THE GLOBAL ECONOMY – CHINA & BOND MARKET ARE QUICKSANDS

In my January 2015 write-up, Global economy – Quagmire & Quicksand, I alluded to 2015 will see a more stormy global economy and volatile financial markets than the year preceding.

http://www.tremeritus.com/2015/01/21/global-economy-quagmire-quicksand-part-13/.  Goldman Sachs (GS) preferred a much more benign positive outlook, forcasting global growth poise to accelerate and US striking above-trend growth – China slowing.  http://www.goldmansachs.com/our-thinking/archive/2015/ . GS was slightly more positive of gold raising its 2015 average price forecast for gold to US$1,262 per oz.  http://www.reuters.com/article/2015/01/23/metals-goldman-forecasts-idUSL1N0V21PS20150123. By July, GS’s Jeffrey Currie, Head of Commodities Research, took a decisively bearish stance  to gold, predicting that the metal is likely to trade below US$1,000 per oz. “Going forward if we continue to see improvement in U.S. economic growth we tend to maintain downside risk in gold," he added http://www.cnbc.com/2015/08/26/not-seeing-weak-deamand-in-energy-goldmans-currie.html . The presumption is that gold value as an asset class with no interest yielding is countercyclical to economic strength.

Gold, in fact, turned out to be far more resilient till now, in spite of a much stronger dollar, and the US economy actually turning softer than expected – evident in patchy manufacturing, weaker employment data, and recent months declining retail sales, and more tellingly, housing starts/building permits. http://www.tradingeconomics.com/united-states/housing-starts... The Fed Reserve growth forecast for US economy this year is only 2.1% and 2.3% for 2016 – far below the long-term growth rate of 3.2 in recovery phase. http://www.marketwatch.com/story/imf-trims-global-forecast-as-brazil-canada-outlooks-deteriorate-2015-10-06 With only one qtr remaining, it is stunning that IMF has revised global growth for 2015 (and 2016) forecast by 0.2%  to 3.1% from its July revised forecast of 3.3% against a year beginning forecast of 3.5% - noting of weakened conditions in China, Brazil – both heading for their fifth straight year of declining growth. http://www.imf.org/external/pubs/ft/weo/2015/02/index.htm  Both GS and IMF have been more optimistics of global economic outlook than warranted.

THE YEAR TO DATE IN RETROSPECT

Volatility in the global economy and financial market, indeed, proved to be far more pronounced this year than 2014. Right from the beginning, we saw a 42% sudden rise in Swiss franc in January followed by steep fall of the Euro. By early March, the Euro sank to the 12-year low against the US dollar – no thanks to the Greece contagion effect and the declared divergent strategies intent of the US Fed Reserve to raise interest rate. http://www.theguardian.com/business/2015/mar/11/euro-12-year-low-gainst-the-dollar  Then came next is a mini crash of the German bund (bond) in May (the steepest upward climb in a quarter of a century). The yield on Germany’s 10-year bunds was a mere 0.059% on 17 April rocketed up to 0.70% by the first week of May. By historical standards, yields were still incredibly low, but the spike up was visible even with a long-term 10-year view on the chart. http://www.businessinsider.sg/germanys-bund-yields-boomed-at-the-fastest-pace-in-a-generation-this-week-2015-5/#.Vg0rZeyqooI .That sent shivers to peripheral eurozone bond markets, the euro, 10-year US treasury yield and commodities market.

 http://blogs.ft.com/gavyndavies/2015/05/10/bund-tantrum-warns-of-future-accidents/. The bund tantrum caught financial market by surprise –  10-year bond yields had seen steep decline since January in the wake of collapsed oil price, raging firestorm warning of deflationary threats, euro us dollar exchange rate saw continuing pressure. There was no expectation that the European Central Bank QE to taper off in such dismal economic outlook prevailing. Nominal yields of Bunds below 7 years duration was negative – suggestive of a bubble in the bond market. Was the shock rebound a “psychologically triggered”, not wholly explained by fundamentals – other than a fear of exit illiquidity?

Fear of illiquidity left financial market prone to evaporation of values. IMF’s Global Financial Stability Report warned of this. http://www.imf.org/external/pubs/ft/survey/so/2015/pol092915a.htm Regardless, there is strong evidence of hard assets mispricing of risks which brings with it risks of sudden extreme volatility that this writer predicted to erupt in 2015.

Risk is, to my mind, a volatility construct, rather than financial construct – much harder of estimation quantification & forcasting despite the academic finance teachings - much debunked now. The impact is necessarily financial, and at times, really huge.Indeed IMF warned of this - If financial conditions worsen or investors become weary of a particular asset class or financial market, market liquidity and value can quickly evaporate. We saw the shares in Glencore PLC tanked 29% in a single day on Monday 28 September but rebound within the next 5 trading days enjoy a bounce-back to more than recover all the losses. http://www.cnbc.com/2015/09/28/glencore-tanks-another-25-whos-next.html. What is less capable of explanation in this strength of confident rebound is why Glencore’s US$36 billion bonds were then being traded at pricing akin to junk bond in financial market. http://www.cnbc.com/2015/09/30. With deeply contentious view of the group’s equity might be worthless unless commodity pricing picks up swiftly, one side could be badly wrong as the gyrations in commodity pricing continues to escalate in growing uncertainty.  The mystery unresolved is this – is the equity market in Glencore shares ‘deceiving” the commodity market feeding its volatility or the volatility and downward pressure in the commodity market misleading the equity valuation and debt borrowing costs of Glencore in the equity market. The focus of deeply divided perspective on Glencore is on China and implicitly the global economy –specifically the state of its economy as the key driver.

