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Symbols, JJC, DBB, BHP, RIO, GCC, FXI, FXA, FXB, and FCX
“You unlock this door with the key
of imagination. Beyond it is another dimension, a dimension of sound, a
dimension of sight, a dimension of mind. You’re moving into a land of
both shadow and substance, of things and ideas. It’s a journey into a
wondrous land, whose boundaries are that of imagination. That’s a
signpost up ahead, your next stop, the “Twilight Zone!”
Rod Serling
was a multi-talented man and a prolific writer. His television series
“The Twilight Zone” ran for five seasons in the early
1960’s and was extraordinary, winning three Emmy Awards. As the host
and narrator, and writer of more than half of 151 episodes, he became an
American household name and his voice always sounded a creepy reminder of a
world beyond our control. For many traders in the commodity pits, every
trading day is like entering “a fifth dimension beyond that which is known
to man, that lies between the pit of man’s fears and the summit of his
knowledge. It is an area called the “Twilight Zone,” Serling used to say.
Such has been the case for the once high
flying Copper market, which touched an all-time high of $4.6250 /pound, in
February 2011, yet last week, briefly plunged to as low as $3 /pound, and
tumbling -35% below its all-time high. Most of the slide occurred within a
nine week period, starting on August 7th. It was the most rapid
downward spiral the copper market has experienced since the “Crash of
2008.” Hedge fund traders, that control as much as $2-trillion is
customer funds, were reported to be selling a wide array of commodities,
including, corn, gold, silver, soybeans, and copper, in order to meet redemption
calls by jittery investors, who were shell shocked by $11-trillion of losses
in global stock markets.
Yet how does one explain the sudden
sharp drop in copper prices that sliced off a third of its value? At last
count, global demand for copper is not too far from record highs, and
furthermore, demand for copper is expected to exceed new supplies by roughly
200,000-tons this year, leading to a supply deficit, which should buoy copper
prices. “There has been some softening in copper demand, but not to the
extent seen in the copper price,” said Richard Adkerson,
chief executive of Freeport McMoRan Copper &
Gold FCX.N, the world’s largest publicly traded copper miner.
“There’s this disconnect right now, and that’s because
investors are concerned about the future. There are huge macroeconomic
uncertainties, and it’s driven by that,” Adkerson
said. In other words, the traders in the copper market are operating in the
Twilight Zone, where its
difficult to separate illusion from reality.
Part of the
reason for the sharp slide in the copper market since August 7th,
are indications that activity in the global factory sector has slowed down to
stall speed. On Oct 3rd, JP-Morgan reported that the Global
Manufacturing PMI had contracted worldwide for the first time in over two
years last month as incoming orders for new work dried up. The Global Factory
PMI fell in September to 49.9 from 50.2 in August, the first time since June
2009 that the index has fallen below the 50-mark that divides growth from
contraction, after sliding for the last seven months. More ominously, the New
Orders index fell to 48.5, down from 49.4 in August, it’s
lowest since May 2009 and the third straight month it has been below 50.
On Oct 4th, Fed chief Ben
Bernanke to Congress that “the US-economy is close to faltering,”
and Goldman Sachs warned that the
US-economy is on the edge of recession. “The European crisis
threatens US-economic growth via tighter financial conditions, reduced credit
availability and weaker growth of US-exports to the region. This impact is
likely to slow the US- economy to the edge of recession by early 2012,”
Goldman said. Earlier, the Economic
Cycle Research Institute also warned that the US-economy was already past the
point of no return, and beyond the ability of policymakers to help. “The most reliable forward-looking indicators are now collectively
behaving as they did on the cusp of full-blown recessions, not soft
landings,” the ECRI said in a report.
