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Wednesday, October 25, 2006
This is a great article countering the commodity skeptics' view that China's growth is "unsustainable."
By David Coffin & Eric Coffin
October 24, 2006
Editorial Comment from the HRA Journal
The reason for this revisit to the “BRIC” story is the enormous amount of press about the “burst bubble” in commodities this month. It’s an important, some might say, critical, topic. How we should act and react in the market is intimately related to the type of market we are in. Viewed in isolation, a bear market rally will look pretty much like a small piece of a bull market rally. But while you might be looking for periods of weakness to accumulate positions in a bull market you’d be much more likely to be watching like a hawk for any weakness as a sell signal in a bear market rally.
Much of chatter recently focused on “unsustainable” growth in China. This is said to prove the point that commodity prices have to fall.
We look at metals and energy commodities as individual cases (and so should you) but some general clarifications have to be made. There is too much erroneous information out there and too many analysts comparing Chinese oranges to North American apples and proclaiming them equal. There are several parts to the bear case and we’ll touch on each briefly:
1) Unusual Length
We find it surprising that this one comes up any more but it does. We won’t know just how long China’s (or India’s or …) secular expansion lasts until it’s come to an end. What we do know is that if it looks like recent periods of above trend growth in the region, namely Japan and South Korea, it will last for at least 25-30 years.
This is not wild eyed optimism. Similar growth periods moving through mass industrialization in both Europe and North America had similar time frames. That is about how long it takes to move to and through the process and to upgrade infrastructure (both public and private) to the level where it becomes sustainable. There is absolutely nothing unusual about the length of the China expansion and we expect the one just starting in India will fit the pattern as well.
2) Unusual Strength
Another common concern is that the growth rates being experienced by China are so high that they must denote an overheating economy. Again, there is no evidence to support the idea that growth rates are unusually high, especially if one lops a percent or two off the “official” numbers, as most observers do.
China’s growth has averaged about 9% over the past 20 years. An impressive number, but not unusual under the circumstances. During their own periods of rapid industrialization and economic development other Asian countries managed the same feat. Japan grew at an annual rate of 8% for 30 years (1950-1980) and Hong Kong and South Korea managed averages of 7.7% and 8.1% respectively for over 35 years from 1960 until 1995. There is nothing “magical” about China’s performance. It is not out of line with its Asian neighbors or, for that matter, with North America during its late 19th - early 20th century industrialization.
3) Zero Sums
Basically, the zero-sum argument holds that any increase in commodity usage is merely a diversion of resources from other countries. In other words, China is acting as a giant assembly line, which is partially true, and most of the “usage” is simply parts and sub assemblies that are moved from other places to be fitted together and shipped out again.
It’s easy to see the political appeal of this theory. Job losses and trade deficits can be blamed on cheap labour and westerners, especially Americans, can smugly assume that any gains made are just accounting fiction that involved some level of cheating.
Whatever the emotional appeal of this theory it doesn’t stand up to close scrutiny. Yes, there is a lot of assembly and remanufacturing going on in China but that is not the main area of commodity consumption. A boat load of DVD players or kid’s shoes does not contain a lot of metal. Power lines, wiring, and sewer pipes do. That is where the bulk of the consumption ends up. It is not substitution; its addition. More to the point, it’s additions to infrastructure and durable goods. It’s not stuff that will get recycled in two years. Economics is not a zero sum game. If it was, all attempts at development and economic betterment would be pointless. And North Americans would still have the living standard of their great great grandparents.
4) It’s inherently unstable
This argument is based on concerns about economic imbalances and overinvestment. It’s another popular one with politicians which usually leads to them blaming the US Current Account deficit on “excess saving” elsewhere on the planet. Excess saving?
Although this argument sounds the silliest it’s ironically closest to the truth. One of the most interesting outcomes of our study of periods of rapid growth was the apparent underlying cause. It’s not some form of selfless Asian togetherness or good karma or a form of government suited to whipping up the populace into a homogeneous production line. It’s savings. Period. High levels of savings were the most consistent predictive data across all the economies that saw extended surges of growth in the past 50 years.
High savings levels that allow for high investment levels at a relatively low cost of capital are the secret to the success of one Asian tiger after another. All of the countries noted earlier in this article have and had extremely high levels of savings in relation to GDP. Most of them range from 30-40%. That’s a level unheard of in the West and it easily explains the high capital formation and enormous levels of investment. Why do they invest so much? Because they can.
It’s All About Savings
Like its predecessors, China has seen surging savings levels in recent years. There was a dip during the Asian Crisis in the late 1990’s but the rate moved back up to the 40% level in the past five years. Based on current rates the strong growth profile of China is expected to continue for some time.
Western economists have warned about these levels. They assume they must be too high and that they imply overinvestment. We see no reason to assume there is less “dumb money” in Asia than anywhere else but, in the end, it doesn’t seem to matter much. China, like the US, has an economy that is efficient (some would say ruthless) about punishing firms that build the wrong things at the wrong time.
