February 20, 2019

Global Market Comments
February 20, 2019
Fiat Lux

Featured Trade:

(COPX), (GLD), (FCX), (BHP), (RIO), (SIL),
 (PPLT), (PALL), (GOLD), (ECH), (EWZ), (IDX),
(DHI), (LEN), (PHM), (ITB)

The Next Commodity Supercycle Has Already Started

When I toured Australia a couple of years ago, I couldn’t help but notice a surprising number of fresh-faced young people driving luxury Ferraris, Lamborghinis, and Porsches.

I remarked to my Aussie friend that there must be a lot of indulgent parents in The Lucky Country these days. “It’s not the parents who are buying these cars,” he remarked, “It’s the kids.”

He went on to explain that the mining boom had driven wages for skilled labor to spectacular levels. Workers in their early twenties could earn as much as $200,000 a year with generous benefits.

The big resource companies flew them by private jet a thousand miles to remote locations where they toiled at four-week on, four-week off schedules.

This was creating social problems, as it is tough for parents to manage offspring who make more than they do.

It’s starting to look like we are on the eve of another great commodity boom, the start of a long-term super cycle. China, the world’s largest consumer of commodities, is currently stimulating its economy on multiple fronts, including generous corporate tax breaks and relaxed reserve requirements. Get a trigger like a settlement of its trade war with the US and it will be off to the races once more for the entire sector.

The last bear market in commodities was certainly punishing. From the 2011 peaks, copper (COPX) shed 65%, gold (GLD) gave back 47%, and iron ore was cut by 78%. One research house estimated that some $150 billion in resource projects in Australia were suspended or canceled.

Budgeted capital spending during 2012-2015 was slashed by a blood curdling 30%. Contract negotiations for price breaks demanded by end consumers broke out like a bad case of chicken pox.

The shellacking was reflected in the major producer shares, like BHP Billiton (BHP), Freeport McMoRan (FCX), and Rio Tinto (RIO), with prices down by half or more. Write-downs of asset values became epidemic at many of these firms.

The selloff was especially punishing for the gold miners, with lead firm Barrack Gold (GOLD) seeing its stock down by nearly 80% at one point, lower than the darkest days of the 2008-9 stock market crash.

With both prices and volumes in a race to the bottom, the effect on profits was especially traumatic. Highly leveraged, smaller, undercapitalized firms have filed for bankruptcy in droves, such as the Western Australia-based Allmine Group (see, a service provider.

You also saw the bloodshed in the currencies of commodity-producing countries. The Australian dollar led the retreat, falling 30%. The South African Rand has also taken it on the nose, off 30%. In Canada, the Loonie got cooked.

The impact of China cannot be underestimated. In 2012, it consumed 11.7% of the planet’s oil, 40% of its copper, 46% of its iron ore, 46% of its aluminum, and 50% of its coal. It is much smaller than that today, with its annual growth rate dropping by more than half, from 13.7% to 6.6%.

The rise of emerging market standard of living will also provide a boost to hard asset prices. But as China goes, so does its satellite trading partners, who rely on the Middle Kingdom as their largest customer. Many major commodity exporters themselves, like Chile (ECH), Brazil (EWZ), and Indonesia (IDX), are looking to come back big time.

As a result, western hedge funds are currently moving money out of paper assets, like stocks and bonds, into hard ones, such as gold, silver (SIL), palladium (PALL),  platinum (PPLT), and copper. A massive US stock market rally has sent managers in search of any investment that can’t be created with a printing press. Look at the best performing sectors this year and they are dominated by the commodity space.

The bulls may be right for as long as a decade, thanks to the cruel arithmetic of the commodities cycle. These are your classic textbook inelastic markets. Mines often take 10-15 years to progress from conception to production. Deposits need to be mapped, plans drafted, permits obtained, infrastructure built, capital raised, and bribes paid. By the time they come on line, prices have peaked, drowning investors in red ink.

So a 1% rise in demand can trigger a price rise of 50% or more. There are not a lot of substitutes for iron ore. Hedge funds then throw gasoline on the fire with excess leverage and high-frequency trading. That gives us higher highs to be followed by lower lows.

