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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 arabianmoney.net 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

1.5bn potential Chinese gold bugs a new demand factor

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The inscrutable Chinese are hardly likely to inform the world that they are on a gold buying spree for fear of sending the gold price through the roof before they can finished their acquisition plans.

China’s gold reserves amount to 1,054 tons, ranking fifth in the world, said Yi Gang, central bank vice governor on Tuesday. China is the largest gold producer in the world, with more than 300 tons of gold produced annually, all of it consumed locally and not exported.

Private gold reserves

China is the second largest gold consumer in the world, with a consumption of over 400 tons of gold a year, second only to India. And it has been conservatively estimated that there are far more than 3,000 tons of gold accumulated among Chinese people.

Indeed it was only at the start of last year that China suddenly announced to the IMF that it had doubled its official gold reserves to 1,054 tons from 2003. Nobody knew anything about it before then, although there must have been suspicions in the trade.

Ah but let me run that past sharp readers again. Yesterday the Chinese central bank announced gold reserves of 1,054 tons, exactly the same figure as it gave the IMF a year ago. Is that not suspicious? When will we see the true figure including whatever they bought last year?

‘Gold is not a bad asset but currently a few factors limit our ability to increase foreign-exchange investment in gold,’ Mr Gang, also director of China’s State Administration of Foreign Exchange, told a news conference during the National People’s Congress.

He went onto explain that the supply of gold was too limited for the precious metal to play a major role in currencies, and that if China bought too much the price would go up.

Accumulating gold

But China should be judged on its record and not its rhetoric. In 2006 the World Gold Council said its central bank held 600 tons and had doubled its reserves to this level at the time when the UK was selling its gold reserves.

China has clearly been increasing its gold reserves steadily for a decade and has benefited from the quadrupling of gold prices over that period. But never mind the central bank, surely the surging private gold and silver holdings are the thing to watch.

When a population of 1.5 billion Chinese become gold bugs then $5,000 an ounce gold will be seen as far too conservative as a forecast and $200 silver will also be history.

Written by Peter Cooper

March 10, 2010 at 9:39 am

Fed set to raise key target interest rate 0.25% next Tuesday?

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The Federal Reserve is set to raise its key overnight interbank rate by a surprise 0.25 per cent next Tuesday when the Federal Open Market Committee meets, a senior banker from a top global bank specialized in currency trading told ArabianMoney last night.

This will signal an end to the brief era of near zero interest rates as a policy response to the worst global financial crisis since the Great Depression. It will serve both as a check to inflation and bolster confidence in the US dollar while reminding investors that asset prices have become inflated.

Window jumping

The interbank rate rise will follow last month’s unexpected increase in the discount rate from 0.5 to 0.75 per cent. The discount rate is the interest rate charged to commercial banks and other depository institutions on loans from their regional Federal Reserve Bank’s lending facility, the so-called discount window,

The interbank rate is the effective benchmark for all loans made in the US financial system. Any change in the latter has major implications for the US economy and by default the rest of the world.

By raising interest rates at this point in the cycle the Fed will be both proving its confidence in the tentative economy recovery that chairman Ben Bernanke has proclaimed, and underlining its commitment to preserving the value of the US dollar at a time of mounting deficits and bond issuance programs.

But there is much downside risk to this strategy. If the recovery is actually weaker than thought then the raising of interest rates could help push the economy into a double-dip recession.

Crash or correction?

There will also be an inevitable revaluation of financial markets to reflect the higher cost of money. Again there is a risk that if confidence is not as strong as generally held then financial markets will crash rather than undergo a healthy correction.

Recovery in economies and markets is seldom in a straight line, and the Fed will be only too aware of the dangers of fueling up an even bigger bubble in US equities and bond prices.

Reflationists will throw their arms up in horror at this action as imperiling a very fragile recovery. But it is a very fine judgment call, and a lot will depend on how much credibility the markets give the accompanying statements from the Fed about the likely speed of additional rate rises.

However, the Fed has to keep its street-cred and being a part of the gradual global tightening of interest rates – after a long period of loose monetary policy – should actually be better for the long-run health of the economy.

Written by Peter Cooper

March 9, 2010 at 9:10 am

Worst GDP growth in USA since 1946

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You have to go back to the year following the Second World War for a comparable fall in GDP to last year in the USA. Overall GDP fell by 2.4 per cent in the world’s largest economy.

