paul Krugman
China's inflation dilemma. Charlie Fell
China's SHIBOR bounces big. Zero Hedge
China NPL's. Michael Pettis
30% chance of Chinese hard landing. Ambrose Evans-Pritchard
Greatest bear market rally in history. Calculated Risk
The efficacy of capital controls. VOX(h/tNaked Capitalism)
The future of Fannie & Freddie. NYT
Europe's secret fiscal integration. Bloomberg
Inflation nutters. Samuel Brittan
The love of LPTs. Ian Verrender
Melbourne's whacko house price figures. The Age
Commodity speculation. PragCap
India's ore export ban. Bloomberg
BarCap corners lead. Reuters
Thermal pause, coking moonshot. Coal Portal

Friday, January 21, 2011

Guest post: Of China and guano

Following the La Niña-related floods in Queensland earlier this month food prices have spiked, adding to an already serious inflation crisis around the world and toppling the government of Tunisia.

And while protesters in Tunis were hardly thinking of Queensland bananas or sugarcane as they mobbed the streets, the changing and dramatic climatic conditions that brought about the floods (which have since moved south to Victoria) were at least partly to blame.

Weather-induced agflation is here, as analysis from the respected Worldwatch Institute and statistics from the Food and Agricultural Organisation amply demonstrate. And you don’t need to believe in global warming to be worried about it either. The current La Niña weather pattern illustrates that disruptions to global trade in agricultural commodities and impacts on crop yields and harvests will continue for months at the very least, giving all the more impetus to those steadily rising futures contracts.

It’s always difficult to predict political events from economic phenomenon (let alone economic phenomenon derived from the weather). The globalised and increasingly finanicalised market for agricultural commodities means that causal relationships happen so much faster and as we’ve seen with Tunisia, what was once a particularly stable, affluent and secure Arab state on the periphery of Europe has dissolved into anarchy. Consider too that Tunisia was never originally thought of as particularly vulnerable to food price shocks either. In investment bank Nomura’s September 2010 index of food vulnerability Tunisia came 18th – a respectable level for a largely desert country. By contrast, Morocco and Algeria came second and third, Egypt came sixth, Sudan eight and Libya sixteenth. Ominously for a country of 164 million and a history of asylum seekers, Bangladesh comes first.

As disturbing as this is, what is of particular concern to this lounge chair dandy is candidate number two: Morocco. Although the Saharan monarchy has not seen the levels of unrest felt elsewhere across the Maghreb (and elsewhere from Oman to The Sudan), it does have a track record of food price riots with 33 killed in a weekend of riots in 1990 and over 100 killed in the ‘Bread Intifada’ of 1984.

It’s a concern that hasn’t gone unnoticed by Aida Alami in the Global Post who writes that despite the unifying symbol of King Mohammed VI, Morocco has high structural unemployment and soaring inflation.

What Alami doesn’t mention however is that Morocco is the one of the world’s biggest producers of phosphate rock, or phosphorite, a mineral with no substitute in fertiliser. If unrest of a Tunisian scale were to foment in the Kingdom the risks to another key agricultural supply chain are stark.

According to the US Geological Survey's most recent data on phosphate rock, Morocco and its unhappily occupied southern neighbour, Western Sahara, lead the world in phosphate reserves, with more than the other two biggest producers – the US and China – combined. Phosphate, which was previously behind the fortunes of Christmas Island and Nauru, is also a dwindling global resource, based on a study by Professor Stuart White and Dr Dana Cordell of the University of Technology, Sydney. Based on White and Cordell’s research, we may see a global peak in phosphate rock reserves within the next three decades.

Add in a continuing insurgency through Western Sahara’s Polisario Front, the regional presence of Al Qaeda in the Maghreb, clan fighting between Arabs and the Tauareg and, more recently, the emergence of a major international drugs trafficking route in the shifting borderlands where Algeria meets Mali and you have a recipe for a food crisis that lasts well beyond La Niña’s final furies.

While this may be music to the ears of a growing investor class bullish on phosphate and potash stocks, it presents a decidedly bearish scenario for virtually everything else.

That is no truer than for China, which although a major phosphate producer in its own right, is increasingly dependent on food imports and is already getting royally squeezed by supply and demand-side inflation, no matter how much its government might force its latest CPI to heal.

And while food price inflation is so much a problem for everyone that it features its own Financial Times landing page (what else better expresses the economic Zeitgeist?) it is a particular problem for China because of how it’s sandwiched its economic model into a reliance on accommodative money supply, a weak Yuan and low priced exports.

China is sailing between the proverbial Scylla of inflation and Charybdis of GDP growth. Ahead of its 18th National Congress in 2012, where the next generation of the Chinese Communist Party will take over the Politburo, it will need to navigate the rising tide of food prices without tipping over. Braver measures will need to be taken than tightening banking reserve ratio requirements or jawboning confidence in Washington summits; a fundamental reorientation of the economic system is required.

This means less debatable infrastructure and more internal consumption. It means cooling the property bubble and finding sustainable ways to raise incomes.

Above all, it means raising the value of the yuan, which contributes to all of these outcomes without the danger of hot money flows chasing rates higher, until we all blow up.

Australia would, in turn, need to wear any costs of lower commodity exports to China in the interests of a more sustainable demand curve, but that is besides the point. If China’s rampant growth continues without heed for inflation or human needs then all the skyscrapers and shopping malls will be a moot point. The roots of the Tiananmen Square protests was in inflation, which came from Deng Xiao Ping’s economic growth of the 1980s.

According to Credit Suisse research, Chinese consumers spend twice on food what they do on housing. Despite arguments that real estate inflation could lead to revolution, it’s food that is the real worry for China’s power elite.

Flashman is a galavanting Australian poltroon working in the funds management sector.

