Research Watch

PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.

In a previous edition of Research Watch we gave the case for oil against the case for gold, which looks to be forming into something of a yellow-coloured bubble. Still, the argument for “peak gold” – or a permanent supply/demand imbalance – is compelling and proposing that thesis is commodity website The Oil Drum. Meanwhile, Stephen Green from Standard Chartered interrogates the disconnect between China's rising car demand and flat-lining oil sales. Indeed, The Telegraph's Ambrose Evans-Pritchard argues, there also appears to be a very wide disconnect between China's infrastructure supply and its underlying economy. In fact, this week's video sums up that argument as well. The last time we featured Evans-Pritchard he was giving a very bearish prognosis on Japan's economy. This week, it is currency and credit default swap traders who are shorting the Yen. But as for the super bears, this week we start with Berkeley economics professor Brad De Long, who sees further trouble ahead for the US.

The chances of a US crisis increase and the White House will have little recourse to action '¦ For [two-and-a-quarter] years now I have been saying that there is no chance of a repeat of the Great Depression or anything like it – that we know what to do and how to do it, and will do it if things turn south. [But] I don't think I can say that any more. In my estimation, the chances of another big downward shock to the US economy – a shock that would carry us from the one-third-of-a-Great-Depression we have now to two-thirds or more – are about 5%. And it now looks very much as if such a shock hits, the US government will be unable to do a damn thing about it. We could cushion the impact of another big downward shock by a lot more deficit spending – unemployment, after all, goes down whenever anybody spends more (even though sometimes falling unemployment comes at too-high a price in rising inflation), and the government's money is as good as anybody else's. But the centrist Democratic legislative caucus has now dug in its heels behind the position that we cannot undertake more deficit spending right now because we have a dire structural healthcare financing problem after 2030 '¦ We could cushion the impact of another big downward shock by recapitalising the banks again. But the failure of the Fed and the Treasury in the aftermath of Lehman to grab a share of the upside from its capital injection and purchase operations for the public in the form of warrants means that there is no coalition anywhere for a repeat or anything like a repeat of propping-up the banking system: the right thinks it is an unwarranted intervention in the free market, the left thinks that it is a giveaway to the undeserving and feckless super-rich '¦ and the optics are terrible. So if another big bad shock hits the US economy, what could the Obama administration possibly do? (Brad De Long, University of California, Berkeley, November 17)

Watch out Japan, your economy is really set to tank '¦ “The yen is poised for its worst tumble since 2005 as doubts about Japan’s fiscal footing double the cost of insuring its debt. The price of hedging against losses on $US10 million of the country’s bonds with credit-default swaps soared this month to as much as $US76,160 a year from $US37,000 in August, as the new government planned record spending and borrowing, even with tax revenue falling. The rise in debt protection costs contrasts with that of the US, where prices have fallen to about the lowest in a year amid unprecedented issuance '¦ 'The Japanese fiscal situation is horrific,' said Richard Benson, who helps oversee $US11 billion of currency funds at Millennium Global Asset Management in London. 'We went short the yen against the dollar and the euro about a month ago' and then turned 'more aggressive' on the trade as credit-default swaps rose and investors dumped Japanese bonds, he said, declining to specify the firm’s gains. Selling yen for euros and dollars would have returned as much as 4.3% since October 1 '¦ Japan’s unprecedented debt, near-zero benchmark interest rate, ballooning budget deficit, sinking savings rate and worst postwar recession all are aligned against the yen '¦ The Bank of Japan will stand alone in keeping borrowing costs at near-record lows next year to revive the Group of 10’s fastest-shrinking economy, making its assets less attractive to investors '¦ predictions show. The world’s second-biggest economy last year, at $US4.9 trillion, will contract 5.7% in 2009, compared with an average of 2.5% for the nine other largest economies, according to median forecasts '¦ The yen has outperformed all 171 other currencies tracked by Bloomberg over the past two years, appreciating 24% to 89.45 per dollar today '¦ Now, 34 of 38 strategists in a Bloomberg survey see it falling by June 2010, including Landesbank Baden-Wuerttemberg, the most accurate of 46 forecasters in the six quarters ending June 30 '¦ The Stuttgart-based bank predicts a 9.9% decline to 100 from 90.09 at the end of October, which would be the steepest eight-month drop in four years '¦ Option traders are the least bullish on the yen since July 2007 after the spread between demand for three-month contracts to buy and sell the currency narrowed by the most ever in the past year, so-called risk-reversal rates show '¦ The yen’s value 'is not consistent with the underlying fundamentals' '¦ said Michael Hasenstab, who oversees $US45 billion in fixed-income assets for Franklin Templeton Investments '¦ 'The yen is very vulnerable'.” (Bloomberg, November 16)

And watch out China, infrastructure and capacity don't equal demand '¦ "China has now become the biggest risk to the world economy '¦ Far from taking over as the engine of growth from an exhausted West, China is making matters worse. Its 'beggar-thy-neighbour' policies continue to play havoc with global trade and risk tipping the world into a second leg of the Great Recession '¦ 'China is still exporting overcapacity to the rest of us on a grand scale, with deflationary consequences. While some fret about liquidity-driven inflation, Justin Lin, the World Bank’s chief economist, said the greater danger is that record levels of idle plant almost everywhere will feed a downward spiral of job cuts and corporate busts. 'I'm more worried about deflation,' he said '¦ The reality is that much of Beijing's $US600 billion stimulus has been spent building yet more plant and infrastructure so that China can ship yet more goods, or has leaked into property and stocks. Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd. China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53% this year. Once you know that Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again, or that the newly built city of Ordos is sitting empty in Inner Mongolia, you know what must come next [see Video of the Week] '¦ The world economy is still skating on thin ice. The West is sated with debt, the East with plant. The crisis has been contained (or masked) by zero rates and a fiscal blast, trashing sovereign balance sheets. But the core problem remains. The Anglo-sphere and Club Med are tightening belts, yet Asia is not adding enough demand to compensate. It is adding supply.”(Ambrose Evans-Pritchard, Daily Telegraph, London, November 15)

