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Public debt fears overshadow worst-ever US housing data

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The poorest figures for new home sales in US history were largely ignored by financial commentators yesterday as the markets focused on global debt problems that threaten a rise in interest rates before the fragile global economic recovery can handle it.

Portugal saw its sovereign rating cut by Fitch. US treasuries were hit by poor demand in an auction of five-year notes. Japan approved a new budget with a record $49 billion in new bond issuance. And a pre-election budget in Britain offered no relief for its huge debts.

US dollar surge

The main beneficiary was the US dollar with the euro down to $1.33. US financial markets also took a breather from their endless rally as risk aversion crept back into the market. The S&P is now valued at 22 times earnings, 32 per cent above its 30 year average, and clearly overvalued for this stage in the economic cycle. Gold fell to $1,085.

Meanwhile, the market largely ignored data showing that US new home sales fell to the lowest level on record in February. Sales of new homes dropped unexpectedly, falling 2.2 per cent during the month to 308,000. That was the lowest sales rate on record and much worse than expected.

US new home sales are down 23 per cent since last October. New home sales are off 13 per cent from February 2009. With sales falling for four months running, the inventory of new homes has increased, reaching a supply of 9.2 months.

Housing crisis

The construction of new homes in the United States is a critical source of demand for commodities used in building houses. Only a surge in demand from China has prevented a meltdown in building material prices and related commodities from steel to aluminum and timber.

The now frosty relationship between China and the US is symbolized by the Google condemnation of Chinese censorship and its self-imposed exit. The call for tariffs on Chinese goods to protect US industry is growing. At the same time China is tightening up on credit and could start buying less US treasuries.

Far from being in a fragile recovery the world is set for a round of further instability in global financial markets. In the initial stages the chief beneficiary will be the US dollar but the problems in the treasuries’ market is a reminder that dollar strength could be transitory.


Written by Peter Cooper

March 25, 2010 at 8:36 am

Global political consensus unravels threatening economic recovery

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When the global financial crisis first struck 18 months ago there was a commendable consensus among the world’s politicians about the need to tackle the crisis, and the actions that followed have done much to offset a fall into an even deeper slump.

However, global governments do not usually work in harmony. National interests are competitive and usually work to undermine a consensus. That is what now appears to be happening. It will not aid what is only a very tentative global economic recovery. It could undermine it completely.

IMF and Greece

Consider the Greek debt crisis. Far from being resolved by Germany it now appears that Greece will be thrown into the arms of the IMF for an austerity package. Which countries from the European Union will follow? Spain, Portugal and Ireland? Italy perhaps?

Then there is also the simmering potential of a trade war between the US and China. Nobel prize winning economist Paul Krugman is calling for a 25 per cent tariff on Chinese goods if China fails to revalue its currency to rebalance global trade. Google is to exit China over censorship.

It is notable that both these cases involve creditor nations protecting their national interests, and refusing to pick up the bill for debtor nations. You can certainly understand the logic of not wanting to pay off the debts of another nation. Why should German pensioners retire late to pay for the Greeks to retire early?

Yet the risk is that we deteriorate into a downward spiral for trade like in the 1930s. Both China and Germany have reason to pay attention as last year was their worst for trade since the Great Depression with export slumps of 16 and 18 per cent respectively.

Horrific trade slump

These are horrific export figures and the bounce back this year, to levels of trade still nowhere near pre-crisis levels is by no means secure.

The problem is that the creditor nations running export surpluses have been relying on the debtor nations to borrow more and more to fund their imports. Now that cycle has reached its limit or will so very soon as national debts grow bigger courtesy of stimulus package spending.

Ironically what the creditor nations say is right. There is no way out for debtor nations apart from austerity, default or devaluation and the latter is not open to eurozone countries. But this is not going to be good for the creditor countries either.

UAE case

To take the UAE as another example of a creditor nation. A business slump in developed countries will reduce demand for oil and hence the price and revenues. Then there will have to be a draw-down of savings to keep the economy going.

Where creditor nations theoretically win is that they can afford to buy things in a global liquidation sale. That might not be much compensation, however, if the world economy is shattered in the process.

In the meantime, we must hope that mutual self-interest triumphs on the global stage. But the omens are not good right now with nationalism on the rise. This sets the stage for a double dip global recession, not a recovery.

Written by Peter Cooper

March 22, 2010 at 9:58 am

Dubal shows Dubai core economic strength but profits halve

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Healthy profit and revenue figures from the giant Dubai Aluminium Company yesterday are a reminder that the emirate has an economy beyond its failed real estate and construction sector.

Production crossed one million tonnes, up seven per cent. Revenues grew eight per cent to $1.9 billion. But profits halved from 2008 to $299 million in 2009.

