- We continue hold a counter-consensus, long-term bearish view of both international commodity prices and capital expenditures in the basic materials and energy industries.
- The key drivers we expect to perpetuate these secular outcomes are, first and foremost, a generational inflection in US monetary and fiscal policy, followed by a structural rebalancing and cooling of Chinese economic growth.
- The day-to-day noise speculating on further iterations of easing out of the Fed, ECB and/or PBOC are crowding out the fact that the aforementioned shifts are already well underway.
- While we recognize that incremental Policies to Inflate out of the Fed or ECB are likely to reflate commodity markets, we anticipate that any reflation will be to lower long-term highs and that the rallies will be shorter in duration relative to previous iterations.
In the context of our daily research output, which generally aims to help investors manage immediate-term Global Macro risks (both positive and negative), we consistently allude to several big-picture themes that we see emerging and are likely to continue over the long-term TAIL. Over the past 12-18 months, one of those themes has been our non-consensus view on global commodity markets – specifically that:
- We think the USD and the fiscal and monetary policies that back it are the key drivers of commodity prices, trumping the role of more traditional supply/demand dynamics in price formation;
- We continue to think liquid commodity markets and, subsequently, the capital expenditures of certain companies along the international commodity supply chain are poised to decline over the long term; and
- A secular reduction in investment is likely to be a meaningful headwind for rates of economic growth and balance of payment dynamics across various commodity-oriented economies (namely Australia and the bulk of Latin America’s largest countries).
To point #2, we’ve indexed the US Dollar Index, CRB All-Commodities Index, CRB Raw Industrials Index and CRB Food Index to APR 15, 2011, which is the day we initially outlined the aforementioned conclusions on our 2Q11 Macro Themes presentation via our Deflating the Inflation theme. As the chart suggests, structural deflation across various commodities markets has already commenced. Moreover, the amount of intellectual pushback we received on point #1 has receded substantially along with commodity prices over this time frame, suggesting to us that investors are broadly beginning to understand and explore the linkages between the USD and international liquid asset prices.
Below we compiled a list of recent data points from our weekly roundup of Asia and Lain America to support the conclusions laid out above regarding capital expenditures throughout the international commodity supply chain; email us if you’d like to be added to that distribution list:
9/4: Australia, China
- What Happened: With Iron Ore prices down -29.7% over the past month (mirroring price declines across the Chinese steel market), Fortescue cut its full-year CapEx spending forecast by -26%.
- Why This Matters: Fortescue’s negative CapEx guidance mirrors recent maneuvers out of other international industrial companies such as BHP Billiton, Joy Global, Komatsu, Caterpillar, Sany Heavy Industry Co. and Vale. In true interconnected fashion, we continue to highlight how slowing Chinese growth is weighing heavily on multiple points of the international industrials supply chain. Moreover, we continue to hold our counter-consensus view that a broad-based Chinese stimulus package – if any – is likely to surprise elevated expectations to the downside with respect to the intermediate-term TREND. Anything Chinese policymakers do will be far less than spectacular, merely in support of protecting the +7.5% growth target, rather than attempting to reflate the Chinese and global economy in a meaningful way (i.e. no repeat of 2009-10). Refer to our AUG 24 note titled, “IS THE CHINESE ECONOMY ABOUT TO GO DARK?” for more of our thoughts on this topic.
8/31: Japan, China
- What Happened: Hitachi Construction Machinery Co., the world’s third-biggest maker of building equipment, is shutting its Chinese plant for two weeks a month until October as the nation’s economic slowdown triggers a sales slump. (Bloomberg)
- Why This Matters: This is in-line with recent negative guidance revisions, CapEx suspensions and/or temporary plant closures at BHP Billiton, Joy Global, Komatsu, Caterpillar. With Chinese steel and global iron prices collapsing in recent months/weeks, one has to wonder how much of global GDP growth is not just Chinese demand (43.9% since ’08), but also the operations and investments of international suppliers that sell into Chinese demand. For our updated thoughts on the Chinese economy ahead of next week’s PMI data, refer to our 8/24 note titled, “IS THE CHINESE ECONOMY ABOUT TO GO DARK?”.
- What Happened: Chinese heavy excavator sales fell off a cliff in JUL, following a similar plunge in demand from China’s mining industry. Per Bloomberg: “Demand for the biggest and most expensive excavators, which weigh more than 40 tons, had largely withstood the slump because of demand from miners. A slump in coal prices has dented this sector, causing sales to tumble 53 percent in July. Total fixed- asset investment in Chinese coal mining slowed to a 3 percent growth rate from 19 percent in June.”
- Why This Matters: We continue to warn of material long-term risks to the “Weak Dollar/Long Energy, Mining, and Resource Related CapEx” trade, as we see an asymmetric setup in the market value of the US dollar. The slope of US fiscal and monetary policy could inflect materially over the next 6-24 months. In fact, a secular bull market in the USD is arguably the most asymmetric and impactful risk we can identify across global financial markets and the global economy today. For more on our thoughts here, refer to our JUN 8 note titled, “TWO SCHOOLS OF THOUGHT PART II”.
