Key News



The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings.

—Julius Caesar (I, ii, 140-141)


Do stocks and currencies lead commodities? We think stocks are the best discounting mechanism we have. We think sooner or later the fundamentals of supply and demand are factored into prices. If that is true, then fundamentals, judged with the gift of hindsight, are the final arbiter of financial market over- or undershoot i.e. markets valued well above or below their perceived fundamental value. The problem of course is, using commodities (which give some semblance of real demand and not just expectation) is no panacea, as speculation premium or discount resides there as well.

So what are we left with? We are left with watching key intermarket relationships to see if moves in one market are being validated by moves in another. Yet who leads and who follows isn't something we can predict. We can only see divergences on occasion that may reflect that expectations in financial markets are running ahead of what is happening in the real economy. And maybe the chart we show below displays that…maybe! Before you peek at the chart, consider some recent information…

From the FT today:

“WTI [West Texas Intemediate] has been trading at a discount to Brent for much of July, reflecting weak US demand conditions, which were a feature again in US inventories data, released on Wednesday. Eugen Weinberg at Commerzbank noted that declining crude oil consumption was not limited to the US economy.

“'Crude oil imports in Japan, the third largest oil consumer worldwide, plummeted by 19 per cent year-on-year in June to the lowest level in 18 years,” said Mr Weinberg: “To date, only China has seen a noticeable recovery in oil demand. This underlines our sceptical view on the current level of oil prices.” “US inventories data, released on Wednesday showed crude stocks fell 1.8m barrels last week, below the consensus forecast for a decline of 2.1m barrels. Much of the decline was due to a fall in imports as refineries' demand for crude remained subdued, due to weak profit margins and poor demand from end users. Refinery utilisation fell 2.1 percentage points to 85.8 per cent, a bigger-than-expected drop.”

Speaking of China, the word malinvestment of the Austrian School variety  comes rushing to mind. We think malinvestment is pervasive in many industries in China; we know malinvestment is pervasive in Chinese real estate. The comments below are those of a fund manager examining some properties in China, they were posted on the blog of Professor Michael Pettis--a man who consistently provides some brilliant insight on the happenings within China: [our emphasis]:

“I don't know how much you travel around China. Tom and I do a fair bit, and most recently we were in Guiyang. I thought I'd seen insane excess in the past – 200 thousand square meter malls completely empty next to apartment complexes with 40 thousand units and 30% occupancy rates, etc. etc. But what we saw over there is rather hard to fathom. It seems the Guiyang city mayor had the same idea as the Shenzhen mayor – to move the old downtown to a piece of undeveloped land.

“Of course Guiyang has a quarter the population and probably a quarter the per capita income of Shenzhen. They built sprawling new government buildings about a 20-minute drive north of town. And then the residential high rise projects started going up. From driving around the area, Tom and I figured well over 100 20+ storey buildings.

“What was most distressing was that the development has been totally uncoordinated – a project with 15 buildings here, in another field two miles away a project with one building, another mile in another direction three buildings, sprawled over what was easily over 30 square kms. of farmland well north of town. Every building we got close enough to see was either incomplete/under construction, or empty. Our tone gradually went from ‘aha, another one!' to ‘Oh my God, another one.' We conservatively guesstimated that we saw US$10bn of NPLs in one afternoon. The only buildings that were occupied were six-storey towers built to accommodate the peasants who had been displaced by the construction.”

From FT – Lex Today:

The widening valuation gulf between Asian and western stocks has investors nervously eyeing the exits. Asia's forward price/earnings ratio, at 23 times, is teetering some 30 per cent above its three-year average; the US and Europe, at 16 and 13 times, are 7 and 11 per cent above trend, respectively. The spread between eastern and western p/es has averaged 4.5 during that period; now it is 8.6.

Are trailing oil prices reflecting a major disconnect? The glass half-full crowd says no. They are of the opinion oil will surge to reflect an improving global economy. The glass-half-empty crowd, the camp where my allegiance lies for now, says risk appetite assets are ahead of themselves and crude demand is telling the story. So, step right up and place your bet. After all, that's why they call them markets.