The important thing is that the money is there to keep the investment coming. It’s also very important to note that most of the savings are domestic. Yes, China is the poster boy for Foreign Direct Investment (FDI) lately but most of the funds still come from domestic sources or from nearby Asian neighbors.
So far, there is no evidence that savings rates are slackening. Chinese companies are generating profits that can continue the party, though their return on capital is lower than the West. Again, this makes sense. When there are huge pools of money looking for a home those funds have to and are willing to accept a lower return. Its supply and demand. It’s also something we shouldn’t be complaining about. All those “excess savings” help explain the relative popularity of US Treasuries and America’s ability to hold down real interest rates.
One final promising note on savings rates deserves a mention. India, most people’s choice for the next country to see a growth lift off, is seeing its own rapid increase in savings rates. It started much later than China’s but India’s domestic savings rates has moved through 30% in the past year or so. While there are some growth impediments to deal with like an overweening bureaucracy the evidence is that savings alone will ultimately trump this. As with China, India’s growth surge will include intensive commodity usage. Evidence suggests that the savings rate alone is the best predictor and it’s pointing to a longer and stronger boom.
Thursday, October 19, 2006
Here's a great article from Scientific American.com on a Yale study showing there's not enough copper in the world for everyone to enjoy a developed standard of living.
January 17, 2006
Measure of Metal Supply Finds Future Shortage
Copper is used in everything from automobiles to ordnance. Copper allows electricity to be generated, transported and conducted to the various outlets in a modern home. Copper is also relatively scarce compared to other metals like iron or aluminum that make up a good portion of the earth itself. So copper serves as an excellent metallic bellwether for potential future resource scarcity, according to a group of researchers who compiled data on its extraction, use, recycling and discard to estimate whether there is enough copper available to make a developed standard of living available to all the world's people. The short answer is: no.
"We have gathered together the information on these metals that is the stock in use," says team leader Thomas Graedel of Yale University. "This tells you how much copper it really takes to provide electricity, plumbing, road systems. We can say considerably better than people have been able to say in the past how much does it take if the world is going to live like a person from a developed country."
Graedel and his colleagues drew on archaeological, historical and modern data to determine how much new copper has been brought out of the ground and into use as well as how much has been discarded over the course of the 20th century. North America alone mined 164 million metric tons of the reddish-brown metal. Then, based on current discovery rates and existing geologic surveys, the researchers estimated that 1.6 billion metric tons of copper exist that could potentially be brought into use. This figure relies on the broadest possible definition of available copper as well as a lack of energy constraints and environmental concerns. In contrast, the U.S. Geological Survey predicts there is only 950 million metric tons of the metal that could be recovered.
"Certainly every square meter of earth hasn't been dug up but there aren't many places that haven't been investigated pretty thoroughly," Graedel notes. "We're not going to suddenly discover a new continent."
The researchers went on to examine per capita use of copper in the U.S. and other developed countries. While some theorists had predicted that metal use would decline as economies advanced beyond building metallic infrastructure, the teams' data showed that overall copper use in the U.S. climbed to a high of 238 kilograms per person by 1999. Declines in areas like manufacturing and railroads were more than offset by increases in areas like motor vehicles and domestic devices. In fact, residents of Canada, Mexico and the U.S. required an average of 170 kilograms of copper per person. Multiply that by overall population estimates of 10 billion people by 2100 and the world will require 1.7 billion metric tons of copper by that date--more than even the most generous estimate of available resources.
The same dynamic also holds true for other critical metals such as platinum, required for catalytic converters and other pollution control devices, and zinc, used to galvanize steel. While iron, aluminum and other more abundant metals could conceivably be used as substitutes, more research would need to be directed into such technology shifts, the team writes in the paper published online this week in the Proceedings of the National Academy of Sciences. And certainly as much currently processed copper, platinum and zinc should be conserved as possible; the world needs it. "Either the rest of the world can't live like the developed world or we need, as a society, to think more about the technology of providing these services with less intensive use of at least certain materials," Graedel explains. "We need to do a more diligent job of good housekeeping." --David Biello
Tuesday, October 10, 2006
By Steve Saville October 10, 2006
Below is an extract from a commentary posted at www.speculative-investor.com on 8th October 2006.
December copper futures dropped to test support at 320 last week and then reversed upward (see chart below), thus prolonging the consolidation that began in May. The copper chart doesn't look particularly bullish and the next drop to 320 will probably be the one that's followed by a breakdown, but until the breakdown happens there will remain a significant chance that copper will surprise the market by breaking-out to the upside.
The reason we think an upside breakout would surprise the majority of market participants is that the opposite -- a downside breakout -- has been discounted in the share prices of copper producers. Based on current valuations it is clear to us that the stock market is expecting the copper price to drop to the low-to-mid $2 range at some point over the next several months. We've also considered a decline of this nature to be the most likely scenario, but the potential for an upside surprise needs to be taken seriously. This is especially so given that recent stock market strength suggests that we are still at least a few months away from the start of an economic downturn.
