Market Outlook Journal
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October 5, 2006

Guest Commentary By Rudi Filapek-Vandyck Editor, FN Arena www.fnarena.com FN Arena supplies financial and economic news stories, analysis and commentary in the Australian and global financial markets. FN Arena - Passionate about Financial News FN Arena is building the future of financial news reporting at www.fnarena.com. Our daily news reports can be trialed at no cost and no obligation. Simply sign up and get a feel for what we are trying to achieve. Rudi Filapek-Vandyck Editor, FN Arena   Rudi on Thursday Investors would be forgiven for thinking it's all over with the great big commodities boom. Share prices for most resources stocks peaked in April-May this year. Since then these shares have been going through one period of volatility morphing into the next one. The end result is huge losses for those who bought too late and didn't get out. Meanwhile all of the securities analysts have simply raised their recommendations for individual stocks. BHP Billiton (BHP) and Rio Tinto (RIO) currently enjoy ten positive recommendations which is the maximum achievable given that FN Arena only covers ten leading experts in the local market. But share prices keep on going down, with the odd rebound in between the slides. There's something not right here. Ever had the feeling that something's not quite what it should be, or what people tell you it is; when something, somewhere tells you there's more to the story, something you haven't been able to lay your finger on? I had a Eureka experience when I read a recent ABN Amro report on the global mining industry today. The report was published last week already but I only picked it up this morning. I thought it would probably be a good idea to share some of the suggestions and conclusions drawn in the report as I am sure many readers are questioning their conviction regarding the Commodities Super Cycle these days. Especially with the likes of GaveKal stating it is time to say goodbye to commodities and resources stocks. Share prices will start rebounding soon, suggests ABN Amro. History is providing us with the evidence for this thesis. ABN Amro analysts have trailed through the past few decades and found that share prices tend to bounce back and appreciate further once base metals prices have hit their peaks. The analysts would argue that "further substantial declines in equity prices this time would be a significant deviation from the historical behaviour of the markets". You probably heard this theme over and over and over again over the past few weeks (and admittedly FN Arena as well as myself have delivered our contributions as well) but there are simply too many compelling value reasons why resources stocks cannot remain out of favour for too long. ABN Amro has repeated the same mantra throughout their report. There will be additional growth, and a big chunk of it will come from the excess cash flows that have been generated during the price rallies. We all know most prices will likely come down but they are to remain at historically elevated levels. ABN Amro believes major support will come from the traditional laggards in the sector, the bulk commodities. On Monday I wrote that iron ore is likely to surprise over the next half year or so (negotiations for new contract year 2007). ABN analysts agree. They recently increased their iron ore price forecasts to unchanged for next year, from a fall previously, but they expect prices to remain at their current levels for another two years (first price decline in 2009). Also, don't forget the healthy balance sheets and cash flows throughout the mining sector are widely expected to drive further consolidation in the sector. So why are share prices down? Why is BHP closer to $24 than to $30 and Rio equally at 40%+ below its average twelve month price target? ABN analysts think the market is confused. Well, that's not exactly what they're saying, but I think that is a fair summary of their thesis. The analysts suggest the sharp share price declines, after the sector appeared to have recovered from the May slaughter-fest, have now separated the true believers in the Super Cycle from the rest. But now the market is confused as there are, as one might expect, simply less people with a true conviction in the market than there are "others". In the absence of a genuine catalyst for the sector, investors turn to macro-economic data, says ABN, and this translates into big sell-offs one day (because some GDP data disappointed, for instance) followed by a sharp rebound the next one (because inventories have fallen to critically low levels). What the sector needs is a major catalyst, but the analysts suggest between the lines of the report that such a catalyst may well remain absent for the next year or so and investors are therefore likely to take guidance from smaller events and indicators. The result will be ongoing volatility, because one day GDP data will disappoint (or not) and the other day... I am sure you all get the picture. Bottom line is that the big diversified resources stocks are still trading at or near their Net Present Values (depending on whose calculations we use) and ABN analysts would not think twice and simply buy at current price levels. History shows this is usually a wise investment decision (a point brought forward by quite some other experts recently as well). Diversifieds are favoured above single commodity plays, for obvious risk reasons. ABN Amro is not a big fan of uranium, but I would add that uranium appears to have all the ingredients in place to positively surprise over the next few years as well. (without the prospects of a protracted negotiation process with the Chinese steel mills). For those who may have missed it, Paladin Resources (PDN) is currently rated Buy three times out of three while Energy Resources of Australia (ERA) enjoys three Buys out of four. Till next week! Rudi Filapek-Vandyck (Supported by the Fabulous Three Chris, Greg and Terry) StockInterview.com was granted permission to post this story written by Rudi Filapek-Vandyck.