All these
forecasts and reports conjured-up the illusion of an impending
“double-dip” recession in the Trans-Atlantic economy. However,
sentiments can turn on a dime in the commodity markets, especially when
central banks intervene to try and change the realities. On Oct 4th,
Bernanke stopped the
panic on Wall Street, when he strongly suggested to Congress that he would
unleash the Fed’s nuclear option, “QE-3,” to inflate the
stock market’s value. Over the next few days, the S&P-500 soared by
+8%, and escaping the grasp of the grizzly Bear.
Still, the
magnitude of the recent collapse in copper prices is very surprising,
considering that the global demand for copper has increased by an average of
+4% per year for the past 110-years. Furthermore, the size of the
world’s population is increasing 80-million persons each year, thus
placing even greater demands on the world’s resources. On June 22nd, Bank of Canada
Governor Mark Carney highlighted this point, saying that populations in “China and India are
increasing by the entire size of Canada’s population every year and a
half. The middle class globally is growing at 70-million people a year, so
just the marginal demand for these commodities is enormous and being driven
by the major emerging markets. We see strength in commodity prices persisting
for some time,” Carney said.
Yet three months later, the Continuous
Commodity Index, a basket of 17-equally weighted commodities suddenly
nosedived -15%, skidding to as low as the 560-level on October 5th,
as traders dumped a wide array of commodities, including aluminum, corn,
soybeans, sugar, silver, cocoa, nickel, natural gas, crude oil, coffee, and
wheat. Of all the top commodities however, copper was the hardest hit. What
compelled traders to dump this highly prized metal and other important
commodities, in a panicked selling spree, when the reality is, there’s
the inexorable increase in the world’s population background,
that’ll boost demand, irrespective of the swings in the global business
cycle?
As Albert Einstein
used to say, “Reality is merely an illusion, albeit a persistent
one.”
Instead, traders were gripped by fear of Armageddon. The specter of a banking
crisis in the Euro-zone was haunting frightened traders, after the interest
rate on Greece’s 2-year note briefly soared to as high as 100-percent.
Likewise, the yield on its 10-year bond jumped to 24.75%, knocking the price
of the Greece’s 10-year bond to 36-cents per Euro. The odds are very
high that Athens would default on its 357-billion Euros of debt, and based
upon current prices, traders expect that the Euro-zone’s Oligarchic
bankers would be forced to take a “haircut” of about 60% on their
toxic holding of Greek bonds.
“Greece is bankrupt,” said Michael Fuchs, a deputy parliamentary
floor leader for the Christian Democrats in the Bundestag, reflecting a
growing mood of deep pessimism in Berlin. “Probably there is no other way for us other
than to accept at least a 50% forgiveness of its debts,” Fuchs told the
Rheinische Post newspaper. Hedge funds began
dumping commodities, fearing that nervous bankers would call in margin loans,
extended in ultra-cheap US-dollars.
The panic on the stock markets shows that if Greece defaults on its debts,
it could trigger a deep recession in the Euro-zone, that’ll eventually
spill over to the US-economy, which is already beset by stagnating growth and
a high jobless rate. There are worries that companies would
respond with new waves of layoffs, while Euro-zone governments are forced
into further austerity, thus guaranteeing a “double-dip”
recession.
The political elite of France and
Germany have no choice but to bow to the demands of Europe’s banking
Oligarchs, by placing a firewall around this “too-big-to-fail”
cartel. Finance official and central bankers will deny the possibility that
Athens would default on its debts, - until it actually happens! While buying
some extra precious time, France and Germany are preparing the groundwork for
an orderly restructuring of Greece’s debt by year end. The reality is,
Europe’s banking Oligarchs would survive, but could end up as zombie
banks.
As far as the copper market is
concerned, the radar screen is squarely focused on the outlook for juggernaut
Chinese economy, which consumes about 40% of the world’s supply of
refined copper. In fact, the growth in worldwide demand for copper has been
driven by China, increasing by a stunning +215% over the past ten years, to a
record 5.1-million tons in 2010. Recently, traders are becoming anxious about
the unrelenting slide in the Shanghai red-chip index, which tumbled last week
to its lowest level since July 2010, this conjuring-up the illusion of a
so-called “hard landing” in the Chinese economy.
