4/4/2013 8:30 PM ET|
The perils of cheap money
Supply and demand for major commodities are out of whack, thanks to easy money policies. And that creates opportunities for savvy investors.
There is no free lunch.
So, yes, the flood of cash from the world's central banks prevented the crash of the world financial system in the dark days after the collapse of Lehman Brothers and the near collapse of America International Group (AIG) and Citigroup (C). And, yes, European Central Bank President Mario Draghi's promise to do anything necessary to save the euro has headed off the collapse of the market for Italian and Spanish government bonds. And yes, the huge stimulus thrown at China's economy prevented a hard landing, where the nation's growth rate might have slipped below 7%. And, yes, the Federal Reserve's promise to keep interest rates at essentially 0% has revived, finally, the U.S. housing sector.
But we're still counting up the costs.
Sometimes the price is obvious: In China it produced a real estate bubble that has littered the landscape with ghost cities of apartments owned by speculators.
Sometimes the price is obvious but delayed: Someday the bill will come due in higher inflation, higher interest rates and weaker currencies.
And sometimes the price is just not all that obvious. That's the case right now in the commodities sector, where a global policy of cheap money has turned a modest slump into what looks likely to be a long, deep, depression in the worst-hit sectors, such as natural gas, coal and maybe even iron ore.
How is cheap money related to what is already a punishing recession for major commodity sectors? Let me explain.
Because if you buy my explanation of the cheap money/commodity recession connection, I think you'll wind up rethinking your strategy and timetable for investing in commodity stocks.
Boom and bust
Let's begin with the mismatch between what I'm calling the commodity depression and the slowdown in global growth. Certainly the slowdown in China's economy -- the driver for the global market in commodities, from thermal coal to copper to iron ore -- should lead to a drop in commodity prices from their peaks.
A China growing at 10.4% in 2010, thanks to the country's post-global financial crisis stimulus efforts (let alone a China growing at the 12% or 14% annual rate before the financial crisis), would consume more coal, iron ore, copper, oil, etc. than a China growing at 7.8%, as the country's economy did in 2012.
Take a look at iron ore, for example. China's steel mills are the world's largest consumer of iron ore (accounting for 60% of global iron ore imports), and it makes sense that demand from China would slow as China's growth rate hovers near 8% rather 10% or 12%. In fact, Goldman Sachs projects that China's imports of iron ore in 2013 will grow at the slowest rate in the past three years.
But do note that China's demand for imports of iron ore is still projected to grow in 2013 -- by 4%. And global demand for iron ore imports is expected to grow by 8% this year.
Iron ore prices, however, have already retreated 6% this year. And the consensus among analysts surveyed by Bloomberg projects that iron ore prices will fall an additional 34% to finish the year near $90 a metric ton. (Iron ore sold for about $155 a metric ton at its local peak at the end of February 2013.)
That may not even be the worst news. Iron ore prices could continue to retreat through 2014 and perhaps until 2018, according to Morgan Stanley. That would produce a slump that mirrors the nine-year boom that saw iron ore prices climb sevenfold from the late '90s, when the price was $15 to $20 a metric ton.
Prices down, demand up
Projections for a huge decline in price by the end of this year and in the years ahead don't make much sense if you look just at the demand side of the market, however.
Demand from China for imports will climb 4% in 2013 and yet the price of iron ore will not just slide lower, but plunge? Global demand will climb by 8% but prices will fall an additional 34% in 2013?
Ahh, take a look at the supply side. Those same projections that say global demand will rise by 8% in 2013 also call for a 9.1% increase in seaborne supply (the standard term for global iron ore imports since iron ore travels from mine to customer by sea).
And that's just the beginning of a trend that has supply growth outstripping demand growth as new iron ore capacity comes on line. Morgan Stanley projects that the global iron ore market will move into surplus in 2014 and that the surplus will continue to grow through 2018. That's won't be good for prices.
This basic story -- slowing but still solid growth in demand overwhelmed by a big increase in supply -- isn't limited to iron ore. The same holds -- with individual wrinkles for specific commodity markets -- for commodities as diverse as natural gas, thermal coal and copper.
Copper, for example, is projected to move into a global surplus in 2013 as demand rises by 5.3% but supply rises by 6.8% to 8%, according to analysts.
