Against the Grain

The shock House of Representatives rejection (never has there been a better example of the US leaders being so out of touch with the electorate) of the Troubled Asset Relief Programme decimated equity markets before a new mood of optimism settled in as the market believes they WILL pass it next time, wont they? The twists and turns are driving markets down bone shuddering pits before crawling back out. Fundamentals and technicals mean little in this sentiment of fear, however what is becoming evident is Congressmen are listening to the electorate who oppose the bail out and Washington must manufacture a pill voters are prepared to swallow. The complicating factor is all the Congress and half the Senate face the electorate in a month and therefore there is little time for them to forget which way their representatives voted on such an important issue. Basically there is not time for things to heal!

With Shanghai closed the metals came under more sustained selling in early London with cu as low as 6170. In Japan Aug industrial output declined 3.5% yoy, unemployment rose to 4.2% (4.1%) and household spending fell 4% yoy. The metals had some fundamental support as workers at Xstrata’s Kidd Creek operations (cu 125 kt and zn 138 ktpa) in Ontario broke off labour talks. The LME stocks saw rises in al and ni. The Aug German unemployment rate was unchanged at 7.6%. The final UK Q2 GDP was +1.5% (+1.4%). Markets steadied in Europe as expectations grew that the US Congress would vote the right way later in the week, this supported the US$ as the € came under considerable pressure as more banks this side of the pond sought nationalisation.

In the US the Jul Case Shiller home price index declined 1.1%, yoy -16.5% (Jne -15.9%). Then the September Conference Board consumer sentiment index improved to 58.9 (Aug revised to 58.5 from 56.9) however before the latest markets shudder. This type of data will indicate how Main Street reacts to Wall Street tremors. The Spt Chicago manufacturing PMI was 56.7 better than expected (Aug 57.9).

The news from Washington is that Congress and the Administration has reached a deal on the bail out however that has been the news since Thurs and as yet there is still nothing in concrete, with the sword of catastrophe hanging over failure. The lancing of the banking boils continued on a broad front, the UK nationalised mortgage lender Bradford & Bingley set to be nationalized later today, Germany saw a rescue of Hypo Real Estate, a bank specializing in financing property deals. In Belgium, the Benelux countries have agreed to effectively nationalise Fortis Bank followed by Citigroup acquiring Wachovia Bank’s banking operations only last week seen a possible rescuer itself. The boss of the IMF changed his view on Fri he said the world economy would slow to 4% this year and pick back up to 5% in ’09 by the weekend he was gloomier. See attached a thoughtful article by Thomas Friedman of the NYT Spt 28, “Green the Bailout” (www.nytimes.com).

With China on holiday Asia it was extremely quiet. Then a stronger US$ and worries about growth saw the base metals buckle under the selling. The LME stocks were neutral but failed to stem the tide with ni stocks rising 1254 tonne with 960 into Rott. Other commodities are selling off the Chinese weekly iron ore import prices fell 17% and the Australian Newcastle thermal coal price has fallen to a six month low since its Jul 4 high of $194.7 / tonne.

The US began without the expected “bail out” bounce as more bank difficulties spiralled the DJI off over 300 points. The Aug personal income reading fell 0.9% (Jul -0.8%) and spending was flat (+0.1%). The Aug Chicago Fed mid West manufacturing index fell 2.6% (Jul +0.2%). The commodities fell as the market see nothing but gloom for economic growth going forward. The magnitude of the fall in base metals without the Congressional vote could be overdone near term.

Next week the Chinese markets are closed for a national holiday. It is worth noting that whenever one (or more) of the big metal price setting centres are closed significant moves can occur.

In Asia Aug Japanese CPI was 2.4% yoy unchanged from Jul. While NZ saw its GDP fall for a second quarter as Q2 GDP fell 0.2% (Q1 -0.3%) the first recession in 10 years. The LME stocks were highlighted by a 546 tonne rise in ni. Over the week cu stocks fell 9.5 k; al continued to rise 27 k; zn fell 1 k; pb down 3.5 k; ni rose 1 k and sn up 100 tonnes. On the mining front the DRC has extended the deadline for the review of mining contracts in the country to about Oct. 16 from the original date of Sept. 30. In Russian Moody’s Investors Service assigned a “negative” outlook to the country’s banking system after the recent financial upheavals. The Baltic dry freight cargo index has fallen to its lowest level since the beginning of ’07 a further signal that global trade is slowing significantly. The ICSG has reported that cu in H1 ’08 could be in surplus, since ’02 the cu market was only in surplus once ’06. Reuters reports a Chinese official suggesting the country’s ni consumption in ’08 will decline on slower stainless steel demand.

