The problem with the financial analysts is not that they cannot make accurate predictions. Seeing into the future is hard, even for me. It’s rather analysts who cannot or will not recognize current conditions, even when they are blatantly obvious. They peddle fantasy, instead.
I receive John Mauldin’s newsletters by e- mail (who doesn’t) and he publishes various interesting reports from financial analysts off the beaten track (you have to pay for them, in other words.) Says John:
Today I am speaking at a local conference here in Dallas for my friends Charles and Louis Gave of GaveKal along with George Friedman of Stratfor, and get to finally meet Anatole Kaletsky. They graciously allowed me to send their latest Five Corners report as this week’s Outside the Box. I find their research to be very thought-provoking as they are one of the main sources of optimism in my ususal readings (except for their very correct and profitable views on the European debt of the PIGS (Portugal, Italy, [Ireland?], Greece and Spain).
The GaveKal team is scattered all over the globe (and based in Hong Kong), and make my paripatetic travel schedule seem small change, not only being in scores of countries but talking to the movers and shakers in both finance and politics. This is an amazing advantage in information gathering. Thus they have a very global view of the world and tend to spot trends before most analysts have picked up on them.
This week’s Five Corners touches on China, the possible change in investment trends as we go into 2010, currencies, thoughts on styles of investing and more, with contributions from a number of their team.
GaveKal examines some of the issues raised by the rolling default taking place in Dubai:
Will The Three Trends of 2009 Prevail in 2010?
GaveKal Five Corners
Looking back at the past year, we can conclude that three inter-related trends have dominated financial markets: 1) an impressive weakness in the US$, 2) a significant rally in commodities, and 3) a pronounced out-performance of emerging markets, including Asia. Today, these three trends appear to be running out of steam: the US$ has been rallying, commodities have rolled over and, in November, for the first time in what feels like an eternity, the US MSCI actually out-performed all other countries in the World MSCI index. For us, this begs the question of whether the trends of 2010 will prove different to those of 2009? And the answer to that question may be found in the most unlikely of places, namely the Middle-East.
The news that a Dubai World unit would be suspending payments to creditors, was promptly followed by the rumor that two defaulted Saudi groups (the Saad group and the Ahab group) were treating their domestic creditors differently than foreign banks. From our standpoint in Hong Kong, all these bleak headlines lead us to ponder how the Middle East could find itself in this tight spot? After all, who, a decade ago, would have bet on Dubai (soon to be followed by Venezuela?) going bust with oil at US$80/bbl?
Of course, the apparent squeeze may be nothing more than a few bad apples that blatantly mismanaged their liabilities and blew up their balance sheets. But we have to admit that we are also intrigued by the recent announcements that some of the region’s sovereign wealth funds (Qatar, Kuwait…) have lately been selling the large stakes they acquired in Western financials at the beginning of last year’s financial crisis. Of course, these disposals may be the result of a deep relief that the banks are back above their purchase price and, like a money manager who has just been on a gut-wrenching ride, the SWF are happy to turn the page and put this episode behind them. Or perhaps, the sales are an indication that the Middle East needs US$ right now and that we are now confronting some kind of squeeze on the US$.
Thus, the recent strength in the US$ may be highlighting that we are experiencing an important change in the investment environment. Indeed, at the risk of making a mountain out of sand-dune, we believe that one thing is for sure: recent developments in Saudi and Dubai will most likely give pause to foreign banks looking to expand their lending operations in that region. And if financing for projects becomes more challenging, then this raises the question of whether the Middle East will look to pump more oil in a bid to generate the revenue necessary to keep the wheels churning? Could an unfolding financial squeeze in the Middle-East lead to the kind of massive cheating on OPEC quotas that we witnessed in the 1980s?
Of course, a proper financial squeeze in the Middle-East, one that triggered a US$ rally and lower oil prices, would de facto justify the Fed’s decision to keep interest rates low for a long time. With lower oil would come lower inflation expectations, while a higher US$ would help keep the US economy from overheating under the twin stimulus of lower oil and low interest rates. But where would all this leave other emerging markets, most specifically Asian equities which have soared in the past year?
The margin on oil extracted may not allow the kinds of cash flow that countries like Venezuela require. “After all, who, a decade ago, would have bet on Dubai (soon to be followed by Venezuela?) going bust with oil at US$80/bbl?” suggests that all $80 goes into Venezuela’s pocket, rather a large percentage of each barrel must be used to extract the next barrel. Also, Dubai has meager oil reserves, it has acted as the UAE and other OPEC nations’ money laundry.
GaveKal acknowledges a dollar shortage; “Or perhaps, the sales are an indication that the Middle East needs US$ right now and that we are now confronting some kind of squeeze on the US$.” The trend mentioned a few days ago has been an expansion of dollar credit alongside the shrinkage of cash dollars. Dubai is a Middle Eastern manifestation of this trend.
GaveKal asks, “Could an unfolding financial squeeze in the Middle-East lead to the kind of massive cheating on OPEC quotas that we witnessed in the 1980s?” No. OPEC earns more of a return from higher prices than it can on higher volume. In ‘The House of Cards Collapses More’ I suggest that:
Should the Saudis require more cash, the impulse will be to allow prices to rise past $80, decoupling the oil/dollar peg. While this would increase nominal dollar flows, the value of the flows would not increase as this would be a part of overall dollar devaluation which has been ongoing for most of this year. Oil prices would jump along with the dollar- inflated values of other financial assets such as stocks and non- oil commodities. The petro- dependent economy will have a convulsion.
