Canada Market Cheat Sheet (January 31, 2011)

Monday, January 31st, 2011

Cana­dian Equity Mar­ket Cheat Sheet (Jan­u­ary 31, 2011 )

Strengths

• Cor­po­rate earn­ings are set to rise in 2011, accord­ing to the Con­fer­ence Board of Canada's lead­ing indi­ca­tor of indus­try prof­itabil­ity, which in Decem­ber posted its largest one-month gain since 2001, an advance of 0.6 per cent. It is the third straight pos­i­tive month for the indi­ca­tor, which had fallen in the pre­vi­ous six months. [Canada.com]

• Canada's Dol­lar Falls Most in 3 Months as BOC's Car­ney Notes Strength. Canada’s dol­lar retreated the most in almost three months against its U.S. coun­ter­part as Bank of Canada Gov­er­nor Mark Car­ney said “per­sis­tent strength” in his country’s cur­rency is a threat to eco­nomic expan­sion. [Bloomberg]

• Canada's Econ­omy Grew the Fastest in Eight Months in Novem­ber. Canada’s gross domes­tic prod­uct grew at the fastest pace in eight months in Novem­ber on increased oil pro­duc­tion, whole­sal­ing and retail­ing. [Bloomberg]

• Wal­mart Canada, a unit of the world's biggest retailer Wal-Mart Stores, plans to open 40 more super­centers in the coun­try that has been see­ing stronger retail sales growth than its south­ern neighbor.The third-largest employer in Canada with 85,000 asso­ciates expects the new super­centers to gen­er­ate more than 9,200 store and con­struc­tion jobs. [Reuters]

• Canada's annual infla­tion rate rose less than expected in Decem­ber despite pres­sure from ris­ing energy prices, under­scor­ing the view that the cen­tral bank will hold inter­est rates steady in the near term. [Reuters]

Weak­nesses

• Canada Hasn’t Yet Recouped Recession’s Job Losses. Canada’s sta­tis­tics agency cut its job-creation esti­mate and erased an ear­lier find­ing the econ­omy recouped losses from the last reces­sion, bring­ing fresh calls from oppo­si­tion law­mak­ers for Prime Min­is­ter Stephen Harper to rework his stim­u­lus plan. [Bloomberg]

Oppor­tu­ni­ties

• U.S. stim­u­lus to lift Cana­dian exports: agency. Canada's strug­gling exporters can thank the Obama administration's extended tax cuts for an expected bounce in cross-border sales this year, just in time to prop up the sag­ging recov­ery, accord­ing to a report. [Reuters]

• Canada Bears Tripling Bets as Car­ney Says Loonie too Strong for Exporters. The Cana­dian dollar’s 22 per­cent surge against the U.S. cur­rency has become such a threat to the econ­omy that cen­tral bankers and chief finan­cial offi­cers are encour­ag­ing the loonie to weaken. [Bloomberg]
• The “capit­u­la­tion” in gold that drove the metal to its worst Jan­u­ary in 14 years may be end­ing as esca­lat­ing vio­lence in north­ern Africa spurs demand for a haven and after a key tech­ni­cal indi­ca­tor held. [Bloomberg]
• The west­ern Cana­dian province of Man­i­toba, a key pro­ducer of wheat and canola, will see major spring flood­ing if weather con­di­tions con­tinue as expected, the provin­cial gov­ern­ment said on Mon­day. [Globe and Mail] This could lead to shortages.

• Impe­r­ial Oil [Com­mod­ity Pro­duc­ers] prof­its [to be] boosted by com­mod­ity prices. Impe­r­ial Oil Ltd (IMO.TO) said on Mon­day its fourth-quarter profit rose 50 per­cent, mainly due to improved mar­gins in its down­stream busi­ness and higher crude oil prices. The com­pany, Canada's No. 2 oil pro­ducer and refiner, said net income in the quar­ter rose to C$799 mil­lion, or 94 Cana­dian cents a share, up from a year-earlier profit of C$534 mil­lion, or 62 Cana­dian cents a share.

Threats

• The west­ern Cana­dian province of Man­i­toba, a key pro­ducer of wheat and canola, will see major spring flood­ing if weather con­di­tions con­tinue as expected, the provin­cial gov­ern­ment said on Mon­day. [Reuters]

• Harper Pres­sured to Scrap Cor­po­rate Tax Cuts as Cana­dian Law­mak­ers Return. Cana­dian Prime Min­is­ter Stephen Harper will be under pres­sure from oppo­si­tion law­mak­ers to reverse cor­po­rate tax cuts and extend gov­ern­ment stim­u­lus as a con­di­tion for keep­ing his gov­ern­ment in power when Par­lia­ment recon­venes today. [Bloomberg] [CTV]

• Higher prices for petro­leum and met­als lifted Cana­dian pro­ducer prices and raw mate­ri­als prices slightly more than expected in Decem­ber, accord­ing to Sta­tis­tics Canada data released on Mon­day. The indus­trial prod­uct price index rose 0.7 per­cent in the month, top­ping mar­ket fore­casts of a 0.6 per­cent gain and accu­mu­lat­ing a 2.9 per­cent increase on the year. [Reuters]

• Canada’s dol­lar strength­ened the most in a week against its U.S. coun­ter­part as oil prices gained and the nation’s econ­omy expanded in Novem­ber at the fastest pace in eight months. The Cana­dian dol­lar rose after drop­ping 0.8 per­cent last week after Bank of Canada Gov­er­nor Mark Car­ney said the currency’s strength is a threat to eco­nomic expan­sion. The loonie, as the cur­rency is known for the image of a water­fowl on the C$1 coin, increased against the U.S. dol­lar as stocks advanced.

Sources: Globe and Mail, Bloomberg, Toronto Star, Canoe.ca

For more, visit us at http://advisoranalyst.com.

Tags: Annual Inflation Rate, Bank Of Canada, Bank Of Canada Governor, Canadian Equity, Canadian Exports, Canadian Market, Conference Board Of Canada, Corporate Earnings, Currency, energy, Gold, Industry Profitability, Leading Indicator, Mark Carney, Opposition Lawmakers, Prime Minister Stephen Harper, Profitability Index, Retail Sales Growth, Rising Energy, Southern Neighbor, Statistics Agency, Supercenters, Wal Mart Stores, Walmart, Walmart Canada
Posted in Canadian Market, Energy & Natural Resources, Gold, Markets, Oil and Gas | Comments Off

Oil ETF Call Trades Soar to Record, Crude Futures Back Near Highs; What Will Next Week Bring?

Monday, January 31st, 2011

by Michael 'Mish' Shedlock

In light of fire­bomb­ings, riots, and anar­chy in Egypt, cou­pled with social unrest in Yemen, Jor­dan, Alge­ria, and Saudi Ara­bia, call options of those bet­ting on higher oil prices soared to seven times nor­mal activ­ity on Friday.

This week­end we saw the clos­ing of Egypt­ian banks and the announced clos­ing of Egypt­ian stock mar­kets on Mon­day. How­ever, it is hard to know what will hap­pen next week.

To help under­stand­ing the pos­si­bil­i­ties, please con­sider this analy­sis of Friday's crude action.

Bloomberg reports Oil ETF Call Trades Soar to Record Amid Egypt Unrest

Trad­ing of bull­ish options on an exchange-traded fund track­ing crude futures soared to a record as oil surged the most since Sep­tem­ber 2009 after unrest in Egypt raised con­cern that protests would spread to major oil– pro­duc­ing parts of the Mid­dle East.

Almost 242,000 calls to buy the U.S. Oil Fund changed hands today, seven times the four-week aver­age and almost five times the num­ber of puts to sell. The most-traded con­tracts were the Feb­ru­ary $38 calls, which rose six­fold to 48 cents. The ETF gained 4.6 per­cent to $37.58.

“Bull­ish play­ers are bing­ing on call options across sev­eral expiries,” Caitlin Duffy, an equity-options ana­lyst at Green­wich, Connecticut-based Inter­ac­tive Bro­kers Group Inc., wrote in a report. “The mas­sive upswing in demand for the con­tracts helped lift the fund’s over­all read­ing of options implied volatility.”

Oil for March deliv­ery increased $3.70 to set­tle at $89.34 a bar­rel on the New York Mer­can­tile Exchange. The con­tract has risen 0.3 per­cent this week. Oil vol­ume in elec­tronic trad­ing on the Nymex was 1.36 mil­lion con­tracts as of 3:18 p.m. in New York. That’s the high­est level since April 13, when vol­ume for both elec­tronic and floor trad­ing reached a record 1.42 mil­lion bar­rels on the Nymex.

Vol­ume totaled 1.01 mil­lion con­tracts yes­ter­day, 50 per­cent above the aver­age of the past three months. Open inter­est was 1.52 mil­lion contracts.

Crude 15 Minute Chart

click on chart for sharper image

Hedg­ing Plays Push Crude Prices Higher

I was watch­ing crude futures Fri­day morn­ing (3:00AM Cen­tral) and the futures were essen­tially flat. Fri­day morn­ing, how­ever, as oil future call buy­ing began, fol­lowed by equity call buy­ing on OIL ETFs, oil shot up nearly $4.

What hap­pened is options sell­ers (the mar­ket mak­ers on the other side of those trades), can­not risk being naked short those oil calls and had to hedge by buy­ing futures.

To hedge those short calls, the mar­ket mak­ers bought crude futures. This delta hedg­ing activ­ity drove up the price of oil this morn­ing as every­one plowed into the "oil might go to the moon" trade.

No one wanted to be naked short over the week­end. (In a sim­i­lar fash­ion, I do not believe JPM is naked short sil­ver futures either, but I wish they would come out and prove it).

If noth­ing hap­pens over the week­end (which so far appears to be a dis­proved idea already), oil futures could eas­ily sink next week as the trade unwinds. On the other hand, should unrest spring up in Iran or expand in Saudi Ara­bia crude prices could soar.

Given that a col­lapse of the Egypt­ian gov­ern­ment seems likely, and unrest in other areas pick­ing up, if crude prices can­not break north here, then look out below. A short or intermediate-term top is likely in.

For more on the cri­sis in Egypt, please see ...

Egypt­ian Police Dis­ap­pear in Wide­spread Chaos, Vig­i­lantes Defend Homes; Egypt Video With a Mes­sage "We Will Never be Silenced!"

Egypt Closes Banks, Stock Mar­ket; Protests Spread to Saudi Ara­bia, Jor­dan; Saudi King Backs Mubarak; Reflec­tions on Mis­guided US Policy

Mubarak's Acts of Cow­ardice; Obama Calls Mubarak for 30-Minutes; Cell Ser­vice, Inter­net Total Shut­down; Anar­chy in Cairo; How Long can Mubarak Last?

Mike "Mish" Shed­lock
http://globaleconomicanalysis.blogspot.com

Tags: Call Options, Crude Futures, Egyptian Banks, Electronic Trading, Equity Options, ETF, ETFs, Exchange Traded Fund, Greenwich Connecticut, Interactive Brokers Group, Interactive Brokers Group Inc, Michael Mish, Mish Shedlock, New York Mercantile, New York Mercantile Exchange, Nymex, Oil Etf, Oil Prices, Options Implied Volatility, Silver, Social Unrest, Stock Markets, York Mercantile Exchange
Posted in Energy & Natural Resources, ETFs, Markets, Oil and Gas, Silver | Comments Off

WSJ: John Paulson Bests $4B Gains of 2007, with $5B Year in 2010

Monday, January 31st, 2011

by Trader Mark, Fund My Mutual Fund

We'll leave the soci­etal dis­cus­sions of our cur­rently struc­tured finan­cial incen­tives for another day [Apr 8, 2008: Hedge Fund Man­ager — Good Work if You can Get It], but the WSJ reports that John Paul­son has sur­passed his leg­endary 2007 haul of $4B, with a $5B pay­day in 2010.  As we've out­lined in the past, after bet­ting against the mort­gage mar­ket, Paul­son turned around and bet with the gov­ern­ment big time, as moral haz­ard is the new way to gain epic gen­er­a­tional riches.  What is inter­est­ing is the largest hedge funds have now grown so immense in size, [Mar 8, 2010: List of Largest Global Hedge Funds] they don't even have to have excep­tional per­for­mance to cre­ate once unheard of wealth.  Indeed, the aver­age hedge fund in 2010 lagged the S&P 500's per­for­mance — by about a third.   And lagged the aver­age mutual fund by nearly half. Indeed, once you become a cer­tain size it becomes increas­ingly dif­fi­cult to beat the mar­ket.  [Mar 29, 2010: Are John Paulson's Hedge Funds Now Too Big to Out­per­form]  What­ever the case, with this incen­tive pro­gram, expect a con­tin­ued march of the country's best and bright­est minds into this one niche field.

