Nick Rost van Tonningen ~ Gleanings II ~ 526 Posted by John on August 30, 2013

Recently China’s propaganda officials, supposedly upon instructions of President Xi Jinping, released a list of seven topics newspapers & academic meetings are no longer allowed to discuss or mention,ince they are “dangerous Western influences”. They are :
$ the idea of “universal values”, such as entitlements to human rights;
$ freedom of speech;
$ democracy & civil society;
$ civil rights & free elections;
$ independence of the judiciary; and
$ historical errors of the Chinese Communist Party.
In today’s digital era this is likely to be as effective as the Dutch boy who plugged a hole in the dyke with his finger (except that in his case help arrived in the morning).

Last week mention was made of Canada’s ‘paper tiger’ Arctic policy & Russia’s more muscular one. So it is interesting to note that when the government of Canada recently required all foreign vessels entering its Arctic waters to report their presence (to enable it to monitor their compliance with its Arctic environmental laws & regulations), the US, Germany & Singapore were lost no time issuing diplomatic protests. But Russia has taken far greater steps to enforce its Arctic sovereignty (incl. requiring ship owners to request permission to traverse its Arctic waters, charging them a fee for doing so & allowing transit only in convoys escorted by Russian ice breakers) and ship owners have been lining up to comply nobody has said BOO!

The London market features a GOFO rate, calculated by taking the LIBOR rate & subtracting from it the gold leasing rate. While normally positive (i.e. it costs more to borrow money than gold), it has been negative on two occasions in the past, in 1999 & again in 2008, and on each occasion this was followed by a significant rise in the price of gold. Well, it has turned negative again &, while this is no guarantee of another, possibly major, uptick in the price of gold, it does suggest the supply situation in the physical gold market is unusually tight.

On the subject of gold, following are some potentially relevant factoids. In the first decade of this century, China imported an average 3 tons/year of physical gold from Hongkong while in the three years since its monthly imports have averaged 60 tons (although recently it has been more like 100 tons); in other words, while still only the world’s No. 2 gold importer (after India), net of its own domestic production (& it is now the world’s largest gold producer) it accounted for the ‘disappearance of one-third of global newly-mined production. While gold ETFs facing redemption demands were earlier the major source of selling pressure in the gold market, redemptions now are said to have abated. According to the World Gold Council (still one of the best sources of info on gold movements), global Second Quarter gold sales were in the 1,000 ton range (vs. newly mined annual production of less than 3x that amount), with India & China accounting for over half of that, and three other Asian countries (Phillippines, Indonesia & Pakistan) being among the TopTen gold importers. The Indian rupee may have been extremely weak lately & the price of gold in rupees up 25% YTD but for Indian holders this has offset the lower exchange value of their currency.

Byron Wiens, for decades one of Morgan Stanley’s economic “wise men”, & now at Blackstone, recently made an interesting observation in a Bloomberg interview. It was that companies “buying back their own shares is a main reason that corporate earnings are up” (they have the financial wherewithal to do so because their Treasuries have been flooded with cash, courtesy of Ben Bernanke). And, when pressed, he noted companies earnings “guidance” has been subdued & forecast 4% earnings growth for the next 12 months (< half the market consensus). In 2007 Meredith Whitney was a relatively unknown Oppenheimer analyst until October 31st when she published a seemingly unduly pessimistic, but subsequently proven wholly correct, report on Citigroup. The following August she made the front page of Fortune magazine with equally gloomy assessments of Merill Lynch & Lehman Brothers, one month before the latter had to fold. In 2009 she left Oppenheimer to found her own advisory firm, and in December 2010 she opined on CBS’ 60 Minutes that there were as many as a hundred cities, towns & counties liable to cause hundreds of billions of defaults in the US$3TR tax-exempt market (for which she was once again denounced by critics in the industry). Her latest prognostication came when, in the wake of the Detroit bankruptcy, she prognosticated in the Financial Times “There are five more towns like Detroit in Michigan alone ... (and) many more municipalities across the country in similar positions.” (she has also expressed the view that Wall Street will lay off as many as 100,000 workers over the next 18 months) - all local governments are being sucked into a black hole by the unrealistic