There is little doubt in my mind that China is in deep trouble. Few would have predicted the quagmire China found itself in since late June.  It stock market saw a meltdown in June and August  with the Shanghai Composite Index now standing at 3052 points compared to its peak of 5166 of 12 June 2015 – an awesome bloodbath of 40% loss of bubbly value. China claims 7% GDP growth in the first half but not everyone is convinced.  Some of the evidence is anecdotal inside China – foreign businesses are complaining of slower economy than China officially admits. With imports falling and declining PMI manufacturing consistently in negative territory for most of 2015, scepticism about the accuracy of official data has intensified.  China’s factories are still struggling. The government's official purchasing managers' index hit 49.8 in September. http://money.cnn.com/2015/09/30/news/economy/china-pmi-manufacturing/index.html?iid=obnetwork. Any number below 50 represents a deceleration in the manufacturing.Caixin and Markit showed manufacturing PMI dropped to 47.2 in September, a slight decline from 47.3 in August and 6.5-year low, now been below 50 for seven consecutive months. The Caixin China services purchasing managers index fell to a 14-month low of 50.5 in September. http://www.marketwatch.com/story/china-caixin-services-pmi-falls-to-14-month-low-2015-10-01?link=MW_home_latest_news  Dragged by the insipid property sector, growth in China's fixed-asset investment, one of the crucial drivers of the economy, slowed to 10.9 percent in the first eight months of 2015 - the weakest pace in nearly 15 years. https://sg.finance.yahoo.com/news/china-august-factory-output-6-054640890.html. Barclay Bank economists cut China’s GDP growth rate to 6.6% this year and 6% for 2016. http://www.smh.com.au/business/markets/china-is-leading-us-into-a-global-recession-says-citi-chief-economist-willem-buiter-20150915-gjms00.html. Finance Professor Michael Pettis at Peking University reckons the attainment of GDP growth target in the coming years beyond 3% - 4% is practically impossible. http://news.sky.com/story/1559985/china-faces-lost-decade-of-economic-growth. Considering a revised downward GDP growth in 2014 to 7.3%, the weakest in 24 years, any decline in 2015 GDP growth to the predicted 6.6% must be viewed with increasing concern. Remember, the PBOC has cut interest rate 5 times since last November besides reducing reserve requirements three times for most banks to support lending. https://sg.finance.yahoo.com/news/china-grapples-risk-economic-hard-landing-044131334--finance.html  It would signal the ineffectiveness of quantitative easing in juicing up the economy, pointing to the apparent acceleration of descent of sustainable growth for China and suggestive of increased risks of a hard landing next year.

China faces 3 bubbles and a long shadow of weak manufacturing – the stock market bubble, the real estate bubble and the debt bubble – the first two have imploded or at least freezing and the debt bubble still being expanded by monetary easings to contain the adversity impact of the two formers.There is very little buffers left of policy adjustments in managing the mother of all bubbles. Activity in China’s factory shrank again in September with new orders dwindled. http://www.reuters.com/article/2015/10/14/us-china-economy-inflation-idUSKCN0S804H20151014. Consumer inflation is subdued and producer prices declined for the 43 consecutive months raise concern of deflationary pressures unabated. Weichai Power, China's largest manufacturer of engines for heavy-duty trucks used in mining and construction warned its nine-month net profit could fall 75-85 percent due in part to the weakening economy.

OUTSIDE CHINA – THE OUTLOOK FORWARD ADVERSELY -INFECTED

Outside China, the evidences of eroded weaknesses are staggering. South Korean industrial export of intermediate goods to China is fizzling out. http://blogs.wsj.com/korearealtime/2014/08/21/south-koreas-exports-to-china-game-over/ Australian dollar hit a 6-year low against the US dollar on China fears. http://www.smh.com.au/business/markets/currencies/australian-dollar-hits-sixyear-low-on-china-fears-20150901-gjczj9.html Yet given this competitive currency leverage, throughout Australia’s heartland, factories are closing and China is not buying minerals exports like coal, iron-ore and other commodities no matter how cheap the prices are. http://www.smh.com.au/business/markets/australia-pays-the-price-for-relying-on-china-20150924-gjulu2.html  Brazil suffers the most from China’s recent devaluation as 50% of its iron ore, oil and other commodities landed in Chinese ports. http://www.businessinsider.sg/china-devaluation-hurts-brazil-most-2015-8/#.Vg1IEOyqooI . Exports to China tumbled by 19% in the first 7 months of 2015. http://www.wsj.com/articles/how-brazils-china-driven-commodities-boom-went-bust-1440728049 The Brazilian Real came under intense pressure hitting the all-time low at R$3.9901 to the dollar recently. http://www.ft.com/intl/cms/s/0/88903fac-6081-11e5-9846-de406ccb37f2.html#axzz3nKEGGDDZ. The falling Real prompted the Brazilian Central Bank to publicly state that it is willing to use the country’s US$370 billion foreign-currency reserves to defend the Brazilian currency. http://www.wsj.com/articles/brazils-real-strengthens-against-dollar-1443125945. Brazil is not the only deeply troubled by falling currency amidst growing fears of Chinese slow down. Among emergent economy facing high inflation or huge foreign currency debt, falling currency spells disaster. Indeed there is carnage out there, notably in South Africa, Turkey, Indonesia and Malaysia. http://www.cnbc.com/2015/09/25/its-carnage-out-there-for-emerging-markets.html. During her press conference on 18 September decision not to raise interest rates, Fed Chairwoman, Janet Yellen invoked China 16 times in one hour. This is how serious China’s diminishing growth prospect has become the epicentre of global growth narrative within the Fed, IMF, World Bank, OECD etc. http://money.cnn.com/2015/09/18/news/economy/china-yellen-global-economy-worry/. This is in spite of the fact that US-China trade account for less than 1% of the US GDP statistics but it is China’s trading relationship with the rest of the world is alarming. A recent Brooking-FT index report warned of "sharp divergences in growth prospects between the advanced economies and emerging markets, and within these groups as well", notably resourcess rich economies like Russia, Canada  and Brazil already mired in recession. The danger is that emerging economies ‘leading the world economy into a slump.” http://www.cnbc.com/2015/10/04/emerging-market-turmoil-flashes-warning-lights-for-global-economy.html