$5.7bn Emal start-up

Dubal is also an equal shareholder with Abu Dhabi state fund Mubadala in the $5.7 billion Emirates Aluminium Smelter start-up at Al Taweelah. This project is 80 per cent complete and production will rise from 300 tonnes per day to 700,000 tonnes per annum by December, officials told MEED.

Once Emal is fully operational Dubal is set to become an even bigger contributor to the GDP of Dubai. By 2013-14 Emal is set to boost its capacity to 1.4 million tonnes per annum.

That would roughly double the contribution of Dubal to the GDP of Dubai from four to five per cent to nearer 10 per cent – actually around the contribution that Dubal used to make to Dubai GDP before the recent oil boom.

It is not surprising then that Dubal officials say they are bullish about the outlook for the aluminium market in 2010. They have a lot riding on a recovery in the global economy that will increase demand for their basic industrial metal.

Of course this is also the problem. What if the global economic recovery does not come through? Demand for US autos and housing – both big consumers of aluminium – remains stubbornly down.

Global boom or bust?

Indeed the US housing market seems set for more distress with mortgage resets coming up over the next couple of years. Then there is the Chinese economic bubble that could burst, instantly depressing demand for industrial metals and depressing the price.

Dubal has already seen its profits cut in half in 2009 by the global economic recession. But large fixed capital investments like aluminium plants always have to plan for the business cycle. Their investments are phased over many years and not all will be in the good times.

That said energy is the main cost input into aluminium production and the UAE has an abundance of cheap power, so if aluminium production is going to make a profit anywhere it will do so here.

Written by Peter Cooper

March 18, 2010 at 8:41 am

Posted in Banking, China, UAE Stocks

All the good news now priced into global stock markets?

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Wall Street breathed a sigh of relief yesterday as the Fed confirmed that ultra-low interest rates would continue for ‘an extended period’, generally thought to be over six months, and rumors of a rate rise once again proved to be greatly exaggerated.

Some kind of a relief rally might be anticipated over the next few days. But there is also a contrarian view that says all the good news is now priced into the market.

Chart view

Certainly the chart from last March shows a picture of a strong initial recovery, a flatter upturn later in the year and then a dome pattern. Breakouts might now indicate another leg up but the deteriorating quality of news suggests this may not follow.

The Chinese monthly purchasing managers’ index showed its smallest expansion in manufacturing activity in a year. Meanwhile, a hike in inflation has put Chinese savers into negative real interest rates. An inflection point seems close in the Chinese economy with a scaling back of last year’s colossal stimulus package.

Then again the European Union lifeline for Greece is just the first in a long queue, with Spain a much larger problem and other indebted nations also in need of a bailout. Business is not good in Europe. Germany just published revised figures showing a heart-stopping 17.9 per cent fall in exports in 2009, with China taking over its position as the world’s biggest exporter.

Czech retail sales declined the most in four months in February. Spanish home prices fell for the ninth quarter in a row through December. Japan is caught in a debt trap. The UK and USA are facing possible loss of their triple-A credit ratings. US housing and auto sales are way down.

V-shaped recovery?

None of this supports the V-shaped recovery thesis now priced into global stock markets. The world economy has fallen into a trough and shows very little sign of being able to dig itself out anytime soon.

Where is the magic catalyst to make it happen? Interest rates can hardly go any lower. Government spending causes more debt and is ultimately a burden on an economy, draining money from far more productive private enterprise.

No a further shake out of asset prices to reflect the reality of a world of falling profits over a number of years, and a series of further economic shocks is inevitable. Try to present the reverse argument and you really struggle because there is no credible counter view.

Written by Peter Cooper

March 17, 2010 at 9:07 am

KHI investors should accept a gift from silly Prince Alwaleed

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Prince Alwaleed’s holding company has made an offer to buy out the shares in Kingdom Hotel Investments that it does not own, and investors would be wise to seize this generosity.

Most hotel groups all around the world presently have assets up for sale. In Dubai Union Properties has publicly stated that it is in negotiations to sell its Ritz-Carlton in the Dubai International Financial Centre even before it is finished. Prince Alwaleed himself has been trying to sell The Savoy in London.

Hotel doldrums

So why would Prince Alwaleed want to buy shares in KHI when hotels are a hard sell all over the world? Basically the owners just cannot get the prices that they want because their business models do not justify such prices in a recession.

It is true that the KHI listing on the Nasdaq Dubai has been a disaster and dogged by poor liquidity from Day One, but then there is a cross listing in London.