China’s economic engine helped
propel the world out of the last recession, after Beijing unveiled a
4-trillion yuan ($570-billion) stimulus package,
that kick-started its economy, and helped to catapult many commodities to
record heights. However, the cylinders driving China’s economy appear
to be slowing down. HSBC’s purchasing managers’ index was stuck
at 49.9 in September, and staying
submerged below the 50-mark for a third-consecutive month. That
helped to knock commodity markets lower and fed fears that this time, the
world’s #2 economic engine will not be able to overcome a downturn in
the European and US-economies, while Japan has already been stuck in
recession for the past nine months.
Beijing’s stimulus package
unveiled in November 2008, left in its wake massive
amounts of excess liquidity of yuan swirling in the
economy that ultimately fueled an upward spiral in inflation. Combined with
credit-fuelled growth, an increasing number of bad bank loans, and a inflating property bubble, Beijing was forced to tighten
its monetary policy using its various macro-tools. For about
1-½-years, the People’s Bank of China (PBoC)
has sold T-bills and hiked bank reserve requirements to drain excess
liquidity, and manage to slow the growth of the M2 money supply. On July 6th, the PBoC lifted the benchmark one-year lending rate to 6.56%, and its benchmark one-year deposit rate to 3.50-percent. Beijing has
also allowed the yuan to appreciate by +7.2% versus
the US-dollar since June 2010.
Reflecting the
success of the PBoC’s operations, the growth rate of China’s M2
money supply slowed to a +13.5% annualized rate in September, down sharply
from +29.7% in November 2009. Much of the drainage of excess liquidity was
accomplished by hiking banks’ reserve requirements to a record high of
21.5%, thus forcing banks to park more of their customer deposits at the
central bank, and leaving less yuan available for
lending. Furthermore, five quarter-point interest rate hikes, by the PBoC, flattened China’s yield curve to the brink of
inversion. In late August, the yield on China’s 1-year T-bill rate and
its 10-year bond was only 5-basis points apart, narrowing the spread from
+170-bps a year ago,
The specter of a possible
“Inverted” yield curve in Shanghai, coupled with the descent of
the Shanghai red-chip market into Bear market territory, whipped-up fear
mongering ideas that Beijing could miscalculate, by tightening its monetary
policy too far, and possibly topple its juggernaut economy into a “hard
landing.” It’s still unclear when such a long awaited correction
would happen, or whether it’s just an illusion, that’s at odds with reality. On July 27 Xia Bin, an
influential member of the PBoC, told the
People’s Daily newspaper that monetary policy should stay relatively
tight in the foreseeable future to help tackle inflation. “China should
gradually make real bank deposit rates positive and continue to use open
market operations and bank reserve requirements to slow money supply,”
he said. Bin’s remarks spooked traders in both the Shanghai copper and
red-chip markets.
After
global stock markets fell to a 2-year low and the Euro tumbled to its weakest
level against the Japanese yen in more than a decade on October
4th, as illusions of a Greek default moved closer to becoming a
reality, the yield on China’s 1-year T-bill fell sharply, by a
half-percent to 3.42%, while yields on the 10-year bond fell to 3.75-percent.
The sharp drop in China’s T-bill rate, and the widening of the yield
curve, sent a signal that Beijing would not cross the line into an inverted
yield curve that could’ve weakened China’s economy.
Beijing also sent a
strong signal to the marketplace, on October 10th, that
it’s prepared to rescue the Shanghai red-chip market, and stop its
slide, when it instructed the Central
Huijin Investment Co, a unit of
China’s sovereign wealth fund to start buying more shares in the
country’s big banks. The
additional share purchases of the Agricultural Bank of China 1288.HK,
Industrial and Commercial Bank of China 1398.HK, China Construction Bank
Corporation 0939.HK and Bank of China 3988.HK are the first
by Central Huijin Investment since the fourth
quarter of 2008, when the Politburo first officially acknowledged that it was
intervening in the marketplace to prop up share prices during the financial
crisis.