Links January 21: Ratcheting up

China's loan cap. Caixin (h/t Naked Capitalism)
China's illusory decoupling. Asia Times
China overheating. FT, Michael Sainsbury
Ore price drivers. FT
China can beat inflation. Gavyn Davies
Ore price record. Bloomberg
Ore volume record. The Oz
Indian exports the key to rally. Reuters
Chinese sabre rattling. Washington Times
More US homes. Calculated Risk
Financialisation of cows. GMM
Ramp mining tax to pay for flood recovery. Ian MacilWraith
Levy instead. The Age
Oh dear ... Minerals Council decries vested interests. (The Oz)

Thursday, January 20, 2011

Pillars of boom

Yesterday Bloomberg published an interesting article on Rio's iron ore output:
Production climbed to 50.1 million metric tons in the three months from 47.2 million tons in the same period a year earlier, according to a statement today from London-based Rio, the second-biggest exporter of the commodity. The figure beat a UBS AG estimate of 46.1 million tons.

“Iron ore was much better than what I was expecting,” said Tim Schroeders, who helps manage $1 billion at Pengana Capital Ltd. in Melbourne, including Rio shares. “Given they continue to raise the bar, expectations are pretty high.”

Rio Chief Executive Officer Tom Albanese, who is studying expanding iron ore operations by a further 50 percent by 2015 at a cost of about $14.8 billion, said today that demand is growing from steel mills. Prices may rise to a record $250 a ton this year, Credit Suisse Group AG said this month.

Don't adjust your computer. You read it right. CSG are forecasting a $250 ore price this year, despite the rising supply.

We should perhaps take it with a grain of salt. Such forecasts tend to be harbingers of a top. Nonetheless, there is no disputing that the iron ore price is surging above $180 per tonne, and probably on to a record above $190. And with monthly contracts in the offing, forecasts for Australian iron ore revenue will be blown away.

To give you some idea of just how big this boom threatens to become, I've graphed above Australia's top 10 export earners since 2003/04.

There are several points to make.

First, Blind Freddy can see the boom is based largely on iron ore and coal, with gold, gas and education chipping in.

Second, the projected revenues for 2010/11 iron ore and coal revenues are drawn from ABARES. They were made in mid December (find the documents below). In the case of iron ore, they used an average contract ore price of $132 per tonne which included a likely jump in the Q1 quarterly contract price to around $155.

However, if monthly contracts are forced through then the average price will suddenly jump, as it did when annual pricing shifted to quarterly pricing. The projected ramp in iron ore revenue will go vertical.

In the case of coal, the ABARES projection obviously does not include the QLD floods. It may fall, but this blog reckons the market is currently re-pricing the weather risk attached to coal owing to the giant La Nina. The question is, will volumes fall more than the price rises? Bloomberg also reported yesterday that:
Queensland cut its forecast for coking coal output in the 12 months ended June 30 by 10.5 percent to 177.3 million metric tons after flooding inundated the state, Mines and Energy Minister Stephen Robertson said in a telephone interview today. It may take between two and three months for normal mining operations to resume, he said.

If the same 10% is applied to exports, that will be a fall of around 16 million tonnes in the year, approximately $3 billion. This blog reckons higher prices will recover that figure but not until later in the year. The figure will anyway be swamped by the broader boom.

Of course, the longer and higher this boom goes, the bigger the bust at the end of it will be. And the same monthly contracts currently threatening to send the boom parabolic will ultimately deliver the downside of that same curve.

FeO & met coal

thermal coal

Links January 20: Ore rocket

Ore approaching record high. Bloomberg
Commodities bust. Zero Hedge
Asian inflation. Reuters
China should get guarantee to buy euro. Bloomberg
China and Germany. FT
Ireland defaults. Bloomberg
China and the US, mutual interests. Martin Wolf
How to get tough with China. Naked Capitalism
China NOT selling Treasuries. Econompic
Banks want to raise again. SMH
China's holiday home. Bernard Salt

Wednesday, January 19, 2011

Links January 19: Chk Chk ... Boom

Spend big on recovery. SMH
No Qld labour shortage. The Age
Commodities rocket. The Oz
Are banks fixed? Robert Peston(h/t nakedcapitalism)
The tinkerbell market. Naked Capitalism, Zero Hedge
Germany offers truth or dare to market. Calculated Risk
Market takes dare: Greece, Ireland, Portugal, Spain, Italy, Belgium
World bank vs China. FT
China's Treasury holdings. Zero Hedge
Kashkari on US debt. Bloomberg
Currencies, controls and exports. Alphaville

Tuesday, January 18, 2011

S&P's missing $400 billion

Regular readers will recall that this year's coverage began with the unwholesome news that S&P were in the process of downgrading Australia's BICRA score - the credit rating given to the Australian financial system.

This blogger has chopped a rather important chart from the primary BICRA document (see above, full document below) in order to ask a question.

Credit junkies will note that Australia's debt to GDP ratio is graphed in the upper 120 percentage point range. To be precise, it is 127.3%.

The question is this. Why is Australia's debt to GDP so low?

Dr Steven Keen puts the ratio at 160%, which would clearly push Australia into the nasty territory currently occupied by Spain, the UK and the US.

This blogger has double checked Dr Keens' figures and they are correct. It then played around with the credit aggregates available at the RBA (D02), adding and subtracting them in various ways, leaving some credit components out and calculating against GDP. But nothing has worked to produce 127.3%.

Wondering if this was a straight error, the same was tried with New Zealand's debt to GDP figures. Again, no rearrangement of figures served to justify the quoted ratio.

So clearly S&P uses some kind of proprietary formula for calculating debt to GDP that loses more than 20% or roughly $400 billion of Australia's debt.

The above graph hints at that formula in the description "Domestic credit to the private sector". But what exactly does that mean?

Perhaps it means that international banks that extend credit in Australia are excluded. Or, perhaps it means that offshore borrowings are excluded. Or, perhaps it means that some portion of Australian credit ends up offshore.

This blogger is buggered if he knows. So it rang S&P. They haven't answered his inquiry.

Given the rather important nature of this question, perhaps someone out there can help locate the missing $400 billion.

S&P Preliminary BICRA in 23 Countries Jan 6 2011 (1)

S&P FI RfC Methodology for Determining BICRA May 13 2010 (1)

Tough choice

A slew of material out yesterday and today has bearing on the medium term outlook for interest rates. First, Reuters reported uncomfortable news on inflation:
A private gauge of Australian consumer prices showed annual inflation ran above target in December, with price pressures likely to grow as the Queensland floods push up food costs.

