Wednesday 27th August 2008

Asia Is About to Give U.S. a Kick in the Fannie - This is an interesting, albeit sobering, column by William Pesek for Bloomberg. Here is a section:

The great stampede out of dollar assets that many analysts predicted hasn't happened. Demand for U.S. debt has been quite resilient amid a sliding dollar and a widening credit crisis. Even problems at Fannie Mae and Freddie Mac haven't yet precipitated a massive capital exodus.

The operative word is ``yet.'' The almost $10 billion drop in central-bank holdings of agency debt this month doesn't necessarily mean the flight is afoot. Yet Asia is anxiously awaiting news of how the U.S. handles troubles at government- sponsored mortgage-finance companies.

China, for example, holds $376 billion of long-term U.S. agency debt and, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong, most of it is in Fannie and Freddie assets. Fannie and Freddie aren't
just too big to fail -- they're too geopolitical to fail.

Catastrophic Risk

``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu Yongding, a former adviser to China's central bank, said last week. ``If it is not the end of the world, it is the end of the current international financial system.''

Even if Fannie and Freddie are bailed out, recent events mark the end of the U.S.'s financing arrangement as we know it. It's a reality for which the U.S. should now plan.

China alone will be a prickly customer to deal with. A conservative estimate would put China's U.S. agency holdings at 10 percent of its gross domestic product.

Say the U.S. opted not to repay investors on time and in full. How would China's 1.3 billion people, awash in post- Olympics confidence, respond to the wealthy U.S. leaving China with big losses? If the tables were turned, you can just imagine the public outcry for the U.S. to stop lending to China.

My view - If the choice is between slow growth borrowers and higher growth lenders, and equity valuations are approximately the same, I know where I would rather invest.

Email of the day (1) - On another theory behind the USD's rally:

"I would like you to comment on the following article which is trying to explain the rise of US dollar from a different perspective than the one you were presenting earlier:

"Beijing swells dollar reserves through stealth"

My comment - It is an interesting theory and may be a factor. I also enjoyed some of the readers' comments following The Telegraph article, ranging from sensible to manic or conspiratorial. However as a general aside, there are innumerable theories and views regarding the outlook for any currency, equity, commodity or bond - but there is only one price trend for each instrument in question. For this reason, many of us do best when our theories are subordinate to market action.

The Weekly: The Issue is Time… and Timing - My thanks to Rod Smyth, Bill Ryder and Ken Liu for their weekly timing report, published by RiverFront. It is posted in the Subscriber's Area but here is the opening:

In our judgement, the stock rally which began in mid July is coming to an end. The gains have not been broadly based as reflected in the New York Stock Exchange advance/decline line, which has barely risen over the past month, and the increasing number of issues making new 52 week lows. The NYSE advance/decline line simply subtracts the number of stocks that were down from those that rose, and then divides that figure by the total stocks that were traded. The result is then added to the previous day's advance/decline line. We regard this as a good indication of the breadth of any market move. If we are right, then a re-test of the S&P 500's July lows around 1220 is likely and the long term support levels of 1140 to 1170 may also come into play. Technical confirmation of the rally's demise would be a break below 1260 on the index in our view.

My view - I would expect advance/decline data to lead on the downside at major peaks, often reflected by the weakness of smaller cap indices. However I would not necessarily expect a/d to lead on the upside.

The oversold rally commencing in mid-July has certainly stalled. Here is what it would take to revive it:

This item continues in the Subscriber's Area.

Email of the day (2) - On paid-up subscribers per capita:

"Very interesting to see the global breakdown of paid up subscribers. Clearly the big three are UK, USA and Australia but considered on a per-capita basis Australia is way out in front. The same applies to Olympic medals of course, which should be a salient rejoinder to the British hubris over beating Australia's medal count at long last!"

My comment - Well observed - Australia wins the per capita gold medal in terms of Fullermoney subscribers. Personally, I would prefer an Olympics without the flag waving and national anthems, and I often cheer for those who are exemplary role models for their sport, regardless of nationality. Australia is a great sporting nation but since underdog victories can also be inspirational, and in the interests of a true rivalry, I will be hoping that great Englishman, Kevin Pietersen, can inspire his team to win back the Ashes next year.

Email of the day (3) - On Vietnam:

"Attached is commentary from SGAM re Vietnam - thought you may find it of interest."

My comment - Many thanks for this.

This item continues in the Subscriber's Area.



Additional Commentary by Eoin Treacy

Commodity Shipping Traders See `Miracle' Market: Chart of Day - This article by Alaric Nightingale for Bloomberg covers an important seasonal move in shipping prices. Here it is in full:

Traders of derivatives reflecting the future cost of shipping coal, iron ore and grain are betting on a ``miracle'' market in the fourth quarter, boosted by demand from Chinese steelmakers and accelerating grain shipments.