September 20, 2006

Alignment To War: Asian Commodity Demand Versus The US Printing Press Guest Commentary By Greg Peel Senior Writer, FN Arena www.fnarena.com FN Arena supplies financial and economic news stories, analysis and commentary in the Australian and global financial markets. FN Arena - Passionate about Financial News FN Arena is building the future of financial news reporting at www.fnarena.com. Our daily news reports can be trialed at no cost and no obligation. Simply sign up and get a feel for what we are trying to achieve. Greg Peel Senior Writer, FN Arena   Marc Faber has a PhD in economics and a famously contrarian view of the world. He is the author of the popular "Gloom, Boom & Doom" report and became a best-selling author in 2002 with his book "Tomorrow's Gold". At the invitation of fund manager US Global Investors, Faber last Friday spoke live on the internet to the topic "Investing in a world of rapidly changing geopolitical and economic trends". This is a summary of that presentation. Taiwan is more vital to the delicate game of geopolitics than most would realise. While never particularly amiable, relations between China and Japan have deteriorated in recent years and a lot of that has to do with Taiwan. The US has a policy of supporting the independence of Taiwan (a sort of quasi-independent Chinese state inhabited by those who escaped the Maoist revolution) while China has long wished to rope the renegade back in. Japan has aligned itself with the US. The US is the world's largest consumer of oil, with China second. As the US is 40% self-sufficient in oil production, China is actually the world's largest net consumer. Japan has no oil. 75% of Japanese oil imports come from the Middle East (compared to the US with 20%). The Middle East also supplies the bulk of Chinese oil imports. Tankers which leave the Persian Gulf en route to China and Japan sail through the Straits of Malacca, between Malaysia and Indonesia, and up through the South China Sea – right past Taiwan. Says Faber: who controls Taiwan controls Chinese/Japanese oil. China and the US create a fragile dichotomy. While once clear enemies on an ideological basis, China's capitalist evolution has meant relationships have become more co-operative, but not particularly less strained. While China has become the factory for the manufacture of US goods, it has also become the largest foreign investor in US financial assets. While US businesses are happy to invest in China, US Congressmen are calling for protectionist policies. The US is bordered by two friendly nations – Canada and Mexico. Both are significant suppliers of oil and other commodities to their neighbour. China is bordered by 14 nations of various levels of influence and ideology. They include Russia, India and North Korea. China enjoys a friendly relationship with Russia. They have formed an alliance with each other known as the Shanghai Co-operation Organization (SCO), which includes members Uzbekistan, Kirgizstan, Tajikistan, and oil and uranium-rich Kazakhstan. Aside from these members, the SCO includes "observing members", being Mongolia, India, Pakistan and Iran. If these countries became full members, the SCO would represent 45% of the world's population. Faber notes it is US foreign policy that has pushed China closer to Russia. The SCO has set a timetable for the US to withdraw its central Asian military bases. Central Asia boasts significant amounts of oil and gas. Under its alliances, China can contemplate direct overland access through to Iran, which currently supplies 15% of Chinese oil imports. Already India is building an oil pipeline from Iran, through Pakistan (with Pakistan's co-operation). From Iran it is a hop, skip and a jump to Sudan – another exporter of oil to China. Faber notes Africa today is similar to China pre-industrialisation – little industry, but vast resources and population. To date the US and the rest of the West has been interested only in exploiting African oil and other resources. The US has also been globally criticised for pricing vital, patented drugs out of the reach of the average African. In the meantime China has been creating alliances in Africa – building infrastructure and commencing agricultural projects. You can see where Faber is heading with this. Slowly but surely the world's most populous nation is setting up ties with the rest of the non-Western world. [What Faber didn't include here is South America. The oil and gas-rich northern part of the continent has been undergoing a transformation towards self-rule and nationalisation of industry. Led by Venezuela's charismatic president Hugo Chavez, Bolivia and Peru have fallen into line and Ecuador has been teetering. Mexico remains loyal to the US, for now. This alliance is mentored by Cuba's Fidel Castro. China has been very busy organising