Palm oil price rebound may not set a trend

by Agrimoney.com

A revival in palm oil prices on Wednesday may not herald sustained recovery, despite weakened output prospects, analysts said, flagging the headwinds of strong output of soyoil and softened Chinese and Indian demand.

Palm oil for October delivery, the benchmark contract, closed up 1.0% at 2,252 ringgit a tonne in Kuala Lumpur, on Wednesday, following five straight negative sessions in which benchmark futures tumbled more than 7%.

However, the rally offered an opportunity to sell rather than buy, Phillip Futures said, flagging the prospective boost to supplies of vegetable oils from strong US and South American soybean crops.

"We see this rally as just a bear rally, and a good opportunity to sell into strength," Phillip Futures analyst Sim Han Qiang told Agrimoney.com.

Standard Chartered cut by up to 300 ringgit a tonne its forecast for palm oil futures.

Output slowdown

Production prospects for palm oil have actually decreased, with analysis group Oil World trimming to 19.2m tonnes, from 19.6m tonnes, its forecast for Malaysian output in 2013.

For Indonesia, the top ranked producing country, production growth this year may be constrained to some 6.7%, taking it to 28.7m tonnes, Standard Chartered said.

"We note that the market is beginning to drift towards the 28m-29m tonne mark for Indonesia's 2013 output, compared with 30m-31m tonnes at the start of the year," StanChart analyst Abah Ofon said.

Chinese consumption worries

However, with output of rival vegetable oils growing, Oil World forecasts production of the eight main edible oils rising 3.4% to 159.5m tonnes in 2013-14, compared with a 3.1% rise to 158.7m tonnes in consumption.

That looks set to increase stocks by 2.6% to 21.4m tonnes, Mr Sim noted, flagging the brake on demand hopes reflected by lower Chinese economic growth.

The transition by China from an economic model based around trade growth to one stressing domestic consumption "will be tough, meaning slower growth", with an impact on palm oil demand, he said.

Crude vs refined

Mr Ofon too noted "renewed concerns about demand from China", but highlighted more the danger to orders from India, where a weak rupee was, in making imports more expensive, adding to the disincentive to purchase.

Already, margins for Indian processors of refining crude palm oil had turned negative, cutting capacity utilisation rates at mills to 35% from the typical 50%, and forcing consumers to buy more expensive, already-refined product.

"We believe the combination of tight margins and higher import costs is unsustainable for the industry and will contribute to inflation expectations," Mr Ofon said, noting talk that India will raised to 12.5%, from 7.7%, the import tariff on refined palm oil.

"At a time when Indian policy makers are trying to address a large current account deficit gap, any further increase in the edible oil import bill would be a concern."

Forecast downgrade

Chinese and Indian dynamics, "coupled with a potentially large edible oilseed harvest in 2013-14, suggest that the crude palm oil market will need to adjust lower", Mr Ofon said.

StanChart, which has been one of the more upbeat commentators on palm oil price prospects, cut its forecasts for palm oil prices in the rest of 2013, and in 2014.

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Why Freddie and Fannie Failed

by Ramsey Su

Freddie and Fannie (F&F) were placed under conservatorship September 2008. The agencies, including FHA, are now responsible for 90% of the mortgage market. In recent quarters, the agencies have been profitable (subject to debate) and returning billions to the Treasury.

Finally, after almost five full years, Senators Corker and Warner are working on a bill to phase out the agencies and pass the secondary market back to private hands. As part of Dodd-Frank, the Consumer Finance Protection Bureau is working on a mountain of regulations, mostly for unknown purposes other than red tape.

Are the agencies ready to stand on their own again?

We should first examine why they failed. It is easy to attribute the cause to the broad villain called sub-prime, but how did it affect Freddie and Fannie? During the worst of times, F&F still adhered to conforming loan guidelines, though they might have been relaxed. F&F did not buy the no down payment, no qualifying NINJA loans.