Janet Yellen spoke of these words – it is no secret that China’s economy is slowing….. The question is how much it will impact the rest of the world, including the United States….. Canada, a major U.S. trading partner, is already in a recession, largely because China is no longer buying commodities like it once did. Many emerging markets like Brazil are also struggling for the same reason.”  The truth is that China’s growth cannot be independent of protracted subdued conditions in the developed world and the emergent world even more vulnerable to downward pressures. Many of these economies are severely leveraged on China’s continued growth but now exhausted. It is a vicious self-reinforcing circle.

Alcoa slashes its outlook for China's production of cars & heavy duty trucks are good bellwhether. http://www.marketwatch.com/story/alcoa-slashes-it-outlook-for-chinas-production-of-cars-heavy-duty-trucks-2015-10-08?dist=tbeforebell  The “macro softening” in China’s economy is taking hit on US corporates, suddenly souring their outlook of Yum Brands, even Nu Skin Enterprise Inc. - China accounting for 26% of its revenue base. http://www.marketwatch.com/story/china-could-become-a-big-problem-for-us-stocks-again-2015-10-07 . The fear forward is weak consumer demand inside China will infect US /global corporate earnings alongside a weakening Chinese services sector. No where is this Chinese economic slowdown more clearly felt as in Caterpillar Inc. http://www.marketwatch.com/story/10-worst-sp-500-stocks-led-by-caterpillar-decline-2015-09-24 Caterpillar planned to cut its global work force by some 10,000 through to 2018.With sales declining for three straight years so far, Caterpillar CEO Doug Oberhelman said Caterpillar was facing “a convergence of challenging marketplace conditions” in mining and energy – implicitly all mining & oil and gas jurisdictions from Canada, Australia, Brazil, South Africa, Middle East, China and USA itself. Mining provides the raw material for construction and manufacturing and energy is needed to drive production, distribution of input/output and consumption – without recovery of both adversity of challenging convergence  of market conditions, Caterpillar Inc. at the forefront,  is telling us no economic recovery forward  is in sight for the next 3 years. The World Bank sees China slowing for the next 2 years. http://www.marketwatch.com/story/world-bank-sees-china-slowing-over-next-2-years-2015-10-05.  Some Asian currencies are plummeting to multi-year lows including Singapore, Malaysia and Indonesia. Corporate Indonesia is likely to face enormous pressure in 2016 to roll over US$42 billion of foreign currency denominated debts – an ominious reminder of possible repeat of the 1997 Asian Currency Crisis. http://www.cnbc.com/2015/10/04/indonesia-inc-faces-tough-time-rolling-over-debts.html. IMF’s Global Stability Report warned the “excess” of emergent market corporate sector over-leveraging to the tune of US$3 trillion in the last decade. A wave of default in a credit crunch of higher interest rate environment could imperil an already weak global economy. Policy-makers has no margin of error in  navigating through the inevitable normalisation of interest rate and market conditions, any miscalculation risks wiping out economic growth for the next 2 years.  http://www.telegraph.co.uk/finance/economics/11916485/3-trillion-corporate-credit-crunch-looms-as-debtors-face-day-of-reckoning.html Export-dependent Germany, eurozone’s key economic engine, is also sputtering.  http://business.financialpost.com/investing/global-investor/germany-the-eurozones-economic-engine-is-sputtering-as-its-biggest-companies-struggle.  A steep decline in manufacturing orders over summer from outside the eurozone tells of bleaker economic outlook ahead – the advantage of 20% depreciation of euro against US dollar through 2015 notwithstanding.Anaemic conditions in EU & Japan depress their currencies, juice up their economies but little to show even short term  growth. IMF warned that the euro depreciation will restrain US and China for years, reducing 1% of the US GDP and China by 2% respectively.http://blogs.wsj.com/economics/2015/04/14/imf-euro-depreciation-will-restrain-the-u-s-and-china-for-years/. The mighty US dollar in a decade has already sent its August exports to a 3-year low. http://www.marketwatch.com/story/us-exports-fall-in-august-to-three-year-low-2015-10-06  World trade volume grows modestly, slower than global real GDP – hinting of weak demand compounded by growing uncertainty and turmoil in financial and currency markets. http://www.gbm.scotiabank.com/English/bns_econ/forecast.pdf  The downside risks to growth still dominates outlook going into 2016.

