Central Banks Have Shot Their Wad – Why The Casino Is In For A Rude Awakening, Part I – David Stockman’s Contra Corner 07-25-15

Salient to Investors:

David Stockman writes:

The central banks have shot their wad after increasing their aggregate balance sheet from $3 trillion to $22 trillion over the last 15 years, which falsified financial prices.

The coming deflation will bring a plunge in corporate profits and collapsing prices of vastly inflated risk asset classes. The Bloomberg commodity index will fall below the 100 index level as the cycle from asset accumulation and inflation to asset liquidation and deflation continues. The lagged effect of the project completion cycle causes excess capacity to continue to grow, meaning the plunge in commodity and industrial prices and profit margins has only just begun, and will fall for years to come. Production cuts and capacity liquidation in virtually every materials sector is being drastically delayed by the continuing availability of cheap finance, meaning prices and margins will be driven even lower than would otherwise be with excess capacity.

Central banks engineered massive household borrowing and consumption/housing spending in the developed economies which then ignited an export manufacturing boom in China et al which over-taxed the supply of raw materials as the commodity price boom peaked with $150 oil in July 2008. Governments and central banks then battled the plunge in consumer spending and liquidation of bad mortgages, excess inventories and over-stocked labor by triggering a second artificial economic boom in CapEx and infrastructure spending in China and the emerging markets. China’s total debt went from about 150% of its GDP in 2007 to nearly 300% of GDP today.

Central bankers drove interest rates towards zero to try to spur spending by the middle classes, already at peak debt, but instead generated a scramble for yield among money managers and capital outflows of $4-5 trillion into emerging market debt: the resulting tidal wave of capital investment caused a second surge of commodity prices which peaked in 2011-2013. The monetary expansion has left the developed world at peak household debt and the emerging markets drowning in excess capacity to produce commodities and industrial goods.

CapEx by the world’s top 40 miners rose from $18 billion in 2001 to $42 billion by 2008, paused during the financial crisis, and then rose to a peak $130 billion in 2013. New projects then halted, but big projects in the pipeline when commodity prices and profit margins began to roll-over in 2012, are being completed due to the sunk cost syndrome: thus on-line capacity continues to soar despite falling prices.

CapEx on oil and gas rose from $100 billion in 2000 to $400 billion in 2008 and to the peak at $700 billion in 2014. Lifting costs even for shale and tar sands are modest compared to the front-end capital investment so the response of production to plunging prices has been limited and will be substantially prolonged.

Steel capacity has doubled from 1.1 billion tons to over 2.3 billion tons during the past 15 years, far outstripping current demand. Excess capacity could easily reach 35%, or more than the combined steel industry of the US, Europe and Japan.

Thompson Reuters reports global CapEx for manufacturing, transport, construction, process industries and utilities rose from $450 billion in 1991 to $700 billion in 2001, a 4.5% annual rate, and to $2.6 trillion in 2013, a 12% annual rate.

Read the full article at http://davidstockmanscontracorner.com/central-banks-have-shot-their-wad-why-the-casino-is-in-for-a-rude-awakening-part-i/?utm_source=wysija&utm_medium=email&utm_campaign=Mailing+List+Sunday+10+AM

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Commodities Drop Signals Global Growth Concern: Chart of the Day – Bloomberg 09-22-14

Salient to Investors:

  • The slump in commodity prices to a 5-year low signals investors are cautious about the strength of the global economy. Brent crude touched a 2-year low last week and iron ore at Qingdao is the lowest since 2009.
  • Economists expect China to grow 7.4% in 2014, the weakest since 1990.
  • Daniel Briesemann at Commerzbank sees high pessimism among speculative financial investors on commodities.
  • IEA said oil inventories in developed countries probably expanded in August at twice the usual pace for the time of year Morgan Stanley expects supply to beat demand in aluminum to nickel to iron ore in 2014.