The main reason is simple, but is often overlooked. As an example, let us take a property which had a value of $300,000 before sub-prime, but was inflated to $500,000 at the peak, resulting in a $200,000 bubble. Assume F&F bought a loan secured by this property using prudent underwriting guidelines such as good credit, a 20% down payment and low debt-to-income ratios. This loan should be safe, right? NO. Even with 20% down, the property is over encumbered by a $400,000 loan or 133% LTV based on a true value of $300,000.

It was the bubble, not the underwriting, that was the primary cause of failure. Shouldn't the objective of any future policies be to focus on the prevention of bubbles? Isn't price stability one of the missions of the Federal Reserve?

Ten years ago, it was a Fed Chairman and Wall Street greed that were largely responsible for creating the sub-prime bubble. Now once again, it is another Fed Chairman and a new group of Wall Street 1%ers who are trying to inflate a new bubble, all to the detriment of the little people.

What improvements are in the works that would prevent Freddie and Fannie from failing again, regardless of how significant a role they may play in real estate finance in the future? Can the new and improved system endure a, say, 20% decline in real estate value? The short answer is: NO.

Qualified Mortgage, or QM, is receiving the bulk of attention in the mortgage industry right now. QM is supposedly going to offer a safe harbor for the originators and a product that is marketable in the secondary market. In reality, QM is just a new term for "agency conforming loans", something that Freddie and Fannie had for as long as they were in existence, and did not prevent them from failing.

Part of QM is a magical formula that somehow determines the ability-to-pay. If property value declines by 20%, does it really matter whether the debt-to-income ratio was 40% or 45% at origination? I expect QM to add a mountain of red tape. The compliance cost is going to be passed on to consumers. Underwriting standards will be tightened as pegs of all sizes are forced into the round QM hole. Small lenders simply cannot compete due to the compliance burden. These issues should all surface before the end of the year as the effective dates for the new regulations approach. I do not see how QM will make financing more affordable to borrowers. Ironically, the  destructive force behind this calls itself the Consumer Finance PROTECTION Bureau.

In summary, nothing has changed. Instead of trying to prevent another bubble, Bernanke is busy sowing the seeds for one. Instead of paving the way for the private sector to re-enter the mortgage market, the CFPB is putting a strangle hold on the existing monopoly. It remains to be seen how long the real estate market can be supported by endless Fed buying of mortgages and Wall Street funds buying up houses.

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Fannie Mae common stock, monthly since 1987. It is interesting that its all time high occurred well before the now infamous sub-prime credit bubble. Recently speculators bid the essentially worthless stock up to $5. It still trades at $1.50 or so, in spite of actually being worth zilch – a sign (one of many) that we are indeed in an echo bubble   (chart via BigCharts, notes by PT) – click to enlarge.

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Recourse or Non-Recourse

by Ramsey Su

As long as real estate value appreciates, any system will work, even sub-prime. It is when value depreciates that all the flaws are exposed. There are misguided efforts in the works, supposedly intending to correct these flaws. The most notable are the CFPB's (consumer financial protection bureau) mountains of worthless red tape and the Corker/Warner proposal for phasing out the agencies.

This post discusses the most basic terms in real estate finance – recourse or non-recourse.

Think of real estate financing as a real estate investment partnership between two partners, the borrower (B) and the lender (L). There are two types of partnership: recourse and non-recourse.  When property value appreciates, the two types of partnership are identical. The B partner receives all the appreciation, while the L partner receives the original principal plus interest.

When the relationship turns sour, usually due to default by the B partner, the two types of partnership cannot be any more antithetically different. When massive numbers of B partners default due to declining property values, all hell breaks loose.

Under a non-recourse partnership, the burden is on the L partner, who can only seek recovery from the collateral. Underwriting standards should emphasize the collateral. For example, if the borrower is looking for a $50,000 loan against a property that is worth $100,000, it is irrelevant what the borrower's income is, or some random FICO score. This is a good loan. It is a much better loan than, say, a 90% LTV loan to highly qualified borrowers, who always have the option of strategic default if the property value falls below the loan amount.

