Friday, February 25, 2011

The Economic Recovery that Never Was

It is my belief that as the headlines continue to roll in about fiscal woes from sea to shining sea that we are going to get a full appreciation for the fraud that has been perpetrated on the American people in the form of the ‘economic recovery’ that the media has been stumping for since the middle of 2009. This ‘wag the dog’ type undertaking has been about confidence, perceptions, and little else. Absolutely, there are pockets of the nation where people have found work. After all, when your government dumps nearly a trillion dollars into the economy it is going to have SOME effect. Our goal from the beginning of these hyperstimulation maneuvers was to point out the unsustainability of this course of action and more importantly to predict the consequences thereof. 

Is .4% really that big of a deal?

This morning, the Commerce Department revised its GDP estimate for the fourth quarter of 2010 by .4% to the downside. That in and of itself is certainly not newsworthy, but the reasons given for the downward revision most certainly are. For the first time in quite a while, the government and the media are actually allowing the light of truth to shine into government reporting. One of the biggest reasons (which has been included in many headlines) is that cuts in state government spending are largely responsible for the cut in GDP. So what, that is common sense isn’t it? It will be, but let’s analyze. I’ve talked many times about how GDP numbers have been overstated because they included government spending that comes from borrowed money. While those discussions generally focused on the federal government, this includes the states too. The states issue debt in the form of general obligation and specific bonds to do much of their spending since they, like the federal government, are largely insolvent. This spent borrowed money counts in GDP the same as a dollar spent that had been kept in savings. The thesis proposed months ago was a simple one; the states are going into extremis and when they do, down goes GDP. Double that for the federal government.

This is one of the biggest reasons that no one in Washington really wants to cut government spending, putting the rhetoric aside. They all know that if they were to cut a trillion dollars from the federal budget that GDP would fall by around 1/14th and we’d have an instant depression. Yet at the same time, a trillion dollar cut in spending is exactly what needs to happen along with a bevy of program reforms; and that is just for starters. Hopefully this gives you a better appreciation of the predicament we’re in as a nation. This is one of the reasons I think politicians are taking up the stance that they agree cuts need to be made, but can’t agree on which ones. This will give them all political cover to maintain the status quo thereby cutting essentially nothing, while making much in the way of fanfare over insignificant token cuts. The idea of shutting down the government and its massive entitlement system has already been floated to scare people into pressuring their leaders into maintaining the status quo. Stay tuned; it gets better.

Chaste Consumers?

Consumers also did not escape blame for the lack of more vigorous ‘growth’. Spending had originally been thought to have increased at a 4.4% annualized rate. It turns out spending likely only increased at 4.1%.  Bad consumers! From our good friend Jeannine at AP:

“Consumers spent a little less than first thought. Their spending rose at a rate of 4.1 percent, slightly smaller than the initial estimate of 4.4 percent. Still, it was the best showing since 2006. And it suggests Americans will play a larger role this year in helping the economy grow, especially with more money from a Social Security tax cut.”

Talk about opinion shaping. This should be another indicator that nobody is really intent on fixing anything. While I am all in favor of a tax cut, one without reform seems rather obtuse, especially given the fact that Social Security is already in the red and busted out beyond description in terms of its unfunded promises. The program needs a massive overhaul, not insipid palliatives.

What cannot be left alone in the above press line is the suggestion that consumers are going to lift the economy in such a Herculean manner. First of all, let’s get it straight that much of the ‘gain’ in consumer spending (as measured by retail sales) came from the fact that consumers are paying more for food and gasoline and, sadly, have increased their debt burdens slightly to do so. More unsustainability.

To demonstrate this, I’ll show a couple of charts; the first is the slight, but significant increase in consumer credit followed by the steady increases in both food and energy prices throughout all of 2010:

Now let’s get a better idea of where at least a portion of those borrowed dollars went – first food and beverage prices:

Now, for energy…

Consumers paying more for staple goods doesn’t constitute economic growth, yet this is exactly what the Keynesian deficit-lovers would have you believe. And we know the CPI is in most cases grossly understating the real increases, but at least you now have a visualization of the issue. It may very well be that this next boom in consumer indebtedness comes more from necessity rather than greed and avarice. With the labor market still incredibly soft, and thousands of discouraged workers falling out of the BLS counts each month, the credit card is the only place many people will be able to fill the gap. 

Further anecdotal evidence that supports the notion that this ‘recovery’ was nearly entirely a contrived event (thanks to borrowed government money and increasing prices of finished goods) is the housing market. Home prices have continued to drop despite the frantic calls of ‘bottom’ from market analysts, hopeful professional associations like NAR, and the mainstream press. Foreclosures continue to mount and even CNBC got on the bandwagon a few weeks back reporting that around 11% of all homes in the US are now sitting empty. A genuine bottom up fix would have corrected many of these problems. Spending a trillion dollars to rebuild our manufacturing base would have created jobs beyond those necessary to do the building. It would have employed people on an ongoing basis, miraculously converting bad debts into good ones. Instead we chose to do a top-down fix, lavishing trillions of dollars on banks, brokerages, and lobbyists in the hope that a few bucks might find their way to Joe Q. Public. It reeks of too much textbook and too little practicality.

The recovery that never was is over. Continuation of the current state of affairs will result in further debt accumulation by a system that is ready to disintegrate on its own weight. Assuming the consumer can step in and spend up where even state governments leave off is an absurd idea. Assuming they can fill the black hole left by a gutted and fiscally impotent federal government is laughable.

Top 12 Countries at Extreme Risk of Economic Collapse

Risk analysis firm Maplecroft just released its new fiscal risk index ranking of 163 countries. Europe trumps all other regions with 11 out of twelve courtiers rated as "extreme risk." However, quite surprisingly, only one PIIGS country--Italy which takes the top spot--is in the top 12.

The others include many big economies in Europe - Belgium (2), France (3), Sweden (4), Germany (5), Hungary (6), Denmark (7), Austria (8), United Kingdom (10), Finland (11) and Greece (12). Japan at No. 9 is the only other country not in Europe within the highest risk category (See map below).

Aging Demographics

While high national debt and public spending are two common denominators, the study finds it is the aging demographic that puts these countries at extreme fiscal risk. An aging population will place increasing pressure on public expenditure such as pension and health care, while a shrinking working-age population means less productivity and less tax revenues to support public spending and debt payments.

High Dependency Ratio

Aging population also means high dependency ratio, or the number of people 65 and older to every 100 people of traditional working ages. For example, according to Maplecroft, the dependency ratio in France is 1 to 47 (i.e. 47%), Germany at 59%, Italy with 62%, and Japan at the very top with 74%, while the ratio in UK is currently 25%, and is forecast to rise to 38% by 2050.

Source: Maplecroft

Low Senior Labor Participation Rate

Another problem within Europe is that it has the low labor participation rate in the 65+ age bracket. In fact, the labor market participation of age 65+ amongst the ‘extreme risk’ nations range from 1.4% in France, 7.71% in UK, to 11.7% in Sweden, vs. a 28% average across all countries ranked in the index.