export alliances in South America. One goal is to bring Venezuelan oil across the continent to the Pacific, for easier sea-access to China. The US has declared Chavez an enemy. A summit has just concluded in Cuba, and as the Sydney Morning Herald reported "Heads of state and government from 56 countries and delegates from 118 countries were due to adopt a voluminous final declaration backing Iran's right to nuclear energy; urging UN reform to give greater weight to poor countries; opposing terrorism and what they see as US interventionism". The draft also condemns Israel's "unlawful" policies in the Palestinian territories and the recent intervention in Lebanon.] As China, then India, and other developing nations, move to industrialisation, resources are becoming more scarce. Notes Faber: most of the wars throughout history began over scarce resources. This does not mean Faber is warning of World War III on the horizon. He simply intends to put things into perspective. There is little doubt that global tension has increased significantly of late. How the US deals with this tension becomes very important from an economic point of view. The last time the prices of oil and gold were at their highs was in 1980. Between 1980 and 2000 the Cold War ended, global tensions eased (if you discount the first Gulf War) and commodity prices fell. The resources sector went into the doldrums. Since 2001, global tension has reared again, and at the same time China has accelerated its extraordinary economic growth. Commodity prices have skyrocketed. It is usual for commodity prices to skyrocket in times of war, and for military spending to increase, funded by borrowings from capital markets. When the technology boom collapsed in 2000, the US moved to an ultra-easy monetary policy in order to reinvigorate the economy. 9/11 evoked more of the same determination. Since then the US has tightened monetary policy significantly, but Faber suggests that from such a low base, policy is currently still expansionary. In response to the oil shocks of 1979-80, then Fed governor Paul Volker responded by squeezing the system. This ushered in a period of high interest rates. Volker was able to do this, notes Faber, because US debt levels were contained. Current governor Bernanke does not have that option open to him. US debt levels were 120% of GDP in 1980. They are at 300% today. Between 2000 and 2005 the expansion of US debt ran at six times the rate of GDP growth. The bulk of that debt has gone into buying real estate. Housing prices as a percentage of US GDP are now at all time highs. Households have then extracted money from home values to finance consumption. Despite a drop in the US housing market, such extraction and consumption continues today. Household drawdown of funds for the purpose of investment in real estate, and the stock market, has led to US savings becoming negative and has fuelled the economic boom. Thus the system has become more vulnerable. The economic recovery post 2000 has not been driven by capital creation and employment gains, but by credit creation and easy monetary policy. Asks Faber: how can this be sustained? Despite the apparent growing wealth of Americans, median household income has actually fallen by 4% since 1999. The cost of household necessities – for example energy and medical services – has risen substantially. The US regards itself as the economic engine of the world, yet its share of global exports is falling. While the US has fallen, China's exports have grown astronomically. The US now carries trade deficits with every major region of the world. In 1987, the ratio of US foreign investment turned negative, such that today foreigners hold US$12.7 trillion worth of US assets while the US holds only US$10.0 trillion of foreign assets. The US current account deficit (CAD) is growing annually, having commenced its significant blow-out post 2000.This has been due to easy monetary policy which has led to strong consumption growth but not strong investment growth. [Note that the growing US CAD has many economists predicting disaster ahead, while others show little concern. Noted bears such as Faber, and Morgan Stanley's Stephen Roach and Nouriel Roubini believe the growing US CAD spells imminent disaster for the US dollar. Other economists suggest the dollar cannot collapse because no other currency provides an alternative. Yet other strategic thinkers, such as Charles Gave, suggest CAD measurements are deceptive as they do not account for the consequent rise in US profits. As long as the US has assets to sell, says Gave, the CAD can safely blow out much further.] Production and investment have shifted away from the US, to China and other developing nations. While China may have exported its deflation to the rest of the world, it has also promoted deflation at home. Faber notes it