Author, Andrew Sheldon
Global Mining Investing is a reference eBook to teach investors how to think and act as investors with a underlying theme of managing risk. The book touches on a huge amount of content which heavily relies on knowledge that can only be obtained through experience...The text was engaging, as I knew the valuable outcome was to be a better thinker and investor.
While some books (such as Coulson’s An Insider’s Guide to the Mining Sector) focus on one particular commodity this book (Global Mining Investing) attempts (and does well) to cover all types of mining and commodities.
Thursday, August 30, 2007
I frankly doubt the Fed is considering such an easy monetary policy. Certainly such cuts would reduce borrowing costs for consumers and businesses and mitigate the payment shock faced by 2 million mortgage holders as their adjustable rate mortgages reset in coming months. But since when does the Fed act as a welfare agency? Consider the Fed response to the collapse of the Thai baht in 1997 that was the beginning of the Asian financial crisis. It took the Fed more than a year to respond with a rate cut in Sept'98. Alot of investors suffered in the meantime. People might argue that this was an Asian crisis, but the reality is that the Fed policy is to preserve 'sustained growth' and to do that it needs to consider the inflation consequences of its policy.
Yahoo also suggests "The Fed is seen as having the leeway to cut interest rates because inflation is easing". But the implication that inflation is a 'product demand' phenomena is wrong - its a monetary demand phenomena. Excessive growth in money supply relative to the productive capacity spells inflation in at least some segments of the market. The reason food prices were not running away in recent years whilst money supply was increasing is because financial assets like shares and property were growing appreciably. Now asset prices are falling, that liquidity has to go somewhere. Well we are not going to eat more because of falling house prices. But there will be a slowdown in investment, so wasted financial resources means economic stagnation while prices increase.
It seems more likely to conclude that the Fed on Aug. 17 was merely calming financial markets when it said the "downside risks to growth have increased appreciably". Some market pundits seem to be interpreting this as justification for a rate cut - that the Fed is now more worried about weak growth than inflation.
Concluding, I dont expect a cut in the Fed Funds Rate on Sept 18th 2007. Tomorrow I suspect Ben Bernacke might even correct the perception somewhat. So I expect a weak market next week (1st week Sept'07).
Wednesday, August 29, 2007
I also dont think the Fed will lower interest rates because of a fear of inflation, or if they do it will be just 0.25%. The reason I expect no increase is because they didnt do it when it counted most, so why would they do it later. The Fed never cared about asset prices on the upside, why are they going to care on the downside. Its not going to support the already falling housing market, it would support higher consumer prices (meaning inflation), so they are not going to lower rates...I
So I believe the market is going down. The question is - will it make new lows, or just return to its previous low at 12,800 points. The media would have us believe that market PERs are reasonable, but there is going to be alot of downgrading to those revenue models given the evaporating consumer confidence, so at the very least there is reason for weakness. But I think it will take bad inflation figures or a financial failure to get the market to fall to around 11600-11800 level, or a recession, but a recession will take time to unfold. A financial collapse of a hedge fund will unravel the market. The Fed can boost the liquidity of the banking system, starving off a run on banks, but it cannot raise investor or consumer confidence without lowering interest rates...and I doubt that will happen.
Monday, August 27, 2007
Looking first at the Dow, its apparent to me that the index is at a critical point where it could go either way. It might shrug off the negative news in the housing sector. At this point in time 2AM Eastern Standard Time (Sydney) the US market is down 44points, though it appears to be holding.
The ASX is at a similar turning point with the index surging over the last week to over 6200 points, not far off its high of around 6400 points. I personally dont see the ASX breaking its current resistance, even though the index finished just off its daily high. I think the index will face selling tomorrow, but I will wait for direction from the market because there are alot of 'political wills' that want this market to go higher. Notwithstanding the uncertainty, the volatility is making great trading conditions.
The gold index is poised for similar direction from the markets. We are still waiting for a break out on the up or downside. I actually think gold will fall off, along with equity markets, with $US550/oz my target.