WHAT DOES THE COMMODITIES MARKET TELLS US?

I would say – lots, and mostly grim statistics. Glencore PLC, the mining and natural resources trading behemoth lost 57% of its traded value this year and survived a death-defying plunge in late September. It is shutting down its Eland platinum mine in South Africa, zinc production at Lady Loretta In Australia,  Iscaycruz in Peru, cutback the same at George Fisher and McArthur River in Australia and at various locations in Kazakhstan and suspended all its copper/cobalt production in Katanga Mining Ltd in DRC and at Mopani in Zambia. http://www.bloomberg.com/news/articles/2015-09-07/glencore-zambian-move-to-halt-26-of-country-s-copper-output. Seven out of 10 worst performing S & P index stocks this year are in commodities-related business. http://www.mineweb.com/articles-by-type/analysis/commodity-collapse-has-more-to-go-as-goldman-to-citi-see-losses/. Out of 21 major financial benchmarks tracked by Reuters, only two – US dollar and 10-year US Treasury bonds – have yield positive returns this year.
http://www.smh.com.au/business/markets/investors-brace-for-stocks-to-fall-again-ahead-of-us-earnings-20151003-gk0hdw.html . It is hard to argue for a strong case for a price recovery in commodities in 2016. Only 3 commodities – rice, cocoa and cotton – all agricultural and supply shortfall-induced escaped the 2015 carnage and the worst deflationary price decline was lumber. http://www.marketwatch.com/story/only-3-commodities-have-managed-to-escape-2015-carnage-2015-09-29. Industrial metals like aluminium, copper, platinum and energy -relevant Brent crude featured on the top end of price fall. Together with rubber, they tell a compelling story of underlying economic fundamental also told by Caterpillar Inc. & Alcoa. Historical natural rubber price chart showed a steep declining secular downtrend since February 2011 http://www.indexmundi.com/commodities/?commodity=rubber&months=60 and on a 12-months chart read, it exhibits a sharp cyclical decceleration in price since June 2015. http://www.indexmundi.com/commodities/?commodity=rubber&months=12. China’s January-August rubber imports down 4.4 per cent to 1.66 million tonnes. India’s natural rubber imports slumped 32 per cent on YoY basis to 33292 tonnes in August http://globalrubbermarkets.com/37258/geofin-comtrade-daily-report-on-natural-rubber-september-28-2015.html. India and China account for roughly 30% of the world’s automobile production. Nearly 70% of the natural rubber is used in automotive industry. Growth of Chinese car sales slowed right from the start of CY2015 compared to CY 2014 as slowing economy weighs on the world’s largest auto market. http://www.wsj.com/articles/china-car-sales-get-a-tap-on-the-brakes-1425972198. That trend continued weaker for the rest of 2015 – purchase in July was a 17-month low after the steepest rout in Chinese stock market since 1996. http://www.bloomberg.com/news/articles/2015-09-09/china-auto-sales-rebounded-in-august-as-discounts-lured-buyers. Given these weak numbers and supply/demand imbalance, it is no surprise of the lagged fall in crude oil price, behind the deteriorating weakness in rubber. The evidence pointed to incipient investing class lost a lot of money and reduced capacity to spend on consumption forward. http://fortune.com/2015/09/09/china-economy-trouble/.  China’s and global economy are in deep trouble navigating in uncharted waters.Caterpillar Inc knows that and retrenching 10,000 through CY2016 – citing a convergence of challenging conditions in mining and energy markets. http://www.miningweekly.com/article/caterpillar-restructuring-to-see-more-than-10-000-retrenchments-by-2016-2015-09-25

Until I see a rebound in rubber, platinum & lumber prices, I cannot see a rebound in the global economy. Some 70% of natural rubber found its use in tyre and platimum – outside jewelry market – is largely consumed in catalytic converters in car manufacturing. Other than Japanese, China already accounts for more than two-thirds of platinum jewelry globally and further consumer penetration might be limited – therefore it is most unlikely for platinum price to recover without a recovery in the auto sector. http://www.kitco.com/news/2015-09-02/Barclays-Foresees-Strong-Chinese-Imports-Of-Precious-Metals-Over-Next-Several-Years.html  If consumers in EU and China cannot afford to buy cars (and rubber & crude oil), how can they afford to buy mortgage-financed real estates in an environment of higher interest rate forward?

Lumber price is a good forward proxy of the housing and construction sector – notably in US and China – and it is falling since year beginning. http://www.nasdaq.com/markets/lumber.aspx?timeframe=3y. US new housing starts near an 8-year high in July but permits fall. Weyerhaeuser (WY) reported deteriorating Chinese & Japanese housing markets in summer aggravated by stronger US dollar aggravating its export volume – China is its biggest export market.   http://www2.laufer.com/falling-west-coast-exports-dampen-loggers-sales.html . (WY), one of the world’s largest owner timberlands, saw its share price collapsed. http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=wy&insttype=&freq=&show=  New home orders by builders like D.R. Horton & Lennar Corp trend upward, but the annual rate for new single-family houses sold is not at pre-recession high. http://www.wsj.com/articles/homebuilding-industry-after-the-recession-1443671769 - Their share prices appear to have peaked.The US housing sector recovery since the last GFC has been shallow and could tipping over ahead of rising interest rate.

