economic outlook - what's the impact on commodities?
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Objective Capital's Global Resources Investment Conference 2011Stationers' Hall, City of London27-28 September 2011Day 1- Session1: The context in which we operate Speaker: Chris Watling, Longview EconomicsTRANSCRIPT
GLOBAL RESOURCESINVESTMENT CONFERENCE
STATIONERS’ HALL, CITY OF LONDON ● TUESDAY-WEDNESDAY, 27-28 SEP 2011
www.ObjectiveCapitalConferences.com
Opening Keynote: Economic outlook – what's the impact on commodities? Chris Watling – Longview Economics
Other sponsors & participating organisations:
GLOBAL RESOURCESGLOBAL RESOURCESINVESTMENT CONFERENCE 2011INVESTMENT CONFERENCE 2011
Lead sponsor:
Media partners:
@Objectivelive
Twitter: Chris@LongviewLinkedIn Group: Longview Economics – all welcome Website: www.longvieweconomics.com
304/07/23Twitter: Chris@LongviewLinkedIn Group: Longview Economics – all welcome Website: www.longvieweconomics.com
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3
Macro & Markets
Chris Watling, CEO, Longview Economics September 2011
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Contents
1. Macro Outlook– Euro crisis– Structural growth headwinds– Whiffs of Western Stagflation– Slowing EM economies– Risks in China’s property and infrastructure bubble
2. Western Indebtedness & structural deleveraging3. Commodities outlook
– Next 12 months– Next 5 - 10 years
Twitter: Chris@LongviewLinkedIn Group: Longview Economics – all welcome Website: www.longvieweconomics.com
504/07/23
Rising Sovereign Risk – Italy; Belgium; Spain amongst others
Spain Italy Belgium
Source: Reuters EcoWin
Sep
08
Dec
09
Mar Jun Sep Dec
10
Mar Jun Sep Dec
11
Mar Jun Sep
CD
S (
Bas
is p
oint
)
0
50
100
150
200
250
300
350
400
450
500
Cost of Insuring against Default in Various Euro zone sovereign bonds (CDSs bps)
Ireland, 5 Year Portugal, 5 Year Greece, 10 Year
Source: Reuters EcoWin
Sep
08
Dec
09
Mar Jun Sep Dec
10
Mar Jun Sep Dec
11
Mar Jun Sep
CD
S (
Bas
is p
oint
)
0
500
1000
1500
2000
2500
3000
3500
4000
4500
Cost of Insuring against Default in Various Euro zone sovereign bonds (CDSs bps)
Spain, Italy & Belgium Ireland, Portugal & Greece
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604/07/23
Euro Crisis - Possible outcomes/Policy Options1. A disorderly default (i.e. with markets forcing that default) – this would be the worst of all outcomes with particularly
severe global economic outcomes. In particular this would likely lead to bankruptcy of many parts of the European financial system, a major tightening of credit conditions and with that a major European (& probably global) recession/a depression.
2. Unsterilised ECB intervention – i.e. The ECB ‘electronically’ prints money and buys the sovereign bonds of the troubled euro zone economies. This, however, compromises the ECB’s monetary independence and risks its own solvency (i.e. as it would then grow the size of its balance sheet with assets of questionable quality). Its independence is compromised because monetary policy would be operating in the sphere of fiscal policy;
3. Full political/fiscal union – i.e. some form of communal guarantee of all euro zone debt by all euro zone countries (e.g. a Eurobond). There appears, however, to be little appetite in Northern Europe (i.e. the fiscally strong Euro zone countries) for this outcome. Opinion polls in Germany highlight a growing preference, for example, amongst a growing segment of the population to leave the Euro – rather than become more deeply intertwined. The recent election success of the ‘True Finns’ party in Finland, who campaigned on a platform of ‘no more bailouts’, highlights the lack of Finnish enthusiasm for deeper European fiscal integration.
4. A European bailout led by and primarily (or at least significantly) funded by the emerging market world. Many of the BRIC economies, Middle Eastern economies and other emerging market economies have significant reserves at their disposal. With the right attached conditionality, it would be in the interest of the emerging economies to use these funds to invest in propping up the Euro area in some way (e.g. by committing to and becoming a major buyer of Euro zone debt in Italy, for example, or by buying EFSF debt).
5. Leveraging the EFSF – perhaps in conjunction with the ECB – thereby increasing up the €440 billion current firepower up to €1.5 – 2 trillion.
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704/07/23Twitter: Chris@LongviewLinkedIn Group: Longview Economics – all welcome Website: www.longvieweconomics.com
704/07/23
Structural western economic growth headwinds
See Longview Letter no 56 July 29th 2011 for full update: “The ‘Old’ or ‘New’ Normal”
US real house price index (rebased to 100 @ 1 Jan 1975)
Source: Reuters EcoWin
1975 1980 1985 1990 1995 2000 2005 2010
US
real
house
pri
ce
index
90
100
110
120
130
140
150
160
170
Peak '79
Trough '82
Trough '75
Peak '89
Trough '95
Peak '06
+16% rise
14% fall
+16% rise
+58% rise
8% fall
Trend?