The initial
reaction in the Shanghai red-chip market was surprisingly muted, surrendering
an early +2.5% gain, to close unchanged for the day. However, the Hang Seng Index in Hong Kong managed to extend gains for a
fourth day, closing at 18,141, but still hovering far below last
November’s peak at the 25,000-level. Beijing aims to squeeze short
sellers in Hong Kong, where 14% of all outstanding shares have been sold
short by speculators. Any significant rebound in Chinese equity markets could
buoy sentiment tin the base metals markets.
Another reason cited for the surprising
-35% drop in copper prices to its lowest in 14-months, is the rebound in the
value of the US-dollar, against a basket of six currencies. A strong
US-dollar makes copper and other commodities more expensive for holders of
other currencies. The British pound fell by nearly 12-cents versus the
US-dollar to as low as $1.5270 on October 7th, after the Bank of
England (BoE) decided to inject a further £75-billion into the London
money markets in the months ahead. Thus, a suddenly resurgent US-dollar is
mostly attributable to a destructive BoE policy aimed at weakening its own
currency, while at the same time, the Fed has paused its own QE money
printing operations.
The BoE decided not to wait to launch
QE-2 until November or beyond, after hearing of grim figures that showed the
British economy is in worse shape than previously thought. The Office for
National Statistics (ONS) data showed the UK economy grew by just +0.1% in
the second quarter of the year and +0.4% in the first quarter – slower
than the 0.2 per cent and 0.5 per cent previously reported. The ONS also said
the UK-economy shrank by -7.1% in the depths of the Great Recession –
more than the -6.4% originally thought.
Yet the BoE’s main goal was to
manipulate the British stock market, and prevent the Footsie-100 Index from
falling below the key psychological 5,000-level. When the BoE succeeded in
jigging-up the Footsie-100 and its companion FTSE-250 Index, it also helped
to stabilize the copper market, finding support at the psychological $3
/pound level, before bouncing higher. For several weeks, currency traders
were short selling the British pound vs the US$, in
anticipation of QE-2 in London. As is often the case, traders decided to
buyback short positions after hearing the news of QE-2. As the British pound
rebounded towards $1.5650 - the copper market also jumped +10% higher to
$3.36 /pound.
There’s also speculation that
Chinese users of copper might decide to take advantage of the sharp drop in
prices, by replenishing their depleted stockpiles. In the warehouses in
Shanghai, the supply of copper has been whittled down to as low as
98,000-tons. With excess stocks now extremely low and
assuming the illusion of hard landing in China, doesn’t materialize
into reality then China’s purchases of the red-metal could increase. Last October, Chinese traders began to
rebuild their inventories of copper, by doubling the size of their stockpiles
to 180,000-tons, and helped to push-up the price of copper to above
72,000-yuan /ton.
Copper is the metal
with a PH-D in Economics
because it’s regarded as a leading indicator of the health of the
global economy. It is used in the construction of buildings, power generation
and transmission. Copper wiring and plumbing are integral in these items. By using
copper for circuitry in silicon chips, microprocessors are able to operate at
higher speeds, using less energy. From the beginning of civilization copper
has been used by various societies to make coins for currency. In the US, one
cent coins and five cent coins contain 2.5% and 75% copper, respectively.
Euro coins, first introduced in 2002, also contain copper.
So generally speaking, the higher the
price for copper, the more buoyant the global economy is thought to be.
That’s why the recent fall off a cliff is perplexing. Usually at the
beginning of a change in trend that the fundamentals do not explain or
support what the market is doing. By the time the time the fundamentalists
realize what’s changing, it’s often too late to profit. In other
words, while the known fundamentals have already been discounted in the
market, prices are now reacting to the unknown. Some of the most dramatic
market movements in history have begun with little or no perceived change in
the fundamentals.
