Against the Grain

In late trading the DJI jumped nearly 11% as panic was replace by p/e bargain hunting sending the al producer Alcoa soaring 19%. The move was ignited by a market belief the Fed will cut rates 1% today in an aggressive move to halt the economic decline. Below this move was talk that the US car manufacturing icon GM might approach the government for aid. In this environment to what degree can officials not bow to the whim of the market for fear of an uncontrollable back lash? It remains to be seen how the massive government distortions to the world financial system now being executed in an attempt to stem the multiple failures eventually leaves the lie of the land. In recent times we have seen bank bail outs, huge rate moves, Iceland increased rate 6% y/day, and interventions in equity markets from market closures to short selling bans now IMF bail outs agreed in hours if not days. On top of this an array of government meetings all aimed at rush remedies which one suspects is more to help the leaders keep their crowns and deflect blame.

Asian stocks followed the US however without the same euphoria (Nikkei +7.7%, Hang Sang unchanged and Shanghai down) which tempered metal prices moves. The weekly US ABC / Washington Post consumer sentiment index improved to -49 from previous -50 just above the dubious record. From Japan a mixed day of data, Oct small business confidence was 37.6 (Spt 40.2), Spt industrial production rose 1.2% (Aug -3.5%) yoy +0.4% (-6.9%) and vehicle production rose 4.2% yoy (Aug -10.9%). Further cu production cuts in China as Tongling announced a 14% (80 kt) reduction in ’08 output. The LME stocks are in a grove most up except pb and sn.

The US Spt durable goods orders rose 0.8% (Aug -4.5%), however ex transport it fell 1.1% (-4.1%). After that equities led a stampede into anything the markets had scrambled to exit recently. The markets now wait for the Fed; the metals are beginning to show their old form as supply problem news trigger waves of buying squeezing out the recently confident bears. The rally does not surprise us as we have for sometime believed Wall Street has over reacted to its own problems.

The US Federal Reserve’s FOMC begins a two day meeting which is widely expected to see a 0.5% cut in rates. In Asia stocks steadied and even recovered led by the Nikkei (+6%) where a short selling ban was brought forward from Nov 6. Despite steady LME metal prices Shanghai cu for a fifth day fell its 5% limit then recovered. To highlight the slow down in China metals demand a subsidiary of Chalco, the biggest processor of cu said orders fell 20% in Q3 which represented a monthly output of 7 kt per month from 9 kt to 9.5 kt per month in the first half. Further it shows how diverse demand for metals is when as the largest user consumes less than 10 kt of cu per month. On the other hand the Rio Tinto chief economist believes there will be a significant bounce in Chinese demand and prices if the country’s growth remains around 9% next year. The mining group was surprised by the fall in metal prices and their inability so far to recover as the cost of production remains high. Currencies are playing a part, Lihir Gold said the falling A$ was reducing costs. In South Korea Oct consumer confidence fell to 88 (Spt 96) as Spt Japanese retail sales fell 0.5% (+0.7%) and 0.4% yoy the first drop since Jul ’04 (Aug +0.7%).

In Europe good news the Nov German Gfk consumer confidence index was +1.9 (Oct +1.8). However, then bad news Oct French consumer sentiment was -47 (Spt -44). The LME stocks are getting into a pattern of a general rise reflecting lower demand in a slowing global economy except for pb heading for Asia and sn. As well as better equity markets the metals are getting support from a general swirl of stories and rumours about base metal production cuts and postponements.

In the US the Aug Case Shiller home price index of 20 leading cities fell 16.5% (Jul -16.3%) and the news got worse, the Oct Richmond Fed manufacturing index fell to -26 (Spt -18) and the Oct Conference Board consumer sentiment index collapsed to -61.4 (Spt -38).

The emerging markets are centre stage as they re couple with the G7 in a direction that no one anticipated, as ’08 began the BRIC nations and other emerging countries were going to lead the world forward on a trajectory of never ending growth. Investors flocked to commodities as a proxy to this new paradigm. When the financial markets began to batter the G7 it seemed the wise had chosen well and the BRIC and emerging nations would miraculously miss the storm after all it was their domestic growth credentials that would carry them forward. Perhaps it was just the size of the turbulence that saw investors lose faith in the new economies but one must suspect that there is more to it than that. Wherever you look in the emerging markets there are drastic actions being taken, large rate cuts or hikes, IMF support, markets closed and other government type intervention.

