Good Evening: On the surface, the tiny changes in asset prices in the U.S. on Tuesday might not seem like much to write about. Mixed earnings results, debatable economic data, and dwindling volatility levels may indicate a snoozer, but real asset prices (i.e. our standard of living) actually fell today because our currency continues to fade. And while the U.S. government keeps trying to find new ways to restart borrowing and lending, China has apparently decided to do something about their large exposure to the greenback. They’re buying raw commodities and cutting long term deals for access to more. I hope we as a nation learn to stop creating paper and the unsustainable debt load the resulting dollars support.
Equities in overseas markets responded to yesterday’s rally in Wall Street with one of their own last night, but the accompanying uptick in U.S. stock index futures didn’t last once the April housing starts figures were released. Starts were down; permits were down; and both set new record lows in the process. While I agree with those who tried to spin this release as a positive development in that fewer starts will lessen the supply of unwanted new homes, the optimists then tried to have it both ways. Some pointed out that single family starts actually rose (condos & apartment construction tanked), saying it was further evidence the housing market had reached bottom. Nice try, but not quite.
There were some positives to report. LIBOR continued to recede, even though many other credit spreads were napping today. SKS was able to convince investors its earnings report was worthy of a buy ticket or two, but HD was unable to pull off the same trick when they reported. The good news, at least to me, was that the total number of outstanding OTC derivative contracts is starting to shrink (see above). We still have a long way to go before this time bomb is defused, and I applaud Congress and the Obama administration for trying to tackle this issue. Contracts need to be more standardized and they need to be moved on to proper exchanges, but at least this situation is starting to improve.
Equities opened near the unchanged mark and then proceeded to spend the day within sight of it. Reports of frayed and/or decaying CMBS structures hurt financial shares, but even this news had an offsetting announcement. The Fed has decided to further loosen the TALF eligibility to now include existing CMBS paper (see above). The news couldn’t prevent the BKX from declining 3.5%, but it did seem to help hold the rest of the tape together. As the closing bell approached, however, stocks retreated from their highs for the day to finish mixed. Every index finished less than 0.5% away from yesterday’s close, and a new, post-panic low in the VIX reflected it. Treasurys, too, were virtually unchanged. The 10 year note saw its yield rise a mere 1 basis point. The dollar was the only scene of any real action, and the greenback suffered another loss that approached 1%. The precious metals finally awoke with a small stir to the upside, but, like stocks, the rest of the commodity complex remained mired near the flat line. The CRB index rose all of 0.1% today.
As last summer’s Olympic games in China were coming to a close, so did that nation’s appetite for commodities. Oil, iron ore, base metals, grains — just about any raw material that could be shipped — all saw Chinese demand disappear. Cramer fretted that FCX and other materials names were “doomed until China comes back”, and prices of all global commodities fell between 30% and 80%. Now that the rest of the world is on its back, this large and getting larger Asian nation is back buying commodities and taking advantage of the large price discounts on offer. Economists have pointed to this new demand from China as proof positive that these orders signal an upswing in China that will soon lift the rest of the globe out of its economic funk.
Not so fast, at least according to RBC analyst, Brian Jackson. He sees China’s recent purchases as not only a stockpiling effort to take advantage of lower prices, but also as a sovereign hedge against dollar depreciation. In the article above he states: “Increased spending on commodities represents a reallocation of China’s sovereign wealth away from the accumulation of financial assets,” Jackson said in a May 15 research note (source: Bloomberg.com). Some may pooh-pooh this analysis because it doesn’t make sense for a nation to buy raw materials for anything other than current production. What these folks forget is that China has pulled off similar moves in the past, albeit on a much smaller scale.
Back in the 1970’s and 1980’s, the large orders for various grains by the PRC would often roil the commodities pits. As a command economy, the government oversaw all purchases of grain imports, and they would sometimes try to game the system they felt was trying to game them. Just when analysts and speculators thought they had Chinese demand figured out, the authorities in Beijing would pull the plug and forego a major shipment or two. Prices would plummet, and, after a time, the Chinese would come back in and buy their fill at lower prices. It’s a neat trick, and we might be seeing something similar writ large here in 2009. The clinching evidence that China is serious about the long term value of commodities is in all the deals they’re cutting with commodity producing nations. From Central Asia to South America, the Chinese have their checkbooks open while the G-7 nations have their central bank vaults open.
What’s important is that, just as Mr. Jackson points out, this move might signal something other than economic demand in China. They know they will eventually need these items; what they fear is that the dollar price of them might rise. Buying up global commodities in excess of what their economy actually needs is a hedge — against either inflation, a falling dollar, or both. The message this sovereign wealth hedge sends to those of us here in the U.S. is that China sees raw materials as an offset to what might happen if we continue to run the printing presses as hot as we have of late. As the greenback declines, our standard of living declines in relation to China and the rest of the world. Mineral-bearing rocks and other raw materials are productive goods that have uses. As such, they might just be a better store of value than the paper currency known as the U.S. dollar. The rules of the competitive child’s game don’t apply to the Chinese. For them, rock beats paper.
— Jack McHugh — for an outstanding explanation of why our nation’s policies might give the Chinese a reason to prefer commodities over our paper for now, please read John Mauldin’s latest edition of “Outside the Box”. In “The End Game Draws Nigh — The Future Evolution of the Debt-to-GDP ratio”, Horace “Woody” Brock does a first rate job of bringing together many of the themes I’ve been writing about in a cohesive and meaningful way. You can subscribe to John Mauldin’s site here. It’s a must read, especially for our leaders. JJM