The simple truth revealed in falling lumber prices is that the Asian economies of China and Japan are slowing. Japan’s industrial output dropped by 1.2% in August over July, far steeper than earlier anticipated 0.5%. http://www.marketwatch.com/story/japans-factory-output-slumps-hints-at-recession-2015-10-15  The US recovery story is sluggish at best, marked by tepid consumption, slower consumer inflation and falling producer’s price index in September, even as gasoline prices at multi-year low. http://www.cnbc.com/2015/10/14/consumers-shutting-down-as-us-economy-deflates.html  Buried in the minutes of the Fed’s meeting of 16-17 September disclosed a pessimistic economists forecast within the Fed of a much subdued economic growth averaging only 1.74 % over 2015 – 2020. http://www.marketwatch.com/story/buried-in-the-fed-minutes-is-another-downgrade-to-the-us-economy-2015-10-09. Chinese Finance Minister Lou Jiwei over the weekend at the International Monetary Fund's annual meeting of 9-10 October 2015 warned that the US “is not yet in the condition for an interest rate hike”- indicate Beijing's unease about the impact that the move might have on the Chinese economy. http://www.marketwatch.com/story/chinese-finance-minister-says-us-shouldnt-raise-rates-yet-2015-10-12.  China’s imports collapse in September, exports remaining weak. http://www.cnbc.com/2015/10/12/china-exports-imports-continue-to-fall-in-september.html. Any interest rate rise in US will lift its dollar (indirectly the Yuan) and its tailwind likely to undermine the Yuan’s competitiveness relative to the rest of the world. Relative to rest of major competitive currencies like the Euro, Yen, and Chinese Yuan depreciates less against the muscular US dollar in the last 20 months.

SO WHAT IS THE OUTLOOK FOR CHINA & GLOBAL ECONOMY?

Notwithstanding the weaker crude, bulk commodity prices & Yuan’s August devaluations, September trade figures in Yuan-denominated terms, indicate weak domestic demand and tepid external conditions. The downward pressure on the Chinese economy has intensified. The Chinese, for political and strategic calculations wants a stronger Yuan, but economically can’t afford that. Chinese policy-makers have been lobbying hard for the Yuan to be included in the IMF’s “Special Drawing Rights” basket which now comprises only four currencies – namely, the US dollar, Japanese Yen, Sterling Pound and Euro. That would confer the Chinese Yuan as de facto as “reserve currency” status – a decision IMF could make in November. http://www.marketwatch.com/story/china-will-be-able-to-support-the-yuan-for-a-long-time-2015-10-07. Yet we saw two small quick sudden Yuan devaluations in 11 & 12 August – they underscore the capacity of & for shift in Chinese policymaking paradigm - in response to shifting external conditions taking global financial market by surprise. It is a strategic move and tactically well executed. The Chinese could not have taking a bigger cut in August – if they want to - for fear of triggering a global currency war and provoking a capital outflow in panic fear.

THE CHINESE DEVALUATION  CONUNDRUM

My suspicion is that these are not the end of the Yuan devaluation, never mind the Chinese Central Bank have been burning its foreign reserves to prop up the Yuan and hold on to its US dollar currency peg. Bigger shocks are ahead, once Chinese Yuan is internationalized, if any. Foreign Central Banks are likely to re-balance their foreign exchange holdings of the Yuan, the buying of Yuan could drive Chinese Yuan higher, severely undercutting Chinese exports’ global competitiveness and raising import prices fueling domestic inflation, risking further erosion of domestic consumption demand. In a weak growth environment, that spells big trouble for China’s external competitiveness and the rest of the world of shrinking Chinese demand. China is by far Australia’s biggest trading partner. Investment banks warned of overly-inflated property bubble burst leaving worst damaging consequences than recession triggered by further fall in demand for Aussie commodities exports in the event of a Chinese hard landing. The Yuan’s exchange rate volatility will have major impact on Australian property investment. http://www.smh.com.au/business/the-economy/housing-bust-now-the-greatest-recession-risk-say-investment-banks-20151012-gk6pjz.html. Australia don’t want a hard landing of its economy accompanied by a hard landing in its property market as strong demand by cash-rich Chinese had been a big factor driving economic actvity as mining slowed. China’s economy is in a much weaker state than it publicly acknowledged officially. Adjusted for inflation-fueled stimulus spending impact on construction and consumption – which China cannot engage in these periodic timely fiscal stimulations to boost spending demand forever – the underlying real growth in Chinse GDP is probably closer to 3% or 4% at most.  Falling commodities prices cannot alone explain the entire decline in recent Chinese Yuan-denominated imports and despite almost uninterrupted falling producer’s price index (ex-factory prices) since 2012; Chinese exports have not soaring in tandem. That tells me that China’s transition from a heavily investment and export-driven dependency to a domestic consumption economy had been excruciating more difficult of balancing achievement than economic modelling and theorising had predicted. The takedown of this economic rebalancing can be seen in falling official GDP growth since the GFC. Overcapacity keeps reinforcing and further fiscal stimulus will only adds to this weight – all too apparent to global mining industry. In most recent times, we read of Glencore shutting  or reducing production  in South Africa, Peru, Kazakhstan, Peru, DRC following other big mines closures such as NMG’s huge Century zinc mine in Australia and Irelan’s Lisheen, owned by India’s Vedanta. For the first time in a decade, Chinese steel production has contracted.  http://www.reuters.com/article/2015/09/11/us-china-steel-ahome-idUSKCN0RB20I20150911  Industrial overcapacity is "the largest problem facing the Chinese economy now," according to Xu Shaoshi, chairman of powerful state planning body the National Development and Reform Commission.We see a persistent trend of negative Chinese PMI manufacturing statistics, punctuated by brief spikes, have worsen of late, and recently, this downtrend accelerating since the June stock market swoon.