pension-, healthcare- & other benefit promises made by politicians in years gone by to buy labour peace in their time without regard for the long-term consequences thereof (which have materialized sooner than anyone had expected because the Fed’s low interest policy, which has sharply reduced the discount factor used to calculate the PV of their resultant liabilities, thereby ballooning their unfunded liabilities). One positive aspect of the rise in interest rates currently underway that many people expect to continue is that it will raise the discount rate used in calculating, & thereby reducing, the PV of their liabilities (although there will be an offset from the rise in their cost of debt service on short maturity debt). The media headlines were that in July new home sales in the US had been down 13.4% to an annualized 394,000 (vs. the expected 490,000) & that prices had continued to rise. But drilling down into the data suggests the situation isn’t quite as straightforward. For while the initially reported June new home sales number had been 494,000, it had since been revised to 455,000 (which had been the basis for calculating the rate of MoM decline), the 490,000 expected had represented a decline from the original June number, albeit a marginal one, the 394,000 number represented a 6.8% YoY increase, the new housing market has become a “barbell market”, with the rising average price being a function of high-priced ‘monster’ homes for the well-to-do selling well but with a growing share of all units built & sold now being more modestly-priced homes & condos, & finally, & most importantly, the supply of unsold, completed homes, that YTD had been in the 4.0-4.5 months’ range, in July jumped to the equivalent of 5.2 months. Last week’s annual central bankers’ clambake at Jackson Hole, Wyo., hosted by the Kansas Fed, was billed by the media as a non-event since Bernanke wouldn’t attend (the first time in 20+ years that the Fed Chair hasn’t given the keynote address), and neither would the ECB’s Mario Draghi & the BoE’s Mark Carney, while Fed Vice-Chair Elizabeth Yellen’s role was to be low-profile. It was nevertheless well-attended. Some criticism was heard of QE & tapering as ‘weak policy instruments’ & there was near-unanimous agreement that the Fed shouldn’t withdraw its ‘policy accommodation’ too soon. One paper by Northwestern University’s Arvind Krishnamurthy suggested that, since the Fed’s purchases of UST securities had lowered the government’s borrowing costs while its MBS purchases had benefitted consumers, any tapering should have the following priorities : first quit buying more-, & then start selling-, UST securities, and only then first quit buying & then start selling MBS. Another by Stanford University’s Robert E. Hall noted that, after having dropped three times since 2008 to 88%, the ratio of consumption to disposable income had recently returned to its pre-2008 93% level, the ratio of real household liabilities to disposable income had recently dipped below 92%, down from its 2007 high of 108%, & that the Personal Consumption Expenditure (PCE) growth rate (that the Fed prefers to use as its inflation benchmark, rather than the CPI ) had fluctuated in a narrower 1%-2% range since 2007 than the CPI’s -2.1% (in mid-2009) to 5.6% (in mid-2008) range. Executive Orders are issued by US Presidents to initiate direct action by their governments without having to go to Congress for legislative authority. According to Cycles Research LLC, an investment advisory service, the last three Presidents have hiked its use exponentially. Thus, while it was used only 41 times by various Presidents during the 60 years prior to 1993, Clinton used it 15 times in his eight White House years (a post-FDR high; he used it 11x in 12 years), Bush 43 used it 62 times in his two terms & Obama so far has used it 923 times. While their critics will blame this on their being bent on concentrating more power in the executive branch, it is more likely a reflection of the breakdown in cooperation between it & the legislative branch. Wang Qishan, a top level trouble shooter, was elected last fall to the all-powerful Communist Party’s Politburo Standing Committee & now is China’s anti-corruption czar. What is interesting about his appointment is that he has no children. For it’s the upper echelon’s second generation brats who have been making the headlines, & infuriating the public, in recent years with their blatantly excessive lifestyles & their “we’re above the law & you can’t touch us” attitudes. The latest such case is that of 17 year-old Li Tianyi who stands accused of participating in a five men gang rape last February & whose trial started on August 28th, two days after the end of that of previously high-flying Bo Xilai (who early last year had been deemed a shoo-in for election to the Politburo’s Standing Committee). Tianyi is the son of two PLA generals, 72 year-old Li Shuangjian & his second wife Meng Ge, age 47, both