Maplecroft cited pensions and discrimination as two examples that would push people away from the work force. 

U.S. – High Fiscal Risk

Although the United States is not ranked among the "extreme fiscal risk," the nation is nevertheless classified as high risk, along with Spain, another PIIGS country, Turkey, Iraq, Australia, Canada and Russia.

Let's take a look at the two metrics mentioned here.

The dependency ratio in the U.S. is 22 in 2010, but is projected to climb rapidly to 35 in 2030, according to the U.S. Census Bureau, mainly due to baby boomers moving up into the 65+ age bracket. The ratio then will rise more slowly to 37 in 2050.

The labor participation for age 65 and over in the U.S. is at 17.5 according to data at Bureau of Labor Statistics (BLS). This is better than most of the European countries, but below the overall average of 28%.

U.S. in Wave 2

Most people typically associate a country’s fiscal risk to its government’s monetary and fiscal policies, and Lehman Brothers has taught us that banking and housing crisis could push the entire world into the Great Recession.

While these are all definite risk factors, a highly productive labor force and relatively young population makeup tend ensure more sustainable prosperity and better odds at digging out of a hole.

The Maplecroft study concludes:

" high risk countries, it is increasingly likely that the private sector will be called upon to contribute in the form of pensions and private health care.... Without significant adjustments, such as raising taxes or reducing spending, countries risk going bankrupt."
So, while Europe is being forced to do all that amid sovereign debt crisis in the middle of widespread protests over raised pension age and austerity measures, the U.S. and other "high fiscal risk” countries seem be set up as the wave 2 of this global fiscal chain of events.

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World Economy Returns to Pre Financial Crisis Levels

By: Pravda

The year 2010 ended with considerable growths in the volumes of global trade. This index reached the pre-crisis level in December. The volume of trade increased by 15.1 percent during the year. The world economy demonstrated a stable improvement after the critical year of 2009, when the volume of global trade dropped by 13 percent. The commodity circulation is expected to increase as well, experts believe.

The lengthy recession in the world economy was directly connected with the economic crisis. The GDP in many countries began to decline, which made many economies refuse from many goods. The recession triggered a considerable reduction of prices on raw materials, Rosbalt reports.

According to the Russian Statistics Agency, Russia's foreign trade turnover during the critical year made up $495.8 billion, having dropped by 35.1 percent in comparison with the previous year. The commodity circulation in the US-Russian trade made up a bit more tan $23.6 billion, which was as much as 35 percent lower than in the previous year ($36 billion). The reduction in trade was based on the consequences of the global economic crisis.

Stats speak for themselves. The US exports in Russia in 2009 made up nearly $5.4 billion, whereas the imports amounted to $18.2 billion. Therefore, the positive trade balance for Russia exceeded $12.8 billion. A year before, the balance was $4.6 billion higher. As for specific positions, the Americans cut the imports of Russian fuel and lubricating materials - down to $13 billion vs. $17 billion a year before. They also halved the imports of metals and chemical goods (from $5.4 to $2.6 billion and from $2.95 to $1.4 billion respectively).

The crisis of the year 2009 touched upon absolutely all countries of the world. Exports of the European Union dropped by 16 percent, whereas imports declined by 23 percent. Exports from Europe's largest economy, Germany, experienced a record decline since 1950 as they dropped by 18.4 percent. As of the end of 2009, Germany gave up its status of the world's largest exporter to China. Chinese exports reduced as well - by 17 percent. WTO experts came to conclusion that the volumes of global trade reduced by 12 percent, which was the largest reduction since 1945.

Pascal Lamy, the leader of the World Trade Organization, stated in July that the volume of global trade in 2010 may increase by 9.5 percent.

"We see the light at the end of the tunnel and trade promises to be an important part of the recovery. But we must avoid derailing any economic revival through protectionism," he said.

The state of affairs was getting better and better, and the World Trade Organization increased its forecast on the growth of international commodity circulation up to ten percent. The WTO originally predicted that the index would grow by only 5.8 percent, reports.

World cotton stocks to rebuild as use lags - USDA


Cotton consumption will in 2011-12, for a second successive season, break with history and fall behind world economic growth, US officials forecast, as a broker cautioned that the fibre's rally may be past its peak.
Global cotton use will expand by 3.0% in 2011-12, lagging economic growth, which is expected to reach 4-5% in 2012 for a third successive calendar year, US Department of Agriculture economist James Johnson said.
Traditionally, the figures have moved in step, a reflection of cotton's use in clothing, largely an item of choice, rather than in food, like other farm commodities.
Indeed, in the five years before the world recession the world economy expanded by 4.6% a year, and cotton consumption by 4.7%.
However, next season, the tie will be broken by mills' enthusiasm to rebuild inventories depleted by the shortfall in supplies this season, and a slowdown in clothing demand as soaring cotton prices, which hit a record earlier this month, feed through to retailers.
Stocks to recover 
"Consumption levels will continue to be affected by supply limitations, a lagged response to the current record prices, and industry desire to hold more stocks," USDA economist James Johnson said.
USDA view of world cotton, 2011-12 and (year-on-year change)
Production: 127.5m bales, (+10.6%)
Consumption: 120.0m bales, (+3.0%)
Exports/imports: 42.0m bales, (+10.2%)
Year-end stocks: 50.3m bales, (+17.5%)
Stocks-to-use: 41.9%, (+5.2 points)
Cotlook A: 135 cents per pound, (-23%)
High prices will also provoke a continued shift demand to polyester, which is roughly twice as cheap compared with cotton as it was five years ago.
The consumption lag, coupled with the prospect of a cotton values inspiring a strong rebound in production, will enable world inventories to jump by 17.5% to 50.3m bales.
At this level, stocks would represent 42% of consumption, a large rise on this season's 32% figure, but "low relative to the recent average", Mr Johnson told the USDA Outlook Forum.
The stocks-to-use ratio, a widely used metric for gauging the availability of a crop and therefore its pricing potential, suggested a drop in values, as measured by the Cotlook A index from an average of 175 cents a pound in 2010-11 to 1.35 cents a pound next season.
The index stood at 209.30 cents a pound on Friday, down 6.45 cents on the day, and below a record high hit earlier this month.
Highs behind us? 
And cotton prices may fail to revisit their highs, if falling prices encourage farmers, who have been stockpiling the fibre in the hope of selling out at the top, to cash in, Rabobank analysts said.
"The possibility exists that the declining values actually encourage selling by producers who are worried about further price weakness," the bank said.
"A surge in selling along with likely bullish indications of large northern hemisphere plantings may mean that, without a disruption in production, values may find it difficult to revisit the recent highs."
Nonetheless, the fibre was set to find support from bargain-hunting speculators, and from trade buyers, "once it looks like prices have bottomed out".
And with supplies thin until the next harvests are in the bag, "volatility and sharp moves are likely to continue over the coming months".
In New York, cotton for March delivery gained 2.2% to 185.34 cents a pound, looking for its first rise in five trading days.
The better-traded May lot was 1.9% up at 180.52 cents a pound.
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Rich Man, Poor Man (The Power of Compounding)

by Richard Russell

MAKING MONEY: The most popular piece I’ve published in 40 years of writing these Letters was entitled, “Rich Man, Poor Man.” I have had dozens of requests to run this piece again or for permission to reprint it for various business organizations.

