30 Oct 2008

Trading Countries

Emerging economies will, according to a recent MasterCard report, soon contribute 12 times as much to world growth as the developed world does. That's not hard to imagine if growth rates in the BRIC nations continue at even half their recent rate whilst growth in the developed world grinds to a halt. How long this will take is unknown but with rapid globalisation and population growth it's a fair bet it will be quicker than most imagine.

Then it becomes a fight for resources and those countries that lack them are going to find it tough. Energy and food have for too long been taken for granted and squandered by the 'first world'. It's time to pay the piper and it's partly the reason I'm heading back to South Africa after 11 years in the UK. It's also partly along the lines of the 1st degree lecture in Freemasonry; "...and above all, by never losing sight of the allegiance due to the Sovereign of your native land, ever remembering that nature has implanted in your breast a sacred and indissoluble attachment towards that country whence you derived your birth and infant nurture."

If you were to pick a country to live based on resource availability for survival then I imagine a list might look something like this:

Water - Northern hemisphere generally OK except Middle East. Southern hemisphere a little stretched except parts of South America and Africa. However, effective solar powered desalination is only a few years away so no big issues on the water front.

Food - Cereal crops and meat are the big issues. North America generally OK. Most of Europe a little stretched. India and China quite stretched and getting worse as population grows. Australia and Indonesia quite stretched too. Africa north of South Africa is always stretched but Africa has always survived on less than her fair share. South America generally OK.

Energy & Minerals - This is the big one! The big producers are Russia, China, USA, Canada, Australia and South Africa whether it's coal, uranium, aluminium, iron ore etc. China and the US are also the biggest consumers and China is a net importer of fuel and minerals. There is going to be a fuel shortage in the world and Russia is going to be a king-maker in Europe. It's going to happen within 3 to 5 years and it's going to be ugly. I fear there will be some sort of conflict. I only hope and pray that we will find an alternative and abundant energy source and find it quick. I'm afraid that the wind and waves are ineffective for baseload power generation, no matter how many masts you stick up. I think the only solution is based on the sun and Europe is a little screwed in this area too.

Of course I'm not only going to South Africa for economic reasons alone but clearly you can tell I think it's going to be a fairly safe place to ride out the coming global economic storm. We've built our economy as a house of cards on the sand and no matter how much regulation we now introduce I'm afraid that gearing is not going away. The wind has started picking up and has knocked over a few of the cards but the tide has yet to come in.

I realise I run the risk of crime but with apologies to Theodore Roosevelt, I shall "...spend myself in a worthy cause and (at best) know the triumph of high achievement. At worst (if I fail) I shall at least fail while daring greatly, so that my place shall never be with those tired and timid souls who knew neither victory nor defeat." I'll also make sure I get enough 2010 world cup tickets for whoever would like to come over. We can surf in the morning, chill out with a 'braai' on the beach for lunch and catch the game in the evening.

Wherever you choose to enjoy this life over the next 5 to 10 years I wish you the very best for your future, whatever it may be.

16 Oct 2008

What price sustainability?

So with all the fear and loathing in London at the moment, where exactly do markets have to fall to before we can touch the bottom?

I think it all boils down to what the real economy can support in terms of inflation adjusted growth. The graph shows indexed prices for the Dow Jones Industrial Average, the UK Nationwide house price index and spot crude oil prices.

I've indexed them to around 1973 both because that's the year I was born and also because that's the year the Black and Scholes option pricing formula was unleashed on the world. I'm not necessarily saying that derivatives are bad but they do tend to create leverage which outstrips natural growth with inflation. Hence the reason why we need to come back to roughly where the green line is. Looks like the Dow is almost there now, give or take a couple of 100 points.

10 Oct 2008

Gold - Prepare for Lift Off

Many gold bugs have been asking why gold has not soared in the face of the global financial crisis. After all, shouldn't it be a given that inflation will soar as governments print their way out of this crisis? Is not the yellow metal a haven of safety should the world go mad and currencies lose all value? The answer is that it is but short term issues are at play here.

Central banks lease physical gold out at around 3 to 4% for 1 month or 3 months at a time. They make a risk free profit on this and they get their gold back at the end. Many banks are still short of 1 and 3 month USD funding so they lease gold from central banks and sell it on the spot market thus holding the spot price of gold down. It's a cheaper way of raising USD funding when you consider that interbank lending rates have gone well above 5%.

The banks that are selling the physical gold on the spot market clearly don't want to be exposed to the gold price moving against them while they have the gold out on loan. So they buy up the future to hedge themselves. Look at the gold forward curve and notice how steep the contango is i.e. futures prices are much higher than spot prices.

While all this is going on everyone around the world is stockpiling their own physical gold and gold miners are facing production problems due to power shortages etc. Many banks are also talking of stockpiling their own physical gold reserves. Once interbank lending rates come back in line (assuming they do at some point) then I would expect to see a classic 'short squeeze' as the banks buy back the physical gold from the spot market in order to return it to the central banks of the world. Certainly the forward curve will flatten out as the spot price rallies and futures are unwound.

Gold will have its day of reckoning and it's getting closer.

8 Oct 2008

Trading in the Age of Aquarius

A great esoteric scholar and Masonic friend of mine once told me the following...

4000 BC - Age of Taurus - Bull Worship
2000 BC - Age of Aries - Old Testamanet Lamb of God
0 AD - Age of Pisces - New Testament Fishers of Men
2000 AD - Age of Aquarius - Water Bearer, the Great Leveller

Combine this with esoteric scholars who reckon the Mayan calendar had the next age starting in 2012 and we must surely start asking some questions...

Nothing can keep growing or going up forever. Nature teaches us that we are born and we die. The economic cycle has recently become divorced from the cycle of life.

We are told that inflation destroys growth and that therefore things can infact keep going up forever. That was before derivatives and gearing... Derivatives are great when they are used to hedge 1:1 against movements in the underlying. However, human nature being what it is we like to get as much as something for as little as possible and we gear up massively. Trade in financial derivative positions in physical commodities, FX, interest rates, shares etc. vastly outstrips the value of the underlying instruments. We are going to need years and years of massive inflation to pay off all the 'future' value of money that has been wiped out by loss-making derivative positions.

Now would be a great time to invest in something real like bricks and mortar. House prices, fuel prices, bread prices etc. are all going to rise massively over the next few years. Interest rates will stay relatively low to try and kick start the economy again which means any debt burden will quickly be eroded as salaries rise to keep up.

We will start to question what is really important again and we will start to see real things like the environment, family and friends and good old value for money take centre stage again.

My Masonic friend also mused that at the end of every age there is a great battle between those who hang onto the excesses of the previous age and the visionaries of the new age. Which side are you going to be on?

Lehman Employees Stage Protest

Lehman Brothers employees stage protest outside front gates of head office...

29 Sep 2008

What is value?

As a trader you don't really care what a number is. All you care is whether that number will be higher or lower in the future and this will dictate your action.

How could banks have lent so much against dodgy mortgages? Simple. They thought it would be worth more in the future. And it will be. Given 10 years of inflation.

Oil got up to $150. Now it's back down at $100 again. What has changed fundamentally in the oil market? Nothing on the way up and nothing on the way down. It's the perception of how that number will change in the future that drives what that number will become.

Which makes it a little troublesome when the real economy starts to depend on these numbers. Things like house and oil prices tend to have real meaning again and with the whole world starting to focus on them we will start to see real 'value' emerge. What that means for us as dependant economies is a matter of some interest. It's going to get interesting.