THE LUNACY OF MERGERS & ACQUISITIONS – ASSETS FINANCIALISATION MANIA

Directly or indirectly, the developed economies consumed most of the world’s production of commodities. Plummeting prices across industrial metals, even foods, speak of soft demand in weak advanced economies. Consumer deleveraging is continuing, matched by even greater excess of corporate leveraging binge salivating on cheap money made readily available through successive quantitative easings in all major economies. We saw big mergers and acquisitions, perhaps a record in 2015, in value terms often cemented by paper valuation rather than the discipline of cash from past retained earnings – the eye is on burning redundant competition and squeezing efficiency to uplift profits in the face of stagnation of demand revenue flow. Carl Icahn pooh-poohed these mergers & acquisitions as “financial engineering at its height,” http://blogs.wsj.com/moneybeat/2015/09/29/carl-icahn-is-skeptical-of-the-ma-boom/ . These combinations create no wealth but ultimately destroy the acquiror’s balance sheet when the acqusition fails to deliver of expectations. In practical world, most acquisitions turn out to be costly failures. Clearly what is missing of this economic equation is one word – production and its lack stems from weak demand. In the next downturn, what would you be selling? An inflated asset valuation in circumstances of insolvency? Economists forgot this tragic fact – while the world’s Central Bank’s money printing have staunched losses in the financial sectors, they failed to achieve the final objective of creating credit to stimulate demand and re-ignite the global economic engine of recovery. Post GFC quantitative easings only inflates asset price, lower exchange rate in parts of global economy (and uneven), bails out banks, foster financial interest differential arbitrage of carrying trade and resolves no underlying overcapacity.

THE PSEUDO-GLOBAL ECONOMIC RECOVERY QUAGMIRE

Post-GFC of 2009, US’s real GDP growth was 2.2% at an annual rate, eurozone barely limping at half that rate at 1.2% annual growth and Japan’s start-stop economy hardly reaching 1%. – all sub-par recovery rates after a recession. Note that these dismal rates of growrh start from a low recessionary base and fertilized by unprecedented mountain of quantitative easing manure for all economies except in US where QE 3 ended in 2014.If the US economy is strong, how come the strongest listed entities are buying back their own shares instead of investing in new/growth businesses and also retrenching employees at the same time? http://www.marketwatch.com/story/companies-are-cutting-jobs-and-buying-back-stock-at-the-same-time-2015-10-02 There is practical no self-sustaining life in developed economies. China has failed to reverse or at least support from falling its own economic slowdown after 5 interest rate cut and repeated easing of its required reserve requirements since November 2014? http://www.bloomberg.com/news/articles/2015-10-02/oil-bulls-lose-faith-in-recovery-as-russia-adds-to-global-glut China is the main prop supporting emergent economies – now found itself sinking at a time when the rest of the world is trapped with  sinking commodities prices, currency depreciations and US$3 trillion of corporate credit crunch of “over borrowing” over a decade according to IMF study . http://www.telegraph.co.uk/finance/economics/11916485/3-trillion-corporate-credit-crunch-looms-as-debtors-face-day-of-reckoning.html  With interest rate rise looming, they are facing the prospect of another financial crisis not disimilar to the Asian currency crisis of 1997. In the event of mass defaults, global economic growth will be imperiled as no economy – be it China’s manufactured exports or developed economies will be spared of this mayhem. In the best of circumstances, the global economy is locked into a gear of modest to moderate growth. The Singapore Government Investment Corporation, in its 2015 Annual Report, warned of modest global growth and even negative return on some asset investments for the next 5 to 10 years. http://www.gic.com.sg/report/report-2014-2015/?confirmeng=1

Former Fed Chairman, Alan Greenspan warned in October 2014 that he does not believe the normalisation of interest rate to market conditions can be achieved without turmoil in the financial market, after years of extraordinary stimulus. http://www.bloomberg.com/news/articles/2014-10-29/greenspan-sees-turmoil-as-qe-boost-to-markets-unwinds. I agree with him. There will be economic tantrums in different parts of the global economy and Janet Yellen faced exactly that in September this year.

CHINA'S STOCK MARKET BUBBLE BURST – SIMMERING IMPACT

Few people would be aware of this Bloomberg news leak - Zhou Xiaochuan, governor of China’s central bank, said three times to a G-20 gathering that a bubble in his country had “burst,” Japanese Finance Minister Taro Aso said. http://www.bloomberg.com/news/articles/2015-09-04/china-s-zhou-kept-repeating-the-bubble-burst-at-g-20-meeting. This was before the US Fed reserve meeting of 16-17 September to decide on US interest rate. The PBOC, China’s Central Bank, came up with clarification that Zhou was referring to the Chinese stock market, not the economy. I believe the fate of the Chinese stock market is indeed hanged in suspended animation – the real blood will spill once all the restrictions on securities trading are lifted. It could be really ugly if global conditions spiral downwards – just like Malaysian stock market found post the 1997 Asian currency crisis. A lot of cash strapped entities disappeared from listing while others severely financially- impaired, unable to raise new capital in lost market confidence, were taken over in rescue restructuring. I will watch the Chinese banks closely.