China is the
world’s biggest buyer of iron ore -- a key steel-making material. The price
of iron ore in the Chinese spot market has fallen by -13% from its peak level
of $189 /ton reached in February 2011, and far less than the -35% drop in
copper prices. Iron ore has not yet tumbled below its key pivot level of
support seen at the $165 /ton level, distancing itself from the copper
market, even though the two key industrial metals had closely traded in
synchronization for the past few years. One reason perhaps, is that
speculators cannot trade in the Chinese spot market for iron ore, and the
supply of the iron ore is largely under the control of an Oligopoly of three
major metal miners.
Iron ore
accounts for 73% of Rio Tinto’s earnings, mostly extracted from the Pilbara region
of Australia and also in Canada. BHP
Billiton earns 40% of its profits from iron ore. Only Brazil’s
Vale mines more iron ore each year. However, Rio Tinto aims to expand its iron ore output by +50% to 333-million
tons a year by the first half of 2015, which is expected to cost $11-billion
in capital spending. BHP
Billiton is earmarking $10-billion of a planned $80-billion spending spree
over the next five years to expand its iron ore and coal mining.
Chinese steel production continues to
grow, expected to hit 680-million tons in 2011, up from 627-million tons in 2010, and
567-million tons in 2009. That’s 46% the world’s total output. In the 31-year time period through 2009,
China’s economy grew an average +9% /year enabling it to become the
world’s second largest economy. China’s steel industry, along with a number of other key
industries such as the automotive, construction, textile, home appliances,
and petrochemical industries are considered to be key barometers of its overall economy. Nearly
91% of the crude steel produced in China, comes from integrated mills, which
use iron ore. More than half of the iron ore has to be imported.
China’s
steel output hit an all-time record high of 60.25-million tons in May, but
inched lower to 58.75-million tons in August. That was still +14% higher than
a year earlier, but many traders are convinced that China’s steel
output has reached a cycle peak. However, “What we’ve seen over the past five years is that China continues
to climb a wall of worry. It continues to see concerns, but it grows past
those concerns,” said Rio Tinto’s RIO.AX,
RIO.N’s chief executive Tom Albanese said on October 11th.
China’s
imports of iron ore in August totaled 59-million tons, up +8.3% higher
compared with July, and up +32.5% from a year earlier. Yet index-based
spot prices for iron ore fell -5% in September, skidding to $165 /ton today.
“We continue to see robust business conditions for Rio Tinto products
into China, particularly in iron ore. We would not foresee real significant
changes in that demand profile in the next few months,” said Albanese.
The fear arising from the European debt
crisis that shook the world’s commodity and stock markets this past
summer, and slammed the copper market, don’t seem to reflect the
realities of the “real economy” as the underlying demand for iron
ore and coal remains strong. “My
sense is that these expectations are gloomier than what’s actually
taking place on the ground. From what I’m seeing, the actual real
economy is doing better than the financial markets are worrying about,”
Albanese added.
“The risks around Greece and the
contagion beyond Greece are probably having a dampening on sentiment. I would
just hope that the leaders, particularly in Europe, who are dealing
immediately with the debt crisis in Greece, recognize that they themselves
can influence expectations.” Albanese said last month that Rio’s
order books were full and pricing was strong. “Since I made those
comments in September, we haven’t seen that much of a change in sentiment
or our underlying businesses. What we’ve been seeing in our business is
that the general economy is going OK, even in the US,” he said.
Coking coal is also a key raw material
in steelmaking.
As a major coal mining country, China
is the world’s leading miner of coke, with annual output of 3.3-billion
tons, the largest in the world. China was a net exporter of coal until
2008, when its demand for coal to meet its energy and manufacturing
needs outpaced the domestic supply. In
2009, China became a net importer of coal for the first time. It bought
104-million metric tons of coal, including both thermal coal - used to fire
power plants for generating electricity, and coking coal.
