Europe in turmoil, China retreats, trade financing freezing and rare earths fell out of love
Past 8 weeks since my last Update 10 – Global economies heading for turbulence, financial markets in turmoil as advanced economies slipping off the precipice into another recession – financial market and economic conditions in Europe have deteriorated significantly, threatening to slow down global economies and destabilizing China’s efforts to engineer a soft landing of its slowing economy. Two EU Prime Ministers cleared their desks – unprecedented in a financial crisis even in 2008 GFC
Anecdotal evidences of credit squeeze similar to 2008 are taking shape as risks aversion is gripping both trade and investments. US corporate and money market are withdrawing their funds from European banking system suggestive of a banking run has already commenced. http://www.cnbc.com/id/45417735/Has_the_Bank_Run_Begun_in_Europe. Chinese shippers have stopped payments to Norwegian ship-owners. http://sg.news.yahoo.com/1-second-major-chinese-firm-fails-pay-ship-041643010.html Both institutional/retail investment interest in an emerging Australian rare earths minerals producer (otherwise a hottest commodity speculative sector in the wake of Chinese export curtailment) collapsed - forcing Arafura Resources Limited to cancel its A$74 million renounceable rights issue needed to fund the bankable feasibility study of its promising Nolan’s project. http://www.asx.com.au/asxpdf/20111124/pdf/422smsldx0gdp4.pdf, Rare Earth minerals are a very small segment within the metals market but its aggregate end demand - being largely dependent on highly discretionary consumer use products - is therefore volatile and its pricing economics are highly sensitive to prevailing economic conditions. Commodities prices continue to fall, along with commodity-based currencies relative to the US dollar – except for oil. New sanctions against Iran by US, UK and Canada have buoyed oil prices and that could strangle the last hope for economic recovery to germinate from US. http://business.financialpost.com/2011/11/22/iran-sanctions-buoy-oil-prices-despite-demand-worry/. Across the board, base metal shares continue to fall in Australia and Canada – almost a 12 months rolling decline as destocking in end user market continues. BHP, the world largest miner, has revised its forward outlook from just a month ago, conceding publicly that tightening credit conditions and customers’ reluctance to restock inventories are threatening its business prospect forward. http://www.marketwatch.com/story/bhps-kloppers-cautious-on-market-outlook-2011-11-16-2023280. This is in line with earlier Rio Tinto’s negative forecast for the commodity sectors near to medium term outlook. BHP reported that the European crisis had negative impact among European banks’ capacity and willingness to undertake trade financing. http://www.smh.com.au/business/europe-crisis-hits-bank-financing-bhp-says-20111128-1o1zl.html
While corporate balance sheets in US is stronger than 2008, there has been precious little investment in fixed capital formation. Banks in US continue to report “better” earnings without top-line revenue gain – all thanks to hollow log accounting of bad debt provisions. European banks are strongly suspected of capital adequacy sufficiency – particularly French banks much weakened by massive loan assets write-off in “haircuts” concession made to Greece’s sovereign debt. Any slight decline in asset base value could have magnified negative implications on their solvency. Tightening credit conditions within China and the adverse impact of its export sector are shrinking domestic consumption demand just as property prices in major cities showing signs of steep decline. Latest news out of Chinese political leadership emphasizes continuation of property lending curbs despite damaging slump in prices. http://www.smh.com.au/business/world-business/china-to-maintain-property-curbs-20111128-1o2nz.html China’s economy is also from turning amber to red as I forewarned on August 5, 2011 – Update 9, Global economies heading for turbulence, watch out China.
The traffic signal of deleterious global economic outlook since May this year which turned amber towards August looks almost certain of turning red in 2012. Against a background of fast collapsing economic conditions in Europe and a slowing China impacting on other developing countries, the world faced the ugly prospects of downside risks confronting a steeply uphill struggle to keep the global economies on an even keel, resting upon some brighter (surprising and certainly much-welcomed) economic seeds germinating of improving American consumer spending. US private household’s debt is slowly being repaired over the last few years. But US consumer confidence is unlikely to sustain in 2012 as partisan politics in economic agenda will mean tougher economic targeting both in government spending and spending cuts adding uncertain to job security.