The US opened with another bank failure as JP Morgan acquired Seattle based Washington Mutual Inc the nation’s biggest thrift.  The final Q2 GDP figure was revised to -2.8% previously +3.3%. Then the final September Uni of Michigan consumer sentiment index was 70.3 (Aug 63.0), current reading 75.0 (71.0) and expectations 67.2 (57.9).

At the close of the week cu is down 285, al off 55, zn dipped 19, pb rose 65, ni drifted 50, sn jumped 900 today, gold up US$ 14 / oz, oil down US$ 0.4 / bbl with the DJI 245 points.

It appears that the markets have traded themselves to a standstill over the US bailout plan, having rallied on the news late last week only to give most back this week they now seem to have decided to wait for the outcome rather than jump at shadows. How things have changed, till recently the Bush and his administration went to great lengths to play down any notion that the US economy was heading into recession. In his address last night he said if Congress did not pass the bailout package then the value of your home could plummet, foreclosures rise dramatically, it would be harder and more expensive to get credit, widespread loss of confidence and America’s financial system are at risk of shutting down. Amazing how the wording has spun 180 degrees. Event the king pins are split, having just bought 10% of Goldman’s Warren Buffett supports the deal while George Soros calls it ill conceived.

The base metals were almost unchanged in Asia. In Europe Oct German GfK institute consumer climate survey rose to 1.8 (Spt 1.6) boosted by a falling oil price. Irish Q2 GDP declined 0.3% (Q1 -0.8%) the first European economy to slide in recession. The LME stocks were again dominated by a rise in al, with Rott landing 4 kt. From Oct 1 the LCH is lowering the initial margins of al and ni. Bloomberg is quoting sources that predict Codelco’s annual European cu premium will decline to US$ 98 / tonne over the prevailing LME cash price in ‘09 the lowest since ’04 (US$ 115 / tonne). Analysts expect European cu demand will probably be down 3% this year with spot premiums between US$ 40 / 60 / tonne cif Rotterdam. In China it is reported steelmakers will use domestic sources to counter the move by Brazilian exporter Vale to halt the export of some higher grade iron ore as it attempts to enforce a proposed 11.5% price rise recently agreed with Europe.

In South Africa Jul PPI rose 0.5%, yoy standing at 19.1% (Jne 18.9%). The US weekly jobless claims rose 32 k to 493 k the highest since Spt ’01 from previous 445 k and Aug durable goods fell 4.5% (Jul revised to +0.8% from +1.3%). At 15:00 Aug new home sale fell 11.5%% to 460 k units (+4% or 520 k units). The US equities steadied the ship as confidence rose of an agreement in Congress.

The events in Washington going forward will make us all experts on US politics as the markets duck and dive as scraps of news affect trader’s perception. Today things are off to a good start as market cheer Warren Buffet’s decision to invest US$ 7.5 billion in Goldman Sachs and getting his pound of flesh for it. The weekly US ABC / Washington Post consumer sentiment index was -41 unchanged, however the readings were completed last Tues before the major financial upheaval. The next hurdle is how contagious the Wall Street events will be on Main Street. While it is reasonable to assume the ramifications will be big in the NY area it is the ripple effect into Middle America that could have more weight. Expect this to be further influenced by the forthcoming election especially if the expectation grows that it can only get better, whoever wins. See the attached article from the International Herald Tribune, Spt 24, by Andrew Ross Sorkin “Power grab and a roll of the dice” (www.iht.com).

In NZ Q3 consumer confidence advanced to 104.8 (Q2 81.7) following recent rate cuts, we believe Aust / NZ having cut rates could lead the world economy out of a slow down. Watch their data and maybe the US for signs of the first shots of growth. In the meantime EM and BRIC data should continue to deteriorate. Not good news out of Europe as Sep business confidence declined the Germany Ifo Institute business climate index was 92.9 (Aug 94.8), French business confidence 92.0 (97.0) and Italy 82.7 (83.5). The LME stocks were routine except for ni that rose 606 with Rott landing 884 tonnes.

Mexican Jul retail sales rose 0.7% yoy +2.9%. The US Aug existing home sales fell 2.2% to 4.91 million units (Jul +3.1% or 5 million units). Interest in US weekly DoE crude stocks gained some interest after a fire at a Texas oil loading terminal.