Via WSJ

• Hedge-fund man­ager John Paul­son per­son­ally net­ted more than $5 bil­lion in prof­its in 2010—likely the largest one-year haul in invest­ing his­tory, trump­ing the nearly $4 bil­lion he made with his "short" bets against sub­prime mort­gages in 2007.  Mr. Paulson's take, described by investors and peo­ple close to invest­ment firm Paul­son & Co., shows how prof­its con­tinue to pile up for élite hedge-fund managers.
• Appaloosa Man­age­ment founder David Tep­per and Bridge­wa­ter Asso­ciates chief Ray Dalio each per­son­ally made between $2 bil­lion and $3 bil­lion last year, accord­ing to investors and peo­ple famil­iar with the sit­u­a­tion. James Simons, founder of Renais­sance Tech­nolo­gies LLC, also pro­duced prof­its in that range, say investors in his firm.
• Mr. Paul­son and his fel­low man­agers sel­dom take much of their prof­its in cash. Some of the prof­its are so-called paper gains, which reflect the ris­ing value of their firms' hold­ings, and could erode if those invest­ments sour. Other gains come from sell­ing invest­ments, and most of those are rolled back into their funds.
• Assets man­aged by hedge funds have grown to a near-record $1.92 tril­lion, up 20% over the past year. Assets jumped almost $150 bil­lion in the fourth quar­ter alone, the largest quar­terly growth on record, accord­ing to Hedge Fund Research, Inc.
• Still, the aver­age fund gained just 10.49% last year. That's well below the 15% gain of the Stan­dard & Poor's 500 stock index, includ­ing div­i­dends, and the 19% return of the aver­age stock mutual fund, rais­ing ques­tions about whether the indus­try can prof­itably invest the influx of new cash.
• Indeed, the enor­mous gains by Mr. Paul­son and the other man­agers resulted from solid, though not spec­tac­u­lar, per­for­mance. Their per­sonal gains came in part from the sheer scale of assets under their con­trol. The largest hedge fund in Mr. Paulson's $36 bil­lion invest­ment port­fo­lio, Advan­tage Plus, grew 17% last year, while another big one rose 11%, falling below returns for the broader stock market.
• Part of Mr. Paulson's more that $5 bil­lion profit came from his firm's 20% cut of his funds' prof­its, known in the indus­try as the "per­for­mance fee." Those fees amounted to roughly $1 bil­lion last year, accord­ing to a per­son famil­iar with the mat­ter. An added plus for Mr. Paul­son: A chunk of those prof­its are treated as long-term cap­i­tal gains and taxed at a far lower rate than the stan­dard income-tax rate. More than $4 bil­lion came from gains on Mr. Paulson's invest­ments in his funds.
• The per­for­mance last year.....paled in com­par­i­son to his 2007 returns, when Mr. Paul­son made a huge wager against sub­prime mort­gages and his funds scored gains of as much as 590%.
• The hedge-fund busi­ness now is so big that some man­agers are hint­ing they'll return money to clients instead of invest­ing it. Han­dling so much cash can make it hard to gen­er­ate big gains in some trad­ing strategies.
• Mr. Tep­per, for exam­ple, has told some investors to expect to receive some cash back in 2011. He returned $500 mil­lion to investors last year. This year, he may return sev­eral bil­lion dol­lars, accord­ing to peo­ple close to the mat­ter.  Other firms, such as Paul­son & Co., have closed cer­tain funds to new investors, but are actively rais­ing new money for other funds.

Copy­right © Trader Mark, Fund My Mutual Fund

Tags: 4b, 5b, Appaloosa, Bests, Bridgewater Associates, David Tepper, Financial Incentives, Founder David, Hedge Fund Manager, Hedge Fund Managers, Hedge Funds, Incentive Program, Investment Firm, James Simons, John Paulson, Moral Hazard, Mortgage Market, Renaissance Technologies, Subprime Mortgages, Wsj Reports
Posted in Markets | Comments Off

Roubini: Question Marks in the Arab World

Monday, January 31st, 2011

The report below comes cour­tesy of Nouriel Roubini’s team of ana­lysts at RGE.

Two MENA gov­ern­ments have suf­fered mas­sive blows in the past week. Extended protests in Tunisia forced long-time ruler Zine El-Abidine Ben Ali to flee the coun­try, while Hezbol­lah pulled out of the dead­locked Lebanese unity gov­ern­ment, caus­ing its col­lapse. While the Lebanese government’s fall was only the most recent set­back in a coun­try that has seen the rise and fall of sev­eral gov­ern­ments, the events in Tunisia are rever­ber­at­ing through­out the Arab world. Despite Arab lead­ers’ insis­tence on the excep­tional nature of the devel­op­ments in Tunisia, the under­ly­ing triggers—weak employ­ment prospects, stag­nant incomes, ris­ing prices and a lack of representation—are com­mon in much of the region. Using a selected group of eco­nomic, social and polit­i­cal indi­ca­tors, we assess the resilience of the region’s insti­tu­tions in our lat­est MENA Focus.

It is dif­fi­cult to pre­dict if other regimes will go the way of Tunisia, but the volatile mix­ture of eco­nomic griev­ances will add pres­sure to frag­ile polit­i­cal insti­tu­tions in the MENA region and could tem­per invest­ment. Arab lead­ers’ imme­di­ate response of boost­ing sub­si­dies on food and fuel as well as other social trans­fers and their hyper-vigilance about protests sug­gest that these regimes may mud­dle through. Also, we con­tinue to see strong oil prices in 2011 sup­port­ing growth in the MENA region, one of the few in the world where growth will accel­er­ate from the 2010 pace.

How­ever, with com­mod­ity prices, espe­cially food prod­uct prices, set to rise, we see sev­eral linked eco­nomic risks across the region. These include the dete­ri­o­ra­tion of fis­cal and exter­nal bal­ances, financ­ing issues and a clam­p­down on eco­nomic and social lib­er­ties, includ­ing access by for­eign investors. Main­tain­ing expen­sive sub­sidy regimes (and adding more gov­ern­ment spend­ing) will be par­tic­u­larly detri­men­tal to the fis­cal and exter­nal posi­tions of oil importers. Some, like Jor­dan, may turn to bilat­eral aid. Oth­ers, includ­ing Tunisia, could face sig­nif­i­cantly higher financ­ing costs and may be forced to delay inter­na­tional bond issuance and turn instead to local mar­kets, pos­si­bly crowd­ing out pri­vate investment.

These poli­cies are unsus­tain­able in the medium to long term. Sub­sidy mea­sures will do lit­tle to dampen infla­tion­ary pres­sure, espe­cially if gov­ern­ments pair them with higher public-sector wages and other types of fis­cal sup­port to soothe trou­bled pop­u­la­tions. More­over, as RGE noted in the last MENA Focus, the main­te­nance of social spend­ing and sub­si­dies may cur­tail planned infra­struc­ture spend­ing. All of this makes the macro­eco­nomic and invest­ment cli­mate for fuel importers more uncer­tain. These trends are not con­sis­tent across the region, how­ever. We believe that investors will con­tinue to dif­fer­en­ti­ate between the stronger and weaker bal­ance sheets in the region, with oil exporters with ample sav­ings (includ­ing US$1.8 tril­lion man­aged by the region’s sov­er­eign investors) and more open invest­ment cli­mates con­tin­u­ing to attract the bulk of investment.

The sit­u­a­tion in Tunisia remains uncertain, with the new gov­ern­ment on the verge of col­lapse as oppo­si­tion mem­bers have pulled out. Public protests con­tinue, call­ing for a com­pletely new government. Whatever gov­ern­ment finally emerges will need to deal with the eco­nomic griev­ances that trig­gered the unrest while recov­er­ing from the chaos of recent weeks. We assume that the devel­op­ments will dampen Tunisia’s growth in the cur­rent quar­ter by reduc­ing its abil­ity to attract invest­ment and dent­ing its cru­cial tourist revenues.

The demon­stra­tive effect of the over­throw of the ruler is clear, as events lead­ing to Ben Ali’s ouster were watched all across the Arab world on Al-Jazeera. Self-immolation, a potent sym­bol that many say cat­alyzed events in Tunisia, has been present in Alge­ria, Egypt, Mau­ri­ta­nia and Yemen in a dan­ger­ous copy­cat trend. Fail­ure to respond to the under­ly­ing causes could cre­ate fur­ther issues for rulers and stymie eco­nomic devel­op­ment. How­ever, in some of these coun­tries, the com­bi­na­tion of con­tin­ued trans­fers, strong mil­i­tary pres­ence and polit­i­cal restric­tions includ­ing lim­its on vot­ing and pub­lic assem­bly rights could keep the regimes in place for some time.

Source: RGE Mon­i­tor, Jan­u­ary 19, 2011.

Tags: Arab Leaders, Arab World, Commodity Prices, Economic Risks, Employment Prospects, External Positions, Food And Fuel, Food Product, Foreign Investors, Hyper Vigilance, Lebanese Government, Mena Region, Nouriel Roubini, Political Indicators, Political Institutions, Question Marks, Social Transfers, Unity Government, Volatile Mixture, Zine El Abidine Ben Ali
Posted in Energy & Natural Resources, Infrastructure, Markets, Oil and Gas, Outlook | Comments Off

Welcome, "Peak Oil"

Monday, January 31st, 2011

The arti­cle below is a guest con­tri­bu­tion by Puru Sax­ena of Puru Sax­ena Wealth Man­age­ment in Hong Kong, cour­tesy of The Daily Reck­on­ing.

The day of reck­on­ing is approach­ing and the world does not have a con­tin­gency plan.

The truth is that the world’s out­put of con­ven­tional crude oil peaked in 2005 and global oil exports are also past their prime. Fur­ther­more, the uncon­ven­tional sources (tar sands, heavy sour crude, ethanol, nat­ural gas liq­uids, bio-fuels and shale) are strug­gling to keep up with the ongo­ing deple­tion in the world’s largest oil fields. There­fore, it is prob­a­ble that the world’s cur­rent pro­duc­tion of total liq­uids is at or near max­i­mum capacity.

Vet­eran clients and sub­scribers will recall that we have been extremely con­cerned about ‘Peak Oil’. How­ever, for many years, ours was one of the lone voices in the dark. It is inter­est­ing to observe that up until 2007, var­i­ous gov­ern­ment spon­sored energy agen­cies were extremely opti­mistic about their oil pro­duc­tion fore­casts. In fact, before it com­mis­sioned its first field by field analy­sis in 2008, the IEA used to claim that the world could eas­ily pro­duce over 110 mil­lion bar­rels of total liq­uids per day! Iron­i­cally, other agen­cies such as CERA and the EIA were even more lib­eral with their oil pro­duc­tion pro­jec­tions and ‘Peak Oil’ was dis­missed as a lunacy.

There­after, in Novem­ber 2008, the IEA released its World Energy Out­look 2010 report, which con­tained a thor­ough analy­sis of the world’s 800 largest oil fields. In this study, the IEA admit­ted (for the first time) that most of the world’s largest oil fields are deplet­ing at a rapid clip and seri­ous cap­i­tal spend­ing is essen­tial to avoid an energy crunch in 2020. Although this report was a step in the right direc­tion, in our view, the IEA was still paint­ing an unre­al­is­tic picture.

For­tu­nately, it has taken the IEA only two years to realise its mis­take and its lat­est World Energy Out­look 2010 report presents a far more real­is­tic sce­nario. Accord­ing to its lat­est study, the IEA now expects global total liq­uids pro­duc­tion to increase to just 96 mil­lion bar­rels per day by 2035! Bear­ing in mind the fact that the world cur­rently pro­duces 88 mil­lion bar­rels of total liq­uids per day, the IEA is now essen­tially imply­ing that out­put will only increase by 9% over the next 25 years!

It is notable that in 2009, the IEA stressed the impor­tance of oil for eco­nomic growth and con­cluded that 106 mil­lion bar­rels per day will be required by 2030; rep­re­sent­ing an increase of approx­i­mately 18 mil­lion bar­rels per day above cur­rent out­put. Inter­est­ingly, in last year’s report, the IEA pre­dicted that global pro­duc­tion will peak at only 96 mil­lion bar­rels per day in 2035! So, within the course of a sin­gle year, the energy watch­dog for the devel­oped world low­ered its pro­duc­tion esti­mate by 10 mil­lion bar­rels per day!

To com­pli­cate mat­ters fur­ther, the IEA’s lat­est fore­cast of 96 mil­lion bar­rels per day of peak pro­duc­tion depends on the assump­tion of find­ing an extra 900 bil­lion bar­rels of oil over the next 25 years! How­ever, given the fact that over the recent past, we have man­aged to dis­cover only 10 bil­lion bar­rels of oil each year, we can­not help but take the IEA’s rosy fore­cast with a pinch of salt. Call us skep­tics, but at the cur­rent rate of dis­cov­ery, it will take us 90 years to dis­cover 900 bil­lion bar­rels of oil. Yet, the IEA some­how believes that this task can be accom­plished by 2035!

The chart below is taken from the IEA’s World Energy Out­look 2010 report and it does a good job of cap­tur­ing the sorry state of affairs. As you can see, the IEA now expects the out­put from the cur­rently pro­duc­ing fields (dark blue area on the chart) to drop from approx­i­mately 70 mil­lion bar­rels per day to only 16 mil­lion bar­rels per day by 2035. Fur­ther­more, the IEA also believes that 60% of oil pro­duc­tion in 2035 will come from oil fields not yet found (light blue area on the chart) or devel­oped (grey area on the chart)! Once again, call us skep­tics, but we do not believe that oil fields yet to be found or devel­oped will some­how suc­ceed in off­set­ting the ongo­ing depletion.

It is our con­tention that the world will strug­gle to pro­duce more than 91–92 mil­lion bar­rels of total liq­uids per day and global demand will col­lide with avail­able sup­ply. Of course, we do not know the exact tim­ing of this event but if global con­sump­tion con­tin­ues to grow by 1.5% per annum, we will get there within the next 2–3 years.

Need­less to say, when aggre­gate demand hits avail­able sup­ply, the price of oil will rise sharply. More impor­tantly, if demand con­tin­ues to increase in the devel­oped world, there will be a per­ma­nent short­age of crude and gov­ern­ments will prob­a­bly end up rationing petro­leum. Fur­ther­more, it is our firm belief that ulti­mately, oil will only be used for its high­est uses (agri­cul­ture and aviation).

If his­tory is any guide, the price of oil will not rise in a straight line and the sec­u­lar uptrend will be punc­tu­ated by severe eco­nomic reces­sions. After all, the cure for a high oil price is a high oil price! At some point dur­ing the course of this busi­ness cycle, as the price of oil con­tin­ues to rise, it will (once again) cause eco­nomic pain for the over­stretched cit­i­zens of the devel­oped world. When that hap­pens, con­sump­tion will slow down and we will expe­ri­ence demand destruc­tion in some parts of the world.