I am old enough to have lived through a couple of these cycles now, so it is all old news for me. The previous bull legs of super cycles ran from 1870-1913 and 1945-1973. The current one started for the whole range of commodities in 2016. Before that, it was down from seven years.

While the present one is short in terms of years, no one can deny how business cycles have been greatly accelerated by globalization and the Internet.

Some new factors are weighing on miners that didn’t plague them in the past. Reregulation of the US banking system is forcing several large players, like JP Morgan (JPM) and Goldman Sachs (GS) to pull out of the industry. That impairs trading liquidity and widens spreads— developments that can only accelerate upside price moves.

The prospect of flat US interest rates is also attracting capital. That reduces the opportunity cost of staying in raw metals, which pay neither interest nor dividends.

The future is bright for the resource industry. While the gains in Chinese demand are smaller than they have been in the past, they are off of a much larger base. In 20 years, Chinese GDP has soared from $1 trillion to $10 trillion.

Some 20 million people a year are still moving from the countryside to the coastal cities in search of a better standard of living and improved prospects for their children.

That is the good news. The bad news is that it looks like the headaches of Australian parents of juvenile high earners may persist for a lot longer than they wish.






The Emerging ?BUY? on Emerging Markets

No asset class has been beaten more severely this year than emerging markets. Since the March, 2011 high, the iShares MSCI Emerging Market ETF (EEM) has plunged from $48 to $35.80, a loss of 25%. Individual markets have fared far worse. The Market Vectors Indonesia ETF (IDX) has taken a 39% haircut, while the Powershares India Portfolio ETF (PIN) has cratered by 46%.

It wasn?t supposed to be like this. These countries boast GDP growth rates of two to four times those found in the developed world. Many, like Chile (ECH) and Indonesia (IDX) are endowed with abundant natural resources. India (PIN) offers one of the world?s most attractive demographic pyramids, a precursor to stable long term growth.

The Philippines (EPHE) boasts a great, low waged, educated labor force. It is no accident that to subscribe to the San Francisco Chronicle your call gets directed to an obscure location 200 miles south of Manila, where call center workers live well on $2,000 a year.

You can blame China for starting the malaise. The Middle Kingdom is the largest customer for many of these countries, and successful efforts to throttle back the economy to control runaway home price inflation have spilled far beyond its borders. Since 2007, China?s economy has slowed from a near 14% annual growth rate to a probable 7%. This is a rate not to be sneezed at, but it is still quite a hit. Weak emerging economies then slow China further, creating a vicious negative feedback loop.

China isn?t the only problem. Most emerging nations are highly dependent on imported energy, and are in effect shorts on oil. So when Middle Eastern turmoil drives Texas tea up 28% over the past five months, as it has, balance of payments bleed. This has pummeled their currencies, boosting the local cost of fuel even further. In some countries gasoline costs have soared by more than 50% since the spring. This is terrible for their economies.

The big surprise is how much Ben Bernanke?s ?taper? thoughts are pounding the emerging markets. Much of the excess cash that the Federal Reserve has created over the past five years has poured into the emerging space, boosting share prices and ETF?s to heady heights. Cut off that supply, even by a piddling $5 billion a month, and everyone tries to leave the party at the same time. The price action has been reminiscent of the proverbial flash fire in the movie theater.

Excess liquidity has in fact turned the emerging markets into ?reach for yield? assets, much like master limited partnerships, sovereign debt, junk bonds, municipal bonds, and REIT?s. All of these asset classes have held hands jumping over the cliff since April, when the ?taper? talk began. When investors take inordinate risks for small, incremental improvements in returns, it always ends in tears.

Once emerging markets started going down, all the dirty laundry came out. Tales of corruption have always been endemic to the region. China has started arresting foreign drug company executives for bribery, a classic case of the pot calling the kettle black. The human rights records of several are less than sterling. Having spent time in jail in some of these places because of what I wrote, I more than sympathize.

