Monday, 24 November 2008

Commodity Price Directions

Commodity indices have lost 50% of their value since July 2008 in response to the global financial crisis, deleveraging and worsening economic outlook. With many developed economies in recession and emerging economies to follow, it seems quite likely that prices may even fall further, outpacing production cuts.

Those commodities that grew the most expensive in the shortest period have suffered the sharpest price drops in recent months. Metals and energy (oil) led the decline while agricultural commodities fell less as their price climbs were not as excessive. Across the commodities group, inventory buildup and falling demand creates conditions ripe for a continuing current bear market despite the fact that some commodities, such as oil, seem to have fallen below production costs.

Crude oil futures have fallen from a peak of $147/barrel in mid July to around $50/barrel, well below the 2007 average price. U.S. government data suggest that demand is about 6-7% lower than last year, with the sharpest declines in jet fuel. Forecasts from the EIA and OPEC suggest that 2009 might mark make the largest contraction in oil demand in decades, despite the recent price correction. EM oil demand will be insufficient to offset growing declines in the OECD countries. Financial market trends and macro fundamentals point in the same direction, towards weaker energy prices, at least for the foreseeable future.

In the short-term, it might take a major supply shock - say one that cuts off Iran’s oil supply - to boost prices. OPEC's willingness to comply with current production cuts may be the most significant supply side factor. The elevated cost of new oil supplies may lead to future supply crunches. Canada’s oil sands are very expensive at today’s prices and projects are being deferred if not canceled. Demand for alternative energy tends to move inversely to fossil fuel prices, so the deep cuts in oil and coal prices could pose a headwind for alternative energy, unless counteracted by climate change mandates. Fortunately for producers, falling grain prices will help relieve the profit margin squeeze, even if the credit crunch impairs borrowing for expansion.

Base metal prices have suffered even steeper drops than oil. This commodity group is the most sensitive to the slowdown in industrial production. Nickel and zinc initially led the group’s decline, but were succeeded by copper and aluminum. Expectations that supply gluts will mount next year brought metals prices back to levels closer to operating costs. These two metals’ strongest sources of demand - stainless steel for nickel, auto parts for zinc – are withering, and the supply glut will be exacerbated by output from new mines. Meanwhile, copper and aluminium prices have yet to undershoot their historic break-even levels.

Steel prices have nose-dived from above US$1,200/ton in June to below US$300/ton. Prices will likely resume crashing next year, on weakening demand, particularly from China, falling freight costs and lower cost of inputs (coal and iron ore). Like other base metals, the demand collapse has left steel producers with high order books and expensive inventory.

Inflation hedging and flight-to-safety bids drove gold to an all-time high price of $1033 per ounce on March 17, but faded away on deflation fears and broader commodity selloffs. Gold now trades between $700-750, about 30% below the March peak. Slowing inflation and the U.S. dollar’s uptrend diluted gold's store of value. Though gold tends to be less sensitive to a global economic slowdown than industrial metals or energy commodities, deflation is a danger for gold prices. Even physical demand for gold looks likely to weaken alongside consumer confidence.

Agriculturals are the commodity group least sensitive to the economic cycle, but have nonetheless suffered from the deleveraging which has seen investors move into cash. Livestock prices plunged on faltering protein demand as the global growth slowdown reduces incomes. Fundamentals such as biofuel production, population growth, and the rising income and protein demand of developing countries, argue for a secular bull market. In the medium-term though, the exit of speculators and the supply overhang from production growth may bring downward pressure – especially in grains.

Slowing Chinese economic growth has contributed to the collapse in commodity prices, just as expectations of Chinese demand growth drove the recent bubble. Imports of key metals have slowed sharply since July, and the slackening industrial production growth – 8.2% in October, a 7-year low – indicates no reversal. Meanwhile, Chinese electricity production actually fell in October, the first such contraction in a decade, suggesting that China’s slowdown might be more pronounced and that the price of coal, the prime fuel for power plants could fall further.

While the infrastructure focus of China’s recent fiscal stimulus may support commodity demand, especially for some base metals, it may only offset the reduction in demand from the property and manufacturing sectors. Meanwhile, Chinese stockpiles of many commodities may take time to absorb, meaning that Chinese commodity demand might remain weak until the second half of 2009.

Quoted from: RGE Monitor's Newsletter, 19 November 2008.

Monday, 17 November 2008

When Capitalism Failed...

The following story is told by Oliver White, senior investment writer for the Motley Fool Stock Advisor, which may change the way you view the economy, the stock market, and life's fortunes.

"I need to go back 80 years. Back to 1928, in Altoona, Pennsylvania. When a 2nd-generation Irish railroad worker named John Reilly bought a single share of Knight's Life Insurance of Pittsburgh...

John, the father of six, paid $10 for the stock. Then defended it for decades from lowballers and scoundrels who tried to buy it out from under him and his family.

Then in the late 1950's, American General insurance company started acquiring Knight's Life. And after a few years, the Reilly family investment was split and converted to American General shares...

