Lost On Oil: False Reality Or Inflation Dynamics In Play?

This is another evidence on how regulators and the public seems lost on what has been happening in the markets and the real economy.


According to the Economist, ``THE oil market is behaving like a bucking bronco again, and politicians are once more blaming speculators for careening prices. It is difficult to assemble a definitive explanation for the rally: a weak dollar helps oil prices, but evidence for improving supply and demand remains thin. Positions held on NYMEX, the New York commodities exchange, have indeed soared. In 2008 America’s Commodity Futures Trading Commission (CFTC), which regulates NYMEX, examined how the changing positions of hedge funds affect prices. It found correlation, not causation, but its investigations were hampered by the fact that it could not examine intra-day trades. Nor could it monitor certain derivatives, such as those traded via London’s InterContinental Exchange (ICE), in which Wall Street dealers are particularly prominent. But in a sign of things to come in the oil market, on June 12th the CFTC said it had launched a public investigation to see whether the biggest natural-gas contract traded on ICE was moving prices around in the more regulated futures markets." (bold highlight mine)

Essentially regulators as much as the mainstream can't find sufficient answers to the conundrum of rising oil prices and weak fundamentals.

Instinctively, regulators always blame such predicament on speculators, when in the contrary, "speculation" has signified as direct responses to the policies imposed.

We have been saying repeatedly that this has been mostly monetary forces dominating both the financial markets and the real economy or inflationary dynamics in motion.

As we earlier quoted Ludwig von Mises in his Stabilization of the Monetary Unit? From the Viewpoint of Theory, at an earlier post, Our Mises Moment Answers Mainstream’s Conundrum of Market-Fundamental Disconnect

``If people are buying unnecessary commodities, or at least commodities not needed at the moment, because they do not want to hold on to their paper notes, then the process which forces the notes out of use as a generally acceptable medium of exchange has already begun. This is the beginning of the “demonetization” of the notes. The panicky quality inherent in the operation must speed up the process. It may be possible to calm the excited masses once, twice, perhaps even three or four times. However, matters must finally come to an end. Then there is no going back. Once the depreciation makes such rapid strides that sellers are fearful of suffering heavy losses, even if they buy again with the greatest possible speed, there is no longer any chance of rescuing the currency. In every country in which inflation has proceeded at a rapid pace, it has been discovered that the depreciation of the money has eventually proceeded faster than the increase in its quantity.”

All these constitute an evolving process known "demonetization". Where sooner or later a seemingly "benign" environment may turn into mayhem, if the inflationary process isn't halted.

And additional regulations won't be enough to curtail this process as the public has virtually been responding only to inflationary policies being effected.

A China Bubble?

Has China's incredible defiance of the financial crisis been a bubble?

For some analysts the answer is yes.

Here is Bloomberg's Chart of the day, ``Rallies in commodity prices and mining-company shares stem from a “bubble of belief” in China’s economy that is likely to burst, according to Albert Edwards, a strategist at Societe Generale.

``“I believe we will look back on the Chinese economic miracle as the sickest joke yet played on investors,” Edwards wrote yesterday in a report. To support his argument, he cited falling earnings at the country’s industrial companies.

``The CHART OF THE DAY shows year-over-year percentage changes in profits, as compiled by China’s National Bureau of Statistics. The chart combines monthly data from 2005 and 2006 with a quarterly index, started in 2007, that tracks companies in 22 provinces. This quarter’s report is set for June 26.

``Commodity prices climbed 21 percent this year through yesterday, according to the UBS Bloomberg Constant Maturity Commodity Index. Mining stocks paced a 23 percent gain in the MSCI World Materials Index, the year’s top performer among 10 industry groups in the MSCI World Index.

``While the Chinese economy expanded 6.1 percent in the first quarter from a year earlier, Edwards wrote that he was skeptical about its ability to sustain that level of growth during a global recession."

“The bullish group-think on China is just as vulnerable to massive disappointment as any other extreme example of bubble- nonsense I have seen over the last two decades,” his report said. “The fall to earth will be equally as shocking.”