We began the last week by saying “The financial world is in a state of flux and it seems far too early to see through the haze”. Well flux didn’t come near describing the foundation rocking events that continue to occur with the Paulson US$ 700 billion bailout plan going into the political “snake pit” – Congress. It is far too early to see how this all impacts on the world economy, however the omens are not good as there were already strong signs that the recent co ordinated expansion was under severe stress.

The volatile conditions continued Mon as US equities fell on worries about the progress of the Bailout. This spilled over into the US$ that weakened to 1.48 against the €, gold scaled US$ 900 / oz , the base metals rallied and oil literally exploded as the Oct crude contract expiry sparked a US$ 25 / bbl stampede as it closed at US$ 120, the Nov contract at US$ 109. The move has reignited calls for curbs on speculative positions in commodities. Travelling in Asia where there is mood of cautious optimism that the region will avoid the depth of slowdown seen in the G7. In China Hunan Chuangyuan Aluminium (330 ktpa), the only smelter in the southern province has increased production cuts to 20% of capacity from Spt 20. They cited higher costs and lower price but from discussions we have had maybe they should add lower demand. This was followed by Sichuan Aostar Aluminum (125 ktpa) will close a third of capacity. Y/day Aug Chinese metals trade data showed some interesting points cu concentrate imports fell 42% (year to date +8.4%), refined and scrap cu imports were unchanged making them -20% and +12% respectively in the ytd. Bauxite imports down 13% (ytd +20%), alumina -4.5% (ytd -9%), ni ore -70.9% (ytd -10.5%), pb concentrates +69% (flat ytd) and zn concentrates -6% (ytd+12%). Unwrought al alloy exports jumped 138% and ytd up 139%. In domestic output Aug al products rose 27.2% in the year to Aug up 35%, alumina production rose 24.4% (+21.3% ytd), Aug cu output +7.2% yoy and 18.3% ytd.

With the political shake up in South Africa comes as the economy slows Jul retail sales fell 4.6% (Jne -1.5%). In Europe the flash Spt Euroland composite PMI was 47.0 (Aug 48.2), manufacturing 45.3 (47.6) and services 48.2 (48.5), Spt Italian consumer confidence survey 102.8 (99.6), Jul Euroland industrial orders rose 1% (-0.5%) and Aug French consumer expenditure in manufactured goods fell 0.3% (+0.4%). The LME stocks saw cu fall for the second day as cancelled warrants moved out of Korea; al kept rolling in y/day Korea landed 14 kt and today Sing 2776 finally ni in Rott up a net 500 tonnes.

The focus is on Washington as Bernanke and Paulson addresses the Congress and it seems they cannot expect early passage of their plan. At 15:00 the Spt Richmond Fed manufacturing index fell to -18 (-16), retail revenue index -30 (-24), service revenue index -15 (-6) and shipments index -16 (-13).

The US equities set the world alight in the last hour of trading as news broke that the US Treasury, Fed and Congress were in talks to halt the credit market seizure. For a second day governments and central banks continued to take action to halt the decay in financial sector by offering a copper bottom boat to the liberal capitalist system (you could call it socialising losses and capitalising profits). The injection of liquidity in the world banking system was backed up restriction on “free trade” in the equity system as short selling was banned in banking and financial stocks. After the DJI rose nearly 4%, S&P had a 19% range bottom to top and NASDAQ 5% it is no surprise that Asia and Europe has followed taking back the recent losses, BRIC’s back the local Russian market rose 18% and China’s CSI 300 up 9.3%. Market sentiment will now hinge on the detail of the US government bail out.

The base metals were sidelined, the rally then retreat y/day almost sapping the last bit of energy out of traders. In the present equity frenzy (it is London Spt option declaration today), periphery markets are pushed aside. The perceived reduced risk saw gold lose favour (Wed record rally mirrored by a fall today), the US$ recover with oil – the latter helped by Russia testing a missile and more trouble in Nigeria. The weekly Shanghai stocks saw cu increased 3518 tonnes to 17,072; al up 1564 tonnes at 194,765 and zn inched up 39 tonnes to 71,214. The LME stocks registered cu up 5650 with the US getting 8500 and Korea3150 out which reduced cancelled warrants; al saw more into the US and ni rise into Rott. On the week al jumped 157 kt up 13%; cu rose 6 kt; zn down 2 kt; pb off 6 kt off 8%; ni rose 2.4 kt and sn increased 360 tonnes. Mid morning with the FTSE up nearly 8% metals began to move up behind the equities cu 6840. Very little economic data out today which under the circumstances is perhaps a good thing. German Aug PPI was 8.1% yoy (8.9%). In emerging markets as stocks rally the Egyptian central bank raised rates by 0.5% to 11.5% in attempt to control inflation. At 11:00 oil crossed back above US$ 100 / bbl.

