Monday, August 31, 2009
JNK & LQD update
Sunday, August 30, 2009
Copper and BHP
The crux of our pitch was that with World GDP growth expected to fall towards 2%, metals prices were going to take a hit. Following is a chart of GDP and copper prices since 1990 (source: IMF):
See the Asian crisis? It’s easy to miss given the more recent gyrations. It begs the question – how can copper prices (and commodity prices generally) continue to levitate at current levels in the face of such widespread demand destruction?
Now clearly the world has changed a great deal since the Asian crisis. The desperately low copper prices of the late 90’s and early noughties were the catalyst for consolidation and restructuring on the production side of the ledger. Producers now have greater pricing power. On the consumer side, the emergence of China into full throttle industrialisation logically puts a flaw under medium term demand. BHP sees China doubling its annual demand from current levels by 2025.
To get a sense of the demand and supply equation consider the following table:
There are a couple of things that jump out from this breakdown. The first being the absolute dominance of China, the second being that ‘high income’ countries (to use IMF vernacular) in aggregate remain significant to world demand.
Which leads to the obvious question – if there was a surplus in 2008, then what happens in 2009 when world GDP really falls off the edge (annualised Q1 GDP in US down 6.4%, Germany down 6.7%, Japan down 14.2%). Even if GDP has stabilised and (just maybe) begun to recover in the second half, it is now coming from a low base. Think we can reasonably expect the copper surplus to persist this year.
And going forward into 2010, even if China’s physical demand were to level out at a higher level (say 2 million tonnes per annum) if world GDP grows by 1% YOY after dropping 2.5% the year before, then there’s a reasonable chance that there will be a surplus for that calendar year as well.
So it’s a fair probability that for at least the short to medium term, physical demand for copper will be outstripped by supply.
How then can commodity prices be trading at their current levels? It’s not because the cost of production demands it (witness BHP’s current EBIT margins at around 40%, nearly double that of the dark days of the Asia crisis). Or put another way, who has been the marginal buyer pushing up prices beyond the physical demand for the metal. The answer not unexpectedly is China. The following chart of refined copper imports in China illustrates the point. (Source: China Customs Office)
Impressive isn’t it. The fact is China has been sucking in copper above and beyond its current needs. Macquarie estimates as much as 400,000 tonnes have been stockpiled in the first half. While there have been reports that China has bought 235,000 tonnes for its strategic reserves.
So will stockpiling continue?
As with all things China it is hard to get definitive, but a couple of arguments would suggest not.
Firstly, logic would suggest China does not need to chase the price higher. The whole point about building strategic reserves in a very weak market is to facilitate management of supply when demand picks up. With around 40% of their annual import requirements covered by stockpiles, China’s consumers can afford to be a little less hasty in bidding for supplies even if they are for additional reserves.
Secondly, indications are that liquidity is being reined in. Statements about the reclassification of sub-debt in relation to bank reserves and about how the proceeds of loans should be applied suggest anecdotally (if not in substance) that the Party is concerned about liquidity-fuelled speculation. The fall in new lending in July mirrors the decline in copper imports. Early indications are that liquidity and its handmaidens, greed and lust, are on the wane.
To BHP then – what is its valuation looking like with the share price over $37? Consensus forecasts look something like:
The commodity assumptions underlying these earnings are many and varied depending upon the broker. But as a generalisation on a straw poll, they are pretty much extrapolations of current prices continuing to strengthen from here (UBS for example has forecasts for copper of 223 cents per pound for FY2010 and 255 cents in FY011 - compared to a realised price of 224 cents in FY2009).
In short, I’d class the current valuation as pretty rich. While the long term Chindia industrialisation story remains favourable, as with all things, this fundamental outlook should be risk weighted to reflect the many uncertainties in our world. At 15x to 20x earnings, and on the basis that these earnings are calculated using favourable commodity prices, there is not much room for error (or upside).
On the other hand, maybe we are living on the verge of an inflationary world where the USD will plummet, commodity prices will soar, and China will lead us into another era of excess and fine dining. Maybe…
Wednesday, August 26, 2009
Signs of retail capitulation
Reflections of a credit junkie
Tuesday, August 25, 2009
Marc Faber - extending the liquidity thesis
Monday, August 24, 2009
LQD - same non-confirmation
JNK - a leading indicator?
