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Economics and Finance

The world is not coming to an end. BUT, QE3 is short term gain and fundamental economic drivers (and debt restructuring) are the only means to future growth from here.

Yes, the world is NOT going to come to an end. Fundamentals always drive growth and hence equity markets over the medium to long term and the world still has fundamentals (albeit depressed at this point). This is perhaps currently best demonstrated by the graph below of ICSA (US initial jobless claims) and the S&P 500 (that appear to be highly correlated). Note however, that this does not necessarily correlate to future growth.

So, how has the ICSA fallen within a slowing (recessionary?) global growth environment. Well, QE and consumption. As the US is insular in many respects the country can grow through internal consumption and continue to (but not forever) as long as a plan for debt reduction is agreed to (early next year). As such, the ICSA can continue to fall. If this occurs then expect US equity markets to cement this apparent “slow bull” market we appear to be entering. But the equity growth will most likely come from “non-commodity” based sectors (refer to China assessment within this article) so the focus will be on tech, energy, consumer etc. However, should debt issues and global (more importantly USA) growth continue to deteriorate as fundamental drivers deteroriate, the US will not be immune and as such, expect the ICSA to rise (that is more people filing for benefits) over the coming period(s). Hence, expect a corresponding fall in the S&P 500.

Now to China. The Chinese leading indicator and GDP growth tells a story (see graph below). GDP trend is down (and continuing). No sustained recovery…yet.

Also, this was published 8:09 AM, 6 Sep 2012 in Xinhua News: Iron ore has continued to build up at 25 major ports as Chinese steel makers posted widespread losses over the seven months to July, Xinhua News reports. According to the news agency, iron ore inventories waiting at ports increased 1.86 million tonnes to 102.53 million tonnes last week. Xinhua analysts have blamed the build up on weakening demand for the product. “In the short-term, the iron ore market will continue to suffer from oversupplying and the downward trend seems irreversible,” Xinhua analysts said in the report.

The following steel inventory graphic illustrates this point well:

Additionally, here are some important points to consider on the demand side:
China represents less than 11% of the global economy, but it commanded 30% to 40% of total global demand for copper and 60% of total global demand for cement and iron ore thanks to the massive social modification projects that required bridges, roads, ports, cities, subways and skyscrapers. This is not sustainable and so demand for the raw ingredients will decline. Additionally, the nature of future growth will change and more consumer driven growth will again demand less materials.

Now for the supply side:
– Previous phase of China demand due to imbalanced growth. The next phase of China’s growth will be less commodity-intensive.
– The last phase of commodity purchasing by China appears to have added to inventory.
– Chinese growth, even if it does bounce, will be drawing down on these inventories.
– Lagged supply to increase despite the declining demand. For example, supply of copper to 2019 will be roughly equal to the increase in supply over the decade to 2011.
– Iron ore supply response even more dramatic – capacity tripled to 2,600 million tons in decade to 2020. Will lead to lower prices for the long term.
– Stockpiling in China to ensure bounce in economy doesn’t lead to permanent rise in commodity prices.
– Chief Executive Officer Yusuf Alireza of Noble Group Ltd. (NOBL), Asia’s biggest listed commodity supplier, says tough environment for the next 12 to 24 months.
– Vale SA – the world’s largest iron-ore producer – says China’s golden years are gone. (Source: http://www.rogermontgomery.com)

So oil (and commodity) prices will fall (collapse?) here to promote further global growth (we may have just seen that initial occurrence in September with the price falls in oil but commodity prices have been depressed through 2012). Energy is key here as always. If new energy sources keep coming online in North America / Asia with a corresponding fall in oil and commodity prices (which has begun) then global growth will start to creep out of this malaise (perhaps also thanks to QE and the ECB guarantee?). Once increasing growth occurs acceleration of inflation will occur and that is going to be the killer towards the later part of this decade (perhaps we have not yet seen how bad things can get until this pending inflation nightmare hits – so buy GOLD?). The extent to which all sovereign debt is re-structured (and/or written off) and how fiscal tightening is applied and enforced over the coming 20-30 years will also play a massive part in how all this plays out. Europe is not going away. Growth will not come until the debt is restructured.

Anyway, just my opinion. But note the tapering off of the ICSA index since the beginning of 2012 and the catch up of the S&P 500 since that period. And the S&P 500 is at or close to an all time high. Just this morning evidence that key people view economic conditions as stagnant when Federal Reserve President Charlie Evans stated that he would like to see Operation Twist continue for all of 2013 and not end in 2012. Others opine that QE3 will have little to no affect on growth and that rising inflation will be the largest issue this decade. Something is going to give here and the coming month or two will tell the story. Things may be about to come to a head (or certainly at some point in 2013). Debt will be written off and someone will take a haircut. It will just be a matter of when and how much. Or has the ECB guarantee, QE3 (and a future US congress debt restructure plan) saved the developed world? Unlikely, so volatility remains. Be ready either way. Beware October and a US presidential election. Sentiment in the US can change rapidly. Leave it with you.

Note: Views expressed here are the authors own. Seek independent professional advice before making any investment decisions.


About Glenn Smith

High growth business leader, independent management consultant & investment manager, board member, entrepreneur. An entrepreneurial leader/executive with >20 years experience in, and preference for, high growth enterprises capable of leaving a commercial and social legacy. Specialties: strategy, innovation, commercialisation and investment execution (venture capital /private equity). This successful executive career has been built around being involved in and/or growing businesses at all stages of the growth cycle (listed and private), from existence (start-ups), to survival ($1B). P.S. Impressario, esquire, bon vivant, viticulturist and oenologist.


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