In our view, the next eco­nomic reces­sion will be caused by yet another spike in the price of oil and dur­ing the next busi­ness slow­down, crude will get whacked again. This is the rea­son why we will liq­ui­date all our energy related invest­ments prior to the onset of the next eco­nomic recession.

Turn­ing to the cur­rent sit­u­a­tion, the price of oil is trad­ing around US$90 per bar­rel and dur­ing the course of this busi­ness cycle, we expect it to sur­pass its pre­vi­ous record of US$147 per barrel.

In addi­tion to crude oil, we are also opti­mistic about the prospects of ura­nium. As you may know, var­i­ous nations are scram­bling to build new nuclear reac­tors and this is good news for ura­nium (raw mate­r­ial used for a nuclear reaction).

As the world approaches ‘Peak Oil’ and crude is con­served, demand for elec­tric­ity will surge. Either that or the world will go back to horse drawn car­riages, which we seri­ously doubt! Fur­ther­more, given the envi­ron­men­tal dam­age asso­ci­ated with burn­ing poor qual­ity coal, the world will turn to nuclear energy to meets its energy needs. There­fore, world­wide con­sump­tion of ura­nium will appre­ci­ate over the fol­low­ing years and this will exert enor­mous pres­sure on mined supply.

At the time of writ­ing, the price of ura­nium has climbed to US$61.5 per pound and it is prob­a­ble that it will at least dou­ble from this level. In the pre­vi­ous cycle, the price of ura­nium peaked around US$140 per pound and we will not be sur­prised to see that level exceeded within the next 2–3 years. Such a bull­ish sce­nario for ura­nium is great news for the unhedged ura­nium min­ing com­pa­nies and a mod­est expo­sure to these stocks seems like a rea­son­able bet.

In sum­mary, given the real­ity of ‘Peak Oil’ and our bull­ish bias, we have allo­cated approx­i­mately 30% of our clients’ cap­i­tal to those assets which will ben­e­fit from the loom­ing energy crunch. At present, we have expo­sure to upstream oil com­pa­nies, inte­grated energy giants, oil ser­vices firms, renew­able energy stocks, ura­nium and elec­tric car/rechargeable bat­tery man­u­fac­tur­ers. It is our con­tention that these busi­nesses will pros­per over the fol­low­ing years, thereby reward­ing our investors.

Source: Puru Sax­ena, The Daily Reck­on­ing, Jan­u­ary 29, 2011.

Tags: Bio Fuels, Contingency Plan, Conventional Crude Oil, Daily Reckoning, energy, Energy Agencies, Energy Crunch, Global Oil, Lone Voices, Natural Gas Liquids, Oil Fields, Oil Sands, Peak Oil, Production Forecasts, Rapid Clip, Realistic Scenario, Saxena, Step In The Right Direction, Tar Sands, Unconventional Sources, Voices In The Dark, World Energy Outlook
Posted in Energy & Natural Resources, Markets, Oil and Gas, Outlook | 1 Comment »

Sentiment Signals: Bulls and Bears Approach Neutral Levels

Monday, January 31st, 2011

The results of the lat­est AAII Investor Sen­ti­ment Sur­vey show that the bull­ish and bear­ish sen­ti­ment read­ings have eased fur­ther from the pre­vi­ously extreme lev­els. For the week ended Jan­u­ary 26, 2010, the bulls declined to 42.0% from 50.3% two weeks ago and the bears increased to 34.3% from 29.1%.

Nonethe­less, bull­ish sen­ti­ment stayed above its his­tor­i­cal aver­age of 39% for the 21^st con­sec­u­tive week – the sec­ond longest streak in the Survey’s his­tory since incep­tion in 1987. Bear­ish sen­ti­ment climbed to its high­est level of pes­simism since Sep­tem­ber 2, 2010, mark­ing only the fourth week since then that bear­ish sen­ti­ment has been above the his­tor­i­cal aver­age of 30%.

Sources: AAII Investor Sen­ti­ment Sur­vey; Plexus Asset Management.

Wheras the AAII Sur­vey focuses on indi­vid­ual investors, the Investor Intel­li­gence Sur­vey deals with finan­cial newslet­ter writ­ers. This sur­vey mea­sured sen­ti­ment over the same period as the AAII and indi­cated bull­ish sen­ti­ment drop­ping to 55.1% from 56.0% dur­ing the pre­vi­ous week – a read­ing some­what below the Octo­ber 2007 all-time high of 62.0%. The bears were down to 19.1% from 20.9%.

Although I do not have raw data going very far back for the Investors Intel­li­gence series, the com­bined AAII and Investors Intel­li­gence Sur­veys nev­er­the­less make for inter­est­ing reading.

Sources: AAII Investor Sen­ti­ment Sur­vey; Investor Intel­li­gence Sur­vey; Plexus Asset Management.

Tags: Aaii, Asset Management, Bearish Sentiment, Bullish Sentiment, Bulls, Bulls And Bears, Extreme Levels, Inception, Individual Investors, Intelligence Survey, Investor Intelligence, Investor Sentiment, Investors Intelligence, Newsletter Writers, Pessimism, Raw Data, Reading Sources, Signals, Surveys
Posted in Markets | Comments Off

Kathleen Gaffney and Martin Fridson discuss Bond Investing

Monday, January 31st, 2011

This week on Wealth­track, Con­suelo Mack talks to two of the bond world’s bright­est top man­agers on the out­look for fixed-income invest­ments in 2011. Kath­leen Gaffney, co-manager of the Loomis Sayles Bond Fund, and Mar­tin Frid­son, high yield guru and Global Credit Strate­gist at BNP Paribas Asset Man­age­ment, tell us what to buy and what to avoid in bonds in the year ahead.

Note: The tran­script of this inter­view is not avail­able yet, but will be posted here as soon as it arrives.

Source: Wealth­track, Jan­u­ary 28, 2011.

Tags: Bnp Paribas, Bnp Paribas Asset Management, Bonds, Consuelo Mack, Fixed Income Investments, Global Credit, Guru, high yield, Kathleen Gaffney, Loomis Sayles Bond, Loomis Sayles Bond Fund, Martin Fridson, Strategist, Top Managers, Wealthtrack
Posted in Bonds, Markets, Outlook | Comments Off

Gold bullion – Is a Cycle Low Imminent?

Monday, January 31st, 2011

In what is prob­a­bly an over­due cor­rec­tion after a stel­lar per­for­mance (+29.6%) dur­ing 2010, gold bul­lion has declined by 6.0% since the turn of the year. How­ever, with the tur­moil in Egypt as cat­a­lyst, the yel­low metal sharply reversed course on Fri­day from an intra­day low of $1,308.10 to close the week at $1,335.40.

The ques­tion that invari­ably comes to mind is whether we have seen the worst of gold’s decline. A few com­ments from Richard Rus­sell, author of the Dow The­ory Let­ters, regard­ing cycles are of par­tic­u­lar interest.

“Ana­lysts are talk­ing about gold cor­rect­ing down to 1,200 or even 1,000. How­ever, I believe that the more impor­tant pic­ture is that the gold bull mar­ket has much fur­ther to go on the upside. I’ve been read­ing the McClel­lan Mar­ket report for years. McClel­lan does a good deal of research on cycles, and I must say some of its cycle stud­ies work out quite well.

“McClel­lan has dis­cov­ered that a cycle low appears for gold roughly every 12.5 months. The cycle lows have run as fol­lows: Jan 6, ‘06, Jan 8, ‘07, Jan 7, ‘08, Jan 5, ‘09, Jan. 4, ‘10, Jan. 8, ‘11. McClel­lan puts the next cycle bot­tom for gold at Feb­ru­ary 8, 2011 which means it should arrive at any time between now and Feb­ru­ary 8, give or take a few weeks before or after that date.

“Inter­est­ingly, the McClel­lan cycle bot­tom for gold is due to arrive amid a good deal of pro­fes­sional bear­ish­ness regard­ing gold. Thus many traders have traded out of their gold posi­tions, just as we near the date for the McClel­lan cycle bottom.”

The red arrows in the chart below mark the McClel­lan cycle lows.

Source: StockCharts.com

Sep­a­rately, Adam Hewi­son (INO.com) also pro­vided a brief video analy­sis on the tech­ni­cal out­look for gold, argu­ing that a buy sig­nal has not been given but that gold see a pop to the upside. Click here to access the presentation.

Although it is dif­fi­cult to pin­point short-term bot­toms, I am of the opin­ion that the gold bull mar­ket remains intact, espe­cially with infla­tion blow­ing up all around the world. Mean­while, China and a num­ber of other Asian coun­tries keep adding gold to their reserves. These pur­chases should pro­vide a floor to price declines – an “Asian put” so to speak.

Tags: 5 Months, Bottoms, Catalyst, China, Decline, Dow Theory Letters, Egypt, Gold, Gold Bullion, Gold Market, Ino, Jan 7, Lows, Mcclellan, Pop, Red Arrows, Richard Russell, Separately, Stellar Performance, Technical Outlook, Turmoil, Video Analysis
Posted in Energy & Natural Resources, Gold, Markets, Oil and Gas, Outlook | Comments Off

U.S. Equity Market Cheat Sheet (January 31, 2011)

Saturday, January 29th, 2011

U.S. Equity Mar­ket Cheat Sheet (Jan­u­ary 31, 2011)

The fig­ure below shows the per­for­mance of each sec­tor in the S&P 500 Index for the week. Three sec­tors increased and seven decreased. The best-performing sec­tor for the week was energy which rose 1.16 per­cent. Other pos­i­tive sec­tors were mate­ri­als and tech­nol­ogy. Health­care was the worst per­former, down 1.8 per­cent. Other bot­tom per­form­ers were con­sumer dis­cre­tion and con­sumer staples.

Within the energy sec­tor, the best-performing stock was Baker Hughes, Inc., up 14.11 per­cent. Other top-five per­form­ers were Hal­libur­ton Co., Helmerich & Payne, Inc., Massey Energy Co., and El Paso Corp.

Strengths

• The elec­tronic com­po­nent group was the best-performing group for the week, up 11 per­cent. Corn­ing, Inc. increased after report­ing quar­terly earn­ings. Its Spe­cialty Mate­ri­als sales increased 24 per­cent sequen­tially and 79 per­cent year-over-year, dri­ven by strong sales in Corn­ing Gorilla Glass, a scratch-resistant glass used in smart­phone and tablet com­puter screens. Amphe­nol Corp. increased after report­ing that its board of direc­tors had approved a stock repur­chase program.
• The indus­trial REITs (real estate invest­ment trusts) group rose 7 per­cent, led by its single-member, Pro­L­o­gis. The com­pany and AMB Prop­erty Corp. announced they were in dis­cus­sions regard­ing a poten­tial merger.
• Two of the top ten groups were in the energy sec­tor (oil & gas equip­ment & ser­vices, up 7 per­cent, and oil & gas refin­ing & mar­ket­ing, up 5 per­cent). These increases were dri­ven by strong earn­ings reports from Baker Hughes, Inc. and Hal­libur­ton Co. in equip­ment & ser­vices, and Valero Energy Corp. in refin­ing & marketing.

Weak­nesses

• The auto­mo­bile man­u­fac­tur­ers group was the worst-performing group, los­ing 9 per­cent. The group’s sin­gle mem­ber, Ford Motor Co. reported earn­ings below the ana­lyst con­sen­sus estimate.
• The spe­cial con­sumer ser­vices group under­per­formed, down 9 per­cent, led by its sin­gle mem­ber, H&R Block, Inc. This group was the best-performing group last week, so some profit-taking by investors might have occurred.
• The employ­ment ser­vices group was down 6 per­cent. Its sin­gle mem­ber, Robert Half Inter­na­tional, Inc., issued first quar­ter earn­ings guid­ance below the con­sen­sus esti­mate. The firm said it expects a sequen­tial reduc­tion in gross mar­gins in its tem­po­rary employ­ment busi­ness, mainly hurt by higher state unem­ploy­ment rates.

Oppor­tu­ni­ties

• There may be an oppor­tu­nity for gain in merger and acqui­si­tion (M&A) trans­ac­tions in 2011. Cor­po­rate liq­uid­ity remains high, thereby pro­vid­ing the means to pur­sue acquisitions.

Threats

• Should investors’ expec­ta­tions for an improv­ing econ­omy not come to fruition on a rea­son­able time­frame, it could be a threat to stock prices.
• Quan­ti­ta­tive eas­ing cur­rently being imple­mented by the Fed­eral Reserve might result in unin­tended consequences.

Tags: Amb Property Corp, Amp Services, Amphenol Corp, Analyst Consensus, Automobile Manufacturers, Baker Hughes Inc, Consensus Estimate, Consumer Services Group, Consumer Staples, Earnings Reports, energy, Ford Motor Co, Halliburton Co, Massey Energy, Massey Energy Co, Quarterly Earnings, Real Estate Investment, Real Estate Investment Trusts, Stock Repurchase Program, Valero Energy, Valero Energy Corp
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off

The Economy and Bond Market Cheat Sheet (January 31, 2011)

Saturday, January 29th, 2011

The Econ­omy and Bond Mar­ket Cheat Sheet (Jan­u­ary 31, 2011)

U.S. Trea­suries ral­lied, dri­ving yields mod­estly lower. The mar­ket chopped around some this week and was roughly unchanged through Thurs­day, but on Fri­day the con­tin­u­ing unrest in Egypt and the sur­round­ing region ini­ti­ated a flight to safe assets such as U.S. Trea­suries. Fourth quar­ter GDP rose 3.2 per­cent, just under expec­ta­tions, but under­ly­ing trends remain pos­i­tive. Growth of 3.2 per­cent is not a bad show­ing and is about what the econ­omy aver­aged in the 10 years before the finan­cial crisis.