Read the full article at http://www.bloomberg.com/news/2014-09-22/commodities-drop-signals-global-growth-concern-chart-of-the-day.html

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The 2014 Contrarian Investment Tour, From Rupees to Copper – Bloomberg 12-10-13

Salient to Investors:

Lewis Braham writes:

Contrarian funds can be a hedge of sorts, though a potentially volatile one as out-of-favor sectors tend to be cyclical and prone to booms and busts. Shorting is inherently dangerous as markets have been trending higher.

Brian Singer at William Blair Macro Allocation Fund said currencies help diversify portfolios because they behave very differently from stocks and bonds. Singer recently put 19 percent of the fund in the Indian rupee which he says is undervalued by as much as 70 percent and India’s new central bank governor has already taken actions to stabilize it by raising interest rates. Singer uses financial derivatives to earn a 6 percent yield on the equivalent of a bank deposit. Individual investors can buy currency CDs – a 3-month FDIC-insured rupee CD from Everbank yields 7.25 percent. Singer is short the iShares Russell 1000 Growth ETF and long the iShares Russell 1000 Value ETF  and says people believe the US is the only source of growth and stability in the world but will be surprised in 2014 at how volatile growth stocks can be.

Don Hodges at the Hodges Pure Contrarian Fund is betting on coal, iron and copper mining stocks and said a recovery in the sector will begin when the Chinese work off their commodity inventories and begin buying again.

Jason Hsu at Research Affiliates said emerging market stocks are at a tremendous discount to US stocks. Hsu said the Shiller PE ratio for the S&P 500 is 24 versus its 16.5 average, versus 13.5 for emerging markets. Hsu is buying TIPS – TIPS with maturities of more than 20 years are yielding 1.5 percent over inflation, and is betting on a decline in large US stocks as well as on improved prospects for high-yield and emerging market bonds.

The BlackRock Municipal Target Term Trust trades at an 11.5 percent discount to portfolio value and yields 6.73 percent on a tax-free basis.

Rudolph Riad-Younes at RSQ International Equity Fund does not like gold because it trades closer to 20 percent above its cost of production versus 10 percent to 15 percent historically, and that cost will fall in the next 5 years, further driving down gold prices.

Read the full article at http://www.bloomberg.com/news/2013-12-10/the-2014-contrarian-investment-tour-from-rupees-to-copper.html

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Our Chat With Jeremy Grantham – The Wall Street Journal 09-20-13

Salient to Investors:

Jeremy Grantham at GMO said:

Commodity prices fell for a hundred years by an average of 70 percent, and then from 2002 basically everything tripled and regained the whole decline in 6 years – tobacco was the only commodity that fell. The game changed because of the ridiculous growth rates in China whose 1.3 billion people use 45 percent of the coal used in the world, 50 percent of all the cement and 40 percent of all the copper.

The most important, valuable and critical commodity is phosphate or phosphorous, which is necessary for all living things. Yet we are mining and depleting it. 85 percent of the low-cost, high-quality phosphorous is in Morocco and belongs to the King of Morocco, and the rest of the world has 50 years of reserve if we don’t grow too fast.

I would own stock in the ground, great resources, reserves of phosphorous, potash, oil, copper, tin, zinc, but aluminum and iron ore less so because there is so much. I would not own coal or tar sands because it is hugely expensive to build coal utilities, and plants for tar sands are massive. So before they get their money back, the price of solar and wind will have come down so much.

The pressures on food are worse than anything else, so invest wisely in very good farmland, though it has had a big run and you can never afford to ignore value. Look for farmland in distinctly stable countries like Australia, New Zealand, Uruguay, Brazil, Canada, and the US. Forestry is a little overpriced but we are in a world where everything is overpriced because of incredibly low interest rates that push people into investing.

A career politician has a very short horizon and is not interested in problems that go out five or 10 years, as are corporations because a dollar in 10 years has a much lower value than a dollar today. The oil industry is making a bundle so does not want to change to a system that recognizes climate change and the need to have a tax on carbon.

With politicians so dependent on campaign contributions from the vested interests, the financial world, but more particularly the energy world, it is a miracle anything gets done.