Structural Growth Headwinds i) Downtrend in US/UK Real House Prices. In real terms, US house prices are still above trend and are expected to continue to trend lower.…a resumption of normal housing activity has not begun.
ii) Structural Deleveraging. While there is evidence of some modest growth in consumer credit since September last year, the overarching theme with respect to debt is one of deleveraging. Because the deleveraging was ‘cut short’ during the recession
iii) Future & current Fiscal Austerity: Loose fiscal policy and the use of the government’s balance sheet to ‘bailout’ companies, financial institutions, households (e.g. cash for clunkers, housing stimulus) and the economy (extending the Bush tax cuts, fiscal stimulus packages etc) during the crisis has created major fiscal imbalances.
iv) Jobless Recovery: With most sectors of the economy facing headwinds, job creation which responds to actual and perceived demand growth, is anaemic.
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804/07/23
Structural deleveraging
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804/07/23
Source: Longview Economics, Federal Reserve flow of funds, Reuters EcoWin
1945 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Fin
an
cia
l s
ec
tor
de
bt
as
% o
f G
DP
0
10
20
30
40
50
60
70
80
90
100
110
120
130
accelerating rate of financial sector indebtedness (in recent decades) in particular since the Asian crisis in 1997
122% of GDP peak q109
1997 @ 62%
1952 2.7% of GDP
1950s - heavily regulated banking & financial system - banks stuck to core intermediary business - taking in deposits and lending them onwards
Beginning of financial deregulation 1970s & early 80s
now 95.1%
US financial sector debt as % of GDP
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904/07/23
BRIC – Leading Economic Indicators – Mostly turning/trending lower…
China, Leading Index Brazil India Russia
Source: Reuters EcoWin
04 05 06 07 08 09 10 11
Inde
x
75
100
125
150
175
200
225
250
275
Inde
x
90
100
110
120
130
140
150
160
170
China - Trending up but at a slower pace...
Brazil & India - trending over......
trending down...
Russia - rolling over?
BRIC economies – Leading economic indicators (index)
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1004/07/23
Various (Western) Leading Economic Indicators
Euro zone LEIs (source: OECD)
US LEIs (source: OECD)
US LEIs (source: Conference Board)
Source: Reuters EcoWin
70 75 80 85 90 95 00 05 10
Y-o-
Y %
-15
-10
-5
0
5
10
15
20
US vs. Euro zone LEIs (Y-o-Y %)
Euro zone LEIs are now in/very close to recession warning territory
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1104/07/23Twitter: Chris@LongviewLinkedIn Group: Longview Economics – all welcome Website: www.longvieweconomics.com
1104/07/23
Market overly optimistic on China….….
South Korea Singapore Japan China Taiwan
Source: Reuters EcoWin
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Inv
es
tme
nt
sh
are
as
% o
f G
DP
5
10
15
20
25
30
35
40
45
50
'97 Asian crisis
'90 Jpn peak
Investment Share as % of GDP – Various Asian economies
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1204/07/23 1212
Chinese Overbuild?
“Perhaps Rome cannot be built in a day. But at China’s current rates of construction, it would take roughly two weeks. It took the Asian hyper-economy (i.e. China) roughly a decade to build the equivalent of Europe’s entire housing stock (excluding Turkey), and there are few signs that the seemingly insatiable appetite of Chinese consumers for bigger and better housing will slow substantially.” From attached EIU report – published last week.
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1304/07/23
(Slowly) building global inflationary pressures
-30.0%
-20.0%
-10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
Jan-
05
Mar
-05
May
-05
Jul-0
5
Sep
-05
Nov
-05
Jan-
06
Mar
-06
May
-06
Jul-0
6
Sep
-06
Nov
-06
Jan-
07
Mar
-07
May
-07
Jul-0
7
Sep
-07
Nov
-07
Jan-
08
Mar
-08
May
-08
Jul-0
8
Sep
-08
Nov
-08
Jan-
09
Mar
-09
May
-09
Jul-0
9
Sep
-09
Nov
-09
Jan-
10
Mar
-10
May
-10
Jul-1
0
Sep
-10
Nov
-10
Jan-
11
Mar
-11
May
-11
Jul-1
1
Infla
tion
perv
asiv
enes
s (%
)
UK US EZ
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1304/07/23
UK, US & Euro zone Longview Inflation Pervasiveness models
07/04/2314www.longvieweconomics.com
07/04/23
Indebtedness of the Western Economies
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1504/07/23
Why BUY Commodities?1. The alternatives…..
