Just over a year ago, I wrote in TRE - Global Economy on a Spacewalk,
http://www.tremeritus.com/2014/01/03/global-economy-on-a-spacewalk-part-1/
http://www.tremeritus.com/2014/01/05/global-economy-on-a-spacewalk-part-2/
Stormy global economy and financial markets looming ahead this year – likely to be far more turbulence than we have seen in 2014! The US dollar proves itself a raging bull since last July and the Swiss Franc depegged from the euro in January this year. The global economy spacewalk has become more dangerous of maneouvring outside the pegged currency protection of the shuttle. Free fall in both soft and hard commodities roiled emerging and resource exporting economies alike – the impact of which will witness much more intense visibility this year.
THE COMMODITIES’ PERSPECTIVE.
Looking back the year past, GOLDMAN SACHS (GS) predicted that gold will tank 16% in 2014 – down to US$1050 per oz from year beginning US$1250 level. Jeffrie Currie, Goldman Sachs’ Head of commodities research urged CNBC of his gloomy pessimism of gold outlook on expectations that the US economy reaching “escape velocity” http://www.cnbc.com/id/101331595#. Currie repeated the same negative forecast in March 2014 after a largely unexpected one-off weather-induced negative 2.1% US first quarter GDP decline. http://www.mineweb.com/mineweb/content/en/mineweb-gold-analysis?oid=233976&sn=Detail
GS was essentially a betting on substantial recovery in the US economy leading the world out of its economic quagmire. Well, it was not so near escape velocity and way off the mark for gold, and much of the rest of the global economy I might add. Except for November, gold was traded above US$1,200 and much of the time above US$1,250 per oz – against a background of and despite surging strength of the US dollar of late. Some gold stocks even rallied up 30% to 80% in the recent 3 weeks alone. http://www.mineweb.com/top-10-gold-miners-leaping-golds-u-turn/ . Yet GS still rattled off a litany of reasons it sees gold dropping further. In other words, if it didn’t do it last year, it would this year. http://www.mineweb.com/2015-outlook-goldman-growls-gold/ . Only time will tell.
Against a basket of six rival currencies, the US dollar gained a staggering 12.8% since end 2013 – the rarity of this magnitude within a year not lost on this writer. http://www.marketwatch.com/story/dollar-index-on-track-for-best-year-since-2005-2014-12-31 It is almost like all the other rival currencies devalued double-digit and devaluation of this size is rare historically. Against most major currencies, physical gold actually gained between 5% - 10% in 2014. http://goldprice.org/ - implied hedge against rising US dollar raging bull.
But GS was NOT alone of this incorrect forecast. After a strong surge in bullion in early 2014, Robin Bhar, the head of metals research at Societe Generale SA in London and the most-accurate forecaster tracked by Bloomberg in the past two years. “We would still want to be bearish gold,” http://www.bloomberg.com/news/2014-02-18/top-two-gold-forecasters-remain-bearish-after-2014-rally.html. Another top forecaster, Justin Smirk, at Westpac Banking Corporation was even more bearish, settling for US$1,020 per oz fourth-quarter average. Consensus forecast of 6 big global banks average around US$1,209 per oz. http://blogs.marketwatch.com/thetell/2014/01/15/how-low-will-gold-go-in-2014-consensus-forecast-says-down-14-5/. Visual inspection of US dollar gold price chart will show gold hovered around an average price closer to US$1,250 per oz. This suggests that top investment banks, particularly analysts, were more pessimistic on gold, and more optimistic of global economy, than reality in the market-place.
As for the US economy grinds forward in the face of diminishing stimulus, the broad consensus of gold analysts within global investment banking in early 2014 had expected the strengthening of US recovery to take hold, bullion’s gain will run out of steam. The logic being equities will reward dividend, gold investing has no yield and increasingly losing its safe haven appeal in the absence of and without eruption of geopolitical turmoil. In US dollar terms, gold held stoically unchanged from year beginning despite surging US dollar and increasing mine production – an astounding resilience of gold investment appeal against the strength of global recovery expectations – the latter largely unfulfilled. Central banks, particularly Russia was buying physical gold as the Russian Ruble headed south in the opposite direction of the US dollar. What does that tells me?