The central idea in the stock market is patience and value and mean reversion and in society, it is resources and climate damage.

The market can go a lot higher with the Fed pushing it – to yet another real bubble, like the one in 2000 with Greenspan, the housing bubble and financial bubble with Bernanke and Greenspan.

America and Australia are the two very, very optimistic-biased societies. Mention housing bubble to Australians, they hate you for years! Optimism is very useful in enterprise, in start-ups because when the smoke clears, you end up with the Amazons and the Googles – we just throw more darts at the dartboard. But the downside is only 10 percent survive, but they all think they’re going to win.

Read the full article at http://online.wsj.com/news/articles/SB10001424127887323665504579032934293143524

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Jeremy Grantham – Charlie Rose 03-11-13

Salient to Investors:

Jeremy Grantham at Grantham Mayo Van Otterloo says:

The US is muddling through reasonably well in the short-term, but long-term we are in a slowdown unappreciated by most economists – because they are not interested in the long-term.

US growth won’t ever return to previous levels because it is determined by population growth plus productivity. US population growth – a huge component of GDP growth – often hit 1.5% but has now fallen to 0.2%-0.3%. Workers work a little less each year. Women, who hardly worked in 1950s, entering the workforce was a big boost to GDP but their acceleration peaked in 2000 and is now over. We should not expect more than 0.2%  increase in hours offered to the workforce.

Bernanke’s erroneous belief that we can return to 3 percent growth implies productivity will increase by 1% and offset the decline in workplace hours growth, but productivity will continue to decelerate modestly going forward. In the 40 years following WWII, productivity was 1.7%-1.9%, and in the last 30 years was 1.3%. So even assuming we can hold 1.3%, which is optimistic, then adding in 0.2% population growth gets you to 1.5% versus Bernanke’s 3% and the IMF and World Bank’s 2.5%.

Even that 1.5% assumes that an increase in resource cost is a boost to GDP – if you drill a more expensive well then GDP goes up but that cost of resources is a cost of doing business for the rest of the economy. The more people it takes to get one barrel of oil is counted as a contribution to GDP and make the economy look stronger when in actually it is weaker. If you take out the resource component in the last 10 years, the economy grew 0.4%- 0.5%  less than is measured by GDP, thus bringing our 1.5% down to 1%.

The cost of resources declined – the typical commodity dropped by 70 percent – for the 100 years prior to 2000, so GDP was understated by 0.25%.  From 2002-2008 we gave the whole decline back as resources went up more steeply than in WWII – no one talked about it despite overnight running out of cheap resources because of steady population growth and the enormous surge in Chinese demand for resources – growing 10% per year.

China uses 53% of all cement, 47% of all coal, 46% of all iron ore. If China slows to 7% it means 10 years from now we need to find another 47% of coal just for China.

China shifting to a domestic demand economy would be a good engine for economic growth in the US and Europe and Latin America in the short-term, but long-term the problem is that growth is incredibly energy intensive and burning coal and oil has enormous environmental consequences as well as pushes up the price of oil in the short-term. Oil was $25 in 2000 and is $100 today and makes up half the cost structure of producing the other resources – e.g. mining copper combined with lower quality ore means the price of oil is going up . Resource prices are rising faster than global GDP growth.

The carbon math shows global temperatures have increased 0.8 degree centigrade – spring comes 2 weeks earlier. Scientists say 2 degrees is the critical boundary – above that brings dire consequences which will worsen for a long time.  A rise of below 2 degrees means we might limp through. The carbon in our proven reserves is five times that needed to raise global temperatures 2 degrees and guarantee starvation and floods for our grandchildren. We will pump all the easy oil and gas. Pumping tar sands and digging coal is extremely costly and ruinous to the environment – we are racing toward getting rid of the earth’s bio diversity. We have done enough to frighten the Scientists but not the average man in the street. In a real crisis, we will belatedly do something.

Since most of the stock value in oil companies is in their reserves, they have to pump and promote oil.