Making money entails a lot more than predicting which way the stock or bond markets are heading or trying to figure which stock or fund will double over the next few years. For the great majority of investors, making money requires a plan, self-discipline and desire. I say, “for the great majority of people” because if you’re a Steven Spielberg or a Bill Gates you don’t have to know about the Dow or the markets or about yields or price/earnings ratios. You’re a phenomenon in your own field, and you’re going to make big money as a by-product of your talent and ability. But this kind of genius is rare.

For the average investor, you and me, we’re not geniuses so we have to have a financial plan. In view of this, I offer below a few items that we must be aware of if we are serious about making money.

Rule 1: Compounding: One of the most important lessons for living in the modern world is that to survive you’ve got to have money. But to live (survive) happily, you must have love, health (mental and physical), freedom, intellectual stimulation – and money. When I taught my kids about money, the first thing I taught them was the use of the “money bible.” What’s the money bible? Simple, it’s a volume of the compounding interest tables.

Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why. And you need a knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time.

But there are two catches in the compounding process. The first is obvious – compounding may involve sacrifice (you can’t spend it and still save it). Second, compounding is boring – b-o-r-i-n-g. Or I should say it’s boring until (after seven or eight years) the money starts to pour in. Then, believe me, compounding becomes very interesting. In fact, it becomes downright fascinating!

In order to emphasize the power of compounding, I am including this extraordinary study, courtesy of Market Logic, of Ft. Lauderdale, FL 33306. In this study we assume that investor (B) opens an IRA at age 19. For seven consecutive periods he puts $2,000 in his IRA at an average growth rate of 10% (7% interest plus growth). After seven years this fellow makes NO MORE contributions – he’s finished.

A second investor (A) makes no contributions until age 26 (this is the age when investor B was finished with his contributions). Then A continues faithfully to contribute $2,000 every year until he’s 65 (at the same theoretical 10% rate).

Now study the incredible results. B, who made his contributions earlier and who made only seven contributions, ends up with MORE money than A, who made 40 contributions but at a LATER TIME. The difference in the two is that B had seven more early years of compounding than A. Those seven early years were worth more than all of A’s 33 additional contributions.

This is a study that I suggest you show to your kids. It’s a study I’ve lived by, and I can tell you, “It works.” You can work your compounding with muni-bonds, with a good money market fund, with T-bills or say with five-year T-notes.

Rule 2: DON’T LOSE MONEY: This may sound naive, but believe me it isn’t. If you want to be wealthy, you must not lose money, or I should say must not lose BIG money. Absurd rule, silly rule? Maybe, but MOST PEOPLE LOSE MONEY in disastrous investments, gambling, rotten business deals, greed, poor timing. Yes, after almost five decades of investing and talking to investors, I can tell you that most people definitely DO lose money, lose big time – in the stock market, in options and futures, in real estate, in bad loans, in mindless gambling, and in their own business.

RULE 3: RICH MAN, POOR MAN: In the investment world the wealthy investor has one major advantage over the little guy, the stock market amateur and the neophyte trader. The advantage that the wealthy investor enjoys is that HE DOESN’T NEED THE MARKETS. I can’t begin to tell you what a difference that makes, both in one’s mental attitude and in the way one actually handles one’s money.

The wealthy investor doesn’t need the markets, because he already has all the income he needs. He has money coming in via bonds, T-bills, money market funds, stocks and real estate. In other words, the wealthy investor never feels pressured to “make money” in the market.

The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art or fine jewelry or gold is on the “give away” table, he buys art or diamonds or gold. In other words, the wealthy investor puts his money where the great values are.

And if no outstanding values are available, the wealthy investors waits. He can afford to wait. He has money coming in daily, weekly, monthly. The wealthy investor knows what he is looking for, and he doesn’t mind waiting months or even years for his next investment (they call that patience).

But what about the little guy? This fellow always feels pressured to “make money.” And in return he’s always pressuring the market to “do something” for him. But sadly, the market isn’t interested. When the little guy isn’t buying stocks offering 1% or 2% yields, he’s off to Las Vegas or Atlantic City trying to beat the house at roulette. Or he’s spending 20 bucks a week on lottery tickets, or he’s “investing” in some crackpot scheme that his neighbor told him about (in strictest confidence, of course).

And because the little guy is trying to force the market to do something for him, he’s a guaranteed loser. The little guy doesn’t understand values so he constantly overpays. He doesn’t comprehend the power of compounding, and he doesn’t understand money. He’s never heard the adage, “He who understands interest – earns it. He who doesn’t understand interest – pays it.” The little guy is the typical American, and he’s deeply in debt.

The little guy is in hock up to his ears. As a result, he’s always sweating – sweating to make payments on his house, his refrigerator, his car or his lawn mower. He’s impatient, and he feels perpetually put upon. He tells himself that he has to make money – fast. And he dreams of those “big, juicy mega-bucks.” In the end, the little guy wastes his money in the market, or he loses his money gambling, or he dribbles it away on senseless schemes. In short, this “money-nerd” spends his life dashing up the financial down-escalator.

But here’s the ironic part of it. If, from the beginning, the little guy had adopted a strict policy of never spending more than he made, if he had taken his extra savings and compounded it in intelligent, income-producing securities, then in due time he’d have money coming in daily, weekly, monthly, just like the rich man. The little guy would have become a financial winner, instead of a pathetic loser.

RULE 4: VALUES: The only time the average investor should stray outside the basic compounding system is when a given market offers outstanding value. I judge an investment to be a great value when it offers (a) safety; (b) an attractive return; and (c) a good chance of appreciating in price. At all other times, the compounding route is safer and probably a lot more profitable, at least in the long run.

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Global Food Crisis, Not Only Speculation

THE BIG PICTURE - Recent massive food commodity price rises, with occasional day trade plunges on the back of market rumours, price chart gazing or analysts' theories – followed by a return to the growth trend - is taken by many as a key proof of the Ponzi scheme new economy. The food commodity sell-off through February 21-23, 2011 is a typical example, explained by market watchers as due to speculation by traders that riots in North Africa and the Middle East could cut government spending and curb food demand from the Arab world, which buys about 33 percent of global shipments. 

Price rises will however return like night follows day, and even liberal minded politicians are calling for a clamp down on the commodity speculation driving up oil and food prices, although speculation on equity prices or on credit default swaps linked to bond sales of the PIGS and other super-debt states is still respectable, fair game and politically correct. 

These facets of the paper economy, however bizarre or derisory they might be, are however not the big picture. World food is in crisis. 