The afternoon was given over to equities.

WARNING: these prices bear little reflection to the actual intra week gyration. Over the week the cu down 342, al fell 149, zn off 160, pb down 130, ni flopped 2550, sn retreated2450, gold jumped US$ 114 / oz, oil rose US$ 2.8 / bbl, the DJI up 145 points, FTSE off 7 points and US 10 year bonds increased 0.11% in yield.

The vultures kept circling the equity market looking for the weakest investment bank y/day Morgan Stanley that fell 40% as the DJI lost 4% and NASDAQ 5%. These loses pale a bit into insignificance when you look at the BRIC markets, trading is suspended on the Russian markets after losing over 60% since May, Chinese CSI 300 index off over 60% from its high and the Hong Kong Hang Sang index falling 7% today alone, finally the Brazilian Bovespa index is at its lowest level in a year down 6.7% y/day. Talking to a contact in China y/day they came up with a very telling comment saying they thought “the rest of the world is looking to China to save the world economic growth, China will not”.

The commodities continue to find new alliances with gold out on its own rising to test $900 / oz (it rallied US$ 90 y/day the largest rally ever), oil is higher on the back of rebel attacks in Nigeria disrupting up to 1 million barrels of output / day; the US$ has weakened yet the base metals are under pressure an worries about growth mount. Early London cu fell below its year opening level of 6640 the LME stocks improved the mood, they remain dominated by al rising 10,900 tonnes with Rott landing 8975; ni rose 378 and cu up 175 offset by a 1525 tonne cancellation in Busan. In Japan the Jul tertiary industry activity index rose to +1.2% (Jne -0.8%). Mid morning the world’s central banks (Fed, BoE, BoJ, ECB, SNB and BoC) carried out a coordinated injection of US$ 247 billion into the banking system which saw the overnight US$ loan rate fall to around 2% from 5% before the announcement. This saw the US$ fall, gold was steady, oil and the metals rallied with cu putting on US$ 200 in less than two hours to 6870. On the fundamentals OZ Minerals said in ’09 they would reduce zn production at their Golden Gove mine in WA by up to 40% (85 kt from 135 kt) while boosting the mine cu output by 53% (14 kt to 40kt). Following y/days Bloomberg report on a possible cut in Chinese zn not to be out done Reuters today carries an article that Chinese pb smelters may cut output on a shortage of concentrates up to 40% of capacity could be affected. Chinese steel demand in Aug rose 6% on weaker demand and rising costs (first 7 months grew at 13%). In the UK Aug retail sales rose 1.2% more than expected on clothing sales (Jul +0.9%) yoy +3.3%.

Short covering in the commodities powered oil above US$ 102 / bbl and cu led the metals as it got to 6950. The US weekly jobless claims were 455 k from previous 445 k. At 15:00 the Spt Philadelphia Fed Midwest manufacturing index was at +3.8 boosted by higher orders (Aug -12.7) and the Jul Conference Board leading economic indicator index was down 0.5% (-0.7%); coincident index fell 0.1% (+0.1%) and lagging index +0.4% (-0.4%). The commodity rally flagged as the US equities failed to be set alight.

In these volatile days big government (G7 and BRIC) decisions are being made almost by the minute, in the UK the government allowed Lloyds TSB bank to takeover HBOS bank giving it over 30% of the mortgage and deposit markets (yet refused it permission to take over the smaller Northern Rock a year ago); a combination of central banks poured liquidity into the system and Russia pledged US$ 20 billion to the Russian equity market and cut the oil export tax by 25% from Oct 1 to encourage exports and boost revenue. China will scrap the stamp duty on share purchases and buy stock in the 3 largest state owned banks. – is it pragmatism or panic?

The newest sovereign wealth fund “US Treasury & Fed LLP” acted last night to calm financial markets by extending an US$ 85 billion loan to troubled insurer AIG and taking a 79.9% share of the group, following on from it foray into the US mortgage market last week (Freddie and Fannie). In part the Fed announcement said “The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorised the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers. The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance”. The new SWF has a major stake in the US mortgage and insurance sectors for when not if the economy recovers. As an aside the Fed FOMC voted to leave the Fed Fund rate unchanged at 2%. The Committee said the downside risks to growth and the upside risks to inflation are both of significant concern and economic and financial developments will be carefully monitored and acted upon if needed to promote sustainable economic growth and price stability. Now we wait and see if the markets and press are satisfied or want more blood.