wasn't long ago that the Chinese were buying their first locally-produced car for US$20,000 in real terms. Today the equivalent car (everyday sedan not dissimilar to those which GM produces) costs US$3,700. At US$20,000, roughly one million Chinese could contemplate owning a car. At US$3,700 this figure rises to 50 million. China is now the second largest car market in the world behind the US. In the US, first-time car buyers represent 1% of the market. In China that figure is 84%. Similar price deflation has occurred for other items the West takes for granted, such as TV sets and mobile phones. While the US boasts the largest economy in the world, Faber suggests the Chinese economy is actually far bigger than anyone realises. Officially, the current size of the US economy is US$12 trillion and China's US$2 trillion. But if you measure not in monetary terms, but in volume of goods produced, then China represents 60% of the global economy. And the Chinese economy is growing at the rate of 13-15% per annum in industrial production and 20% in capital spending. China is now the biggest consumer of the world's commodities. Yet Chinese per capita consumption of commodities is much lower than the West's. India's is much lower still. Faber notes India is still probably twenty years behind China. The history of oil consumption provides a revealing example. Prior to industrialisation, the US consumed one barrel of oil per capita. Today it consumes 27 barrels. Japanese industrialisation in the 1950s took its consumption from one barrel to 17 barrels today. China's current consumption is 1.7 barrels per capita. India's is 0.8. Today all of Asia (including Japan) consumes 22 million barrels of oil per day. This is consumed by 3.6 billion people. The US also consumes 22 million barrels of oil per day, with a population of 300 million people. Asian oil consumption will double at some point in the future. Can current oil production (84 million barrels per day) be sufficiently increased to meet that demand? Says Faber: oil prices simply must keep going up. Commodity prices in general in the 1990s were at their lowest level, in real terms, in the history of capitalism. Commodities price cycles can last 45-60 years, notes Faber. We are only at the beginning of the bull market. This does not mean there cannot be, and won't be, major price corrections along the way – even in the order of 50%. The price of copper, for example, has risen from US30c/lb to US$4/lb. Faber would not be surprised to see the price of copper reaching US$2/lb in the current correction. Or oil reaching US$50/bbl. History is littered with major corrections in ongoing bull markets. The price of gold moved from US$30/oz in 1970 to US$175/oz by 1974. In 1976 it fell to US$103/oz before hitting US$850/oz by 1980. In 1987 the Dow Jones index fell 40%. It is now seven times higher. In 1987 the Hang Seng index fell 50%. It is now ten times higher. If commodity prices rise, interest rates rise and consumer prices rise, and vice versa. Between 1960 and 1980 the price of oil rose, and interest rates rose. Between 1980 and 1999 the price of oil fell, and interest rates fell. Today the oil price has risen to new highs, but interest rates remain low. What is wrong? Bond prices are wrong, says Faber. And why are bond prices wrong? Because the US is printing money. Even if the economic growth of China and India begins to slow, notes Faber, there will not be a pullback in oil consumption. Fed governor Bernanke has stated that declining asset prices strengthen the system. He is the money printer. In fact, he has said that as long as asset prices are declining "you could throw dollar bills out of helicopters". Faber entreats his audience to buy at least one US Treasury bond to frame and hang on the wall. That way, he says, you can show your kids how the US dollar became worthless. The US has not experienced a real bear market in equities since 1929-32 when the Dow Jones fell 90% in nominal terms. Between 1964 and 1982 the Dow Jones moved basically sideways in nominal terms, but in real terms it lost 75%. Notes Faber: you can make the Dow go wherever you like by printing money. So how should an investor respond to Faber's dissertation? Firstly, he notes, the prices of agricultural commodities have barely moved. Secondly, the price of gold is now inexpensive compared to other commodities – particularly oil. The gold price may yet go to US$500-550/oz, but there it should be bought. If the Dow Jones continues to rally, as many expect it will, and it does so because the US is printing money, then the price of gold must rally. Buy gold, says Faber. Note: Marc Faber's full presentation can be found in streaming audio at www.vcall.com/CustomEvent/NA012124/index.asp?id=108754. StockInterview.com was granted permission to post this story written by Greg Peel.