Strengths

• GDP grew 3.2 per­cent and rein­forces the idea of a sus­tained eco­nomic recovery.
• The Fed announced no change in pol­icy at this week’s Fed­eral Open Mar­ket Com­mit­tee (FOMC) meet­ing, keep­ing very stim­u­la­tive poli­cies in place.
• The National Asso­ci­a­tion for Busi­ness Eco­nom­ics sees hir­ing pick­ing up over the next six months based on its Net Ris­ing Index for employ­ment which hit the high­est level since the index was cre­ated in 1998.

Weak­nesses

• Ini­tial job­less claims rose to 454,000, well ahead of expec­ta­tions and send­ing mixed sig­nals on the health of the job market.
• Durable goods orders for Decem­ber fell 2.5 per­cent on weak air­craft orders.
• The British econ­omy unex­pect­edly con­tracted in the fourth quar­ter by 0.5 percent.

Oppor­tu­ni­ties

• The rise in yield on the 10-year Trea­sury since the Octo­ber low to lev­els com­pa­ra­ble to those exist­ing in May 2010, may offer an attrac­tive entry point for bonds.

Threats

• The econ­omy appears to be per­form­ing bet­ter than many expected and could be a threat to fixed income mar­kets as yields move higher in response.

Tags: Aircraft Orders, Bond Market, Bonds, British Economy, Business Economics, Cheat Sheet, Durable Goods Orders, Economic Recovery, Federal Open Market Committee, Financial Crisis, Fixed Income Markets, Fourth Quarter, GDP, Initial Jobless Claims, Mixed Signals, Open Market Committee, Quarter Gdp, Six Months, Treasuries, Unrest
Posted in Bonds, Markets | Comments Off

Gold Market Cheat Sheet (January 31, 2011)

Saturday, January 29th, 2011

Gold Mar­ket Cheat Sheet (Jan­u­ary 31, 2011)

For the week, spot gold closed at $1,336.75 per ounce, down $5.93 per ounce, or 0.44 per­cent for the week. Gold equi­ties, as mea­sured by the Philadel­phia Gold & Sil­ver Index, fell 0.2 per­cent. The U.S. Trade-Weighted Dol­lar Index slid 0.09 per­cent for the week.

Strengths

• Stan­dard & Poor's says it is opti­mistic about the con­tin­ued improve­ment of North Amer­i­can met­als and min­ing com­pa­nies, espe­cially gold, call­ing the pre­cious metal "the one con­sis­tent bright spot in the min­ing and met­als sec­tor." In an analy­sis pub­lished this week, S&P ana­lysts advised, "Look­ing ahead into 2011, we believe gold prices could remain high through­out the year as a result of eco­nomic uncer­tainty in the west and grow­ing con­cerns about inflation."
• The surge in gold prices dur­ing 2010 was dri­ven not only by strong invest­ment but a recov­ery in jew­elry con­sump­tion and even indus­trial demand, said the World Gold Coun­cil Wednes­day in its quar­terly Gold Invest­ment Digest. “The gold story in 2010 was about growth in all sec­tors in demand and not just due to eco­nomic con­cerns,” said Juan Car­los Arti­gas, invest­ment research man­ager with the World Gold Council.
• Gold pro­duc­ers reduced their hedges by almost a third dur­ing the third quar­ter, GFMS and Soci­ete Gen­erale said in their third quar­ter “Global Hedge Book” report. This action left the out­stand­ing adjusted hedge book at around five mil­lion ounces.

Weak­nesses

• Peru reported pro­duc­tion declines in nearly every sec­tor of pre­cious met­als and base met­als min­ing for the year 2010. Peru's Min­istry of Energy and Mines reported an 11.19 per­cent decline in annual gold pro­duc­tion, with sil­ver pro­duc­tion declin­ing 7.27 per­cent, and cop­per falling 2.28 percent.
• Guinea plans to dou­ble its stake in min­ing projects to at least 33 per­cent, its newly-elected pres­i­dent said, a move that could rat­tle some of the world's biggest min­ing com­pa­nies. "There will be three to five dif­fi­cult months, since we've decided not to rene­go­ti­ate con­tracts but instead to define a new min­ing pol­icy that will give Guinea at least a third," Pres­i­dent Alpha Conde said.
• The world’s most pop­u­lar gold ETF, SPDR Gold Shares, doesn’t seem to be very pop­u­lar lately. On Tues­day, the ETF had its biggest single-day reduc­tion ever, putting its hold­ings at their low­est level since May.

Oppor­tu­ni­ties

• John Embry, Chief Invest­ment Strate­gist at Sprott Asset Man­age­ment, reit­er­ated his beliefs on a gold bub­ble. As for those who say that the “gold bub­ble” has started to burst, Embry noted that the idea that gold is in a bub­ble is “beyond pre­pos­ter­ous unless one hon­estly believes that the author­i­ties can and will rein in the pace of money cre­ation through­out the world. The sim­ple truth is that they can’t in our debt-logged uni­verse unless they are pre­pared to accept a defla­tion­ary crash that will make the 1930s look like child’s play.”
• TD Secu­ri­ties believes that the gold bull run is not over. In its gold pre­view report, TD Secu­ri­ties noted, “Look­ing ahead to 2011 and 2012, the con­sen­sus eco­nomic fore­cast is for global eco­nomic con­di­tions to con­tinue to improve such that the unprece­dented fis­cal and mon­e­tary stim­u­lus deployed over the past three years can begin to be unwound. Despite poten­tial Fed tight­en­ing head­winds, we believe there is still a pos­i­tive case to be made for gold. Cen­tral banks became net buy­ers of gold in 2010 for the first time since 1988. Mine sup­ply growth has been restrained; despite 10 years of ris­ing gold prices, and global cur­rency and trade imbal­ances remain.”
• Ana­lysts at New York-based MSCI ESG Indices said that a new United States law aimed to stop the trade in con­flict min­er­als might lead to higher prices of met­als used in devices such as com­put­ers and cell phones. The Dodd-Frank Act, which includes a clause requir­ing com­pa­nies to report on whether they use min­er­als sourced from the Demo­c­ra­tic Repub­lic of Congo (DRC) or its neigh­bors, will come into force on April 1.

Threats

• The road to higher returns in the first quar­ter is not paved with gold, accord­ing to most Cana­dian invest­ment advis­ers. BetaPro Management's quar­terly sur­vey on adviser sen­ti­ment indi­cates that only 33 per­cent of the country's invest­ment advi­sors are gold bulls, down from 64 per­cent from the recent fourth quar­ter. The fad­ing allure of bul­lion and gold stocks is tied to ris­ing prospects for the global econ­omy, said Howard Atkin­son, the pres­i­dent of BetaPro Man­age­ment, which puts out a quar­terly sur­vey on adviser sentiment.
• Global investors are becom­ing more con­fi­dent about the eco­nomic out­look, accord­ing to a quar­terly poll of 1,000 Bloomberg sub­scribers. Almost twice as many of those sur­veyed said they will cut gold hold­ings in the next six months, instead of increas­ing them. More than half said the gold mar­ket is a bubble.

Tags: American Metals, Base Metals, Canadian Market, Currency, Economic Uncertainty, energy, ETF, Gfms, Gold, Gold Equities, Gold Investment, Gold Market, Gold Prices, Gold Producers, Gold Production, Gold Story, Investment Digest, Investment Research Manager, Ministry Of Energy And Mines, Philadelphia Gold, precious metals, Silver, Silver Index, Silver Production, Spot Gold, World Gold Council
Posted in Canadian Market, ETFs, Gold, Markets, Outlook, Silver | Comments Off

Energy and Natural Resources Market Cheat Sheet (January 31, 2011)

Saturday, January 29th, 2011

Energy and Nat­ural Resources Mar­ket Cheat Sheet (Jan­u­ary 31, 2011)

Strengths

• China imported 164.8 mil­lion tonnes of coal in 2010, up 31 per­cent com­pared to 2009, and exports dropped 15 per­cent to 19.03 mil­lion tonnes. Indone­sia remains China's largest sup­plier fol­lowed by Australia.
• The lat­est U.S. weekly crude steel out­put reported by the AISI is back to lev­els last seen in June, at 83.3mtpa, rep­re­sent­ing a capac­ity uti­liza­tion rate of 73 percent.
• China’s stain­less steel out­put rose 28 per­cent last year to 11.3 mil­lion tonnes. Imports fell by 18 per­cent to 1.07 mil­lion tonnes, while appar­ent con­sump­tion increased 14 per­cent, accord­ing to the Stain­less Steel Council.
• India pumped 3.34 mil­lion tonnes of crude oil in Decem­ber, the high­est monthly out­put, accord­ing to the oil ministry.

Weak­nesses

• U.S. nat­ural gas futures prices fell 8.5 per­cent this week on a fore­cast for milder weather.
• The Baltic Dry Index fell to the low­est level in almost two years as Aus­tralian floods curbed coal car­goes and sup­ply of new ves­sels increased.

Oppor­tu­ni­ties

• Envi­ron­men­tal reg­u­la­tors in Texas have approved an air qual­ity per­mit, thus paving the way for con­struc­tion of a ther­mal power plant in Cor­pus Christi. The EPA had ear­lier requested that Texas deny the per­mit. This event adds to the ongo­ing feud between Texas and the EPA. There are still fur­ther per­mits needed for the plant to come to real­ity, and in all like­li­hood, this ini­tial per­mit will be challenged.
• Cop­per prices will rise as the global econ­omy grows and con­struc­tion recov­ers in devel­oped coun­tries, accord­ing to Cater­pil­lar, Inc. Cop­per will aver­age $4.25 a pound in 2011, Cater­pil­lar said in its fourth quar­ter earn­ings state­ment. That’s up 24 per­cent from last year’s aver­age. Global pro­duc­tion of cop­per will increase 2 per­cent as prices are cur­rently very attrac­tive for new invest­ment, the com­pany said.

Threats

The lat­est esti­mates by the Queens­land Resources Coun­cil sug­gest coal pro­duc­tion loss may cost the indus­try up to $9.5 bil­lion and out­put may go down by up to half of fore­cast pro­duc­tion of 51 mil­lion tonnes dur­ing the quar­ter end­ing March 31. The report says that 85 per­cent of Queensland’s mines are “impaired by excess water.”

Tags: Aisi, Apparent Consumption, Baltic Dry Index, Capacity Utilization Rate, Cargoes, Caterpillar Inc, China, Copper Prices, Crude Steel, energy, Fourth Quarter Earnings, Gas Futures Prices, Global Economy, Global Production, India, Natural Gas Futures, Natural Gas Futures Prices, Oil Ministry, Paving The Way, Queensland Resources, Resources Council, Steel Output, Thermal Power Plant
Posted in Energy & Natural Resources, India, Markets, Oil and Gas | Comments Off

Emerging Markets Cheat Sheet (January 31, 2011)

Saturday, January 29th, 2011

Emerg­ing Mar­kets Cheat Sheet (Jan­u­ary 31, 2011)

Strengths

• Taiwan’s indus­trial pro­duc­tion rose a stronger-than-expected 18.2 per­cent year– over-year in Decem­ber and 4.3 per­cent month-over-month from Novem­ber, dri­ven by machiner­ies, elec­tronic parts and base met­als. Con­sumer con­fi­dence rose to a 10-year high of 86.8 in Jan­u­ary from 83.2 in Decem­ber due to closer ties with China, a solid labor mar­ket recov­ery and asset price reflation.
• In a recent research trip to China, our ana­lyst observed that all the air­plane seats were sold. Most of the trav­el­ers in China were migrant work­ers and col­lege stu­dents who couldn’t afford air travel 10 years ago. As incomes increase, the peo­ple in China are upgrad­ing their consumption.
• Also in his China trip, our ana­lyst wit­nessed seem­ingly count­less con­struc­tion projects break­ing ground in Chongqing, a south­west munic­i­pal­ity of 30 mil­lion people.

Weak­nesses

• Accord­ing to a quar­terly Nielsen sur­vey, 79 per­cent of Asian con­sumers cut spend­ing to save on house­hold expenses in the fourth quar­ter of 2010, com­pared with 65 per­cent of North Amer­i­cans and 62 per­cent of Euro­peans. Higher prices for food and fuel may have con­tributed to the rise of frugality.
• India’s cen­tral bank raised its bench­mark inter­est rate for a sev­enth time since March 2010 by 25 basis points to 5.5 per­cent and raised its infla­tion fore­cast to 7 per­cent from 5.5 per­cent by March 31, cit­ing a wide­spread increase in food prices. India has been the worst-performing Asian mar­ket so far this year.
• Thailand’s indus­trial pro­duc­tion dropped 2.5 per­cent year-over-year in Decem­ber, the first decline in 14 months and worse than the mar­ket expec­ta­tion of a 0.7 per­cent gain, reflect­ing weaker exports for the same month due to a higher base in 2009.

Oppor­tu­ni­ties

• At the UBS Greater China Con­fer­ence, an NRDC offi­cial said China’s planned urban­iza­tion rate for the next five years is to rise from the cur­rent 40 per­cent to 60 per­cent. That means China expects 600 mil­lion more peo­ple to live in cities. Experts esti­mate that demand for base mate­ri­als, such as cements and steel, will increase at an aver­age annual growth rate of 7 per­cent until 70 per­cent of the pop­u­la­tion moves into cities. Urban­iza­tion will also bring about demands for urban trans­porta­tion, plumb­ing, inte­rior design and other con­sump­tion of urban lifestyles.
• The China Min­istry of Rail­way esti­mated recently that rail­way pas­sen­ger turnover will increase 13 per­cent a year until 2015. High speed trains have changed lifestyles in China. They shorten dis­tance and make the pop­u­la­tion much more mobile. China now has 8,300 kilo­me­ters (about 4,960 miles) of high speed rail, and plans to build another 4,700 kilo­me­ters (2,814 miles) by 2013.

