Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Longshoremen, Copper, and Credit Suisse: The “copper top” I’d like to discuss should bring no frenetic little pink robot to mind. There’s no cute bunny here that just keeps going and going and going. There is a rabbit, in our opinion – but it is already cooked.
The topic is copper and what it tells us about an economy that has been running for the last decade like a hare. Copper prices have been in decline for the better part of 14 months, moving lower by 28% from recent peaks. In addition to prices (an important economic indicator – currently negative), let’s also look at the unexpected and considerable buying of copper in China.
We see confirmation of economic decline in China written in its inventory disclosures this week. Inventories were assumed to be as high as 1.5 million tons. The release this week from the International Copper Study Group suggests that while the Chinese have continued regular buying of copper in 2010-2011, they have not been using it as expected for infrastructure needs. The result is a build-up in inventories, exceeding 1.9 million tons.
A 26% increase in stockpiles is not to our mind an indication of interest in tangibles, or some sort of inflation hedge. The latter is likely a coincidental benefit (copper is also an asset that can be pledged as collateral).
Instead, the Chinese are playing for time. The choice to continue buying more copper above what is needed speaks to the need to maintain the appearance of growth and economic strength. Circumstances can deteriorate further by confessing to the true severity of declining economic growth. Another round of stimulus in China would not likely have the same effect as the first in 2008, with banks already running into problems with non-performing loans.
We hear other voices concerned with structural weakness in China: Credit Suisse has estimated that unwinding bad bank loans could impact bank equity by as much as 60%.
Recall the lightning fast recovery in the Chinese economy in 2008, resulting from government stimulus (the equity market there has not reflected a “return to growth” thematic). This record stimulus was directed through banks into real-estate development projects and infrastructure schemes. While money did swirl through the economy, certain ghost towns in China’s interior now resemble the storied unfinished projects in Dubai. Don’t hold your breath waiting for the Field of Dreams dynamic to take effect (if you build it, they will come). If that dynamic drives events at all, it will likely do so far in the future.
The interesting choice by the Chinese government, via one of its sovereign wealth funds, was the quiet support of their four primary banks this past week though share purchases. Those banks will be preserved at any cost. Remember the last five-year plan. Financial institutions are needed to implement policy shifts deemed important by the Communist Party elite.
A final comment on retail sales and consumer spending in the US: Port activity is too low. Retail purchasing managers seem to be anticipating the consumer cutting back on spending this holiday season. We don’t mean to ignore the retail sales figures out this week (seasonal adjustments helped add significantly to the 1.1% September improvement), but the container activity in Los Angeles and Long Beach has been down considerably. Typically at this time of year, it jumps higher in anticipation of the Christmas retailing season.
That normal purchasing cycle was broken in the recessionary period of late 2009, and again this year (it’s only happened twice – ever). Are we entering into a double dip? Perhaps we are already there. On that unfortunate note, we nonetheless hope you enjoy a restful weekend, recharging your own batteries.
2. Sound Retreat? “Stimulus” is quickly being replaced with “Recapitalization” as the buzzword behind the rally in stocks. Central Banks of Europe, Asia, and the US have all announced repeatedly (without many details) the intention to liquefy their otherwise insolvent banks and coordinate budget policies. This comes as nothing new to any of us insofar as money printing is concerned, but to the banks this new-found capital may be serving different purposes.
On Wednesday, the Financial Times ran an article titled “EU banks could shrink to hit capital rules.” The article asserted that banks are more likely to sell assets to meet the 9% core tier-one capital requirement (under Basel III) than accept the recap funds or raise capital through equity/debt offerings. What’s apparently becoming clear to the banks after a long, hard journey is that economic “growth,” for now, is essentially elusive.
To put it in laymen’s terms, the banks are unable to lend with so few remaining entities able to borrow or grow. This prompts a question: If the banks start to unload assets, what impact will it have on the markets and the economy?
We could be wrong, but we think it better than an educated guess that the impact won’t be positive. As we said last week, the current likelihood is that bailout funds will be applied to banks that may be subject to panicked withdrawals.
Regardless, dreams of money printing elicited the usual animal spirits in the markets during the week. Stocks were up across the board about 5.00%, led by the Google-powered Nasdaq (up 6.8%), while Treasuries were clobbered. The 30yr added 22bps to yield 3.23% and the 10yr added 15bps to yield 2.25%. Commodities advanced 4.40%, aided by the G20’s desire to join in on the euro rescue plan. The dollar fell 2.60%, while gold and silver gained 1.99% and 3.26%, respectively.
Earnings season is also upon us, to conclude the 3rd quarter. U.S. corporate earnings in large part seem set to match 2nd quarter results, with an emphasis on reduced expectations leading into the 4th quarter.
Alcoa missed expectations, citing higher costs and lower margins (inflation). JP Morgan met expectations, but leaned on accounting creativity to do so – reversing loss reserves and recognizing losses in bonds as gains. Google once again showed no weakness in Internet advertising growth. Its shares rose 6% after the announcement of record revenues and earnings ($9.7B and $8.33/sh).
U.S. economic data was sparse and had very little influence on the markets in light of the central bank cheerleading. Retail sales rose 1.1% vs. expectations of 0.7%, aided by autos/parts and gas, while jobs continued to disappoint. Jobless claims stood at 404K in early October, above that critical 400K mark. MBA mortgage applications rose a meager 1.3% – suggesting once again that lower rates produced by the rally in bonds are losing steam. The trade balance was essentially flat at $-45.6B in August, though it has been steadily worsening since January of ’09 – mainly due to oil’s advance.
Overseas, all seventeen eurozone countries have ratified the EFSF rescue fund. The €440B facility cannot be leveraged (fractional reserves). This was part of the plan rejected at first by policymakers in Germany. Belgium is set to nationalize most of Dexia for €4B, and China is set to buy more shares in four of its largest banks (as David McAlvany discusses above). S&P downgraded Spain’s national debt by one notch (now AA-), along with 10 Spanish banks, and Fitch downgraded Swiss bank UBS. Fitch also issued warnings to several other banks – including Barclay’s, Credit Suisse, Deutsche Bank, and BNP Paribas.
With the reality of a no-growth/debt-crisis scenario, combined with inflation settling in for the powers that be, we continue to believe that the current optimism in stocks is operating on borrowed time. As for the metals, we also believe the lows have been put in and that we are now in the rebuilding process – temporary shocks notwithstanding. There is still a risk of revisiting the lows in gold around the 1540 level. Patience will be needed since the metals have not taken over for Treasuries and cash as the safe haven of choice – but all in good time.
Best regards,
David McAlvany
President and CEO
MWM LLLP
David Burgess
VP Investment Management
MWM LLLP
