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Good Morning,
The new week got off to a 'stimulating' start in the commodities markets, following China's weekend announcement of a massive spending plan aimed at getting its (and, indeed, the world) economy back on track. While much of that track had been laid on loose speculative gravel and contained many a worn-out section, the alternative of heading into the dark tunnel of depression was not seen as palatable in Beijing. We are talking about the largest contributor to global growth here.
China's leaders saw the global economic wrecking ball swinging in their direction and decided to duck it with a nice, fat wad of bills at the ready. The action plan looks set to make for a red-carpet arrival by China at the upcoming G-20 Summit in DC, as it can loosely be translated as: "We recognize the global-scale of the problem and are doing something about it while also helping ourselves." The question remains whether the trillions of yuan to be spent will suffice to cushion or stop the contraction that is already well underway in China and elsewhere.
New York precious metals markets opened with solid gains this morning, as players read the Chinese tea leaves and felt good about demand prospects from a once-again vigorous economy. While it is important to keep in mind that the 4 trillion yuan will all not be doled out this week, or this month, the sector can use a stimulus of its own after an October slump of epic proportions. This is now a case of buy the rumour, buy the news, and buy future headlines as well. Just buy. Gold remains within the recently established range and still requires a break above $780 to stimulate more bulls into action.
Gold spot prices rose $22 on the open, quoted at $756 as the outlook for commodities brightened enough to yield a $3.33 pop in crude oil (to $64.37) and gains in industrial metals as well. Silver climbed 45 cents to $10.42 per ounce, while platinum rose $28 to $872 and palladium added $5 to $226 per ounce. The dollar fell 0.42 to 85.19 on the index and stock futures showed plenty of stimulated bulls ready to break through the gates this morning. Too early to categorize this whole thing in the "Band-Aid" or "Panacea" bins, but it is news good enough to partially drown out the continuing debacles at AIG, Nortel, GM, Allianz, and the Chapter 11 filing by Circuit City - finally blowing its fuse after weeks and months of agony.
Let's take a closer look at the Chinese plan via Xinhua, and see whether Confucius would agree that "Wise man stimulates the economy with mountains of cash when the leaves fall in autumn"
"China's government announced a two-year stimulus exceeding a half-trillion dollars to offset the impact of slowing global growth and unlock the spending power of its vast population. Premier Wen Jiabao's cabinet set plans for 4 trillion yuan, or $586 billion, in spending and stimulus measures through the end of 2010 aimed specifically to target people's livelihood, the official Xinhua News Agency said Sunday night.
It was unclear how much the plan, which will target 10 areas from rural infrastructure to low-cost housing, represents new spending and how quickly it can stimulate domestic demand. The government also will adopt an "active" fiscal policy -- meaning it will spend money and cut taxes -- while the central bank will set a "moderately easy" tone that appears to signal further interest rate cuts and efforts to make banks boost lending, Xinhua said. China's economy grew at the slowest rate in five years in the third quarter, slipping to 9% from the year before. China has joined international calls to address faltering global business and consumer confidence, announcing plans that President Hu Jintao will visit Washington this week to meet other world leaders, including U.S. President-elect Barack Obama.
Economists say that while China remains a hopeful source of global growth, its momentum is pulling back more quickly than anticipated. Property prices are under downward pressure, factories are closing as export orders dry up and foreign direct investment is being called into doubt. As demand in its major export markets falls, many agree on the need to stimulate spending by China's consumers, unlocking their $4 trillion in savings. A particular concern are the hundreds of millions of people in China's countryside, where the government appears particularly determined to boost spending power and has, for instance, already lifted grain purchase prices.
In Sunday's statement, the government said that among its earmarks will be money for transportation networks, ecology, technical innovation and post-disaster reconstruction. Few specific details on the spending plans were immediately announced. Other measures include a restructuring of value-added taxes that Xinhua said will reduce business taxes by 120 billion yuan annually. The government will also look for banks to boost lending, removing a government-set lending ceiling and encouraging them to offer credit to smaller businesses, rural borrowers, technical innovators and buyout-oriented firms.
Bold action from Beijing isn't unexpected. The government has in recent months reversed course by slashing interest rates, pouring money into ailing stocks, giving developers leeway to build. What had been missing in Beijing's aggressive policy mix so far, according to a report last week by JP Morgan, was a "big announcement."
Many economists have been looking for Beijing to unveil a big stimulus package similar to the one it relied on during the Asian Financial Crisis more than a decade ago. Then, Beijing issued massive amounts of domestic bonds to pay to extend highways, repair airports and build ports, a program that was deemed a strong success. Just a year ago, China had adopted an unprecedented "tight" monetary policy, a step up in its three-year effort to keep the fast-growing economy from barreling out of control because it was expanding too quickly."