We might know if I am wrong or right tomorrow, but it might otherwise take a day or two.
Friday, August 24, 2007
Given that this was a financial (sub-prime) crisis you might have expected the losses to have been largely restricted to the financial sector. But it was not just a case of investors worrying about non-disclosed non-performing loans, the sell-off reflected a deeper problem.
The rationale for the equity sell off
The rationale for the sell off lies in the nature of the crisis itself. The panic arose when the sub-prime mortgage-backed security holders realised that they couldn't sell or price their exposure in the market so that they could sell them. This forced these investors to raise capital, and by the time the problem had hit the market, their financiers were demanding margin calls. This forced sub-prime security holders to sell their quality assets to cover their illiquid positions. Hedge funds and others were thus forced to sell everything as markets continued to fall, so a snow-balling liquidity problem emerged, which was only stalled when the central banks and bargain hunters moved back in the market.
Clearly there was a ‘flight to quality’ which resulted in a stronger USD. Surprisingly the panic resulted in even low-risk investments like municipal bonds and hospital stocks being sold off, whilst quality smaller stocks fared even worse, particularly those stocks exposed to the discretionary consumer, energy and raw materials sectors. The sell off was not totally irrational, given that during a credit crunch small stocks have the greatest difficulty raising capital – whether as loans or equity. Thus its understandable that the Russell 2000, a small-cap index, should fall more than the S&P500 or Dow Jones Industrial Average (DJIA). But the extent of the fall should highlight the systematic risks inherit in the market.
Individual investors added their share of panic to the market as they were not immediately in a position to know the extent or ramifications of the crisis. All 10 sectors of the S&P 500 fell between 2.6% (for consumer staples) to 12.76% (for the energy & raw materials sector). The reason of course is that investors perceived this crisis as signalling a downtrend in the economy and a softening in retail sales and commodities demand. Its interesting that the contagion was even worse in commodity producing countries like Australia, South Africa and Canada, which experienced plummeting currencies that would only preserved their local dollar earnings, even though commodity prices did not fare so bad.
But there is another reason why certain high-yielding currencies were signalled out – the carry trade. The yen carry trade involved Japanese financial institutions placing their low-yield institutional funds in higher yielding commodity markets. When there is a loss of confidence in Australia and other countries, the Japanese unwind those currency trades, resulting in a rapid drop in the $A and NZD. The worst performers were the smaller, less liquid stocks. But we must remember that the smaller stocks were trading at significant premiums prior to the crisis so they were always more vulnerable to a correction.
What can we say about the meltdown?
1. There is no question that markets are unstable, and for this reason markets are in need of greater information. This is a financial crisis, not an economic crisis. The problems started in the sub-prime credit market, investors panicked masse, leaving the Fed merely trying to prevent a self-fulfilling prophecy.
2. The sub-prime crisis took on a global magnitude as a result of European and Asian bank exposure to property foreclosures in the US market, giving investors reason to think the crisis was bigger. In reality the risks were distributed more widely.
3. The confidence problem emerges because the financial industry has created an array of new debt instruments that are hard to price, particularly in times of uncertainty. Really they were attempting to make products commodities (securities) which were never really commodities. Because these products don’t offer the same level of transparency as simpler instruments, in bad times the liquidity evaporates and the result is a market crisis. The problem was this crisis arose in one of the biggest credit markets, even though it represents just a small fraction of it. The problem was inadequate disclosure to reassure markets.
4. The crisis does however highlight a poor capacity of credit rating agencies to quantify risk, or a preparedness of the agencies to overlook certain risks for the sake of profits. The situation is reminiscent of the auditing fiasco a decade ago when the major auditing companies came under attack for conflict of interests. The credit rating agencies or investors needed to understand the nature of the instruments they were trading – they didn’t. The risk assessment was just not adequate.
What can we say about the Fed response?