But yesterday’s $5 a share offer for the outstanding 44 per cent of KHI offers a 25 per cent premium to the current share price. That values the group at $843 million against yesterday’s full-year earnings reported at $22 million, up 27 per cent on 2008.

KHI has its assets spread across emerging markets including Africa, and the prince clearly believes that the stock market is undervaluing the future potential gain in these countries.

But then again you can hardly argue that emerging markets are undervalued from an equity perspective at the moment. Most have almost doubled since the lows of last March and have strongly outperformed the industrialized world. The downside risk from here is obvious.

Cashing out

So the choice for investors is simple: do you cash out of a disappointing stock at a high point in the cycle with a 25 per cent buy-out premium, or wait for the next market downswing to wipe you out?

Admittedly Prince Alwaleed is thinking longer term but his optimism about emerging markets may well prove unfounded. China in particular is an economic powder keg about to explode, and downturns in emerging markets dependent on China, like Africa, will be particularly vicious.

Foreign investors in Africa have not had much success since the end of the British Empire and turning a quick profit is the only sensible thing to do in such unstable countries.

Written by Peter Cooper

March 16, 2010 at 9:56 am

Posted in China, Hotels, Saudi Arabia

AAA-ratings fear for US to trigger 0.25% interest rate hike?

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Warnings from credit rating agencies like Moody’s that the US and UK are in danger of losing their AAA ratings could be the final straw that persuades central bankers to jack up interest rates by a marginal amount this week.

An article on the financial website last week that cited senior banking sources as predicting a 0.25% rise in the Fed funds target overnight rate on Tuesday, has set pulses racing (click here).

Fed cred

But few commentators give this source much credence and the tendency is to believe the Fed and its promises of an extended period of low interest rates.

Words can always be twisted, of course. The Fed could jack up rates 0.25 per cent and still claim that it is sticking true to its word, with rates still low and expected to stay low for the foreseeable future.

The impact on financial markets would be instant. The AAA-rating would be assured and bond prices surge. Stock markets would come off their recent highs and this might be greeted as a healthy correction from overvalued levels.

Dangerous complacency

Markets dislike the unexpected but they may have become unduly complacent recently believing that emergency low interest rates are an indefinite phenomenon.

All history says otherwise if only because artificially suppressing the cost of money is inflationary and unfair to those paid low interest rates. It is also bad for government debt ratings and the government has a lot of debt to raise this year.

Standby for a shock announcement from Fed chairman Ben Bernanke tomorrow night. The fear in the market today is that China is tightening but the real gorilla in the front room might be much closer to home.

Written by Peter Cooper

March 15, 2010 at 1:45 pm

Will Chinese inflation hike oil and gold prices back up?

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The Middle East could be enjoying another oil price boom much sooner than expected as Chinese inflation gathers pace after one of the biggest experiments in loose monetary policy in history.

Once an exporter of deflation to the rest-of-the-world, a nasty side-effect of the record stimulus plan in China last year is a surge in inflation that jumped to 2.7 per cent last month. Officials claim this is ‘mild and controllable’. Veteran observers sense an inflation genie let out of the bag.

Handbag shortage

One reader recently commented on shortage of handbags in China. This small example is illustrative of too much money pursuing too few goods. Inflation in prices is the inevitable result.

Chinese officials blame rising international commodity prices for domestic price rises. Yet where is that demand coming from but China? The latest oil studies have all concluded that demand is surging in China and flat or falling in the rest-of-the-world.

How long before the cost of Chinese exports begins to increase and this inflation is literally exported to the rest-of-the-word? It can only be a matter of time, and not so long at that.

Gold investors selling last week on fears that interest rates would go up in China are really barking up the wrong tree, as is anybody who thinks the Chinese are not buying more gold themselves.

Oil producing countries have been very content with oil prices in the $70-80 range. But they worry about higher prices because that might give their customers another economic heart attack.

There is also mounting concern about the durability of the Chinese economic recovery and the quality of recent GDP growth. Speculative bubbles inflated by cheap credit have a habit of going spectacularly bust and leaving the formerly rich and successful in deep trouble.

Stimulus risk

No country has ever masterminded a bigger per capita stimulus plan than China last year. It is the boldest ever plan of its kind, and therefore also carries the most risk.

For one thing higher oil prices will be desperately bad news for the developed economies still struggling to emerge from the worst recession since the 1930s, and having saved the world with its massive reflation China risks blowing up its client’s economies with inflation.

Not that the developed economies have been pursuing exactly deflationary policies themselves, and this just adds to the witches brew now imperiling the global economy. If there is an oil price spike now it may be nasty, brutal and short. Gold is the more solid inflation hedge.

Written by Peter Cooper

March 14, 2010 at 8:52 am