Hopefully, the measures will have their intended effects. Why are commodity (and gold) speculators so eager for this to succeed? Read what Avner Mandelman had to say in his recent Globe and Mail article, for a clue (thank you to Mr. R.K. - a loyal reader- for sending us the link):
"A few months ago, amidst comfy consensus that China's prospects are rosy, this column noted that the country is really a bubble. This contrary opinion generated much e-mail flack. But then, an e-mail arrived from a Canadian engineer in China whose team had just finished a government project in a town so small that (in the guy's words), "dogs were chasing chickens down the street."
Despite the town's size, it sported dozens of condo towers and a posh hotel. And so, to celebrate the completion of the project, the Canadians went to dinner at the hotel's restaurant with the local bigwig (the son of an army general), who, by the way, also owned the hotel and condos.
They were the only diners present - the hotel was empty and dark, the condos emptier and darker. But there were lots of staff members, and during dinner the bigwig kept complaining that the Beijing bank that lent him the construction money was suddenly demanding interest. The cheek! How could one keep restive peasants employed if one had to pay interest?
My e-mailer noted wryly that all over China there are many such empty hotels and condos - and factories too - built with loans to the well-connected and intended to maintain employment, but also (allegedly) to allow loyal bigwigs to enrich themselves.
The economic value of such enterprises is, of course, zip, yet the "loans" are carried on the books of Chinese banks as good ones - just like U.S. mortgages to shirtless Joes and Janes were carried on Freddie Mac's and Fannie Mae's books before the mortgage corporations blew up. And, yes, just like loans to Sony or Sumitomo were carried by Japanese banks in the 1990s before the Japanese economy blew up.
And, similarly again, just as everyone in Congress knew that Freddie and Fannie would soon come to grief - or just as everyone in Japan in the '90s knew that most corporate loans were unpayable - the same is known in today's China. Yet most China bulls in the West maintain that the country's growth has merely slowed temporarily and will soon resume.
Will it? Not according to my informants. China, they insist, is like Japan of the '90s times three; it is Nortel writ large, maybe even Russia before the 1988 upheaval. You think this is extreme? Think again. Just last week Chinese Premier Wen Jiabao finally admitted that slow growth could risk "social stability." Slow growth? How about no growth? Or even negative growth? It's coming, and here's why.
You see, China, like Nortel and Japan and Soviet Russia, has been selling most things below true cost - which is the direct cost of production plus the cost of capital - and thus lost money on much of what it produced, and so destroyed much of its capital. A company that does so must eventually lay off workers and go bust. China, in my opinion, now faces similar risks, which Mr. Wen finally admitted.
Why does China sell below true cost? Because it is a dictatorship that wants to keep its restive people employed, and so, like (democratic) Japan before it, it keeps throwing good savings at bogus products. I say bogus because if you sell below true cost you create fictitious demand that otherwise wouldn't be there had the product been priced realistically. Thus the large factory you built to satisfy the goosed-up demand cannot be rebuilt once it wears out because you didn't include depreciation in the product's price.
Say you charged a mere $5 for a bottle of a 30-year-old Mouton Cadet because that's the cost of the corkers' wage, the bottle's glass, the unfermented grape juices and the paper label, and charged nothing for the 30 years of fermentation in an air-conditioned cellar. You would, of course, sell a large number of $5 Moutons, but would go bust once you had to rebuild the cellar.
Just like Japan did when it sold transistors for pennies when they really cost dollars if Japan had included the cost of capital; or just like Nortel a few years ago, when it sold products obtained (or improved) through acquisitions, for prices that excluded the amortized cost of the acquisition, in effect treating capital as having little or no cost; and just like China today, which sells nearly everything at the "China Price" - the cost of labour plus (alleged) pay-offs to, for example, generals' sons - while ignoring most capital costs because many loans do not have to be repaid. That's why much of China's manufacturing sector, although impressive to look at, is uneconomical, having been built to produce stuff that, were it priced to include the full cost of capital, might not have sold at all. For a while it worked - just like dot-coms or Japan or Russia - but now the party is over and China is about to meet the fate of all those who sell below true cost: mass layoffs, upheaval and perhaps a change of management.
Why should you care? Because of gold.
Recently gold has been very volatile, and could tack on $50, or even $100, in the short term. But longer term, if inflation - already quashed by Freddie and Fannie's blow-up - is further squashed by China's punctured bubble, gold is likely heading down.
Why? First, low inflation, even deflation, will lessen the need for inflation hedges. But second, and more crucial, as the West buys less of China's more fully priced products, and as China's cash needs escalate, its government, to feed the peasants and to maintain its power, will sell state assets - including gold. This, plus inflation, could push gold much lower than anyone thinks, perhaps to half its current price. How's that for a real contrary opinion?
As we have previously observed, there is no shortage of opinions when it comes to the hotly debated topic of China and its role in international markets and economics. For now, we will keep an eye on hairy crab sales in Chinese restaurants as a sign of returning confidence and (risk) appetite among local diners.
Happy Stimuli,
Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal
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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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