The European Central Bank, the Federal Reserve and other central banks acted quickly to pumped hundreds of billions of dollars into the world's banking system, the largest injection since the 9/11 tragedy, when the Fed injected $334 billion into the markets between 12-19th Sept 2001. The actions by the Fed were an appropriate step towards restoring confidence in the banking system. Nevertheless:
1. Liquidity is only a short term measure. If the markets experience another shake out it will be because of further bad news lacking perspective. This just might give us a double-bottom entry into the market.
2. The Fed decided not to cut interest rates on the 7th Aug 2007, insisting that inflation was the greater threat to the economy - not credit disruptions. This is a sign that the Fed has a more realistic assessment of the problem.
3. The Federal Reserve will need to lower the Fed rate if they want to soften the impact of the sub-prime crisis.
I believe the Fed will NOT lower interest rates because of the greater concern about inflation, and its clear that a market anticipation of such a cut might undermine the market at a later date. I think at some point the market will conclude that the global economy is in good shape, even if the US market will be subdued for several years. It also makes no sense for the Fed to ease credit conditions for financial institutions since the financial institutions are only going to tighten credit conditions upon consumers.
What is likely to be the short term impact?
We can expect that there will be several short term impacts:
1. Credit growth will slow as banks lending activities take a hit, and their profits will tank for 2007. And credit growth is likely to fall longer term as interest rates rise. We can expect the banks to focus on their wealth management divisions as we experience a recovery in broad market equities.
2. Markets are in good condition: Investors need to place the current financial problems in perspective. The credit risk in the USA will affect only a small portion of the USA market, so the ramifications for the global economy are quite small. The global economic fundamentals are excellent. Equity market valuations are reasonable, interest rates are still relatively low, employment growth is strong, and global economic growth is booming.
Some of the selling is not unwarranted in those sectors exposed to the US property and financial markets, as well as US-based retailers who will face some exposure to lower consumer spending as US household mortgage payments rise.
So is there a long term crisis brewing in the long term?
As the dust settles it is clear that there is a short term and longer term problem. The central banks injection of liquidity was an appropriate response to the short term panic, so the immediate threat has been addressed. There is however the threat of more bad news, though it is likely to be tempered. Franklin Roosevelt once said that "the only thing we have to fear is fear itself". He made this assertion upon shutting down the nation's banks in 1933 as he assumed the Presidency. The good news is that the Fed will use this opportunity to assess the risk rating procedures of banks and credit agencies, to avert a similar flight of confidence in future.
There are 2 concerns for the Fed:
1. Inflation: The Fed, along with other central banks, are worried about inflation. This is a global problem of much greater global ramifications than a segment of the US property market.
2.. Weak property markets: We must remember that the sub-prime crisis is a problem for poor households as well as aspirational property investors in the USA. Regardless the weakness in the US property market will affect spending there, but we must remember that US households don’t look at their house values in a way which would affect their psyche, at least until it results in higher mortgage payments, and so far interest rate increases have been subdued.
So what is an investor to do?
BUY! BUY! BUY! The recent collapse in equity prices was an over-reaction sparked by institutional demands for liquidity. The global reach of the sell-off was really a manifestation of foreign institutional exposure. Clearly the best buys are those sectors that suffered the most during the sell off, so:
Commodity based currencies are going to benefit from retention or recommittals to the carry trade
Commodity (raw material & energy) stocks are likely to recoup the losses they experienced over recent weeks
Small cap stocks that we particularly punished are likely to experience the best recoveries.
There are already signs that this is occurring. The Yen was weak last weak, as Japanese fund managers re-entered forex markets to buy AUD and NZ. The commodity sectors were the strongest sectors of the economy – particularly the smaller quality stocks like Matrix Metals – up 40%.
Tuesday, August 14, 2007
I have shown two scenarios on the chart - a more favourable 'green outlook' and a more pessemistic 'purple outlook'. The rationale is that I think the market will rally from 13,800pts, however 12,000pts is a stronger support. But I think it can only get to 12,000pts if there is a plethora of bad news. In any respect I think the spec end of the market that carried the greater burden will recover quickly, then profit-taking will set in. So I dont see the market going to 12,000pts in a hurry. But if a few financial institutions fail it could be a very different story. But even if that were the case, expect the Fed and other central banks to step in to save the market.