On the other hand, in a recourse partnership, the burden is on the B partner, who is liable to the L partner for any loss. In this case, the lender couldn't care less if the LTV is 100%, 150% or higher, as long as the borrower has the ability to pay. The property is not much more than a cushion if unexpected hardship falls upon the borrower.

Taking it a step further, the underwriting can be fine-tuned. For example, in a recourse partnership, if say the borrower is a heart surgeon in his early 40s, with over 20 years of high earnings potential ahead, the lender is happy to extend a loan against that stream of income. If the same surgeon is now in his mid 60s and approaching the end of the career, the lender should cut back the loan amount substantially.

In a non-recourse partnership, a lender should look at the future growth of the underlying asset. For example, in a highly stable area with restricted supply, a lender may provide a higher LTV versus a declining area such as Detroit. Whether the borrower is a surgeon or a dishwasher is less relevant.

While logical, the aforementioned methods are illegal under current laws. If a lender refuses to lend to the older surgeon, that would be regarded as age discrimination. If a lender refuses to lend in the dilapidated areas of Detroit, that would be red-lining.

In the history of real estate financing, recourse and non-recourse have never been properly tested. The sub-prime fiasco was the first serious test and the system failed miserably. There are too many gray areas. For fear of political repercussions, many lenders have chosen not to exercise their recourse rights or are prevented from foreclosing regardless of their contractual rights.

It makes no sense to have one nation and two totally different financing systems. It makes even less sense to force odd shape pegs into one round hole, as the CFPB is trying to do now with all its meaningless regulations. If we are going to continue down the path of having both recourse and non-recourse mortgage loans, then it is imperative that they be separated at birth because they are completely different animals. They should have different underwriting guidelines, most likely different pricing and be sold in the secondary market as different products.

Finally, law makers and policy makers must respect the law. They must stop interfering with the right to exercise the terms of a contract, be it recourse or non-recourse. Until this issue is finalized, all other reforms are prematurely putting the cart before the horse.

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Bernanke: The Only Game In Town

by Lance Roberts

It is becoming much more apparent that, as we have seen each year for the past three, the Fed's prediction of stronger economic growth by the end of 2013 will be revised lower from the current level of 2.5%.  This is due to the continued negative annualized trends in the data which continue to deteriorate despite the Fed's ongoing monetary interventions.  The economic data, since the beginning of this year, have continued to point to slower economic growth.

The chart below shows the quarterly change in industrial production at an annualized rate.  While not at recessionary levels currently - it is clear that industrial production has peaked for the current economic cycle is now on a decline.  Historically, when industrial production has fallen below 0% growth the economy has been near, or in, a recession.

With corporate earnings deteriorating, energy and gas prices rising and unemployment still at very elevated levels the bullish case for equities remains solely supported by the Fed's ongoing interventions.

The recent spike in inflationary pressures, which is almost entirely due to the surge in energy costs, also negatively impacts the economy.  The chart below shows the composite inflation index (an average of PPI and CPI) as it relates to economic growth.  The spike in inflationary pressures in 2011 coincided with the peak in economic activity. Falling inflationary pressures, as shown, suggests a much weaker economic environment than is currently being reported.

I would not be surprised to see rather substantial negative revisions to current GDP levels in the next year or so.  One of the reasons that I think GDP is being over-inflated is due to the retail sales data and the abnormal adjustments to the reports.  Bill King, editor of the King Report, also touched on this topic recently stating:

"The soft June retail sales report induced several Wall Street firms to lower their Q2 GDP estimates.

Retail Sales used to correlate exactly to Nominal GDP. Since the Great Crisis the correlation is looser.

Retail Sales vs. Nominal GDP – The probable over-stating of GDP has changed the correlation."

The problem, of course, is that if the only thing supporting the bullish case for equities is the Fed's "bond buying" program; then Bernanke is caught in a very difficult position.  This week Bernanke will go to Capitol Hill for his annual Humphrey-Hawkins testimony where the markets will be parsing every word looking for signs of the Fed's intention to reduce monetary support.  After the Fed's colossal failure with their recent attempt at "taper-talk," which sent stocks and confidence dropping and interest rates spiking, it is highly likely that Bernanke will be very guarded in his testimony.

