-- Posted Tuesday, 2 March 2004 | Digg This Article
The Daily Reckoning
London, England
Tuesday, 2 March 2004
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*** More about indeflation that you didn't particularly want to know...
*** Dr. Copper and Professor Bond...at odds...
*** Pssst...wanna lose some money? Outsource government! And more...
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Indeflation.
That is the word we have given to this curious creature in front of us. Neither inflation nor deflation...indeflation is a ghastly unnatural hybrid, with rising consumer prices (caused by a drop in the dollar, not by economic growth) in the middle of a long, drawn-out Japanese-style slump.
Presently copper and oil, for example, are going up - typically, signs of inflationary pressure. Copper is at an 8-year high. And gasoline rises about 3 cents every week. Copper is often referred to as "Dr. Copper...the metal with a Ph.D. in economics" because it is said to predict trends. When copper goes down, the economy follows. When it goes up...the economy soon gets "overheated," with rising consumer prices.
But the bond market is no dope either, and it continues to forecast (with low and falling yields) a sluggish economy with declining prices.
Who's right? Could it be they both are...or, that both are heralds of this new indeflation we're worrying about?
For several years now, we have noted the way in which the U.S. economy seemed to follow the Japanese model - with a 10-year lag. Asset prices rose on Wall Street throughout the '90s...and peaked in January or March of 2000....just as they had in Japan 10 years earlier. Even the 'recovery' that we see today still looks a lot like the 'recovery' in Japan in 1994...just before the stock market headed down again, and the nation slipped into deflation.
Of course, America isn't Japan - in one especially potent particular. Savings rates in Japan never fell below 10%. And, 10 years ago, Japan was still the world's biggest creditor. America enters its decline with savings rates near 1%...and as the world's biggest debtor.
For most economists, this nuance is not only telling, it is conclusive. Ben Bernanke and the Fed have already pledged to do what they have to do to save a nation of debtors from getting what they deserve. They've announced that they will inflate the nation's money supply as much as necessary to avoid Japan's 10-year-long deflationary slump. Almost everyone takes them at their word. Besides, America can't stand deflation, they point out.
But wanting isn't getting, we counter. Every debtor in America may crave inflation...but that doesn't mean they will have it.
The world is even stranger than it seems. What is said to guarantee inflation - America's lack of savings - may be what actually seals the deal for deflation...or this new indeflation we have been describing.
The Japanese did not have to borrow from abroad to fund their businesses, households or government. They 'owed it to themselves' and could simply hunker down - even for 10 years - until the mistakes were gradually written off and cast away.
But America depends on the kindness of strangers in order to pay for its War on Terror, its big screen TVs...even for drugs for its old people. The nation and its currency are vulnerable to foreign lenders in a way Japan never was. The dollar has lost 40% against the euro already. As kindness becomes more costly for them, you can expect even the nice Japanese and Chinese to turn away from it. There is no law that says the dollar has to fall further...but with an unresolved current account deficit of nearly 5% of GDP and the U.S. national debt rising by about $2 billion every business day...the dollar could still lose 50%...or more...of its value.
A falling dollar increases prices for imports - notably oil - and thereby increases Americans' cost of living. It has the probable additional consequence of destroying the U.S. economy...which lowers employment and many domestic prices...while collapsing stock and real estate markets. Indeflation, in other words.
Here's more news from our man on The Street:
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Eric Fry, musing in Manhattan...
- Mr. Market doesn't care what J.P. Morgan thinks...The prestigious Wall Street firm downgraded Intel shares to "neutral" from "overweight," as analyst Christopher Danely expressed concerns over subdued notebook PC demand and product delays. But the bellwether semiconductor stock soared anyway, leading the stock market to its biggest rally in two weeks.
- The Dow Jones Industrials Average climbed 94 points to 10,678, while the Nasdaq jumped 28 points to 2,058. The technology-laden Nasdaq had fallen 5.2% amid a six-week losing streak.
- We are, of course, sympathetic to the Morgan analyst's sense of value...or anti-value. But it's a fool's mission to try instructing Mr. Market about value; he simply doesn't care...and neither does the lumpeninvestoriat.
- "We assume investors will buy until it is patently clear that they shouldn't," says UBS equity strategist Gary Gordon. More likely, investors will buy until well beyond the moment that it is patently clear that they shouldn't...Isn't that what investors always do?
- Morgan's downgrade of Intel might have gained more traction, but for an upbeat report from the Semiconductor Industry Association yesterday morning. The SIA announced that worldwide sales of semiconductors rose 27.4% in January from a year earlier and are on track to grow more than 19 percent for 2004 as a whole. Upon hearing this wonderful news, the lumps couldn't restrain themselves; they simply had to buy Intel shares, no matter how much Christopher Danely disliked the stock. The Philadelphia Semiconductor Index (SOX) jumped 2% yesterday.