Worldwide stocks of the major food grains, and other foods are in most cases lower than they were in the 1970s - when world population was close to one-half the present 7 billion. The UN FAO repeatedly underlines the acute shortage of arable land for the world's population which is still growing at about 65 million per year. Arable land resources, which are shrinking in net terms, are about 1.4 billion hectares: the average per person is therefore 0.2 hectares. Taking the staple maize, US Agriculture Department (USDA) data issued in February 2011 shows the lowest world inventories since 1974, 37 years back in time. Farmers around the globe are failing to produce enough of this major food staple, and the others, from grains to meat and dairy foods, to meet constantly rising world consumption. This is despite increased planting and food commodity prices that have doubled since early 2010. The outlook is almost sure and certain: food prices are set to go on rising. 

For the 3 major food staple grains of wheat, rice and maize, and key livestock feeds and human foods including soybeans and colza (rapeseed), growers from Canada and the USA to Russia, the EU-27, Brazil, Argentina, Australia, India, China and Thailand have boosted annual output by an average of about 15 percent since 2000, but this is outdistanced by demand growth of more than 20 percent in the same period, using USDA data. In all cases it is unlikely there will be significant growth in output, either short-term and perhaps also long-term. For the key livestock feeds including maize and the oilseed colza, due to several factors including their use for producing bio-ethanol and bio-diesel to trim growing oil import costs, and the dependence of all the grains on costly water-intensive irrigation to boost output, plus the impact of climate change and loss of arable land acreages, the outlook for any sustained growth in supply is low. For the grain staples and the key livestock animal feeds led by soybeans, world stockpiles are forecast by agro-industry specialists like R J O'Brien to go on shrinking. 


Global inventories of all grains are forecast by the USDA to continue shrinking and to decline at least 13 percent before the next harvest season (from Autumn 2011), making this the first net decline since 2007, when surging food prices sparked more than 60 deadly food price riots in over 40 lower and middle income countries from Haiti and Niger to Egypt and Somalia. As in 2007, increasing demand is again causing food shortages while it powers inflation in developing countries: the collateral damage already includes several Arab dictators unable to cling onto power. 

While straight price rises for grains, oilseeds, sugar and non-food soft commodities (such as rubber and cotton) are generating more income for their farmers and producers, downstream food producers dependent on these inputs are strangled by a combination of rising input prices, but slow growing output or selling prices, sometimes capped by consumer-friendly price mechanisms or by often irrational and wasteful food subsidy programmes. 

Price rises for the feed grains needed to produce downstream dairy products, meat and fish are moving so fast that producing these key foods for convenience food-oriented urban, and urbanising populations worldwide is now often pure-and-simple uneconomic. In some countries, such as the EU-27 countries in which the EU's Common Agriculture Policy operates, data from the major farming and food organizations paints a dire picture. Regional pork meat farmers in major pork producing regions of France such as Vendee and Brittany, polled by national and regional agro-development and producer associations, such as the SAFER of Vendee, say that up to 15 percent of pork producers in both regions are either bankrupt or likely to go bankrupt by end-2011 unless selling prices rise by at least 25 - 33 percent. 

In several African countries, where transport costs for food and feed grains imported from Europe, USA and from South Africa add to fast rising costs, the UN's OSAA (Office of Special Advisor for Africa) reports that a return to serious food shortage, and probable social unrest, is increasingly likely in a string of countries including Niger, Senegal, Mali, Central Africa Republic, Nigeria, Somalia and Ethiopia. Despite generally low yields in much of Africa, the intensity of farming measured by the available land used for food production is high, according to the IUCN, the Millenium Ecosystem Assessment and other specialized entities, making increase of African cropland acreages difficult. Outside the low income countries, other higher income but food import dependent countries such as Egypt, Morocco and Algeria will also remain exposed to the social, political and economic impacts of rising food prices. 


Rising incomes in the Emerging economies led by China and India are intensifying the shortage of world food. As people eat more meat, aquaculture raised fish, and dairy products from crop-fed livestock, demand for the input feed grains will further grow. As much as 10 kilograms of input feed grains can be needed to produce 1 kilogram of downstream meat or fish, butter, cheese and cream. For US agro-industrial operations, an average of about 6.4 kilograms of maize is needed to produce 1 kilogram of beef, and about 3.5 kilograms to get a kilo of pork, according to industry analysts and sector specialist processing firms such as Tyson Corp.
To mid-February 2011, grain futures on the Chicago Board of Trade rallied to the highest since 2008. Maize prices have grown about 95 percent in the past 12 months, soybean prices have risen about 85 percent, while wheat prices have risen about 75 percent. Rice has however not yet started to power ahead, with international traded rice recording only a 12.5 percent price rise in the 12 months since early 2010. This however will change. Major importers led by the world's-largest, Bangladesh, are set to raise their imports. For Bangladesh, plans are for doubling its 2011 rice-import target, to cool domestic prices driven to record highs as consumers and farmers hoard the grain, according to Bangladesh's Directorate General of Food. Indonesia is also considering boosting rice stockpiles, and has removed import duties on wheat, wheat flour, soybeans, and livestock feed in an attempt to slow price rises. 

Maize will probably reach or surpass a record US$ 8 per bushel by 2012, and could attain more than US$ 10 a bushel (1 bushel in volume is 35.24 litres) according to many analysts and commodity trading specialists, like Goldman Sachs Group Inc. The so-called "investor community" outlook is for soybeans to continue their recent and record price run, with traded rice quickly making up for lost time, in its own upward price march. Some speculator entities, such as Goldman Sachs, forecast that wheat, maize, rice and soybean prices could rise as much as 15 percent, from their current levels, by May 2011. 


We can be sure that consumers can do without smart phones and Internet access, and even trim their oil consumption, if price rises are big enough or consumers become aware of some clear supply limit. But with food things are different. Doing without food or not eating enough - which the UN FAO reports is daily reality for 950 million persons worldwide as of late 2010 - soon has major impacts on their political behaviour, on the economy, public health and society. The outlook for 2011-2012 is therefore particularly sombre because, even if world grain harvests are at record levels for 2 successive years, this will only just restore the global stocks-versus-demand situation to pre-2007 levels. There is no nearterm possibility of restoring the situation which prevailed in the late 1980s and the 1990s when the impact of Green Revolution crop hybrids, more arable land, and cheap oil, generated higher food supply. The food price trend is likely going to remain set on a rising profile for years to come. The impacts, and implications of this for the economy, urban development, political stability and social values are almost open-ended - and will necessarily generate responses and solutions. 

The major boost in world food prices has surely triggered more planting but for simple reasons linked to average yields for planted acreages in major producer countries, this is unlikely to generate supply growth of more than about 5 percent. USDA data on farmers' planting intentions tends to indicate US maize and wheat farmers, for example, will raise their 2011-2012 crop acreages by at most 4 to 5 percent. Reasons why the vaunted, economics textbook "price-elastic response" is so weak at the level of net supply and output do not feature speculative hoarding at the producer level, even if this certainly exists in the so-called investor community. The real reasons include continued loss of good arable land, for example due to urbanisation and industrialisation, water shortage and the costs of fuel, irrigation, pesticides and fertilizers, as well as lowered yields on increasingly marginal land that is more exposed to crop losses from drought, erosion, excess rainfall, wind damage and so on - an economic classic at least as old as the hallowed price-elastic response. 