Every ton of
crude steel needs about 600-kilograms of coking coal, according to BHP, which
forecasts demand for the fuel to gain more than +50% by 2025. China
is not the only force driving up world coal demand. India’s rising coal
needs, along with those of South Korea, and Taiwan are contributing to the upturn
in demand. Indeed, world crude steel production in
the first six months of 2011 was 758-million tons, or +7.6% higher compared
with the same period of 2010, with all geographical areas showing signs of
growth.
Yet the
collapse in copper prices and the share prices of the world’s top-2
miners, BHP and Rio Tinto appear to be discounting a deep and troublesome
global economic slump in the months ahead that might not occur. The deep
seated sense of pessimism isn’t matched by the price of NewCastle coal or iron ore in the Chinese spot market.
Instead, both commodities are still clinging to their key pivot points of
support. New Castle thermal coal has limited losses, tumbling by just -10%
below its peak level reached last January. Global steel
mills including Baoshan Iron & Steel,
China’s biggest publicly traded steelmaker, Sumitomo Metal Industries,
Japan’s third-largest steelmaker, and India’s Tata Steel, would
be happy to see coking coal and iron ore prices tumble further, in order to
help lower their input costs.
Coal and iron ore are
Australia’s top-2 export earners, and their price direction is a key
driver for the Australian dollar. The boom in commodity prices fueled by the
Fed’s $600-billion printing operation, dubbed QE-2, helped to lift many
global commodities to record highs, and elevated the Aussie dollar to 29-year
peaks at $1.1050. The Australian Bureau of Agricultural and Natural Resources
is projecting $255-billion in annual commodity export earnings -- equal to a
fifth of the country’s gross domestic product -- over the next four
years.
Australian
iron ore exports, the biggest earner, are forecast to jump +5% to 425-million
tons in 2011,
fuelled by a recovery in global demand from steel-makers, and could near
600-million tons by 2016. The main drivers will be the urbanization of China and India. Australia is uniquely
blessed to benefit from a rise world
steel production, that’s expected to grow +7% to 1.5-billion tons
and +6% /year through 2016 to reach 2-billion tons. Australia’s exports of metallurgical coal, used to heat steel
furnaces, are projected to grow at an average annual rate of +5% to reach
219-million tons in 2016.
Australia’s
export prices in June were +10.5% higher than a year earlier, far
outstripping import prices which were down -1% on the year. That pushed the ratio of export to import prices, to double the average for the
whole of the 1990’s. The Reserve Bank of Australia (RBA)
has estimated that for every year the terms of trade stays at such
stratospheric levels, it is worth a staggering 15% of the country’s
A$1.3-trillion of annual economic output. This A$200-billion in extra income shows up in profits, wage, and
employment and is fuelling massive investment as miners scramble to meet
demand from China and India.
Yet the income
gains are very unbalanced, and actually have created more losers than
winners. For example, BHP Billiton posted a $22-billion profit -- nearly a
third of the total $71.4-billion profits reported by Australian companies. In
fact, the state of Western Australia, with 10% of the population is earning
about 60% of Australia’s foreign exchange. The
other 90% of Australia is earning less than half the foreign exchange. Industries
trying to win exports or fend off imports have shed 90,000 jobs in the past
three months as they try to deal with the cost of the high Australian dollar,
while miners reaped record profits.
Fears of a
cyclical top in Australia’s top-2 export earners, coal and iron ore,
have already led to a sharp slide in the value of the Australian dollar, to
as low as 94-cents on October 4th. Yet the highly volatile Aussie
dollar, - the symbol of global risk taking, rebounded back to parity with the
US-dollar, after Fed chief Bernanke hinted at unleashing QE-3. For now, all
eyes are focused on Europe, waiting for the crooked politicians to rescue the
banking Oligarchs, because that’s a big part of what’s needed to
turn the copper market upward.
Gary Dorsch
Editor, Global Money Trends
www.sirchartsalot.com
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