Investors’ sentiments penciled in bigger turmoil yet to come even as the strengthening US recovery drives the US dollar rising trajectory in the face of divergent policy paths of a hawkish Federal Reserve and dovish Japanese and European central banks. Global economy was on a space walk as I warned - an uncharted journey of cautious optimism and a giant step into a big unknown - awaiting big surprises in directions unexpected in 2014. And we saw big commodities/currency volatility, EU sinking back into turbulence and Abenomics stumbled badly needing unprecedented quantitative easing support.
The surprising strength of bullion contrasted with the steep 50% fall in the US$ crude oil price in the second half of 2014. No oil analyst forecasts Brent crude to fell below US$90 a barrel, in part due to consensus bullish global forecast of an improved global economic outlook, including the IMF. Gas, coal and iron-ore prices matched this steep decline as structural imbalance of supply exceeding weak demand in these commodities exerted pressure on pricing. http://www.indexmundi.com/commodities/?commodity=iron-ore&months=12 But the bigger surprise is the apparent loss of expected strong positive correlation between the resilience of gold and the plummeting steep decline of oil price in the last 6 months. Is oil price’s steep fall preceding fall in gold price ahead – the common factor being the inflation linking these two variables?
Empirical analysis indicates consistent trends between the crude oil price and the gold price with significant positive correlation coefficient 0.9295 from January of 2000 to March of 2008. There seems to be a long-term equilibrium between the two markets, and the crude oil price change linearly Granger causes the volatility of gold price, but not vice versa https://ideas.repec.org/a/eee/jrpoli/v35y2010i3p168-177.html That is to say oil price movement is a “good” predictor of gold price. A National University of Singapore research came to the same conclusion – oil price can be used as a predictor of gold price direction. http://www3.ntu.edu.sg/hss2/egc/wp/2011/2011-02.pdf Empirical results from Cashin P. et. al. for the period 1960 to 1985 also demonstrated that there exists significant correlation between oil and gold. CASHIN, P. et al. (1999). Booms and slumps in world commodity prices, Reserve Bank of New Zealand Discussion Paper vol. 99 (8). Is the divergence away from gold crude oil positive correlation telling investors/economists that deflation pressure is stronger than inflation threat looming and falling oil price is the reliable scripture written on the wall? Oil price is the pivot of forward economic recovery discovery, or otherwise, and gold price trailing from here?
Gold price actually outpaced the performance of some of the other commodities despite 8% decline in jewelry demand – much to the surprise of GS I suspect. http://www.mineweb.com/2015-outlook-goldman-growls-gold/ Or will forward gold price the “rogue” of “safe haven” demand as in 2014 and another rout of commodity prices and a tumbled global economy in wait to “prove” GS forecast “wrong” again? What about base metals, nickel, copper, zinc etc? Copper said to be the PhD of economic forecasting, plunged a staggering 5% on the 14 January this year. http://www.marketwatch.com/story/copper-prices-slump-to-2009-levels-sparking-growth-concerns-2015-01-13?dist=beforebell. These are ominious signs as the red metal is used in a variety of construction and manufacturing activities. The broad selloff in the metals sector spearheaded by accelerated pace in copper price decline cannot be explained by supply alone. The 2015 outlook for copper has a wider spread of forecast of relative demand/supply imbalance.International Copper Study Group - http://www.icsg.org/ - forecast a surplus of 390,000 tonnes in 2015 but Glencore Xstrata forecast a deficit of some 94,000 tonne.That copper plunge was overshadowed by energy price collapse tells of weak fundamentals. Nickel and zinc face curtailing supply concerns also came under selling pressure!
Analysts noted the uneasiness in the base metal market came after the World Bank lowered its global growth outlook on reduced prospects in Eurozone, Japan and some emerging economies after struggling to maintain growth momentum of 2.6% last year compared to 2.5% in 2013. It forecast a global growth this year of 3% seems, to me, a little too ambitious. http://www.worldbank.org/en/publication/global-economic-prospects. At its 5-year January low of US$2.50 per pound, copper’s freefall is already doing a lot of damage to nearly all major Canadian copper producers. Top liners like First Quantum Minerals Ltd, Hudbay Minerals Inc, Nevsun Resources Ltd, Lundin Mining Corps., are all likely to be negative free cash flow after capital spending. http://business.financialpost.com/2015/01/14/canadian-copper-miners-have-negative-free-cash-flow-at-current prices/ They are consuming resources in their balance sheets and under enormous costs cutting pressures to push their all-in sustaining cash costs to lower bottoms. Unlike gold, copper is far less malleable to high-grading of mining operations,entire higher costs mines have to shut down and new start ups postpone indefinitely. The nature of commodities is that both demand and supply is inelastic and is therefore a “good” predictor of short-term economic outlook. The signs visible now are ominious forward of stormy economy and financial markets ahead.