Threats

• Although Shang­hai and Chongqing’s prop­erty tax pro­grams have been widely expected in China, their imple­men­ta­tion, announced only one day after the cen­tral gov­ern­ment released eight harsher pol­icy guide­lines to com­bat prop­erty spec­u­la­tion, was much sooner than investors had antic­i­pated. A higher fre­quency of anti-speculation pol­icy mea­sures and tighter coör­di­na­tion between cen­tral and local gov­ern­ments may increase the risk of over-intervention and lead to an immi­nent decline of prop­erty trans­ac­tions and even a price cor­rec­tion like what hap­pened in 2008. Pend­ing a prop­erty mar­ket shake­out, investors may stay away from higher-end prop­erty devel­op­ers with lower asset turnovers and higher leverage.

Tags: Airplane Seats, Asian Consumers, Asian Market, Asset Price, Base Metals, Benchmark Interest Rate, Breaking Ground, China, China Conference, China Trip, Consumer Confidence, Emerging Markets, Expe, Food And Fuel, Greater China, Household Expenses, India, Nielsen Survey, Reflation, Research Trip, S Industrial, Trip To China, Urbanization Rate
Posted in India, Markets | Comments Off

Ten Things You Should Eliminate From Your Diet, and other Weekend Reads

Friday, January 28th, 2011

Here are this weekend's read­ing diver­sions for your per­sonal enlight­en­ment. Have a  great weekend!

12 Tips to Avoid­ing Win­ter Weight Gain

Did you know that, on aver­age, 30 per­cent of peo­ple don't exer­cise at all dur­ing the win­ter months and gain on aver­age 10 or more pounds?! While it's tempt­ing to hiber­nate and turn into a couch potato dur­ing the cold, win­ter months, this won't help you stay in shape, main­tain or reach your goal weight. Here are a few tips to keep your mind and body moti­vated to keep mov­ing and eat­ing health­fully when, baby, it's cold out­side!

***

Ed and Deb Shapiro: Six Ways to Keep Your Cool When You've Been Burned

Have you ever felt angry and didn't want to speak to some­one ever again for hurt­ing your feel­ings? It's a com­mon sce­nario: some­one says some­thing that's rude, wrongly accuses us of doing some­thing wrong, or in some other way makes us get reac­tive or defen­sive

***

Susan Stiffel­man: Tiger Mother? How About the Bat­tle Hymn of the Human Mother?

Kids need to expe­ri­ence frus­tra­tion and dis­ap­point­ment as they grow up, and they need strong, car­ing par­ents who can han­dle their upset with­out either cav­ing in or mor­ph­ing into tiger moth­ers and fathers who rule with an iron hand.

***

Health Ben­e­fits of Mango

One of the most deli­cious and most fat­ten­ing fruits, mango is truly called the 'King of Fruits'. A trop­i­cal fruit, it comes in as many as 1000 dif­fer­ent vari­eties, each of them totally delec­table. Though native to South­ern and South­east Asia, the fruit is now also grown in Cen­tral and South Amer­ica, Africa and the Ara­bian Penin­sula also. Apart from being high in calo­ries, man­goes are also rich in a large num­ber of nutri­ents and hold great nutri­tional value. Infact, they have been known to have pos­i­tive effects in case of a num­ber of ail­ments. In the fol­low­ing lines, we have listed numer­ous health and nutri­tion ben­e­fits of eat­ing man­goes.

***

About Nat­ural Sore Throat Reme­dies

Sore throats are the most com­mon rea­son that patients visit their doc­tor. The ton­sils and throat are very open to infec­tion due to the con­t­a­m­i­nated air that flows through the area.

***

Ten Things You Should Elim­i­nate From Your Diet

Everyone's body works dif­fer­ently. Some peo­ple may strug­gle with weight gain while oth­ers are gluten-intolerant. If you want to eat health­ier, elim­i­nate processed foods and add more fresh food to your daily diet.

***

How to Heal Cracked Lips

***

Headache Causes: 11 Things To Con­sider

Could it be some­thing you ate? Not enough sleep? Want to know what could be caus­ing your headache? Our com­pre­hen­sive list just might help you out.

***

Diana Mer­cer: 10 Best Ways to Screw Up Your Divorce

Before I became a medi­a­tor, I was a divorce lit­i­ga­tion attor­ney for 12 years. My nick­name was "Jaws." Lit­i­ga­tion was fun–for me, the lawyer–but prob­a­bly not so much for the clients who were pay­ing a king's ran­som for a lot of stuff they insisted that needed to be done which I knew was counter-productive. If I said that at the out­set of the case, I'd be accused of being on the other spouse's side, yet after I fol­lowed the client's instruc­tions of "damn the tor­pe­dos " after the fact I'd be accused of churn­ing the case to jack up the bill. So 22 years later, I'm a full time medi­a­tor and as a result have the free­dom to tell you how divorce lit­i­ga­tion clients screw them­selves and waste their money. Think I'm kid­ding? I was once fired by a client because I handed her hus­band a Kleenex after I made him cry at a depo­si­tion. Seri­ously.

***

Teens' Nar­cis­sis­tic Behav­ior Explained by Brain Activ­ity

So he failed to hold the door for you — he's a teen, what do you expect? Sci­en­tists and the aver­age adult have known young ado­les­cents to be self­ish. With brain-scanning tech­nol­ogy, researchers are now fig­ur­ing out how most of these "delin­quents" trans­form into respectable adults.

***

Alex Pat­takos: Mod­ern Sto­ry­telling and the Search for Mean­ing

It seems like just yes­ter­day I was lis­ten­ing to my par­ents lament the changes that were hap­pen­ing in soci­ety. "What's the world com­ing to?" were words that stuck in my mind as I was grow­ing up. At the time, espe­cially dur­ing my teenage years, I didn't really under­stand or appre­ci­ate their con­cern. My par­ents were just old-fashioned and, to me, didn't get it. Well the times have changed and I guess I'm now old-fashioned too because I keep ask­ing myself, "What's the world com­ing to?"

***

Tags: Amy Chua, Arabian Peninsula, Battle Hymn, Caring Parents, Com Ed, Cool Things, Couch Potato, Deb Shapiro, Fattening Fruits, Goal Weight, Hand Health, Health And Nutrition, Huffingtonpost, Human Mother, India, Iron Hand, King Of Fruits, Mothers And Fathers, Natural Sore Throat Remedies, Nutrition Benefits, Nutritional Value, Personal Enlightenment, Six Ways, Sore Throat Remedies, Sore Throats, Southe, Tropical Fruit, Winter Weight Gain
Posted in India, Markets | Comments Off

A Bull Market is Underway (Bob McWhirter)

Friday, January 28th, 2011

by Bob McWhirter, Selec­tive Asset Man­age­ment, Sub-Advisor to Nex­Gen Financial

In Canada the Finan­cials, Energy and Mate­ri­als sub­groups accounted for 94% of the 14.5% gain in the S&P/TSX Com­pos­ite in 2010. The S&P 500 Com­pos­ite was up 9.0% in 2010 in Cana­dian dol­lar terms.

2010 was a strong year for equity mar­kets as earn­ings con­tin­ued to rebound from their reces­sion­ary lows.

Strong 2011 fore­cast earn­ings growth of 26% for the S&P/TSX com­pa­nies and 13% for S&P 500 com­pa­nies is expected to drive stocks higher in 2011. We expect 2011 to be the year when ris­ing earn­ings momen­tum dis­tin­guishes the per­for­mance lead­ers ver­sus the laggards.

Con­cerns about ris­ing infla­tion and the U.S. bud­get deficit at 10% of G.D.P. are expected to hold back bond prices in 2011. As a result investors should shift their focus from bond to equity funds in 2011.

Growth vs. Value

We favour growth stocks over value stocks at this stage in the mar­ket. The S&P/TSX Com­pos­ite index has out­per­formed the S&P 500 Com­pos­ite Index in 7 of the past 8 years due to the strong per­for­mance of resource sec­tor stocks. The S&P/TSX is expected to out­per­form again in 2011 as its over 50% resource stock weight ben­e­fits from ris­ing global eco­nomic growth and par­tic­u­larly from the strong ener­giz­ing mar­ket economies.

Oil

Ray Han­son, Tech­ni­cal Ana­lyst at RBC Cap­i­tal Mar­kets, believes that the price of oil will rise above $120 U.S. in 2011 as oil appears to have bro­ken out (to the upside) from an 18 month trad­ing range.

Cop­per

We noted in the Octo­ber com­men­tary that “tech­ni­cal ana­lysts fore­cast that if the price of cop­per rises above $4.00/pound it could rise 50% to $6.00/pound in the next 12 to 18 months.” Cop­per has risen above $4.00/pound and because of strong demand and lim­ited growth in sup­ply for the next 2 years it appears that the price of cop­per will be sig­nif­i­cantly higher by the end of 2011.

Con­sumer Spending

The U.S. house­hold debt ser­vic­ing cost is the low­est it has been in 20 years. This may lead to an upside sur­prise in U.S. con­sumer spend­ing in 2011. Small busi­nesses in the U.S. may be the dri­ver of increased hir­ing lead­ing to fur­ther reduc­tions in the U.S. unem­ploy­ment rate.

Ris­ing energy and raw mate­r­ial costs in 2011 may lead to a squeeze in con­sumer ori­ented profit mar­gins. This occurred in 2007/2008 but nat­ural resource com­pa­nies (the providers of the raw mate­ri­als) ben­e­fited at that time and are expected to ben­e­fit in 2011 pro­vid­ing fur­ther sup­port of our view that the S&P/TSX should outperform.

In Sum­mary…

Since mid-November $20 bil­lion has been with­drawn from U.S. bond mutual funds to pay for equity pur­chases. We expect flows from fixed income funds into equi­ties to con­tinue to drive demand for equities.

We see 2011 as a year of oppor­tu­nity as we believe a new equity bull mar­ket is under­way. A near term pull back of 5 to 10% would be viewed as an oppor­tu­nity to increase resource stock hold­ings. In late August in the growth ori­ented port­fo­lios we “increased the empha­sis on a company’s abil­ity to ser­vice its debt as well as reduce its debt.” This change has con­tributed to the sig­nif­i­cant per­for­mance that has occurred in the growth port­fo­lios since the end of August.

Copy­right © Nex­Gen Financial

Tags: Bob Mcwhirter, Bond Prices, Budget Deficit, Canadian Market, Dollar Terms, Earnings Growth, Earnings Momentum, energy, Forecast Earnings, Global Economic Growth, Growth Stocks, Household Debt, Market Economies, Performance Leaders, Price Of Copper, Rbc, Rbc Capital Markets, Resource Sector, Resource Stock, Selective Asset Management, Technical Analysts, Tsx Composite, Value Stocks
Posted in Canadian Market, Energy & Natural Resources, Markets, Oil and Gas | Comments Off

Potash (POT) Beats by 12 Cents, Guides 2011 a Bit Higher but Excites Crowd with 3–1 Split

Friday, January 28th, 2011

by Trader Mark, Fund My Mutual Fund

It is always bemus­ing to watch stocks jump on stock splits which are noth­ing but an account­ing change.  2x more stock at half the price.  Noth­ing changes but back in 1999 you'd see stocks jump 15–20% on a stock split as long as it was on the NASDAQ.  Some of that behav­ior still lives.  Potash (POT) reported a solid quar­ter, with not that excit­ing guid­ance, but the 3–1 stock split has helped to stoke excitement.

For the quar­ter $1.77 v $1.65 expec­ta­tion, rev­enues up 65% to $1.81B.  For 2011 the com­pany guides to $8.40 to $9.60, vs cur­rent $8.89.  Based on how poorly these fer­til­izer com­pa­nies guided in 2008 and 2009 ver­sus a quickly chang­ing mar­ket, take every­thing with a grain of salt. Even assum­ing Potash hits $10 EPS in 2011, this is a for­ward PE of 17.5 (for­ward, not trail­ing) for an extremely cycli­cal com­pany.  But increas­ingly val­u­a­tion is becom­ing moot across the mar­ket as it was in 1999 — all the cen­tral banker liq­uid­ity has to go some­where.  Indeed we shall see that same dilemma in Amazon.com (AMZN) in a few hours.

• The com­pany said it expects global ship­ments of potash to reach 55 mil­lion met­ric tons to 60 mil­lion met­ric tons in 2011, up from 52 mil­lion tons in 2010.
• Potash Corp now expects 2011 potash ship­ments of 9.5 mil­lion to 10 mil­lion tonnes. It had ear­lier fore­cast sales ship­ments of 9.3 mil­lion tonnes.
• The com­pany has ear­marked $2.0 bil­lion for cap­i­tal expen­di­tures in 2011, with $1.4 bil­lion going to potash expan­sion projects.
• The com­pany will pay out the stock split to share­hold­ers in the form of a stock div­i­dend, with each receiv­ing two addi­tional shares for each one owned on the record date of Feb. 16.

No posi­tion

Copy­right © Trader Mark, Fund My Mutual Fund

Tags: 10 Million, 5 Million, 60 Million, Amazon Com Amzn, Capital Expenditures, Dilemma, Eps, Expectation, Fertilizer Companies, Global Shipments, Grain Of Salt, liquidity, Million Metric Tons, Mutual Fund, Nasdaq, Potash Corp, Potash Pot, Shareholders, Stock Dividend, Stock Splits
Posted in Markets | Comments Off

21st Century Shell Game: How Bankers Play and Taxpayers Pay

Friday, January 28th, 2011

by Axel Lei­jon­hufvud, via VoxEU.org

25 Jan­u­ary 2011

The shell game is a road­side con as old as civil­i­sa­tion. This col­umn argues that the same swin­dle is being per­formed on a mas­sive scale at the expense of the unsus­pect­ing tax­payer. It says that, with their near zero inter­est rates, cen­tral banks are effec­tively sub­si­dis­ing the bank­ing sec­tor – with barely a pea passed on to the public.