A CNNMoney survey among economists has penciled a third-quarter GDP growth of 6.7% and for 2015 as a whole at 6.8%. http://money.cnn.com/2015/10/13/news/economy/china-economy-growth-survey/index.htm. Next year, the outlook is dimmer at 6.5%. Germany’s sputtering economy have just reported its August exports fell by 5.2% compared to July – its biggest monthly decline in 6 years and that was before the outbreak of Volkswagon debacle and much cheaper Euro notwithstanding. German economist identified soft emergent market, especially China – another sign of burst stock market bubble hurting Chinese domestic consumption. German manufacturing output and new industrial order also slowed in August. IMF forecast German economy to grow by 1.5%, slightly lower to Eurozone growth of 1.6% in 2015 – its growth momentum as an economic power house has evaporated.  China, like Japan in the 1980s, the exports-led high rate of savings has contributed to China’s real estate and stock market bubbles.  The Japanese economy suffered the wreckage of its real estate and stock market bubbles and unable to recover since by exporting its way out of malignancy. The Chinese stock market bubble burst leave it little option but also exports its way out of this guagmire and quicksand. The harder it struggles, the deeper it will sink in the quicksand faster and drowns Japan and the rest of the world – this is what I fear most. The signs are already there to see - China is Japan’s second-largest trade partner, accounting for 18.3% of exports in 2014, closely behind the U.S., at 18.6%. The volume of Japan’s exports to China fell 9.2% in August from a year earlier, and available indicators for July — industrial production and machinery orders — have also come in much weaker than expected. http://bruegel.org/2015/09/chinas-woes-could-derail-abenomics/. So who is lifting the world out of this sinking guagmire? Countries with big current account surplus, small budget surplus and price deflation – Japan, Germany and China could fit this descript. http://www.cnbc.com/2015/10/11/who-can-rev-up-the-world-economy-china-germany-or-japan.html  Germany is sputtering, drag by the rest of Eurozone and now its weakest link, Abenomics is falling apart at its core pilllars and China is riddled with stock market bubble burst and debilitating real estate bubble – no one can afford any more fiscal stimulus on the scale prevalent in the last GFC and since. The quarter just past was marked by the worst global equities performance in 4 years, notably Chinese stock market crash. http://business.financialpost.com/investing/global-investor/global-stocks-rally-on-final-day-of-worst-quarter-in-four-years My bet on the gambling table is a recession waiting in 2016 – coming out of China, this time.

NEGATIVE INTEREST RATE POLICY - PARASITIC SPECULATION, NOT PRODUCTION

And even if pessimism is overdone & China escapes the worst fate, its de-acceleration will be painful for the rest of global economy. Canada, Brazil, Argentina, South Africa, Australia are either in recession already or in feeblest growth rate since 2009. Post GFC, China is the main prop of global economic resilience for emergent economies and faltering.  Within sickly EU, Germany is sputtering. Abenomics is about the taste the best medicine of derailment and the US Fed fearful to even raise a modest token of its Fed fund rate –almost 6 years since the GFC.  What is scary is this – even the Fed is in quiet contemplation of delving into negative interest rate to fight any further downturn of the US economy. “Some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren’t as great as you anticipate,” said William Dudley, the president of the New York Fed chapter. http://www.marketwatch.com/story/fed-officials-seem-ready-to-deploy-negative-rates-in-next-crisis-2015-10-10. What a shocker of monetary devils residing inside the Fed. It is not the question of the costs – if at all clearly measurable in isolation but its ineffectiveness but leaving a continuing trail of future unknowns that all the quantitative easings already damaged the global economy structure. In Europe, the massive ECB bond buying of “whatever it takes” mantra has no impact on asset price, consumer spending ,  or business lending as EU banks continue shrinking,  economic resuscitation but adding to volatility in currency, bond, commodities and equities market.  The commonality of adversities includes growth in financialisation, parasitic speculation than production. Even former Fed Chairman, Ben Bernanke admitted as much – it wouldn’t be a panacea but a support to a weakened economy. The tantalizing prize – illusory as it may be – is that aggregate demand is no longer a scarcity. There will be no savers, more spenders.