CURRENCY & CBOE VOLATILITY INDEX
On 15 January, the Swiss National Bank, in a surprise move, abandoned its three-year old cap at 1.20 Swiss francs per euro. It closed at 1.0350 francs, up almost 16%, reflecting the strength of the Swiss currency amidst pressure from investors seeking a safe haven from eurozone’s economic and political woes. The Swiss franc fallout drives the euro to an 11-yr low against the dollar. http://www.marketwatch.com/story/swiss-franc-pares-back-after-shock-rally-2015-01-16?siteid=bigcharts&dist=bigcharts In “space walk” analogy, it is like the Columbia shuttle’s rendezvous and orbital docking systems with the space station is malfunctioning, endangering astronauts’ lives needing urgent repair. Just like a look at this CBOE volatility index one-yr chart – VIX – investor’s fear gauge. http://www.investopedia.com/terms/v/vix.asp
It tells a compelling story of financial market’s fearful nerve tremors since September 2014, both of comparative monthly and intra-day trading range. http://www.bigcharts.com/quickchart/quickchart.asp?symb=VIX&insttype=&freq=1&show=&time=8. In that same interval, the US dollar Index – DXY – surged more than 15% against a weighted basket of major currencies, euro, Japanese Yen, Canadian Dollar, British Pound, Swedish Krona & Swiss Franc to a 10-yr record strength. http://www.investopedia.com/terms/u/usdx.asp The surge in US dollar in the last 6 months is wreaking havocs in financial market. US stocks and US dollar is now the “the most crowded trade in the world” despite weak peak season December retail sales and bullish sentiments returning to the bullion market. http://www.marketwatch.com/story/betting-on-us-stocks-and-the-dollar-now-most-crowded-trade-in-the-world-2015-01-12?siteid=bigcharts&dist=bigcharts . The summation of that tells me Swiss franc, US dollar, US stocks and gold bullion are safe havens as all other currencies melting and commodities taking a rout, and expecting more if China’s economy weakens faster than expected.
FROM THE PERSPECTIVE OF US ECONOMY
So how did the US economy fared in 2014? After a negative first quarter of 2.1% decline, US economy rebounded strongly to 4.6% growth in the second quarter before easing slightly to 3.9% growth in the third quarter. http://www.forbes.com/sites/samanthasharf/2014/11/25/u-s-gdp-grew-3-9-in-third-quarter-2014-up-from-first-estimate/. That means that the US economy grew by more than 3% in 4 out of the last 5 quarter – some hint that it “is finally casting aside the shackles imposed by the financial crisis”. It needs the December quarter to re-affirm confidence that the US economy has reach “escape velocity” of sustainable recovery but a surprise December retail sales decline of 0.9% suggests that falling oil price and stronger US dollar had no desired expected positive impact on deteriorating consumer spending. http://www.marketwatch.com/story/us-stocks-open-lower-dow-drops-190-points-2015-01-14?dist=lcountdown. Acceleration in personal consumption expenditure (PCE) had been a positive factor in the third quarter strong GDP growth of 5%. That data is a reversal of cyclical trend which had been expected to be strong given Christmas seasonal factors. The Fed also reported “modest” to “moderate” growth across the US for the period from mid-November to end December with residential sales and construction “largely flat”. http://www.cnbc.com/id/102338135.