The TD Securities-Melbourne Institute measure of consumer price inflation rose 0.2 per cent in December, compared to November when it rose 0.4 per cent.

The index was 3.8 per cent higher than in December 2009, above Reserve Bank of Australia's (RBA) long-term target range of two to three per cent.

The TD-MI gauge has tended to grow faster than the official measure of the consumer price index (CPI), which ran at an annual 2.8 per cent in the third quarter.

Official numbers for the fourth quarter are due on January 25.

TD head of Asia Pacific research Annette Beacher estimated the CPI would rise 0.8 per cent in the quarter, nudging the annual pace up to 3.1 per cent.

"Our monthly gauge confirms that uncomfortable inflation pressures emerged in the final months of 2010," Ms Beacher said.

Contributing most to the overall change in December were price rises for fuel, fruit and vegetables, and holiday travel and accommodation.

Those were partly offset by falls in prices for audio, visual and computing, sport and other recreation, and books, newspapers and magazines.

... Damage caused by the floods in Queensland would likely see some food prices climb this quarter, while a massive rebuilding effort in coming months could put upward pressure on wages and inflation over time Ms Beacher said ... "with vast tracts of the Brisbane CBD severely affected by the floods, the concentration of infrastructure to be repaired could exacerbate already stretched labour and building materials, hence the upside to inflation could last longer than the temporary food price spike."

No doubt RBA governor, Glenn Stevens, will 'look through' the food price spikes at the February meeting. But the danger of a medium term labour price spiral will be of concern.

That danger is going to quickly worsen because the government today acknowledged that the:
"...commitment to return the federal budget to surplus in 2012-13 is coming under more pressure as the likely damage bill from the most devastating series of floods in Australia's recorded history continues to mount.

With the still unfolding crisis in Victoria adding to a colossal damage bill in Queensland, Ms Gillard and Treasurer Wayne Swan yesterday conceded that the budget would be stretched by flood recovery and rebuilding costs for years.

Pointedly, when discussing the financial implications of the floods, Ms Gillard did not repeat assurances earlier this month that the promised schedule for a return to budget surplus would be unchanged.

''We will be managing the federal budget so that we can meet the needs of recovery and rebuilding,'' Ms Gillard said. ''I know that there is going to be a lot of effort, money and resources needed to rebuild, particularly rebuild Queensland.''

Mr Swan said the government would be up for a ''very substantial amount … It will involve billions of dollars of Commonwealth money and also state government money and there's going to be impacts on local governments as well.''

This blog isn't arguing against spending this money. What's the point of saving if not for a rainy day?

However, as the coverage on this blog has recently illustrated, the world is quickly swinging from a GFC-deflation toward a recovery led by commodity price inflation. This blog also noted last Friday that Australia's commodity majors are moving to capitalise on this by pushing short term contacts for iron ore (and coal). When they succeed the national economy will face an explosion of cash in the first half of the year.

Late last year, Glen Stevens, observed that Australian monetary authorities are vulnerable to the charge that they haven't raised interest rates early enough in past business cycles. In a November senate testimony the Gov said:
I cannot think of very many cases in history where we looked back and thought, ‘Yep, we tightened too soon.’ I can think of several times where we looked back and thought we should have tightened a bit earlier. I think that if we are doing it right the decisions will be finely balanced most of the time—that is where we should be—and we will probably move a little bit earlier than the moment when it is clear that you have to. That is if we are doing it well. There is some risk that you do things you do not need to do—I agree with that. We have to balance that risk, obviously, against the risk of getting behind the game. Historically, for many central banks, including us, that has tended to be the mistake that we made.

So, in the new normal course of events, we would expect to see rate rises flowing through as soon as the new commodity contracts see ore and coal prices soaring.

Sadly, however, there's a complicating factor: The effect of the floods on asset prices. The SMH also reported yesterday that:
House prices in Queensland may sink as the financial effects of state's devastating floods strain household budgets and dent banks’ willingness to lend, a ratings agency has warned.

Credit ratings agency Fitch said today that while the full impact of the Queensland floods is impossible to gauge at this point, they are expected to have a negative impact on house prices, borrowers and banks.

Property damage may “temporarily or permanently affect” borrowers' ability to pay and could cause “lower than normal recovery rates for damaged properties”, the credit agency warned.

Losses for banks could also mount if people can't fully repay loans. Fitch said lenders' mortgage insurance - insurance held by the banks themselves - does not cover flood damage.

... Defaults on home loans may force Fitch to reconsider assumptions it made about recoveries on losses when it initially rated the mortgage-backed securities linked to Queensland's real estate, it said.

“Moreover, the market value for properties located in the flooded areas might now be permanently adjusted downwards due to future flooding risk," the agency said.

This blogger will add that if RMBS are in the gun for downgrades, so, most likely, are QLD banks. It's not yet clear whether this will be sufficient to prompt an increase in the major's funding costs. Let's hope not. But the piece goes on suggest that:
RMIT Property & Valuation lecturer Matt Myers said the values of the homes depend in large part on how viable the local economy remains after the floods.

“Some areas will see an eventual return to similar values - lots depends on the economy of those areas,” he said.

“If there are jobs, people want to stay, and if enough people have adequate insurance to rebuild, then these areas will do well,” he said. “But I expect some of the rural areas may never fully recover.”

Houses that are blocks away from creeks that have been flooded will probably be valued lower, by as much as 10 per cent, said RP Data's Cameron Kusher.

“For the next five years of so, a flood report is going to be the buzzword for anyone wanting to buy property in Queensland or other states, as well.”

This blogger reckons the article has it backwards. It's not quite so pessimistic in the short term because there will also be increased activity in non-flood affected areas as people move. This could put some areas under upwards price pressure.

Looking further out is a different matter. The article neglects a major problem facing flood-effected home owners - the cost of insurance is going to rise - a lot. As Bloomberg reported yesterday:
The Queensland floods may cost insurers and reinsurers worldwide as much as $6 billion in what might be Australia’s costliest disaster in history.