07/04/2315www.longvieweconomics.com
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1604/07/23Twitter: Chris@LongviewLinkedIn Group: Longview Economics – all welcome Website: www.longvieweconomics.com
1604/07/23
The (biggest) Bear case – US & Europe follow Japanese Path…..
European STOXX 600 (from 1 Jan 1990 - rebased to 100)
Japan, Nikkei, 225 (from 1 Jan 1979 - rebased to 100)
US S&P500 (from 1 Jan 1990 - rebased to 100)
Source: Reuters EcoWin, Longview Economics
0 1000 2000 3000 4000 5000 6000 7000 8000 9000
Inde
x
0
100
200
300
400
500
600
700
European STOXX & S&P500 (10 years prior to their secular bull market peak in 2000)
vs...
Nikkie 10 year prior to its secular bull market peak in 1989...
X Axis = No of Trading days
Europe, US & Japan – rebased to 100 10 years prior to the end of their secular BULL market*
*i.e. 1979 for Japan, 1990 for US & Europe
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1704/07/23
Attractive Valuation or Value Trap?
Equity Risk Premium (US equities) US Cyclically adjusted PER (Shiller)
S&P500 PE ratio calculated by the Shiller method (i.e. based on 10 year rolling historical earnings)
Long term average
Source: Shiller, Reuters EcoWin
1890 1905 1920 1935 1950 1965 1980 1995 2010
PE
ra
tio (
cy
clic
all
y a
dju
ste
d)
0
5
10
15
20
25
30
35
40
45
2000 peak
5x
6x
6.6x
currently @ 20x - above long term average levels
1982
1932
1920
1929 Peak
1965 peak
1901 peak
1937 peak
9.0x
1949
Source: Longview Economics, Reuters EcoWin
1996 2000 2002 2004 2006 2008 2010
Eq
uity
Ris
k P
rem
ium
(%
pp
)
-1
0
1
2
3
4
5
6
7
8
9
Main recent lower bound (i.e. since '02)
Equities expensive rel. to bonds
Equities cheap rel. to bonds
Main recent upper bound (i.e. until recently)
Negative ERP - i.e. suggesting that bonds are riskier than equities
4.9% ERP at '03 lows
ERP currently 8.9% - all time high
7.8% record highs Nov '08
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07/04/23
S&P500 & DJIA inflation adjusted indices (1896 to 2010)
Western Equities – in a Secular Bear Market
S&P500 (real terms, rebased to 100 in Jan 1940)
Dow Jones Industrial Average (Real terms, Rebased to 100 Jan 1940)
Source: Reuters EcoWin
1890 1905 1920 1935 1950 1965 1980 1995 2010
Inde
x (re
base
d to
100
Jan
194
0)
25
50
100
200
400
800
1600
Criss-crossed areas = commodity super cycles
Secular bullSecular bull
Secular bull
Secular Bear
Secular Bear
Secular BearSecular Bear
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1904/07/23
The Alternatives: Government bonds - attractive?
Yield (at month end) Annual average yield
Source: Reuters EcoWin
1875 1890 1905 1935 1965 1980 1995 2010
Ger
man
bon
d yi
eld
(%)
1
2
3
4
5
6
7
8
9
10
11
12
German bond yields - up over 11% peak in 1981
lowest yield ever...
1870 - 1st data point
1925
German 10 year government bond yields (1870 – 2011)
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2004/07/23
Why BUY Commodities?2. The Demand drivers
07/04/2321www.longvieweconomics.com
07/04/23
Demand Drivers:Developing (& industrialising) Asia: A 3 billion elephant
Asia (Population rank in size relative to RoW)
GDP ($bn 2008)
GDP per capita (US$2010)
population(bn; % of ASIAN total)
Long term Real growth rates
Asia (23) (a) $7,239bn 4,070 3.60 (100.0%)
China (1st) $3,206bn 3,999 1.33 (36.9%) 9.1% (1997-2007)
India (2nd) $1,200bn 1,124 1.13 (31.4%) 9.7% (1997-2007)
Indonesia (4th) $433bn 2,858 0.23 (6.4%) 5.9% (2001-2010)
Pakistan (6th) $143bn 1,067 0.164 (4.6%) 4.8% (2000-2009)
Bangladesh (7th) $68.4bn 624 0.147(4.1%) 7.4 % (1997-2007)
Vietnam (12th) $68.6bn 1,168 0.086 (2.4%) 10.0% (1997-2007)
a: excludes HK, Japan, Singapore, South Korea & Taiwan
NB USA = 3rd 304mn pop; Brazil =5th 191mn; Russia = 8th 142mn; Nigeria = 9th 137mn; Japan = 10th 128mn; Mexico = 11th 110mn
Largest non developed Asian economies
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2204/07/23 2204/07/23
Forecasts for Next 40 years
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04/07/23