Mergers & Acquisitions – slow to bargain hunt, quick to dump
The first half of 2011 saw the busiest activity season of mergers and takeovers ever in the mining history, according to a PricewaterhouseCoopers study. Now all that evaporated in the second half. http://findarticles.com/p/articles/mi_hb5976/is_201110/ai_n58403165/. Volatile global market put downward pressures on mining assets. Mega mergers of recent past are history and most recent deals activity in commodities sectors center on biggest miners taking over much smaller explorers with very high quality assets. Classic case in point is the uranium giant, Cameco’s hostile bid for Hathor Exploration Inc. keenly contested by Rio Tinto. Hathor owns the Roughrider (a very large, high grade, and therefore, potentially offering low cost production possibilities) uranium deposit in Saskatchewan said to have the potential yield of C$2 billion pre-tax earnings over its currently estimated 11-year mine life. http://www.mineweb.com/mineweb/view/mineweb/en/page72103?oid=135381&sn=Detail. This is an outstanding rarely available acquisition opportunity in terms of mineral economics, except in a hostile bid. Cameco finally walked away from the bidding war. http://www.theaustralian.com.au/business/mergers-acquisitions/rios-bid-for-hathor-gets-boost-after-cameco-drops-offer/story-fn91vdzj-1226208754683. One must remember that China Guangdong Nuclear Power (CGNP) lowered its bid price for Kalahari Minerals by 7%, only to drop it completely last week in the face of opposition from the UK Takeover panel. http://www.miningweekly.com/article/extract-shares-fall-after-cgnp-withdraws-kalahari-offer-2011-05-11.
The contrasting results tell of how sensitive to quality asset pricing in takeover bids even in the newly effervescent uranium sector. No one else is bidding for Kalahari Minerals other than CGNP. The Chinese voracious appetite for takeover seems now to be only looking for depressed valuations in this climate of worsening economic conditions. Minmetals Resources’ $1.3 billion bargain takeover bid for Anvil Mining is one good example. http://af.reuters.com/article/investingNews/idAFJOE7AM0D820111123. At its pre-GFC peak, Anvil Mining was valued nearly 3X as much. That hit the economic nationalism brick wall in Congo and might also fell through.
It is particularly insightful that despite valuations of equities engaged in gold-mining significantly lagging the spectacular upsurge in bullion price, little is heard of gold mergers and takeovers in recent months. Shandong Gold’s predatory bid for Jaguar Mining showed how shrewd of their hunting of distressed assets at severely knocked-down pricing offering big premium on recently traded price but effectively paying very cheap valuation for underlying assets. http://www.bloomberg.com/news/2011-11-18/jaguar-record-premium-still-cheap-as-china-hunts-for-brazil-gold-real-m-a.html?cmpid=yhoo. Other cashed-up rich miners just sat on the sidelines waiting for lower valuations despite longer term structural supply deficiency issues in gold and base metals.
Commodities market is telling us a recession in 2012 awaits us all. No one wants to be caught acquiring even good assets on highly leverage financing and balance sheets - the painful lessons of pre-GFC days driving big miners on the verge of financial bankruptcy and/or financial vulnerabilities of an excessively geared capital base are not forgotten!
KEY MAJOR ECONOMIES – WEAKENING IN SULLEN MOOD OF FINANCIAL BAILOUT QUAGMIRE.
- OECD WARNING
OECD have reduced their growth forecasts to 1.9% this year and 1.6% in 2012 compared to 2.3% and 2.8% respectively made 5 months ago. Instead of uptrend momentum of recovery, the OECD is forecasting a downward slide of the 34-nations OECD economies. http://www.quamnet.com/newscontent.action?request_locale=en_US&articleId=2104774&view=NEWS. OECD warned of major western economies is just one step of plunging into the abyss of a deep recession driving a lot of businesses into bankruptcies. http://www.theaustralian.com.au/news/world/oecd-issues-depression-warning-on-debt/story-e6frg6so-1226208766511
- ESCALATING SOVEREIGN BORROWING COSTS
Yields on benchmark 10-year bonds have skyrocketed to record levels for many eurozone troubled economies of Greece, Italy (7.89%), Spain (7%), even relatively untroubled Belgium (5.65%), France (3.46%) and Germany (2.2). The bond market charges US 10-year bond 1.88% and UK Gilts 2.18%. In effect, Germany is also now viewed as so swamped with EU debt bailout that its own credit ratings have been endangered of higher risks default that until now has no precedent. The debt crisis contagion has spread from Greece, to Italy, Spain, France and Germany. The survival of euro is increasingly in doubt and its collapse could have serious damage to all EU economies and the rest of the world.
Italy and Spain are prime bailout candidates as yields of 7% on a 10-year bond auction implied that borrowing costs would have doubled their debt value within 15 years – that is very burdensome indeed given the state of intrinsic indebtedness and structural issues inhibiting recovery efforts forward.