Insured losses from this week’s deluge in and around the capital Brisbane may be as high as $4 billion, while damage from floods further north late last year may cost $2 billion, according to Milan Simic, managing director of catastrophe modeler AIR Worldwide.

Political pressure is mounting on Australian insurers, which include Suncorp Group Ltd., Insurance Australia Group Ltd. and QBE Insurance Group Ltd., to pay claims as residents return home to assess damage. Those companies are spared from the bulk of the costs by policies designed to pass on the bill.

This blog noted last week that the experience of New Orleans' home owners following Hurricane Katrina was an immediate surge in prices that was followed by relentless deflation, owing in part to onerous insurance premiums, especially at the top end. This blogger reckons a similar dynamic is set to put downward pressure on Brisbane house prices.

So the RBA is also likely looking at accelerated declines in QLD asset prices in the medium term. And there will also be immense political pressure to not raise rates as suffering Queenslanders rebuild.

The RBA is facing a tough choice sooner rather than later. Raise rates and face opprobrium. Or, wait, and get hoisted on its own petard.

Links January 18: Fiscal flood

Germany's European rescue. Wolfgang Munchau
Weather hitting steel. FT
Pox Americana. Niall Ferguson
Albert Edwads gets the chills. Zero Hedge
Canada tightens macroprudential. Bloomberg
Surplus washed away. SMH
Interest rates. Ian Verrender
TAFE gets Dutch Disease. The Age
Coal damage. The Age
Resources wage demands. Jennifer Hewitt
Chinese port ore stocks at record highs. Mineweb
Ore rocket. Bloomberg

Monday, January 17, 2011

Retailers need therapy

From the SMH today:
The Retail Coalition is preparing to hand in documents to the securities regulator to officially incorporate its activities, enabling it to hire staff and ramp up its calls for urgent tax reform.

The documents will detail plans to establish a new independent company with a constitution, board of directors, company secretary, employees and hands-on chief executive. At a national dial-in set for 10am today representatives of each company in the Retail Coalition will further discuss their battle plans, BusinessDay can reveal.

Those plans include the transformation from an informal gathering into a company under the Australian Securities and Investments Commission, providing a crucial foundation to r tchet up the lobbying campaign.

The conference call is part of a commitment to talk to one another twice a week, with chief executives personally dialling in on most occasions. It is the clearest signal since the debate erupted after Christmas that the big retailers that make up the coalition are far from backing off or intimidated by the wave of public abuse provoked by their case, and will push ahead with their public policy concerns. But it will also bring a more professional pitch to their campaign, which to date has been dismissed as the complaints of a few billionaires threatened by competition and drowned out by the howls of shoppers who feel they are trying to cut their access to overseas bargains.

Gosh, the retailers really did go off half-cocked didn't they? Whatever happened to research, plan and execute? Perhaps they felt the campaign couldn't wait until after Christmas.

Shifting the campaign to a more professional approach, however, is hardly going to convince the body politic of the need for protection. Especially when it involves supposedly competing CEOs getting together weekly to discuss how to prevent competition.

In short, nothing has changed since this blogger wrote in the lead up to Christmas:
The first point to make about this is that the campaign is up against it in winning over the public. Anti-RSPT miners had three advantages that the retailers do not. The tax was distant and complex, making it a PR-makers dream to combat. All it needed was a million conflicting 'facts' and the population gets lost, the policy ceases to make sense and, in the confusion, the clear message of risk shines through.

The retailers on the other hand are attempting to increase the price on sub $1000 household goods. For consumers it is a personal and very clear affront.

Second, the RSPT debacle unfolded in a very different political economy. The combination of an election and a post-GFC moment in which mining was at least one part of saving the nation made the anti-RSPT message stick.

The retailers face an environment of higher interest rates and one in which although the economic recovery is reasonable, it is patchy.

Moreover, just about every official and private economist everywhere has been selling the nation the idea that we need to shift economic resources to the resources sector so it's moment in the sun is not dimmed by labour or infrastructure bottlenecks.

Other sectors need to give it up, according to this chorus.

Another difference to the anti-RSPT campaign is that its goal was to prevent a new government policy. The retailers want to create new government policy that will fly in the face of RBA objectives and rhetoric.

On the last point, this blogger will observe that the retailer's demands can be seen as a gift to a government with no productivity agenda and no reform credentials. It can just sit on its hands and boost both by looking tough on rent-seeking. And with the populace against the billionaires, it's all politically risk-free benefit.

The retailers are wasting their shareholders' money.

La Nina as Black Swan update

For those that missed it, Yves Smith of Naked Capitalism fame quoted liberally from our very own Flashman over the weekend, firing off a frenzy of activity.

Amongst that traffic was a comment from Bruce Krasting that included an excellent link comparing this super La Nina with those of the past. He concludes:
You are correct that an extreme La Nina is responsible for the wacky global weather of late. The good news is that the cycle peaked in December and we are now reverting to more neutral conditions.

NOAA has an excellent graph that tracks this. Look at how steep this La Nina is. Look also how it compares to the 73' event.

Hang in the Australia (and many other parts of the world) better weather is coming.

The graph referred to is reproduced above. Clearly the mid seventies ENSO suggests a reprieve. But it also displays a worrying double dip. The 1955 super La Nina shows a similar pattern.

The conclusion of the paper referenced by Krasting says it all:
Stay tuned for the next update (by February 5th) to see where the MEI will be heading next. While La Niña conditions are indeed guaranteed well into 2011, it remains to be seen whether it can rally once more to cross the -2 sigma barrier, and/or whether it will indeed last into 2012, as discussed five months ago on this page. I believe the odds for a two-year event remain well above 50%.

Should coal carry a risk premium for the next twelve months?