Saturday, August 11, 2007
1. Unemployment in western markets where the bulk of consumption occurs is tight
2. Productivity has fallen off considerably as asset prices have undermined consumption
3. Debt creation has reached its limits as wsterners become fully leveraged and home ownership rates have never been higher.
4. Interest rates are tightening after reaching their lows
5. Asset prices are falling from their peaks, giving people with high debts reason to pause
6. Inflation is feeding into the basic cost of living, particularly with high energy, food costs. The factor that has not readily been apparent to us has been monetary inflation, although we had witnessed the associated asset inflation. We were lead to believe that was due to higher incomes, growth in income and employment and easy money. But it was more than that. There was a shift in pricing from market prices to the consumers ability to pay, which itself reflected the ever-presence of easy money. Those days are now over. Inflation and debt liquidation will bring money supply back in sync with global output. We tend to talk about inflation and deflation as if they are univeral phenomena, but the reality is the nature and reason for price increases. Over the last 15 years we have seen strong equity and property prices, whilst in the last 5 years commodity prices have been strong. In future we are likely to see subdued asset prices and higher prices for basic commodities. At this juncture there seems to be 2 ways the market can go - each outcome depending on the governments attitude to inflation. It has a choice of achieving a market equilibrium by allowing prices to rise or credit to fall, but normally its some politically palletable combination. It can respond with:
1. Easier monetary policy: This would involve the Fed ignoring inflation and responding to falling asset prices with an injection of credit or paper money into commrcial banks to support credit growth. Of course this would result in run-away inflation culminating in choice 3.
2. Modest monetary policy: That assumes that the governments respond to higher prices with slightly higher interest rates. Despite the increases in nominal rates importantly the increases maintain cheap money in real terms. Eventually this results in negative real interest rates, but asset holders still benefit from higher prices, but only after loan defaulters have been squeezed out of the market. Governments take this approach because it shifts pain to the poor, whilst protecting the asset rich. This stratgy involves the economy working its way out of problems. The consequence is what might be referred to as a 'lost decade' of low returns that occurred in the late 1970s and early 1980s.
3. Tight monetary policy: This strategy involves staying above the curve, to rein in money supply, to force prices down by raising rates, ending credit expansion. This strategy causes a precipitous fall in markets, though once the correction has ended markets are able to build on a firm footing. It hurts everyone, but particularly the holders of assets.
So basically we are looking at 5 years of subdued growth and stable asset prices, or a precipitous shakeout of asset market and credit liquidation culminating in a rapid transition to economic growth, though a calamitous shift in wealth from those with asset or liability exposure to those with cash. The question is:
1. Does the Fed have the skills to maintain a flat market for 5 years?
2. Will global markets be exposed to exogenous factors that might impose instability, eg. bird flu?
Sunday, August 05, 2007
Its hard to make informed decisions on these issues since the information to assess the market is not readily available. Up until a few weeks ago I was thinking that the market had enough momentum to keep growing, that the US housing market was turning around and the amount of money in the global economy would sustain a stronger market, with also the remote prospect of Fed stimulus in the form of lower rates. I was particularly heartened by the fact that copper inventories are very tight and copper and tin prices are very high. But thats a precarious position to hold as well.
I was originally expecting a fall back to the 12,800-12,900 level in the Dow Jones, but I actually would not be surprised if we see a fall to 11,700 pts as its a much stronger support, particularly as I think there is more bad news looming.
Its seems likely that the Dow Jones is about to fall to its trend support of 12800-12900 points. Given that the collapse in the sub-prime market is a US phenomena, you might think this is a US-only phenomena. Well the rationale is that the US consumption has been fuelling the global economy, so a contraction there will have a significant impact on the global economy. I have recently become pessimistic on a US recovery until late 2008, and I see a short recession caused by the housing slump, with the prospect of an inflation-fuelled slum next year, which could make the forthcoming recession about 4-5 years long. I suspect it will take this long for the asset inflation to work its way out of the market and for production capacity to be re-adsorbed.
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