Daily Note – Is Goldfinger copper-fastened?

Copperfastened

Summary

United States: WSJ Hilsenrath- next cut looms in Fed bond buys

China: Forbes weekend article piles more pressure on the China interbank market forcing the PBOC to inject liquidity overnight

Commodities: we wait to see if improving developed market demand can offset slowing emerging market dynamic

 

Good morning.

What have James Bond, Martin Luther King, South Wales and the price of copper got in common? The answer is slavery.

I don’t think of South Wales that often although it is really very close to us here in Dublin, however, looking at the draw for the quarter finals of the Heineken Cup this morning got me thinking about a possible return journey to Cardiff for the final – if Leinster progress. It’s a big if, but the last time I was in the Welsh capital it was for the same final three years ago, when Leinster came from way, way behind at halftime to beat Northampton.

No one thinks about South Wales without thinking about rugby and the tradition the Welsh have for playing brilliant, free-flowing, working-class rugby.  However, another thing South Wales was famous for was the industrial heartland of the Valleys and copper. As well as industry, I was fascinated to learn the last time I was there, that it is home to one of the oldest black communities in Britain. The Tiger Bay area of  Cardiff was/is home to one of the oldest black communities, because there was an enormous slave trade based in South Wales, second only to the slave trading centres of Bristol and Liverpool.

The reason that this part of the world had a slave trading business was copper. Copper was central to the slave trading “Atlantic Triangle” from Britain, to west Africa and to the British colonies of the Caribbean and the southern colonies of the pre-revolutionary USA.

90% of British copper was smelted in South Wales and was traded for slaves in west Africa. The African slave traders were well past trinkets by the early 18th century and wanted copper. They exchanged copper for  slaves and these poor people were sold/exchanged for sugar and cotton in the Americas. The sugar and cotton were brought back to Britain and exchanged for more copper and the trade started again. Indeed another commodity made in Wales which was part of the Atlantic slave trading triangle was wool. The sheep rich hills of mid Wales produced a coarse type of wool and this became known as “negro cloth” as it was the staple uniform of slaves working on plantations in Virginia, South Carolina and Jamaica.

The last time I was in Cardiff, my son and I went on a tour of the city ahead of the game and we headed to Tiger Bay – the ancient black community of the 1800s. These people were originally slaves bought with Welsh copper. How any other millions were enslaved because of copper? Could even the ancestors of Martin Luther King be amongst them? Were the ancestors of the most famous black resident of Tiger Bay, Shirley Bassey, who sang the theme songs to the early James Bond films “Goldfinger” and “Diamonds are Forever” also victims of copper?

Interestingly, globalisation and the expansion of copper mining, caused a dramatic slump in the price of copper in the late 19th century and it was this, not the abolition of the slave trade, that put paid to Wales as a slave trade outpost.

Today the price of copper is weak again. My hunch is there may be an opportunity for us here, which I will talk about a bit later in the note. And if we come back to South Wales it will be because Leinster will have beaten Munster in the Heineken Cup semi finals, a event which should prompt fireworks here in Ireland.

United States: WSJ Hilsenrath: Next cut in Fed bond buys looms

With the US markets on holiday yesterday for Martin Luther King day, global markets went into slow motion after the initial frenzy around the large Deutsche Bank profit warning (the stock finished down over 5%). Earnings session in the US continues today, for updates keep your eye on @Globalmacro360 for updates

Elsewhere in the US, markets are beginning to focus on next week’s Federal Reserve meeting –  the last pow wow of Chairman Bernanke. The USD overnight has strengthened and US yields moved a bit higher (5 Year back to 1.67%.)  The chatter in the markets overnight is that the Fedhead Hilsenrath’s latest missive in the Wall Street Journal may be having an impact:

The Federal Reserve is on track to trim its bond-buying program for the second time in six weeks as a lackluster December jobs report failed to diminish the central bank’s expectations for solid U.S. economic growth this year.

A reduction in the program to $65 billion a month from the current $75 billion could be announced at the end of the Jan. 28-29 meeting, which would be the last meeting for outgoing Chairman Ben Bernanke.

See the here for the full story

As I outlined after the December US employment report, I continue to expect a further $10b of “tapering” from the FOMC next week and then every month till the program is wound up. This may be  slowed by a meaningful wobble in the US economy and/or a significant sell off in risk assets, particularly stocks.

China: Forbes article piles more pressure on the China interbank market, forcing the PBOC to inject liquidity overnight

Forbes magazine got hold of the story we had last Friday regarding the danger of default of an investment vehicle that was used to finance a mining project.

While Forbes paints a rather catastrophic picture of the Chinese banking sector, if that default happens it may not be the “end of the world” event they think it is. As regular readers know, we strongly believe expecting the world to end (“EOW”)for the vast majority of the time is an unprofitable exercise. Trying to find the “EOW” investment is a quick way to go broke.

Many people who missed the 2008 crash are still trying to resurrect themselves by finding the next great collapse. We like to focus on actionable investing ideas with a three to six month timeline and leave the EOW of the world predictions to others.