Links January 17: Inflation nation

China trade tensions vs consumers. Wharton (h/t nakedcapitalism)
China's gigantic white elephant. Credit Writedowns
Issues 2011. Doug Noland
Week ahead for the DOW. Calculated Risk
Oil shocks. Econbrowser
Coal shock. The Oz
PIMCO goes for MBS. Zero Hedge
Commodities and dollar inflation. Calafia Beach Pundit
China bears. Telegraph
China must buy dollars. Reuters
Whither next food riots? Business Insider
The FED on housing in 2005. Tim Duy
Retail whingers comeback. SMH
28,000 homes need reconstruction in QLD. The Age
Peak olives? Bloomberg
The Black Gate Opens. Stephen Munchenberg
JPMorgan claims copper deficit vs JP Morgan has cornered copper.

Saturday, January 15, 2011

Weekend Reading: Seventies bogue

China: credit and bank requirements surge. FT
Korea innovates on macroprudential. Gillian Tett
Commodity speculation. FT
No to position limits. Zero Hedge
Jim rogers goes for rice. Zero Hedge
Weather worries. AR Screencast (including our own Flashman)
Indian inflation on charge. Bloomberg
German inflation up. Bloomberg
US inflation up. Calculated Risk
Sustainability of recovery. Tim Duy
US demand is all about exports. Econompic
China bust. Colin Kruger

Friday, January 14, 2011

Cash explosion

Reuters reports today that:
Mining giant BHP Billiton Ltd has begun auctions for spot iron ore shipments to Chinese steel mills, local media reported on Friday, marking the latest shift in its pricing strategy to cash in on rocketing prices.

BHP, the world's third largest iron ore producer, has started to auction a 170,000-tonne spot iron ore shipment every fortnight to Chinese customers, the China Securities Journal reported, citing a procurement manager at an unidentified steel mill in southern China.

A tight supply market, combined with fast-rising spot prices, meant that BHP was unwilling to extend even quarterly prices to new customers, the paper reported, forcing many steel producers to buy iron ore either priced on a monthly basis or to take extra spot market shipments.

Spot iron ore prices were on course to hit an eight-month high on Thursday, after all major price indexes rose to trade as high as $US184 per tonne, powered by sustained Chinese buying and supply concerns as a tropical cyclone threatens to interrupt production and shipments in Australia.

Last March, all three major iron ore producers, including Vale SA and Rio Tinto Ltd, agreed with Asian customers to shift pricing for the majority of its iron ore to shorter term contracts based on market-cleared prices and on a landed basis.

According to this blogger's calculations, the Dec10 contract price was around $142. The average for the quarter was in the mid $150s. A 8-9% rise was looking a fair bet for Q1 2011.

However, the current spot price is headed inexorably through $180 per tonnes. if BHP can force through these monthly contracts, presumably based on the trailing average of prices for the previous month, then the price is going to rise into uncharted territory very quickly.

In the 09/10 year, we exported 266 million tonnes plus of iron ore to China and another 124 million or so elsewhere. Rising prices go straight to the bottom line so we're talking roughly an extra $390 million income for every $1 rise.

According to a 2005 RBA study that money is distributed thus:
A substantial part of the increase in profits accrues to state and federal governments. Royalties, which are a pre-tax item, are payable to state governments on mineral and onshore petroleum production.

A substantial part of the increase in profits accrues to state and federal governments. Royalties, which are a pre-tax item, are payable to state governments on mineral and onshore petroleum production. These are mostly at ad-valorem rates, and although there is substantial variation in rates and dei nitions, they probably imply that around 5 per cent of additional revenues from higher commodity prices typically accrue to state governments. More signii cantly, based on the statutory corporate tax rate, up to 30 per cent of the increase in proi ts would be payable in corporate income tax to the Australian government. The higher level of proi ts would also result in some additional tax revenue from personal income taxes paid by shareholders on dividends or – in the longer run – on capital gains. Although the payment of these royalties and taxes may initially reduce the stimulus from higher commodity prices, there will still be an expansionary impact to the extent that higher government revenues allow higher government spending or a reduction in tax rates. Over a period of time, assuming government net fiscal positions are held roughly constant, the increase in revenues owing from higher export revenues to domestic governments would thus represent a corresponding stimulus to the economy

... The remainder of the initial boost to revenues (roughly two-thirds of the total) accrues to shareholders of the companies. This occurs either in the form of higher dividends, or if earnings are retained, in the form of capital gains. Domestic shareholders include both households and institutional investors such as superannuation funds. However, to the extent that there is foreign ownership of the Australian resources sector, part of the addition to incomes will accrue to foreigners.

Although there are no precise figures on aggregate foreign ownership, some ABS data for 2000/01 suggest that foreign ownership in the resources sector is around 50 per cent. This is probably somewhat higher than at the time of earlier resource booms.

The expansionary effect of these income flows on the Australian economy can be expected to operate through a number of channels. Higher dividends and capital gains accruing to domestic shareholders will feed into household income and wealth and, over time, into household spending. More importantly, higher commodity prices are likely to have substantial effects on the behaviour of resource producers, assuming that the price increases are not viewed as completely temporary.

Australia may be taking a hit from the dropping coal volumes and flood damage, but as reconstruction stimulus begins, and coal shipments resume, these incredible terms of trade developments are going to pour cash over everything.

The RBA may want to look through short term inflation spikes but it will do so at its peril. La Nina is setting the stage for a giant Australian blowoff.

Guest post: La Niña, the black swan

This week’s disastrous floods in Queensland have tragically claimed many lives in addition to leaving thousands homeless and without businesses to return to, but the biggest cost economically may be felt abroad. I’m not talking about reinsurance here – though that is indeed an issue considering the estimated $5 billion damages bill – but about the disaster’s ramifications for the price of food and the price of energy: two issues that I see as defining for 2011.

Queensland’s floods may also be just the tip of the iceberg, so to speak, of a much larger weather phenomena that could in turn further exacerbate food and fuel inflation: a ‘super La Niña’ of a size and scope which, according to US meteorologist Art Horn, rivals the La Niña pattern of 1973-4, when Queensland and its capital city Brisbane last sank under a flood of today’s magnitude.