The two pio­neers of mod­ern mon­e­tary eco­nom­ics – Irv­ing Fisher and Knut Wick­sell – were pas­sion­ately con­cerned to find mon­e­tary arrange­ments that would insure against arbi­trary redis­tri­b­u­tions of income and wealth. They saw such dis­trib­u­tive effects as offenses against social jus­tice and con­se­quently as a threat to social and polit­i­cal stability.

Fisher and Wick­sell thought that price level sta­bil­ity was a suf­fi­cient con­di­tion for avoid­ing dis­trib­u­tive effects. In this they were in error. A hun­dred years later, the moti­vat­ing con­cern for their work has long since dis­ap­peared from mon­e­tary economics.

But the error sur­vives. For example:

• The Fed is sup­ply­ing the banks with reserves at a near-zero rate. Not much results in bank lend­ing to busi­ness, but banks can buy Trea­suries that pay 3% to 4%.
• This hefty sub­sidy to the bank­ing sys­tem is ulti­mately borne by tax­pay­ers. Nei­ther the sub­sidy, nor the tax lia­bil­ity has been voted for by Congress.

The Fed pol­icy dri­ves down the inter­est rates paid to savers to some small frac­tion of 1%. At the same time, banks lever­age their cap­i­tal by a fac­tor of 15 or so, thus earn­ing a truly out­stand­ing return from buy­ing Trea­suries with cost­less Fed money or very nearly cost­less deposits.

Wall Street bankers are then able once again to claim the bonuses they became used to in the good old days and to which they feel enti­tled because of the genius required to per­form this oper­a­tion. These bonuses are in effect trans­fers from tax-payers as well as from the mostly aged savers who can­not find alter­na­tive safe place­ments for their funds in retirement.

The shell game: “Now you see it, now you don’t.”

The Fed’s low-interest-rate pol­icy has turned into a shell game for the gen­eral pub­lic who are unable to fol­low how the money flows from losers to gainers.

• The bailouts of the banks dur­ing the cri­sis were clear for all to see and caused wide­spread out­rage; now the pub­lic is being told that they are being repaid at no cost to the taxpayer.
• What the pub­lic is not told is that the repay­ments come to a sub­stan­tial extent out of rev­enues paid by tax­pay­ers for the banks to hold Treasuries.
• Both par­ties sup­ported the bailouts so nei­ther party seems ready to protest the claim that they are being repaid at no cost to taxpayers.

The goals of mon­e­tary policy

Present mon­e­tary pol­icy achieves two aims.

• One is to recap­i­talise the banks and to do so with­out the gov­ern­ment tak­ing an equity stake.

The author­i­ties do not want to be charged with “nation­al­i­sa­tion” or “social­ism.” So the banks have to be given the funds out­right. Econ­o­mists have ago­nised a lot lately about the zero lower bound to the inter­est rate as an obsta­cle to effec­tive pol­icy in the present cir­cum­stances. The agony seems mis­placed. As long as the big banks are to be sub­sidised, why not just pay them to accept reserves from the friendly cen­tral bank?

• The sec­ond aim, of course, is to pre­vent the hous­ing bub­ble from deflat­ing all the way.

In this respect, the pol­icy has had some effect. Home­own­ers whose houses are not “under water” can often refi­nance at long-term rates around 5% and some­times even lower.

Mis­cal­cu­la­tion of eco­nomic val­ues: Who pays?

Any finan­cial crash reveals a large, col­lec­tive mis­cal­cu­la­tion of eco­nomic val­ues. The inci­dence of the losses result­ing from such mis­cal­cu­la­tions has to be worked out before the econ­omy can begin to func­tion nor­mally again. Because the process of a crash is unsta­ble, it can­not be left for the mar­kets and bank­ruptcy courts to work out the even­tual inci­dence. In the present case, doing so would sim­ply have led into another Great Depression.

This means polit­i­cal choices have to be made to deter­mine who bears the losses from this col­lec­tive mis­cal­cu­la­tion. Obvi­ously such choices are ter­ri­bly dif­fi­cult. Yet, tem­po­ris­ing can pro­long the period of sub­nor­mal eco­nomic per­for­mance indef­i­nitely – as the his­tory of Japan over the last 20 years illus­trates. The shell game, as presently played, is in effect an attempt to set­tle a large part of the inci­dence prob­lem “under the radar” of pub­lic opinion.

The risks of this quiet bank subsidy

Quite apart from its dis­tri­b­u­tional effects, the pol­icy is not with­out risk.

• To the extent that it suc­ceeds in induc­ing the banks to load up on long-term, low-yield assets, a return to more nor­mal rates will spell another round of bank­ing troubles.

If the US were to suf­fer years of slow defla­tion, a return to higher rates will be long post­poned. At present, strong defla­tion­ary pres­sures are kept at bay by equally strong infla­tion­ary poli­cies. If the US escapes the Japan­ese syn­drome, the Fed will sooner or later have to raise rates to stem infla­tion or to defend the dollar.

Cen­tral bank independence?

For the last 20 or 30 years, polit­i­cal inde­pen­dence of cen­tral banks has been a pop­u­lar idea among aca­d­e­mic econ­o­mists and, of course, heartily endorsed by cen­tral bankers. Such inde­pen­dence has not been much in evi­dence in the recent cri­sis. But cen­tral banks would very much like to restore their independence.

The inde­pen­dence doc­trine, how­ever, is pred­i­cated on the dis­tri­b­u­tional neu­tral­ity of their poli­cies. Once it is realised that mon­e­tary pol­icy can have all sorts of dis­tri­b­u­tional effects, the inde­pen­dence doc­trine becomes impos­si­ble to defend in a demo­c­ra­tic society.

Copy­right © VoxEU.org

Tags: Banking Sector, Banking System, Central Banks, Fed Policy, Hundred Years, Income And Wealth, Irving Fisher, Knut Wicksell, Massive Scale, Monetary Arrangements, Monetary Economics, Political Stability, Shell Game, Sufficient Condition, Swindle, Tax Liability, Tax Payers, Treasuries, Zero Interest, Zero Rate
Posted in Markets | Comments Off

Why China Missed the Industrial Revolution

Friday, January 28th, 2011

by Jan Luiten van Zan­den, via VoxEU.org

26 Jan­u­ary 2011

China has been one of the world’s most dynamic economies in recent decades, but how did it fall so far behind? This col­umn argues that the indus­trial rev­o­lu­tion occurred in Europe rather than China because Euro­pean entre­pre­neurs were eager to adopt machines to cut down on high labour costs. China didn’t “miss” the indus­trial rev­o­lu­tion – it didn’t need it.

One of the big debates in eco­nom­ics is about the causes of the arguably most dra­matic change in devel­op­ment tra­jec­tory in (recent) world his­tory, the indus­trial revolution.

• Before about 1800, growth did occur, but it was mainly “exten­sive”, lead­ing to more peo­ple but almost no growth in income per capita.
• After about 1800 this changed, and growth became (increas­ingly) “inten­sive”, focused on an almost con­tin­u­ous growth of GDP per head.

There is con­sen­sus about the fact that this change in growth pat­tern started in north­west­ern Europe, and grad­u­ally spread to large parts of the west­ern and, after a lag, east­ern and south­ern world.

Why this hap­pened, and where it hap­pened are top­ics of heated debate among his­to­ri­ans. The recent “Chi­nese mir­a­cle” – fab­u­lous growth since about 2000 – has had an impor­tant impact on this debate.

• How could the Chi­nese econ­omy, which is clearly capa­ble of dra­matic eco­nomic change (in view of what hap­pened since 1979), man­age to “miss” the indus­trial rev­o­lu­tion of the 19th century?
• How devel­oped was China in the 18th cen­tury, when it was (under the Qing) expe­ri­enc­ing a long period of eco­nomic sta­bil­ity and development?

The Great Diver­gence debate

Recent lit­er­a­ture, most famously Ken­neth Pomeranz’s The Great Diver­gence (2000), has sug­gested that China’s level of eco­nomic per­for­mance was more or less at par with that of West­ern Europe. More­over, the lower Yangzi delta formed a core of eco­nomic pros­per­ity com­pa­ra­ble with the North Sea area, the most devel­oped part of West­ern Europe.

In Pomeranz’s view, the fact that the indus­trial rev­o­lu­tion occurred in Eng­land was due to for­tu­nate geo­graphic cir­cum­stances (the avail­abil­ity of cheap coal in the right places) and the fact that Euro­pean coun­tries had access to colonies, which China lacked.

This the­sis has started a large inter­na­tional debate about ‘the Great Diver­gence’ among econ­o­mists and eco­nomic his­to­ri­ans. Pomeranz’s inter­pre­ta­tion was per­haps not entirely con­vinc­ing as it was largely based on qual­i­ta­tive evi­dence and some snips of quan­ti­ta­tive infor­ma­tion that could be inter­preted in var­i­ous ways.

Indeed, recent research by my col­leagues and I on the devel­op­ment of wages and prices in China and West­ern Europe has pro­duced results that do not sup­port the Pomer­anz hypoth­e­sis. It turns out that real wages in var­i­ous parts of the coun­try were at best half of those in the North Sea area (Allen et al. 2011). But it was also argued that wage labour was a rather mar­ginal phe­nom­e­non in the Chi­nese econ­omy, imply­ing that real wage esti­mates are a poor guide to eco­nomic performance.

New com­par­a­tive research

In a recent CEPR work­ing paper with Bozhong Li (Li and van Zan­den 2010), we go one step fur­ther and make detailed esti­mates of the struc­ture and level of GDP per capita of two regions, which are among the most advanced parts of West­ern Europe (the Nether­lands, with a level of GDP per capita com­pa­ra­ble to that of Eng­land) and China (a more or less com­pa­ra­ble region within the Yangzi delta, the Hua-Lou district).

The two regions have a lot in common.

• They are both sit­u­ated in a river delta con­trol­ling trade with a vast hin­ter­land, caus­ing them to both spe­cialise in ser­vices and related man­u­fac­tur­ing activities.
• They are both highly urbanised; about 39% of the pop­u­la­tion of Hua-Lou lives in cities, in the Nether­lands this share is 35%.
• Agri­cul­tural con­di­tions were sim­i­lar as well; both have dif­fi­cult to work clay soils and water man­age­ment is key to the high lev­els of agri­cul­ture pro­duc­tiv­ity found there.
• Finally, per­haps because of the advanced state of their economies and soci­eties, in both regions rel­a­tively good eco­nomic sta­tis­tics were col­lected, mak­ing it pos­si­ble to esti­mate the level and struc­ture of GDP in the 1820s.

But the pic­ture changes rad­i­cally when lev­els of pro­duc­tiv­ity and income are com­pared. GDP per capita in the Nether­lands is 86% higher than that of Hua-Lou dis­trict. Much of this is caused by a par­tic­u­larly large pro­duc­tiv­ity gap in indus­try and ser­vices, where labour is at least twice as pro­duc­tive in the Nether­lands. Only in agri­cul­ture is the gap between ‘East and West’ very small.

So why is labour in ser­vices and indus­try so much more pro­duc­tive in the West? Fac­tor prices form prob­a­bly a large part of the expla­na­tion – real wages in the Nether­lands were at least 70% higher than those in the Yangzi Delta, but inter­est rates were much lower in the West (but data on inter­est rates in China are still very scarce and not very reli­able). Since the late Medieval Period (in fact, since the Black Death of 1348), the North Sea area was a region with high real wages and low inter­est rates, and pro­duc­ers had devel­oped and selected pro­duc­tion tech­nolo­gies which are con­sis­tent with these rel­a­tive prices. Mean­while, in China – in the Yangzi delta and else­where – wages were much lower, and cap­i­tal mar­kets prob­a­bly not that well devel­oped as in West­ern Europe. A com­par­i­son of pro­duc­tion tech­niques used in dif­fer­ent indus­tries is illuminating.

In China, water man­age­ment was car­ried out largely by hand using sophis­ti­cated machines (see Fig­ure 1 below). In the Nether­lands the wind­mill had been adapted to ser­vice water man­age­ment, result­ing in the huge mills that dom­i­nated the rural land­scape (Fig­ure 2 is a design of one of the first 17th cen­tury mills). The same dif­fer­ence applies to oil press­ing, a large indus­try in both regions. The Dutch devel­oped a highly capital-intensive wind­mill tech­nol­ogy to press their oilseeds, the Chi­nese ver­sion of this was dri­ven, again, by humans or oxen. Inland trans­port along canals and rivers was pulled by horses in the Nether­lands, by humans in China.

Fig­ure 1. Pump­ing of water in the Yangzi Delta: A sophis­ti­cated machine dri­ven by human labour

Fig­ure 2. Pump­ing of water in the Nether­lands: A sophis­ti­cated machine mon­i­tored by one miller (the first design of the typ­i­cal Dutch wind­mill by Leegh­wa­ter, early 17th century)

Most famous is per­haps the dif­fer­ent choice of tech­nique in print­ing. Although the Chi­nese had invented the print­ing press, com­mer­cial print­ers pre­ferred to use a more labour-intensive tech­nol­ogy, wood­block print­ing. Since the mid­dle of the 15th cen­tury, West­ern Europe con­cen­trated on move­able type print­ing as the most impor­tant tech­nol­ogy, which was a very capital-intensive process, with high lev­els of labour pro­duc­tiv­ity. Fig­ures 3 and 4 illus­trate the dif­fer­ence in capital-labour ratio between the two tech­nolo­gies; typ­i­cally, the press­ing in China is done by humans, in Europe by a machine.

