China, Shipping and the Great Commodity Carry Trade 50 comments
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In a volatile market, rather than trying to get ahead of the daily movements, successful investors spend their efforts figuring out the big picture of long term fundamentals. Many people often draw the wrong conclusion when their views are too narrow: They look at only the demand side and forget the story on the supply side, or they fail to see the effect of government intervention or speculative forces.
Recently, in researching the market trends of currencies, commodities and shipping, I made a stunning discovery, yet almost no one else discussed it in any public literature.
Where is the US Dollar Going?
A dollar bear means a commodities bull. The 2009 US federal budget deficit will be $1.75 TRILLION or even more! It's utter insanity! Any budget bill can be decreed into law, regardless of the deficit. But no one can decree new economic laws. Where do we get the $1.75T? It will be printed out of thin air, as no one, not even China, can lend this much money to us, unless we lend our money printing machine to China first. History has proven repeatedly that mass printing of fiat money always leads to currency debasement and hyperinflation.
My shocking discovery is that we HAVE already lent our money printer to China!
I am fearful of the worst case scenario for America. Current gigantic deficit spending is not the worst part. The worst part is that capital may escape from American soil for better overseas opportunities, taking away jobs and tax revenues, reducing us to the only option: print more money and debase the dollar further, a nightmare scenario for America.
US dollar bear leads to commodities bull. People and nations will hoard physical goods to preserve wealth, hence generate demands higher than immediate needs and higher than available supplies. China is on a big natural resources shopping spree around the world lately, in order to divest its huge foreign currency reserves.
Both events are occurring as people have noticed: Capital is escaping American soil; and China is on a global shopping spree of raw materials. But people who notice these two things explain it as simply market behavior driven by speculative forces. They fail to see a more direct, conscious and deliberate reason behind what's going on, because no one noticed one quiet fact...
People watch the US Dollar index daily, but are they watching the Chinese Yuan? Investors trade trillion dollars between the USD, Euro and Japanese Yen daily. But there is not much trading between USD and Chinese Yuan. That is because for the past one year, trading between USD and CNY is equivalent to exchange one dollar into four quarters, nothing is gained or lost.
The Chinese government has locked the exchange rate at a constant Y6.832 = US$1.00, for over a year now. WHY? Insightful investors such as Jim Rogers, Peter Schiff, Marc Faber all predicted a US dollar collapse and the appreciation of Chinese Yuan, and advised people to sell the dollars and buy the Yuan. Many people listened. They sold their houses and furniture in the USA, sold all their US assets. They brought boat loads of US dollars to China, exchange into Yuan, and sit on their piles of Yuan, betting on the Yuan appreciation over US dollar to collect some profits.
And they collected some dust instead. Making money should never be easy. Straight line thinking is never how great investors make their money. Why would China allow foreign speculators to profit on its currency while it suffers loss?
As the flood of US dollars flows in, China merely cranks up its own money printing press to print more RMB Yuan to exchange for the US dollars. It then uses some of the dollars to buy US Treasury bonds and prop up the value of the dollar, maintaining a constant USD/Yuan exchange rate. But China's real goal is not to support the dollar in long term, but to buy time to allow it to divest the huge dollar assets it is holding, in exchange of physical assets: natural resources, raw commodities, foreign mining companies and other physical assets. It costs China nothing to print more Yuans to buy more US dollars and then use the dollars to buy up the whole world.
Thanks to currency speculators, we have lent our money printing machine to China. This opportunity allowed China to launch the greatest Commodity Carry Trade ((CCT)) in history! It is an absolutely ingenious move: US government has no choice but to keep printing more dollars; Speculators betting a dollar collapse flee the US market and bring the dollars to China; the drainage of market capital from the US market forces the US government to print even more dollars and drives more investors away from the US and into China; China then prints more of its own currency at virtually no cost, swap for the dollars, and then holding the dollars at hands, they go around the world to buy up everything, and go to the USA to buy up everything. At the end when China is done, they will let the US dollar collapse; meanwhile, the Chinese Yuan, due to strong backing of all the physical assets China hoarded, will hold up its value.
On the concept of China's Commodity Carry Trade ((CCT)), credit must be given to Andrew Snyder, whose article on the CCT is an interesting read. I smiled big when I read his pitch on a certain metal and a certain US mining company as the next big target of China's CCT. I knew he was talking about palladium, my favorite metal, and Stillwater Mining (SWC), my favorite mining stock. There is also North American Palladium (PAL) for a palladium play. I am not sure whether palladium is China's next big strategic purchase. But even without China's CCT purchases, palladium is extremely bullish.