Horn's arguments on the current La Niña bear careful consideration not just because of the potential ramifications for global markets, but because they are being echoed by others from Neville Nicholls of the Australian Meteorological and Oceanographic Society to the always thought provoking John Clemmow of UBS, who discusses the Australian Bureau of Meteorology’s latest ENSO (El Nino Southern Oscillation) report. And, as Adam Mann discusses in Nature, conditions are likely to remain abnormally cool and wet in Australia, while windy and dangerous in North America’s hurricane belt for some months yet.

That doesn’t bode well for coal, of which Australia is the top global exporter, or for oil, of which a significant share comes from the hurricane-prone Gulf of Mexico and Caribbean.

When we consider the impact of other previous super La Niñas, whether in 1955, when epic floods stormed the Pacific North West and New South Wales, 1917, when the Ohio River froze over and the seeds of the 1918 pandemic were arguably sown, or as recently as 2007-8, when food prices reached previous records, the situation bodes even less well.

Simply put, a glance at La Niña’s previous appearances shows up a pattern of dramatic climactic risk, especially at a time when food and fuel are already commanding high prices. Figures from the UN’s Food and Agriculture Organisation, for instance, show that prices of staples are already higher than the peak in 2008, while both Nicolas Sarkozy as chair of the G-20, and World Bank president Robert Zoellick have put food prices at the top of the agenda.

Brent crude, meanwhile, is nearing $US100 a barrel on lower US stockpiles, a leaking Trans-Alaskan pipeline and unsure political situations in Sudan, Belarus and Lebanon.

And these are merely the supply-side issues of a weather phenomenon that cuts both ways. In terms of example, Bloomberg reports that heating oil futures are at a 27-month high on snowstorms in the US, while in China what Xinhua describes as the most extreme weather in ten years is adding impetus for further food price controls.

In India, meanwhile, there’s an onion crisis, Indonesia’s government is encouraging citizens to grow their own food, South Korea has released emergency supplies and deadly riots have broken out across the Maghreb.

But the issues, as it were, keep rolling in. The US Department of Agriculture has just released data reducing soybean and corn estimates, sending futures in those products to 30-month highs.

No doubt the Ponzi scheme of derivative trading, much of it cornered, is adding to the volatility of these commodities.

Yet you cannot argue that we’re seeing a bubble. On the back of Queensland’s floods, analysts from National Australia Bank are now expecting an increase in Australian fruit and vegetable prices of 30%, adding 75 basis points to the March CPI. This, alongside the blockage of Queensland grain ports – which comes in turn after estimates that half of Australia’s wheat harvest could be downgraded to fodder or milling grain – spells further chaos.

Amid dangerously accommodative monetary policy in the US and China, where the latter's M2 money supply has surged by some 20% in the past year, inflation matters dearly. As Patrick Chovanec from Beijing’s Tsinghua University's School of Economics points out, the recent fall in China’s CPI from 5.1% in November to 4.3% in December is a misleading indicator, due to the ultimately unsustainable retail food price crackdown and tepid cash rate measures. And as fellow expat academic, now securities strategist, Michael Pettis, writes this week, no lending quota – China’s de rigueur disinflationary measure – has yet to be set, much to everyone’s surprise.

China is caught between fuelling an economy based on cheap exports and fixed investment with arguable social returns, and the commodity inflation that this development model drives.

These concerns have been noticed by John Berthelsen and Benjamin Shobert, who respectively write that China faces grave social risks from food price inflation and food insecurity as a result of imbalanced economic policy, poor agricultural practices and the effects of climate change and deforestation. Shobert furthermore notes: “of the 13 major famines China has endured, six have been inexorably inter-related to political upheaval and conflict. China’s current leaders are aware of this part of their history,” he writes, “which is why the government’s stated goal of ‘95% self-sufficiency’ [in food supply] is deemed so critical.”

As much as the mainstream press likes to focus on China’s stranglehold of rare earth materials, the real danger in an era of trade wars and rising commodity prices is China’s dearth of food and fuel supply. China’s policy reaction to these challenges will be the ultimate determinant of whether the New Year ends in growth or ends in recession.

It is in this context, perhaps, that China has been spending so much money on its new J-20 stealth fighter plane, tested by the People’s Liberation Army as US Defence Secretary Robert Gates was meeting China’s civilian leaders in Beijing, and on its naval ‘string of pearls’ strategy. Both as a potent symbol, and as a latent weapon, China is acquiring the means to ensure commodity supply well into the future. Suddenly America’s foreign policy in the Middle East doesn’t look so unique.

Of course the only thing that China cannot defend itself against is the whims of the planet and it seems ironic indeed that the place from where climate changing coal was mined has now been inundated by epic flood. Following a Malthusian act of nature, highly combustible coal has been tossed onto the blaze of the world's growing commodity inflation.

And with La Nina still skipping coolly across the Pacific, more may be yet to come.

It would indeed be the ultimate black swan if La Niña pushed Chinese inflation into a cycle-busting inflation spike.

Flashman is a galavanting Australian poltroon working in the funds management sector.

Links January 14: Food crisis

US crop downgrade. WSJ
Looming food price shock. FT
US PPI goes bananas. Econompic
Agencies warn on US debt. WSJ
$US smashed. Bloomberg
Boooooring. France, Germany veto EFSF extension. Ambrose
All PIIGS bonds rally.
US trade deficit shrinks. Calculated Risk
Oil shocks. Econbrowser
Australia's employment flood. Peter Martin, The Oz
Chinese auto bubble. CNN
Ore soaring on cyclone, supply. Reuters
This bastard's headed for records. Bloomberg

Thursday, January 13, 2011

Inundated houses

In the year following Hurricane Katrina, something unexpected happened to New Orleans house prices. They rocketed 27% over a period of months. According to USA Today "displaced residents bid up median prices".

This blogger thinks it unlikely that we will see such a dramatic price escalation in Brisbane. The floods are not as serious nor as persistent as those that afflicted New Orleans. The clean up will be more swift too. Another major difference is that this event is associated with a 20-30 year major La Nina. It is a climate system that is well understood and not indicative of a frequent danger. New Orleans, on the other hand, had been dodging hurricanes for years and there remains a very real prospect of another any given year.

