Chronicle: Commodity super cycle ending versus QE in the eighth inning

Commodity super cycle ending versus QE in the eighth inning

http://www.tradingfloor.com/posts/commodity-super-cycle-ending-versus-qe-eighth-inning-562603731

I am in Singapore at the moment, a place that always stimulates a good deal of thinking on global macro themes. This time, I am taking my cue from high ranking officials here, who are warning about two issues: The need for reform in China and the bubbles caused by global quantitative easing (QE). Or, as the headline to this piece reads: Commodity super cycle ending versus QE in eighth inning. (For non-baseball aficionados, note that a standard game has nine innings - i.e. we are very late in the game.)

Ninth inning delayed due to Carney
The only reason we are not in the ninth inning is that Mr. Carney has yet to assume the helm at the Bank of England from July 1, meaning the world is likely yet to see the final pusher of US-inspired monetary drugs arriving on the world scene this summer.

Mr. Mark Carney's career is of the classic Keynesian stripes through and through: Chairman of the G20 Financial Stability Board, former employee of Goldman Sachs, worked in Canada's Department of Finance and finally, of course, served as Bank of Canada Governor. His degrees are from Harvard and Oxford. You cannot get more Keynesian/dirigiste than that. So get ready for the UK version of QE to Infinity. We are very negative GBP for the second half of 2013, and awaiting the catalyst to this trade.

Singaporean officials advocate reform
Back to Singapore – the officials here, whom I must say I respect greatly, have all been out advocating defensive strategies and the need for reform. That is a drum I have also been beating on a good deal over the last couple of years, with the key challenge in a crisis being that things usually need to get so critically bad before you can arrive at the necessary mandate for real change.

On Monday, Singapore's Deputy Prime Minister and Finance MinisterTharman Shanmugaratnam struck a tone we should all embrace: "The global economy could face the risk of stagnation if it does not embark on fiscal consolidation and structural reforms for more sustainable growth in the next 10 years".

Directly on China he said: "China must tackle institutional reform if it is to maintain dynamic economic growth in the long term and avoid falling into a so-called middle income trap of rising costs and falling competitiveness". Note that Singapore is a key advisor to the government of China.

On the present state of the economy: "There is too much reliance on central banks to do the heavy lifting but it will also delay the reforms needed to get the global economy back to normal growth".

The part of the speech that European (and US) policymakers need to listen to or learn from was: "We know what needs to be done in tax reforms, in labour market reforms, in building up human capital, in redressing imbalances and competitiveness, in allowing new growth industries to emerge in advanced economies, pension reforms in China, in the old emerging economies".

I could not agree more – the way out of this present low growth/low productivity environment is to do exactly that: Increase incentives with appropriate tax structures, make sure you have the best and most flexible workforce, and support any start-up or emerging industry which is able and willing to take risk. This is the supply side at work – and the micro-economy, which, as I have stated so often before, is 80-85 percent of the economy. Also, do not forget the Bermuda Triangle of Economics concept – which discusses the insidious mentality and effects of the "macro-prudential" bubble-blowing.

Current accounts do not lie
The end of the commodity super cycle means lower growth from China. The key transformations for driving a Chinese economic retooling are indicated on the slide below.

Some of the lower growth potential is due to an increasing loss of competitiveness, a development that is clear to see from the trends in Asian current account data. During the best years, the Asian export powers and BRIC countries' (Brazil, Russia, India, China) current account surpluses amounted to 5-7 percent of GDP. Now the BRIC current accounts are barely positive and Asia as a whole is down below 2 percent. Current account data does not lie: it is the first place to look for rating competitiveness.

Smaller current account surpluses to recycle means less domestic demand in China, which again means less growth in commodity currencies and for Asia as a whole. On the more positive side, the world is more balanced today than it was in 2006-07, when the Asian surplus versus US/Europe deficit was at its most extreme. The challenge has always been to smooth these global imbalances, or we would have ended with an Asia with all the wealth and no customers in a bankrupt US and Europe.

Commodity super cycle pauses
Now, while US and European governments are clearly still on the brink of bankruptcy, the private sector is roaring back to life.

Speaking at the 66th CFA Institute annual conference, former chief investment officer of Government of Singapore Investment Corp.(GSIC), Mr. Ng Kok Song summed it up nicely: "China has become a change factor in the global economy over the past years – the question is whether China will continue to be the significant change factor in for the global economy and what the implication is for us as investors".

Clearly the Commodity Super Cycle is on "pause" or has even ended, and this will dramatically change our allocation – the current account trend above shows this, the dramatic sell-off in Australia is another, and soon other commodity currencies should be following here in the region. (See more about the most commonly traded commodity foreign exchange currencies in this article: Commodity super-cycle warnings put these currencies most at risk.) The irony here is that it has taken the "pundits" almost two years to figure out that the CRB index topped in 2011 (and at a level still lower than in 2008!) I guess that is the work of QE to Infinity, then?

Listen when Singapore speaks
The implication, at least in the eyes of GSIC's new chief investment officer Mr. Lim Chow Kiat, is lower returns on bonds and stocks for the next 10 years.

Citing different portfolio models, he said the average annual return on bond yields will be about 1.9 percent over the next decade, while equities may offer a 1.6 percent median real return a year in that period. Adding later that "more and more investors are being crowded into searching for yields and taking risk, this leaves little on the table to cushion adverse outcomes".

Indeed it is nice to be in a country that is so pragmatic, faces challenges head-on and believes in the longer term. When Singapore speaks, I tend to listen. This country is a refreshing change of pace from what I see almost everywhere else in my 100 days a year on the road: promises of reform and a recovery "only" six months away. Yeah, right. The rest of the world could stand to take a page from Singapore's playbook.

Safe travels,

Steen

 

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