John's six children eventually inherited the stock. And by the 1980s, through splits and reinvested dividends, their investment was worth hundreds of thousands of dollars...
It helped buy homes in places like Pittsburgh and Somerset, PA, and Vienna, VA. And helped pay for college degrees for John Reilly's grandchildren from schools like Wharton, Penn State, and Stanford.

And with plenty of American General shares still in place after all this, continuing to multiply and grow all the way up to 2001 when AIG acquired American General -- no member of the Reilly family ever once thought of selling. After all, AIG was a bellwether of the American economy. And the insurance business had been profitable for the Reilly family. So much so, that...

By 2007, John Reilly's ONE SHARE had grown into more than $480,000!

And it looked as if his amazing investment could one day help pay college tuition for his great-grandchildren. Yet, I'm afraid you know the rest...

Last month, over the course of a few days, AIG's share price plummeted. Destroying $180 billion in shareholder wealth (that's roughly equal to 3 Enrons)... and almost brought down our entire financial system, before the government loaned the company $85 billion.

And while the Reilly family (my in-laws) was coming to terms with the fact that their total AIG investment is now worth less than $12,000, and that the vision and hard work of their of their patriarch had been mostly obliterated -- top AIG executives took a posh spa retreat to California. Threw themselves a banquet and awarded each other handsome bonuses.

It was a slap in the face! And a wake-up call...

We've seen Wall Street play fast and loose with our investment money for too long!

In recent years, Wall Street firms basically turned themselves into massively leveraged casino operations: Lehman Brothers was leveraged 25 to 1... Goldman Sachs was leveraged 26 to 1... while Morgan Stanley was leveraged 34 to 1. Heck, even AIG, an insurance company, was leveraged 13 to 1!
'The US economy is in big trouble. Many Americans are outraged at the way our financial security has been sacrificed.'-- The Wall Street Journal, July 28, 2008

It's no wonder so many Americans are hopping mad! A lot of people woke up to the news recently that some of their "conservative" blue-chip investments had a lot less in actual assets than they thought...

Tuesday, 11 November 2008

Learning the hard way

"When things are going well, most of us spend all of our time high-fiving and celebrating, whereas when things go sour, we turn to sulking, worrying, and even panicking."

"Meanwhile, when the going gets tough for the toughest, smartest, and most successful people out there, they do something drastically different ... they learn from it. And that's what sets them apart."

"Take Benjamin Graham, for example ... He went bankrupt three separate times as an investor. But each time, he documented and studied his failures, and he was eventually able to impart this investment wisdom to countless others -- including Warren Buffett, who in turn learned from his own mistakes and failures. Early in Buffett's career, he mistakenly believed he could save a failing textile mill. After being forced to liquidate its textile operations, Buffett learned to pay up for quality and turned that company into a $170 billion legend."

"Another great example is Pixar's John Lasseter. After graduating from college, Disney hired him and gave him a shot at being an animator, and he quickly recognized the ability of new computer technologies to revolutionize animation. But Disney was so unimpressed with his first feature that they fired him on the spot. So Lasseter literally went back to the drawing board. After fine-tuning his process, he went on to found Pixar, win two Academy Awards, and churn out a string of blockbuster hits that included Toy Story, A Bug's Life, and Cars. Oh, and let's not forget, he and Steve Jobs later sold Pixar to Disney for a cool $7.4 billion."

Quoted from an article written by Austin Edwards, Motley Fool, 27 October 2008.

Thursday, 6 November 2008

Obama's Challenges

Barack Obama, the newly elected US president, faces like President Roosevelt during the Great Depression immense challenges to cure the US economy's woes. While the sorry state of the US economy was certainly a great companion to his successful presidential campaign, the moment when he takes office in January 2009 it will become his greatest enemy.
Obama will face an economy in the middle of a severe and prolonged recession where households have to bear unaffordable mortgage and other debt, declining value of homes, foreclosures, tight access to credit, erosion of retirement savings amid the bearish stock market, rising unemployment and critical foreign policy decisions.
One of the first challenges for Obama would be to cushion the impact of the recession on consumers by means of a large fiscal stimulus package. For example, infrastructure spending to create jobs, tax cuts for lower income groups and small businesses, government aid for the auto industry and tax credits for labour-intensive industries. He also would like to impose a 90-day moratorium on foreclosures, mortgage tax credits for the middle class and setting up a foreclosure-prevention fund. Obama is in favour of greater financial sector oversight. He would like to prevent taxpayer funded bailouts of banks or that CEOs of failed institutions can receive large bonuses (golden parachute) as in the recent past.
Obama will face an increasing fiscal deficit. The financial rescue package plus the downturn in the economy, problematic medical care and social security bills will only add to the challenge of containing the fiscal deficit. One of Obama's key reforms will be to give more tax cuts to low and middle-income groups, while raising taxes on high-income groups.
Further challenges await Obama in health care reform, trade policies, labour reform, and foreign policies - especially dealing with the Iraq war, Taliban forces in Afghanistan, a resurgent Russia, Iran's nuclear ambitions, and Asian economies.
Source: RGE Monitor Newsletter, 5 November 2008.