Investors punished Asian markets or did the markets punish investors trying to flee, the Nikkei fell 6.3%, Hang Sang 4%, ASX 1.5%, China’s CSI 300 5.2%, India’s Sensex 5.2%, Philippines 12%. The yen strengthened after a statement by the G7 of its move but no action was seen as official impotency in the present situation. The Shanghai cu and zn contacts returned to trading only to again fall the 4% limit. South Korea cut interest rates 0.75% to 4.25%. In the non traded markets commodities are also under pressure, the Oct 24 weekly Newcastle thermal coal price fell 8.3% to A$ 96 / mt, the lowest level since Jan. The European equities opened lower however the percentage moves are misleading and levels soon steadied. The LME stocks saw rises dominate except for pb that continues its long term decline, Italy saw 650 tonnes out almost certainly heading for Asia. The ILZSG saw both zn and pb in surplus in the period Jan to Aug ’08 with zn at 108 kt and pb 34 kt. The IAI reported Spt inventories at 2.985 million tonnes (Aug 3.024 mill tonnes). The Oct German Ifo institute business climate index was 90.2 (Spt 92.9).

In the US markets began with some good news with Spt new home sales rising 2.7% at 464 k units (Aug -11.5% at 452 k units). Then the data took a worse turn, the Oct Dallas Red manufacturing outlook survey for Texas was -59.4 (Spt -39.6) and the Oct Chicago Fed Midwest manufacturing index was 2.6% lower at 100.6 (Spt -2.6% 103.3). At time of writing the DJI is struggling to stay positive.

The equities continue to dominate proceedings the DJI posted a 2% rise with a 550 point trading range in the last hour leaving all the US equities in a mixed state. The cart went off the rails in Asia as poor results and growth fears battered the region’s equities Nikkei off 9.6%, Hang Sang -4.5%, ASX 2.5% and Korea tumbled 11.7%. The latter followed the release of South Korean Q3 GDP at +0.6% (Q2 +0.8%). In Japan Sony reported poor results and the world’s second largest auto manufacturer Toyota reported Spt quarter sales decline 4.5% the first quarterly fall in 7 years. Some good news Spt Singapore industrial production rose 2.4% (Aug -12.5%) accounting for 25% of the economy the two major components electronics fell 14.6% (-8.2%) and pharmaceuticals jumped 44.4% (-36.2%).

The metals having ended y/day in a rather buoyant mood dropped away in Asia as the gravitational pull of equities, stronger US$ and lower oil encouraged sellers. The Shanghai cu and zn contracts recommence trading Mon with a 4% price limit, while the exchange’s weekly stocks saw cu fall 3737 tonnes to 31,053; al down 275 tonnes at 204,407 and zn up 167 tonnes to 72,693. This gave the metals a small bounce then the Oct flash Euroland PMI estimated the composite index would be 44.8 (Spt 46.9), manufacturing 41.3 (45.0) and service 47.0 (48.4). The Oct Italian business confidence was 77.7 (Spt 81.8). The LME stock release was delayed 30 minutes by a technical fault but the result was the same rising cu and al stocks. On the week cu rose 500 tonnes; al jumped 21 kt; zn up 2 kt; pb down 5 kt with 20% stock cancelled; ni increased 1032 tonnes and sn off 500 tonnes. In Vienna, OPEC agreed a 1.5 mbpd production cut from Nov the initial reaction of the market was disappointment. The flash UK Q3 GDP contracted 0.5% the first quarterly decline since ’92 (Q2 0%) and yoy +0.3% (+1.5%). The FTSE tumbled nearly 9% and the electronic screens the US S&P and DJI futures were limit down, if the index falls 10% trading is halted for an hour. Both Russian equity indices fell 14% and suspended till Oct 28.

The metals touched lows in the official rings and since then begun to gain ground especially gold with a low of 680. With growing talk on the newswires of a US equity meltdown it would be no surprise to see investors look again at hard assets either that or after all the talk a giant anti climax or the futures down was a circuit breaker. At 15:00 good news Spt US existing home sales rose 5.5% to 5.18 mill units per annum the highest level in a year (Aug -2.2% at 4.91 million units). The rest of the afternoon was watching the equities and some profit taking ahead of a weekend.

On the week cu flopped 1031 with half the fall occurring outside London hours on the back of US and Asian equity moves, al eased back 35, zn off 60, pb down 189, ni off 400, sn fell 1650, gold down US$ 55 / oz, oil fell US$ 7.2 / bbl, the DJI declined 500 and US 10 year bond yields off 0.33%

We are trying to understand how the upheaval in the financial market impacts on the broader economy. Apart from obvious sectors - housing, construction and pensions, to what extent will it impinge on general day to day activity? The run up in “food and fuel” earlier in the year crimped family budget, since Jul the rapid decline will be a boost to disposable income. This will be supported by rate cuts and other government moves like pressurising banks to lend. While doubtful it will negate the full impact of the banking implosion it could perhaps mitigate the contagion. In another area it seems the de coupling of emerging markets from the developed world is over as they hurtle to re couple in the downturn, the MSCI emerging market index of shares is having its worst monthly decline in 20 years. See attached NYT Oct 23 edition article “China, an Engine of Growth, Faces a Global Slump” (www.nytimes.com).