Returning to the China story, the amounts involved are tiny in the overall scheme of things. Sales of the investment vehicle totalled 3.03bn Yaun which is around $496m. This money was then lent to, what has turned out to be, a rather struggling company called Zhenfu.

The product was sold through the ICBC, one of China’s biggest banks and one of the world’s most profitable lenders. Forbes states that they will not assume the main responsibility for any default.

The potential risks from such defaults have hit the market before and have been soaked up by the banks, while the PBOC kept the market calm. My sources in China claim that the banks have been setting aside huge amounts to deal with bad loans and other “rainy day” events. Back in October the market got spooked by a story of significant debt write downs by Chinese banks. On closer inspection, it wasn’t as shocking as it was made out. The numbers involved were small and the provisions large enough.

However, if we take a bit of altitude, there is one thing we all know and it is that a period of massive credit expansion never ends well.You won’t read this many places, but is there a risk of a Lehmans moment in China? I am not a EOW merchant, but a banking system with lots of leverage, unsophisticated credit controls and a country in the midst of a housing/credit bubble, are enough to make us cautious. I want to commit capital to Chinese stocks at these low valuations, but am willing to wait a bit longer, just to be on the safe side.

These concerns about the liabilities of the large China banks, sent the 7 day repo market higher again, forcing the PBOC to inject liquidity overnight.

  • PBOC to inject 180 billion yuan via 21-day reverse repos today
  • PBOC to inject 75 billion yuan via 7-day reverse repos today

This forced the 7 day repo market down to 5.25% vs. 6.6% at the close of business yesterday. The rate was over 7% at one point yesterday. On the back of this action, China stocks had their first up day in five (+90bps).

It’s still a very murky world in Chinese banking and shadow banking and no doubt if the default happens we are likely to see some volatile days in Chinese markets. This could spread. The response from China will be telling should the authorities let the default happen as a warning to others. If they do allow the default  then we could have some rough days. If they cover it, then the market will likely not bat an eyelid – this time. But, as we have seen in the past, kicking the can down the road isn’t always the best strategy.

We continue to sit on the sidelines when it comes to China; no reason to put your toe in the water just yet.

Commodities: we wait to see if improved developed market demand can offset slowing emerging market dynamic

Let’s go back to South Wales now. I have been asked by a number of subscribers to give my view on commodities.

Take a commodity like copper. The price has fallen significantly in 2013 (circa 10%). People argue that because copper is in practically everything we buy, from computers to cars, if the world economy is turning, should the demand and thus the price of copper be set to skyrocket?

Fig 1 Copperfastened

Not that quick mate.

The outlook for commodities is not a simple one. While macro economic drivers are important, there is a supply and demand dimension to commodity investing which adds a layer of complexity.

This new down cycle in commodities is exactly the opposite of the “super cycle” (2002-2011) that was so positive for commodities in previous years.

Back then, weak US economic growth following the 2001 recession lead to  Greenspan’s expansionary monetary policy. This weakened the dollar.

Domestically, the US recovered between 2004 and 2007, fuelled by cheap credit in both housing and consumer borrowing, The overall impact of US fiscal and monetary policy reinforced the growth in demand of all emerging markets and China in particular. Many emerging market countries became the manufacturing base for the majority of US consumer products as corporate America invested abroad.

After the G20 meeting in the UK in 2009, a traumatised rich world convinced emerging market economies to use their large current account surpluses to build capacity. It was hoped that this investment splurge would drag global economy out of recession.

Unfortunately, as the global economy stumbled from the sub prime crisis in the US to the Eurozone sovereign debt crisis in 2010, global demand failed to pickup. Now all this capacity (empty factories, ghost cities and unused roads in China) forced a rethink. If investment couldn’t lead to growth, it had to be stopped. And without massive investment projects, the price of raw materials had to plummet.

China made the decision in late 2012 to move from a resource hungry manufacturing and export economy to internal demand. This pulled the investment support from global commodity demand.

With copper prices declining by more than 25% over the past two and a half years, it is tempting to call a turn in the market. This is especially the case given the bullish “top down” outlook for global demand growth – led by an acceleration in growth in the developed markets.

Recent supply disruptions – including an ongoing Chilean port strike, disrupted exports from Indonesia, and smelter problems  in China, Zambia and the Philippines have also been supportive of pricing in recent months.

Nonetheless, we believe that the events of the last 18 months driven by the rotation away from emerging market (raw material heavy) towards DM demand (raw material light) as well as the supply increase, particularly the US Shale Revolution, are creating a new commodity cycle which is the previous cycle inverted. As the US economy continues to see an improving growth outlook driven in part by cheap energy leading to a manufacturing renaissance, the Federal Reserve will continue to “taper” asset purchases.

The less accommodative monetary policy puts more downward pressure on EM demand for commodities while the associated devaluation of EM currencies incentivizes these countries to produce more commodities to raise cash (i.e., a weaker Brazilian Real has stimulated more soybean planting).

The net of all this is broadly more commodity supply and while there may become a point where prices becoming very compelling we don’t see this happening in the short term.

Portfolio: Little change in the portfolio as we await the US returning to the market

Portfolio 21 jan

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Global Macro 360 Daily Note – Is Goldfinger Copper-fastened_

 

 

 

 

 

 

 

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