Oil was $16 a barrel for 100 years until OPEC in 1934, then moved to $35 where it traded for 30 years before moving to $80-85 in the last few years. We are never going back to $35 because the price is cost driven – Shell will tell you it costs $80-85 to find and drill for a barrel of good oil.

There is no substitute for water, soil, potassium and phosphorus. Phosphorus has no substitute and no living thing grows without it, yet we will run out of non-Moroccan reserves in 50 years. Water desperately tries to recycle, but phosphorus stays underground and requires a lot of energy to extract it.

Malthus described the past very accurately. Coal arrived at the time of his treatise and with oil and gas bought us a 250-year timeout with virtually infinite energy – 1 gallon of oil is equivalent to 200 man hours of labor. Science has helped us in this 250 year window but not before that? Coal and oil have given us superman power. Before coal came along, every civilization from Rome to the Mayans collapsed due to their arrogant self-belief and overreach once the weather turned against them.

Every wave of technology has been hugely energy intensive – coal and steam for railroads, oil for cars, energy for refrigerators and air conditioning, and to power iPhones and iPads.

There are 2 gifts that we have that none of the prior civilizations had that might get us off the hook. The first is our dramatically declining fertility rate which has fallen contrary to all predictions – 1.8 children per couple in developed countries. Even Iran has gone from 7 per woman in 1960 to 1.5-1.6 today. The global population has to drop to a level that can be sustained by our reserves of carbon fuel. Science will give us an out if we can maintain  the population decline from 10 billion today to 4 billion in 200 years – very doable – and ensure complete self-sufficiency.

The second gift is alternative energy sources like solar and wind power, and a storage grid system that is happening faster that people realize, all suppressing demand for finite resources.

The rich half of world, including China, is pricing out the poor half. The rich half consumes wheat while the Moroccans, Libyans and Tunisians who live on wheat cannot afford it.

Was able to spot the prior bubbles by focusing on the numbers. Every asset bubble in the financial world has burst. There is enormous pressure in the investment business to deliver good news – stockbrokers, investment houses thrive on it. To talk about gross overpricing and downside risk in asset bubbles is an invitation to get fired because people just don’t want to hear it. Doing so cost my firm half its book of business in the great tech bubble. Being bullish sells but you won’t easily hear honest advice when it is bearish.

The stock market P/E in 1929 of 21 times earnings was exceeded in late 1997 by a market that eventually reached 35 times in March 2000. In the tech bubble most of my investment committee thought we were in a golden new era of tech and that the internet would drive away the dark clouds of ignorance.

Markets can be from time to time become crazily inefficient  because economic theory doesn’t work with humans: like incredibly well-informed buyers know as much as sellers which is complete nonsense. Bernanke has inherited complete academic view that markets are efficient – he did not see the housing bubble in 2007, unlike all of the couple of dozen of newsletter writers,  economists, stock advisors we listen to.

Japan real estate was the biggest bubble in history – land under the Emperor’s palace was worth more than all of California. Right behind was the Japanese stock market bubble which went to 65 times earnings versus the previous record of 25 times.

The statistical definition of a bubble occurs every 44 years in a random world but occurs every 30 years in the real world. Black swans are not as common.

Citigroup was insolvent and should have been allowed to fail in order to show that we would not bail out ludicrous bets.

Investors can make good money in cheap stocks in the long-term. However, while valuations for the great franchise companies like Coca-Cola are a little expensive, the rest of the market is very expensive and assumes profit margins will return to normal. Overseas emerging markets offer better returns.

Currently slightly underweight global equities and heavily underweight US equities excluding the 25% of the market which are great franchise companies.

Bernanke is whipping an economy that can only grow at 1% thinking it can grow at 3%, and does not have the tools to generate employment, which should not even be in their mandate. Creating jobs requires fiscal policy. 74 year-olds should still be working because they are not the 70-year olds of 100 year ago. The unemployed should do useful projects that bring societal benefit, like  installing insulation in cold areas, redoing the grid system.