of whom reached their exalted ranks not by military prowess but by their ability to belt out patriotic songs at Army-, Party-, & public events. And while Tianyi has pleaded Not Guilty, he has three strokes against him. His four co-accused all pleaded guilty at their earlier trial. His track record : two years ago, at age 15, he crashed the BMW he was illegally driving into another car, beat up its two elderly occupants, & then dared bystanders to call the police (which escapade earned him one year in a correctional facility). And finally, the public wants an example made & the country’s leadership likely also (especially if it involved throwing the child of a non-core senior official under the bus) - and it may be significant in this context that President Xi Jinping recently issued orders revoking all privileges hitherto accorded prominent singers (even though his own wife is one), curbing their ‘commercial’ (i.e. money-making) activities, & forbidding them to use their (senior) army ranks. Japan’s nuclear power regulator has upgraded the severity of the recent leaking of radioactive water at Tokyo Power’s troubled Fukushima facility to Level 3, i.e it is serious enough for there to be the potential for non-lethal, but still substantial, radiation exposure. Fabrizzio Pedroni, age 49, owned & operated an electrical components factory near Modena, Italy founded 50 years ago by his grandfather. Early this month he waved his 40 employees goodbye as they set off on their annual summer holiday. But a couple of weeks later the latter learnt that he was moving the whole operation, lock, stock & barrel, to the town of Olawa in Southwestern Poland. And, when they turned up at the plant to stop this, they found it empty with the last of twenty trucks hauling away the equipment about to leave (which they managed to prevent from doing so). Pedroni said this drastic action was necessitated by the fact that high wage costs , crippling taxes & low productivity had made the whole operation profitless for the past five years and that he didn’t intend to return any time soon since he had received death threats. _______________________________________ 1 Another of those infernal creations of the academic mind : it it really fair, or realistic to say that inflation is less because people spend less? 2 According to Pedroni for every Euro he pays out in wages to workers, he must pay the government another 1.5 Euros in various social costs. GLEANINGS II - 526 Thursday August 29th, 2013 RISING RATES CAST A SHADOW ON GOLD’S FUTURE (G&M, Scott Barlow) $ Higher interest rates must take (part of?) the blame for the recently weaker gold prices; for historically the price of the precious metal has moved in the opposite direction to real interest rates for at least three reasons. Rising real rates also imply inflation is stable or declining & fewer investors are interested in an inflation hedge during such a period. Secondly, rising real rates indicate stronger economic growth, a time when investors are more interested in buying growth-oriented stocks than in capital preservation. And, finally, rising real rates hike the opportunity cost of holding non-income-generating gold. The Bloomberg chart he uses to bolster his case shows that in the entire time since 1975 there have been only three relatively brief periods of a strong inverse relationship between the two : 1975-1980, 2002-2005 & 2009-2011. Secondly, the gold market today is driven, not by Western “investors” in “paper”-, but by Asian “savers” thirst for physical-, gold. Thirdly, in recent years the basic demand/supply situation has fundamentally changed : newly-mined production has been relatively flat while the central bank complex has changed from being a net supplier to a significant net buyer & financially newly empowered middle class in China & India has unleashed a second new major source of demand (& while in India the government has sought to alleviate downward pressure on the rupee by hiking its import duty on gold, the rupee’s very weakness & the government’s tightening of monetary policy to prop it up, are prompting domestic inflationary pressures that are enhancing gold’s appeal for the locals). And finally, to some extent the gold price strength has been the mirror image of the waning foreign confidence in the “full faith and credit” of the US government/dollar. NUCLEAR OPTION MAY BECOME OBSOLETE (Telegraph, Louise Armitstead) $ Andrew Birch is a Scot & a University of St. Andrew’s physics graduate who worked for a while the City of London’s financial world. In 2007, armed with a Master’s degree from the University of New South Wales in Photovoltaic & Renewable Energy Engineering, he launched, & is now CEO of, Oakland, Cal.