The news overnight was dominated by the fall in US equities (DJI -5.7) and its flow on into Asia, however on closer scrutiny the major Asian markets held up pretty well (Nikkei -2.5%, ASX -4.4% however Korea -7.5%, India -4% while in South America Brazil -10.1% and Argentine -14%) the currencies were little changed. So at London opening with the metals lower, cu touched 3850 in Asia, bargain hunters were quickly in and rewarded. The NZ Reserve Bank cut rates 1% to 6.5% as widely anticipated. The Shanghai cu contract has been halted tomorrow after falling the limit for a third day, dependant on LME moves there could be further mandatory close outs before the reopen. The LME stocks saw increases in most metals, cu 1500 tonnes; al 3475 moving the total over 1.5 mt; zn 3050 Dubai 2700 and ni 840 tonnes into Rott. The Oct French business confidence index fell to 88 (Spt 91). The Spt UK retail sales fell 0.4% less than anticipated (Aug +1.1%). Now for some good news, Spt Polish unemployment declined 8.9% (Aug 9.1%) and Aug retail sales up 11.6% yoy.

Shortly after 11:00 the European equities went red and pressure built on the metals as the US$ strengthened and oil declined. By the officials cu had posted a new low of 3820 and gold low 697. In very volatile trading currencies and commodities hurtled around like a ball bearing in a pin ball machine, pb bid offer spread US$ 24 with the bid US$ 27 below the last trade, like a good Shane Warne over unplayable.

The weekly US jobless claims were 478 k from previous 463 k. The catalyst for a US$ 155 twenty minute rally in cu was a comment that China was mulling positively the Washington G20 emergency meeting. It helped oil jumping US$ 1.5 / bbl with OPEC meeting tomorrow. The DJI quickly up over 150 points then equally fast back to down 40 in first 15 minutes of trading as the opening rolls through the stocks they do not all open at once, cu in particular clattered off with it, no wonder someone pointed out that metals are now 90% correlated to equities so for the time being losing their much vaunted non correlation tag, but a lot of sacred cows have been slaughtered recently. The DJI up over 200 points and everything else trended higher as we entered the pm rings.

The US$ moved significantly higher overnight as “good news” vanished, the Governor of the BoE declared the UK to be entering recession with the banking system close to collapse and the country far from the end of the road back to stability. This saw investors focus on slowing global growth and potential cuts in interest rates. This time y/day global equities were advancing while today its is disorganised retreat after the DJI was off 2.5% - the Nikkei down 6.8%, Korea 8.3%, India 3.7%, ASX 3.4%, Hang Sang 5.9%, China’s CSI 300 index -1.9% and in South America Brazil 1% and Argentina a special case dumped 11%. Following moves by the government to take over pension funds an analyst said Argentina was disappearing into irrelevance. The talking heads are at it again, Nov 15 Bush is holding a G20 global economic summit in Washington.

The metals did not stand a chance, a stronger US$, weaker oil and Shanghai cu and zn again locked in limit down prices buckled with cu trading below 4300 off US$ 200 from Tues kerb close. The weekly US ABC / Washington Post consumer sentiment index was -50 from previous -47 while gasoline demand there has fallen 6% yoy. In Asia, Japanese Aug all industry index was -1.8% (Jul +0.8%). The Australian Q3 inflation rates rose 1.2% to 5% yoy (Q2 +1.5%). Mining giant BHP reported disappointing Spt Q cu and ni production data including a 32% reduction in Escondida mine production caused by lower ore grades and mechanical problems. Like its peer group it acknowledged a slowing in Chinese demand for its commodities. In China al producer Chalco aims to cut al capacity by 18% equivalent to 720 ktpa, however as we know Chinese production cuts do not always crack up to what is expected. In its metal market there is now an avalanche of stories about defaults and delays in transactions of scrap and metal.  The Korean stainless steel maker Posco is cutting production by over 30% this quarter, which collates monthly reductions already announced. It is reported that Spt global crude steel output declined 3.2% to 108.4 million tonnes. The big guns stood out in the LME stocks cu rose 1850 tonnes Rott 1075 and St L 1275 while al up 2 kt Johore 1425 and US 750.

In the kerb the floodgates opened as the gravitational pull took hold, lower European equities, a strong US$ and weaker oil cascaded in on the metals only zn managed to withstand the pressure. The selling was compounded by the spectre of a weak US opening, which eventuate with the DJI quickly off 300 points over 3% on worries about corporate earnings. The selling pressure on everything eased around 16:00 signalling small recoveries.