- RECESSION LOOMING IN EUROPE
In any case, any bailout of Greece, Italy or Spain is only buying time, not solution. The world is drowning in debt funding asset bubbles and Europe’s distress is the epicentre of that un-sustainability. And without economic growth that must accompanied spending cuts in austerity drive, debt cannot be repaid with good money. Final Market Eurozone Manufacturing PMI read in October was 47.1, the third consecutive decline. That hint of EU is already in recession. Germany’s October PMI read of 46.1 is a steep decline from month preceding of 49.6 and the grim reading extends to Italy’s 5 points manufacturing PMI October drop to 43.3 point. http://finance.yahoo.com/news/Euro-zone-factory-data-rb-722517790.html?x=0&sec=topStories&pos=3&asset=&ccode=
Looking at the back mirror view of GDP growth statistics, eurozone has been teetering on the edge of recession – registering two consecutive razor-thin growth of a mere 0.2% in the June and September quarter. http://money.cnn.com/2011/11/15/news/international/europe_gdp/index.htm?hpt=hp_t2 After Canada, the EU is the US second largest export market and therefore a deep and/or prolonged recession poses considerable risks to the US economic recovery.
Just read the comment in this Bloomberg news http://www.bloomberg.com/news/2011-11-27/imf-readying-600-billion-euro-loan-offer-for-italy-stampa-says.html The La Stampa said this - "The money would give Italy’s Prime Minister Mario Monti 12 to 18 months to implement his reforms without having to refinance the country’s existing debt", There is no painful de-leveraging in Italy and Greeks fought austerity drives on the streets of Athens. There is strong evidence of political fatigue of de-leverage among EU governments as much as the austerity fatigue among EU’s citizenry already impoverished by poverty since the 2008 GFC. Worries of the EU sovereign debt drags on, regardless of bailout efforts constantly reworked in European capitals. It is EU’s version of the American real estate sub-prime crisis that will take maybe at least a decade to work through.
- THE DEMOGRAPHIC DEBT WALL CONSTRAINTS
All major western economies are riddled with demographic debt wall creating a fiscal squeeze. Declining labor market participation by the baby boomers generation in weakening economies reduced their national income and tax revenue contribution. It is further aggravated by increased welfare spending in health care and income support adding to national budgetary distress at a time when heavily indebted governments all need relief. Choices are limited of resorting to either other program spending cut reducing growth, further borrowings selling long-term bonds at inflated costs, raising taxes – all are politically very difficult choices. The easiest one is printing money with inflation pressure reducing real income further down the track.
European leaders have been very busy working this week structuring some urgent bailout funds for Italy to create a large-scale fire-wall to protect EU members from contagion and to calm financial markets from spiraling further upwards of long-term bond yields.
- PARTIAL SOLUTION WILL UNDERMINE MARKET CONFIDENCE.
Options canvassed include the use of the much-depleted European Financial Stability Facility (EFSF with a mere 250 billion euro in its coffer) as co-investor of bailouts and providing some sort of insurance coverage to private investors, possibly with IMF backing. Prospects do not look optimistic in view of US-led IMF objection and even European Central Bank declined to be the lender of last resort. http://www.theaustralian.com.au/business/in-depth/european-leaders-to-tackle-bailout-fund/story-fnawdwo8-1226208732077.
The leaders agreed on a standby credit facility of 500 to 700 Euros which they concede the agreed amount has insufficient capacity to bail out Italy, Spain and troubled European banks. Financial market was looking for a bailout fund between 1 to 2 trillion Euros. http://www.theaustralian.com.au/business/wall-street-journal/europe-leaders-concede-bailout-fund-to-have-less-capacity/story-fnay3ubk-1226209901667
The Chinese are not participating in this EFSF proposition tossed about on the table, preferring to invest in EU infrastructure projects instead but these are not offered for sale anywhere even in EU’s troubled economies.
Over the US, efforts to contain its debt explosion to place us public finance on a sustainable basis have also hit the wall. The failure of the so-called super committee to reach an agreement on spending cut has led Fitch to downgrade US outlook. http://www.quamnet.com/newscontent.action?request_locale=en_US&articleId=2104482&view=NEWS
All that failure means a trigger of a $1.2 trillion automatic spending cut. And even 2012 election year, short-term partisan politics will drive a lot of economic rationality. The US is heading for more fiscal gridlock as EU tumbles into turbulence and recession.
- IMPACT OF EU SOVEREIGN DEBT CRISIS ON OTHER ECONOMIES.
• Britain
Recession is looming in Europe, the UK economy on the brink with the latest forward forecast of 0.7% growth in 2012 from its Chancellor of Exchequer.