With regard to the stock market's economic message, a sizable stock market decline will not necessarily be followed by a substantial slowing of economic growth, but a substantial slowing of economic growth will invariably be preceded by a sizable stock market decline. In other words, as a leading indicator of economic recession the stock market tends to generate many false positives but no false negatives.
But, the conspiracy theorists will say, the strength in the US stock market over the past few months is largely artificial. It is, they claim, mainly the result of the US Administration's efforts to paint an unrealistically rosy picture in the lead-up to the November elections.
This conspiracy theory has many logical flaws, however, one of the most important being that the US stock market's performance over the past several months has been consistent with what's been happening in stock markets throughout the world. To be specific, global stock markets have rallied in synch from their June-July lows with each market's relative strength generally being determined by its level of commodity exposure (in general, the more commodity-oriented a stock market the worse its performance has been since the June-July lows). For example, one of the first stock markets to reach new highs for the year was the commodity-light Hong Kong market.
Another big problem with the above-mentioned conspiracy theory is that a significant driver of the GLOBAL stock market rally has been the relentless decline in the oil price, a decline that has, in turn, been driven by a rise in oil supply relative to oil consumption. That is, the decline has resulted from what's been happening with the supply of and the demand for oil in the spot market, not by what's been happening with oil-related derivatives. Furthermore, the bearish near-term supply/demand situation in the oil market has been exacerbated by the fact that there haven't been any hurricane-related supply disruptions this year. Should we therefore conclude that the US Government has figured out a way of controlling the weather?
Getting back to the base metals, the likelihood of global economic growth remaining fairly strong for another 1-2 quarters is one bullish factor. Another bullish factor is the stubbornly-low levels of metal inventories relative to daily consumption. For example and with reference to the following www.fullermoney.com chart, although the amount of copper stored in LME-approved warehouses has drifted higher over the past year the total copper inventory remains very low by historical standards (the sum total of current LME copper stockpiles is equivalent to less than three days of global consumption). And it's not like the tight supply situation is confined to copper. Lead stockpiles have shrunk to near multi-year lows over the past three months, zinc stockpiles have been trending lower in relentless fashion for almost two years, and nickel remains immersed in a high-profile supply squeeze that has not yet shown any signs of abating.
If copper is going to breakout to the downside (a daily close below 320 in the December contract would constitute such a breakout) then the coming 4-week period probably affords the best opportunity for it to do so. After that we enter the seasonally-strong period for base metals and the shares of base metal producers.
With no major growth downturn looming in the near future, with metal stockpiles low relative to demand and with 'investors' having dumped commodity stocks en masse over the past few months in anticipation of the downturn that has, to date, failed to materialise, the coming seasonally-strong period could be particularly strong.
Thursday, October 05, 2006
By Saijel Kishan
Oct. 5 (Bloomberg) -- The commodities ``supercycle'' isn't over and prices may rise because of production shortages next year, said Morgan Stanley, the world's biggest securities firm by market value.
Global supplies, which are three to five years behind demand, may test record lows in 2007, the New York-based bank wrote in a report today. ``The next leg upward in the commodities cycle'' will happen in the next 12 months, it said.
``The best-ever fundamentals for the sector remain fully in place,'' analysts led by Wiktor Bielski said in the report. ``We believe that we may not yet have seen the highs for commodity prices and therefore the commodities supercycle is just pausing for breath.''
The Reuters/Jefferies CRB commodity Index has slumped 19 percent from its May 11 record, ending a rally in prices that began in 2001, because of concern that rising interest rates and slower global economic growth may curb demand for raw materials.
``We believe these fears are overdone,'' Morgan Stanley said. Consumers in Europe, Japan and other Asian countries will replace the slowdown in U.S. consumer spending, the bank said. An increase in company expenditures and the effects of globalization will limit the slowdown in U.S. housing.
Economic expansion in China, the world's most populous country, a shortage of mining supply and investor demand for commodities will drive prices higher for a ``number of years, although we of course expect pauses and bumps in the road,'' the bank said. Pension and mutual funds have invested $120 billion to $150 billion in commodities, it said.
Morgan Stanley raised its 2007 forecast for average copper prices by 17 percent to $3.50 a pound and $3.15 a pound for this year, compared with its previous 2006 forecast of $2.98 a pound.
The bank also increased its forecast for nickel prices next year by 30 percent to $10.75 a pound. Iron ore prices may rise 15 percent next year, Morgan Stanley said.
The bank cut its forecasts for coking coal, used to make steel, by 9 percent to $105 a metric ton for the Japanese financial year 2007 and 2008.
Morgan Stanley also reduced its forecast for aluminum by 16 percent to $1.05 a pound in 2007, and forecast a ``modest decline'' in steel prices early next year.
Bielski's views on commodities conflicts with those of Morgan Stanley chief economist Stephen Roach, who said last week that a correction in commodities has only just begun. ``As always, there will be fits and starts and possibly some tradable rebounds along the way. But a China slowdown, in conjunction with a downturn in commodity-intensive U.S. homebuilding activity, will challenge the widely held belief in the commodity supercycle,'' he said in an e-mail response to questions.
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