Shipping and China's Strategic Investments
If China is buying commodities for strategic stockpiling, it will boost demand in the dry bulk shipping sector. I correctly called the bottom of the Baltic Dry Index on Dec. 5, 2008. Shares of dry bulk shippers are up tremendously from the early December, 08 bottom, and from the early March, 09 double bottom. I was betting on a reasonable recovery of shipping, but I never dreamed that the BDI could reach 4291 merely 6 months after it bottomed at 666! Today shipping stocks are still very cheap, as analysts are not convinced the global economy is in recovery. But isn't it now an open secret that China is spending out its US dollar holdings in exchange for natural resources and raw materials it can buy and hoard at current low prices. When China purchases for strategic hoarding, current industry demand is not even relevant.
There is but one small cloud in the shipping sector. The Drewry report calls the current dry bulk sector recovery temporary, as they see a big number of new order ships joining the fleet in the next few years. How credible is Drewry's bearish call based on their new ship order prediction?
Drewry said that BDI "seems to have reached the bottom", six months after the fact. That doesn't give them much credibility predicting something six months after the fact. I actually called the bottom spot on. In 2003, Drewry also made a similar bearish call on dry bulk shipping, based on their prediction of excessive number of new ships. We now know that shipping saw an unprecedented boom period in the next 5 years, peaking in August, 2008. If the new ships Drewry predicted since 2003 are still on paper in 2009, they may stay on paper for 6 more years. Most new order ships may never be built, due to reasons discussed before.
One of the criteria I use to pick the best shipping stocks in which to invest, is by looking at the ratio of shipping capacities of their fleets versus current market capital, as the shipping tonnage is ultimately what earns revenue. I will leave the detailed discussion till next time. My favorites are Excel (EXM), Eagle Bulk Shippin (EGLE), Dry Ships (DRYS), TBS International (TBSI) and Genco (GNK), in that order.
On Precious Metals
Gold will continue to be a laggard in precious metals. The world is never in shortage of gold. Gold is just money, or just cash. Recently some gold bugs made a lot of noise of China revealing that it doubled its gold reserve in the past 5 years. But it must be pointed out that China's foreign currency reserve increased more than 10 fold during the time, so gold is now actually a smaller percentage of China's total currency reserve.
Silver is a better story than gold. If fiat currencies fail, silver is the only monetary metal that is cheap enough to be used as bartering currency. The Chinese consider gold as a luxury but silver as money and storage of wealth. In Ancient China the gold/silver price ratio was 2:1. As Chinese investors turn their attention towards precious metals, silver will be their most favorite metal.
But the best precious metal story is in platinum and more so in palladium. The bullish palladium news from Norilsk Nickel (NILSY.PK) in Russia keeps getting better. Norilsk had announced the production result of Q1, 2009. The Q1 palladium production had fallen to only 557K ounces in the Russian division. Annualized it's 2.23 million ounces per year, compare with a normal year's 3.1 million ounces. I predicted Norilsk's 2009 palladium production would be only 2 million ounces, because they are producing the ores rich in nickel content and poor in palladium. The Q1 result had confirmed my prediction.
The current low palladium price provides no economic incentive to recycle auto catalytic converters. So as the palladium recycling grinds to a halt, it removes another one million ounces of global supply. The drop of recycling is confirmed in Stillwater Mining (SWC)'s Q1 report.
Palladium has huge future potential due to recent renewed interest in Cold Fusion, especially after CBS 60 Minutes aired a special report on Cold Fusion on April 19, 2009.
Other Commodities To Consider
Crude oil price has now surges back to $68 per barrel due to the weakness in US dollar. Some predict oil could surge to $200 in the near future. Comparatively, natural gas price still far lags behind. This creates a great buying opportunity, as natural gas is still cheap to buy, when most other commodities have rallied from recent bottom. Even Marc Faber called natural gas the most under-valued commodity recently.
Two reasons to buy natural gas here. First, current price is far below the marginal production cost. In the US, the conventional natural gas fields are depleting rapidly. Natural gas production was boosted in the past two years only because of new technology and higher natural gas price made it economical to develop the so called shale gas. But as the price falls below $10-$13 per thousand cubic feet (TCF), shale gas is no longer profitable so producers must cut back.