- Overvalued tech stocks are not the only things that Mr. Market doesn't care about. He also doesn't care about the inflationary auguries issuing from the commodity pits. Crude oil jumped 70 cents yesterday to a one-year high of $36.86. Meanwhile, metals of all sorts soared yesterday. Zinc jumped to a new three-year high, while platinum rocketed to a new 24-year high of $906.10.
- "Copper rose to an eight-year high on the London Metal Exchange," Bloomberg reports, "as inventories of the metal dwindle because of rising demand in the U.S. and China. Inventories in warehouses monitored by the LME, the Comex division of the New York Mercantile Exchange and the Shanghai Futures Exchange have fallen 22 percent this year to 634,615 metric tons." [Ed note: More on the commodity bull from Dr. Steve Sjuggerud, below. You can also learn the story behind China's insatiable appetite for commodities - and its inevitable consequences - here: http://www.agora-inc.com/reports/DRI/china312/ ]
- Gold tagged along with the other metals, gaining $2.80 to $399.60.
- Meanwhile, out on Main Street, folks continue to spend money they are not earning on things they are unlikely ever to use. Personal spending rose 0.4% in January, even though personal incomes increased only 0.2%. The January data continues the December trend, when personal spending climbed 0.5%, even though incomes increased only 0.3%.
- This sort of math can become very tricky after a while...so please don't try this at home.
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Bill Bonner, back in London:
*** Want to lose some money? Want to buy something goofy? How about a semiconductor stock? Fred Hickey, by way of Barron's, reports that the industry has shown negative growth for the past three years...and only 1% annual growth over the past 8. Doesn't sound like a "growth" industry to us. Still, you can buy a share of Applied Materials, for example, at 42 times earnings, nearly 3 times its 10-year average. Or how about KLA Tencor? Act today, and you can still get it at 50 times earnings...twice its 10-year average. Xilinx goes for 53 times earnings.
Better yet, sell them.
*** We're delighted by the public debate on outsourcing. We've seen two points of view: 1) that America has to take action to protect its jobs...and 2) that nothing needs to be done; who wants those 'low prestige industrial jobs' anyway. It's like a presidential debate...a battle of wits between completely unarmed opponents...in which our fondest hope is that they will both lose. For both points of view are as empty-headed as the people putting them forward.
In the last 2 centuries, American and European workers have earned much more than, say, Indian or Chinese workers only because they have had access to more capital - physical, intellectual, and social. They had better machines to work with...knew how to use them...and lived in societies that valued and protected modern economies. But now, Chinese and Indians are getting more advanced technical degrees than Americans. They are building more modern factories. And while Americans take turns greeting each other at Wal-Mart, these foreigners are developing the skills and habits needed to operate in an extremely competitive world.
Relative to the rest of the world, American and European wage levels are destined to go down. The only way to keep them up would be to do the very thing Americans seem incapable of doing - saving money, and investing it in ever more modern factories...and more training for workers. It would mean a major reduction in current living standards...in order to protect those of the future.
*** Among the jobs that could easily be outsourced to India are those in government. Most government jobs are useless 'paper pushing' anyway. And no group of people pushes paper more uselessly than Indians. The Indian bureaucracy is famous world over for not doing anything...slowly...and at great expense.
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The Daily Reckoning PRESENTS: The ghastly beast called indeflation has peculiar tastes...but seems to have a developed an appetite for commodities. Dr. Steve Sjuggerud lays bare another force behind the bull market in raw materials, below...
END OF THE 100-YEAR BEAR MARKET By Steve Sjuggerud
"To accommodate the roughly 20 million people per year migrating to the cities, the Chinese, in effect, have to build a Houston, Texas, per month..."
- Ed Yardeni of Prudential, 1/21/04
John Neu's trash has made him incredibly rich. He sold 2 million tons of it to China last year...
Just beyond the Statue of Liberty, in Jersey City, he's collecting old toasters, bed springs, old cars, you name it. "Everything including the kitchen sink," he jokes. Well not everything, exactly...but everything that's metal.
Neu, it turns out, was the major processor of mangled steel from the World Trade Center. It was 300,000 tons...which he shipped around the world. More than a third of Neu's scrap metal is sent to China...up from none five years ago.
Initially, China didn't want America's scrap. But China's economy is growing so extraordinarily fast, it'll take it from where it can get it. China has made John Neu a happy man...when China joined the WTO at the end of 2001, a gross ton of scrap steel cost $57. The price more than doubled to $127 by the end of 2003. A few weeks ago it had soared to $150.
In the grand scheme of things, John Neu's 2 million tons of steel scrap is small potatoes. China's appetite for steel right now is insatiable. China needs steel. And it needs other commodities, too.