That will take copper to a projected surplus of supply over demand of 330,000 tons in 2013 from a deficit of 95,000 tons in 2012 and 132,000 tons in 2011. Copper for delivery in three months closed at $7,958 a ton on April 3. The average price for 2013, according to Goldman Sachs, will be $8,458 a ton before falling to $7,250 a ton in 2014.
This pattern of boom to bust and then back (commodity investors hope) to boom is typical of the commodities sector. High prices lead producers to increase their capital budgets and invest in new capacity. But it takes so long to find and develop these resources that the result is often over-investment in new capacity, as every mining company invests in new capacity that then yields a temporary surplus in the sector, driving down prices.
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One important point that I didn't notice in Jim's article is how speculators and electronic frequency traders are manipulating the Markets. That's the Huge Bubble that costing everyone also yet is rarely talked about. Why is that JIM!
as i recall when QE 1 started and QE 2 continued this farce all these wonks were raving about how 'happy days are here again' now with permanant QE, the euro on a razors edge and the cyprus robbery it seems like some are starting to see that slowly the balls are starting to fall out of the air and ben 'the juggler' cant seem to keep up. so now that the truth is starting to peek thru the smokescreen he lets drop that he might bail.
its also funny that the media and the financial wonks act like the iceland sucess story is the leper of the time but reality is they are on a fast track to recovery after jailing their banksters and refusing to cover the banks bad bets.
comming soon the new american dollar now in improved 2 ply
Cheap money is great, after all, the only thing better than your own money is someone else's money. But the problem you run into is that you can very easily over extend yourselves. This is the crisis we're on the edge of in the USA. And Europe is going through some of the worst economic events in decades, all due to their crushing debt.
You still have to pay back that 'cheap money' and if your 'eyes were bigger than stomach', you're in trouble with your debt service, putting you in danger of default. It's very easy to calculate if your debt ratio is in line with your respective industries. Debts/Assets= debt ratio. If your number is higher than your industry norms, you better take some action to control it before it controls you.
My advice is still the same as it was this time last year: pay down your debt as much as you can. When interest rates rise, you don't want to be caught in another default crisis.
This is how it will go. The Obamanation admin will KNOW when the crap hits the fan, no doubt. But they will attach "Republicans" to any blame about to happen. The dumb masses will thenbelieve the crap, and the GOP will be even more vilified.
Until voters wake up and learn what's happening instead of being told lies about what's happening, we will not return. Our American politics is sadly not about what's right for our country, it's just about one side "Winning."
What typically happens is when there is a lot of money printing is simular to what happens when you raise the minimum wage. First the market place gets more buyers as the extra money is spent and buys goods and services priced prior to the raise and then the prices adjust to account for the increased number of dollars as the older stock get replaced with newer stock reflecting the higher costs added in.
Inflated money, at first allows those with money to buy assets at non-inflated prices and then prices rise to account for the increased money in the system (assuming that the prices would not change much with normal supply and demand factors).
However since the market is ruled by people who are and act emotionally, the market does not react merely to monetary policy. Increased prices in itself may spur increased sales as people who have the money see prices rise and pile on in to get on board before it goes up even higher. Thus the creation of market bubbles as asset prices rise quickly and beyond usual market supply and demand factors.
The government is counting on this response to get the economy moving again as more cash is injected back into the market place from where they were stored prior.
As stocks and real estate prices rise, the increased paper wealth effect makes the gainers more confident and thus more willing to buy more goods and services. More money in the economy finally yields more economic activity and job creation.
The boomers contiue to reach retirement age at the rate of 300K per month. More of them, who are employed are opting to stay at work since their net worths are so low that they do not feel comfortable retiring with an uncertain financial future.
At the same time, more boomers are also choosing / forced to retire early due to health, layoffs, or increased workloads put upon them by their employers as they try to get every last ounce of productivity from their existing workforce.
The reduction of extended unemployment benefits are also adding to the rolls of the unemployed.
And finally the sequester is beginning to have an impact as potentially affected employers and employees begin to cut back spending as uncertainty of employment reduces their confidence.
We may see a pause in growth of the GDP, if not another mild recession.
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