Second, from the energy point of view, 5.3 TCF of natural gas contains the same amount of energy as one barrel of oil, so $4 per TCF is equivalent to $21 per barrel oil. When crude oil price is already at $68, the low price in natural gas is unsustainable as industry energy consumers will try to use more natural gas and less oil.
How to play natural gas? Buying the United States Natural Gas fund (UNG) is the best way. Stocks of natural gas producers would go up with the commodity. But judging from past experience, the rice of the natural gas itself could jump up faster and more furiously than stocks of producers. Some producer stocks to consider: Chesapeake Energy (CHK), Southwestern Energy (SWN), Cabot Oil & Gas (COG), Contango Oil & Gas (MCF) and Wiliams Companies (WMB).
Full Disclosure: The Author is heavily invested in palladium producers SWC and PAL. I am also heavily long shipping stocks EXM, DRYS, EGLE, TBSI and GNK. I also own UNG.
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Re natural gas, I have concluded that portability and storability may be the major reasons it has not kept pace with oil. To build an oil storage container, one only needs steel and welding machines. Transporting natural gas requires cooling and pressurizing as does storing it and it is highly explosive vs oil. Over time the infrastructure will be built as it is such a cleaner fuel and I agree prices will rise. I long it with UNG ETF and with CME futures - steep contango currently and seasonal factors to consider in determining best way (or month) to buy.
www.hellenicshippingne...
Quote from the above source: "Currently, Chinese shipyards have a combined production capacity of 28.81 million DWT, accounting for 29.5 percent of the world's total, MIIT figures showed."
That gives a global total of ship building capacity of no more than 98M DWT per year. Dedicate just 1/3 of the global ship building capacity to dry bulk ships, that means no more than 33 million DWT of new dry bulk ships will enter service each year, even if ship yards turn out new ships at their full capacity. Compare this number with the approximate 600M DWT existing global dry bulk shipping fleet, 33M DWT new ships is a rather small number to make a difference.
So there is no need to worry about the bearish Drewry Report. There may or may not be a huge number of new ship orders on the order book. But it doesn't matter if the ship builders' capacility of actually turning out new ships is limited.
On Jun 07 10:36 AM coreopsis wrote:
> More accurately not 'yet' in recession. Australia is strictly a one-trick
> pony, with all due respect. You are the only country spanning a continent
> with rich mineral resources which the great manufacturing economies
> need to actually make something. It sure helps that the original
> penal colony (once again, with due respect) was not very fecund and
> thus there are only 21 million of you.
>
> 'Advanced economy' in name only.
>
> On Jun 06 10:49 AM maxe wrote:
Bottom line: fantastic mineral wealth spread over 21 million people doesn't produce an advanced economy. Advanced economic activity does: that means sophisticated technology, manufacturing, creative and entrepreneurial business leadership, global marketing and partnering. Talking tough with the Chinese on iron ore pricing is, well, not indicative of an advanced economy. It's much more like OPEC or some pathetic developed nation with only one pot to kiss in. Please don't talk about banks. The fact that the US continues to allow banking executives to drive the US economy is tragic to the point where the next large systemic collapse (maybe 2 presidential elections out, maybe less) will cause us all to question our survival. I have no insight into whether the Australian banks are healthy or not (I don't have knowledge as to whether the Swedish banks with their exposure to Latvia are healthy either) -- I plead ignorance.
On Jun 08 02:57 AM Rokjok777 wrote:
> Coreopsis, doesn't sound like you've been to Australia. Yes, only
> 21 million people, wonderful if you ask me. But to say it's not an
> advanced economy belies ignorance on your part. Have a look at the
> banks: Westpac is right now the most profitable bank in the world
> and the 9th largest by market cap. The central bank is widely regarded
> as one of the smartest, if not the smartest, in the world. Very well-developed
> tourism and eco-tourism industries. Have a look at Melbourne sometime:
> interesting new architecture, public spaces, and public art everywhere
> you look. Vibrant restaurant and arts scene. I was in Melbourne two
> weeks after visit to New York: the contrast was shocking. New York
> was shabby, every sidewalk and road needs replacing, shabby burnt-out
> shopfronts everywhere, no cranes anywhere, and definitely no challenging
> new architecture anywhere (WTC site still an ugly hole after 8 years),
> homeless people and unemployed people everywhere. New York looks
> like the underdeveloped world, not Australia...
The expected 2009 delivery of 40 m. dwt. is the equivalent of 240 Capesize ships, and is hardly a small amount. Add that to the lessening of demand for steel, which creates the lessening demand for ore and met coal. And you have oversupply of ships.