Back to Bill King:

"Bernanke and many other advocates of QE have a big problem. They are now trying to convince people that tapering or halting QE is separate from rate hikes. For years they asserted that once ZIRP is employed further rates cuts can be administered via QE because the asset monetization generate benefits similar to those that would accrue from negative interest rates.

In fact numerous Fed officials prepared the market for QE by insisting that X amount of QE would be the same as a Y interest rate cut. Now Bernanke and his ilk are trying to convince the market that QE tapering isn't the same as rate hikes. This contradicts their earlier assertions and modeling.

Indeed, in a Congressional hearing on February 9, 2011, Representative Tim Huelskamp questioned how the Fed 'picked $600 billion' when the FOMC decided on a second round of QE (called QE2) at its November 2010 meeting. Fed Chairman Ben Bernanke responded, 'We asked the hypothetical question, if we could lower the federal funds rate, how far—how much would we lower it?' He noted that 'a powerful monetary policy action in normal times would be about a 75 basis point cut in the federal funds rate. We estimate that the impact on the whole structure of interest rates from $600 billion is roughly equivalent to a 75 basis point cut.'"

So, either Bernanke was lying back then or is he lying now? The problem is that the Fed is literally caught in a "liquidity trap" from which there is currently no escape.  If they reduce liquidity the markets tank, taking down consumer confidence and negatively impacting the economy.  If they keep the liquidity going they will inflate an asset bubble which will ultimately burst destroying the financial markets and the economy.  The choice is, ultimately, a lose-lose scenario even as the bullish case for equities persists.

Of course, as Chuck Schumer stated to Bernanke at the last Humphrey-Hawkins testimony, "You are the only game in town."

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Focus on Big Ben

by Marc to Market.

The US dollar is somewhat firmer against most of the major and emerging market currencies as Federal Reserve Chairman Bernanke's testimony is awaited.   The greenback remains largely within the ranges seen in recent days. 

Sterling may be the exception.  In response to the BOE minutes that showed the MPC vote unanimous and a better than expected employment report spurred a quick cent rally in the sterling that saw it rise above last week's Bernanke-inspired highs and stretch to almost $1.5250 before finding sellers. 

The 9-0 verdict by the MPC says more about organizational behavior than monetary policy proper.  It was the new governor's first meeting, having been in office barely a few days and, according to press reports, was having trouble with the proper underground stop.  It would have simply been impolitic, if not rude, to have the dissenters at past meetings (Fisher and Miles) to do anything but what they did.   It means nothing in terms of monetary policy signals.  The next key is the August 7 quarterly inflation report.

The minutes would seem to confirm the expected shift toward forward guidance.  The market's initial take away is that this reduce the chances of new gilt purchases and has seen UK bond yields retrace yesterday's decline, though the implied yield of the short sterling futures curve is soft through the end of next year. 

The UK employment report is consistent with the recent string of data that is better than expected and consistent with  a mild cyclical recovery.  The claimant count fell 21.2k, more than twice the decline the market expected and the May count was revised to show a 16.2k instead of the 8.6k decline initially reported.   

Bernanke's testimony before the House of Representatives today is the main focus.  It overshadows the housing starts and permits.  Bernanke's prepared remarks will be released at the same time as the data (8:30 am ET), which is 90 minutes before his testimony.  Recently, it has been in the Q&A that the most market sensitive comments were made. 

It seems unlikely that Bernanke's comments will be perceived as dovish as last week.  Market positioning does not appear as extreme and, therefore, less vulnerable.     It  is unreasonable for Bernanke to go beyond his recent comments regarding the potential timing of the tapering.  

Many observers have argued that the problem is that the Fed wants to draw a distinction between tapering and tightening that the market refuses to accept.  We don't see it that way.  Of course, investors know the difference.  However, they also know that the talk of tapering is part of the exit strategy and that interest rates have likely bottomed before the Fed does anything.  The markets are anticipatory in nature. 