Quite frankly, I think commodities will turn out to be a fantastic place to invest for the rest of this decade. Returns in commodities should easily beat stocks and bonds for the next five years. It happened in the 1970s, as the table below shows, and it'll happen again...
Commodities Crush Stocks Annual % Gain, 1970-1980
Asset Annual Gain Oil 34.7% Gold 31.6% U.S. coins 27.7% Silver 23.7% U.S. farmland 14% Housing 10.2% Inflation (CPI) 7.7% Stock prices 3.6%
What I like even more about commodities is that nobody is interested in commodities...yet. Go to MSN's MoneyCentral, or Yahoo's Finance page, and try to get a quote on gold or oil, and you'll see what I mean. Nobody cares yet. Nobody has commodities as part of their portfolio asset allocation yet...and I love it! As Jim Rogers said in his book Adventure Capitalist, "when Merrill Lynch starts trading commodities again, it's time to get out."
After bottoming in late 2001, commodity prices (as measured by the CRB Index) have soared by 40%. But don't feel like you've missed the move in commodity prices...long-term, commodities are the cheapest they've been in 100 years.
Right now, you've got two camps of investors out there when it comes to commodities...those that don't want to buy because commodity prices have fallen for 24 years, and those who don't want to buy because commodity prices have risen 40% in the last two. Now where's the camp that's willing to buy? There really isn't one, yet.
What happens when commodity prices fall this dramatically over such a period of time is predictable, says commodity trading advisor John Di Tomasso:
"Mines are closed, exploration budgets are slashed, and new production is discouraged. In a free market economy production without profit cannot continue indefinitely. At some stage prices must rise...otherwise overall production of these raw materials will shrink, causing prices to ultimately rise, anyway - Adam Smith's 'invisible hand' restoring equilibrium to the marketplace."
Demand has arrived, but there's not enough supply. It's a perfect recipe for higher commodity prices in the coming years, until the production can match the demand.
And where has this demand come from? The answer, as John Neu discovered while hawking his trash, is simple: China.
China is THE hot topic, again...just as it was 10 years ago. Same story, almost exactly. Investors are just throwing their money at China once again, and many of them have no idea what they're buying.
To give you an idea, there are four Chinese "dot-coms" trading on the Nasdaq with over a billion dollars in market value each. Added up, these four companies have a market value of about $6 billion dollars, on combined total sales of $300 million. That means that these four companies as a group are trading for nearly 20 times SALES...not 20 times earnings...20 times sales. As a point of reference, even wildly overvalued Microsoft trades at only 8 times sales. So these companies are almost three times as expensive as Microsoft. Does that make any sense? To me it doesn't.
The latest big IPO of a Chinese company on the New York Stock Exchange was China Life. A Chinese insurance company. Talk about a dumb investment. The Chinese financial sector is known to be corrupt and dysfunctional. I laughed out loud when, three months after the IPO, China Life's parent company was caught in a $650 million accounting fraud.
The worst part is, the U.S. investment banks can't tell you how dumb an investment China Life (or the upcoming Chinese banks) will likely be...because they're busy wooing them for investment banking business.
I feel like I saw this movie in 1994, and I know how it ends. Five years from now, investors will probably want nothing to do with Chinese investments, once again. But that's February 2009...a long way from today. For now, the best course of action might be to follow George Soros's advice...
I'm taking a unique approach to China. I'm recognizing the trend "whose premise is false," as Soros said. And I'm going to ride that trend until it is discredited.
For the moment, China is booming. And China's appetite for raw materials and commodities (such as steel, copper, and oil) appears insatiable. But I won't bite on the direct China plays like the ones above, many of which will eventually disappear.
Instead, I'm playing the China story through commodities. When China's bust comes again (and that may not be until the second half of this decade), chances are that commodities won't be hurt badly. They'll participate handsomely in China on the way up, and be just fine on the way down, producing exceptional returns in the process.
Regards,
Steve Sjuggerud, for the Daily Reckoning
Editor's note: Dr. Steve Sjuggerud has worked in the investment world as a stockbroker, the vice president of a $50 million global mutual fund, an international hedge fund manager, and the director of several research departments. An international currency expert, he is also a member of the Oxford Club advisory panel.
In the March issue of True Wealth, his monthly investment advisory, Dr. Sjuggerud further explores the commodities bull market with an eye to China...and exposes a promising company that will be a key outside provider of the exact raw materials China needs. Out of respect for paying subscribers, we can't divulge the name here...but you can learn more by signing up for:
True Wealth http://www.agora-inc.com/reports/TRW/WTRWDC17/
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-- Posted Tuesday, 2 March 2004 | Digg This Article