So we can expect less damage and less displacement.

Nonetheless, in the short term, we might still expect flood inspired sales and movement. And in that sense there may be a pick-up in housing turnover and perhaps price shifts accordingly.

Following the Brisbane floods of 1974/5, the median price in the city did jump 19% (according to this Macquarie Univerity paper). This was well ahead of Sydney at 8%, Melbourne at 12.5%. But not far ahead of Adelaide at 18%, and behind Hobart at 26% (Perth figures are similar but appear unreliable).

This blogger is hesitant to conclude anything from these figures beyond the fact that the nation was caught up in a housing boom.

Following it's sudden 05/06 house price surge, however, New Orleans has faced sequential years of declining prices. Needless to say, this deflation mirrored broader falls in US housing. A condition playing out on a longer time frame here in Australia as well, with a particular concentration in and around Brisbane.

But there has been one factor in New Orleans that has effected greater falls at the top-end of the market that may play out in Brisbane as well. That is the cost of insurance.

Yesterday Business Spectator has a decent take on the likely economic fallout from the floods. But the one paragraph stuck this blogger as unrealistic was the insurance fallout:
To date the floods are located in more sparsely populated regions minimising the economic impact. Approximately 800,000 people live in the broad region affected by the flooding.

Robert Whelan, chief executive office of the Insurance Council of Australia estimates that while this is a major weather event, due to low population densities in the region, it is a moderate insurance event. Preliminary estimates suggest insurers will receive about 4,300 claims and pay out about $150 million. By comparison, the industry received about 161,000 claims and paid out about $1 billion dollars after a 20 minute Perth hail storm early last year.

The operative quote being "to date". According to the ABC, 3,000 homes were inundated in Ipswich alone yesterday and "already thousands of homes in some Brisbane suburbs have waters past the second-storey after Wednesday's peak". AP reported that in Brisbane, "a total of 14,600 homes and 2,800 businesses are expected to be flooded and at least 50 suburbs affected."

Thankfully, reports this morning suggest the flood is below 1974 peaks but the preliminary insurance estimate is still very optimistic. Insurance costs in flood-effected districts are going to rise.

The question is, will the inflation be so onerous as to accelerate price falls in top-end realty, as in the case of New Orleans?

Many of the flood effected areas of Brisbane are prime realty so it meets that criterion but the conditions of the flood explored above suggest that even though premiums will rise, the irregularity of the incidents should contain the inflation.

Again, some reassurance is to be found in the 1974 experience, in which there is no evidence of Brisbane median prices departing from national averages in the years after the flood.

This blogger will admit, though, this is speculation. The best it can offer at this stage is the observation that insurance premiums are worth watching. Any rise cannot help an already struggling market.

Links January 13: 11th hour euro

Portugal sells bonds. Rehn indicates expanding EFSF. Reuters
In a lot: Ireland, Portugal, Greece, Belgium
In a little: Spain, Italy
Italy in the gun. Zero Hedge
Euro to fall most. Ken Rogoff
Perhaps. US debt spike. Econompic.
Geithner ramps China rhetoric as Hu approaches. FT
So does China. IMarketNews
My former baby making waves on China's J20. The Diplomat (h/t nakedcapitalism)
US begins rifle-shot protectionsim. FT
US will go broader. Michael Pettis
Gail Kelly getting the boot. Banking Day
Or is she? SMH, SMH, The Oz
Flood impacts. BS
Another Indian state banning ore exports. Reuters
Iron ore contracts going monthly. The Oz
Oil rocket. Bloomberg
And Hizbollah isn't helping. FT
India's record gold imports. Zero Hedge

Wednesday, January 12, 2011

Not posting today

Hi Everyone,

Out of respect for those that have perished and those that are grieving, I won't post today. My sympathies go out to all who are suffering.


Links January 12: Random walk

Mish calls Australian bubble bust. Mish
US foreclosure pipeline. Alphaville
US housing headed for new low. Calculated Risk
Macroprudential goes global. FT, Stephen Bartholomeusz
McKibbin demands flood stimulus. The Age
More capesize carnage. Dry Ships
Contagion today: Belgium out. All else in.
Gold not a bubble till $2k. BusinessWeek
Alcoa sees China slowing. Bloomberg
China rampaging credit growth. Reuters
China's great pile of paper. Econompic

Tuesday, January 11, 2011

Uh oh, euro

Yes, that pattern could be seen as a nice head and shoulders top for the euro. No surprise, really, with Europe's bail-ins rolling inexorably toward Portugal. As FT Alphaville illustrated so nicely overnight: took Greece and Ireland less than a month to request EU/IMF aid after their 10-year bond yields breached that all-important 7 per cent level (as indicated in the charts above). Though it’s worth noting that Portugal has been through the 7 per cent barrier a couple of times before and saw yields decline after. Nevertheless, all eyes are on the Club Med member this week.

The crisis has no end in sight. Also in the FT, one of the clearest thinkers on the rolling debacle, Wolfgang Munchau, explains why:
The most glaring manifestation of this lack of leadership is the EU policy consensus that this crisis will eventually be self-correcting, and that a robust liquidity backstop is all that is needed. This is a tragic error. What makes this crisis self-sustaining is the presence of two interacting components: a combined private and public sector solvency crisis, and a competitiveness crisis. To address a lack of competitiveness, southern Europe, including Italy, would need outright deflation. In some cases wages and prices would need to drop by 30 per cent to fall in line with northern eurozone levels. Yet deflation would increase the real value of debt. It may just be conceivable that the periphery will get on top of their competitiveness problem, or on top of the debt problem, but surely not on top of both at the same time, without devaluation or default.

And indeed, that's what David Rosenberg sees coming sooner rather than later. His proximate cause is one of this blogger's favourite themes, that the Irish body politic may flip the bird at the European bail-in in its March/April election.

This blogger has been relatively confident that European fiscal authorities will see reason in time to avert catastrophes. But there is a rather uncomfortable convergence ahead that will put a great deal of pressure on this thesis. As we know, following Portugal is Spain. The Source offers this asessment of the extent of that bail-in:
A rough calculation by Barclays Capital suggests that after paying for Ireland and Portugal, the EFSF would have about €235 billion left, not enough to cover the €290 billion that a Spanish bailout would likely entail.