• China
China’s industrial juggernaut is slowing down. Bubbly house pricing is buckling in Beijing and Shanghai with some suburban apartments falling 30% within weeks to less than a year sparking angry protests from recent buyers. http://www.ipinglobal.com/ipin-live/406072/chinese-protests-against-property-prices-falling
HSBC flash estimate of China’s November PMI read came in at 48 – that is a 32-month low. The steeply-dipping decline signals further fall ahead. The corresponding monthly PMI read since July was 49.3, 49.9, 49.9, 51.0. Against this background is GDP quarterly print of 9.7, 9.5 and 9.1 for the latest September quarter. http://money.cnn.com/2011/11/23/news/international/china_pmi_hsbc/index.htm. October trade figures showed imports stood at $140.46 billion while exports rose to $157.49 billion, leaving a trade surplus of $17.03 billion according to General Administration of Customs figures. http://www.upi.com/Business_News/2011/11/10/China-October-trade-surplus-1703-billion/UPI-83771320985418/ The GAC data showed China's foreign trade with its major trading partners -- the European Union, the United States and Japan – slowed this year. Total trade volume with Europe and US continues to grow robustly by 20.2% and 16.8% respectively, China’s external trade surplus have been shrinking. In the first 10 months of this year ended October, China's trade surplus totaled $124.02 billion, down 15.4 percent year-on-year. Rising Yuan and rising costs and a more competitive external market conditions were the main culprit.
• Japan
View the much-weaker-than expected Chinese PMI’s November read in the context of Japanese recent trade figures, there must be concerns that global trading conditions have weakened considerably. Japanese exports declined in October and its return to trade deficit in the same month (after recording a surplus in the month preceding) may signal the beginning of euro-led export slowdown impacting on export-oriented Asian economies.
The fear is that Japan is tipping back into recession again after recovering from the Fukushima-instigated downturn. Japanese exports are falling. http://www.cnbc.com/id/45455888. The tightening on trade financing from European banks is having negative impact on contract as far as BHP’s mineral sales to China as much as the dried up credit also sending economies in Eastern Europe wobbling on unsteady footing.
• India
India is also facing the heat of the eurozone contagion. The falling rupee relative to the US dollar due to uncertainty arising from the uncertain global economic environment, particularly unfolding eurozone sovereign debt crisis is hurting India’s economy badly. India imports 70% of its oil and gas from abroad, and falling rupee adds inflationary pressure to the headline inflation of 9% for 11 consecutive months. http://economictimes.indiatimes.com/news/economy/indicators/rupee-fall-due-to-global-economic-uncertainty-government/articleshow/10918728.cms
• Other Asian economies
Elsewhere, Taiwan’s October PMI dropped to a 33-month low, Singapore non-oil domestic export declined by a much-worse-than-forecast 16.2% on a year-on-year comparison. The island state’s electronic exports declined by 33.4$ compared to the year earlier. http://sg.finance.yahoo.com/news/UPDATE-1-Singapore-Oct-rsg-655314700.html?x=0
• USA
The US economy is less cloudy at the moment – thanks to stronger retail sales over the last 6 months but that is suspect too of part attribution to inflation, seasonality of Black Friday boost, and help from consumers debt de-leveraging since 2009 improving balance sheets of those employed and a tapering of employment retrenchment. A gauge of US consumer confidence in November showed its highest reading of 56 in July helped in part by lower gas prices at the pump. http://www.marketwatch.com/story/consumer-confidence-leaps-in-november-2011-11-29?link=MW_home_latest_news
But all that could change when unemployment benefits vanishes for 6 million unemployed by next year along with the commencement of automatic spending cuts of US$1.2 trillion taking effects. US corporate balance sheet is definitely stronger but where is that capital spending to create jobs when global economies keep hitting bumps after bumps of turbulence? Big US corporate remain stuck in predatory mentality – many made huge profits but paid no taxes and in some cases received “negative” taxes from a Government mired in public debt exceeding $15 trillion. http://www.marketwatch.com/story/big-profits-zero-taxes-for-large-us-companies-2011-11-03
Third-quarter US GDP growth has been revised downward to 2% from earlier more optimistic flash estimate of 2.5%. Ben Bernanke is predicting “frustratingly slow” growth ahead for the US economy.
CONCLUSION
The unfolding events in the bailout of Italy, and Spain – if the contagion spread beyond that and it seems to be already germinating of banking credit freezing evolving - is pivotal as to whether the headline read for 2012 is recession in most advanced economies except China, India, and maybe again the commodities-rich exporting countries of Canada, Brazil and Australia. As of now, there is little scope for optimism that a recession can be avoided next year, and at best delayed of its inevitable reaching.
Anyone disagreeing?
Zhen He
30 November 2011