Fig­ure 3. Advanced print­ing tech­nol­ogy in China

Fig­ure 4. The print­ing press as it was devel­oped in West­ern Europe.

Per­haps Chi­nese and Euro­pean pro­duc­ers had, as in the case of the print­ing press, in prin­ci­ple access to the same rel­a­tively advanced tech­nolo­gies, but rad­i­cally dif­fer­ent rel­a­tive prices induced them to select dif­fer­ent modes of pro­duc­tion, result­ing in the big gap in labour pro­duc­tiv­ity that can be observed in the 1820s. The story for agri­cul­ture is dif­fer­ent, how­ever. There, land pro­duc­tiv­ity was much higher in the Yangzi delta – where advanced sys­tems of mul­ti­ple crop­ping had been devel­oped – and total fac­tor pro­duc­tiv­ity was much higher than in the West. This may have been a par­tic­u­lar fea­ture of “rice agri­cul­ture” in com­bi­na­tion of very inten­sive forms of irri­ga­tion. It resulted in a level of labour pro­duc­tiv­ity which was almost as high as in the Nether­lands (or Eng­land). This also implied that, in the Yangzi delta, labour pro­duc­tiv­ity in agri­cul­ture was much higher than in indus­try – the reverse of the “nor­mal” struc­ture of rel­a­tive pro­duc­tiv­i­ties known from the work by Simon Kuznets and Colin Clark. This may also have had con­se­quences for struc­tural trans­for­ma­tion – it lim­ited the incen­tives to move from agri­cul­ture to indus­try (although Hua-Lou dis­trict, with its high level of urban­i­sa­tion, is prob­a­bly not the best case in point).

Mixed moder­nity

This detailed com­par­i­son results in a very mixed pic­ture of Chi­nese eco­nomic moder­nity com­pared with that of West­ern Europe. Yes, the Yangzi delta had a rel­a­tively advanced econ­omy, with high lev­els of agri­cul­tural pro­duc­tiv­ity and urban­i­sa­tion and a high degree of struc­tural trans­for­ma­tion; we can accept this part of Pomeranz’s the­sis. But this did not imply that it was “ready” for an indus­trial revolution.

The indus­trial rev­o­lu­tion was a process of mech­a­ni­sa­tion in which expen­sive labour was sub­sti­tuted for by machines dri­ven by coal – as Bob Allen (2009) has demon­strated. Chi­nese fac­tor costs were not at all con­ducive to such a change.

Whereas entre­pre­neurs in Europe were very eager to develop new tech­nolo­gies that increased labour pro­duc­tiv­ity via the capital-labour ratio, Chi­nese busi­nesses barely had any incen­tive to do so. That the indus­trial rev­o­lu­tion emerged in Eng­land was there­fore not acci­den­tal or the result of luck, but the long-run effect of its fun­da­men­tally dif­fer­ent fac­tor prices, reflect­ing its dif­fer­ent eco­nomic and insti­tu­tional trajectory.

Ref­er­ences

Allen, Robert C (2009), The British Indus­trial Rev­o­lu­tion in Global Per­spec­tive, Cam­bridge Uni­ver­sity Press.

Allen, Robert C, Jean-Pascal Bassino, Chris­tine Moll-Murata, and Jan Luiten van Zan­den (2011), “Wages, Prices, and Liv­ing Stan­dards in China, Japan, and Europe, 1738–1925”, to be pub­lished in Eco­nomic His­tory Review, vol. 64, issue 1.

Pomer­anz, K (2000), The Great Diver­gence. China, Europe and the Mak­ing of the Mod­ern World Econ­omy, Prince­ton Uni­ver­sity Press.

Li, Bozhong, and Jan Luiten van Zan­den (2010), “Before the Great Diver­gence? Com­par­ing the Yangzi Delta and the Nether­lands at the begin­nings of the nine­teenth cen­tury”, CEPR Dis­cus­sion Paper 8023.

Tags: China, Chinese Economy, Chinese Miracle, Continuous Growth, Dramatic Change, Dynamic Economies, Economic Change, Economic Performance, Economic Prosperity, Economic Stability, European Entrepreneurs, Gdp Per Head, Great Divergence, Income Per Capita, Industrial Revolution, Kenneth Pomeranz, Labour Costs, Northwestern Europe, Sea Area, Van Zanden, Yangzi Delta
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off

The New Carry Trade

Friday, January 28th, 2011

by Pasquale Della Corte, and Lucio Sarno Ilias Tsi­akas, via VoxEU.org

26 Jan­u­ary 2011

The carry trade in for­eign cur­rency has attracted con­sid­er­able atten­tion from aca­d­e­mics and prac­ti­tion­ers. This col­umn presents evi­dence of a new carry trade strat­egy – this time spec­u­lat­ing on the volatil­ity of for­eign exchange. This is done by buy­ing or sell­ing for­ward volatil­ity agree­ments. It sug­gests that investors fol­low­ing the new carry trade can do extremely well – regard­less of whether the value of these cur­ren­cies go up or down.

The stan­dard “carry trade” is a pop­u­lar cur­rency spec­u­la­tion strat­egy that invests in high-interest cur­ren­cies by bor­row­ing in low-interest cur­ren­cies. This strat­egy works well if, for exam­ple, spot exchange rates are unpre­dictable. There is ample empir­i­cal evi­dence point­ing in that direc­tion or, in aca­d­e­mic jar­gon, show­ing that exchange rates fol­low a ran­dom walk (Meese and Rogoff 1983). In this case, investors engag­ing in carry trad­ing will on aver­age earn the dif­fer­ence in inter­est rates with­out hav­ing to worry about move­ments in exchange rates. The return to cur­rency spec­u­la­tion can be sub­stan­tial over time. It should be no sur­prise, there­fore, that the carry trade has attracted con­sid­er­able atten­tion from aca­d­e­mics and prac­ti­tion­ers over the years.

Spec­u­lat­ing on volatility

In recent years, investors have been able to spec­u­late not only on the value of cur­ren­cies but also on the level of volatil­ity of these cur­ren­cies. This has become pos­si­ble by trad­ing a con­tract called the for­ward volatil­ity agree­ment (FVA), which effec­tively allows investors to trade volatil­ity. Tech­ni­cally speak­ing, the FVA is a for­ward con­tract on future spot implied volatil­ity, which for a one dol­lar invest­ment deliv­ers the dif­fer­ence between future spot implied volatil­ity and for­ward implied volatil­ity. To make our ter­mi­nol­ogy clear, implied volatil­ity is a mea­sure of expected volatil­ity, which is directly quoted in traded cur­rency options (Jorion 1995). When we say “spot” implied volatil­ity we mean the implied volatil­ity for an inter­val start­ing today and end­ing in the future (e.g., start­ing today and end­ing one month from now). “For­ward” implied volatil­ity is the implied volatil­ity deter­mined today for an inter­val start­ing in the future and end­ing fur­ther in the future (e.g., start­ing in one month and end­ing in two months from now).

The main point of the FVA is that it allows investors to spec­u­late on the level of future volatil­ity. Then, the “carry trade in volatil­ity” is a spec­u­la­tion strat­egy that buys and sells FVAs, where investors try to make money by guess­ing the level of future spot implied volatil­ity. Sim­i­lar to the stan­dard carry trade, the carry trade in volatil­ity works well if spot implied volatil­ity is unpre­dictable. Then, investors engag­ing in this new carry trade will on aver­age earn the dif­fer­ence between spot and for­ward volatil­ity with­out hav­ing to worry about move­ments in exchange rates.

Is for­ward volatil­ity a good pre­dic­tor of future volatility?

The FVA sets a for­ward implied volatil­ity by mak­ing a guess about future spot implied volatil­ity. For exam­ple, today it might set a for­ward volatil­ity of 10% for the period start­ing in one month and end­ing in two months from now. This for­ward volatil­ity is meant to be an unbi­ased pre­dic­tor of the future spot implied volatil­ity for the same period, which may end up being higher or lower than 10%. As any for­ward con­tract, the FVA is designed so that on aver­age the ex ante for­ward volatil­ity matches the spot volatil­ity that hap­pens ex post.¹ If these two volatil­i­ties end up being very sim­i­lar, buy­ing and sell­ing FVAs will not be prof­itable and the carry trade in volatil­ity will not work. In this case, spec­u­lat­ing on volatil­ity will not gen­er­ate prof­its. But is this the case?

In a recent paper (Della Corte et al. 2010), we inves­ti­gate the sys­tem­atic rela­tion between spot and for­ward volatil­ity in for­eign exchange by esti­mat­ing the volatil­ity ana­logue to the famous Fama regres­sion (Fama 1984). Using a num­ber of cur­ren­cies, alter­na­tive mea­sures of volatil­ity, and dif­fer­ent esti­ma­tion tech­niques, we find a fairly robust result. For­ward volatil­ity is a poor pre­dic­tor of future spot implied volatil­ity. This is called the “for­ward volatil­ity bias.” In fact, for some cases, the rela­tion between spot and for­ward volatil­ity is prac­ti­cally non-existent, which implies that spot volatil­ity may be close to a ran­dom walk. This is a strong result with impor­tant implications.

Is volatil­ity spec­u­la­tion profitable?

If for­ward volatil­ity is a poor pre­dic­tor of future spot implied volatil­ity, buy­ing and sell­ing FVAs can be very prof­itable. For exam­ple, buy­ing (sell­ing) FVAs when for­ward implied volatil­ity is lower (higher) than cur­rent spot implied volatil­ity will con­sis­tently gen­er­ate excess returns over time. Even bet­ter, we show that investors can design sim­ple dynamic asset allo­ca­tion strate­gies that exploit the for­ward volatil­ity bias. These strate­gies can con­sis­tently gen­er­ate high prof­its even when the trans­ac­tion cost of trad­ing FVAs is rather high. Sim­i­lar strate­gies assum­ing that spot volatil­ity fol­lows a ran­dom walk gen­er­ate equally high profits.

Another impor­tant result is that the returns to the stan­dard carry trade in cur­rency and the carry trade in volatil­ity tend to be uncor­re­lated over time. This point can be seen clearly in Fig­ure 1, which shows the annu­alised out-of-sample Sharpe ratios for the stan­dard carry trade in cur­rency and the carry trade in volatil­ity, labelled CTC and CTV respec­tively. The Sharpe ratio is sim­ply defined as the excess return of each strat­egy per unit of risk. The CTV strat­egy tends to per­form bet­ter at the begin­ning and end of the sam­ple, whereas the CTC is bet­ter in the mid­dle period. More­over, it is inter­est­ing to note that for the last two years of the sam­ple the Sharpe ratio of the CTV strat­egy is ris­ing but that of the CTC is falling. This indi­cates that the CTV strat­egy has done well dur­ing the recent credit crunch when the CTC has not.

Fig­ure 1.

Con­clu­sion

There is money to be made in trad­ing foreign-exchange volatil­ity. If there is a bias in the way the mar­ket sets for­ward volatil­ity, then the carry trade in volatil­ity strat­egy will be prof­itable. We find strong sta­tis­ti­cal and eco­nomic evi­dence that this is indeed the case. Hence, there is a new carry trade. Finally, our empir­i­cal find­ings on volatil­ity spec­u­la­tion can pro­vide valu­able insight to mar­ket par­tic­i­pants and pol­i­cy­mak­ers who can ben­e­fit from tak­ing a stance on the future volatil­ity in currencies.

Ref­er­ences

Della Corte, P, L Sarno, and I Tsi­akas (2010), “Spot and For­ward Volatil­ity in For­eign Exchange”, Jour­nal of Finan­cial Eco­nom­ics, forth­com­ing. Cen­tre for Eco­nomic Pol­icy Research Dis­cus­sion Paper 7893.

Fama, EF (1984), “For­ward and Spot Exchange Rates”, Jour­nal of Mon­e­tary Eco­nom­ics, 14:319–338.

Jorion, P (1995), “Pre­dict­ing Volatil­ity in the For­eign Exchange Mar­ket”, Jour­nal of Finance, 50:507–528.

Meese, RA and K Rogoff (1983), “Empir­i­cal Exchange Rate Mod­els of the Sev­en­ties: Do They Fit Out of Sam­ple?”, Jour­nal of Inter­na­tional Eco­nom­ics, 14:3–24.

¹ Tech­ni­cally speak­ing, as any for­ward con­tract, the FVA’s net mar­ket value at entry must be equal to zero. There­fore, its exer­cise price (for­ward implied volatil­ity) rep­re­sents the risk-neutral expected value of future spot implied volatil­ity. Hence the for­mer must be an unbi­ased pre­dic­tor of the latter.

Copy­right © VoxEU.org

Tags: 26 January, Academic Jargon, Carry Trade, Currency, Currency Options, Currency Speculation, Dollar Investment, Empirical Evidence, Foreign Currency, Forward Contract, Fva, High Interest, Ilias, Implied Volatility, Lucio Sarno, Meese, Pasquale, Random Walk, Rogoff, Spot Exchange Rates, Trade Strategy
Posted in Credit Markets, Markets | Comments Off

The Threat of Rising Food Prices

Friday, January 28th, 2011

by Luis AV Catão, and Roberto Chang, via VoxEU.org

Ris­ing food prices once again pose cen­tral banks a tricky ques­tion. How far should they ignore food price infla­tion? This col­umn sug­gests that food tends to have stronger pre­dic­tive power on global infla­tion cycles than oil. The prob­lem is more severe in emerg­ing mar­kets where con­sump­tion bas­ket weights for food are two or three times larger than in rich nations. Cen­tral banks should pay close attention.