The Shanghai index has been up about 66% from the 2008 troughs.

Chart from World Bank

Our view is that while China's booming economy may have evinced some signs of bubble blowing, as shown by the exploding loan growth, mostly in response to government fiscal and monetary actions, it seems unclear that this bubble will implode anytime soon.

So far China's boom has clearly been engineered by government stimulus as shown by the massive growth in government Fixed Asset investments (FAI)...

And the apparent impact has been a resilience in consumer income and spending as shown above.

The idea of a "China bubble" shouldn't be confined only to China, because China has the capacity to absorb more debt considering its high savings and low systemic leverage.

Instead "bubble dynamics" should be seen applied to generally most OECD and key emerging nations as governments collectively had been printing money to get around this crisis.

Chart from Danske

Moreover, the recent commodity boom isn't largely tied to an "economic boom" but rather China's tacit desire to diversify away its US dollar holdings from US government's attempt to inflate away its overindebtedness problem.

Bubbles, which actually represent business cycles shaped by government policies, can last longer than what mainstream experts project.

Besides, governments around the world, considering their adopted economic ideology, will probably continue to pump money to sustain price levels.

We see the next bubble to be a government debt bubble which would probably be vented mainly on the currency markets.

Remember, it seems more than just traditional "demand and supply" at work. It appears that "inflation dynamics" have been growing a far larger influence in today's world.

Evidences of Monetary Forces Gaining Upper Hand in Hong Kong

In our previous post, Monetary Forces Appear To Be Gaining An Upper Hand, we argued that the tsunami of monetary programs applied by global governments have been distorting financial markets relative to the real economy. This has prompted for glaring disconnections which has caused quite a confusion between the bears and the bulls looking for justification for their causes.

We find further proof of these phenomenon evolving in Hong Kong.

We excerpt an article from the Wall Street Journal, (bold emphasis mine)

``A wave of money flooding into Hong Kong from mainland China and the rest of the world has propelled property and stock prices even as the economy falters.

chart from tradingeconomics.com

``Hong Kong's government predicts the economy will shrink up to 6.5% this year and unemployment is at a three-year high. Yet home prices are up about 13% this year, while the benchmark Hang Seng Index has gained 18% in the same period.

chart from stockcharts.com

``The strong inflows of capital from abroad have kept Hong Kong's de facto central bank busy. Since January, it has pumped more than US$22 billion of Hong Kong dollars into the market to keep the pegged currency within its mandated trading band against the U.S. dollar. The result is a wave of liquidity washing into asset prices.

``Hong Kong's real-estate market may be one of the more pronounced beneficiaries of a global effort by governments to print money and stimulate lending. Quantitative easings by central banks in the U.S., Europe and Asia have created "booming capital flows" that are "swamping" some markets, Sean Darby, a Hong Kong-based strategist for Nomura International, wrote in a recent report.

From Wall Street Journal

``Hong Kong's situation, however, is unusual. In other places, a net inflow of foreign funds can lead to both a rise in asset prices and a rise in the value of the local currency. But thanks to Hong Kong's link to the dollar, only the asset prices can rise -- and because the currency can't, the gains are more pronounced.

``The peg also makes Hong Kong attractive to investors during a period of currency instability. And Hong Kong's stock market is one of the most accessible and liquid places for foreign money to bet on a recovery in mainland China, where currency controls make direct investment trickier.

``Andrew Fung, head of investment and insurance for Hang Seng Bank in Hong Kong, believes that, with Western markets still sputtering, Hong Kong investment dollars that have long flowed overseas may now be coming back home.

``Anecdotal evidence also suggests some of the money is coming from mainland China, where Beijing's efforts to hurriedly channel four trillion yuan ($586 billion) in stimulus measures into the domestic economy have energized bank lending and unleashed a flood of liquidity."

So there you have it; quantitative easing, China's stimulus program and repatriated capital driving the Hong Kong Financial Markets where inflationary programs have indeed been buoying the marketplace.

Welcome to the new bubble.