The US equities posted gains before the AIG rescue and economic data was positive, the weekly ABC / Washington Post consumer sentiment index rose to -41 from previous -47 and Spt NAHB housing market index was 18 (Aug 16) the first rise in 7 months (health warning both figures were completed before the latest excitement). The markets struggled in Asia time then gained confidence as London got going as risks of further economic slowdown eased. European equities posted early gains then gave them back. The LME stocks again swamped by al as 88,175 tonnes poured in US 84 k around the country and Gwangyang 10 kt; sn rose 935 Sing got 965 with declines in cu and pb. Following its demise the LME has suspended Lehman Brothers’ Cat 2 membership and advised any counterparties to submit unsettled contracts by Dec 17. An article on Bloomberg says Chinese zn smelter TC could drop up to 14% in ’09 as a result of peripheral zn mine closure and mothballed projects this year, they take 70% of their concentrate requirements from domestic mines and lower prices are squeezing some of these it is though. The UK Q2 unemployment rate rose to 5.5% (Q1 5.3%). In Russia for a second day the Micex Stock Exchange (rouble denominated) and RTS halted trading as losses mounted.

The Aug US housing starts fell 6.2% to 896 k units a worse than expected result (-11% at 965 k units) while building permits came off 8.9% at 854 k units (-17.7% at 937 k units). The markets are reacting quite erratically and setting new alliances, the US$ rallied, gold rose to test 800, oil unchanged, the DJI off 170 points and base metals on the back foot. In the present circumstances the weekly US Dept of Energy crude oil data did not have the attraction of recent weeks. An afternoon dominated by gold in a flight to security.

The financial world is in a state of flux and it seems far too early to see through the haze. Y/day the PBoC cut Chinese rates to commercial banks by 0.27% to 7.2% as signs grow that the global slowdown is beginning to affect them. In the past fortnight there is mounting evidence that China is suffering from similar problems to other economies falling equities and a slowing of the housing sector while retail sales remain strong. Today the focus is on the US Federal Reserve FOMC meeting with a result expected around 19:15 BST. Certainly the odds on an easing have risen sharply since the Lehman’s demise however the press release will be the key. Financial markets have suffered two days of turmoil as a holiday in major Asian markets Mon saw the pain drawn out. It will be interesting to see how markets perform over the remainder of the week as governments and central banks take steps to steady the ship. We suspect things will have calmed considerably as they come to terms with the changed environment. The key is to what extent the troubles in the financial markets spill over into the real economy so far this cross over has been far less manifest in the US than expected, Europe seems more intertwined while in emerging markets it is still unfolding.

After taking on a safe haven mantel in the aftermath of the Lehman announcement the base metals quickly came under pressure as a combination of position liquidation and economic growth worries took hold. In line with other commodities crude oil y/day sank below the ‘08 opening level of US$ 95 / bbl. With Asia catching up overnight metals remained under pressure. In these conditions the economic data and fundamental news is pretty irrelevant however it worth keeping a breast of it. In China preliminary customs data showed the imports of refined cu was up 9.5% at 101 kt that is down 16% in the year to Aug at 1.02 million tonnes. The LME stocks were dominated by a dump of 55 kt of al mostly into Detroit.  In Japan the Aug consumer confidence survey was 30.1 (Jul 31.4). The German Spt ZEW economic sentiment index was -41.1 (Aug -55.1). In the UK Aug CPI rose 0.6% fuelled by a 27% jump in energy prices (Jul flat), yoy +4.7% (4.1%), core CPI was 2% yoy (+1.9%) while the RPI rose 0.3% (+0.3%) and 4.5% yoy (5.0%). With a weakening currency the UK is not getting the full advantage of the US$ priced declines. The Aug EU harmonised CPI was 3.8% (Jul 4%). In the emerging markets Q2 Nigerian growth was 6.7% (Q1 5.5%) pushed by oil, crop production and telecoms.

There is rather a surreal calm in the markets as traders await the Fed decision with a growing expectation of upwards of a 0.5% easing pushing the US$ slightly lower € 1.424, gold higher 783, oil around 92 / bbl and base metals steady to a touch higher. The European equities remain under pressure with the FTSE over 150 points lower. The US Aug CPI fell 0.1% the first fall since ’06 as the crude price fell (Jul +0.8%) yoy +5.4% (+5.6%) while core CPI rose 0.2% (+0.3%). The US equities opened lower with the DJI off 100 then turned to be up 50 points by 16:00, with a stronger US$, weaker gold and higher oil / base metals, call it positioning ahead of the Fed decision. At 17:00 the DJI was almost unchanged on the day.