Saudia can let prices rise by temporarily shutting in some production. On the other hand, an increase in oil production would have little effect on the real price of oil which is demand dependent. Witness the price decline and recovery which took place earlier this year; the lower price stimulated demand which quickly bid up the price. Oil prices at -$35 coincided with the world’s economic ‘green shoots’ period. The resulting increase in activity amplified oil demand. Whatever OPEC can produce now can be consumed. Current spare capacity – when added to current production – is less in total than world production of a few years ago.
Demand has increased during that same period, only the money available to satisfy demand has declined.
The real, as opposed to nominal price is a powerful incentive to keep production under check. This leaves aside the issue of production constraints. The depletion landscape has changed since 1998. Many countries are producing as much as possible, this has little effect on price. Saudia has gained control of OPEC decision making. They have spare capacity, the rest of OPEC doesn’t. Saudia can let the others pump their fields empty. Doing so cannot effect prices significantly. OPEC’s oil has much greater money value than does the defaulting finance toys that OPEC has imported to entertain itself. OPEC is a monopoly. There are insufficient non- OPEC reserves to push onto the oil markets and effect prices in a meaningful way.
GaveKal recognizes the Niewe Hard Dollar relative to oil, but gets their takeaway is puzzling. The idea that low nominal energy prices, “would de facto justify the Fed’s decision to keep interest rates low for a long time “ suggests that low oil prices are a result of economic disorder sufficient to destroy oil demand. Maybe this is so. There certainly isn’t anything economically bullish about declining oil prices any more than high oil prices. Declining prices suggest the next leg of credit deleveraging has begun.
Rising oil prices alongside other commodities would reflect the success of Ben Bernanke’s ‘Zero Dollar’ strategy. Instead, the Fed has lost the power to control its own destiny; its strategy to bluff dollar inflation has failed. Wall Street finance is flooding the world with dollar denominated credit; Bernanke suggests that this is all real money. Ali al- Naimi has simply called the Fed’s bluff. After all, he has oil, Bernanke has nothing.
Dollar long is shorting the Fed, pure and simple. You have to know that ‘The Dudes’; Bernanke, Geithner and Obama are going to screw up.
While the dollar is now super- hard, a ‘low oil price’ will be a nominal, only. The real oil price – along with real interest rates – is excruciatingly high. These high costs are ripping through the world’s economies, repricing investments that require low real- priced inputs. GaveKal fails to see forests through trees:
GaveKal Published: June 08 2006
The Bullish Growth in China’s Road Infrastructure
By Louis-Vincent GaveLast year, we entered into a partnership with Dragonomics, a Beijing based, China dedicated research firm. Dragonomics (www.dragonomics.net) produces a very thorough review of China every quarter. In the review published last week, Tom Miller dwells on what we believe is a very important them: the impressive highway construction program currently occurring in China. The construction of roads in China is not dissimilar to what the US undertook in the 1950s and it is an important structural force for growth.
One would certainly have had to pay quite a bit of money to receive the rest of this nonsense, which applauded the Chinese government for embracing the US development model just as that model headed over the cliff. Every inch of new road subtracts from the energy cost advantage China enjoys over the rest of the world. Too bad the Chinese didn’t expand rail transport and forget the road building. As the Chinese are cursed to have to live through their Wall Street advisors’ terrible advice, the new and heartbreaking reality emerges. (This is from the BBC):
Tough 2010 Irish budget unveiled
Brian Lenihan: “We’ve had to make some very tough choices”
The Irish government has unveiled one of the most severe budgets in the Republic’s history. Finance Minister Brian Lenihan announced pay cuts for public sector workers, as part of efforts to achieve savings of 4bn euros ($5.9bn; £3.6bn). Taoiseach (Irish Prime Minister) Brian Cowen will have his pay reduced by 20%. “Those at the top will lead by example,” Mr Lenihan said.
The Irish economy will shrink by 1.25% in 2010, he forecast. He had previously estimated a contraction of 1.5%. The economy is expected to shrink by 7.5% this year, confirming a previous reading.
“Our economy is still in a weakened condition, and our self confidence as a nation has been shaken,” Mr Lenihan said. “The government’s strategy over the last 18 months is working and we can now see the first signs of a recovery here at home and in our main international markets.”
Richard Bruton, finance spokesman for the opposition Fine Gael party, called the budget “jobless and joyless”. He added that the proposed cut in the Taoiseach’s pay was “simply a sham” and did not take into account previous adjustments. The real cut was much lower than 20%, he said.
Mr Lenihan announced savings in 2010 of:
• 1bn euros on the public sector pay bill. Public servants will face pay cuts, ranging from 5% on those earning 30,000 euros to 15% on those earning more than 200,000 euros
• 760m euros on social welfare
• 980m euros on day-to-day spending programmes
• 960m euros on investment projects.
But he said the pay cuts in the public sector would not apply to existing public service pensioners. He also reduced the rates of child benefit by 16 euros per month, bringing the lower rate to 150 euros per month and the higher rate to 187 euros per month.
And he introduced a carbon tax, equivalent to 15 euros per tonne.
Shapes of things to come as deflation tightens its grip. Unfortunately, Ireland is leading all the world’s other governments which will soon face equal austerity pressures. The world will have to cut back to bring its accounts – energy and financial – into balance. One way or the other, this is going to happen, whether anyone in finance or out likes it or not.