The yield on the Spanish 10 year is currently 5.5%. Last November, it took just three weeks for Portugal's 10 year bond to rise from the same level to above 7%. It seems to this blogger that it is quite possible that Spanish bonds could trace the same path even as we approach the Irish elections.

The spectacle of the European Financial Stability Facility (EFSF) concurrently attempting to bail-in Spain whilst Ireland defaults out is so Kafkaesque that the credibility of European authorities may suffer an altogether larger run, with all too predictable outcomes.

But let's take a breather for a moment and back away from this precipice. Let's assume instead that some form of eleventh hour fiscal integration solves these problems (which is this blogger's central case). The pressure needed to bring that about is still going to be very large. The euro is going to fall and the US dollar rise on the flight to safety.

This will set up a self-fulfilling sell cycle for global equities. As this blogger has noted many times before, contemporary capital markets are not based upon discipline and fundamentals but sentiment and liquidity. As such, behavioural economics is king and the narrative that underpins recovery is just as important as the recovery itself. Without a weakening $US, the recovery narrative of correcting global imbalances that supports internal Chinese growth, US exports and rising commodity prices ceases to make sense.

As this blogger described late last year, it's central case is that European convulsions are buying opportunities because the growth in emerging markets is so impressive and the larger global cycle will grind higher. If you ignore the danger of a critical crisis in European fiscal credibility, this is still the case.

But this is no time to be toying with markets.

Disclaimer: The content on this blog is the opinion of the author only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation, no matter how much it seems to make sense, to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author has no position in any company or advertiser reference unless explicitly specified. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult someone who claims to have a qualification before making any investment decisions.

Links January 11: Next wave

Out: Spain, Italy, Belgium
In: Ireland, Greece, Portugal,
Timeline Portugal. Alphaville
Europe's combined solvency & competitiveness crisis. Wolfgang Munchau
Rosenberg sticks with bonds, buys dollar. Globe and Mail
Dollar bull. The Source
Will oil stuff the recovery? Tim Duy
Era of cheap capital over. The Source
Brazil embraces trade war. FT
Capesize hammered again. Dry Ships
China December ore imports up. Bloomberg
OMG, that's another cup and handle on the ore chart. Bloomberg
Coal rocket. The Oz

Monday, January 10, 2011

What's up (or down) with the BDI? (updated)

Coal, iron ore and grain prices are all headed one way - up.

Yet the Baltic Dry Index, the generally reliable gauge of demand for bulk commodities is collapsing.

Last year the BDI correctly foreshadowed and tracked the mid-year slowdown in the global economy, despite being given short shrift by many bullish commentators seeking to rationalise an upward bias in markets. So what's going on now?

The answer appears to be the QLD floods. As Reuters reports:
Australia's key coal port of Gladstone said on Sunday devastating floods have left it so short of coal that a queue of ships waiting to load would likely be diverted elsewhere.

A deluge in Queensland state has flooded mines and damaged roads and railways, cutting the major Blackwater rail line that goes from the coal centre of Emerald through the flooded town of Rockhampton and south to Gladstone.

Queensland is a major world supplier of coking coal for use in steel-making, and the floods have pushed global prices up.

Although Gladstone itself was not flooded, a Gladstone Ports Corporation spokeswoman told Reuters only two trainloads of coal arrived last week, only two ships loaded and the coal arriving was only for domestic use.

"We have got about 18 ships sitting out waiting," spokeswoman Lee McIvor told Reuters on Sunday. "We are expecting the coal companies to reallocate and reschedule these ships elsewhere."

On a normal day, Gladstone would receive around 24 trainloads of coal, McIvor said.

A glance at the index's internals offers further evidence that the floods are playing a role in the drop. According to Wikiinvest, 25% of the BDI is made up of capesize ships. Capesize vessels dominate trade in iron ore and coal. And it is in the capesize component of the index that we find by far the highest carnage.

Further confirmation comes from Lloyd's List which notes that owing to the knock-on effect of QLD floods and the lack of demand for capesize vessels:
...Rates for West Australia to China iron ore trips are so low that owners are considering withdrawing tonnage from the spot market as daily returns from such voyages barely cover operating costs.

Finally, for future reference, the below video is an excellent exposition of the value of the index:

Bloomberg has another good piece today on imminent increases in capesize supply.

S&P spoils the party

It's an 'happy new year' all around this morning. Except, apparently, from Standard and Poors who, according to Banking Day are about to downgrade our financial system:
Persistently high rates of credit growth relative to GDP and seemingly high property prices could filter into lower credit ratings for banks as Standard & Poor’s revises its approach to credit analysis.

Amid numerous recent reviews of methods applied by the ratings agencies, in light of the credit shock, one S&P review is producing results that will demand attention by investors in bank debt and other securities.

On Friday, S&P published a series of papers on its revised criteria for rating banks, and on which it seeks comment by early March.

While S&P noted, in its media release, that the proposals “would have a modest impact” on banks, changes in ratings of one notch or more (and both up and down) are in prospect.

In the case of Australian banks the risk of a ratings change appears to be a downside one.

One of the papers summarises S&P’s latest work on its “Banking Industry Country Risk Assessment” or BICRA score. These scores range from one, the safest, to 10, the riskiest.

At present, S&P includes Australia’s banking industry as one of six banking markets scored as a “one”.

Under the new approach, the S&P BICRA score for Australia’s banking industry is, tentatively, a “two”.

Banking Day is unsure how this national financial system downgrade will affect individual bank ratings but it doesn't make a lot of sense to downgrade a system then endorse its main parts. Looks like funding costs are going up again with all that that entails.

This blogger has obtained the preliminary assessment as well as the new methodolgy (find them below). See page 4 of the first document for the pending BICRA scores.

S&P Preliminary BICRA in 23 Countries Jan 6 2011 (1)

S&P FI RfC Methodology for Determining BICRA May 13 2010 (1)