BOND MARKET QUICKSAND

The biggest danger is that money flows away from negative yield investments into junk bond and highyield corporate bonds of equivalent junk bond grade. Added to that risk is the likely drag of downward pull of longer-dated 10-yr treasury bonds yield, fueling a bond market rally that is unsustainable. Retail investors don’t understand that bond investments are the trickest investment risks. http://www.neamb.com/finance/bonds-risky-investment.htm. The bond market is thin, institutions-dominated and Central Bankers the main sellers and buyers – everyone else is peripheral. Such financial instruments are illiquid, mispricing is dangerous because yields might spike when everyone rushes for the exit door in a panic when there is no buyer except Central Banks. We saw the bond market collapsed in May & June this year. http://business.financialpost.com/investing/why-no-one-should-be-surprised-by-the-bond-collapse-that-has-wiped-out-2015-gains. As one fund manager put it this way - “What we’re seeing is a repricing of the ultra-low interest rates to where they should be….the new normal is going to be price discovery — figuring out where bond yields are actually supposed to be, because at zero or even negative yields is obviously not right as the market has realized.” And the consequences of bond market collapse? Norway’s $900 billion sovereign wealth fund announced on April 29 that it would exit long-term euro bonds in its $328 billion bond fund. This was after it degraded its European bond exposure to 40% from 60% the preceding October. Obviously their clients demand higher rate of return than zero or worst still negative returns. In conditions of extreme volatility, which Central Bank will step in to buy?  What about those managed funds which face disgruntled retail investors seeking redemption in extreme market volatility in the bond market?  In those circumstances, fund managers sells equities – the era of cheap, even negative interest rate, is going to end up in a bubble burst crashing bang!
The easy money of falling interest rate to near zero on risks asset investment in equities and real estate is behind us, the page that is facing investors forward is fraught with sudden dangers of inmense severe impact. Quantitative easing has NOT worked for US, EU, Japan or China. Huge trillions were printed thrown at the economy and disappeared without a trace. Central bankers have lost control over monetary policy and fiscal stimulations have limited life-span of safety-net support as economies dip in rotation. In China, it simply adds to overcapacity way overloaded, exacerbates the crisis of economic instability and financial turbulence in rotation – transmitting from the equities to the bond, commodities and currency markets and recycling within this closed loop. Government bond rates are stubbornly low in the sea of deflationary pressures and credit spread, as a measure of default risk, is silently rising. Very few retail investors in the high-yield bond market understand the financial calculation involved in risks pricing implied of capital loss in the event of actual default.

Investors are aware of the extent of corporate/institutional debt leverage but not the earnings base to justify this risks escalation, notably in some sectors  like shale gas and  industrial metals which are the most economically sensitive to downturn. Corporate high yield bonds are really junk bonds. A 5% default rate implies investors expect to average a 5% loss of 5 cents in each dollar of principal invested. Adjusted for time value of money – if the 7-yr “risks free” US Treasury rate is 2% - the lenders (bond buyers) are assumed the risks that he/she is going to get a capital return equivalent to 70% of invested capital. That is to say, a 7-yr low quality high-yield bond offered by a corporate issuer at 7% return is NOT an attractive return at all for the investor. If the corporate bond offers at a higher rate than this – it means the risks of default and bankruptcy is much higher than 5% default risks.  Glencore corporate bond, otherwise is blue chip investment, is priced as junk bond grade risks pricing. How many of the shale gas entities in the US are staring at death now unable to generate cash flow to fund even on-going drilling/fracking operations, forget about interest and loan repayments? Banks in China exposed to overcapacity sectors are riddled with huge non-performing loans. Without the implicit but unsustainable guarantee of support against insolvency, how many of the behemoth Chinese State-owned enterprises riddled with over-capacity will survive the next downturn and credit life line from Chinese Government? In a slow-growth environment, you can’t grow earnings and financial reserves to pay off your ballooning debt. IMF warned of “sudden evaporation” of asset values in emergent economies, notably China where corporate debts borrowing including high-yielding (read junk) bonds far exceeded their market capitalisation. http://www.telegraph.co.uk/finance/economics/11898936/World-set-for-emerging-market-mass-default-warns-IMF.html  China’s 42.2 trillion yuan ($6.7 trillion) bond market was flashing red hot in August when its equity market crashed. Investors practically shifted from one bubble to another bubble even as corporate earnings shrinking. http://www.bloomberg.com/news/articles/2015-10-08/if-you-thought-china-s-equity-bubble-was-scary-check-out-bonds. Overall corporate debt as estimated by Commerzbank is 161% of its national GDP base in the first quarter of 2015. http://www.marketwatch.com/story/are-bonds-markets-telling-us-that-gloom-over-china-is-overdone-2015-10-12?page=2.  Interest rate cut is ineffective in lifting a debt-heavy Chinese economy.

Low interest rate and worst still, negative interest rate policy, pursued by central bankers, are toxic inducement of flawed economic policy. Because of excess supply and cheap availability, borrowers arbitrage for gains in sectors of easy over-supply to seeming escalating demand. Like power surges damaging electrical appliances, supply surges of money in oversupplied markets (the global iron & steel, oil and gas sectors for example in the fast receding commodities super-cycle) is dangerous. They kill the industry, kills the borrowers/investors, the economy and society.

THE WORLD OF PSEUDO-RECOVERY, DEBT TSUNAMI AND DEFLATION THREAT

The world is in that precarious brink now, can’t afford any misstep.  We are living in a new era of pseudo-recovery, swimming in a sea of debt tsunami, volatile bond/commodities market, inflated asset bubbles of equities and real estate, financial fragility in emerging economies and a real threat of deflation. Imprudent debt leveraging beyond financial affordability can take a lesson from this Fed’s instruct – “.It is appropriate for monetary policy to take a step back from the emergency measure of zero interest rates.” http://www.marketwatch.com/story/feds-mester-says-economy-can-handle-rate-hike-2015-10-15?link=MW_home_latest_news  Even the Fed Reserve Chief agrees the risks around China and global (read China) outlook is daunting – she said “The situation abroad bears close watching,”. Never before have the Fed mentioned of these heightened concerns of growth in China & frailty of emerging market economies its deliberations of interest rate policy. The Fed knows that China has been a major contributor of low-inflation global growth for nearly two decades – that is gone or will be gone soon.

China and/or the bond market are quicksands which can tip us over into a deep recession.  Beyond the temporary false prosperity boom fed by the steroid of quantitative easings globally which must end, what comes next behind these dark shadows?  

Zhen He