Car sales and fuel consumption don’t compute '¦ “Car sales in China are booming, but gasoline consumption seems to be stuck in the slow lane '¦ Sceptics point to this odd turn of events as evidence that cars are being bought en masse by state firms and government departments and then simply left to rust. Such behaviour, they argue, is driven by a desire to save local car firms and keep the economy going '¦ People are buying smaller, more fuel-efficient cars and retiring bigger, less fuel-efficient cars. Cars with engines of under 1.6 litres have enjoyed the fastest sales growth of all categories in 2009, helped by tax breaks for small cars '¦ As we noted above, other vehicles use gasoline too, including small trucks. As a result, the slowdown in freight traffic in the first half of 2009 probably affected their demand for fuel '¦ Some 40% of total gasoline consumed in China goes into industry, so the sharp slowdown in industrial activity since the fourth quarter of 2008 has probably had a big effect on gasoline demand. However, this should not have affected gasoline sales at the pump much '¦ People are travelling less, perhaps as a result of slower income growth '¦ Slower income growth this year also probably means that people are driving their cars less. Last week in Beijing, the author passed dozens of cabs parked late at night in a Beijing suburb. A taxi driver explained that the drivers park there and take a bus home because of the 'high cost of gasoline’.”

(Stephen Green, Standard Chartered,via FT Alphaville, November 16)

Are we beginning to see 'peak gold'? '¦ "Yesterday the President of the largest gold mining and production company, Barrick Gold, noted that after 10 years of declining production it is time to recognise that the world has seen the peak in gold production. To maintain production, ore is being mined with increasingly less gold in it '¦ 'Ore grades have fallen from around 12 grams per tonne in 1950 to nearer 3 grams in the US, Canada, and Australia. South Africa's output has halved since peaking in 1970.' [he said] The supply crunch has helped push gold to an all-time high, reaching $US1118 an ounce at one stage yesterday '¦ As with peak oil, the fact that global production has peaked does not mean that there is no gold left to mine. Rather, it means that less gold will be mined each year into the future. It will likely, in time, bring back into debate the environmental costs of mining '¦ Gold has been a valuable mineral for a long time and for nations all around the world. All the good and easy places to find it, therefore, have been sought after and largely found. The gold deposits that are worked have become smaller, of lower value and found in places that are harder to get to '¦ Mines in South Africa and in South Dakota have been worked down to more than two miles (3.2km) below the surface, to recover the ore '¦ [Yet] Gold production in South Africa had fallen 9.3% year-on-year last September; this in the country that once led the world in gold production '¦ [And] production will continue to fall as the reserves become even harder to extract. Beyond a certain point there is not a lot that technology can do, except perhaps to find ways of getting gold out of veins that are too small and costly to mine at present." (The Oil Drum, November 14)

Goldman Sachs apologises for the bubble, pledges help for small businesses '¦ “Goldman Sachs [has] apologised for its role in the financial crisis '¦ and pledged $500 million over five years – or about 2.3% of its estimated bonus and salary pool for 2009 – to help 10,000 US small businesses recover from the recession. The moves come as the bank tries to defuse a political and public backlash over its plans to share billions of dollars among top dealmakers after rebounding sharply from the turmoil and earning record profits in the first nine months of the year. Lloyd Blankfein, Goldman’s chief executive, told a corporate conference in New York that the bank regretted taking part in the cheap credit boom that had fuelled the pre-crisis bubble. 'We participated in things that were clearly wrong and have reason to regret,' said Blankfein. 'We apologise.' Blankfein also told the conference he wished he had not told the UK’s Sunday Times newspaper that Goldman did 'God’s work' – a remark that was seized upon by the bank’s critics – and said it had been meant as a joke '¦ In choosing to help small businesses, Goldman has identified one of the US administration’s policy priorities. Tim Geithner, Treasury secretary, is hosting a summit on Wednesday with members of Congress, small companies, financial regulators and banks to work on ways to kick-start lending to the sector. Goldman has set aside $16.7 billion for compensation in the first nine months of the year. Brad Hintz, an analyst at Alliance Bernstein, recently estimated total compensation expenses in 2009 would reach $21.8 billion.” (Financial Times, November 17)

Yet the firm still 'abandons' kittens '¦ “Goldman Sachs has more than $600 million socked away in its charitable foundation, much of which the company will dole out this year to atone for the sin of making too much money. Let's hope they'll spare some for the kittens, the five kittens they said they'd take care of and then 'abandoned', according to a recent editorial in The Villager: '[T]he firm has not yet paid a few thousand dollars of vet bills for the five kittens born in its headquarters building nearing completion in Battery Park City. In August, after our sister publication Downtown Express reported the kittens’ discovery, Goldman offered to pay the bills and encourage its employees to adopt the [so-called] “BlackBerries”'¦ [While] It may be just a matter of Goldman waiting to get the vet invoices, we can’t imagine they’d stiff kittens while writing out bonus checks worth $23 billion; but the cats still need adoptive homes.” (New York Magazine, November 12)

Video of the Week: China's empty city of Ordos '¦ Socialist planning is credited with China's extraordinary economic growth. But could it in reality be creating extraordinary economic white elephants?

(Al Jazeera English, November 10)