September 1, 2006

Guest Commentary By Rudi Filapek-Vandyck Editor, FN Arena www.fnarena.com FN Arena supplies financial and economic news stories, analysis and commentary in the Australian and global financial markets. FN Arena - Passionate about Financial News FN Arena is building the future of financial news reporting at www.fnarena.com. Our daily news reports can be trialed at no cost and no obligation. Simply sign up and get a feel for what we are trying to achieve. Rudi Filapek-Vandyck Editor, FN Arena   China Warns Of Inflation Risk On the 1st of June FN Arena sent out its first and only news alert email thus far. At the time CLSA, a leading provider of brokerage and investment banking services in the Asia-Pacific region, had noticed how its monthly Chinese manufacturing surveys showed input price pressures were continuing to rise. CLSA announced the end of the global deflationary wave that China had started a few years ago. It has repeated that view in subsequent monthly updates. Now the Chinese authorities seem to have adopted CLSA's view. Yesterday, China's National Bureau of Statistics warned of an increased inflation risk as a result of ongoing excessive investment growth in the country. The warning caught the eye of equities economist Martin Arnold at CommSec. The public admission that inflation may now become a problem in China is something that deserves global investors' attention, Arnold believes, because of the central role the Chinese economy plays in maintaining global growth at a reasonable pace. So far, there's no sign yet of an inflationary break-out, Arnold suggests. He notes the July CPI figure in China showed inflation growing by 1% on an annual basis. However, he points out, producer prices have recently been rising at their fastest pace in nearly a year and that could well translate into higher consumer and export prices from now on. As such, CommSec is now singing from the same song sheet as CLSA in early June. So far, CommSec adds, there are no signs that the higher pace in producer prices has filtered through to the retail sector. No doubt, Chinese economic data in September will be followed closely by economists and strategists worldwide. Another possible cause of concern remains the Chinese authorities determination to step on the economic brakes. CommSec believes that as long as there is a risk the Chinese economy may overheat, further policy tightening and constraints on domestic bank credit is to be expected. It is a view shared by the experts at BCA Research who, a few months ago, stated China would succeed in slowing down its economic growth eventually, simply because the Chinese government would put everything in place to achieve what it wants to achieve. BCA's China Investment Team has reiterated the view this week. The team notes the central government has now dispatched inspection teams to local governments to make sure its administrative tightening measures are being enforced. This underscores that policymakers are determined to induce a clear downshift in capital spending growth, BCA says. StockInterview.com was granted permission to post this story written by Rudi Filapek-Vandyck.

August 25, 2006

Oil Price Downside Risk Is Misguided Guest Commentary By Greg Peel Senior Writer, FN Arena www.fnarena.com FN Arena supplies financial and economic news stories, analysis and commentary in the Australian and global financial markets. FN Arena - Passionate about Financial News FN Arena is building the future of financial news reporting at www.fnarena.com. Our daily news reports can be trialed at no cost and no obligation. Simply sign up and get a feel for what we are trying to achieve. Greg Peel Senior Writer, FN Arena   For some reason there is a growing belief that the oil price is artificially inflated by investor inflows (perhaps in a way that gold appeared to be earlier this year) and that any toppling over of the fear premium could lead to mass panic as investors head for the exits. One analyst is reported in the Wall Street Journal as suggesting oil will reach US$50/bbl by next year, and another poor misguided fool sees single digit prices in three years. Barclays Capital stops short of being incredulous, but does provide some solid home truths. And this is before we even talk about growing demand from the developing world. Barclays estimates that across all categories of commodities, in both futures and over-the-counter positions, there is US$100-120 billion of investment. Does this number seem big? Well consider first that the market capitalisation of the world's five biggest oil companies is more than US$1.3 trillion. The current market cap of Exxon-Mobil alone is US$417 billion and institutional investors currently hold 52.3% or US$220 billion. Investors hold twice as much capital in Exxon-Mobil alone than they do in all commodity investments. The total assets held by institutional investors is some US$50 trillion, so that means they hold less than one quarter of a percent directly in commodities. But wait, there's more. Allowing for all oil transactions, physical and derivative, the current nominal annual value of the world's oil market is US$40 trillion. There would certainly be some price response if, out of the US$120 billion of commodity investment, oil was suddenly sold down, but single digits? Barclays notes (and this may have something to do with sell down fears) that Iran appears to have tempered its nuclear stance by asking for more time, but this is only likely a ploy to split the security council between those (eg China and Russia) who would like to offer more time and others (eg the US) who are already impatient. There is no indication Iran will give way on nuclear enrichment. There is every indications the response will be "robust", says Barclays. If anything, Barclays is expecting institutional investment in oil to grow. StockInterview.com was granted permission to post this story written by Greg Peel.

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