Debt is vastly exaggerated and we have been conned by the financial world that it is everything. Debt is in the accounting, paper world and distracts us from the real world, which is the quantity and quality of your people , capital spending being inventive, training, education relative to South Koreans. In 1982, total debt was 1.25 times GDP and then it shot up at a a 45 degree angle over the next 30 years to 3.5 times GDP, yet the growth of economy has slowed proving debt doesn’t create long term growth despite Bernanke thinking it does.

Housing explains why this recovery slow – there is nothing more dangerous than messing with housing. Just going back to trend would have tripled oil, triple food, triple copper so don’t need debt.

By keeping interest rates low, the Fed is hurting retirees and transferring money from the poor to the rich, to the banking system, hedge funds, speculators, corporations, who are spending less than at any time in history. It is better to stimulate the economy through government spending than to play games with the monetary system and interest rates and transferring money to people who don’t spend it.

View the full video at http://www.charlierose.com/view/interview/12812

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Best Metals Forecaster Smirk Sees China Recovering: Commodities – Bloomberg 11-14-12

Salient to Investors:

Justin Smirk at Westpac Banking focuses primarily on economic cycles, central banks and financial markets to make commodity predictions. He says:

  • Industrial metals will rally through June 2013 as the economy strengthens in China. China’s economy is at a turning point both for policy and inventories, said
  • We are at the worst for the growth cycle and commodity prices will rise through 2012 and into 2013.
  • Aluminum will rise to $2,380 a metric ton by June because of China’s recovery and central-bank actions in Europe and the US, boosting energy prices, which are 40 percent of smelters’ production costs.
  • Nickel will rise 14 percent to $18,500 a ton, copper as much as 11 percent to $8,500 a ton, zinc gains 7.7 percent to $2,100 a ton
  • See little value in gold so tend to miss the bullish runs, and its price stability is surprising.
  • Iron ore  has seen the worst of the rise in costs, so expect $170 by June.

Barclays  increased estimates for an aluminum glut for 2012 and 2013 said prices will decline. Goldman Sachs is increasingly cautious about copper for the next several months, partly because of record stockpiles in China’s bonded warehouses.

The median analysts expects aluminum to average $2,200 in Q2, copper $8,225, zinc $2,200 and nickel $18,875.

 Barclays estimates China consumes 43 percent of all aluminum, 41 percent of copper, 44 percent of nickel and 43 percent of zinc. Europe consumes 18 percent of all copper and 14 percent of aluminum.

Itay Simkin at Krom River Trading said having an economist on staff is a must.

Read the full article at http://www.bloomberg.com/news/2012-11-14/best-metals-forecaster-smirk-sees-china-recovering-commodities.html

Chanos Sees No Shortage of Overpriced Stocks in U.S. Bull Market – Bloomberg 09-19-12

Salient to Investors:

Jim Chanos at Kynikos Associates says:

  • He expects declines in companies that may be inexpensive compared with earnings, like in natural gas, which have enormous cash needs, and iron-ore producers, where industry capacity will expand globally even as demand stalls because of China’s slowdown
  • A number of high-profile natural gas companies may be in financial difficulty as early as next year.
  • In tech, it’s very difficult to prosper again when you have been leapfrogged.
  • The US economy and banking system is in better shape than others
  • The surprises will be on the positive side in the U.S. market
  • Questions being asked about the Chinese banking system are getting more granular

Read the full article at http://www.bloomberg.com/news/2012-09-19/chanos-sees-no-shortage-of-overpriced-stocks-in-u-s-bull-market.html

China’s $23 Billion Steel Push Seen Igniting Iron Ore – Bloomberg 06-06-12

Salient to Investors:

Bloomberg analyst poll expects iron ore to rise to $152 a metric ton before year end on increased Chinese demand.

Predictions:

Korean analyst says commodity prices are close to a bottom and set to rebound on speculation China will stimulate its economy.

Chinese analyst says Guangdong province needs more than 50 million tons of steel products a year.

Read the full article at http://www.bloomberg.com/news/2012-06-06/china-23-billion-steel-push-seen-igniting-iron-ore-commodities.html