On the positive side, consumer credit cycle growth sustains in 2014 and seems to have past its deleveraging bottom in 2012. Other positive indications include moderate acceleration in the pace of gross fixed capital formation throughout 2014, to pre-GFC levels, underpinned by consistent gain in productivity but that business confidence is not reflected in stagnating average hourly earnings even as unemployment fell from 6.6 % down to 5.6%. Falling energy prices in the second half held down producer prices. On the weaker side, manufacturing PMI, most surprisingly, has been consistently falling since 57.9 in August to 53.9 in December – any score above 50 indicates expansion and below that implies contraction. Annualised 2014 GDP growth up till September quarter was 2.2%, much weaker than 3.1% growth in 2013. http://www.tradingeconomics.com/united-states/gdp-growth
Much of these economic growth feasted on rising productivity, slow wage increase and very little on gains from escalating gross fixed capital formation in recent years. There is little evidenc e of growth cultivation except the shale oil and gas sector. Given recent falling PMI manufacturing data and deceleration in PCE, this writer is expecting a weaker December quarter GDP growth to come in under 3% and 2.6% for the whole of 2014.The long-term sustainable growth rate since 1990 averages around 3%. This would strongly suggest that the US economy has NOT yet reach escape velocity trajectory contrary to Goldman Sach’s premature optimism. It is fueled by cheap money, not endogenous cultivation.The US economic recovery 5 years since the GFC in 2009 is still fragile despite an improving picture.
EUROZONE PERSPECTIVE
Eurozone saw another tough year barely avoiding another recession by the narrowest of margins after that 6-quarters double-dip recession ended mid-2013. Another renewed downturn in 2015 is possible and likely. Most of its leading economic indicators remain slightly in expansive terrain but weakening. The sustained fall-off in its manufacturing & services PMI reading is worrying, particularly in the second half of 2014. Again falling oil price have not helped – except debt sustainability. Industrial production in the last few months was anaemic of zero growth. Since 2010, consumer credit has trended down with no sign of recovery in sight. Consumers are still deleveraging and confidence has not recovered since the last recession. https://sg.finance.yahoo.com/news/eurozones-big-economies-increasingly-drag-101502919.html
The biggest risks in EU are deflation and electoral political uncertain due 25 January surrounding Greece’s continued stay within the eurozone. Political uncertainty stressed on financial market trending up Greece’s long term bond yield above 10%. This makes the third bailout of Greece by EU much more difficult of constructing a rescue package program, and its acceptance and implementation in follow. Ironically falling oil price adds to deflationary fears engulfing consumer confidence and spending further. Eurozone’s December inflation was negative 0.2%. http://www.marketwatch.com/story/eurozone-inflation-falls-to-negative-02-2015-01-07 . It is the first time in 5 years and sharply falling oil price is one contributing factor – negative inflation likely to persist for the next few months, driving down inflation expectation and consumer confidence - trapping EU into an economic crisis. It ramped up pressure for a much heavier dosage of quantitive easing by the ECB. Whether in this belated crunch will it works is another big unknown. Against this adversity of economic background, how can EU bail out Greece when it itself is sinking?
CHINA AND JAPAN PERSPECTIVES
China is the strongest beneficiary of fallen commodity prices – from oil, gas, coal, iron-ore and base metals. It will boost consumer spending, at least temporary, more than infrastructure building. IEA has cautiously forecast crude oil has hit the bottom and I agree its forward outlook is better. http://blogs.barrons.com/emergingmarketsdaily/2015/01/16/global-energy-stocks-rally-did-oil-hit-bottom-this-week/ Whilst China is the world largest consumer of energy and metals, its growth has slowed down faster than anticipated last year. The World Bank expects China's gradual pace of deceleration to continue, forecasting growth in the world's second largest economy to slow to 7.1 percent this year from an estimated 7.4 percent last year. http://www.cnbc.com/id/102339274.
China carried the legacy of perpetual ly inflated asset (housing) prices and a credit bubble. It cannot inflate that further without risking other parts of its economy the way Japan is now trapped of impossible to extricate quagmire, not even Abenomic can do the trick. China is shifting its economy away from reliance on manufacturing exports and infrastructure via endless stimulus spending to a domestic consumption-driven economy. The adjustment is often proving difficult to manage and no prospect of it returning to its former discarded growth model of broad-based stimulus for long. Until last November’s surprise interest rate, the PBOC had held a tighter monetary stance for two years. Speculation that this will lead to further liquidity easing was squashed in December following a spike in shadow banking activity. PBOC has to continuously balance local government and business loan demand of deflationary threats and yet not allowing easy money flowing into rampant stocks and property market speculation. http://www.cnbc.com/id/102343425 These headwinds adjustments will mute much of the beneficial impact of lower commodity prices otherwise flowing through the Chinese economy.