By the fourth quarter an unprecedented stimulus package and near zero interest rates brought the economy back to life. But inventory restocking – after a run down in stock levels – accounted for most of this growth.

Rebound over

The question is whether this growth is sustainable going forward. The signs are not good. First quarter sales have been hit by exceptionally bad weather, quite apart from the bad economy.

The US dollar has also been rising – due mainly to the poor economic health of Japan, Europe and the USA – and that is bad for US exports.

What has also greatly aided the bailout has been a surge in financial markets from the bottom last March. Whether this has been overdone is almost to ask a silly question.

Stocks are up 70 per cent in the worst year for GDP growth in 64 years. How is that for contrarian thinking by investors? It leaves considerable room for almost immediate disappointment.

Where is the catalyst to drive this recovery? Inventory rebuilding will be over in the first quarter. New and existing home sales are coming in below expectations. Long-term unemployment is rising. Consumer sentiment is weakening, not getting stronger.

No we should rather be wondering what is the catalyst for a double-dip back into recession. Is it not obviously going to be the very financial markets that were so helpful last year and have now over played their hand?

Catalysts multiply

There is no shortage of possible catalysts to send markets lower, besides disappointing financial results. The Bank of China fears a reversal of the dollar carry trade, worth $1.5 trillion and bigger than the yen carry trade ever became.

Certainly any hint of higher interest rates threatens to get this money pulled out of riskier asset classes, like equities.

Surely the point at which the downside risk to financial markets greatly outweighs any further potential upside must be close, and given the ongoing rally in the US dollar and bonds the sell-off must be near.

Written by Peter Cooper

February 27, 2010 at 10:11 am

Latest interview with Bob Prechter Part Two

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Also hear Part One (click here).

Written by Peter Cooper

February 24, 2010 at 7:45 pm

Latest interview with Bob Prechter on the coming Great Crash

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Also hear Part Two (click here).

Written by Peter Cooper

February 24, 2010 at 7:17 pm

Why bonds suddenly look such a bad risk

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The $300 billion Greek debt crisis has thrown the spotlight on government debt as an investment class. Greece cheated Brussels into thinking its debt was lower than now proves to be the case, hence the nasty surprise.

But actually a huge question mark hangs over the viability of long-term investment in almost any government bond at the moment. Put simply it is a matter of pricing: are bonds priced too low for the inflation outlook?

Inflation coming

Inflation as we normally understand it means upward price revisions for goods and services. But inflation is always a matter of the money supply. Too much money chasing too few goods equals inflation.

And where does the money supply come from? Well, actually the bond markets that allow commercial banks to create credit.

And what do we know that governments all over the world have been doing to counter the global financial crisis? They have been issuing more and more bonds, and even buying their own debt in a bizarre process called quantitative easing. So the money supply is rising, even if commercial credit is still actually shrinking.

Eventually that new money will find its way into global financial markets and cause inflation. How long will that take?

There is presently no immediate fear. Indeed, the most immediate prospect is a downturn in global equity markets that will rally the dollar and boost bond purchases, at least for a short time. Some think central banks are about to cause a stock market crash for that very reason.

But look at a 10-year British Gilt paying four per cent interest, or for that matter Greek bonds paying not much more. You have to be a bit of a loony to think that will represent a good buy over a decade.

In the 1970s bonds were dubbed ‘certificates of confiscation’ because inflation eroded their real value and gave them a negative yield after inflation. This time will not be different.

Bond yields are presently very low and bond prices therefore exceptionally high. What has gone up in price will go back down, not up further, or not for very long.

Deflation versus inflation

The confusing mixture is first deflation as house prices and equities fall, then inflation as governments overdo their rescues and finally something bordering on hyperinflation to eliminate debts. Timing this is very difficult.

If you are a bond holder then you hold debt, and that is not a position you want to have when inflation really roars and destroys debt.

In previous major financial crises this has always been the penultimate phase, and when the bond market implodes then comes the final, or ‘ultimate’ bubble as George Soros calls it, in gold and silver.

Thus while owning short-term bonds and cash makes sense in a stock market crash, a swift move into precious metals thereafter should be contemplated.

You do not have to go back far in history to find government bond defaults. Think Russia 1998, Argentina 2001. The wonder is surely that investors continue to believe governments have some kind of magic as creditors.

Written by Peter Cooper

February 16, 2010 at 9:14 am