Compared with 2000-2001 and using International Grains Council and USDA data, the most-recent global grain harvest increased to 2.179 billion metric tons from 1.874 bn metric tons, but this was nonetheless down 2.4 percent from the 2008-2009 harvest. The 2.18 bn ton most-recent harvest can be compared with estimates by UN FAO, the USDA and other sources of world food grains demand in 2010-2011 standing at about 2.25 billion metric tons. This will demand a drawdown of stocks and lead to further falls in global stockpiles, unless the world enjoys at least one, or two successive bumper harvests for all 3 of the major food grains. 

The knock-on of rising food prices, which rose about 25 percent in 2010 according to the FAO, has been and will be rapid. In a February 15, 2011 statement, World Bank president Robert Zoellick estimated that an additional 44 million people worldwide have been pushed into extreme poverty because of the rising cost of eating in the 8 months since July 2010. While all the food grains outside rice, and all the oilseeds providing vegetable oils and animal feeds have strongly risen in price, sugar prices have also soared. In a predictable short-term future and intensified by rising oil prices meat, fish, milk and dairy product prices will all rise. 

In a major change from “laisser faire” policy typical of neoliberal mindsets, governments are now treating agricultural investment as politically correct, and planning to raise agricultural investment in an attempt to revive crop and food supplies. Until 2007-2008, according to the FAO, development aid to farming provided by the OECD donor countries had been declining each year for over 10 years, presumably on the fond hope that “market forces” would make up the massive shortfall in funds needed. Premier Wen Jiabao told China Central Television on February 10, 2011 that his government will spend 12.9 billion yuan (US$ 1.96 billion) this year to bolster grain production, improve water supply to farming, and fight desertification through tree planting, among other measures. Chinese and Indian buying of major food staples including the oilseeds is further intensifying shortage on world markets. Food import dependent countries that have benefited from higher export revenues on their minerals and metals exports, such as Bolivia, are also considering plans to use some of their record foreign exchange reserves to produce more food, and purchase food on world markets on a “precautionary basis” before prices rise further, increasing their stockpiles of the basic food staples. Increased purchases of traded food commodities inevitably spurs speculation and higher prices. 

Overseas buying of agricultural products from the U.S., the largest exporter country for maize, soybeans, wheat and cotton, probably jumped 18 percent by value (but not tonnage) to a record US$ 115.81 billion in 2010, the US government announced in February 2011. China became the largest market for U.S. farm goods for the first time, with the value of shipments increasing 34 percent to US$ 17.5 billion, reflecting China's leading role as food importer – as well as manufactured goods exporter. Rising disposable incomes in India, China and other trade-surplus countries has quickly raised their ability to pay for higher food imports, but at the cost intensifying speculation. 

Grain import demand is rising worldwide. Saudi Arabia’s cereal imports may reach a record this year, the FAO said on February 3, 2011 while Algeria, Morocco, Iraq, Bangladesh, Pakistan, Turkey and Lebanon have all issued tenders to buy more wheat or rice in February, as food price inflation further stoked the political unrest that has toppled long-standing dictators in Tunisia and Egypt. Wheat purchases by Algeria, North Africa’s second-largest importer (after Egypt), climbed to 1.75 million metric tons in January alone, according to commodity analysts at Goldman Sachs. 

As noted previously, food import dependence is intensified by changing food habits. China, the world’s largest pork meat consumer, boosted demand for pork by 30 percent since 2000, and beef demand by about 10 percent, while its population only increased 5.3 percent in the same period, using UN data. Similar import growth trends apply in other Emerging economies, especially for feed grains used in poultry and fish rearing, driven by a shift in livestock, dairy and poultry production from small, family farms depending on pastures and local-produced, local-sourced inputs to bigger, more energy and chemicals-intensive agro-industrial production, with animals fed on maize and soybean meal. In turn this generates nearly total dependence on food trade, transport, and industrial inputs like pesticides, fertilizers and antiobiotics. 


Suppliers of industrial goods, chemicals like fertilizers, and services for world agro-industrial food production have enjoyed a rapid growth in their turnover, with a large upward impact on their own input prices. Since January 2011, industry analysts such as food sector specialists at JPMorgan Chase in New York have continually raised their price targets for the share value of fertilizer makers such as Agrium Inc. and Potash Corp. of Canada, and farm-equipment makers like Deere & Co., Claas Corp. and Agco Corp. of USA, YTO of China or Mahindra & Mahindra of India. World agricultural equipment makers report that key inputs, such as metals, other raw materials and energy for manufacturing farm machines are often suffering price rises of above 15 percent annual. 

The trend to further intensification of world agriculture, needing more and larger machines, chemicals and bioscience inputs such as GM plant hybrids is dictated by two main factors. These are declining arable land availability and declining food stockpiles. As food and agriculture study organizations note, rebuilding the “stockpile cushion” will be impossible in only 1 or 2 years. In major developed country food producers countries, including the USA and European net food exporters such as France, loss of arable land, water and chemicals costs, and other factors are tending to reduce total productive capacity, year after year. Analysts including USDA researchers and other specialists conclude that by about 2017, the USA may become a net food importer in value terms. For the analyst Dan Basse of AgResource Co, the US is in a context where net losses of land and increasing input costs since 1979 result in what he calls an acreage wall: “We have reached an acreage wall where the U.S. can no longer be the world’s pillar of exports for maize, soybeans and wheat.” 


Due to the size and output volume of the world food industry, changes tend to be slow moving and costly in terms of capital spending, reinforcing the outlook for several more years of high food prices. This outlook is backed by rising input prices for increasingly agro-industrial production systems, and long-term climate changes affecting global producer regions. Quick fixes, such as GM hybrid plants now used in approximately 60 percent of world soybeans production, for example, are themselves input intensive and unlikely to provide any “silver bullet” despite claims to the contrary, according to industry specialists and several major food conglomerates such as Nestle Co. 

Solutions will therefore tend to be slow, incremental and ground-up. The return of traditional-style food production as niche-oriented biological and wholefoods production is already established in some higher income countries, but the main potentials for producing more food with less inputs will focus the sustainable cropping of drylands and formerly-marginal land acreages, where water conservation will be the main goal. World Bank data indicates that about 78 percent of world water needs are for agriculture, and raising water supply for agriculture is both difficult and costly. Due to high biomass and ecological productivity in wetlands and semi-saline coastal and estuarine environments, these generally neglected but high potential “new lands” are another key target for agricultural research and development, along with drylands farming and energy saving techniques such as no-till. Food waste, despite the claims of fastfood defenders, is radically increased by urban food habits and supply structures where recovery and recycling of food wastes is difficult and transport-intensive. 

Heavy capital investment in existing systems and infrastructures, and rising food prices make it difficult to break out into new solutions and alternatives. Nestle CEO Peter Brabeck-Letmathe in an October 2010 statement to shareholders explained that high food prices increase the pressure to improve efficiency, "But when you start only after prices have gone up, you are too late”. In general, as the food chain extends over distances able to span the globe, waste tends to rise. Local food production for local consumption is the solution but existing commercial practices, consumer habits and expectations are major obstacles to change in the absence of government intervention and legislation, which itself is only likely under crisis conditions.