Japan is struggling too. The results coming through of Abenomic risk strategies have been poorly disappointing till now. The Bank of Japan is stepping up its money printing press – with a surprise end-October announcement that its annual target for expanding monetary base will rise to 80 trillion Yen (US$724 billion), up from the previous 60 to 70 trillion Yen. http://www.economist.com/blogs/banyan/2014/10/japans-quantitative-easing The Japanese economy basically sunk by the increase of its VAT sales tax from 5% to 8% in April 2014. Japan’s 2nd quarter GDP collapsed by annualised 6.7% with marked fall in consumer spending. BOJ’s expectation of a third quarter rebound failed to materialise – the economy dipped again by another 1.9% annualized. BOJ have since halved its 2014 economic growth forecast to a mere 0.5%. And this latest quantitative easing had to provide immediate “panadol” relief of Abenomic economic headache even if it may not be certain of the cure. It is a HUGE long term bet of structural financial reform roughly equating to 15% of its 2013 GDP base from which Japanese economy either swim or sink.The US Fed Reserve in 2008 started stimulus spending lift was only US$600 billion in contrast though it eventually added up close to US$4.5 trillion.
WHAT ARE WE LEFT WITH?
Quantitative easing programs by the Federal Reserve and the Bank of Japan have helped to create massive stock rallies in both countries – totally detached from gloomy economic fundamentals. Ebullient stock markets and its manifestation of asset bubbles are NOT the economy. The combination of low growth and QE was sufficient for stocks to rally in the United States……..in Europe too, but QE without growth remains a risk. http://business.financialpost.com/2015/01/05/how-deflating-europe-could-force-central-bank-into-action/ The Chinese are paying dearly for the legacies of its last GFC’s massive money printing equivalent to nearly 9% of its GDP base. Shadow banking is still crippling the PBOC’s capacity to manage money supply and economic aggregates. It is not going back to the same old way. And Eurozone will soon be forced to embark on this similar treacherous pathway – struggling to crawl out of its enduring quagmire.
At this moment, the world economy is basically running on one throttling engine – the US. Fear that the US growth can’t compensate for eurozone, emerging market woes explains the World Bank’s global growth downgrade, similarly evidently reflected in falling energy and metal prices. China is slowing down and EU/Japan is at BIG BET risks of tipping over without massive quantitative easing support. In the latter two, fallen oil price, sharply depreciated currencies and a big dose of quantitative easing might forestall a steep downward readjustment of their economies – they might both still manage to steal a razor-thin rate of growth this year if no surprise erupted from the US. There are, yet largely unnoticed, warning signs of sustained deterioration in the US real estate sector, since 2013 – new residential mortgages made by top lenders has been steadily decaying and the nation’s top home builders warned in December 2014 of soft demand and narrowing margins. http://www.marketwatch.com/story/as-builders-warn-bank-optimism-over-housing-rising-2015-01-15?siteid=bigcharts&dist=bigcharts. This post GFC US economic recovery, it must be remembered, is led by the housing sector. And that is faltering as the expectation of a rising interest rate looms large. I fear a reversal.
IF THE US ECONOMIC LOCOMOTIVE STUMBLES BADLY – any of these residual three major economies could still fumble badly in this quagmire and financial market will turn into a morass of quicksand. Any surprise that gold price is so resilience despite plummeting energy prices and GS almost contemptuous respect for gold investing? US treasury yields are pointing of bearish inflation expectation and economic outlook ahead. It has been 5 years since the GFC; none of the major economies emerge out of sustained growth on its “escape velocity”.
If China in its strong growth phase can’t do it, can the mature slower growth US economy do it? My read has it that GS got their maths “too optimistic” of US economic recovery on renewed self-sustaining pathway. The US economy will not be strong enough to lead the rest of the world out of the malaise still lingering of the last global financial crisis. Instead, a frightful quagmire and quicksand await of surprise in 2015 – the economy of EU/Japan teetering on the brink is ominously threatening and the strength of US recovery running out of stamina moderated by a stronger US dollar. I keep asking myself this question – why is gold price so strong?
What do you think?
Zhen He