8/24: Hong Kong, China
- What Happened: Companies listed on the Hong Kong Stock Exchange are guiding down at a historic pace. Per Bloomberg: “Such warnings have been issued by 331 companies since the start of June, the most for a three-month time frame since Hong Kong Exchanges & Clearing Ltd. started compiling the data in July 2007…. Of a record 138 companies that issued such statements last month, 79 percent derive more than half their revenue from China, while 45 percent are industrial-related or commodity producers…”
- Why This Matters: We are inclined to view this as a leading indicator for broader negative revisions to corporate guidance across developed markets over the intermediate term. Corporate executives across the developed world are constantly getting their heads pumped full of expectations for economic “stimulus” out of the Fed, PBOC and/or ECB by their bankers and the manic media. If and when the stimulus A) doesn’t come or B) comes and is ineffective ($150 oil?), we would expect a material slowdown in global economic activity. Expectations remain the root of all heartache…
- What Happened: Indonesia, which accounts for 40% of world tin exports, has just announced that it will idle 70% of it tin-smelting capacity, likely to exacerbate a what they are perpetuating as a global tin shortage. Sounds eerily similar to the bull thesis on copper, which is also not working as demand growth continues to slow…
- Why This Matters: Tin, which is down over -27% from its YTD peak in early FEB, is a key ingredient in everything from cans to televisions and smart phones. The price action here continues to signal to the growth bulls that they need to wake up and smell the tin in their coffee.
8/15: Germany, Brazil, China
- What Happened: Hamburger Hafen und Logistik AG and Vale SA are taking/talking down their Chinese growth expectations with respect to the TREND and TAIL durations, respectively. Per Bloomberg: “Hamburger Hafen und Logistik AG, which handles two thirds of containers in Hamburg, cut its forecast for 2012 on July 25, saying it now sees container throughput at the same level as last year, compared with an earlier 5 percent growth estimate. Such an increase would have led to volumes exceeding the record 7.3 million standard containers handled in 2008, the year before the global financial slump prompted a 33 percent drop.” Per Vale DIR Castello Branco: “We are not going to see the spectacular growth rates of 10, 12 percent per year. The golden years are gone.”
- Why This Matters: While we continue to assign rather minimal weight to corporate guidance in our Global Macro process (companies tend to be equally as wrong as their bankers are at the turns), we do find it interesting that companies with sales exposure to China at 33% and 44%, respectively, would talk so frankly about the prospects for Chinese economic growth. More importantly, their subdued commentary is completely in-line with our TREND and TAIL expectations for the Chinese economy. Ping us for our collection of relevant notes on the subject.
Jay Van Sciver, Hedgeye’s own Managing Director of Industrials, has also been vocal in recent months about the bubble in global mining capex, as producers have chased rising prices with attempts to secure incremental supply.
We have also been vocal calling out similar trends in the US; when overlaid with a plot of the US Dollar Index, it’s easy to see why miners have been ramping up production over the last 10-plus years. In fact, the latest ramp is reminiscent of the last time US monetary policy was overtly attempting to sustainably debauch the USD (1970s).
The obvious implication here is that the spread risk here is at an asymmetric wide. Moreover, global economic growth is likely to continue being rebalanced over the long term – particularly in economies overly exposed to international commodity markets. Refer to our AUG 10 note titled, “THINKING OUT LOUD RE: GLOBAL GROWTH” for how bumpy this secular transition could potentially be. For us, Australia and Argentina have been two countries that come to mind here:
- 6/5: SLOWDOWN-UNDER: We see further weakness in the Australian economy over the intermediate-term TREND as well as a growing number of key questions regarding Australia’s long-term TAIL growth potential. As such, we are reiterating our TREND-duration bearish fundamental call on Australian equities and the Aussie dollar – barring incremental accommodation out of the Fed over the immediate term.
- 4/18: ARGENTINA, IMPLODING: Keep a small space on your white board(s) for the risk of another large-scale Argentine default over the long-term TAIL. At a bare minimum, another bout with domestic hyperinflation is an elevated risk over that duration, as the country seeks to deplete the very resources it needs to maintain stability in its currency.
Regarding Australia specifically, it’s hard to watch the following YouTube video of Fortescue’s “impressive” operations and not come away with an overwhelming feeling that you’re at/near the top of a bubble in international mining capex: http://www.youtube.com/watch?v=lA0MSsd0dvQ.
All told, with the Strong Dollar message continuing to gain political influence in the US fiscal and monetary policy arena and Chinese economic growth continuing to slow to more sustainable rates and more balanced levels of composition, we see no reason to back away from our long-term bearish bias on international commodity prices. Furthermore, while we recognize that incremental Policies to Inflate out of the Fed or ECB are likely to reflate commodity markets, we anticipate that any reflation will be to lower long-term highs and that the rallies will be shorter in duration relative to previous iterations.