The political importance of food security – as opposed to energy security – is surely growing but is still far behind economic growth goals and the search for technology and science quick-fixes that could or might radically raise food productivity from existing systems and infrastructures. As with the delayed response to rising food prices to invest in new and alternate farming methods, the political impact of current food supply and commerce inevitably includes food riots in the most exposed, lower and middle income countries. Despite the long history of failure, the so-called strategy of laisser faire still commands massive and obligatory spending of government revenues on subsidy programmes, stockpiling, and attempts to raise agricultural productivity in many countries, instead of investing in innovation and alternatives. 

Sustainable food production and affordable food will certainly become key political goals, following the Arab revolt of 2011. Measures and programmes for achieving these goals will quickly grow, not only in an attempt to maintain political stability, but also due to the long-term trend of declining food inventories and increasing difficulties in raising production from existing croplands using present commercially profitable, conventional techniques. Likely one of the major coming food sustainability and security measures will be urban food supply restructuring, extension and development within new and necessarily radically different national development policies and programmes. Such action is already under study by many research, science and technology and academic institutions, but it is unlikely there will be major movement before the current crisis deepens enough to command the full attention it deserves.

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Timber Investing: The Inflation Hedge That Pays Off in Every Type of Market

Larry D. Spears writes: If you start a conversation about the building inflationary pressures already sapping consumer pocketbooks, that talk will almost certainly turn to such classic hedges as gold, silver and even crude oil.

But one of the best inflationary hedges of the 20th century is often forgotten - even though it's likely to be just as effective this time around.

We're talking about timber - and timber stocks. And the facts speak for themselves. Investing in timber is a move virtually every investor should carefully consider.

Timber Trumps Inflation
In case you're sitting in Oregon, Kentucky, or some other state that's rich with forests - and therefore doubt the value of timber as an inflationary hedge - here is some research to consider. If you look at this with an open mind, you'll see that timber is not only a great hedge against inflation, but it's a market-beating investment in virtually every type of investment environment.

If you need to be persuaded timber investing is a strategy you need to employ, consider that:
•In the modern era, inflation has never been a match for timber, which has risen faster than overall prices for more than a century. During America's last major inflationary period - from 1973 to 1981, when inflation averaged 9.2% - timberland values increased by an average of 22% per year. On average, the price of harvested lumber itself has risen more than 5% annually over the past 100 years.
•Since 1910, the value of timberland as an investment has risen faster - and with less volatility - than stocks as measured by the Standard & Poor's 500 Index. Since 1987 alone - in spite of minor losses in 2010 due to the U.S. housing slump - the Timberland Index maintained by the National Council of Real Estate Investment Fiduciaries (NCREIF) has risen roughly 15% per year, compared to an annualized return of just 9.61% for the S&P 500.
•Timber investing has proven to be particularly alluring during bear markets. During the Great Depression, when stocks plunged more than 70%, timber gained 233%. And timber easily outperformed the S&P 500 during the 20th century's other major bear-market periods. Most recently, in 2008, when the S&P 500 lost 38%, the NCREIF Timberland Index gained 9.5%.
•Timber is a valuable tool for portfolio diversification since its price movements have a very low correlation with most other asset classes - less than +0.1.
•In spite of the glass-and-steel towers dominating the globe's urban landscapes, demand for timber is now higher than ever. The U.S. is the world's No. 1 consumer of wood products, using 27% of the timber harvested each year. The average American uses the equivalent of one 100-foot tree per year, and the rest of the world is quickly catching up. In fact, the United Nations now predicts demand for wood will double in the next 30 years, with China - already No. 2 in wood consumption - pacing the growth. As evidence of that demand, lumber exports from Canada to Asia have nearly quadrupled in the past five years alone.
•Although timber is considered a renewable resource and new trees are planted each year to replace a growing portion of the annual harvest, the world's wood supply is steadily shrinking (by an estimated 2.4% annually in the 1990s). In tropical regions, about 130,000 square kilometers (50,193 square miles) of forest is being destroyed each year. Roughly half of the forests that originally covered 46% of the earth's land surface are now gone, and 56% of North America's coastal rain forests have been destroyed. This is yet another persuasive argument that timber investing represents a significant long-term profit play.

Not Just an Inflation Hedge
If inflation isn't a worry for you, you still shouldn't ignore timber stocks. Historically, timber has proved itself to be a highly profitable investment - and thanks to rising global demand, timber shares should be top performers (as measured against other assets) in years to come.

Globally, the long-term supply-demand outlook for lumber - and for wood products in general - is highly bullish. And when you factor in shorter-term cyclical considerations - such as those related to the U.S. housing market - it gets even more attractive.

U.S. housing prices have experienced a major decline since 2006. And as prices have fallen, so has new construction. But while housing prices remain near their nadir, both buyer demand and building activity have started to increase. 

The U.S. Department of Commerce, which tracks the U.S. housing market, reported that sales of new single-family homes rose to an annual rate of 329,000 in December, the highest level since the expiration of the federal-homebuyer tax credit in April (though the total for all of 2010 was just 321,000, down 14.4% from 2009). The available supply of new homes also dropped (from 8.4 months' worth of inventory to just 6.9 months' worth), and the median price leaped from $215,500 in November to $241,500.

Looking forward, the National Association of Realtors (NAR) also reported that pending home sales rose 2.0% in December, the fifth increase in the past six months, although the NAR's pending sales index was still 4.2% below year-ago levels. 

On the construction side, the Commerce Department said U.S. home construction fell 4.3% in December to an annualized rate of 529,000, though some of the decline in housing starts was blamed on bad weather. More importantly, permits for new construction - a better gauge of future housing-market activity - rose to an annualized rate of 635,000 in December, well above expectations and the highest level since March 2010.

The number of potential homebuyers also is likely to increase in the months ahead: The Conference Board just reported that its index of consumer confidence climbed to 60.6 in January, sharply higher than expected and the highest reading since May 2010. Consumer optimism was particularly strong in terms of the outlook for higher wages and more job creation.

That prospective surge in housing demand bodes well for a continued rise in raw lumber prices, which have actually increased (25% in 2009 alone) in spite of reduced building activity over the past four years, thanks to lower output by lumber producers.

Top Profit Plays
Unfortunately, it's not that easy for individual investors to make direct investments in lumber. And it's even more difficult to invest in the land on which lumber-producing trees grow. Although 71% of North American timberland is privately owned (the rest resides in national forests), the owners are almost exclusively companies in the forestry business or Timberland Investment Management Organizations (TIMOs).

TIMOs, created in the 1970s after Congress mandated broader diversification for institutional investment portfolios, are similar to real estate investment trusts (REITs). But TIMOs cater to large investors - pension funds, mutual funds and some wealthy individuals who can afford the typical minimum investment of $5 million. At the end of 2009, TIMOs had about $24 billion invested in U.S. timberland, up from just $1 billion in 1989.