In addition, the FOMC minutes made clear that "almost half" of the participants, which is a category that includes voting and non-voting members, wanted to end QE by the end of the year.  On the other hand, ":many members", which is a category that includes only voters on the FOMC, wanted to see more job growth.

Bernanke leads the dovish contingent, which includes the Board of Governors and several regional presidents.  Yet, investors are well aware that Bernanke most likely will not Chairman next year.   It is not clear that his words are binding for the next chair person. 

Bernanke's assessment of the economy will be scrutinized.  Since the FOMC met,  the data has been mixed.  There has been a constructive jobs report, but other data have been mixed.  Importantly, Q2 GDP estimates have been revised lower, with more talk of a sub-1% print.   The FOMC meeting at the end of the month concludes a few hours after the first estimate of Q2 is reported on July 31. 

Later today, after Bernanke's testimony is long done, the Beige Book will be released.  The most important aspect to look for are signs that the backing up of interest rates is having a cooling effect on activity.    Some officials, including Bernanke, seemed surprise by the magnitude of the increase in yields on the tapering signal.  The Fed's reaction function is more sensitive to surprises than as expected developments.  The rise in long-term interest rates, if sustained, may impact the Fed's economic forecasts and feedback into policy.  

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Sugar futures poised for strong rebound

by Agrimoney.com

Sugar futures present a buying opportunity – at least, those for distant delivery, which could see gains of some 25% given the damage to production prospects provided by current prices at three-year lows.

New York's October raw sugar contract on Tuesday hit 15.93 cents a pound, the lowest for a spot lot since June 2010, depressed by decent weather for harvesting cane in Brazil, the top producing country, and growing it in second-ranked India, besides by a round of producer selling.

"The drop was also attributed to the Brazilian real weakening against the dollar, which encouraged producers to sell the dollar-denominated commodity to alleviate currency loss," Joyce Liu at broker Phillip Futures said.

The decline has been felt throughout the futures curve, with the March 2015 lot, for instance, setting a contract low of 17.47 cents a pound on Tuesday.

'Clear deterrent'

However, even if pressure remains on prices short-term, "as we approach the peak of the Brazilian Centre South crush and as the Brazilian currency continues to weaken", investors may be too gloomy over long-term prospects, given the incentive that low values are giving to producers not to invest in output, Macquarie said.

Even the values of March futures are below costs of producing sugar, which the bank estimates at about 18 cents a pound for Australia and Thailand, and 20 cents a pound "if not higher" for India and Europe.

Brazil's average industry breakeven costs rose above 21 cents a pound in 2011, but have since retreated to about 17.7 cents a pound thanks to the depreciation of the real.

"We think this will be a clear deterrent to producers from investing in further mill expansion," Macquarie analyst Kona Haque said

Beet vs cane

Indeed, given the need for a strong incentive to attract investment into cane mills and a crop which takes some three to reach its full potential, "prices need to stay 5-6 cents a pound above costs of production for a sustained period before new investment can take place", Ms Haque said.

Indeed, producers of beet, an annual crop for which area can easily be switched to grains, "will be the first to respond to the negative price trend," led by Russia and Ukraine, "followed by other high cost producers".

Former Soviet Union growers have already cut back on beet sowings, with consultancy Ikar forecasting an 18.9% drop to 3.85m tonnes in Russian sugar output in 2013-14.

'Market trend reversing'

While annual world sugar production has grown some 9% since 2010-11 to an estimated 179.1m tonnes, "at today's prices it is questionable whether we can repeat such a strong supply growth", Ms Haque said

Output growth, which has already more than halved below 3% from levels of the past two seasons, is still to fall to about 1% by 2014-15.

With demand expected to rise by 2.4% in 2014-15, encouraged by stockpiling at low price levels, the world will fall back into a production shortfall that season of about 2m-3m tonnes.

"With the market trend now reversing into one that is tightening, as opposed to loosening, we would expect prices to respond," Ms Haque said, foreseeing prices ranging from 19-22 cents a pound in 2014-15.

"This is clearly much higher than the 17.8 cents a pound currently priced in the futures forward curve."

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