-based Sungevity Inc., a company that has doubled in size each year since & now employs 300 people. He was also behind the “Globama” (write-in) campaign that convinced President Obama to have solar panels installed at the White House (which began this week). $ Birch recently said “It alarms me to read the UK debate where there is talk about further subsidies to support a new nuclear plant that will generate its first electricity in 2023 ... Given the ... cost curve in solar, that nuclear plant could be obsolete before it’s switched on. Politicians must be careful not to lock Britons into 20th century energy prices.” Would ‘locking into 20th century energy prices” be that bad an idea? To the extent there has been much media coverage of the solar industry recently, it has mainly focused on the problems of solar panel makers faced with rapidly falling product prices. But solar is “hot”; in the US installed capacity rose seven-fold to 7,000MW between 2009 & 2012. Sungevity, that GE last year bought into, has a business model different from that of its competitors. Most of its sales are residential. And, rather than selling solar panels & having customers & third parties do all the work, it provides ‘one-stop shopping’, designing customized systems remotely over the Internet with the help of a proprietary technology, having its own staff install them & then leasing the installations to the customers (typically for 20 years), thereby saving the latter the (heavy) upfront costs & a lot of hassle, and generating visible savings for them from Day One. At last report it had 55,000 clients in a dozen states, had installed 46MW of capacity in the First Quarter (rather than the 41 expected) & had “guidance” for the year of 250MW. One problem is, however, is that by transferring all training-, & upfront capital costs to itself it has yet to make money and must borrow huge gobs of money, which it so far has been able to do successfully because the 30% investment tax credit on any investment in solar is passed on to its investors (it supposedly IPOd last December on NASDAQ & has a US$2.5BN market cap). HOLD THE WATER : SOME FIRMS ARE FRACKING WITHOUT IT (Houston Chronicle, Ingrid Lobet) $ In the US 95% of all fracking is done with often quite toxic water-based fluids (that in the Eagleford Shale in water-scarce Texas involves as much as 6MM gallons per well). This alienates people in places where rivers & groundwater is drying up due to a lack of rain & over-pumping (thus in Texas one farmer is said to have had to sell 500 of his cattle due to a lack of water for them to drink after 104 wells had been drilled on his land). But San Antonio-based BlackBrush Oil & Gas LP, with help from GasFrac, a Calgary-based company with a proprietary technology for doing so, is using a mixture of liquid propane, butane & pentane instead. And it has found that doing so doubles production, requires less fluid & does less damage to the oil & gas-bearing formation and that, while it costs more upfront than water, at the end of the day it can recover its fracking agent & sell it, rather than having to bear the cost of disposing of heavily polluted water. While initially GasFrac had problems with the combustible nature of its fracking medium, more recently this appears to have been less of a problem, if no longer a problem at all (although it cannot be denied that its methodology entails a higher element of risk than using water). And the same goes in spades for the so-called “dry” fracking, using natural gas, that some companies are experimenting with in Texas & California. And with fracking so critically important to producing oil & gas, & to the nation’s greater energy self-sufficiency, and in its present form so opposed for environmental-, & water demand-, reasons, it is not surprising that the oil service industry is working hard to find & develop other, less controversial, fracking technologies. FOREIGN POLICY BY WHISPER AND NUDGE (NYT, Thomas L. Friedman) $ In reviewing America’s Middle East foreign policy three facts stand out. The locals blame America for everything that has gone wrong (I just finished re-reading Leon Uris’ 1984 book Haj - which provides a good review of the historical background to today’s Israeli-Palestinian conflict - an underlying theme of which is that it’s part of the Arab culture to blame someone else for whatever ill befalls oneself. The foreign policy experts say Obama has gotten it all wrong. And the American public increasingly thinks it’s a waste to waste time & money on a bunch of ungrateful wretches. And in a way they’re all right. $ During the Cold War we needed allies in the region (to keep our oil supplies safe & them out of the Soviet clutches). So we didn’t care about their internal behaviour whereas today we are preoccupied with their internal governance & dismayed at what we find. But in the two decades since Bosnia we have learnt how hard it is to change other countries’ internal behaviour, or as Michael Mandelbaum, John Hopkins University’s foreign policy expert, puts it “guns, money and rhetoric - simply don’t work anymore ... It’s like trying to open a can with a sponge.” For trying to help another country change internally requires different tools, a mix