Given that significant "barrier to entry," the best way for most individual investors to tap into these substantial opportunities in timber is by investing in the stock of corporations that own lots if it. Two timber-investing possibilities worth considering are:

•Plum Creek Timber Co. Inc. (NYSE: PCL), recent price $41.09: Plum Creek is based in Seattle, but has a long reach; it owns timberland in 19 states - from Washington to Maine and Wisconsin to Mississippi. Its forest holdings are also broadly diversified by species - from redwood and spruce, to ash and oak - as well as by age. The company also has a secondary division that focuses on mineral extraction and natural-gas production, giving it an extra edge in the inflation-hedge category. Plum Creek had revenue of $1.19 billion in 2010, producing earnings of $1.24 a share. The dividend of $1.68 gives the stock a very nice yield of 4.06%.
•Rayonier Inc. (NYSE: RYN), recent price $59.83: Structured as a REIT, Rayonier owns, leases or manages around 2.5 million acres of timberland in the United States and New Zealand. It also owns three sawmills in Georgia, and two specialty cellulose mills. The company produces both cellulose fibers and fluff pulp and engages in the international log-trading market. It also owns a separate portfolio of non-timber-related real estate. Based in Jacksonville, Fla., the company had 2010 revenue of $1.315 billion, which generated diluted earnings per share (EPS) of $2.54. Rayonier shares pay a dividend of $2.04 each, for a yield of 3.60%.
If you'd like more of a "nameplate" stock - not to mention one that's got more room to rebound from the effects of the recent housing downturn - a third possible timber-investing candidate worth consideration is:
•Weyerhaeuser Co. (NYSE: WY), recent price $23.66: This Washington-based forest-products giant ($13.47 billion market cap) has customers worldwide, serving them with a wide range of construction materials, paper products, fibers and lumber. It manages 22 million acres of forests in 10 countries, and also has numerous mineral, oil and gas operations. Its Real Estate division also engages in property development, home construction and the real-estate brokerage business. The stock traded above $50 a share in April 2010, but eased off in May and June with the rest of the market. Don't, however, let the current low price confuse you - it reflects a special stock-or-cash dividend of $5.6 billion (about $26 per share) paid Sept. 1, 2010, to stockholders of record in July 2010. That payout is a key step in Weyerhaeuser's plan to become a REIT. The company reported $6.55 billion in total revenue for 2010, up from $5.52 billion in 2009. That translated into diluted earnings per share of $3.99 for the year, up from a loss of $2.58 in 2009. The stock pays a regular dividend of 60 cents a share, representing a yield of 2.55%.

For investors who don't want the risk of a single-company investment, there are several exchange-traded funds (ETFs) that hold a broad portfolio of timber stocks, including those just mentioned. Two of the leaders are:

•Claymore Beacon Global Timber Index Fund (NYSE: CUT), recent price $21.93: This fund attempts to mirror the performance of the stocks making up the Beacon Global Timber Index, which is composed of companies from around the world that own or lease forest land, harvest trees for lumber and other wood-based products, and that produce such finished products as lumber, paper and even packaging. All have a minimum market capitalization of $300 million, and trade in the United States - as common stocks, American depositary receipts (ADRs), or global depositary receipts. The fund's 52-week low of $8.00 a share occurred during last May's "flash crash." But its "effective (non-flash-crash) low" for the year was around $17.50 in late August, meaning it has gained about 28% over the past six months. The fund paid a 59-cent dividend in 2010, good for a current yield of about 3.00%.
•The iShares S&P Global Timber & Forestry Index Fund (Nasdaq: WOOD), recent price $47.34: This ETF seeks to mirror the price and yield performance of the S&P Global Timber & Forestry Index, which consists of roughly 25 publicly traded companies engaged in the ownership, management or upstream supply chain of forests and timberlands. These include forest products companies, timber real estate investment trusts (REITs), paper-products companies, paper-packaging companies and agricultural-products companies. The fund bottomed with the rest of the market in early July at $21.05, climbing steadily since. This iShares fund has no regular declared dividend, but paid two special dividends totaling $1.12 in 2010. The expense ratio is 0.48%.

If the housing market finally moves into a full-fledged recovery, and the consumer middle class continues to emerge in countries around the world (both virtual certainties), then timberland and wood products should continue to follow the bullish path that they've followed for the last 100 years. 

And that means that timber investing shouldn't be viewed as just an inflation hedge - it should be looked at as a core investment strategy every investor should employ.
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China Risks and Investor Opportunities

Opinion is currently divided on the world’s second largest economy. 

On one hand of the spectrum, the bears believe that China is a train-wreck and that its economic growth is unsustainable. These sceptics love to highlight the property bubble in China and they never miss the opportunity to mention the fact that fixed asset investment accounts for a disproportionately large chunk of the Chinese economy.  According to the bearish camp, China’s economy is not real; rather, its breakneck economic growth is centrally planned by Beijing. Furthermore, the bears argue that China’s vast foreign exchange reserves are meaningless and that they will be used up in dealing with the aftermath of the Chinese real estate bust. 

On the other side of the equation, the optimists believe that China is the next great nation in the world and its super power status is all but assured. These bulls point to China’s foreign exchange reserves, low debt levels, high savings rate, strong work ethic and growing domestic consumption.  According to these folk, China’s economy is amongst the strongest in the world and Beijing is in total control.

So, given such conflicting views, it is hardly surprising that investors are confused about China.  Furthermore, it goes without saying that over the past few months, we have spent a lot of time thinking about China’s prospects.  Therefore, we will now outline our views about the Chinese economy and its financial markets. 

First and foremost, we want to make it clear that we are not bearish about the long-term prospects of the Chinese economy.  After all, the country has amassed the largest foreign exchange reserves in the world (US$2.85 trillion), it boasts a very high savings rate (37%), its household debt to GDP ratio is very low and its per-capita income is rising rapidly.  Therefore, at first glance, the Chinese economy appears to be in good health. 

Unfortunately, China’s economy also has a soft underbelly; it’s out of control property market.  After reviewing heaps of data, it is clear to us that real-estate prices along the coastal cities in China are grossly over inflated and due for an abrupt adjustment.  When measured in terms of affordability (median home price to median household income), it is blatantly obvious that Chinese property is in a gigantic asset bubble.
Moreover, various other data points also confirm overvaluation and excesses in China’s property market. 

According to some reports, billions of square feet of commercial real-estate is unoccupied in China.  Furthermore, we have also heard accounts from reliable sources that there is rampant speculation in China’s residential real-estate.

For example, the Chinese have been snapping up bare-shell apartments (no internal walls or fittings), for the sole purpose of flipping these properties for a quick profit.  It is interesting to note that these buyers are not the least bit interested in a rental yield, their only intention is to sell these properties to a ‘greater fool’. 

Needless to say, China’s banks have been doing their part to fuel this speculative orgy. For instance, the South China Morning Post recently reported that in 2010, China’s banks originated CNY8 trillion in new ‘official’ loans and this amount exceeded Beijing’s loan target. However, the buck did not stop here and allegedly the Chinese banks loaned out an additional CNY3 trillion via ‘off the balance-sheet’ arrangements orchestrated through various Trust entities.  