The uneven recov­ery in advanced coun­tries is hid­ing an issue that, while off the agenda in the last G20 meet­ing back in Novem­ber, is arguably no less urgent for the global econ­omy – namely, the rise in food prices.

• Fol­low­ing a steep accel­er­a­tion ini­ti­ated last sum­mer, global food prices (as mea­sured by the IMF global food price index) rose by 21% in the year lead­ing up to Novem­ber 2010 (lat­est avail­able figure).
• Global aver­age food prices are now back to their pre-crisis peak, despite a col­lapse in the wake of the 2008/09 finan­cial crisis,

Cou­pled with the most recent round of weather set­backs and slashes in key crop fore­casts world­wide, there is lit­tle hope that such infla­tion­ary pres­sures will abate. If any­thing, the US and EU eco­nomic recov­ery will exac­er­bate them.

In advanced coun­tries, these devel­op­ments have not yet per­co­lated through the infla­tion out­look, which remains broadly dor­mant due to off­set­ting effects of falling man­u­fac­tur­ing prices and con­tin­u­ing slack in labour mar­kets. But this isn’t so elsewhere.

• In emerg­ing mar­kets, non-trivial devi­a­tions from tar­geted infla­tion have begun to emerge.
• Food price sub-indices are well ahead of head­line infla­tion, often two to three times as fast.

This is par­tic­u­larly alarm­ing inso­far as much of the accel­er­a­tion in food infla­tion in emerg­ing mar­kets comes from basic sta­ples such rice and corn, with seem­ingly lim­ited scope for sub­sti­tutabil­ity in con­sump­tion baskets.

In Indone­sia, for instance – where per capita rice con­sump­tion is higher than the Asian aver­age – rice prices were up by as much as 30% in the year to Decem­ber. Sub­si­dies and tar­iffs, mean­while, have mit­i­gated the exter­nal price pass-through only to a lim­ited extent else­where in the con­ti­nent. From Jakarta to Mex­ico City, sto­ries of ris­ing imports mak­ing up for sig­nif­i­cant short­falls in the domes­tic sup­ply of such sta­ples con­tinue to abound.

With food typ­i­cally weigh­ing 20% to 50% in national con­sump­tion bas­kets in devel­op­ing coun­tries, as opposed to 12% to 15% in core advanced coun­tries (see Table 1), this “decou­pling” in the infla­tion out­look is hardly sur­pris­ing. But it does not make the issue of global food infla­tion any less crit­i­cal look­ing forward.

While longer-term price pro­jec­tions for some these sta­ples por­tray a bright pic­ture for many emerg­ing mar­kets in terms sus­tain­able terms-of-trade gains over the cur­rent decade (OECD-FAO 2010), the ongo­ing accel­er­a­tion in food prices cre­ates impor­tant dilem­mas for mon­e­tary pol­icy in net food exporters and importers alike over the near term.

Food infla­tion more impor­tant than oil price rises

His­tory is adamant on the risks. While much has been made of oil prices as dri­vers of global infla­tion­ary spurts since the 1970s, recent work of ours (Catão and Chang 2010) pro­vides evi­dence that food price pres­sures have been no less impor­tant. The data in fact sug­gests that food tends to have stronger pre­dic­tive power on global infla­tion cycles than oil.

As Fig­ure 1 illus­trates, every sin­gle infla­tion upturn over the past four decades has been pre­ceded (with a one to two-year lag) by an uptick in world food prices; this causal­ity rela­tion is con­firmed by for­mal econo­met­ric tests. To be sure, one could arguably blame such past slip­pages on the looser mon­e­tary regimes of the 1970s and 1980s. Yet, later expe­ri­ence indi­cates that this trans­mis­sion mech­a­nism remains quite alive in the more recent era of infla­tion tar­get­ing too.

This is por­trayed in Fig­ure 2, which plots the IMF global indices of food and oil prices (mea­sured along the left ver­ti­cal axis) against the cross-country median of per­cent­age devi­a­tions from the cen­tral infla­tion tar­gets (mea­sured along the right ver­ti­cal axis) for all coun­tries that have for­mally adopted infla­tion tar­get­ing. Clearly, the large swings since 2006 in devi­a­tions of actual from tar­geted infla­tion have coin­cided with atten­dant swings in world food prices. Fur­ther, Fig­ure 2 also con­firms that food prices are bet­ter pre­dic­tors of global infla­tion than oil prices. While oil prices began to climb up in earnest from 2003, sig­nif­i­cant devi­a­tions from tar­geted infla­tion only mate­ri­alised after food prices took off from late 2006. In short, there is sub­stan­tial evi­dence – both recent and well-past – that food prices lurk behind large inter­na­tional swings in infla­tion rates.

Fig­ure 1.

Fig­ure 2.

Against this back­ground, a key ques­tion to national cen­tral banks is the extent to which such imported infla­tion should be accom­mo­dated. In the case of large cen­tral banks like the ECB and the US Fed­eral Reserve, two con­sid­er­a­tions stand out.

• The first is that their actions have a direct bear­ing on global food price given their weight in world income and capac­ity to set world inter­est rates, influ­enc­ing food prices via both demand and sup­ply channels.
• The sec­ond is that their actions have strong exter­nal­i­ties else­where. In the emerging/developing world, this can be far-reaching because food accounts for a very high share in con­sumer spend­ing and, since much of it con­sists of non high-end items, it can­not be sub­sti­tuted away.

Well-known struc­tural weak­nesses of devel­op­ing coun­tries add to the prob­lem. Soar­ing food infla­tion can trig­ger far-reaching unrest wher­ever polit­i­cal insti­tu­tions are frag­ile, finan­cial sys­tems are less mature to smooth out shocks, and social safety nets inad­e­quate, as wit­nessed by the many food-related riots dur­ing 2007-08.

What should mon­e­tary pol­icy do?

A sit­u­a­tion that deserves spe­cial con­sid­er­a­tion is that of the worst suf­ferer – the price-taking small-open econ­omy that is a net food importer with a share of food in the national con­sump­tion bas­ket far larger than that of the advanced world. In that case, our work (Catão and Chang 2010) indi­cates that mon­e­tary author­i­ties should not accom­mo­date the atten­dant rise in CPI infla­tion even if they do not prac­tice price level tar­get­ing. In fact, among the pol­icy rules usu­ally adopted by cen­tral banks, the strict tar­get­ing of broad CPI infla­tion is often the best for domes­tic welfare.

In other words, set­ting mon­e­tary pol­icy on the basis of CPI infla­tion stripped from its com­mod­ity price sub-indices, or tar­get­ing domes­tic pro­ducer infla­tion, is less advis­able. This is so because CPI tar­get­ing strikes a bet­ter bal­ance between sta­bil­is­ing the real exchange rate, which in turn helps sta­bilise domes­tic con­sump­tion, and keep­ing domes­tic pro­ducer infla­tion under con­trol with­out over com­press­ing it.

The rea­son it is desir­able to sta­bilise domes­tic pro­ducer costs (and hence prices) is that not all pro­duc­ers in this small open econ­omy are free to set prices at any moment, which dis­torts rel­a­tive prices across pro­duc­ers, which is sub-optimal. This is more crit­i­cal the more per­sis­tent the food price shocks; and the empir­i­cal evi­dence sug­gests that such shocks are typ­i­cally very persistent.

Com­pletely sta­bil­is­ing domes­tic prices, how­ever, is not desir­able because it robs some lat­i­tude from domes­tic pro­duc­ers, given imper­fect inter­na­tional arbi­trage in goods mar­kets, to raise prices, which will be partly paid for by the for­eign con­sumer. Allow­ing domes­tic prices to be set a bit higher on aver­age as a reac­tion to volatile food prices (and hence to volatile wages and costs), the small-economy pol­i­cy­maker makes more effec­tive use of the so-called “terms of trade externality”.

Finally, as greater real-exchange-rate sta­bil­i­sa­tion also helps sta­bilise the pur­chas­ing power of food-intensive con­sump­tion bas­kets, the dis­trib­u­tive con­se­quences of CPI infla­tion tar­get­ing are less dire than those of pro­ducer price infla­tion tar­get­ing. This is par­tic­u­larly rel­e­vant for coun­tries with highly skewed income dis­tri­b­u­tion and inad­e­quate social safety nets. So, as with some of the lit­er­a­ture on oil price shocks (see e.g. Batini and Terenu 2010; Blan­chard and Gali 2007 and ref­er­ences therein), the above con­sid­er­a­tions make a case for a non-accommodating pol­icy stance toward imported food inflation.

Yet, judged by stan­dard esti­mates of the Tay­lor rule, strict adher­ence to broad CPI tar­get­ing appears to have been the excep­tion and not the rule dur­ing ram­pant food infla­tion in 2007-08. To the best of our knowl­edge, this obser­va­tion has not gained due cur­rency in pol­icy cir­cles and/or among mar­ket observers and, yet, is read­ily apparent.

Table 2 reports regres­sions of the pol­icy inter­est rate on its first-order lag, the HP-filtered out­put (“ygap”), and on cur­rent CPI infla­tion (“CPI inf”). Because cen­tral infla­tion tar­gets move over time in some coun­tries, both the inter­est rate and the infla­tion rate are mea­sured as devi­a­tions from the cen­tral infla­tion tar­get. Finally, the set of explana­tory vari­ables includes the inter­ac­tion of infla­tion with a dummy which equals 1 dur­ing the food price hike of 2007Q1-2008Q3 and zero oth­er­wise. A neg­a­tive coef­fi­cient on this inter­ac­tion term indi­cates that pol­icy rates were set lower in 2007Q1-2008Q3 than they should have been, rel­a­tive to the aver­age reac­tion. That coef­fi­cient is neg­a­tive in all Table 2 coun­tries except New Zealand; it is also sta­tis­ti­cally sig­nif­i­cant at 10% or less in half of them. This is all the more sur­pris­ing in light of evi­dence that food price shocks tend to be highly per­sis­tent and that mon­e­tary pol­icy oper­ates with long lags, par­tic­u­larly in advanced coun­tries. One might expect these two con­sid­er­a­tions to trig­ger a more prompt and aggres­sive response to the 2007-08 hike.

This appar­ent leniency in indi­vid­ual pol­icy responses – at least when mea­sured rel­a­tive to stan­dard Tay­lor rule base­lines – had global impli­ca­tions. World real inter­est rates would oth­er­wise have been higher, which in turn would have helped dampen com­mod­ity prices and pos­si­bly con­tain the widen­ing in global imbal­ances. Higher world inter­est rates at the onset of the cri­sis would also have given cen­tral banks more lat­i­tude for sub­se­quent eas­ing, pos­si­bly obvi­at­ing wide­spread resort to het­ero­dox mea­sures like quan­ti­ta­tive easing.

Pol­icy lessons

Going for­ward, what lessons can we take from this evidence?

• First and fore­most, global food price pres­sures pose a size­able threat to global mon­e­tary stability.
• Sec­ond, they pose an exter­nal­ity prob­lem that demands non-trivial coör­di­nated action by key cen­tral banks.

Left alone, we should fear that coör­di­nated action may come in too lit­tle and too late because the infla­tion spillovers are largely felt first in emerg­ing mar­kets (again, much due to higher food shares in con­sump­tion bas­kets) and because indi­vid­ual advanced soci­eties are bet­ter equipped to with­stand such a price shock at least for a while. So, the asso­ci­ated pol­icy pre­scrip­tion is hardly “one-size-fits all”. These var­i­ous con­sid­er­a­tions sug­gest that strict and wide­spread tar­get­ing of broad CPI infla­tion, while not a sil­ver bul­let, does help.

To be sure, the more aggres­sive inter­est rate reac­tion to imported food infla­tion demanded by broad CPI infla­tion tar­get­ing raises well-known prob­lems of its own for the small open econ­omy, par­tic­u­larly regard­ing cap­i­tal inflows. Stan­dard macro mod­els fea­tur­ing com­plete inter­na­tional cap­i­tal mar­kets and fric­tion­less domes­tic finan­cial inter­me­di­a­tion are ill-suited to address these prob­lems. While devel­op­ments in this area of research are promis­ing, they still fall short of offer­ing clear-cut pre­scrip­tions to pol­icy mak­ers. Absent that, the tar­get­ing of broad CPI infla­tion, when con­sis­tently imple­mented, appears to be a stronger con­tender than other rules in terms of mit­i­gat­ing mon­e­tary pol­icy exter­nal­i­ties on a global basis and help­ing keep global infla­tion­ary pres­sures at bay.

The views expressed in this arti­cle are the sole respon­si­bil­ity of the authors and should not be attrib­uted to the Inter­na­tional Mon­e­tary Fund, its Exec­u­tive Board, or its management.

Ref­er­ences

Batini, Nico­letta and Eugene Tere­anu (2010), “Infla­tion tar­get­ing dur­ing asset and com­mod­ity price booms”, Oxford Review of Eco­nomic Pol­icy, 25:15–35.

Blan­chard, Olivier and Jordi Gali (2007), “The macro­eco­nomic effects of oil shocks: why are the 2000s so dif­fer­ent from the 1970s”, NBER Work­ing Paper13368.

Catão, Luis AV and Roberto Chang (2010), “World food prices and mon­e­tary pol­icy”, NBER Work­ing Paper 16563.

OECD-FAO (2010), Agri­cul­tural Out­look 2010–2019, Paris.

Copy­right © VoxEU.org

Tags: Central Banks, Currency, Economic Recovery, Emerging Markets, Food Price Index, Food prices, Global Economy, Global Food, Headline Inflation, Inflation Cycles, Inflation Outlook, Inflationary Pressures, Labour Markets, Little Hope, Predictive Power, Price Inflation, Setbacks, Silver, Slashes, Staples, Substitutability, Tricky Question
Posted in Energy & Natural Resources, Markets, Oil and Gas, Outlook, Silver | Comments Off