Sunday, August 23, 2009
Don't stray too far from the fallout shelter
Wednesday, August 19, 2009
Conspiracy theory of the day - manufacturing dollar's decline
A short story
- Artificial rally - the rally has been built out of an abundance of liquidity, it doesn't have the strength of the consumer behind it (they are too busy paying down debt, defaulting on their mortgage or worrying about their retirement nest-egg). - (see earlier blog or, for views on the US consumer, Mish regularly covers the data points in detail)
- China's stockmarket, the world's saviour, has turned (see Kevins market blog)
- Sentiment is at extremes - measures are contrarian bearish reflecting the speed of the rally that we have enjoyed. (see Trader Narrative, the Technical Take, and Humble Student of the Markets)
- Quality of the rally has been dubious - the periphery has outperformed, it's a carry trade where equities have been bid up on the back of credit spreads (see Zero Hedge and Crossing Wall Street)
- Smart money is selling - Insiders are selling as quick as they can - the fundamentals don't support the price (see Financial Sense and Crossing Wall Street). And we can expect the hedge fund pack to follow Einhorn's lead (see Market Folly). If private equity are licking their chops on an exit (I hear that Myers is up for sale if you are keen), then the smart money is of the view that current prices are the best they are going to get.
- Earnings - have rebounded on the back of cost-cutting and inventory rebuild, that doesn't leave much room for improvement from here without the consumer coming to the party.
- Technicals are turning down (for example have a look at Afraid to Trade)
- Renewed mortgage stress - prepare for another round of foreclosures and bank failures (have a peek again at Mish and the Evil Speculator has a good take on how this effects the market and finally don't think it's purely a US phenomenom - see a Fistful of Euros)
- Finally we haven't had a 'revulsion' phase - a debt infused bull market of epic proportions deserves an equally an equally large bear market which ends when the last punter has given up the ghost.
Monday, August 17, 2009
Under the pump - close-out QBE
Essential qualities of a speculator
Via the Tischendorf Letter...
Dickson G. Watts was the president of the New York Cotton Exchange from 1878 to 1880. His list of ‘Essential Qualities of the Speculator’ and ‘Laws Absolute” show the timeless value of his insight:
1. Self-Reliance. A man must think for himself, must follow his own convictions. George MacDonald says: “A man cannot have another man’s ideas any more than he can another man’s soul or another man’s body.” Self-trust is the foundation of successful effort.
2. Judgment. That equipoise, that nice adjustment of the faculties one to the other, which is called good judgment, is an essential to the speculator.
3. Courage. That is, confidence to act on the decisions of the mind. In speculation there is value in Mirabeau’s dictum: “Be bold, still be bold; always be bold.”
4. Prudence. The power of measuring the danger, together with a certain alertness and watchfulness, is very important. There should be a balance of these two, Prudence and Courage; Prudence in contemplation, Courage in execution. Lord Bacon says: “In meditation all dangers should be seen; in execution one, unless very formidable.” Connected with these qualities, properly an outgrowth of them, is a third, viz: promptness. The mind convinced, the act should follow. In the words of Macbeth; “Henceforth the very firstlings of my heart shall be the firstlings of my hand.” Think, act, promptly.
5. Pliability. The ability to change an opinion, the power of revision. “He who observes,” says Emerson, “and observes again, is always formidable.” The qualifications named are necessary to the makeup of a speculator, but they must be in well-balanced combination. A deficiency or an overplus of one quality will destroy the effectiveness of all. The possession of such faculties, in a proper adjustment is, of course, uncommon. In speculation, as in life, few succeed, many fail.
These are his ‘Laws Absolute’:
1. Never Overtrade. To take an interest larger than the capital justifies is to invite disaster. With such an interest a fluctuation in the market unnerves the operator, and his judgment becomes worthless.
2. Never “Double Up”; that is, never completely and at once reverse a position. Being “long,” for instance, do not “sell out” and go as much “short.” This may occasionally succeed, but is very hazardous, for should the market begin again to advance, the mind reverts to its original opinion and the speculator “covers up” and “goes long” again. Should this last change be wrong, complete demoralization ensues. The change in the original position should have been made moderately, cautiously, thus keeping the judgment clear and preserving the balance of the mind.
3. “Run Quickly,” or not at all; that is to say, act promptly at the first approach of danger, but failing to do this until others see the danger, hold on or close out part of the “interest.”
4. Another rule is, when doubtful, reduce the amount of the interest; for either the mind is not satisfied with the position taken, or the interest is too large for safety. One man told another that he could not sleep on account of his position in the market; his friend judiciously and laconically replied: “Sell down to a sleeping point.”
Friday, August 14, 2009
How the Fed is feeding the frenzy
Tuesday, August 11, 2009
CEU traffic update and other buys
Sunday, August 9, 2009
Finding time...
Friday, August 7, 2009
Moving on for greener pastures
Thursday, August 6, 2009
Wednesday, August 5, 2009
The Tao of PazzoMundo
XJO turning down?
Don't want to get ahead of myself here, but the market is looking a little toppy...target 4160.