Tuesday, 8 September 2009

Bad moon rising

John Mangun
Outside the Box
Business Mirror

In 1969 John Fogerty wrote the following lyrics:

“I see the bad moon arising.

I see trouble on the way.

Looks like we’re in for nasty weather.

I see bad times today.”

I feel exactly the same way. Over the last two months, and, in particular, during the last two weeks, the situation seems to be tipping in the USA that forecasts major problems ahead.

An amazing announcement came out of China on August 29 that the Chinese state-owned enterprises, or SOEs, “may unilaterally terminate derivative contracts with six foreign banks.” The subprime-lending crisis in 2008 was, in part, based on the fact that many of these bad loans were packaged into derivative contracts. These contracts are highly leveraged and highly speculative instruments that allow the buyer to “bet” on the value movement of the underlying assets, be it a loan, commodity price, or a stock.

The major banks put these contracts together to encourage speculation and when the subprime loans collapsed, the buyers of these contracts saw the value go to nothing. In order to save the banks from these defaulted contracts, the US government spent billions bailing the banks out, creating even more global financial problems.

The subprime crisis has passed, but the derivatives mess is still with us. The Chinese SOEs were sold these dangerously speculative contracts by the banks, appealing to their greed, as prices of commodities like oil, coal, metals, jumped, especially in the first quarter of 2009. Many of these contracts are now in losing positions, and the Chinese government is saying it has no intention of honoring the losses by the SOEs, leaving the foreign banks holding a very large bag of losing positions.

If, or perhaps when, the Chinese SOEs default on the derivative contracts, it may be necessary for another very large bank bailout as it is likely that Russia, India and Brazil (the BRIC nations) will follow suit. And if there is another government bailout...,which brings us to the next point.

Gold attempted another breakthrough, the third this year, of the crucial $1,000-per-ounce level. Conventional thinking might say that there is no reason gold should reach historic highs, as inflation is not currently a factor. Not true.

Gold has never been a hedge against inflation, except in the sense that inflation is usually a function of bad government-money policy. The price of gold is a reflection of the trust and confidence in a government, as that confidence relates to economic policy and, more specifically, the value of the currency. As gold is priced in US dollars, the price of gold is directly influenced by the confidence in the US government economic polices. And what the current price of gold is telling us is that confidence is falling rapidly, forecasting a much weaker US dollar.

The data coming from the United States are terrible. Unemployment continues to rise and the prices of goods are falling. Manufacturers are still producing, albeit at a historic low level, and cannot find buyers for their goods, hence they are dropping prices. But increasing fear of more unemployment is keeping the consumers’ wallets tightly closed. The government has pumped billions into the system, but it is not stimulating anything but speculation in stocks and commodities. If you can borrow money for almost zero interest, why not borrow to speculate. But speculation does not grow the economy. Further, these low interest rates discourage foreign companies and governments from buying US government debt.

At some point, the US Federal Reserve is going to have to raise interest rates as they will run out of money because no one will loan to them. This will further hamper any economic recovery.

An important offshoot of the bad US economy is that oil supplies continue to increase, while demand continues to decrease. Oil, now at $67 a barrel, is at least $10 overpriced due to cheap money, fueling commodity price speculation as potentially with others like copper and certain agriculturals like cocoa and soybeans.

The next six months forecast a much weaker dollar, high gold prices as confidence erodes further, and the likelihood of falling commodity prices

What does all this mean to countries like the Philippines? If borrowed money is cheap and the dollar is going to fall, then the best strategy is to borrow in dollars and then convert to another currency. So then where to invest?

China is a question mark right now. Last week that stock market took a large hit when it was announced that the government was going to reduce bank lending. If the Chinese government is going to reduce domestic spending, there may be a pause in international placements there. Brazil, India and Russia have economic problems of their own that may create more investor caution with India, with its falling exports, and Russia, with the potential of falling oil prices. Brazil is the exception with a very strong recovery there, because the nation is not dependant on exports to the United States and Europe. However, Brazil is still facing negative growth in 2009 and is dependant on strong commodity prices, which may falter.

Countries like the Philippines with real economic growth, a currency poised to appreciate as the dollar drops in value, and steady domestic-fueled growth stand to attract cheap Western capital. With interest rates higher here than in the West, even conservative, guaranteed investments like Philippine government debt is looking very attractive.

The bad moon is not rising over this nation.



PSE stock-market information and technical-analysis tools were provided by CitisecOnline.com Inc. E-mail comments to mangun@email.com.

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