of refereeing, policing, coaching, incentivizing, arm-twisting & modeling, a physical presence & a great deal of patience, and even then can succeed only if the locals want to make it work & to take charge of their own destiny. Thus in both Iraq & Libya the locals didn’t buy into the process & they reverted back to their traditional clannish & self-aggrandizing ways as soon as we withdrew. $ Hence the three reactions noted above, The locals need someone to blame for their own failures. Blaming Obama is the easy way out for liberals with lofty ideals but unwilling to get their hands dirty & for conservatives wanting to intervene without appreciating how difficult it is to make change in cultures whose values differ from ours. And the American public is just tired of it all & can’t understand why the others cannot act like them. $ Societal transformation worked in Japan in the late 1800's, & more recently in South Africa, since both had leaders who asked themselves “what’s wrong with us” & then did something about it. But it cannot work when they don’t. And now, to make matters worse, we think we don’t need the region’s oil anymore; so as one energy expert puts it, “The Middle is East is now China’s problem.” Friedman can connect the dots better than most. But obviously his headline writer couldn’t. SAUDIS OFFER RUSSIA SECRET OIL DEAL IF IT DROPS SYRIA (Telegraph, Ambrose Evans-Pritchard) $ The Head of Saudi intelligence, Prince Bandar bin Sultan , three weeks ago & with the full backing of the US, met with Putin in a closed door meeting at the latter’s dacha outside Moscow. He is said to have sought to pressure him to quit supporting the Assad regime in Syria with a mixture of inducements & threats, warning there can be “no escape from the military option” if Russia doesn’t do so. Among his carrots was a proposal for an alliance between OPEC & Russia (that would control 45% of the global oil output) that included a promise to reduce, if necessary, Saudi output to keep its price above the US$100 Russia, which is in near-recession, needs to balance its budget. He also offered to support Russia’s attempts to create an (OPEC-like?) global gas cartel, an idea most recently mooted in Putin’s “Moscow Declaration” last month (although it is not clear how it might do so since it would require Qatar’s cooperation in cutting its LNG exports & it is unlikely to listen to the Saudis especially now that they are on opposite sides in Egypt). Finally, he is said to have pledged to safeguard Russia’s Syrian naval base in Tartus if the Assad regime were overthrown. On the other hand, he is said to have hinted at a Chechen attack during the Sochi Winter Olympics, allegedly warning “the Chechen groups that threaten the security of the Games are controlled by us.” $ This comes at a time of problems in several large oil producers as Iraq is reverting back to the era of the 20076-2007 Sunni-Shia civil war, Libya is sliding into warlordism & Nigeria is drifting into becoming a bandit state with a steady loss of output. Putin is said to have angrily rejected Bandar’s approach. INDIA’S CENTRAL BANK SHOULD CONSIDER MONETIZING GOLD (Reuters) $ Trade Minister Anand Sharma says the Reserve Bank of India should consider doing so to help stabilize the Rupee & help improve a current account deficit that has been boosted by the unprecedented gold imports driven by the massive retail demand for gold (‘I am not saying that it should, but merely suggesting it should consider the possibility’). The Bank currently holds 558 tonnes of gold and the Chairman of the London Bullion Market Association told the newspaper The Hindu that it could raise $23BN by ‘swapping gold for a payable currency for a period of its choice, while remaining the long-term holder of the gold.’ __________________________________________________ 3 Who served as Saudi Ambassador to the US from 1983-2005, during the terms in office of five US Presidents. A one-time ‘windfall’ of US$23BN would be like peeing on a hot plate in an environment in which the annual current account deficit is in the US$90BN range (i.e. 4.9% of GDP, the third-highest ratio in the world & up from 4.2% during the year-earlier period). GREECE SHOULD NEVER HAVE BEEN ALLOWED IN THE EURO (Telegraph, A. Trotman) $ That’s what Chancellor Angela Merkel told 1,000 supporters on August 27th at a gathering in Rendsberg, saying “Chancellor Schroeder accepted Greece in [2001] and weakened the Stability Pact and both decisions were fundamentally wrong, and are one of the starting points of our current troubles.”