The CHART OF THE DAY shows some traders are speculating that rental rates will advance at least 31 percent by the fourth quarter. The white line shows today's cost of hiring panamax carriers, the largest vessels that can sail through the Panama Canal, according to the London-based Baltic Exchange. The yellow line reflects forward freight agreements, contracts traders buy and sell to bet on where the index will be in the next quarter.

``The premium for the fourth quarter is absolutely extreme, it's never been seen before,'' Steve Rodley, co-managing director of Global Maritime Investments Ltd., the largest hedge fund dedicated to commodities-shipping markets, said by phone yesterday. ``I believe the fourth quarter is going to show strength, but I still can't justify the current premium.''

Traders are betting on a ``traditional'' increase in grain shipments, stockpiling of iron ore in China, and a resumption of demand after the Olympic Games, Rodley said. Current rates are being driven down by more ships competing for spot cargoes, he said. Owners are probably seeking to keep ships available for the anticipated fourth-quarter surge, Rodley said.

The index rose 44 percent over the same period a year ago, comparing the fourth-quarter average with the Aug. 24 spot price.

Still, ``there's no hiding from the index as you get closer and closer,'' he said. ``Either the world is correct, and the latent demand is there and everything is boom time, or all these ships have been treading water.''

My view - The spread between C4 1st month and C4 4th month shipping continuation charts is largely cyclical as can be demonstrated by this chart. Every year, around this time, the spread widens out as expectations grow that demand for ships will increase later in the year. The spread is currently wider than it has been since 2005 and appears to be consolidating in the current region. A sustained move above the 2004 highs would be needed to question scope for this seasonal move to continue. This seasonal condition is the rationale behind an assumption that demand is likely to increase significantly for ships into the fourth quarter.

This section continues in the Subscriber's Area.

Best Farm Economy Since 1970s Comes With Fuel, Fertilizer Risk - This article by Alan Bjerga covers the increasing marginal cost of production which is one of the most compelling arguments to explain a secular bull market in commodities. The full report is posted in the Subscriber's Area but here is a section:

U.S. agricultural income is the highest in three decades after corn and soybeans rose to records. The risk for farmers is that costs are rising even faster, increasing concern of a profit squeeze.

A U.S. Department of Agriculture report tomorrow may show costs are accelerating as revenue growth slows, similar to a pattern that led to a 1980s farm crisis that was the worst since the Great Depression, said Gary Schnitkey, a University of Illinois farm economist. Corn, wheat and soybean prices are all at least 18 percent below their peaks.

Fertilizer costs doubled from a year ago, while fuel increased 62 percent, USDA data show. Expenses probably will surpass the $279.2 billion that the USDA estimated in February, eroding net income the government pegged at a record $92.3 billion for 2008, farmers and economists said.

``Income peaked this year,'' said Kurt Line, who owns or manages more than 6,800 acres of farmland near Momence, Illinois. ``We should see a significant drop in 2009. For the number of dollars we will be risking the next two years, profit margins are not going to be robust.''

The department's first forecast of farm income for 2009 will be made in November.

While income is up from last year, the price rally that began in 2006 for the nation's biggest crops has sputtered since late June and early July, on signs that Midwest flooding may have caused less damage to corn and soybean plants than analysts had predicted.

Fertilizer, Oil
Corn, the most-valuable U.S. crop at a record $52.1 billion last year, dropped 26 percent from its June 27 peak of $7.9925 a bushel on the Chicago Board of Trade. Soybeans, after jumping 78 percent in 2007, plunged 18 percent from a high of $16.3675 a bushel on July 3. Wheat, up 77 percent in 2007, slumped 37 percent from its record $13.4925 a bushel March 12.

Growers will probably spend one-third more to plant their fields next year, Schnitkey estimated.
Fertilizer, the second-biggest expense for corn and soybean farmers after land, is tied to spiraling energy costs, said Bob Young, chief economist for the American Farm Bureau Federation.

``It will take $5 corn next year just to break even,'' said Young, who represents the largest U.S. farmer group.
``People think they're standing at the edge of a chasm.''

Corn futures for December delivery closed at $5.94 a bushel on Aug. 26 on the CBOT, and the price of grain for delivery a year later fetched $6.31.

My view - Deniers of the secular bull market in commodities point to the long-term marginal cost of production and argue that prices will eventually return to this level. However, rising costs for everything from fertilizer to tyres are causing the marginal cost of production to rise. This means that while it remains a possibility that some commodities will occasionally test their marginal cost of production, it is likely to be at significantly higher levels than was the case over the last few decades.

This section continues in the Subscriber's Area.

Please Note - I will be on holiday in France until September 9th.

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