China’s Coming Car growth
0100200300400500600700800900
- 10,000 20,000 30,000 40,000 50,000
Real GDP per head
Motor
vehic
les pe
r 100
0 peo
ple
JapanChinaFranceSpainUSMexicoSouth KoreaItalyNorwayChileGermanyNetherlandsUKCanadaRussiaBrazilIndia
Industrialisation & vehicles per 1000 people
Source: Longview Economics, Reuters EcoWin
The number of vehicles per 1,000 people in China is relatively low (32) - NB India (15), Brazil (198), Canada (597) & US (820)
If China industrialises with the same vehicle intensity of GDP growth as other emerging markets the number of vehicles per 1,000 people in 2030 should still be at low levels (at 170 vehicles)
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2404/07/23
China’s share of world energy reserves
1.2 1.0
6.3
0.52.4
1.30.2 0.6
3.6
13.9
0.9
19.0
7.1
23.4
28.9
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
China Brazil Russia India USA
% o
f wor
ld to
tal p
rove
n re
serv
es
Oil Gas Coal
Energy resources: Share of proven world reserves (%) – key countries
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2504/07/23
China’s Strategic Overseas Investments (2005 – 2011)
Summary by Sector
Outward Chinese Investment
Sector Total Invested (2005 - 2011) Share of total (%)
US$bn
Agriculture 7.0 2.7%
Energy 114.6 43.6%
Finance 34.3 13.1%
Industry 5.1 2.0%
Metals 69.4 26.4%
Power 8.1 3.1%
Real Estate 11.2 4.2%
Technology 4.5 1.7%
Transport 8.4 3.2%
Total 262.7Source: Heritage Foundation, China Global Investment Tracker
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04/07/23
China - Expanding Trade RelationshipsChina’s global reach has expanded significantly in the last decade
Share of selected countries'/regions' trade (imports plus exports) with China
2000 2009last 12
months* 2000 2009last 12
months* 2000 2009last 12
months*G20 Other Significant trading partners Other Significant trading partnersSouth Korea 9% 20% 23% Mongolia 33% 48% 61% Africa 3% 12% 14%Australia 7% 20% 21% Kyrgyz Republic 8% 64% 57% Ghana 3% 13% 14%Japan 10% 20% 21% North Korea 17% 42% 46% Bangladesh 5% 10% 13%United States 6% 14% 15% Sudan 27% 39% 45% Iraq 5% 8% 13%Brazil 2% 13% 14% Angola 18% 30% 37% Thailand 5% 12% 12%South Africa 3% 14% 14% Tajikistan 1% 19% 33% Zimbabwe 2% 7% 11%Indonesia 5% 12% 13% Myanmar 13% 24% 29% Middle East 4% 10% 11%Saudi Arabia 3% 12% 13% Congo 5% 20% 25% Singapore 5% 10% 11%India 2% 9% 11% Kazakhstan 6% 21% 24% Sri Lanka 2% 10% 10%Argentina 4% 9% 11% Uzbekistan 1% 15% 18% CIS and Mongolia 4% 10% 10%Russia 5% 9% 9% Nepal 5% 12% 18% Venezuela 0% 7% 8%Canada 2% 7% 7% Malaysia 3% 13% 17% Syrian Arab Republic 2% 7% 7%Turkey 2% 6% 7% Iran 5% 15% 17% Nigeria 1% 7% 7%UK 2% 6% 6% Zambia 1% 8% 17% Somalia 0% 5% 5%Germany 2% 6% 6% Philippines 2% 8% 15% Spain 2% 4% 4%Italy 2% 4% 5% Turkmenistan 1% 11% 15% Qatar 3% 3% 4%EU-25 2% 4% 5% Pakistan 4% 10% 15% Azerbaijan 1% 3% 3%Mexico 1% 8% 5% APEC 7% 14% 14% Afghanistan 4% 3% 2%France 2% 3% 4% * from Dec 2009 to Nov 2010. Calculated as each country's total exports to China + total imports from China / the country's total exports + total imports
Source: Longview Economics, Reuters Ecowin
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China’s Tentacles (EurAsia, Africa & beyond)
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2804/07/2304/07/23
Long term Risk: GeopoliticsResource Bottlenecks – Potential Conflict Flashpoints
Global trade chokepoints/bottlenecks
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2904/07/23
Conclusion
• Euro zone recession – likely• US recession – close call (probably not)• Euro crisis – all outcomes possible – depends on
European policy makers’ decisions (& with that their electorates)
• Emerging market economies – slowing BUT good long term growth outlook
• Commodities – benefit from: i) inflation hedge; ii) Emerging market demand growth; iii) supply challenges
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3004/07/23
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