We will leave you with this; former executives of the rating agencies are testifying in Congress, one said originators of structured securities “typically chose the agency with the lowest standards, engendering a race to the bottom in terms of rating quality”.

The US equities put in a good move y/day DJI +4.7% and this was followed by similar moves in Asia - Nikkei 2.5% and ASX 3.9% however the base metals were far more cautious as Shanghai cu and zn fell the 4% limit. Weighting on the mood in metals was China’s biggest steelmaker, Baoshan Steel decision to cut prices for the third straight month, reducing them by as much as 20 percent, as an economic slowdown forces carmakers and builders to slash orders. Oil pushed higher as an OPEC meeting approaches Thurs with expectations that they will cut output in a reaction to the recent price sell off. In the past 24 hours two Canadian ni mining operation closures have announced; FNX Mining will halt mining at the Levack deposits at the end of the year and First Nickel Inc will suspend activity at its Lockerby mine both in Ontario. In the UK the Oct CBI manufacturing output survey fell to -31 the lowest level since Jul ‘90 (Spt -16) this saw £sterling fall below 1.70 to the US$. The LME dominated by cu down 6500 tonnes with the material out of Korea and al up 7325 with US 3975 and Sing 3500. The stock move saw cu gain ground taking the others with it in light activity as a stronger US$ and softer oil providing a drag. Reuters is reporting a Chinese copper and semi finished products maker has cut output as demand falls. It is reported from Australia that OZ Minerals is reviewing operations at its Century zinc mine, the second largest in the world yielding 130 kt of contained zn and 18 kt of contained pb.

The official rings saw the metals under sustained pressure with cu below 4500. While the European equities moved higher  at the opening call the US pointed to a lower DJI sending the former eventually lower, despite a stronger US$ and weaker oil the metals held their lower level well – cu 4450, al 2104 with ni higher on mine closure news. Little economic data around so equities could set the trend this afternoon and they did, the DJI opened lower with cu at 4430 then rallied into positive territory sending cu to 4580. The equities, US$ and oil now have a gravitational pull on the metals. The Spt Chicago Fed national activity index fell to -2.57 on a steep drop in the industrial production reading (Aug -1.61). About the afternoon rings the DJI lost its shine with predictable results for our sector.

Amazing stats even in these times the Argentinean government bond 8.25% coupon maturing 2033 is yielding 24.77% up 4.3% on the day ahead of presidential economic statement while the Baltic dry freight index has fallen 88% since Jul.

How times change and quickly, The Times on Fri ran a two page business article entitled “The Commodities Crisis” in Jul the general consensus was of a “Commodities Super Cycle” set to last a generation. In our view going forward it is far easier to make a strong case for latter while the former is short term hype. In late ’07 into ’08 despite the known problems in western housing and the banking system the markets chose to ignore the school of economic cycles and embrace the BRIC growth forever experience. We are in the camp that believes the ’08 commodity price run was “Irrational Exuberance” by investors in a presumed counter inflation trade. Time will heal and the economic cycle will return to an uptrend which will again expose the short coming on the supply side of commodities that leaves the unknown of when.

Another weekend and another G8 meeting organised for Nov to be hosted by President Bush in the US expect a lot of hype and little hard action as usual. In the banking system The Netherlands government shored up ING Bank Sun and do not be surprised to see another bank coming under attack from equity traders this week as the dominos face scrutiny. In Asia the Chinese Q3 GDP growth slowed to 9% yoy, more than expected (Q2 10.1%). Spt industrial production growth was 11.4% yoy (Aug 12.8%), the CPI slowed to 4.6% yoy (4.9%), retail sales remained unchanged at 23.3% yoy. The urban fixed asset investment rose 27.6% in the year to Spt (year to Aug 27.4%), while urban disposable income grew 14.7% in the nine months to Spt rural disposable income increased at 19.6%. In India the Reserve Bank cut rates to 8% from 9%.A better overall tone to Asian equity markets gave the metals a modest boost at the start of the week. The LME stocks saw rises in cu and al, US receieved2475 and Sing 2200. On the metal front uneconomic mine are continuing to close in Canada Blue Note Mining will stop production at two pb / zn mines (21 mt pb and 40 mt of zn in concentrate) Nov 28 and in WA Norilsk Nickel will halt output at its Cawse ni operation without affecting its other mines in the state.

In the US Spt Conference Board leading economic indicators rose 0.3% (Aug -0.5%). The US equities improved as inter bank rates declined and Bernanke told the House Budget Committee he supported further spending stimulates to the economy.