. While she also made the point there could be no question of another “haircut” for Greece’s creditors (the Germans banks are Greece’s largest creditors), Greece’s Finance Minister, Yannis Stournaras the day before had already taken his lead from the German Finance Minister ‘s observation last week that, while a third Greek bailout was inevitable , there could be no question of new money for it, by telling a German newspaper any such a move would just involve tweeking the interest rate & the length of the repayment period on the 240BN it owes. Chancellor Merkel conveniently overlooked the fact that, when her predecessor agreed to a weakening of the Pact, Germany, along with France, had fiscal deficits that were blatantly in breach of it). FRANCE ON THE EDGE OF THE PERIPHERY (Thoughts from the Front Line, John Mauldin) $ Havingspent some time reviewing the European situation, I am more convinced than ever that within a few years France will be the biggest ever economic train wreck in Europe (even if the markets doesn’t seem to share that view; for French interest rates are below those in the US, Canada & the UK - despite its lower credit rating - and half those of Italy & Spain). $ The depth of France’s state of denial is reflected in the following comments by Bruno Mosschetto, who teaches economics at the University of Paris & HEC : $ “France is not bankrupt ... (it) is not, and will not be, bankrupt because it would then be in a state of insolvency”; $ A state cannot be bankrupt ... to foreigners and residents since the latter would be invited to meet the debt by an immediate increase in taxation” - shades of the Citibank Chairman Walter Wriston pontificating, after the Second Oil Price Shock in 1979 but before the Latin American debt crisis a few years later, that ‘sovereign states cannot go bankrupt’, only to later learn they can default; $ “Ultimately our leaders have all the financial and political means, through the levying of taxes, to be facing our deadlines in Euros. And besides that, our lenders regularly renew their confidence, and rates have never been lower.” $ One way to get out of a debt crisis is to grow out of it; but France’s economy has been in recession for two years, its new job creation last year was down 53% YoY & its industrial output has been falling. Its debt growth is unsustainable and, although its interest payments are at an all-time low as a percentage of GDP, that will change when interest rates start rising; thus according to Westport, Conn.-based Bridgewater Associates (which has AUM of US$120BN & one of the best research teams around) “France is approaching the point in its debt expansion phase in which debt service costs will rise faster than the economy” (which will squeeze consumption & retard economic growth). France’s taxes are the highest in Europe and raising taxes further to service foreign-held debt would adversely affect domestic consumption, & hence the economy. And, being part of the Eurozone it cannot devalue its way out of its debt predicament. $ In Germany since 2004 total non-financial debt (i.e. net of bank deposits & other bank debt) has been relatively stable at about 200% of GDP. & in the peripheral group of countries, after rising rapidly from a similar level in 2004, it peaked at 270% in 2007 since when it has more or less stabilized. But in France it has been in a steady, so far uninterrupted uptrend since 2004, at last report stood at 260% & looks bound to soon exceed the peripheral group’s rate. $ France’s fiscal deficit, at 4+%, is well above the EU benchmark & the Eurozone average. It desperately needs labour reforms but hasn’t the political will or the ability to implement them. Its ‘social budget’, i.e. its ‘entitlement spending’, is 35% of GDP, well above the OECD average of 21%. The unfunded liabilities of its entitlement programs, at 362% of GDP, are by far the largest of all EU countries & its pay-as-you-go social safety net is little more than a huge Ponzi scheme. The unemployment rate has risen for 26 consecutive months & now stands at a 15 year-high 11.2%. Since 1999 France’s wages have grown 53%, vs. Germany’s 35% and according to the IMF France is losing competitive ground to Italy & Spain. Foreign holdings of its debt are 50% greater than Italy’s & 4x Spain’s (after foreign investors bailed out of the latter two & plowed the proceeds into French debt). Its government accounts for 56% of its GDP & its debt-to-GDP ratio is now over 90+%. $ While Charles de Gaulle once said “France cannot be France without greatness”, the path France is now on will not take it to greatness, but to insolvency & turmoil. While the world would be a better place with a great France, only the French can make such greatness happen. _____________________________________________ 4 Although the same day his boss said this he told the Saarbrücker Zeitung that the IMF’s estimate that Greece needed another 11BN Euros was “not completely unrealistic”. France’s cities are home to large numbers of Muslims living, in part by choice, in virtual ghettoes, who, while not part of France’s social fabric, & not always by choice, are nevertheless to a disproportionate degree beneficiaries of its social safety net. With any fiscal retrenching in France by necessity having to involve a partial dismantling thereof, this will likely make them a potentially serious destabilizing factor in France’s cities.