What?s worse, some of the emerging fundamentals have deteriorated. Once, you bought these countries because they had little debt, a legacy of dismal credit ratings in the seventies and eighties. What did the Fed?s easy money policies accomplish here? Rising debt levels, both at the national and corporate level. Worst of all, some countries have been borrowing from abroad to subsidize fuel prices to lessen the recent price spike. That weakens national finances at an exponential rate.

It all adds up to a perfect storm for emerging markets. Think of them as a short oil/short dollar/long junk play. Ouch! With the way they have been trading, you?d think their largest export was venereal disease!

Which is all why I am starting to get interested. For many years, emerging market companies sold at large premiums to American ones. They now sell at a 35% discount. The long-term bull case is still valid. Watch the bond market. If it rallies hard in the wake of the Fed?s taper decision, as I expect, then it will be off to the races for emerging markets once again.

But it won?t be your father?s emerging bull market. Forget about the BRIC?s (Brazil, Russia, India, China), which are last year?s story. Just mindlessly buying the (EEM) won?t work anymore either. This is no longer an index play.

In the next cycle single country picks will be the name of the game. What?s on my short list? Mexico (EWW), South Africa (EZA), Indonesia (IDX), Thailand (THD), Malaysia (EWM), the Philippines (EPHE), Columbia (GXG), and Chile (ECH). Industry selection will also be important, with a move away from export industries towards domestic consumption called for.

Maybe it?s time to add Thailand to my short list of potential vacation destinations?

EEM 9-6-13

PIN 9-6-13

IDX 9-6-13

EPHE 9-6-13

Thai Dancer Time to Look at Emerging Markets?

Keep Indonesia on your Radar

If you are looking for another emerging market to add to your list of things to buy on dips, then take a look at Indonesia (IDX). The world?s largest Muslim country offers a combination that I love, a population with great demographics that is also a major energy and commodities exporter.

The archipelago is the biggest country in Southeast Asia and a huge exporter of oil and LPG to Japan on long-term contracts. (An old friend of mine torched their Borneo fields at the beginning of WWII, and spent four years in a Japanese prison camp for his troubles.) Other big exports include marvelous textiles, rubber, and increasingly rare tropical hardwoods. Another plus is one of the world?s most pro growth population pyramids (see below).

The global financial crisis only knocked their growth rate from 6.1% to 4.5%, and now it is back above 6%. No doubt, $63 billion of direct foreign investment into the country helped. A series of tax reforms promise to keep the train moving, cutting the top corporate rate from 30% in 2008 to 28% in 2009, and 25% in 2010. Wisdom Tree had the ?wisdom? to launch the country?s first ETF (IDX) in January, 2009 (what timing!), which became one of the best performers of the year, rocketing over 300% from the lows to $60.

Islamic inspired terrorism is still a lingering concern. I keep Indonesia in the category of highly volatile, high risk, high return frontier markets that you only want to buy on a big dip. Keep it on your radar.

IDX 6-24-13

Indonesia 2010 Population

Indonesian Natives Meet Your New Investors in Indonesia

The Future of Consumer Spending?

As part of my never ending campaign to get you to move more money into emerging markets, please take a look at the chart below from Goldman Sachs. It shows that the global middle class will rise from 1.8 billion today to 4 billion by 2040, with the overwhelming portion of the increase occurring in emerging markets.

The chart defines middle class as those earning between $6,000 and $30,000 a year. Adding 2.2 billion new consumers in these countries is creating immense new demand for all things and the commodities needed to produce them. This explains why these countries will account for 90% of GDP growth for at least the next ten years. It’s all a great argument for using this dip to boost your presence in ETF’s for emerging markets (EEM), China (FXI), Brazil (EWZ), and India (PIN).

Of course, you don’t want to rush out and buy these things today. Emerging markets have been one of the worst performing asset classes of the year. But the selloff off is creating a once in a generation opportunity to get into the highest growing sector of the global economy on the cheap. I’ll let you know when it is time to pull the trigger.

In the meantime, store this chart in your data base so when people ask why your portfolio is packed with Mandarin, Portuguese, and Hindi names, you can just whip it out.

World Middle Class

EEM 6-18-13

FXI 6-18-13

PIN 6-18-13

IDX 6-18-13