Figure 1 captures the sharp increase in China’s Yuan-denominated loans.  According to China Daily, outstanding Yuan-denominated loans stood at CNY47 trillion at the end of October, which is an astronomical sum when you consider that China’s economy is worth only CNY37 trillion.  Unfortunately, this rampant credit growth is not slowing down and apparently, Chinese banks have already created new loans worth CNY1.5 trillion in 2011! 

Figure 1: China’s new Yuan-denominated loans (October 2009-October 2010)

Source: China Daily

So, there you have it. All the conditions are now in place for a property bust – extreme overvaluation, abundant credit and massive oversupply.  The trillion dollar question though is whether the unavoidable bust in housing will impact China’s broader economy or will the damage be confined amongst the property speculators and developers? 

Unfortunately, this is a very difficult question to answer but given the relatively low household debt in China, we are inclined to believe that the pain will be limited to the property developers, leveraged speculators and banks.  We have no doubt in our mind that China’s non-performing loans will escalate in the future, therefore we believe that an investment in Chinese banks is risky. 

Furthermore, when the Chinese property boom turns sour, various asset markets and economies will be impacted. First and foremost, the prices of base metals may fall from their lofty levels and this will affect the earnings of the major mining companies.  Remember, China is the major importer of base metals and any slowdown in its real-estate construction will diminish demand for industrial raw materials. Accordingly, we have recently liquidated our investment positions in the base metals mining companies. 

Moreover, any fallout from the Chinese real-estate bust will surely impact the economies of the commodity-producing nations such as Australia and Brazil.  Thus, investors should remain vigilant and perhaps reassess the risk/reward of their cyclical investments in these resource-rich nations.  

Now, this may sound strange but despite our near-term concern about China’s housing bubble and our bearish stance towards certain sectors, we remain optimistic about the nation’s long-term economic prospects. 

In terms of the broader Chinese economy, we believe that a housing bust in China will cause some hiccups in its breakneck growth.  However, we suspect that this slowdown will be temporary because most Chinese households are not leveraged to their eyeballs (China’s household debt to GDP ratio is below 20%).  

Furthermore, it is notable that currently, China’s private domestic consumption accounts for only 34% of GDP (Figure 2) and in our view, this percentage will increase in the future. Remember, in its latest five year plan, Beijing has made it clear that it wants to increase private consumption and reduce China’s dependence on low-margin manufacturing and exports.

Figure 2: China’s domestic consumption set to increase? 

Source: Trading Economics

It is our contention that China’s policymakers are serious about this issue and they have the necessary tools to encourage domestic consumption.  For instance, if Beijing allowed its currency to appreciate, such a move will undoubtedly increase the purchasing power of the Chinese, thereby increasing private consumption. 

Despite the looming property bust, it is our contention that China’s stock market has already discounted the housing problem and this is why the Shanghai Composite Index is trading approximately 55% below its all-time high.  As far as valuations are concerned, it is notable that the index is trading at 17 times reported earnings, which is remarkably cheap when you consider the 12-year average price earnings ratio of 34.  Last but not least, if you factor in this year’s corporate earnings growth, the index is valued at just 13.1 times projected after-tax earnings. 

In summary, given our long-term optimism towards the Chinese economy and the historically low valuations, we are maintaining our investment exposure to our preferred companies in China.  While we continue to avoid the property developers and banks, we have allocated capital to terrific Chinese companies which should benefit from an increase in China’s domestic demand.  

If our assessment is correct, the ongoing weakness in Chinese stock prices is a good buying opportunity for the patient investor.

Food Price Inflation Calculator

Mark Thornton of the Mises Institute writes, "The price of everything seems to have skyrocketed. Only housing, the dollar and inflation-adjusted income are negative."

I immediately interrupt to wittily say, "Well, housing is going down because nobody wants to buy a still-over-priced-yet-even-lower-quality house that now needs painting, a new water heater, some leaky things fixed and a new roof, especially now that inflation-adjusted incomes are negative!"

The stunned silence at my rudeness was all I needed to continue, "And the ridiculous fiat dollar is going down in purchasing power because the foul Federal Reserve is creating So Freaking Much Money (SFMM) that, vis-à-vis other dirtbag fiat currencies of other dirtbag countries running budget deficits, the dollar is going down in value faster than they are because the Federal Reserve is creating more new money than all the rest of the world's dumb-ass, dirtbag central banks put together!"

Seeing that everybody is completely stunned by the way I just barged into the conversation with one of my patented Stupid Mogambo Remarks (SMR), I, thus emboldened, powered forward by thoughtfully stroking my chin as if contemplating something profound, whereupon I go on, my voice rising in a crescendo of pain and outrage, "But if you calculate all prices in ounces of gold, you will find that prices will have actually gone down! I'm not sure exactly how to prove it, but this has to mean We're Freaking Doomed (WFD)!"

Apparently, Mr. Thornton is not sure how to calculate it, either, but is perhaps suggesting that the horror may be found in the fact that "World food and commodity prices are up 28% over the last six months."

I was surprised that I did not edit his remarks to end with at least one exclamation point, and also surprised at his use of a 6-month time-frame, instead of annualizing it, at least in some simplistic linear manner that a dolt like me can understand.

In doing so, he unwittingly provides an opening for Showoff Calculator Man (SCM), as I happen to be an absolute whiz at multiplying numbers by 2!

Putting my calculator where my mouth is, I quickly crank out 2 X 28% = 56% inflation! See? I CAN do it!
On the other hand, 1.28% X 1.28% = 1.64%, which would seem to be a massive 64% annual inflation when compounded, even more so than the simple 58%. Yikes!

Mr. Thornton ignores me, and goes on, "Higher food prices set off the revolutions in Tunisia and Egypt and the mass protests in countries like Algeria, Jordan, Yemen, Bahrain and Iran. People in these countries buy more unprocessed foods and spend a much higher percentage of their income on food, so they have been severely impoverished by Bernanke's QE2."

Of course, being an American, all I really care about is how it affects me, an American, and American prices, and how in the hell I am going to afford higher prices on my American income which has, as he said earlier, gone down when inflation-adjusted.

In that regard, Joel Bowman, Managing Editor here at The Daily Reckoning notes, "Wholesale prices jumped 0.8% in January. The producer price index (PPI) has now jumped 3% over the last four months. And no, that's not an annualized figure."

Again, Showoff Calculator Man (SCM) comes to the rescue, and multiplies 3 times 3% to get 9% inflation, which IS an annualized figure, and more than 9% inflation when compounded, and which is scary enough to send me running, running, running, like the paranoid little weasel that I am, to the safety of the Mogambo Secret Bunker (MSB).

I was hurriedly shutting the bunker's door when I heard Mr. Bowman go on, "Note that the PPI headline number is for 'finished goods' - stuff that's ready to be sold direct to consumers. In the category of 'crude goods,' the figures are far worse - up 3.3% in January, and up a staggering 15.8% over the last four months."

The last four months! That's almost 48% inflation a year! Man, if ever there was a time to buy gold, silver and oil, this is it! Whee! This investing stuff is easy!

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