By definition, the surge in demand for Iron Ore is unsustainable, without a related surge in demand for Steel.
If you ever decide to do some research rather than conjecture, you could look up.
brs-paris.com
weberseas.com
cotzias.gr
If you would like to look up the demand for steel, there is
steelguru.com
mineweb.net
That is where you can look up the production cuts from all the steel makers, including Arcelor Mittal, the worlds largest, which has made a 50% cut in production, and informed many of those mills that they will stay closed for the remainder of the year.
You have been told that the recent surge in BDI was the result of speculative spot buying of ore, and that the stockpiles could not keep piling up. And that the FFA's were pointing to a reversal in BDI.
You dismissed that idea in favor of your convoluted theory that hoarding by China could be a limitless strategy. CISA said it would lead to disaster, you said it was a national edict.
The BDI is now down 700 points in three days, you might want to accept the FFA's as a good source, even though it doesn't support your thesis. Professionals in the shipping sector rely on it.
One more commodity worth mentioning is Rare Earth elements, which are used in LCDs and batteries. China has a near-monopoly on developed mining sites, and has been buying up Australian companies like Lynas. This could be their biggest resource game of all, since many high-tech industries simply won't be able to compete without access to these minerals.
Can you please throw some more light on this?
Thanks
Excellent article! This is very insightful.
There are a few conditions that are important to point out and make changing the current status quo (exchange rate) very difficult in the next 12-36 months.
- Speculators are dumping USD because of financial policy that is not helping to preserve wealth, but those dollars could be used to buy assets anywhere - so why in China?
- Speculators are dumping dollars and buying CYN due to the long term positive fundamentals in the Chinese economy (large inexpensive labor force, good infrastructure, large trade surpluses)
- 4 years ago, exchange rates were 8.3:1, for the last 12 months it's been 6.84:1 (that's a 17% rise)
- This 17% rise is partially responsible for the closure of many export oriented businesses here in China --- many were already struggling to survive before softening demand in western markets destroyed them.
- The population in China Mainland is not nearly as productive or as well educated as the populations in Taiwan or Hong Kong, where wages are approximately 2x higher but trade barriers (import tariffs) are lower/non existent.
- China Mainland Gov't has raised Export Rebates (to manufacturers) 7 times in 2009 --- making the official policy clear - the current export oriented growth is to be salvaged and preserved for the foreseeable future (rather than moving to fill domestic demand)
You're theory makes a ton of sense. China has been benefiting from FDI and from outright CYN purchases, and can use these reserves to purchase hard assets the world over. If you were sitting on a big pile of USD, you would want to diversify too.
There are also very practical considerations though. If you own raw materials all over the planet, you must have a way to maintain peaceful seas to ensure delivery of those materials.
Basically, the US economy and the CYN economy are locked together for the foreseeable future - a pair of codependents, but the relationship has the impact of long term strengthening the CYN at the expense of the USD, migrating intellectual property, skilled labor, entrepreneurs, and assets from the US to China. The breakup will be rough, but when the dysfunctional couple is finally ready for a divorce, China is walking away with much more than 50%.
--Ryan Erwin
Shanghai, China
China’s Commodity Buying Spree
www.nytimes.com/2009/0...
This NYT article adds to the arguments of my article that China is indeed on a global commodity buying spree to divest the dollars.
I object to the NYT conclusion that buying for stockpiling is "unsustainable". Theoretically any buying spree for stockpiling is always unsustainable, as no stockpile can grow indefinitely. At some point it has got to stop.
But it is WAY TOO PREMATURE for any one to talk about sustainability in just a couple of month. When a huge country like China decides to massively stockpile strategic industry materials, it could be a long process that extends for a decade or more before it feels it has enough.
On Jun 05 11:58 AM tuj wrote:
> "But as the price falls below $10-$13 per thousand cubic feet (seekingalpha.com/symbo...),
> shale gas is no longer profitable so producers must cut back."<br/>
>
> You have no idea what you are talking about here. Seriously, listen
> to the quarterly calls of the producers and see what they are saying
> break-even is for Barnett, Marcellus, Haynesville, etc. You are
> way way way off on the production costs.
>
> Second, while NG is can be stored, there is a limit to how much gas
> can be stored in the US in any given season. Then add in the fact
> that many of those shale producers hedged their production forward
> at $10-13.
Instead it has tanked SWC very badly, as expected.
What is "drainage of market capital"? How will speculators betting on a dollar collapse cause "drainage of market capital"? And how will this force the US government to create more money?
...MANY OF YOU ARE UNDER THE "ILLUSION" that your posts "short or long" GREATLY AFFECT THE PRICE OF DRYS... YOU ARE WRONG... though your posts "short or long" may SLIGHTLY INFLUENCE THE PRICE OF DRYS...
THE TRUTH IS IS "BIG OUTSIDE MONEY" COMING IN and DRIVING UP THE "BUY SIDE" OF THE STOCK.
LOOK AT THE LINK BELOW AND YOU WILL SEE DRYS "MORE THAN TRIPLING" in the period from the beginning of Mar into the first week of May09.
GET IT..."BIG OUTSIDE MONEY" don't give a CRAP ...about your posts illuding to "share dilutions," mgmt ripoffs, etc.
Get It! ...they don't LISTEN TO YOU...I JUST POST HERE for the "small investor" giving him reason for long term play on DRYS, OCNF...and the rest of the DRY BULK SECTOR...which will be one of the safest and profitable plays IF YOU BET "LONG" ON THE STOCK!
NOTICE: IN THE HISTORICAL PRICES on the link...the HUGE RUN-UP IN "VOLUME AND SHARE PRICE"
FOR A PERIOD OF ABOUT TWO MONTHS...sure the shorts will say, yeah but we came back down...
SO WHAT...my point is THAT YOU/THEY HAVE LITTLE INFLUENCE ON THE PRICE OF THE STOCK...
BIG OUTSIDE MONEY CAME IN BECAUSE OF CHINA/BDI...then they MOVED ON...AFTER MAKING A BIG HIT.
NOW, ANOTHER MAIN POINT IS "THAT THEY WILL BE BACK SHORTLY (NO PUN INTENDED) ...
and DO IT ALL OVER AGAIN...AND YOU WILL SEE DRYS run-up OVER 10 once again...and it has little to do with your posts, either "short or long."
This is headed your way: BIG UP AGAIN...why:
1. China growth...proving to be, not just a temp phenomena
2. DRYS has dropped significantly since the 10 range in May09...and will be looking REAL GOOD to the BIG OUTSIDE MONEY.
finance.yahoo.com/q/hp...
so, keep posting like me...BUT BE AWARE THE STOCK RUNS UP BIG TIME...due to BIG MONEY OUTSIDERS...DRIVING IT UP! ...then they move on to another play...but they COME BACK...
BECAUSE THEY DO THIS WITH STOCKS...that have REAL GOOD POTENTIAL...so if they want to STAY IN FOR THE LONGER TERM...there is little DOWNSIDE RISK...of getting stuck in a loser for the long term...
the very fact that they are doing this with DRYS shows THEIR LONGER - TERM CONFIDENCE IN THE STOCK...
SO, WERE HEADED FOR ANOTHER "BIG RUN UP!" ...AND I WOULDN'T WANT TO MISS IT...because some dumb little short scared me out... WHEN THE WAVE UP COMES IN BIG TIME...the shorts will JUST BE FLUSHED AGAIN...it's nice to have 'em ...SHORTS ARE GRAVY on drys run-ups...
and I'M SURE THE BIG-MONEY looks at the SHORT INTEREST when they figure that...
IT'S TIME TO RUN THIS BABY "UP AGAIN!" ...short interests is about it's max for some time...a bit over 4mil...so I FIGURE THE "BIG-MONEY" considering that as a factor..."when they decide to make a move"
know "short interest" is about as high as it's likely to go in this time setting...
so, look out shorts...
regards,
flashrob
I wonder of he still feels that way now that it has totally collapsed since he wrote this? Indeed, in his next blog he said UNG was at 'rock solid bottom' and all over Yahoo he was crowing about having put massive new positions into UNG, and it was now his number 2 hold. SInce then it is in freefall..massive and horrific freefall.
Anthony in dialogue with Yahoo contributors, including myself who warned him of the huge counter party risks in UNG, stated there was no substantive 'counter party risk'...even though they couldn't issue shares anymore and a huge contango was occurring! (He claimed this was GOOD for UNG, lol!)
Of course, as we see now, UNG has collapsed badly since then and with further to fall. This is consistent with so very many other plays that Anthony has touted all over the web. Lots of hype just before a horrific collapse. (EXM for example, which he claimed to 'triple up' on the very day before it collapsed in freefall..due to his mis stating eand mis-understanding their earnings statement, plus their dilutive secondary).
Follow this guy's advice at your extreme peril.